Attached files
| file | filename |
|---|---|
| EX-32.1 - STEELCLOUD INC | v173265_ex32-1.htm |
| EX-21.1 - STEELCLOUD INC | v173265_ex21-1.htm |
| EX-31.1 - STEELCLOUD INC | v173265_ex31-1.htm |
| EX-23.1 - STEELCLOUD INC | v173265_ex23-1.htm |
| EX-31.2 - STEELCLOUD INC | v173265_ex31-2.htm |
| EX-10.38 - STEELCLOUD INC | v173265_ex10-38.htm |
UNITED
STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON,
D.C. 20549
FORM
10-K
x ANNUAL
REPORT PURSUANT TO SECTION 13 OR 15(d)
OF
THE SECURITIES EXCHANGE ACT OF 1934
For
the fiscal year ended October 31, 2009
or
o TRANSITION
REPORT PURSUANT TO SECTION 13 OR 15(d)
OF
THE SECURITIES EXCHANGE ACT OF 1934
For
the transition period from ____________ to ________________
Commission
file number 0-24015
SteelCloud,
Inc.
(Exact name of
registrant as specified in its charter)
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Commonwealth of Virginia
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54-1890464
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|
(State
or other jurisdiction of incorporation or organization)
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(I.R.S.
Employer Identification No.)
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13962 Park Center Road, Herndon,
Virginia
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20171
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(Address
of principal executive offices)
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(Zip
Code)
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(703)
674-5500
(Registrant’s telephone
number, including area code)
Securities registered under Section
12(b) of the Exchange Act: None.
Securities registered under Section
12(g) of the Exchange Act:
Common
stock, par value $0.001 per share.
(Title of
class)
Indicate
by check mark if the registrant is a well-known seasoned issuer, as defined in
Rule 405 of the Securities Act. Yes o No x
Indicate
by check mark if the registrant is not required to file reports pursuant to
Section 13 or Section 15(d) of the Act. Yes o No x
Indicate
by check mark whether the registrant: (1) has filed all reports required to be
filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the
preceding 12 months (or for such shorter period that the registrant was required
to file such reports), and (2) has been subject to such filing requirements for
the past 90 days. Yes x No o
Indicate
by check mark whether the registrant has submitted electronically and posted on
its corporate Website, if any, every Interactive Data File required to be
submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding
12 months (or for such shorter period that the registrant was required to submit
and post such files). Yes o No o
Indicate
by check mark if there is disclosure of delinquent filers in response to Item
405 of Regulation S-K contained herein and will not be contained, to the best of
registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. o
Indicate
by check mark whether the registrant is a large accelerated filer, an
accelerated filer, a non-accelerated filer or a smaller reporting company. See
definition of “large accelerated filer,” “accelerated filer” and “smaller
reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
Large
accelerated filer o Accelerated
filer o
Non-accelerated filer o Smaller
reporting company x
Indicate
by check mark whether the registrant is a shell company (as defined in Rule
12b-2 of the Act). Yes o No
x
The
aggregate market value of the voting stock held by non-affiliates of the issuer
as of April 30, 2009 was $2,578,652.
The
number of shares outstanding of the registrant's Common Stock on January 22,
2009 was 16,027,001.
STEELCLOUD,
INC
2009
ANNUAL REPORT ON FORM 10-K
TABLE
OF CONTENTS
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Page
Number
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PART
I
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Item
1.
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Business
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1
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Item
1A.
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Risk
Factors
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4
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Item
1B.
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Unresolved
Staff Comments
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5
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Item
2.
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Properties
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5
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Item
3.
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Legal
Proceedings
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5
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Item
4.
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Submission
of Matters to a Vote of Security Holders
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5
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PART
II
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Item
5.
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Market
for Registrant’s Common Equity, Related Stockholder Matters and Issuer
Purchases of Equity Securities
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7
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Item
6.
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Selected
Financial Data
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9
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Item
7.
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Management’s
Discussion and Analysis of Financial Condition and Results of
Operations
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9
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Item
7A.
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Quantitative
and Qualitative Disclosures About Market Risk
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21
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Item
8.
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Financial
Statements and Supplementary Data
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21
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Item
9.
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Changes
in and Disagreements with Accountants on Accounting and Financial
Disclosures
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21
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Item
9A(T).
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Controls
and Procedures
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21
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Item
9B.
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Other
Information
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21
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PART
III
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Item
10.
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Directors,
Executive Officers and Corporate Governance
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24
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Item
11.
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Executive
Compensation
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27
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Item
12.
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Security
Ownership of Certain Beneficial Owners and Management and Related
Stockholder Matters
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31
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Item
13.
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Certain
Relationships and Related Transactions, and Director
Independence
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32
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Item
14.
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Principal
Accounting Fees and Services
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32
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Item
15.
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Exhibits,
Financial Statement Schedules
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33
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Signatures
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38
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ii
FORWARD-LOOKING
STATEMENTS
This
Annual Report on Form 10-K contains forward-looking statements within the
meaning of Section 27A of the Securities Act of 1933, as amended (the
“Securities Act”) and Section 21e of the Securities Exchange Act of 1934, as
amended (the “Exchange Act”) and the Private Securities Litigation Reform
Act of 1995 and SteelCloud, Inc. intends that such forward-looking
statements be subject to the safe harbors created thereby. The
forward-looking statements relate to future events or the future financial
performance of SteelCloud, Inc. including, but not limited to, statements
contained in: Item 1. “Business” and Item 7. “Management’s Discussion and
Analysis of Financial Condition and Results of Operations.” Readers are
cautioned that such statements, which may be identified by words including
‘‘anticipates,’’ ‘‘believes,’’ ‘‘intends,’’ ‘‘estimates,’’ ‘‘expects,’’ and
similar expressions, are only predictions or estimations and are subject to
known and unknown risks and uncertainties. In evaluating such statements,
readers should consider the various factors identified in this Annual Report on
Form 10-K which could cause actual events, performance or results to differ
materially from those indicated by such statements. In light of the
significant uncertainties inherent in the forward-looking information included
herein, the inclusion of such information should not be regarded as a
representation by SteelCloud, Inc. or any other person that its objectives or
plans will be achieved. SteelCloud, Inc. does not undertake and
specifically declines any obligation to update any forward-looking statements or
to publicly announce the results of any revisions to any statements to reflect
new information or future events or developments.
iii
PART
I
ITEM
1. BUSINESS
General
Founded
in 1987, SteelCloud, Inc. (referred to herein as the “Company,” or “SteelCloud,”
“we,” “our,” “ours,” and “us”) is a developer of mobility appliance software
solutions primarily for the Research In Motion® (“RIM”) BlackBerry
market. We design and integrate our software into specialized server
appliances targeted at Department of Defense (“DoD”), public sector, commercial,
and remote hosting customers. Until July 2009, we offered
computer integration solutions for the federal marketplace and Independent
Software Vendors. In July 2009, we entered into an Asset Purchase
Agreement with NCS Technologies, Inc., a Virginia corporation (“NCS”), pursuant
to which we agreed to sell to NCS, and NCS agreed to purchase from us, all of
our right, title and interest in and to the assets relating to our computer
integration business. Further, in July 2009 our management and
Board of Directors determined to shift the focus of our operations, resources
and investments to our BlackBerry-related technologies and
products.
We were
originally incorporated as Dunn Computer Operating Company on July 27, 1987
under the laws of the Commonwealth of Virginia. On February 26,
1998, Dunn Computer Corporation ("Dunn") was formed and incorporated in the
Commonwealth of Virginia to become a holding company for several entities
including Dunn Computer Operating Company. Our subsidiary is
International Data Products ("IDP"), which we acquired in May
1998. On May 15, 2001, our shareholders approved an amendment to our
Articles of Incorporation to change our corporate name from Dunn Computer
Corporation to SteelCloud, Inc. On December 31, 2003, Dunn was
merged with and into SteelCloud. On February 17, 2004, we
acquired the assets of Asgard Holding, LLC ("Asgard"). In July 2006,
as part of our restructuring efforts, we closed our sales office and ceased all
of our operations in Florida. Our former subsidiaries, Puerto Rico
Industrial Manufacturing Operations Acquisition Corporation (“PRIMO”), and STMS
Corporation (“STMS”), are currently inactive.
Unless
the context otherwise requires, the "Company," "Dunn Computer Corporation," or
“SteelCloud” ”we,” “our,” “ours,” and “us” refers to SteelCloud, Inc., its
predecessor and its subsidiaries. Our principal executive offices are
located at 13962 Park Center Road, Herndon, VA 20171. Our main
telephone number is (703) 674-5500. Inquiries may also be sent to
SteelCloud at info@steelcloud.com for sales and general information or
ir@steelcloud.com for investor relations information.
Going
Concern
We have
had recurring annual operating losses since our fiscal year ended October 31,
2004. We expect that such losses may continue at least through our
fiscal year ending October 31, 2010. The report of our independent
registered public accounting firm regarding our consolidated financial
statements for the fiscal year ended October 31, 2009 contains an explanatory
paragraph regarding our ability to continue as a going concern based upon our
history of net losses, net working capital deficit and significant doubt as to
whether we will be able to meet obligations coming due in the
future.
We are
dependent upon available cash and operating cash flow to meet our capital
needs. We are considering all strategic options to improve our
liquidity and obtain working capital to fund our continuing business operations,
including equity or debt offerings and asset sales; however, there can be no
assurance that we will be successful in negotiating financing on terms agreeable
to us or at all. If adequate funds are not available or are not
available on acceptable terms, we will likely not be able to take advantage of
unanticipated opportunities, develop or enhance services or products, respond to
competitive pressures, or continue as a going concern. We can offer
no assurances that we will be successful in raising working capital as
needed. Further, we can offer no assurances that we will have
sufficient funds to execute our business plan, pay our operating expenses and
obligations as they become due or generate positive operating results or
continue as a going concern.
Target
Market
Our
primary target markets are in the mobility market space, primarily relating to
Research In Motion’s BlackBerry® technology. We offer a line of
SteelWorks® (“SteelWorks”) integrated appliances for the BlackBerry® Enterprise
Server environment for the federal government and the domestic and international
commercial markets. There are approximately 250,000 BlackBerry
Enterprise Server installations worldwide. We also offer BlackBerry
Enterprise Server license sales and administration for domestic and
international organizations offering hosting services utilizing BlackBerry
technology. We have agreements with RIM to market BlackBerry hosting
licenses in over 100 countries worldwide. In most locations we are
currently the sole provider of BlackBerry hosting licenses.
1
We
utilize both direct and indirect channel models. Our BlackBerry
appliance sales strategy is predominately an indirect sales
model. SteelWorks appliances are distributed by Ingram Micro to Value
Added Resellers (“VARs”) into the domestic commercial
market. Additionally, we have agreements with CDW and CDW-G to sell
SteelWorks into the commercial and federal markets. We also market
our appliances to and through our direct relationships with companies offering
BlackBerry hosting services both domestically and internationally.
BlackBerry®
Enterprise Server Solution - SteelWorks® Appliance
We
developed an integrated appliance solution specifically for the Blackberry
Enterprise Server (“BES”). Developed in conjunction with Research in
Motion (“RIM”), we believe the BES appliance solution is the single best way to
implement the BES software environment for most customers, at a fraction of the
time, cost and resource commitment. SteelWorks is an appliance management
software that provides self-management and self-maintenance functionality to our
appliance server offerings and allows our customers to quickly create a fully
integrated turnkey appliance server. We are working to expand
SteelWorks® to address the needs of small to midsize businesses that require
access to company data and attachments via their Blackberry handheld
device. This product is called SteelWorks® Mobile for the Blackberry
Enterprise Server. This mobile business solution makes a BlackBerry®
connection to company data and attachments easy to install and easy to
manage. It is hardware and software in a low cost easy to install
solution.
The
SteelWorks appliance includes SteelCloud-developed software for patch
management, disaster recovery, back-up/restore, and high availability with
automated fail-over. We have filed for three patents for the
appliance related to the technology we created for the installation wizard,
backup and restore features. These patents are currently pending
approval from the U.S. Patent and Trademark Office. We have enhanced
the security of the BlackBerry Enterprise Server environment by “hardening”, or
securely locking down the operational functionality of the operating
environment, the Microsoft Windows Server environment in all of our SteelWorks
appliances.
In
addition, we developed SteelWorks FedMobile, our Blackberry
Enterprise Server software appliance solution specifically for the Department of
Defense (“DoD”) and other related agencies. The SteelWorks FedMobile appliance builds upon
our commercial appliance by automating the application of the Defense
Information Systems Agency’s (“DISA”) and DoD’s Security Technical
Implementation Guide (“STIG”) to the BES installation process. The
STIG mandates the policies for which the DoD and related agencies must operate
their wireless communications. As a result, our appliance solution
allows those agencies to be STIG compliant in a fraction of the time, cost or
resources allocated to what is an otherwise time intensive, manual
process. We anticipate introducing our new BES 5.0 SteelWorks
FedMobile appliance
product in the second calendar quarter of fiscal year 2010.
Professional
Services
We
provide information technology (“IT”) consulting and contract staffing solutions
for our clients. Our consultants are subject matter experts in
network infrastructure complexities and security technologies.
On
January 11, 2010, we entered into a Purchase and Sale Agreement (the
“Agreement”) with Global Technology Partners, Inc., a Maryland Corporation (the
“Purchaser”). Pursuant to the Agreement we sold to the Purchaser a
large portion of our professional services assets, consisting of certain
consulting contracts and related agreements, and assigned all of our rights to
employment and independent contractor contracts for certain of our contractors
and employees engaged in the consulting business (the “Assets”). As
consideration for the sale of the Assets, the Purchaser agreed to pay a base
price of one hundred forty thousand dollars ($140,000) (the “Base Price”) of
which (a) seventy thousand dollars ($70,000) was paid upon the execution of the
Agreement, and (b) seventy thousand dollars ($70,000) which was paid on January
15, 2010. In addition to the Base Price, the Agreement provides
for contingent payments in the amount of (a) one hundred thousand dollars
($100,000) in the event certain payments are made pursuant to certain of the
Assets, and (b) twenty percent (20%) of the gross margin from all revenue
generated from the Assets for the period beginning from January 11, 2010 and
ending on January 11, 2011. Pursuant to the Agreement, the parties
agreed to cooperate in obtaining novations of all governmental contracts
included in the Assets. We agreed to guarantee payment of all
liabilities and the performance of all obligations that Purchaser assumed under
any governmental contracts included in the Assets. The Agreement
contains standard representations and warranties for a transaction of this type.
The terms of the transaction were the result of arm’s length negotiations
between the Purchaser and us. Prior to the completion of the
transaction, neither we nor any of our affiliates or officers, directors or
their associates had any material relationship with the Purchaser, other than in
respect of the Agreement and the transactions contemplated therein and related
thereto.
2
Government
Contracts
In fiscal
year 2009, we derived approximately 67% of our revenues from sales of hardware
and services to U.S. federal, state and local governments.
GSA
Contract
For the
fiscal year ended October 31, 2009, we had a multiple award schedule contract
with the U.S. General Services Administration (the “GSA
Contract”). The GSA Contract was originally awarded in April
1996. It was renewed in fiscal years 2002 and 2007, and is valid
through March 31, 2012. In August 2006, GSA Contract auditors awarded
us an “Outstanding” rating for our management and execution of the GSA
Contract. The GSA Contract enables government IT purchasers to
acquire all of their needed goods and services from a particular vendor and
largely limits the competition to selected vendors holding GSA
Contracts. For the fiscal year ended October 31, 2009, our GSA
Contract had sales of approximately $586,000 which accounted for approximately
39% of our continuing operations net revenues. The GSA Contract was
one of the professional services assets which we sold in January 2010, as
further described in “Business - Professional Services” at page 2.
Commercial
Contracts
We have a
number of on-going commercial agreements, including:
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·
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contracts
with Dell to manufacture and sell our SteelWorks
products;
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·
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agreements
with RIM to distribute BlackBerry hosting licenses in over 100
countries;
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·
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an
agreement with Global Marketing Partners to distribute our products
through Ingram Micro;
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·
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an
agreement with CDW/CDW-G to sell our products in the domestic commercial
and federal markets; and
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·
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agreements
with BlackBerry hosting companies, both domestically and internationally,
to purchase BlackBerry hosting
licenses.
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Significant
Customer Contract
During
fiscal year 2009, we provided services on a contract for a major federal
institution. The contract called for us to provide various IT
services. Over the last twelve months during the contract engagement,
we recognized approximately $586,000 of service revenue associated with this
contract.
Marketing
We market
our products and services to commercial and government customers, both
domestically and internationally through a number of direct and indirect
channels. We believe that the key to success with our current product
offerings is to build a competent and diverse channel sales organization
encompassing distributors, hosters, and value added resellers
worldwide. We expect to leverage our current channel relationships
domestically and to grow our international channel relationships in fiscal year
2010.
We use
electronic commerce technologies in our marketing efforts and expect our
customers will continue to utilize these technologies. We also use
the Internet to research and reference vendor information. We
maintain an Internet website containing product offerings located at www.steelcloud.com. We
expect to increase our Web 2.0 and social marketing initiatives in fiscal year
2010.
Joint
Venture
In
October 2008, we created a joint venture in the United Arab Emirates (“UAE”)
region with XSAT, LLC, a UAE organization focused on wireless communications and
technology (“XSAT”). SteelCloud MEA, LLC (Middle East, Africa) the
newly formed joint venture company, is jointly owned, 20% by XSAT and 80% by
us. Under the terms of the joint agreement, XSAT will provide a local
presence for our products to its customers within the UAE
region. XSAT will also provide warranty and support for the products
sold within that region.
3
Competition
Our
products assist organizations with the installation and maintenance of their
BlackBerry network environment. Our products provide the end user
base with an alternative means to perform the installation and maintenance
process. There are currently no other products available in the
marketplace that compete with SteelWorks® Mobile or SteelWorks
FedMobile.
Our main
source of competition is from individuals within organizations who choose to
install and maintain their BlackBerry network environment internally and without
the aid of our products.
Management
believes that it maintains a strong relationship with RIM, the maker of the
BlackBerry line of products. Management further believes that our
relationship with RIM may be a barrier to entry for other organizations that may
seek to enter into this market.
Suppliers
We devote
significant resources to establishing and maintaining relationships with key
suppliers. We have recently executed an Original Equipment
Manufacturer partnership agreement with Dell, Inc. (“Dell”) to supply SteelWorks
and SteelWorks FedMobile on their network
servers. SteelWorks and SteelWorks FedMobile will be
manufactured and produced by Dell. In addition, Dell will
supply the logistics and warranty support for the
hardware. Dell will be the primary vendor for SteelWorks and
SteelWorks FedMobile, however, we intend to maintain relationships with multiple
vendors to manufacture and produce our products should the need
arise.
Research
and Development
By
investing in product development, we believe we will have more control over the
functionality and marketing of our products. We also believe that the
resulting intellectual property will increase the competitiveness of our
offerings and improve product margins. During fiscal 2009, we
incurred research and development costs of approximately $233,000. We will
continue to incur costs for product development in the future. We
invest in intellectual property in the form of proprietary products such as
SteelWorks®.
Patents,
Trademarks and Licenses
We work
closely with computer product suppliers and other technology developers to stay
abreast of the latest developments in computer technology. While we
do not believe our continued success depends upon the rights to a patent
portfolio, there can be no assurance that we will continue to have access to
existing or new technology for use in our products.
On March
20, 2008, we were issued patent 3,396,156 titled ”SteelWorks.”
On
September 15, 2008, we were issued community trademark Registration 006430359
(European); Japan #948064 (International), Canada Application Approval titled
“SteelRestore.”
On
October 21, 2008, we were issued patent 3,521,899 titled “Sure
Audit.”
We
conduct our business under the trademarks and service marks of “SteelCloud,”
“SteelCloud Company” and “Dunn Computer Corporation.” We believe our
copyrights, trademarks and service marks have significant value and are an
important factor in the marketing of our products.
Employees
As of
October 31, 2009 and January 18, 2010, we had 15 and 10 employees,
respectively. None of our employees are covered by a collective
bargaining agreement and we consider our relationships with our employees to be
good.
We
believe our future success depends in large part upon our continued ability to
attract and retain highly qualified management, technical, and sales
personnel. We have an in-house training and mentoring program to
develop our own supply of highly qualified technical support
specialists. There can be no assurance, however, that we will be able
to attract and retain the qualified personnel necessary for our
business.
ITEM
1A. RISK FACTORS
Not
applicable.
4
ITEM
1B. UNRESOLVED STAFF COMMENTS
Not
applicable.
ITEM
2. PROPERTIES
During
the fiscal year ended October 31, 2009, we leased approximately 24,000 square
feet for our operations facility. Our operations facility is located
in Herndon, Virginia. Monthly rent for the lease was approximately
$21,000 inclusive of operating expenses. We are negotiating a
settlement with our landlord to terminate this lease in advance of its
expiration in December 2015.
During
the fourth quarter of the fiscal year ended October 31, 2009, we recorded an
impairment charge against discontinued operations on our leasehold improvements
of approximately $276,000. This charge should have been recorded in
the third quarter of fiscal 2009 due to the triggering event of the sale of the
computer network business which would have required an impairment analysis on
the remaining assets related to that business. There was no impact to
any other prior periods. Refer to footnote 5 of our financial
statements.
On
February 2, 2010, we entered into a Lease Agreement (the “February Lease”) with
Merritt-AB5, LLC (the “Landlord”), pursuant to which we will rent approximately
3,461 square feet in the property located at 20110 Ashbrook Place, Suite 130,
Ashburn, Virginia 20147 (the “Premises”) for our operations facility. The
term of the February Lease is for one year beginning on the later to occur of
(i) February 15, 2010, (ii) the date the Landlord completes certain work on the
premises, or (iii) the date when we occupy the Premises (the
“Term”). The Term may be extended for two additional successive
one year periods. The monthly rate is $6,489.38, or $77,872.50 for the
first year, inclusive of operating expenses. If we determine to extend the
term, the monthly rent for the second year will be $6,684.06 or $80,208.68 per
year, and the monthly rent for the third year will be $6,884.58 or $82,614.94
per year.
ITEM
3. LEGAL PROCEEDINGS
On May
22, 2009, we entered into a Stipulation/Consent Order with CRP (the
“Stipulation”), pursuant to an Affidavit and Statement of Account (the
“Affidavit”), stating, as declared by a general manager of Jones Lang LaSalle, a
property management company and agent for CRP Holdings A-1, LLC (“CRP”), the
landlord of 14040 Park Center Road, Suite 210, Herndon, Virginia 20171 (the
“Premises”), that CRP, as landlord, was seeking a judgment against us for: (i)
possession of the Premises, and (ii) monetary damages for nonpayment of rent due
under a sublease, dated September 28, 2004, by and between us and NEC America,
Inc. (“NEC”) (the “Sublease”), and a subsequent assignment of the Sublease to
CRP from NEC, dated December 15, 2008. In the Stipulation we
acknowledged that the balance due for rent and additional rent for the Premises
was $168,637.96, together with attorney’s fees and court expenses of $7,041.00
through May 22, 2009 (the “Judgment Amount”). Pursuant to the
Stipulation, we paid $30,000 (the “Forbearance Payment”) on May 22, 2009 toward
the Judgment Amount. Further we agreed to, and have, vacated the
Premises. CRP agreed to stay enforcement of the Judgment Amount until
the earlier of (a) our receipt of capital in the amount of at least $500,000, or
(b) May 31, 2010. The matter was returned to the court’s files
pending our compliance with the terms of the Stipulation.
There are
routine legal claims pending against us that occur in the ordinary course of
business, but in the opinion of management, liabilities, if any, arising from
such claims will not have a material adverse effect on our financial condition
and results of operation.
Other
than the items previously disclosed we are not a party to any other material
legal proceedings.
ITEM
4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY
HOLDERS
On
October 19, 2009 we held a special meeting of shareholders, which was adjourned
until October 23, 2009 (the “Special Meeting”). The Special Meeting was
called to obtain shareholder approval for the following actions:
|
(1)
|
To authorize the issuance of up
to 14,500,000 shares of our common stock and accompanying warrants to
purchase up to 14,500,000 shares of common stock, together with the
potential issuance to prospective placement agents of warrants to purchase
up to 3,200,000 shares of common stock on the same terms as the
accompanying warrants, pursuant to our Registration Statement on Form S-1,
in accordance with NASDAQ Marketplace Rule 5635(d). This proposal
received 7,741,996 votes for, 435,859 votes against, 26,010 abstentions
and 0 broker non-votes.
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5
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(2)
|
To authorize the issuance of our
common stock, and/or securities convertible into or exchangeable or
exercisable for common stock, in connection with a future financing, in
accordance with NASDAQ Marketplace Rule 5635. This proposal received
7,399,135 votes for, 778,770 votes against, 26,010 abstentions and 0
broker non-votes.
|
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(3)
|
To approve the sale of warrants
by us to our directors in a private placement. This proposal
received 7,167,648 votes for, 932,659 votes against, 103,758
abstentions and 0 broker
non-votes.
|
6
PART
II
ITEM
5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER
MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
Market
Information
Our
common stock was listed on The NASDAQ Stock Market, Inc.’s Capital Market from
April 22, 1997 through January 7, 2010. We changed our symbol from
“DNCC” to “SCLD” on October 19, 2000. On January 7, 2010,
our symbol was changed from “SCLD” to “SCLD.PK”. On January 27, 2010,
our symbol was changed from “SCLD.PK” to “SCLD.OB.”
The
following table sets forth the high and low selling prices as reported on the
NASDAQ Capital Market through January 7, 2010, for each fiscal quarter during
the fiscal years ended October 31, 2009, 2008 and 2007. These
quotations reflect inter-dealer prices without retail mark-up, markdown, or
commission and may not represent actual transactions. On January 7, 2010 our
common stock was delisted from The NASDAQ Stock Market, Inc.’s Capital
Market. Our common stock is currently quoted on the over-the-counter
market.
|
Fiscal 2007
|
||||||||
|
High
|
Low
|
|||||||
|
First
Quarter
|
$ | 1.34 | $ | 0.61 | ||||
|
Second
Quarter
|
$ | 1.47 | $ | 0.94 | ||||
|
Third
Quarter
|
$ | 1.74 | $ | 1.12 | ||||
|
Fourth
Quarter
|
$ | 1.68 | $ | 1.12 | ||||
|
Fiscal 2008
|
||||||||
|
High
|
Low
|
|||||||
|
First
Quarter
|
$ | 1.25 | $ | 0.87 | ||||
|
Second
Quarter
|
$ | 1.21 | $ | 0.80 | ||||
|
Third
Quarter
|
$ | 1.58 | $ | 1.06 | ||||
|
Fourth
Quarter
|
$ | 1.26 | $ | 0.56 | ||||
|
Fiscal
2009
|
||||||||
|
High
|
Low
|
|||||||
|
First
Quarter
|
$ | 0.75 | $ | 0.30 | ||||
|
Second
Quarter
|
$ | 0.38 | $ | 0.14 | ||||
|
Third
Quarter
|
$ | 0.35 | $ | 0.15 | ||||
|
Fourth
Quarter
|
$ | 0.43 | $ | 0.23 | ||||
|
Fiscal
2010
|
||||||||
|
High
|
Low
|
|||||||
|
First
Quarter (November 1, 2009 through January 7, 2010)
|
$ | 0.35 | $ | 0.13 | ||||
The
following table sets forth, for January 8, 2010 through January 22, 2010, the
high and low bid prices on the over-the-counter market. These quotations reflect
the closing inter-dealer prices, without mark-up, mark-down or commission, and
may not represent actual transactions.
|
Fiscal 2010
|
||||||||
|
High
|
Low
|
|||||||
|
First
Quarter (January 7, 2010 through January 22, 2010)
|
$ | 0.16 | $ | 0.08 | ||||
7
Holders
We have
16,027,001 shares of our common stock outstanding as of January 22, 2009 held by
approximately 154 stockholders of record. The number of record
holders was determined from the records of our transfer agent and does not
include beneficial owners of common stock whose shares are held in the names of
various security brokers, dealers, and registered clearing agencies
Dividend
Policy
We have
not paid cash dividends on our common stock and do not intend to do so in the
foreseeable future.
Repurchase
of Securities
We did
not repurchase any of our common stock during the fiscal year ended October 31,
2009.
Securities
Authorized For Issuance Under Equity Compensation Plans
Please
see “Item 11 – Executive
Compensation – Narrative Disclosure to Summary Compensation
Table.”
Recent
Sales Of Unregistered Securities
On
October 23, 2009, we issued 109,375 shares of our common stock to Gersten Savage
LLP in conversion of legal fees due them. These legal fees were
converted at $0.32 per share, the closing price of our common stock on October
23, 2009.
We relied
on the exemption from the registration provisions of the Securities
Act contained in Section 4(2) thereof .
Warrants
On July
1, 2009, we issued 625,000 warrants as an inducement to a lender to make a loan
valued at approximately $130,000. The warrants were issued at an
exercise price of $0.15 and expire on June 30, 2013. The fair value
of the warrants of $85,575 was determined utilizing the Black-Sholes
method.
On June
15, 2009, we issued an aggregate of 350,000 warrants to our seven
directors. These warrants are exercisable for five years from the
date of issuance at an exercise price of $0.25 per share. The
issuance to the directors was approved by our shareholders.
On
September 14, 2007, we issued 100,000 warrants in exchange for investor
relations services valued at approximately $56,000. The warrants were
issued at an exercise price of $1.28 and expire on September 14,
2012. The fair value of the warrants was estimated in four equal
tranches over a four-month vesting period using the Black-Scholes Option pricing
fair value model. On August 24, 2009, the investor relations firm
terminated its right to these 100,000 warrants, and in exchange we issued to
them 115,000 warrants at an exercise price of $0.20 and vesting
immediately. The fair value of the warrants of approximately $20,000
was estimated using the Black-Scholes Option pricing fair value
model.
8
NASDAQ
On March
23, 2009, we received notice, under NASDAQ Marketplace Rule 4310(c)(3), that our
common stock was subject to potential delisting from the NASDAQ Capital Market
because we did not meet the criteria of NASDAQ Listing Rule 5550(b) (the “Rule”)
and did not have a minimum of $2,500,000 in stockholders’ equity, $35,000,000
market value of listed securities, or $500,000 of net income from continuing
operations for the most recently completed fiscal year or two of the three most
recently completed fiscal years. We provided NASDAQ with a specific
plan of how we intend to achieve and sustain compliance with all the NASDAQ
Capital Market listing requirements, including a time frame for completion of
such plan. Our plan includes the following two strategies: (i)
increasing our stockholders equity in excess of the minimum $2,500,000
requirement by raising between $3,000,000 to $4,000,000 through an equity
transaction; and (ii) identifying a strategic partner interested in either
merging with or acquiring us. On April 28, 2009 we received notice
from NASDAQ indicating that NASDAQ had granted our request for an extension of
time to regain compliance with the Rule. Pursuant to the terms of the
extension, we were required to: (a) on or before July 6, 2009, complete an
equity transaction or a merger and/or acquisition, and (b) make appropriate
disclosures to the SEC and NASDAQ on a Form 8-K. We were
not able to complete an equity transaction or a merger and/or acquisition by
July 6, 2009, and on July 8, 2009, we received written notification from NASDAQ
stating that we did not meet the terms of the extension, and that, as a result,
our common stock would be subject to suspension from trading at the opening of
business on July 17, 2009, and delisted from NASDAQ. On July
15, 2009, we requested a hearing to appeal the determination before the Panel
and to present our plan for regaining compliance with the Rule (the
“Appeal”). On August 4, 2009, we received notice that NASDAQ received
our Appeal, and that the delisting action has been stayed, pending a final
written decision by the Panel after an oral/written hearing (the “Hearing”),
where we were required to demonstrate our ability to regain and sustain
compliance with the Rule. The Hearing was held at 11:00 A.M. EST, on
September 3, 2009. On October 7, 2009, we received notice that
the Panel granted our request for continued listing on The NASDAQ Capital
Market, subject to our evidencing, on or before January 4, 2010 compliance with
the Rule and all other requirements for continued listing. On January
5, 2010, we received notice from NASDAQ indicating that the Panel determined to
delist our securities from The NASDAQ Capital Market and trading in our
securities would be suspended effective as of the open of trading on Thursday,
January 7, 2010. We do not intend to take any further action to
appeal NASDAQ's decision. Accordingly, trading of our common stock was suspended
at the opening of business on January 7, 2010, and NASDAQ will file a Form
25-NSE with the SEC as soon as all applicable appeal periods have lapsed. Shares
of our common stock are now traded in the over-the-counter market, and we have
begun the process of having our common stock quoted on the Over-the-Counter
Bulletin Board market by having a broker file a Form 15c211 application on our
behalf.
ITEM 6. SELECTED
FINANCIAL DATA
Not
applicable.
ITEM
7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
Certain
statements contained herein may constitute forward-looking statements within the
meaning of Section 27A of the Securities Act, Section 21E of the Exchange Act,
and the Private Securities Litigation Reform Act of 1995. Because
such statements include risks and uncertainties, actual results may differ
materially from those expressed or implied by such forward-looking
statements. Factors that could cause actual results to differ
materially include, but are not limited to, risks associated with our ability to
obtain financing in the short term; general economic and business conditions;
industry capacity; industry trends; competition; changes in business strategy or
development plans; project performance; and availability of qualified personnel;
and the risk factors set forth from time to time in the reports we file with the
Securities and Exchange Commission. We undertake no obligation to
update any forward-looking statement to reflect events or circumstances that may
arise after the date of this filing.
You
should read the following discussion and analysis in conjunction with the
audited Financial Statements and Notes attached thereto, and the other financial
information appearing elsewhere in this Annual Report.
Overview
Founded
in 1987, we are a developer of mobility appliance software solutions primarily
for the RIM BlackBerry market. We design and integrate our software
into specialized server appliances targeted at Department of Defense (“DoD”),
public sector, commercial, and remote hosting customers.
In
addition, we serve information technology end users directly, in both the public
and private sectors, with products and services focused on IT centric
solutions.
Fiscal
Year 2009 Developments
Significant
Customer Contract
During
fiscal year 2009, we provided services on a contract for a major federal
institution. The contract called for us to provide various IT
services. During the fiscal year ended October 31, 2009, we
recognized approximately $586,000 of service revenue associated with this
contract.
9
SteelWorks
As an
extension of our ISV business, we developed an appliance solution specifically
for the Blackberry Enterprise Server (referred to herein as
“BES”). Developed in conjunction with RIM, we believe the BES
appliance solution is the single best way to implement the Blackberry Enterprise
Server software environment. SteelWorks is an integrated server
appliance that enables virtually any size organization to implement the BES at a
fraction of the cost, time and resource commitment. We have filed for
three patents for the appliance related to the technology we created for the
installation wizard, backup and restore features. These patents are
currently pending approval from the U.S. Patent and Trademark
office.
In
addition, we developed SteelWorks FedMobile, our Blackberry Enterprise Server
software appliance solution specifically for the Department of Defense (referred
to herein as “DoD”) and other related agencies. The SteelWorks
FedMobile appliance builds upon our commercial appliance by automating the
application of DISA’s (Defense Information Systems Agency) and DoD’s Security
Technical Implementation Guide (referred to herein as “STIG”) to the BES
installation process. The STIG mandates the policies for which the
DoD and related agencies must operate their wireless
communications. As a result, our appliance solution allows those
agencies to be STIG compliant in a fraction of the time, cost or resources
allocated to this otherwise time intensive, manual process.
Subsequent
Event - Sale of Professional Services Assets
On
January 11, 2010, we entered into a Purchase and Sale Agreement (referred to
herein as “Agreement”) with Global Technology Partners, Inc., a Maryland
Corporation (referred to herein as “Purchaser”). Pursuant to the
Agreement we sold to the Purchaser a large portion of our professional services
assets, consisting of certain consulting contracts and related agreements, and
assigned all of our rights to employment and independent contractor contracts
for certain of our contractors and employees engaged in the consulting business
(referred to herein as “Assets”). As consideration for the sale of
the Assets, the Purchaser agreed to pay a base price of one hundred forty
thousand dollars ($140,000) (referred to herein as “Base Price”) of which (a)
seventy thousand dollars ($70,000) was paid upon the execution of the Agreement,
and (b) seventy thousand dollars ($70,000) which was paid on January 15,
2010. In addition to the Base Price, the Agreement provides for
contingent payments in the amount of (a) one hundred thousand dollars ($100,000)
in the event certain payments are made pursuant to certain of the Assets, and
(b) twenty percent (20%) of the gross margin from all revenue generated from the
Assets for the period beginning from January 11, 2010 and ending on January 11,
2011. Pursuant to the Agreement, the parties agreed to cooperate in
obtaining novations of all governmental contracts included in the
Assets. We agreed to guarantee payment of all liabilities and the
performance of all obligations that Purchaser assumed under any governmental
contracts included in the Assets. The Agreement contains standard
representations and warranties for a transaction of this type. The terms of the
transaction were the result of arm’s length negotiations between the Purchaser
and us. Prior to the completion of the transaction, neither we nor
any of our affiliates or officers, directors or their associates had any
material relationship with the Purchaser, other than in respect of the Agreement
and the transactions contemplated therein and related thereto.
Subsequent
Event - November Line of Credit and Note Payable
On
November 3, 2009, we entered into a Line of Credit and Security Agreement (the
“Credit and Security Agreement”) with Caledonia Capital Corporation, a Delaware
corporation (the “Lender”) pursuant to which the Lender agreed to extend to us a
revolving line of credit in the amount of $150,000, in the form of a Revolving
Line of Credit Promissory Note (the “Credit Note”). The Credit Note
bears interest at a rate of 15% per annum, and is payable in monthly
installments commencing 30 days after November 3, 2009, which was the date when
we issued the Credit Note. The principal amount of the Credit Note,
together with interest accrued and unpaid thereon and all other sums due, shall
be due and payable in full upon the earlier to occur of (a) March 31, 2010, or
(b) the date we shall have raised a total of not less than $1,000,000 in capital
invested in our equity which is accompanied by our issuing shares of stock which
were not trading in the public markets prior to the date of the Credit Note
(“New Equity Capital”). There are no penalties for early
prepayment of the Credit Note. The Credit Note is a revolving line of
credit note. Principal advances may be made, from time to time, by
the Lender up to the principal amount of the Credit Note, and principal payments
may be made, from time to time by us to reduce the principal balance owing
pursuant to the Credit Note.
Our
obligations under the Credit and Security Agreement and the Credit Note are
secured by a lien in and to all of our rights, title and interest in and to its
furniture, fixtures, equipment, supplies, receivables, intangibles, and
inventory, together with all present and future substitutions, replacements and
accessories thereto and all present and future proceeds and products thereof, in
any form whatsoever (the “Collateral”).
10
Pursuant
to the Credit and Security Agreement, in the event that (a) we fail to pay when
due any principal, interest or other sum owing on any of the obligations
described in the Agreement when due; (b) we fail to perform any other covenant
or agreement in the Agreement, in the Warrant or in any of the other loan
documents and such default continues uncorrected for a period of thirty (30)
days after written notice of such default from the Lender to us; (c) if any
warranty or representation that we made to the Lender shall be untrue or
misleading in any material respect; (d) if a trustee or receiver is appointed
for us or for all or a substantial part of our assets; or if we make a general
assignment for the benefit of creditors; or if we file for bankruptcy; or if an
involuntary bankruptcy petition is filed against us and such petition is not
dismissed within forty-five (45) days after the filing of the same; (e) if any
property that we pledged or hypothecated to Lender, or any deposit account held
by Lender, is levied upon or attached or further encumbered, or garnished or the
Collateral shall otherwise be impaired and same is not removed within thirty
(30) days after written notice thereof from Lender us, as determined by Lender;
(f) if there occurs any material adverse change in our financial condition or
value of the Collateral, as determined by Lender; (g) if a final judgment is
entered against us, and the same is not discharged, appealed (provided such
appeal stays such judgment) or satisfied within thirty (30) calendar days; (h)
if we are liquidated or dissolved; or (i) a default shall occur under that
certain Note in the original principal amount of $250,000 from SteelCloud to
Lender dated July 1, 2009, then the
Lender may, without any further notice or demand, (1) declare any or all
of the obligations not already due to be immediately due and payable; (2)
enforce, by any proceedings or otherwise, any of the obligations; (3) take
exclusive possession of any or all of the Collateral, (4) enforce any liens or
security interests securing the obligations; (5) demand, compromise, collect,
sue for and receive any money or property at any time due, (6) endorse
SteelCloud name on any promissory notes or other instruments, checks, drafts,
money orders or other items of payment constituting Collateral, or collections
or other proceeds of Collateral, that may come into Lender's possession or
control from time to time; and/or (7) terminate, or cease extending credit
under, any or all outstanding commitments or credit accommodations of Lender to
SteelCloud.
As an
inducement to the Lender to make the loan, we agreed to issue to the Lender a
warrant (the “Credit Warrant”) to purchase 2.5 shares of our common stock for
every dollar we borrow pursuant to the Credit and Security
Agreement. The Credit Warrant is exercisable for four years at an
exercise price of $0.25 per share. The exercise price may be adjusted
in the event of any stock dividend, stock split, stock combination,
reclassification or similar transaction. Additionally, our Board of Directors
(the “Board”) has the discretion to reduce the then-current exercise price to
any amount at any time during the term of the Warrant for any period of time the
Board deems appropriate. We have agreed to prepare and file a
registration statement for the purposes of registering the resale of the shares
of common stock underlying the Credit Warrant, commencing on or about December
31, 2009.
On
November 4, 2009, we borrowed $60,000 pursuant to the Credit and Security
Agreement and the Credit Note, and issued to the Lender a Credit Warrant to
purchase up to 150,000 shares of our common stock pursuant to the Credit and
Security Agreement. On November 23, 2009, we borrowed the additional
$90,000 pursuant to the Credit and Security Agreement and the Credit Note, and
issued to the Lender a Credit Warrant to purchase up to 225,000 shares of our
common stock.
Sale
of Integration Business
On July
10, 2009, we entered into an Asset Purchase Agreement (the “Agreement”) with NCS
Technologies, Inc., a Virginia corporation (referred to herein as “NCS”),
pursuant to which we agreed to sell to NCS, and NCS agreed to purchase from us,
all of our right, title and interest in and to the assets relating to our
computer integration business. The purchase price was $475,000
of which $150,000 was paid as a deposit and the remaining $325,000 is an
earn-out amount, which is payable from and to the extent of revenue NCS receives
during the three-year period after the closing date from certain existing and
prospective clients, at a rate equal to 15% of the net sales price received by
NCS from such clients. Any payments by NCS to us are due on or before
the 10th
business day following the month in which NCS receives the payments from the
client(s).
11
Loan
and Note Payable
On July
1, 2009, we entered into a Business Loan and Security Agreement (the
“Agreement”) with Caledonia Capital Corporation, a Delaware Corporation
(referred to herein as the “Lender”) pursuant to which the Lender agreed to
lend us $250,000 in the form of a Secured Promissory Note (the “Note”) which was
issued on July 1, 2009. The Note originally provided for a maturity date of
December 29, 2009 (the “Maturity Date”) and an annual interest rate of
15%. The Note was amended on December 29, 2009 to provide that (a)
the annual interest rate of the Note is 20%, (b) accrued interest under the Note
shall be payable in monthly installments commencing February 1, 2010, and
continuing on the first business day of each successive month, and (c) the
Maturity Date is March 31, 2010. There are no penalties for early
prepayment of the Note.
In the
event that any installment of principal and/or interest due under the Note is
not received by the Lender within ten (10) days after the date when the same is
due, then we shall be required to pay a late charge of 5.0% of such
installment.
Additionally,
in the event that we receive investments from one or more investors in one or
more transactions in an aggregate amount in excess of $750,000, whether in the
form of cash, negotiable or non-negotiable instruments or any form of payment in
exchange for the issuance of any certificated or non-certificated security,
whether in the form of debt or equity (an “Equity Raise”), at any time between
the Issuance Date and the Maturity Date, shall be required, within five (5)
business days after the Equity Raise first exceeds $750,000, to curtail the
accrued interest and outstanding principal balance of the Note by an amount
equal to the amount by which the Equity Raise then exceeds $750,000 (but in no
event by more than the then outstanding principal balance and interest accrued
on the Note). Until delivery of such funds to the Lender, all such funds shall
be deemed held in trust by us for and on behalf of the Lender. All
funds that we deliver to the Lender from the Equity Raise shall be deemed
prepayments of the Note.
Pursuant
to the Agreement and the Note, our obligations thereunder are secured by a first
priority lien in and to all of our intellectual property rights, title and
interest in and to the SteelWorks® Mobile integrated server appliance
software.
As an
inducement to the Lender to make the loan, we issued to the Lender a warrant to
purchase up to 625,000 shares of our common stock, par value $0.001 per
share. The Warrant is exercisable for four years at an exercise price
of $0.15 per share. We determined fair value of these warrants
utilizing the Black-Sholes method. The fair value of these warrants
at issuance date was approximately $130,000. As an inducement for the
Lender to amend the terms of the Note, we agreed to pay the Lender
$25,000.
Board
of Directors Investment
On June
15, 2009, we sold an aggregate of 350,000 shares of our common stock, to
our seven directors, for aggregate cash proceeds of $87,500. The shares of
common stock were sold at $0.25 per share, or $.01 higher than the closing price
of the common stock on the date of sale. Each share of common stock
is accompanied by one warrant to purchase one additional share of common stock
(the “Warrant”). The Warrants are exercisable for five years from the
date of issuance at an exercise price of $0.25 per share. The
seven directors entered into lock-up agreements with us, restricting their
ability to exercise the warrants until such time as we received shareholder
approval for the issuance of the Warrants. We received shareholder
approval for the issuance of the Warrants on October 23, 2009.
Critical
Accounting Policies
The
preparation of financial statements in conformity with U.S. Generally Accepted
Accounting Principles requires management to make certain judgments, estimates
and assumptions that could affect the reported amounts of assets and liabilities
at the date of the financial statements and the reported amounts of revenue and
expenses during the reporting period. We based our estimates and
assumptions on historical experience and on various other assumptions believed
to be applicable, and evaluated them on an on-going basis to ensure they
remained reasonable under current conditions. Actual results could
differ significantly from those estimates.
The
significant accounting policies used in the preparation of our financial
statements are described in Note 3 “Significant Accounting Policies” to our
Financial Statements. Some of these significant accounting policies
are considered to be critical accounting policies. A critical
accounting policy is defined as one that has both a material impact on our
financial condition and results of operations and requires us to make difficult,
complex and/or subjective judgments, often as a result of the need to make
estimates about matters that are inherently uncertain.
We
believe that the following critical accounting policies reflect the more
significant judgments and estimates used in the preparation of our consolidated
financial statements.
12
Revenue
Recognition
We
recognize revenue when all four basic criteria are met: (1) persuasive evidence
of an arrangement exists; (2) delivery has occurred or services rendered; (3)
the fee is fixed and determinable; and (4) collectability is reasonably
assured.
In
the event we enter into a multiple element arrangement and there are undelivered
elements as of the balance sheet date, we assess whether the elements are
separable and have determinable fair value in determining the amount of revenue
to record.
We derive
our revenue from the following sources: product sales, information technology
support services, software license as a reseller and support sales and software
training and implementation services.
For
product sales where title transfers upon shipment and risk of loss transfers to
our customer, we generally recognize revenue at the time of
shipment. For product sales where title and risk of loss transfers
upon destination, we generally recognize revenue when products reach their
destination. Revenue from hardware leased to customers under
operating lease arrangements is recognized over the contract
term. When product and installation services that are not essential
to the functionality of the product are sold as part of a bundled agreement, the
fair value of the installation services, based on the price charged for the
services when sold separately, is deferred and recognized when the services are
performed. The products sold are generally covered by a warranty
ranging from one to three years. We previously accrued an estimated
warranty reserve in the period of sale to provide for estimated costs to provide
warranty services; as part of the agreement with Dell to produce our appliance
hardware, we currently purchase an on-site three year warranty from Dell with
each unit. This warranty is transferred to the appliance end user and
warranty service is provided directly to the customer by Dell.
When we
act as a reseller, we monitor the terms of each new transaction to assess
whether ASC 605-45, “Reporting Revenue Gross as a Principal versus Net as an
Agent” applies to our financial reporting for such transaction. In
accordance with this standard, we recognize revenue associated with the resale
of service contracts on a gross basis.
In
October 2008 we began delivering our appliance solution specifically developed
for Blackberry Enterprise Servers, referred to herein as “BES”. Our
software does not require significant modification and customization
services. We do not have vendor-specific objective evidence (“VSOE”)
of fair value for our software. Accordingly, when the software is
sold in conjunction with our hardware, software revenue is recognized upon
delivery of the hardware.
For
services revenue under time and material contracts, we recognize revenue as
services are provided based on the hours of service at stated contractual
rates.
We incur
shipping and handling costs, which are recorded in cost of
revenues.
Typically
our deferred revenue includes amounts received from customers for which revenue
has not been recognized. This generally results from certain customer
contracts, ISV releases, warranties, hardware maintenance and support, and
consulting services. The deferred revenue associated with customer
contracts and ISV releases represents payments received for milestones achieved
prior to recognition of revenue. This revenue will be recognized as
products are shipped. Revenues from warranties and hardware
maintenance and support are recognized ratably over the service term selected by
the customer. Deferred service revenues from consulting are
recognized as the services are performed.
Equity-Based
Compensation
Share-based
compensation cost is measured at the grant date, based on the fair value of the
award, and is recognized over the employee’s requisite service
period. The fair value of the stock options and employee stock
purchase plan (“ESPP”) awards are estimated using a Black-Scholes option
valuation model. This model requires the input of highly subjective
assumptions and elections, including expected stock price volatility and the
estimated life of each award. The fair value of equity-based awards
is amortized over the vesting period of the award and we have elected to use the
straight-line method for amortizing our stock option and ESPP
awards.
13
Income
Taxes
We
recognize deferred tax liabilities and assets for the expected future tax
consequences of temporary differences between the carrying amounts and the tax
bases of certain assets and liabilities. A valuation allowance is
established, as necessary, to reduce deferred income tax assets to an amount
expected to be realized in future periods. We determine our valuation
allowance by weighing all positive and negative evidence including past
operating results and forecasts of future taxable income. In
assessing the amount of the valuation allowance as of October 31, 2008 and 2009,
we considered, in particular, our forecasted taxable income for the upcoming
fiscal year, current backlog of orders, including those recently received, and
other significant opportunities currently in our sales and marketing pipeline
with a high probability of generating revenues. Based upon this
review, we have continued to fully reserve for all deferred tax assets as of
October 31, 2009.
We
account for uncertainty in income taxes using a more-likely-than-not recognition
threshold based on the technical merits of the tax position
taken. Tax positions that meet the more-likely-than-not recognition
threshold should be measured as the largest amount of the tax benefits,
determined on a cumulative probability basis, which is more likely than not to
be realized upon effective settlement in the financial
statements. Our accounting policy is to recognize interest and
penalties related to income tax matters in general and administrative
expense.
Inventory
Inventory
consists of materials and components used in the assembly of our products or
maintained to support maintenance and warranty obligations and are stated at the
lower of cost or market using actual costs on a first-in, first-out
basis. We maintain a perpetual inventory system and continuously
record the quantity on-hand and actual cost for each product, including
purchased components, subassemblies and finished goods. We maintain
the integrity of perpetual inventory records through periodic physical counts of
quantities on hand. Finished goods are reported as inventory until
the point of title transfer to the customer. Generally, title
transfer is documented in the terms of sale. When the terms of sale
do not specify, we assume title transfers when it completes physical transfer of
the products to the freight carrier unless other customer practices
prevail.
We
periodically evaluate our inventory obsolescence to ensure inventory is recorded
at its net realizable value. Our policy is to assess the valuation of
all inventories, including manufacturing raw materials, work-in-process,
finished goods and spare parts in each reporting period. Inherent in
managements estimates of excess and obsolete inventory are management’s
forecasts related to our future manufacturing schedules, customer demand,
technological and/or market obsolescence and possible alternative
uses. If future customer demand or market conditions are less
favorable than our projections, additional inventory write-downs may be
required, and would be reflected in cost of sales in the period the revision is
made.
Warranty
As part
of the agreement with Dell to produce our appliance hardware, we purchase an
on-site three year warranty from Dell with each unit. This warranty
is transferred to the appliance end user and warranty service is provided
directly to the customer by Dell.
Warranty
and service support for BlackBerry software is provided directly to the user by
RIM as part of the software license agreement. End users contact RIM
directly for support.
We
periodically monitor the performance and cost of warranty activities for other
technology that we develop.
Segment
Reporting
We are
organized on the basis of products and services. Our chief operating
decision maker is our Chief Executive Officer. While the Chief
Executive Officer is apprised of a variety of financial metrics and information,
the Chief Executive Officer makes decisions regarding how to allocate resources
and assess performance based on a single operating segment.
14
Recently
Issued Accounting Pronouncements
In September 2009, Financial Accounting
Standards Board (“FASB”) issued ASC 605-25, Revenue Recognition
- Multiple-Deliverable Revenue Arrangements, formerly Emerging Issues Task Force
(EITF) 00-21. This guidance addresses how to
separate deliverables and how to measure and allocate consideration to one or
more units of accounting. Specifically, the guidance requires that consideration
be allocated among multiple deliverables based on relative selling prices. The
guidance establishes a selling price hierarchy of (1) vendor-specific
objective evidence, (2) third-party evidence and (3) estimated selling
price. This guidance is effective for annual periods beginning after
December 15, 2009 but may be early adopted as of the beginning of an annual
period. We are currently evaluating the effect that this guidance will have on
our financial position and results of operations.
In June 2009, the FASB issued
SFAS No. 168, The FASB
Accounting Standards Codification and the Hierarchy of Generally Accepted
Accounting Principles – a replacement of FASB Statement No. 162, now referred to as ASC
105-10, Generally
Accepted Accounting Principles. The FASB Accounting
Standards Codification (“Codification”) will become the source of authoritative
U.S. generally accepted accounting principles (“GAAP”) recognized by FASB to be
applied by nongovernmental entities. Rules and interpretive releases of the
Securities and Exchange Commission (“SEC”) under authority of federal securities
laws are also sources of authoritative GAAP for SEC registrants. On the
effective date of this statement, the Codification will supersede all
then-existing non-SEC accounting and reporting standards. All other
non-grandfathered non-SEC accounting literature not included in the Codification
will become non-authoritative. This statement is effective for financial
statements issued for interim and annual periods ending after September 30,
2009. The adoption of this statement did not have a material effect on
our financial
statements.
In June
2009, the FASB issued SFAS No. 165, later codified in ASC
855-10, Subsequent
Events. ASC 855-10 establishes general standards of for the evaluation,
recognition and disclosure of events and transactions that occur after the
balance sheet date. Although there is new terminology, the standard is based on
the same principles as those that currently exist in the auditing standards. The
standard, which includes a new required disclosure of the date through which an
entity has evaluated subsequent events, is effective for interim or annual
periods ending after June 15, 2009. The adoption of ASC 855-10 did not
have a material effect on our financial statements.
In April
2009, the FASB issued FASB Staff Position No. 107-1 and APB Opinion
No. 28-1 (FSP 107-1 and APB 28-1), later codified in ASC
825-10-65-1, Interim
Disclosures about Fair Value of Financial Instruments. FSP 107-1 and
APB 28-1 require fair value disclosures in both interim, as well as annual,
financial statements in order to provide more timely information about the
effects of current market conditions on financial instruments. FSP 107-1 and
APB 28-1 became effective for us in the quarter ended July 31, 2009, and
our adoption of FSP 107-1 and APB 28-1 did not have a material
impact on our financial statements.
In June
2008, the EITF ratified EITF Issue No. 07-5, Determining Whether an Instrument
(or Embedded Feature) Is Indexed to an Entity’s Own Stock, now referred
to as ASC 815-40-15. ASC 815-40-15 provides guidance in assessing whether
derivative instruments meet the criteria in paragraph 11(a) of
SFAS No. 133, Accounting for Derivative
Instruments and Hedging Activities, now referred to as ASC 815, for being
considered indexed to an entity’s own common stock. ASC 815-40-15 is effective
for fiscal years beginning after December 15, 2008. The adoption of this
statement is not expected to have a material effect on our financial
statements.
In April
2008, the FASB issued FSP FAS 142-3, Determination of the Useful Life of
Intangible Assets, now referred to as FASB ASC 350-30-65-1. It amends the
factors that should be considered in developing renewal or extension assumptions
used to determine the useful life of a recognized intangible asset under
SFAS No. 142, Goodwill and Intangible
Assets, now referred to as ASC 350. ASC 350-30-65-1 is effective for
fiscal years beginning after December 15, 2008 and may not be adopted
early. The adoption of this statement is not expected to have a material effect
on our financial statements.
In March
2008, the FASB issued SFAS No. 161, Disclosures about Derivative
Instruments and Hedging Activities – an amendment to FASB Statement No. 133,
now referred to as ASC 815. ASC 815 is intended to
improve financial standards for derivative instruments and hedging activities by
requiring enhanced disclosures to enable investors to better understand their
effects on an entity's financial position, financial performance, and cash
flows. Entities are required to provide enhanced disclosures about: (a) how and
why an entity uses derivative instruments; (b) how derivative instruments and
related hedged items are accounted for under SFAS No. 133 and its related
interpretations; and (c) how derivative instruments and related hedged items
affect an entity’s financial position, financial performance, and cash flows.
ASC 815 is effective for financial statements issued for fiscal years
beginning after November 15, 2008, with early adoption encouraged. The adoption
of this statement is not expected to have a material effect on our financial
statements.
15
In
December 2007, the FASB issued SFAS No.141R, Business Combinations, now
referred to as ASC 805.
ASC 805 establishes principles and requirements for how the acquirer of a
business recognizes and measures in its financial statements the identifiable
assets acquired, the liabilities assumed, and any noncontrolling interest in the
acquiree. The statement also provides guidance for recognizing and measuring the
goodwill acquired in the business combination and determines what information to
disclose to enable users of the financial statements to evaluate and financial
effects of the business combination. The guidance will become effective
for the fiscal year beginning after December 15, 2008. The adoption of this
statement is not expected to have a material effect on our consolidated
financial statements, unless we enter into a material business combination
transaction. We are in the process of evaluating the effect, if any, the
adoption of ASC 805 will have on our financial statements, if we undertake an
acquisition.
In
December 2007, the FASB issued SFAS No. 160, Noncontrolling Interests in
Consolidated Financial Statements – an amendment of ARB No. 51, now
referred to as ASC 810. ASC 810 establishes accounting and reporting standards
for the noncontrolling interest in a subsidiary and for the deconsolidation of a
subsidiary. The guidance will become effective for the fiscal year beginning
after December 15, 2008. We are in the process of evaluating the effect, if any,
the adoption of ASC 810 will have on our financial statements.
Fiscal
Year Ended October 31, 2008 Compared to Fiscal Year Ended October 31,
2009
In the
third quarter of fiscal year 2009 we discontinued the operations of our hardware
integration business. The following discussions pertain solely to our
continuing operations and discontinued operations are discussed
separately.
Net
Revenue Discussion:
The
following table summarizes our net revenue for the twelve months ended October
31, 2008 and 2009 in dollars and as a percentage of net revenues.
|
Fiscal Year Ended October 31,
|
||||||||||||||||||||||||
|
2008
|
2009
|
Increase (decrease)
|
||||||||||||||||||||||
|
% of Net
|
% of Net
|
|||||||||||||||||||||||
|
Dollars
|
Revenues
|
Dollars
|
Revenues
|
Dollars
|
Percentage
|
|||||||||||||||||||
|
Products
|
$ | 1,905,228 | 41.55 | % | $ | 319,970 | 21.05 | % | $ | (1,585,258 | ) | (83.21 | )% | |||||||||||
|
Services
|
2,680,526 | 58.45 | % | 1,199,929 | 78.95 | % | $ | (1,480,597 | ) | (55.24 | )% | |||||||||||||
|
Total
net revenues
|
$ | 4,585,754 | 100.00 | % | $ | 1,519,899 | 100.00 | % | $ | (3,065,855 | ) | (66.86 | )% | |||||||||||
The
decrease in product revenue is primarily attributable to the sale of the
hardware integration business. Given the new focus of our business
during the twelve months ended October 31, 2009, we
do not anticipate a significant portion of our revenues to be generated from
ancillary technology products that are not focused around the
SteelWorks product line; however, we will continue to support our
existing customers and may sell products outside of our SteelWorks product line
from time to time.
The
decrease in service revenue for the twelve months ended October 31, 2009 as
compared to the same period in fiscal 2008 is the result of us completing a
large services contract in December 2008, as there were no revenues in fiscal
2009 from January, 2009 through October, 2009.
16
Gross
Profit Discussion:
The
following table summarizes our gross profit for the twelve months ended October
31, 2008 and 2009 in dollars, as a percentage of gross profit and as a
percentage of net revenues.
|
Fiscal Year Ended October 31,
|
||||||||||||||||||||||||
|
2008
|
2009
|
Increase (decrease)
|
||||||||||||||||||||||
|
% of Gross
|
% of Gross
|
|||||||||||||||||||||||
|
Dollars
|
Profit
|
Dollars
|
Profit
|
Dollars
|
Percentage
|
|||||||||||||||||||
|
Products
|
$ | 321,744 | 38.19 | % | $ | 143,212 | 31.75 | % | $ | (178,532 | ) | (55.49 | )% | |||||||||||
|
Products
– GP%
|
16.89 | % | 44.76 | % | ||||||||||||||||||||
|
Services
|
520,773 | 61.81 | % | 307,876 | 68.25 | % | (212,897 | ) | (40.88 | )% | ||||||||||||||
|
Services
– GP%
|
19.43 | % | 25.66 | % | ||||||||||||||||||||
|
Total
gross profit
|
$ | 842,517 | 100.00 | % | $ | 451,088 | 100.00 | % | $ | (391,429 | ) | (46.46 | )% | |||||||||||
|
Total
– GP%
|
18.37 | % | 29.68 | % | ||||||||||||||||||||
The
significant increase in products gross profit percentage for the twelve months
ended October 31, 2009 as compared to the same period in fiscal year 2008 is the
result of our SteelWorks sales, a product that was launched in early fiscal year
2009. Given the significant intellectual property and software we
have created and developed for this product, we anticipate margins will remain
strong in future periods.
The
increase in services gross profit for the twelve months ended October 31, 2009
as compared to the same period in fiscal year 2008 is primarily attributable to
the completion of a low margin services contract in December 2008.
Operating
Expense Discussion:
The
following table summarizes our operating expenses for the twelve months ended
October 31, 2008 and 2009 in dollars and as a percentage of net
revenues.
|
Fiscal Year Ended October 31,
|
||||||||||||||||||||||||
|
2008
|
2009
|
Increase (decrease)
|
||||||||||||||||||||||
|
% of Net
|
% of Net
|
|||||||||||||||||||||||
|
Dollars
|
Revenues
|
Dollars
|
Revenues
|
Dollars
|
Percentage
|
|||||||||||||||||||
|
Selling
and marketing
|
$ | 928,157 | 20.24 | % | $ | 486,942 | 32.04 | % | $ | (441,215 | ) | (47.54 | )% | |||||||||||
|
General
and administrative
|
3,528,249 | 76.94 | % | 2,533,836 | 166.71 | % | (994,513 | ) | (28.19 | )% | ||||||||||||||
|
Research
and product development
|
234,371 | 5.11 | % | 233,312 | 15.35 | % | (1,059 | ) | (0.45 | )% | ||||||||||||||
|
Severance
and restructuring costs
|
-
|
- | 73,205 | 4.82 | % | 73,205 | 100.00 | % | ||||||||||||||||
|
Total
operating expenses
|
$ | 4,690,777 | 102.29 | % | $ | 3,327,296 | 218.92 | % | $ | (1,363,581 | ) | (29.07 | )% | |||||||||||
The
decrease in selling and marketing expense is the result of aligning expenses to
our current and future business models to focus on our SteelWorks products. For
the twelve months ended October 31, 2009 compared
to the twelve months ended October 31, 2008,
marketing activities and expense associated with selling and marketing personnel
decreased as a result of cost cutting efforts. We anticipate our
sales and marketing costs will increase in future periods in order to create
demand for our new products.
The
research and product development expense for the twelve months ended October 31,
2009 slightly decreased compared to the twelve months ended October 31,
2008. We continue to make research and development investment into
our SteelWorks family of products. We anticipate that these research
and development costs will continue in future periods.
17
The
decrease in general and administrative expenses for the twelve months ended
October 31, 2009 compared to the twelve months ended October 31, 2008 is
primarily attributable to a reduction in operating costs resulting from the sale
of our hardware integration business was complete. Furthermore, we
have significantly reduced our operating expenses from the prior year
specifically relating to rent, personnel, insurance and other corporate
costs.
The
increase in our severance and restructuring costs is primarily attributable to a
severance agreement with our former President and Chief Executive
Officer.
Other
Income (Expense) Discussion:
The
following table summarizes our other income (expense) for the twelve months
ended October 31, 2008 and 2009 in dollars and as a percentage of net
revenues.
|
Fiscal Year Ended October 31,
|
||||||||||||||||||||||||
|
2008
|
2009
|
Increase (decrease)
|
||||||||||||||||||||||
|
% of Net
|
% of Net
|
|||||||||||||||||||||||
|
Dollars
|
Revenues
|
Dollars
|
Revenues
|
Dollars
|
Percentage
|
|||||||||||||||||||
|
Other
income (expense) net
|
$ | 8,542 | 0.19 | % | $ | (64,657 | ) | (4.25 | )% | $ | (73,199 | ) | (856.93 | )% | ||||||||||
|
Total
other income (expense), net
|
$ | 8,542 | 0.19 | % | $ | (64,657 | ) | (4.25 | )% | $ | (73,199 | ) | (856.93 | )% | ||||||||||
The
decrease in other income/(expense) is attributable to increased interest expense
relating to the Caledonia Capital Corporation loan which had an annual interest
rate of 15% per year. In addition, we have accrued interest
associated with our settlement with our former landlord on May 22, 2009 at an
annual rate of 18%.
Income
Tax (Benefit)
The
following table summarizes our income tax benefit for the twelve months ended
October 31, 2008 and 2009 in dollars and as a percentage of net
revenues.
|
Fiscal Year Ended October 31,
|
||||||||||||||||||||||||
|
2008
|
2009
|
Increase (decrease)
|
||||||||||||||||||||||
|
% of Net
|
% of Net
|
|||||||||||||||||||||||
|
Dollars
|
Revenues
|
Dollars
|
Revenues
|
Dollars
|
Percentage
|
|||||||||||||||||||
|
Income
Tax Benefit
|
$ | (397,868 | ) | 8.68 | % | $ | - | 0.00 | % | $ | (397,868 | ) | 100.00 | % | ||||||||||
In the
twelve months ended October 31, 2008 we recorded an income tax expense
attributable to discontinued operations and income tax benefit on continuing
operations in accordance with intraperiod tax allocation rules. As
both discontinued operations and operations had a loss in fiscal year 2009, no
such allocation was made.
18
Loss
from Continuing Operations Discussion
The
following table summarizes our loss from continuing operations for the twelve
months ended October 31, 2008 and 2009 in dollars and as a percentage of net
revenues.
|
Fiscal Year Ended October 31,
|
||||||||||||||||||||||||
|
2008
|
2009
|
(Increase) decrease
|
||||||||||||||||||||||
|
% of Net
|
% of Net
|
|||||||||||||||||||||||
|
Dollars
|
Revenues
|
Dollars
|
Revenues
|
Dollars
|
Percentage
|
|||||||||||||||||||
|
Loss
from continuing operations
|
$ | (3,441,848 | ) | (75.06 | )% | $ | (2,940,864 | ) | (193.49 | )% | $ | 450,180 | 13.08 | % | ||||||||||
The
decrease in loss from continuing operations for the twelve months ended October
31, 2009 as compared to the same period in fiscal 2008 was attributable to the
reduction of sales of products not pertaining to the discontinued operations and
completion of a service contract in December 2008, as well as lower cost of
revenue and lower operating expenses as a result of our shift in emphasis to
BlackBerry related products and technologies.
Income
(loss) from Discontinued Operations Discussion
The
following table summarizes our income (loss) from discontinued operations for
the twelve months ended October 31, 2008 and 2009 in dollars and as a percentage
of net revenues.
|
Fiscal Year Ended October 31,
|
||||||||||||||||||||||||
|
2008
|
2009
|
Increase (decrease)
|
||||||||||||||||||||||
|
% of Net
|
% of Net
|
|||||||||||||||||||||||
|
Dollars
|
Revenues
|
Dollars
|
Revenues
|
Dollars
|
Percentage
|
|||||||||||||||||||
|
Income
(loss) from discontinued operations
|
$ | 682,286 | 14.88 | % | $ | (795,698 | ) | (52.35 | )% | $ | (1,477,984 | ) | (216.62 | )% | ||||||||||
The loss
for the twelve month period ended October 31, 2009 as compared to the same
period in 2008, is attributable to discontinued operations, overall downward
economic climate, contract delays, non-renewals and order constriction in our
commercial business.
As a
result of the continuing declines in revenues as well as the cumulative losses,
we determined to discontinue our hardware integration business in the third
quarter of our 2009 fiscal year.
Liquidity
and Capital Resources
We have
experienced recurring losses from operations and negative cash
flows. For the twelve months ended October 31, 2009, we incurred a
net loss of $3,736,562 and an accumulated deficit of $48,605,126 as of that
date. The report from our independent registered public accounting
firm on our audited financial statements at October 31, 2009 contains an
explanatory paragraph regarding doubt as to our ability to continue as a going
concern as a result of our history of net losses from operations, net working
capital deficit and uncertainty regarding the Company’s ability to satisfy
obligations as they become due in the near future. Despite our
history of revenues, we can give no assurance that we will be able to maintain
or increase our revenues in fiscal 2010 or that we will be successful in
reaching profitability or generating positive cash flows from our
operations. We are considering all strategic options to improve our
liquidity and provide us with working capital to fund our continuing business
operations including equity offerings, asset sales and debt financing as
alternatives to improve our cash needs; however; we can offer no assurance that
we will be successful in identifying, obtaining or negotiating financing
terms. If adequate funds are not available or are not available on
terms acceptable to us, we will likely not be able to take advantage of
unanticipated opportunities, develop or enhance services or products, respond to
competitive pressures, or continue as a going concern.
19
As of
October 31, 2009, we had cash and cash equivalents of $60,650 and a working
capital deficit of $576,350. As of January 22, 2010, we have
approximately $109,000 cash on hand, which is adequate for approximately one
additional month of operations. We do not have any working capital
commitments nor do we presently have any external sources of working
capital. Historically, our revenues have not been sufficient to fund
our operations and we have relied on capital provided through the sale of equity
securities. Our working capital needs in future periods will depend
primarily on the rate at which we can increase our revenues while controlling
our expenses and decreasing the use of cash from operations. We are
currently in the process of registering shares of our common stock to sell
directly to investors in order to raise additional capital. We can
provide no assurances that any such financings will be consummated.
For the
twelve months ended October 31, 2009, we used approximately $1,578,000 in cash
from operating activities. Our primary use of cash was to finance our operating
loss. The use and availability of our cash is affected by the timing,
pricing, and magnitude of orders for our products, and the timing of cash
outflows relating to these orders.
We
generated approximately $564,000 from our investing activities and $322,000 in
financing activities for the twelve months ended October 31, 2009.
Our
consolidated financial statements for the twelve months ended October 31, 2009
do not give effect to any adjustments to recorded amounts and their
classifications, which would be necessary should we be unable to continue as a
going concern and therefore, be required to realize our assets and discharge our
liabilities in other than the normal course of business and at amounts different
from those reflected in the consolidated financial statements.
Off-Balance
Sheet Arrangements
Contractual
Obligations and Commercial Commitments
We had
significant contractual obligations for fiscal year ended October 31, 2009 and
beyond for our operating leases and employment agreements.
On
February 27, 2009, we entered into a lease amendment with the landlord of our
operation facility whereby the current lease, which was scheduled to expire on
August 31, 2014, has been amended to provide for (i) the extension of the lease
term for a period of one (1) year and four (4) months ending on December 31,
2015, and (ii) certain other modifications, including a reduction in our rent
cash payments by approximately $60,000 and $34,000 for the fiscal years 2009 and
2010, respectively. Our monthly straight-line rent expense will be
approximately $21,000 a month for the length of the lease.
On May
22, 2009, we entered into a Stipulation/Consent Order with CRP (referred to
herein as the “Stipulation”), pursuant to an Affidavit and Statement of Account
(referred to herein as the “Affidavit”), stating, as declared by a general
manager of Jones Lang LaSalle, a property management company and agent for CRP
Holdings A-1, LLC (referred to herein as “CRP”), the landlord of 14040 Park
Center Road, Suite 210, Herndon, Virginia 20171 (referred to herein as the
“Premises”), that CRP, as landlord, was seeking a judgment against us for: (i)
possession of the Premises, and (ii) monetary damages for nonpayment of rent due
under a sublease, dated September 28, 2004, by and between us and NEC America,
Inc. (referred to herein as “NEC”) (referred to herein as the “Sublease”), and a
subsequent assignment of the Sublease to CRP from NEC, dated December 15,
2008. In the Stipulation we acknowledged that the balance due for
rent and additional rent for the Premises was $168,638, together with attorney’s
fees and court expenses of $7,041 through May 22, 2009 (referred to herein as
the “Judgment Amount”). Pursuant to the Stipulation, we paid $30,000
(referred to herein as the “Forbearance Payment”) on May 22, 2009 toward the
Judgment Amount. Further we agreed to, and have, vacated the
Premises. CRP agreed to stay enforcement of the Judgment Amount until
the earlier of (a) our receipt of capital in the amount of at least $500,000, or
(b) May 31, 2010. The matter was returned to the court’s files
pending our compliance with the terms of the Stipulation.
20
On
February 5, 2009, we entered into an Executive Retention Agreement (the “2009
Agreement”) with Brian Hajost, our current President and Chief Executive
Officer, effective as of January 16, 2009. Pursuant to the terms of
the 2009 Agreement, as compensation for Mr. Hajost serving as our President and
Chief Executive Officer, Mr. Hajost receives (a) a semi-monthly salary of
$8,333.33 (or $200,000 annually); (b) a stock grant of 156,000 shares of our
common stock, which will vest ratably over 12 months; and (c) a stock option
grant of 300,000 shares of our common stock, which will vest ratably over a
three year term and have a five year exercise period. The 2009
Agreement further provides that in the event we terminate Mr. Hajost’s
employment without cause (other than due to Mr. Hajost’s request), or if Mr.
Hajost terminates his employment for good reason, Mr. Hajost will be entitled to
(a) if the termination takes place within three months from the date of the 2009
Agreement, two months salary, (b) if the termination takes place between three
and six months from the date of the 2009 Agreement, three months salary, (c) if
the termination takes place between six months and one year from the date of the
2009 Agreement, six months salary, (d) if the termination takes place after the
first year anniversary of the 2009 Agreement, 12 months salary. In
the event that a majority of our stock or a substantial portion of our assets
are acquired, the acquisition closes while Mr. Hajost is employed by us, and Mr.
Hajost’s employment with us is terminated without cause (other than due to Mr.
Hajost’s request) within 30 days of the acquisition, Mr. Hajost will be entitled
to severance pay equal to the lesser of (a) 24 months salary based on his annual
rate of pay for the calendar year before the calendar year of termination from
service, or (b) two times the IRS limit for qualified plans provided for in 26
U.S.C. § 401(a)(17) for the calendar year of termination of
service.
We do not
have any purchase obligations, capital lease obligations or any material
commitments for capital expenditures. We have not engaged in
off-balance sheet financing, commodity contract trading or significant related
party transactions.
Impact
of Inflation
We do not
believe that inflation has had a material effect on our financial position or
results of operations during the past three years. However, we cannot
predict the future effects of inflation.
ITEM
7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET
RISK
Not applicable
ITEM
8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
|
Financial Statements of SteelCloud,
Inc.
|
Page
|
|
|
Report
of Independent Registered Public Accounting Firm
|
F-1
|
|
|
Consolidated
Balance Sheets
|
F-2
|
|
|
Consolidated
Statements of Operations
|
F-3
|
|
|
Consolidated
Statements of Stockholders' Equity
|
F-4
|
|
|
Consolidated
Statements of Cash Flows
|
F-5
|
|
|
Notes
to the Consolidated Financial Statements
|
F-6
|
|
|
Schedule
II – Valuation and Qualifying Accounts
|
23
|
|
ITEM
9.
|
CHANGES
IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL
DISCLOSURES
|
There
were no changes in and disagreements with accountants on accounting and
financial issues during the fiscal year ended October 31, 2009.
ITEM
9A(T). CONTROLS AND PROCEDURES
We
conducted an evaluation of the effectiveness of the design and operation of our
disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(f)
under the Securities Exchange Act of 1934, as amended) (the “Disclosure
Controls”) as of the end of the period covered by this Annual
Report. The Disclosure Controls evaluation was done under the
supervision and with the participation of management, including our Principal
Executive Officer (“PEO”) and Principal Financial Officer (the “PFO” and
together with the PEO, the “Certifying Officers”).
21
Attached
as exhibits to this Annual Report are certifications of the Certifying Officers,
which are required in accordance with Rule 13a-14 of the Exchange
Act. This “Controls and Procedures” section includes the information
concerning the controls evaluation referred to in the certifications and it
should be read in conjunction with the certifications for a more complete
understanding of the topics presented.
Disclosure
Controls and Procedures
Our
management is responsible for establishing and maintaining adequate internal
control over financial reporting.
The term
“internal control over financial reporting” is defined as a process designed by,
or under the supervision of, our Certifying Officers, or persons performing
similar functions, and effected by our board of directors, management and other
personnel, to provide reasonable assurance regarding the reliability of
financial reporting and the preparation of financial statements for external
purposes in accordance with generally accepted accounting principles and
includes those policies and procedures that:
|
|
·
|
Pertain
to the maintenance of records that in reasonable detail accurately and
fairly reflect the transactions and dispositions of our
assets,
|
|
|
·
|
Provide
reasonable assurance that transactions are recorded as necessary to permit
preparation of financial statements in accordance with generally accepted
accounting principles, and that receipts and expenditures are being made
only in accordance with authorizations of our management and directors,
and
|
|
|
·
|
Provide
reasonable assurance regarding prevention or timely detection of
unauthorized acquisition, or use or disposition of our assets that could
have a material effect on our financial
statements.
|
Under the
supervision of our Certifying Officers, we conducted an evaluation of the
effectiveness of our internal control over financial reporting as of October 31,
2009 using the criteria established in Internal Control—Integrated Framework
(the “Framework”) issued by the Committee of Sponsoring Organizations of the
Treadway Commission (“COSO”). This evaluation included review of the
documentation of controls, evaluation of the design effectiveness of controls,
testing of the operating effectiveness of controls and a conclusion on this
evaluation. Based on this evaluation, our management concluded our internal
control over financial reporting was not effective as of October 31,
2009.
A
material weakness is a deficiency, or combination of deficiencies, in internal
control over financial reporting, such that there is a reasonable possibility
that a material misstatement of our annual or interim financial statements will
not be prevented or detected on a timely basis. In our assessment of the
effectiveness of our internal control over financial reporting as of October 31,
2009, we determined that there were control deficiencies that when aggregated
constituted a material weakness, such as:
|
|
·
|
Inadequate
staffing resulting in a lack of proper review and monitoring controls over
financial reporting,
|
|
|
·
|
Inadequate
segregation of duties and effective risk assessment,
and
|
|
|
·
|
Inadequate
review and evaluation of transactions in the third quarter of fiscal year
2009 leading to a correction of an error for an impairment charge upon our
ultimate evaluation in the fourth quarter of fiscal year
2009.
|
During
the course of our fiscal year, primarily in the second half, we had a number of
both voluntary and involuntary reductions of staff. Due to strategic
business decisions, we decided to discontinue our computer integration business
in the third quarter of fiscal 2009. As the year progressed and these
events unfolded, we were aware of the growing concern over how a reduction of
staff would impact our internal controls, especially with regards to a lack of
proper review and monitoring controls and the segregation of
duties.
These
control deficiencies resulted in a reasonable possibility that a material
misstatement of the annual or interim financial statements would not have been
prevented or detected on a timely basis. As a result of the material
weakness described above, we concluded that we did not maintain effective
internal control over financial reporting as of October 31, 2009 based on
criteria established in the Framework. Our new management, board of directors
and audit committee are currently evaluating remediation plans for the above
deficiencies. During the period covered by this annual report on
Form 10-K, we have not been able to remediate the weaknesses described above.
However, we plan to take steps to enhance and improve the design of
our internal control over financial reporting. Our proposed plans
are set out below under the heading, “Management’s Remediation
Initiatives”.
22
Changes
in Internal Controls
During
our fiscal year ended October 31, 2009 a number of our accounting personnel left
our employment and were not replaced, including the departure of our Controller
in the fourth quarter of fiscal 2009. In addition, our Chief Financial Officer
resigned on November 30, 2009 and we retained a new Principal Financial Officer
immediately. These changes have impacted our internal controls, such as the
segregation of duties and lack of review and monitoring controls over financial
reporting, which has resulted in a material weakness in internal controls
over financial reporting and management’s conclusion that our internal controls
over financial reporting were not effective as of October 31, 2009.
As
discussed above, we conducted an evaluation of the effectiveness of our internal
control over financial reporting during our most recent fiscal quarter ending
October 31, 2009 using the criteria established in the Framework.
Based on our evaluation using the criteria established, our
management concluded that our internal controls over financial reporting were
not effective as of October 31, 2009.
Management’s
Remediation Initiatives
Although
we have been unable to meet the COSO standards because of our limited financial
resources, we are committed to improving our internal control over financial
reporting and disclosure controls and procedures. We are
exploring various alternatives for maximizing our resource utilization as well
as aligning our current business model with the COSO standards.
ITEM
9B. OTHER INFORMATION
Not
applicable.
23
PART
III
ITEM
10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE
The name,
age and position of each of our directors and executive officers are as
follows:
|
Name
|
Age
|
Position
|
||
|
Brian
H. Hajost
|
53
|
President
and Chief Executive Officer and Director
|
||
|
Steven
Snyder
|
50
|
Vice
President of Finance, Principal Financial Officer and
Secretary
|
||
|
James
Bruno
|
74
|
Director
|
||
|
VADM
E. A. Burkhalter, Jr. USN
|
81
|
Director
|
||
|
Jay
Kaplowitz
|
63
|
Director
|
||
|
Ashok
Kaveeshwar
|
68
|
Director
|
||
|
Benjamin
Krieger
|
|
72
|
|
Director
|
Brian H.
Hajost has served as our Chief Executive Officer, President and a
member of the Board since February 2009. From February 2007 until
June 2008, Mr. Hajost served as Executive Vice President of Cryptek, Inc. Mr.
Hajost served as our Chief Operating Officer from December 2003 until June 2006
and President from June 2005 until June 2006. Prior to December 2003, he served
as our Executive Vice President of Sales & Marketing from June 2001 until
his promotion to the Chief Operating Officer position in 2003. Mr. Hajost also
founded two consulting companies in 2006 and 2008.
Steven
Snyder has served as our Vice President of Finance and Principal
Financial Officer since November 2009. Since
April 2009, Mr. Snyder has served as the owner of a general business and
financial consulting and software development company. From September
2000 to February 2009, Mr. Snyder served as the Vice President of Finance of The
Richards Corporation, a privately owned supplier of both aircraft galley
equipment used in corporate and commercial aviation, and imagery analysis
workstations designed to meet a wide range of aerial surveillance applications
used in the United States and by various governments. During his
tenure at The Richards Corporation, Mr. Snyder also simultaneously served as the
Vice President of Information Technology, Operations and Materials
Management. From 1984 to 2000, Mr. Snyder worked for a number of
corporate entities in a variety of financial and operational
roles. From 1981 to 1984, Mr. Snyder worked for Arthur Andersen and
Co. where he became a Certified Public Accountant. He obtained his
Bachelor of Science degree in Accounting from the State University of New York
in 1981.
James
Bruno has served as our director since September 2000. Mr.
Bruno has served as a member of the Audit Committee of our Board of Directors
since January 2004. Mr. Bruno was formerly President of Syntrex
Corporation, prior to which he served as President of the Computer Division of
Perkin Elmer Corporation. He had formerly served in various
management positions with Electronic Associates, Inc. Mr. Bruno has
extensive experience in the computer industry, as well as corporate
acquisitions. He served as a consultant to SteelCloud, Inc. in 1997
and 1998.
Vice Admiral E.
A. Burkhalter, Jr., USN
(Ret.)
has served as our director since January 1997. In July 2006, Mr.
Burkhalter was appointed Chairman of our Board of Directors. Mr.
Burkhalter has served as a member of each of the Audit Committee, Executive
Committee and the Compensation Committee of our Board of Directors since January
2004. Mr. Burkhalter is currently the President of Burkhalter
Associates, Inc., a consulting firm providing services in the areas of
international and domestic strategy, management policy and technology
applications, for both government and industry. Mr. Burkhalter spent
40 years as a member of the United States Navy, during which time he held
several positions, including Director of Strategic Operations for the Chairman
of the Joint Chiefs of Staff. He is currently a member of the Defense
Intelligence Agency Leadership Council. He is also a trustee of the
US Naval Academy Foundation, and a trustee of the Benedictine
Foundation.
Jay M.
Kaplowitz has served as our director since September 2000. Mr.
Kaplowitz has served as a member of the Compensation Committee of our Board of
Directors since January 2004. Mr. Kaplowitz is a founding partner of
the law firm Gersten Savage LLP, our securities counsel. Mr.
Kaplowitz has more than thirty years experience in corporate, banking and
securities law. He has negotiated and structured numerous financial
and business transactions and has extensive expertise in public and private
equity and debt offerings. Mr. Kaplowitz is a managing member of
Formula Capital, LLC, a private equity fund, and is on the board of Rusoro
Mining Ltd., a company listed on the TSXV (CDNX: RML.V) and of several private
companies. He received a JD from Boston University, and a BA from
Brooklyn College, City University of New York.
24
Benjamin
Krieger has served as our director since September 1999. Mr. Krieger has
served as a member of the Compensation Committee and the Audit Committee of our
Board of Directors since January 2004. Mr. Krieger is currently a partner with
WhiteKnight Solutions, LLC, a business consulting firm that specializes in
acquisitions, divestitures and strategic alliances. Mr. Krieger was formerly a
partner with Corporate Development International, an international company
search firm, where he specialized in the pulp and paper, packaging, graphic arts
and distribution industries. Prior to Corporate Development International, he
was President, CEO and a director of Ris Paper Company. Mr. Krieger began his
career with the Mead Corporation where he was promoted through the Company
during his 25-year tenure.
Ashok Kaveeshwar,
Ph.D. has served as our director since March 2007. Dr. Kaveeshwar has
served as a member of the Executive Committee of our Board of Directors since
2007. Dr. Kaveeshwar has 35 years of technical, management and executive
experience with high technology firms serving both the public and private
sectors. He has also served in the Federal Government as the first administrator
of the Research & Innovative Technology Administration (RITA) at the United
States Department of Transportation, a Presidential appointment requiring Senate
confirmation. Prior to that, he was President of Orange Technologies, Inc, a
company providing government and commercial customers with project life cycle
management software and solutions. Previously, Dr. Kaveeshwar held various
senior executive positions with Raytheon Corporation, Hughes Electronics
Corporation, ST Systems Corporation (STX) and Systems & Applied Sciences
Corporation. Dr. Kaveeshwar has a Ph.D. in Physics from the University at
Buffalo (SUNY), Buffalo, NY.
In fiscal
year 2009, the Board of Directors met ten (10) times (including by
teleconference). All directors attended at least 75% of the
meetings.
Involvement
in Certain Legal Proceedings
No
director, person nominated to become a director, executive officer, promoter or
control person of ours has, during the last five years: (i) been convicted in or
is currently subject to a pending a criminal proceeding (excluding traffic
violations and other minor offenses); (ii) been a party to a civil proceeding of
a judicial or administrative body of competent jurisdiction and as a result of
such proceeding was or is subject to a judgment, decree or final order enjoining
future violations of, or prohibiting or mandating activities subject to any
Federal or state securities or banking or commodities laws including, without
limitation, in any way limiting involvement in any business activity, or finding
any violation with respect to such law, nor (iii) any bankruptcy petition been
filed by or against the business of which such person was an executive officer
or a general partner, whether at the time of the bankruptcy or for the two years
prior thereto.
Independence
of Directors
The Board
has determined that Messrs. Bruno, VADM Burkhalter, Kaplowitz, Kaveeshwar and
Krieger, are independent directors as defined in NASDAQ Marketplace Rule
4200.
Committees
of the Board
During
the fiscal year ended October 31, 2009, the Board of Directors held a total of
ten meetings (including teleconference). All incumbent directors attended at
least 75% of the aggregate of all meetings of the Board of Directors and any
committees of the Board on which they served, during the fiscal year ended
October 31, 2009.
The Audit
Committee appoints and provides for the compensation of our independent
auditors; oversees and evaluates the work and performance of the independent
auditors; reviews the scope of the audit; considers comments made by the
independent auditors with respect to accounting procedures and internal controls
and the consideration given thereto by our management; approves all professional
services to be provided to us by our independent auditors; reviews internal
accounting procedures and controls with our financial and accounting staff;
oversees a procedure that provides for the receipt, retention and treatment of
complaints received by us and of confidential and anonymous submissions by
employees regarding questionable accounting or auditing matters; and performs
related duties as set forth in applicable securities laws and the Audit
Committee charter (the “Audit Committee”). The Audit Committee
functions pursuant to the Audit Committee charter adopted by the Board in fiscal
2001. A copy of the Audit Committee Charter can be found on our web
site at www.steelcloud.com. The Audit Committee met four (4) times
(including by teleconference) during the fiscal year ended October 31,
2009. The Audit Committee is currently composed of James Bruno, VADM
Burkhalter and Benjamin Krieger. The Board has determined that all
current members of the Audit Committee are independent directors under the rules
of the NASDAQ Marketplace Rule 4200 and each of them is able to read and
understand fundamental financial statements. The Board has determined
that James Bruno is the Company’s Audit Committee “financial expert” as defined
in Item 407(d) of Regulation S-K.
25
The Compensation Committee
has such powers as may be assigned to it by the Board of Directors from time to
time and is currently charged with, among other things, determining compensation
packages for our Chief Executive Officer, President and Principal Financial
Officer, establishing salaries, bonuses and other compensation for our executive
officers and with administering the Company’s Amended 2007 Stock Option and
Restricted Stock Plan, the Company’s 2007, 2002 and 1997 Incentive Stock Option
Plans, as amended (the "Stock Option Plans"), the 1998 Employee Stock Purchase
Plan, as amended (the "1998 Purchase Plan") and recommending to the Board of
Directors changes to such plans (the “Compensation
Committee”). Generally, on its own initiative the Compensation
Committee reviews the performance and compensation of our Chief Executive
Officer and Principal Financial Officer and, following discussions with those
individuals, establishes their compensation levels where it deems appropriate.
For the remaining officers, the Chief Executive Officer makes recommendations to
the Compensation Committee that generally, with such adjustments and
modifications that are deemed necessary or appropriate by the Compensation
Committee, are approved. With respect to equity-based compensation awarded to
others, the Compensation Committee grants stock-based compensation, generally
based upon the recommendation of the Chief Executive Officer. The
Compensation Committee met one time (including by teleconference) during fiscal
2008. The Compensation Committee is currently composed of VADM
Burkhalter, Jay M. Kaplowitz and Benjamin Krieger. The Board has
determined that all current members of the Compensation Committee are
independent directors under the rules of the NASDAQ Stock Market. The
Compensation Committee does not have a charter.
The Board
of Directors has an Executive Committee (the "Executive Committee"), the members
of which are VADM Burkhalter and Ashok Kaveeshwar. The Executive Committee
has such powers as may be assigned to it by the Board of Directors from time to
time and is currently charged with, among other things, recommending to the
Board of Directors the criteria for candidates to the Board of Directors, the
size of the Board of Directors, the number of committees of the Board of
Directors and their sizes and functions, and the nomination and selection of
Board of Directors' candidates and committee members and rotation of committee
members. In addition, the Executive Committee is responsible for
establishing and implementing an annual evaluation process for the Chief
Executive Officer and the Board of Directors and periodically assessing the
overall composition of the Board of Directors to ensure an effective membership
mix and, when appropriate, recommending to the Board of Directors a Chief
Executive Officer succession plan and succession process. The
Executive Committee met six times during fiscal 2009. The Executive
Committee does not have a charter.
Code
of Ethics
On
September 9, 2004, the Board adopted a Code of Ethics that applies to the Chief
Executive Officer, Principal Executive Officers, Senior Financial Officers and
Board of Directors. A copy of the Code of Ethics can be found on our
web site at www.steelcloud.com. The Code of Ethics sets forth our
policies and expectations on a number of topics, including: Integrity of Records
and Financial Reporting; Compliance with Laws, Rules and Regulations; Conflict
of Interest; Corporate Opportunities; Fair Dealing; Confidentiality; Reporting
any Illegal or Unethical Behavior; and Waivers.
The Audit
Committee of the Board of Directors reviews the Code of Ethics annually, and
proposes changes or amendments to the Code of Ethics as
appropriate. Changes or amendments proposed by the Audit Committee
are submitted to the Board of Directors for review.
Section
16(A) Beneficial Ownership Reporting Compliance
Section
16(a) of the Securities Exchange Act of 1934, as amended (the “Exchange Act”)
requires the Company’s Officers and Directors, and persons who own more than 10%
of the Company’s common stock to file reports of ownership and changes in
ownership of the Company’s common stock with the Securities and Exchange
Commission. Based solely on a review of the copies of such reports
and written representations from the reporting persons that no other reports
were required, the Company believes that during the fiscal year ended October
31, 2009, our Executive Officers, Directors and greater than ten percent
shareholders filed on a timely basis all reports due under Section 16(a) of the
Exchange Act.
26
Changes
in Procedures by which Security Holders May Recommend Nominees to the Board of
Directors
There
have been no changes to the procedures by which security holders may recommend
nominees to our board of directors.
Audit
Committee Report
The Audit
Committee has reviewed and discussed the Company's audited financial statements
for the fiscal year ended October 31, 2009 with management and has received the
written disclosures and the letter from Grant Thornton LLP, the Company's
independent auditors, required by applicable requirements of the Public Company
Accounting Oversight Board regarding communications with the audit committee
concerning independence, and has discussed with Grant Thornton LLP their
independence. The Audit Committee has also discussed with Grant
Thornton LLP the Company's audited financial statements for the fiscal year
ended October 31, 2009, including among other things the quality of the
Company's accounting principles, the methodologies and accounting principles
applied to significant transactions, the underlying processes and estimates used
by management in its financial statements and the basis for the auditor's
conclusions regarding the reasonableness of those estimates, and the auditor's
independence, as well as the other matters required by Statement on Auditing
Standards No. 61 of the Auditing Standards Board of the American Institute of
Certified Public Accountants.
Based on
these discussions with Grant Thornton LLP and the results of the audit of the
Company's financial statements, the Audit Committee members recommended
unanimously to the Board of Directors that the audited financial statements be
included in the Company's Annual Report on Form 10-K for the fiscal year ended
October 31, 2009.
|
Respectfully
submitted,
|
|
/s/
James Bruno
|
|
/s/
VADM E.A. Burkhalter, Jr.
|
|
/s/
Benjamin Krieger
|
ITEM
11. EXECUTIVE COMPENSATION
The
following table sets forth certain information regarding compensation paid by us
during each of our last two fiscal years to our Chief Executive Officer and to
each of the Company’s executive officers who were paid in excess of $100,000
(the “Named Officers”).
Summary
Compensation Table
|
Name and Principal Position
|
Year
|
Salary
($)
|
Bonus
($)
|
Stock
Awards
($) 1
|
Option
Awards
($)
|
Other ($)2
|
Total
($)
|
|||||||||||||||||||
|
Brian
Hajost 3
|
2009
|
158,325
|
-0-
|
32,760
|
10,780
|
15,568
|
217,433
|
|||||||||||||||||||
|
Robert E. Frick 4
|
2009
|
62,758
|
-0-
|
(5,000
|
) |
(32,024
|
) |
43,067
|
68,621
|
|||||||||||||||||
|
President
and Chief Executive Officer
|
2008
|
267,000
|
-0-
|
-0-
|
50,624
|
21,731
|
339,355
|
|||||||||||||||||||
|
Kevin
M. Murphy
|
2009
|
209,288
|
-0-
|
23,380
|
55,881
|
21,596
|
310,145
|
|||||||||||||||||||
|
Chief
Financial Officer and
Executive Vice President |
2008
|
220,000
|
-0-
|
-0-
|
76,274
|
25,988
|
322,262
|
|||||||||||||||||||
27
|
In
fiscal year 2009, two of the named executive officers forfeited
options. Mr. Frick forfeited 66,666 shares of non-vested
restricted stock and 66,666 stock options. Mr. Murphy forfeited
175,000 stock options. In fiscal year
2008, none of the named executive officers forfeited
options. For additional information pertaining to assumptions
made in determining the value of the stock awards, please see footnote 10,
“Stock Based Compensation”, to our financial
statements.
|
|
2
|
Other
compensation includes commissions, accumulated leave payouts, fixed
expense allowances, 401K match expense and Company provided health and
dental insurance.
|
|
3
|
Mr.
Hajost joined the Company in January 2009 as President, Chief Executive
Officer and Director.
|
|
4
|
Mr.
Frick joined the Company in August 2007 as Executive Director and was
appointed to the Company’s Board of Directors. In October 2007,
Mr. Frick was named the Company’s President and Chief Executive
Officer. Mr. Frick’s employment with the Company ended on
January 9, 2009.
|
Narrative Disclosure to Summary
Compensation Table
Employment
Agreements; Termination of Employment
On
January 12, 2009 (the “Agreement Date”), we entered into an Amendment to
Employment Agreement (the “Amended Agreement”) with Robert E. Frick, our then
Chief Executive Officer and President, pursuant to which the terms of Mr.
Frick’s employment agreement, dated August 27, 2007, were amended. Under the
terms of the Amended Agreement, the parties agreed that Mr. Frick’s employment
with us terminated effective January 9, 2009 as a result of Mr. Frick’s
health. Further, pursuant to the Amended Agreement, Mr. Frick
resigned from our Board of Directors. Mr. Frick received paid family
health and dental insurance under our standard policies for six months from the
Agreement Date and $10,231 as compensation for Mr. Frick’s retained leave
balance of 10 days. Additionally, Mr. Frick served as a consultant
for us for six months from the Agreement Date for compensation of $11,250 per
month.
On
February 5, 2009, we entered into an Executive Retention Agreement (the “2009
Agreement”) with Brian Hajost, our President and Chief Executive Officer,
effective as of January 16, 2009. Pursuant to the terms of the 2009
Agreement, as compensation for Mr. Hajost serving as our President and Chief
Executive Officer, Mr. Hajost receives (a) a semi-monthly salary of $8,333.33
(or $200,000 annually); (b) a stock grant of 156,000 shares of our common stock,
which will vest ratably over 12 months; and (c) a stock option grant of 300,000
shares of our common stock, which will vest ratably over a three year term and
have a five year exercise period. The 2009 Agreement further provides
that in the event that we terminate Mr. Hajost’s employment without cause (other
than due to Mr. Hajost’s request), or if Mr. Hajost terminates his employment
for good reason, Mr. Hajost will be entitled to (a) if the termination takes
place within three months from the date of the 2009 Agreement, two months
salary, (b) if the termination takes place between three and six months from the
date of the 2009 Agreement, three months salary, (c) if the termination takes
place between six months and one year from the date of the 2009 Agreement, six
months salary, (d) if the termination takes place after the first year
anniversary of the 2009 Agreement, 12 months salary. In the event
that a majority of our common stock or a substantial portion of our assets are
acquired, the acquisition closes while Mr. Hajost is employed by us, and Mr.
Hajost’s employment with us is terminated without cause (other than due to Mr.
Hajost’s request) within 30 days of the acquisition, Mr. Hajost will be entitled
to severance pay equal to the lesser of (a) 24 months salary based on Hajost’s
annual rate of pay for the calendar year before the calendar year of termination
from service, or (b) two times the IRS limit for qualified plans provided for in
26 U.S.C. § 401(a)(17) for the calendar year of termination of
service.
We have
not entered into an employment agreement with Mr. Snyder, our Principal
Financial Officer. Mr. Snyder receives semi-monthly compensation of
$4,700 for 42 hours of work per semi-monthly period.
Overview
of Compensation Program
Our
compensation programs are intended to enable us to attract, motivate, reward and
retain the management talent required to achieve corporate objectives, and
thereby increase stockholder value. It is our policy to provide incentives to
senior management to achieve both short-term and long-term objectives and to
reward exceptional performance and contributions to the development of the
business. To attain these objectives, the executive compensation program
includes four key components:
28
Base
Salary. Base
salary for the Company’s executives is intended to provide competitive
remuneration for services provided to the Company over a one-year period. Base
salaries are set at levels designed to attract and retain the most appropriately
qualified individuals for each of the key management level positions within the
Company.
Cash
Incentive Bonuses. Our
bonus programs are intended to reward executive officers for the achievement of
various annual performance goals approved by the Company’s Board of Directors.
For fiscal 2009, no performance based bonus was approved for our executive
officers in light of our need for additional working capital.
We
anticipate that a performance based bonus plan will be established for certain
of our executive officers, once we are able to meet our minimum working capital
requirements. The bonus plan will likely be comprised of a
specified profit based bonus pool which will be based upon our achievement of
certain annual profit targets.
Equity-based
Compensation. Equity-based
compensation is designed to provide incentives to our executive officers to
build shareholder value over the long term by aligning their interests with the
interest of shareholders. The Compensation Committee of the Board of Directors
believes that equity-based compensation provides an incentive that focuses the
executive's attention on managing the company from the perspective of an owner
with an equity stake in the business. Among our executive officers, the number
of shares of stock awarded or common stock subject to options granted to each
individual generally depends upon the level of that officer's responsibility.
The largest grants are generally awarded to the most senior officers who, in the
view of the Compensation Committee, have the greatest potential impact on the
Company’s profitability and growth. Previous grants of stock options or stock
grants are reviewed in determining the size of any executive's award in a
particular year.
|
|
·
|
Incentive Stock Option
Plans
|
Under our
1997 Stock Option Plan (the “1997 Option Plan”), options to purchase a maximum
of 2,650,000 shares of our common stock (subject to adjustments in the event of
stock splits, stock dividends, recapitalizations and other capital adjustments)
may be granted to our employees, officers and Directors and certain other
persons who provide services to us. As of January 22, 2010 there were no options
to purchase shares of common stock available for grant pursuant to the Option
Plan. In fiscal year 2008 we granted no options pursuant to the 1997 Option
Plan. In fiscal year 2009 we granted no options pursuant to the 1997
Option Plan.
Under our
2002 Stock Option Plan (the “2002 Option Plan”), options to purchase a maximum
of 1,500,000 shares of our common stock (subject to adjustments in the event of
stock splits, stock dividends, recapitalizations and other capital adjustments)
may be granted to our employees, officers and Directors and certain other
persons who provide services to us. As of January 22, 2010 there were 606,210
options to purchase shares of common stock available for grant pursuant to the
2002 Option Plan. In fiscal year 2008 we granted 1,015,000 options pursuant to
the 2002 Option Plan. In fiscal year 2009 we granted 450,000 options pursuant to
the 2002 Option Plan.
Under our
Amended 2007 Stock Option and Restricted Stock Plan (the “2007 Option Plan”),
options to purchase a maximum of, or restricted stock for a maximum of 1,500,000
shares of our common stock (subject to adjustments in the event of stock splits,
stock dividends, recapitalizations and other capital adjustments) may be granted
to our employees, officers and Directors and certain other persons who provide
services to the Company. As of January 22, 2010 there were 1,065,250 options to
purchase shares of common stock or shares of restricted stock available for
grant pursuant to the 2007 Option Plan. No shares of restricted stock or stock
options were issued in fiscal year 2008 pursuant to the 2007 Option
Plan. 546,000 shares of restricted stock were issued in fiscal
year 2009 pursuant to the 2007 Option Plan.
|
|
·
|
Employee
Stock Purchase Plan
|
In August
1998, the Board adopted an Employee Stock Purchase Plan (the “Purchase Plan”)
whereby employees may purchase our common stock through a payroll deduction
plan. The purchase price of the common stock is 85% of the market price. All
employees, including officers but not Directors, are eligible to participate in
this plan. Executive officers whose stock ownership of our common stock exceeds
five percent of the total outstanding common stock are not eligible to
participate in this plan.
29
An
amendment to the Purchase Plan, which was approved at the 2006 Annual Meeting of
Shareholders, held in 2007, increased the total number of shares reserved for
issuance thereunder from 300,000 to 600,000. As of January 22, 2010 there were
267,765 options to purchase shares of common stock available for grant pursuant
to the Purchase Plan. No shares were purchased under this plan in
fiscal 2008 while 637 shares were purchased under this plan in fiscal 2008 at a
price of $0.69 per share.
Retirement
Plans. We established a discretionary contribution plan
effective May 1, 1999 (the “401(k) Plan”) for its employees who have
completed one month of employment with the Company. The 401(k) Plan is
administered by Fidelity Investments and permits pre-tax contributions by
participants pursuant to Section 401(k) of the Internal Revenue Code of 1986, as
amended (the “Code”), up to the maximum allowable contributions as determined by
the Code. The Company may match participants’ contributions on a discretionary
basis. In fiscal 2009, we contributed $0.25 for each $1.00 contributed by an
employee up to a maximum of 6% of an employee’s annual
compensation.
Health
and Welfare Benefits and Other Perquisites. Our full time
executive officers are entitled to participate in all of the Company’s employee
benefit plans, including medical, dental, group life, disability, accidental
death and dismemberment insurance and the Company’s sponsored
401(k).
Repricing
of Equity Based Grants
No
options or other equity based grants were re-priced during the fiscal year ended
October 31, 2009.
Outstanding
Equity Awards at October 31, 2009
|
OPTION AWARDS
|
STOCK AWARDS
|
||||||||||||||||||||
|
Name
|
Number of
Securities
Underlying
Unexercised
Options (#)
Exercisable
|
Number of
Securities
Underlying
Unexercised
Options (#)
Unexercisable
|
Option
Exercise
Price ($)
|
Option
Expiration
Date
|
Number of
Shares or Units
of Stock That
Have Not
Vested (#)
|
Market Value
of Shares or
Units of Stock
That Have Not
Vested
($) 1
|
|||||||||||||||
|
Brian Hajost
|
-0-
|
300,000
|
2
|
0.28
|
2/5/2014
|
||||||||||||||||
|
Kevin
M. Murphy
|
75,000
|
-
|
2.40
|
6/27/2010
|
|||||||||||||||||
|
170,000
|
-
|
0.62
|
11/24/2011
|
||||||||||||||||||
|
75,000
|
75,000
|
3
|
0.16
|
2/28/2014
|
|||||||||||||||||
|
1
|
Based
on the closing price of the Company’s Common Stock of $0.26 per share on
10/31/2009.
|
|
2
|
100,000
options vest on 2/5/2010, 2/5/2011 and
2/5/2012.
|
|
3
|
37,500
options vest on each of 11/30/2009 and
2/28/2010.
|
Please
see “Item 11 – Executive
Compensation – Narrative Disclosure to Summary Compensation Table” for
the material terms of (a) our employment agreements, and (b) of each plan that
provides for the payment of retirement benefits.
Compensation
of Directors
We do not
compensate Directors who also serve as our executive officers for their services
on the Board. During fiscal 2009, we did not compensate our non-employed
Directors for participation at meetings of the Board and Committees of the
Board. The following table reflects all compensation awarded to,
earned by or paid to the Company’s Directors for the fiscal year ended October
31, 2009.
30
|
Name
|
Fees earned
or
paid in cash
($)
|
Option
awards
($)
|
All other
compensation
($) 1
|
Total
($)
|
||||||||||||
|
James
Bruno
|
-0-
|
14,541
|
2
|
2,186
|
19,504
|
|||||||||||
|
Al
Burkhalter
|
-0-
|
14,541
|
3
|
173
|
18,265
|
|||||||||||
|
Jay
M. Kaplowitz
|
-0-
|
14,541
|
4
|
-0-
|
13,372
|
|||||||||||
|
Ashok
Kaveeshwar
|
-0-
|
14,541
|
5
|
-0-
|
13,925
|
|||||||||||
|
Ben
Krieger
|
-0-
|
14,541
|
6
|
2,434
|
19,888
|
|||||||||||
|
1
|
Consists
solely of travel expenses paid by the Company for travel to Board of
Director Meetings.
|
|
2
|
90,000
option awards outstanding on October 31,
2009.
|
|
3
|
100,000
option awards outstanding on October 31,
2009.
|
|
4
|
85,000
option awards outstanding on October 31,
2009.
|
|
5
|
65,000
option awards outstanding on October 31,
2009.
|
|
6
|
75,000
option awards outstanding on October 31,
2009.
|
The
following table sets forth certain information, as of January 22, 2010, with
respect to the beneficial ownership of the common stock by each beneficial owner
of more than 5% of the outstanding shares thereof, by each Director, each
nominee to become a Director and each executive named in the Summary
Compensation Table and by all Executive Officers, Directors and nominees to
become Directors of our Company. As of January 22, 2010, we had
16,027,001 shares of common stock outstanding. Pursuant to the rules
and regulations of the Securities and Exchange Commission, shares of common
stock that an individual or group has a right to acquire within 60 days pursuant
to the exercise of options or warrants are deemed to be outstanding for the
purposes of computing the percentage ownership of such individual or group, but
are not deemed to be outstanding for the purposes of computing the percentage
ownership of any other person shown in the table.
|
Title of Class
|
Name and Address of Beneficial
Owner 1
|
|
Amount and
Nature
of Beneficial
Ownership
|
|
|
Percentage
of Class
|
|||
|
Common
Stock
|
Brian H. Hajost 2
|
356,000
|
2.2
|
%
|
|||||
|
Common
Stock
|
VADM E.A. Burkhalter 3
|
241,376
|
1.5
|
%
|
|||||
|
Common
Stock
|
Benjamin
Krieger4
|
219,576
|
1.4
|
%
|
|||||
|
Common
Stock
|
James Bruno 5
|
232,376
|
1.4
|
%
|
|||||
|
Common
Stock
|
Jay M. Kaplowitz 6
|
220,506
|
1.4
|
%
|
|||||
|
Common
Stock
|
Ashok Kaveeshwar 7
|
175,000
|
1.1
|
%
|
|||||
|
All
Executive Officers and Directors as a Group (6
persons)(2)-(7)
|
1,444,834
|
9.0
|
%
|
||||||
31
|
1
|
The
address of each of such individuals is c/o SteelCloud, Inc., 13962 Park
Center Road, Herndon Virginia
20171.
|
|
2
|
Includes
100,000 shares of our common stock underlying stock options granted
pursuant to the 2002 Stock Option Plans which are exercisable in 30
days. Includes 156,000 of Restricted Stock, issued to Mr.
Hajost pursuant to his employment agreement and 50,000 shares of our
common stock underlying warrants. The shares of Restricted
Stock vest ratably over a period of one year from the anniversary date of
the grant, February 5, 2009. These restricted shares of stock
were issued pursuant to our Amended 2007 Stock Option and Restricted Stock
Plan.
|
|
3
|
Includes
100,000 shares of our common stock underlying stock options granted
pursuant to the 1997 and 2002 Stock Option Plans, of which all are
currently exercisable, 50,000 shares of our common stock underlying
warrants and 6,000 shares owned by Mr. Burkhalter’s spouse of which he
disclaims beneficial ownership.
|
|
4
|
Includes
75,000 shares of our common stock underlying stock options granted
pursuant to the 1997 and 2002 Stock Option Plans, of which all are
currently exercisable and 50,000 shares of our common stock underlying
warrants.
|
|
5
|
Includes
90,000 shares of our common stock underlying stock options granted
pursuant to the 1997 and 2002 Stock Option Plans, of which all are
currently exercisable and 50,000 shares of our common stock underlying
warrants.
|
|
6
|
Includes
85,000 shares of our common stock underlying stock options granted
pursuant to the 1997 and 2002 Stock Option Plans, of which all are
currently exercisable and 50,000 shares of our common stock underlying
warrants.
|
|
7
|
Includes
65,000 shares of our common stock underlying stock options granted
pursuant to the 2002 Stock Option Plan, of which all are currently
exercisable and 50,000 shares of our common stock underlying
warrants.
|
Equity
Compensation Plan Information
|
Plan category
|
Number of securities to
be issued upon exercise of
outstanding options,
warrants and rights1
|
Weighted-average
exercise price of
outstanding options,
warrants and rights1
|
Number of securities remaining
available for future issuance under equity compensation plans
(excluding securities reflected in
column (a))1
|
|||||||||
|
|
(a)
|
(b)
|
(c)
|
|||||||||
|
Equity compensation plans approved
by security holders
|
857,500 | 0.86 | 1,939,225 | 2 | ||||||||
|
Equity
compensation plans not approved by security holders
|
-0- | N/A | -0- | |||||||||
|
Total
|
857,500 | 0.86 | 1,939,225 | |||||||||
|
1
|
The information
in this table is as of January 22,
2010.
|
|
2
|
Includes
606,210 options pursuant to our 2002 Option Plan,
1,065,250 options pursuant to our 2007 Option Plan, and 267,765 options
pursuant to our Purchase Plan. Please see “Item 11 – Narrative
Disclosure to Summary Compensation Table – Equity-Based
Compensation” for additional information regarding the
foregoing plans.
|
ITEM
13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR
INDEPENDENCE
We paid
approximately $93,000 and $90,000 during fiscal year 2008 and 2009,
respectively, to Gersten Savage LLP in connection with legal
services. Jay M. Kaplowitz, a member of the Company’s Board of
Directors, and a member of the Compensation Committee, is a partner at Gersten
Savage LLP.
ITEM
14. PRINCIPAL ACCOUNTING FEES AND SERVICES
Audit
Fees
The
aggregate fees billed for our fiscal years ended October 31, 2009 and October
31, 2008 for professional services rendered by the principal accountants for the
audit of our annual financial statements and review of financial statements
included in our Quarterly Reports on Form 10-Q for services that are normally
provided by the accountants in connection with statutory and regulatory filings
or engagements for those fiscal years were approximately $117,000 and $182,000,
respectively.
32
Audit-Related
Fees
The
aggregate fees billed for our fiscal years ended October 31, 2009 and October
31, 2008 for assurance and related services by the principal accountants that
were reasonably related to the performance of the audit or review of the our
financial statements which are not reported under the "Audit Fees" above were
approximately $64,000 and $3,000 respectively.
Tax
Fees
The
aggregate fees billed in each of the fiscal years ended October 31, 2009 and
October 31, 2008 for professional services rendered by the principal accountants
for tax compliance, tax advice, tax planning were approximately $19,000
and $110,000, respectively. The nature of the services
comprising these fees was tax return preparation and filing of tax
returns.
The Audit
Committee is responsible for reviewing the terms of any proposed engagement of
the independent auditor for non-audit services and for pre-approving all such
engagements. In providing any pre-approval, the Audit Committee
considers whether the services to be approved are consistent with the Securities
and Exchange Commission's rules on auditor independence. All of the
services described under the caption "Fees Paid to Independent Auditors" were
approved by the Audit Committee.
Fiscal
2009 was the eighth year that Grant Thornton LLP has audited the Company’s
financial statements.
PART
IV
ITEM
15. EXHIBITS, FINANCIAL STATEMENTS AND SCHEDULES
|
(a)
1.
|
Index
to Financial Statements
|
|
Page
|
|
|
Report
of Independent Registered Public Accounting Firm
|
F-1
|
|
Consolidated
Balance Sheets as of October 31, 2008 and 2009
|
F-2
|
|
Consolidated
Statements of Operations for the two years ended October 31,
2009
|
F-3
|
|
Consolidated
Statements of Stockholders' Equity for the two years ended October 31,
2009
|
F-4
|
|
Consolidated
Statements of Cash Flows for the two years ended October 31,
2009
|
F-5
|
|
Notes
to Consolidated Financial Statements
|
F-6
|
|
(a)
2.
|
Index
to Financial Statement Schedules
|
|
Schedule
II – Valuation and Qualifying Accounts
|
37
|
Schedules,
other than those listed above, have been omitted since they are not applicable
or the information is included elsewhere herein.
|
(a)
3.
|
The
exhibits which are filed with this report or which are incorporated by
reference are set forth in the exhibit index
hereto.
|
|
Exhibit
Number
|
Description
|
|
|
3.1
|
Articles
of Incorporation of the Company, dated February 25, 1998, and effective as
of February 26, 1998. (Filed as Exhibit 3.1 to the Company's
Registration Statement on Form S-1, Amendment No. 1, dated April
23, 1998 (File No. 333-47631) and hereby incorporated by
reference).
|
|
|
3.2
|
By-laws
of the Company, effective as of March 5, 1998. (Filed as
Exhibit 3.2 to the Company's Registration Statement on Form S-1, Amendment
No. 2, dated April 23, 1998 (File No. 333-47631) and hereby
incorporated by
reference).
|
33
|
4.1
|
Specimen
common stock certificate for the Company. (Filed as Exhibit 4.1
to the Company's S-8 dated July 15, 2002 (File No. 333-47631) and
hereby incorporated by reference).
|
|
|
4.2
|
Form
of Warrant. (Filed as Exhibit 4.2 to Amendment No. 1 to the Company’s
Registration Statement dated June 25, 2009 (Registration No. 333-158703)
and hereby incorporated by reference).
|
|
|
4.3
|
Form
of Placement Agent Warrant. (Filed as Exhibit 4.3 to Amendment
No. 5 to the Company’s Registration Statement dated October 23, 2009
(Registration No. 333-158703) and hereby incorporated by
reference).
|
|
|
4.3.1
|
Amended
Form of Placement Agent Warrant. (Filed as Exhibit 4.3.1 to
Amendment No. 6 to the Company’s Registration Statement dated October 29,
2009 (Registration No. 333-158703) and hereby incorporated by
reference).
|
|
|
4.3.2
|
Amendment
No. 2 to Form of Placement Agent Warrant (Filed as Exhibit 4.3.2 to
Amendment No. 7 to the Company’s Registration Statement dated December 30,
2009 (Registration No. 333-158703) and hereby incorporated by
reference).
|
|
|
10.1
|
Employment
Agreement by and between Dunn and Thomas P. Dunne (Filed as Exhibit 99.2
to Dunn's Registration Statement on Form SB-2, Amendment 2, dated April 4,
1997 (File No. 000-24015) and hereby incorporated by
reference).
|
|
|
10.2
|
1997
Amended Stock Option Plan. (Filed as Exhibit 10.1 to the
Company's Registration Statement on Form S-1, Amendment No. 2, dated April
23, 1998 (File No. 333-92406) and hereby incorporated by
reference).
|
|
|
10.3
|
Agreement,
dated May 5, 1997, by and between International Data Products, Corp. and
the U.S. Air Force, the Desktop V Contract. (Filed as Exhibit
10.13 to the Company's Registration Statement on Form S-1, Amendment
No. 2, dated April 23, 1998 (File No. 333-47631) and hereby
incorporated by reference).
|
|
|
10.4
|
Employee
Stock Purchase Plan. (Filed as Exhibit 10.22 to the Company’s 10-K, dated
February 16, 1999 (File No. 000-24015) and hereby incorporated by
reference).
|
|
|
10.5
|
Employment
Agreement by and between SteelCloud, Inc. and Kevin Murphy, dated June 8,
2004. (Filed as Exhibit 10.32 to the Company’s 10-K, dated January 26,
2005 (File No. 000-24015) and hereby incorporated by
reference).
|
|
|
10.6
|
Employment
Agreement by and between SteelCloud, Inc. and Brian Hajost, dated June 8,
2004. (Filed as Exhibit 10.33 to the Company’s 10-K, dated January 26,
2005 (File No. 000-24015) and hereby incorporated by
reference).
|
|
|
10.7
|
Sublease
by and between SteelCloud and NEC America Inc., dated September 28, 2004.
(Filed as Exhibit 10.35 to the Company’s 10-K, dated January 26, 2005 and
hereby incorporated by reference).
|
|
|
10.8
|
Revised
Rent Commencement Date Agreement, dated March 16, 2005 between OTR and the
Company (Filed as Exhibit 10.36 to the Company’s 10-K, dated January 30,
2006 (File No. 000-24015) and hereby incorporated by
reference).
|
|
|
10.9
|
Standard
Industrial Gross Lease, dated November 4, 2004 between OTR and the Company
and Lease Amendment #1, dated March 28, 2005 (Filed as Exhibit 10.37 to
the Company’s 10-K, dated January 30, 2006 (File No. 000-24015) and hereby
incorporated by reference).
|
|
|
10.10
|
Loan
Agreement, dated January 22, 2004, by and between SteelCloud, Inc. and
Wachovia Bank, National Association and Promissory
Note issued by SteelCloud, Inc. on March 21, 2005 to Wachovia Bank,
National Association (Filed as Exhibit 10.36 to the Company’s 10-K, dated
January 30, 2006 (File No. 000-24015) and hereby incorporated by
reference).
|
|
|
10.11
|
Employment
Agreement by and between SteelCloud, Inc. and Clifton W. Sink (Filed as
Exhibit 10.1 to the Company’s 8-K, dated June 8, 2006 (File No. 000-24015)
and hereby incorporated by reference).
|
|
|
10.12
|
Separation
Agreement by and between SteelCloud, Inc. and Thomas P. Dunne (Filed as
Exhibit 10.1 to the Company’s 8-K, dated June 19, 2006 (File No.
000-24015) and hereby incorporated by reference).
|
|
|
10.13
|
Employment
Agreement by and between SteelCloud, Inc. and Robert Richmond (Filed as
Exhibit 10.1 to the Company’s 8-K, dated September 21, 2006 (File No.
000-24015) and hereby incorporated by reference).
|
|
|
10.14
|
Amendment,
dated April 19, 2006, to Employment Agreement by and between SteelCloud,
Inc. and Brian Hajost, dated June 8, 2004, originally filed as Exhibit
10.33 to the Company’s 10-K, dated January 26, 2005 (Filed as Exhibit
10.42 to the Company’s 10-K, dated January 23, 2007 (File No. 000-24015)
and hereby incorporated by reference).
|
|
|
10.15
|
Employment
Agreement as Executive Director by and between SteelCloud, Inc. and Robert
E. Frick (Filed as Exhibit 10.1 to the Company’s 8-K, dated August 31,
2007 (File No. 000-24015) and hereby incorporated by
reference).
|
34
|
10.16
|
Employment
Agreement as President and Chief Executive Officer by and between
SteelCloud, Inc. and Robert E. Frick (Filed as Exhibit 10.2 to the
Company’s 8-K, dated August 31, 2007 (File No. 000-24015) and hereby
incorporated by reference).
|
|
|
10.17
|
Employment
Resignation Agreement and Release by and between SteelCloud, Inc. and
Clifton W. Sink (Filed as Exhibit 10.2 to the Company’s 8-K, dated August
31, 2007 (File No. 000-24015) and hereby incorporated by
reference).
|
|
|
10.18
|
Amendment,
dated October 31, 2007, to Employment Agreement by and between SteelCloud,
Inc. and Kevin Murphy, dated June 8, 2004, originally filed as Exhibit
10.32 to the Company’s 10-K, dated January 26, 2005. (Filed as Exhibit
10.1 to the Company’s 8-K, dated November 1, 2007 (File No. 000-24015) and
hereby incorporated by reference).
|
|
|
10.19
|
Amended
2002 Employee Stock Option Plan (Filed as Exhibit 4.1 to the
Company’s S-8, dated June 25, 2007 (File No. 000-24015) and hereby
incorporated by reference).
|
|
|
10.20
|
Amended
Employee Stock Purchase Plan (Filed as Exhibit 4.3 to the
Company’s S-8, dated June 25, 2007 (File No. 000-24015) and hereby
incorporated by reference).
|
|
|
10.21
|
Form
of Restricted Stock Agreement (Filed as Exhibit 10.21 to the Company’s
10-K for the fiscal year ended October 31, 2008, filed with the Commission
on January 29, 2009 (File No. 000-24015), and hereby incorporated by
reference.).
|
|
|
10.22
|
Amended
2007 Stock Option and Restricted Stock Plan (Filed as Exhibit 10.21 to the
Company’s 10-K for the fiscal year ended October 31, 2008, filed with the
Commission on January 29, 2009 (File No. 000-24015), and hereby
incorporated by reference).
|
|
|
10.23
|
SteelCloud
MEA Joint Venture Agreement dated October 2008 (Filed as Exhibit 10.21 to
the Company’s 10-K for the fiscal year ended October 31, 2008, filed with
the Commission on January 29, 2009 (File No. 000-24015), and hereby
incorporated by reference).
|
|
|
10.24
|
Employment
Agreement as President and Chief Executive Officer by and between
SteelCloud, Inc. and Brian H. Hajost (Filed as Exhibit 10.1 to the
Company’s 8-K, filed with the Commission on February 5, 2009, and hereby
incorporated by reference).
|
|
|
10.25
|
Employment
Agreement Amendment by and between SteelCloud, Inc. and Kevin Murphy,
dated February 28, 2009 (filed as Exhibit 10.1 to the Company’s 8-K, filed
with the Commission on March 5, 2009, and hereby incorporated by
reference).
|
|
|
10.26
|
Business
Loan and Security Agreement dated as of July 1, 2009 by and between
SteelCloud, Inc. and Caledonia Capital Corporation (filed as Exhibit 10.1
to the Company’s 8-K, filed with the Commission on July 8, 2009, and
hereby incorporated by reference).
|
|
|
10.27
|
Secured
Promissory Note issued on July 1, 2009 by SteelCloud, Inc. to Caledonia
Capital Corporation (filed as Exhibit 10.2 to the Company’s 8-K, filed
with the Commission on July 8, 2009, and hereby incorporated by
reference).
|
|
|
10.27.1
|
Addendum
(dated December 29, 2009) to Secured Promissory Note issued on July
1, 2009 by SteelCloud, Inc. to Caledonia Capital Corporation (Filed as
Exhibit 10.27.1 to Amendment No. 7 to the Company’s Registration Statement
dated December 30, 2009 (Registration No. 333-158703) and hereby
incorporated by reference).
|
|
|
10.28
|
Warrant
issued on July 1, 2009 by SteelCloud, Inc. to Caledonia Capital
Corporation (filed as Exhibit 10.3 to the Company’s 8-K, filed with the
Commission on July 8, 2009, and hereby incorporated by
reference).
|
|
|
10.29
|
Asset
Purchase Agreement dated July 16, 2009, by and between SteelCloud, Inc.
and NCS Technologies, Inc. (filed as Exhibit 10.1 to the Company’s 8-K,
filed with the Commission on July 16, 2009, and hereby incorporated by
reference).
|
|
|
10.30
|
Engagement
letter dated September 3, 2009, by and between SteelCloud, Inc. and
Westminster Securities, a Division of Hudson Securities, Inc. (filed as
Exhibit 10.1 to the Company’s 8-K, filed with the Commission on September
10, 2009, and hereby incorporated by reference).
|
|
|
10.30.1
|
Amendment
to engagement letter dated October 28, 2009, by and between SteelCloud,
Inc. and Westminster Securities, a Division of Hudson Securities, Inc.
(Filed as Exhibit 10.30.1 to Amendment No. 6 to the Company’s Registration
Statement dated October 29, 2009 (Registration No. 333-158703) and hereby
incorporated by reference)
|
|
|
10.30.2
|
Amendment
to engagement letter dated December 29, 2009, by and between SteelCloud,
Inc. and Westminster Securities, a Division of Hudson Securities, Inc.
(Filed as Exhibit 10.30.2 to Amendment No. 7 to the Company’s Registration
Statement dated December 30, 2009 (Registration No. 333-158703) and hereby
incorporated by
reference).
|
35
|
10.31
|
Line
of Credit and Security Agreement dated November 3, 2009 by and between
SteelCloud, Inc. and Caledonia Capital Corporation (filed as Exhibit 10.1
to the Company’s 8-K, filed with the Commission on November 9, 2009, and
hereby incorporated by reference).
|
|
|
10.32
|
Revolving
Line of Credit Promissory Note issued on November 3, 2009 by SteelCloud,
Inc. to Caledonia Capital Corporation (filed as Exhibit 10.2 to the
Company’s 8-K, filed with the Commission on November 9, 2009, and hereby
incorporated by reference).
|
|
|
10.33
|
Warrant
issued on November 4, 2009 by SteelCloud, Inc. to Caledonia Capital
Corporation (filed as Exhibit 10.3 to the Company’s 8-K, filed with the
Commission on November 9, 2009, and hereby incorporated by
reference).
|
|
|
10.34
|
Warrant
issued on November 23, 2009 by SteelCloud, Inc. to Caledonia Capital
Corporation (filed as Exhibit 10.1 to the Company’s 8-K, filed with the
Commission on November 23, 2009, and hereby incorporated by
reference).
|
|
|
10.35
|
Allonge
to Note dated as of December 29, 2009 by and between SteelCloud, Inc. and
Caledonia Capital Corporation (filed as Exhibit 10.1 to the Company’s 8-K,
filed with the Commission on January 5, 2010, and hereby incorporated by
reference).
|
|
|
10.36
|
Purchase
and Sale Agreement by and between SteelCloud, Inc. and Global Technology
Partners, Inc., dated January 11, 2010 (filed as Exhibit 10.1 to the
Company’s 8-K, filed with the Commission on January 15, 2010, and hereby
incorporated by reference).
|
|
|
10.37
|
Release
of Lien by and between SteelCloud, Inc. and Caledonia Capital Corporation,
dated January 8, 2010 (filed as Exhibit 10.2 to the Company’s 8-K, filed
with the Commission on January 15, 2010, and hereby incorporated by
reference).
|
|
|
*10.38
|
Lease
Agreement, dated February 2, 2010, by and between SteelCloud, Inc. and
Merritt-AB5, LLC.
|
|
*21.1
|
List
of Subsidiaries.
|
|
|
*23.1
|
Consent
of Grant Thornton LLP, Independent Registered Public Accounting
Firm.
|
|
|
*31.1
|
Certification
of Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley
Act of 2002.
|
|
|
*31.2
|
Certification
of Principal Financial Officer Pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002.
|
|
|
*32.1
|
Certifications
Pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of
the Sarbanes – Oxley Act of
2002.
|
36
SCHEDULE
II VALUATION AND QUALIFYING ACCOUNTS
STEELCLOUD,
INC.
|
Additions
|
Deductions
|
|||||||||||||||||||
|
Classification
|
Balance at
Beginning of
Year
|
Charged to
Costs and
Expenses
|
Charged to
Other
Accounts
|
Balance
at End of
Year
|
||||||||||||||||
|
Allowance
for doubtful accounts:
|
||||||||||||||||||||
|
Year
ended October 31, 2008
|
$ | 40,000 | $ | 9,500 | $ | - | $ | 13,500 | $ | 36,000 | ||||||||||
|
Year
ended October 31, 2009
|
$ | 36,000 | $ | (36,000 | ) | $ | - | $ | - | $ | 0.00 | |||||||||
|
Warranty
reserve:
|
||||||||||||||||||||
|
Year
ended October 31, 2008
|
$ | 182,000 | $ | 126,000 | $ | - | $ | 148,000 | $ | 160,000 | ||||||||||
|
Year
ended October 31, 2009
|
$ | 160,000 | $ | ( 157,790 | ) | $ | - | $ | - | $ | 1,755 | |||||||||
|
Deferred
tax valuation allowance:
|
||||||||||||||||||||
|
Year
ended October 31, 2008
|
$ | 16,613,709 | $ | 911,323 | $ | - | $ | - | $ | 17,525,032 | ||||||||||
|
Year
ended October 31, 2009
|
$ | 17,525,032 | $ | 1,342,121 | $ | - | $ | - | $ | 18,867,153 | ||||||||||
37
SIGNATURES
Pursuant to the requirements of
Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant
has duly caused this report to be signed on its behalf by the undersigned,
thereunto duly authorized.
|
SteelCloud,
Inc.
|
||
|
Date:
February 5, 2010
|
By:
|
|
|
/s/ Brian H. Hajost
|
||
|
Brian
H. Hajost
|
||
|
Chief
Executive Officer
|
||
Pursuant to and in accordance with the
requirements of the Securities Exchange Act of 1934, this report has been signed
by the following persons on behalf of the registrant and in the capacities and
on the dates indicated.
|
Name
|
Title
|
Date
|
||
|
/s/ Brian H. Hajost
|
||||
|
Brian
H. Hajost
|
Chief
Executive Officer and President
|
February
5, 2010
|
||
|
/s/Steven Snyder
|
||||
|
Steven
Snyder
|
Principal
Financial Officer
|
February
5, 2010
|
||
|
/s/VADM E.A. Burkhalter
|
||||
|
VADM
E. A. Burkhalter USN (Ret.)
|
Director
|
February
5, 2010
|
||
|
/s/James Bruno
|
||||
|
James
Bruno
|
Director
|
February
5, 2010
|
||
|
/s/Jay Kaplowitz
|
||||
|
Jay
Kaplowitz
|
Director
|
February
5, 2010
|
||
|
/s/Benjamin Krieger
|
||||
|
Benjamin
Krieger
|
Director
|
February
5, 2010
|
||
|
/s/Ashok Kaveeshwar
|
||||
|
Ashok
Kaveeshwar
|
Director
|
February
5, 2010
|
38
Index
to Financial Statements
|
SteelCloud,
Inc. (a Virginia Corporation)
|
|
|
Report
of Independent Registered Public Accounting Firm
|
F-1
|
|
Consolidated
Balance Sheets as of October 31, 2008 and 2009
|
F-2
|
|
Consolidated
Statements of Operations for the two years ended October 31,
2009
|
F-3
|
|
Consolidated
Statements of Stockholders' Equity for the two years ended October 31,
2009
|
F-4
|
|
Consolidated
Statements of Cash Flows for the two years ended October 31,
2009
|
F-5
|
|
Notes
to Consolidated Financial Statements
|
F-6
|
REPORT
OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the
Board of Directors and Stockholders
SteelCloud,
Inc.
We have
audited the accompanying consolidated balance sheets of SteelCloud, Inc. (a
Virginia Corporation) and subsidiaries (the Company) as of October 31, 2009 and
2008, and the related consolidated statements of operations, stockholders’
equity, and cash flows for each of the two years in the period ended October 31,
2009. Our audits of the basic financial statements included the
financial statement schedule listed in the index appearing under Item 15 (a)
2. These financial statements and financial statement schedule are
the responsibility of the Company’s management. Our responsibility is
to express an opinion on these financial statements and financial statement
schedule based on our audits.
We
conducted our audits in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require
that we plan and perform the audits to obtain reasonable assurance about whether
the financial statements are free of material misstatement. The Company is not
required to have, nor were we engaged to perform an audit of its internal
control over financial reporting. Our audit included
consideration of internal control over financial reporting as a basis for
designing audit procedures that are appropriate in the circumstances, but not
for the purpose of expressing an opinion on the effectiveness of the Company’s
internal control over financial reporting. Accordingly, we express
no such opinion. An audit also includes
examining, on a test basis, evidence supporting the amounts and disclosures in
the financial statements, assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our
audits provide a reasonable basis for our opinion
In our
opinion, the consolidated financial statements referred to above present fairly,
in all material respects, the financial position of the Company as of October
31, 2009 and 2008, and the results of its operations and its cash flows for each
of the two years in the period ended October 31, 2009 in conformity with
accounting principles generally accepted in the United States of
America. Also in our opinion, the related financial statement
schedule, when considered in relation to the basic financial statements taken as
a whole, presents fairly, in all material respects, the information set forth
therein.
The
accompanying financial statements have been prepared assuming that the Company
will continue as a going concern. As discussed in Note 1, the Company
incurred a net loss of $3,736,562 during the year ended October 31, 2009, and,
as of that date, the Company had an accumulated deficit of $48,605,126 and a
working capital deficit of $576,350. These factors, among others, as
discussed in Note 1 to the consolidated financial statements, raise substantial
doubt about the Company’s ability to continue as a going
concern. Management’s plans in regard to these matters are also
described in Note 1. The financial statements do not include any
adjustments that might result from the outcome of this uncertainty.
/s/ Grant
Thornton LLP
McLean,
Virginia
February
5, 2010
F-1
STEELCLOUD,
INC.
CONSOLIDATED
BALANCE SHEETS
|
|
OCTOBER 31,
|
|||||||
|
2008
|
2009
|
|||||||
|
ASSETS
|
||||||||
|
Current
assets:
|
||||||||
|
Cash
and cash equivalents
|
$ | 752,351 | $ | 60,650 | ||||
|
Accounts
receivable, net of allowance for doubtful accounts of $36,000 and $0 as of
October 31, 2008 and 2009, respectively
|
1,571,673 | 147,203 | ||||||
|
Inventory,
net
|
521,920 | 10,587 | ||||||
|
Prepaid
expenses and other current assets
|
130,446 | 141,259 | ||||||
|
Deferred
contract costs
|
- | 33,830 | ||||||
|
Total
current assets
|
2,976,390 | 393,529 | ||||||
|
Property
and equipment, net
|
626,440 | 166,754 | ||||||
|
Equipment
on lease, net
|
442,099 | 1,456 | ||||||
|
Other
assets
|
7,020 | 5,374 | ||||||
|
Total
assets
|
$ | 4,051,949 | $ | 567,113 | ||||
|
LIABILITIES
AND STOCKHOLDERS’ EQUITY
|
||||||||
|
Current
liabilities:
|
||||||||
|
Accounts
payable
|
$ | 718,316 | $ | 577,197 | ||||
|
Accrued
expenses
|
561,009 | 174,493 | ||||||
|
Notes
payable, current portion
|
7,538 | 217,919 | ||||||
|
Unearned
revenue
|
8,882 | 270 | ||||||
|
Total
current liabilities
|
1,295,745 | 969,879 | ||||||
|
Notes
payable, long-term portion
|
7,903 | - | ||||||
|
Other
|
132,055 | 270,461 | ||||||
|
Total
long-term liabilities
|
139,958 | 270,461 | ||||||
|
Stockholders’
equity:
|
||||||||
|
Preferred
stock, $.001 par value; 2,000,000 shares authorized, 0 and 0 shares issued
and outstanding at October 31, 2008 and 2009, respectively
|
- | - | ||||||
|
Common
stock, $.001 par value; 50,000,000 and 80,000,000 shares authorized
15,138,376 and 15,993,501 shares issued at October 31, 2008 and 2009,
respectively
|
15,138 | 15,994 | ||||||
|
Additional
paid-in capital
|
50,902,172 | 51,348,405 | ||||||
|
Treasury
stock, 400,000 shares at October 31, 2008 and 2009,
respectively
|
(3,432,500 | ) | (3,432,500 | ) | ||||
|
Accumulated
deficit
|
(44,868,564 | ) | (48,605,126 | ) | ||||
|
Total
stockholders’ equity (deficit)
|
2,616,246 | (673,227 | ) | |||||
|
Total
liabilities and stockholders’ equity
|
$ | 4,051,949 | $ | 567,113 | ||||
See
accompanying footnotes.
F-2
STEELCLOUD, INC.
CONSOLIDATED
STATEMENTS OF OPERATIONS
|
Twelve Months Ended
October 31,
|
||||||||
|
2008
|
2009
|
|||||||
|
Revenues
|
||||||||
|
Products
|
$ | 1,905,228 | $ | 319,970 | ||||
|
Services
|
2,680,526 | 1,199,929 | ||||||
|
Total
revenues
|
4,585,754 | 1,519,899 | ||||||
|
Cost
of revenues
|
||||||||
|
Products
|
1,583,484 | 176,758 | ||||||
|
Services
|
2,159,753 | 892,053 | ||||||
|
Total
cost of revenues
|
3,743,237 | 1,068,811 | ||||||
|
Gross
profit
|
842,517 | 451,088 | ||||||
|
Selling
and marketing
|
928,156 | 486,942 | ||||||
|
Research
and product development
|
234,371 | 233,312 | ||||||
|
General
and administrative
|
3,528,248 | 2,533,836 | ||||||
|
Severance
and restructuring
|
- | 73,205 | ||||||
|
Operating
loss from continuing operations
|
(3,848,258 | ) | (2,876,207 | ) | ||||
|
Other
income (expense), net
|
8,542 | (64,657 | ) | |||||
|
Income
(loss) from continuing operations before income taxes
|
(3,839,716 | ) | (2,940,864 | ) | ||||
|
Income
tax benefit
|
397,868 | - | ||||||
|
Income
(loss) from continuing operations
|
(3,441,848 | ) | (2,940,864 | ) | ||||
| Discontinued Operations: | ||||||||
|
Gain
(loss) on sale of discontinued operations, net of tax
|
- | 69,945 | ||||||
|
Income
(loss) from discontinued operations, net of tax
|
682,286 | (865,643 | ) | |||||
|
Total
income (loss) from discontinued operations
|
682,286 | (795,698 | ) | |||||
|
Net
loss
|
$ | (2,759,562 | ) | $ | (3,736,562 | ) | ||
|
Basic
and diluted income (loss) per share:
|
||||||||
|
Continuing
Operations
|
$ | (0.26 | ) | $ | (0.19 | ) | ||
|
Discontinued
Operations
|
0.07 | (0.05 | ) | |||||
|
Basic
and diluted net income (loss) per share
|
$ | (0.19 | ) | $ | (0.24 | ) | ||
|
Basic
and diluted weighted average shares outstanding
|
14,493,215 | 15,615,817 | ||||||
See
accompanying footnotes.
F-3
STEELCLOUD,
INC.
CONSOLIDATED
STATEMENTS OF STOCKHOLDERS’ EQUITY
|
Preferred
Stock
|
Common
Stock
|
Additional
Paid-In
|
Treasury
|
Accumulated
|
||||||||||||||||||||||||||||
|
Shares
|
Amount
|
Shares
|
Amount
|
Capital
|
Stock
|
Deficit
|
Total
|
|||||||||||||||||||||||||
|
Balance
at October 31, 2007
|
– | – | 14,716,934 | 14,717 | $ | 50,234,099 | $ | (3,432,500 | ) | $ | (42,109,002 | ) | $ | 4,707,314 | ||||||||||||||||||
|
Issuance
of common stock in connection with employee stock purchase plan
exercises
|
– | – | 5,152 | 5 | 4,408 | – | – | 4,413 | ||||||||||||||||||||||||
|
Issuance
of common stock in connection with employee stock option plan
exercises
|
– | – | 196,290 | 196 | 121,503 | – | – | 121,699 | ||||||||||||||||||||||||
|
Stock
compensation expense
|
– | – | – | – | 368,032 | – | – | 368,032 | ||||||||||||||||||||||||
|
Issuance
of common stock in connection with exercise of warrants
|
– | – | 220,000 | 220 | 118,580 | – | – | 118,800 | ||||||||||||||||||||||||
|
Issuance
of warrants for services
|
– | – | – | – | 55,550 | – | – | 55,550 | ||||||||||||||||||||||||
|
Net
(loss)
|
– | – | – | – | – | – | (2,759,562 | ) | (2,759,562 | ) | ||||||||||||||||||||||
|
Balance
at October 31, 2008
|
– | – | 15,138,376 | 15,138 | $ | 50,902,172 | $ | (3,432,500 | ) | $ | (44,868,564 | ) | $ | 2,616,246 | ||||||||||||||||||
|
Issuance
of common stock in connection with restricted stock plan
|
– | – | 395,750 | 396 | (396 | ) | – | – | – | |||||||||||||||||||||||
|
Issuance
of common stock in connection with BOD Sale
|
350,000 | 350 | 87,150 | 87,500 | ||||||||||||||||||||||||||||
|
Issuance
of warrants in conjunction with Caledonia Note
|
– | – | 85,575 | 85,575 | ||||||||||||||||||||||||||||
|
Stock
compensation expense
|
– | – | – | – | 226,725 | – | – | 226,725 | ||||||||||||||||||||||||
|
Issuance
of warrants for services
|
– | – | – | – | 12,288 | – | – | 12,288 | ||||||||||||||||||||||||
|
Issuance
of common stock for services
|
– | – | 109,375 | 110 | 34,891 | – | – | 35,001 | ||||||||||||||||||||||||
|
Net
(loss)
|
– | – | – | – | – | – | (3,736,562 | ) | (3,736,562 | ) | ||||||||||||||||||||||
|
Balance
at October 31, 2009
|
– | – | 15,993,501 | 15.994 | $ | 51,348,405 | $ | (3,432,500 | ) | $ | (48,605,126 | ) | $ | (673,227 | ) | |||||||||||||||||
See
accompanying footnotes.
F-4
STEELCLOUD,
INC
CONSOLIDATED
STATEMENTS OF CASH FLOWS
|
YEARS ENDED OCTOBER 31,
|
||||||||
|
2008
|
2009
|
|||||||
|
Cash
Flows from Operating activities
|
||||||||
|
Net
loss
|
$ | (3,441,848 | ) | $ | (4,219,520 | ) | ||
|
Adjustments
to reconcile net loss to net cash provided by (used in) operating
activities:
|
||||||||
|
Stock
based compensation
|
368,032 | 226,725 | ||||||
|
Depreciation
and amortization of property and equipment
|
482,294 | 524,697 | ||||||
|
Loss
on sale of equipment
|
- | 294,555 | ||||||
|
Amortization
of discount on note payable
|
- | 53,494 | ||||||
|
Warrant
based expense
|
55,550 | 97,863 | ||||||
|
Changes
in operating assets and liabilities:
|
||||||||
|
Accounts
receivable, net
|
1,053,699 | 1,424,470 | ||||||
|
Inventory
|
656,475 | 511,333 | ||||||
|
Prepaid
expenses and other assets
|
162,511 | (9,167 | ) | |||||
|
Deferred
contract costs
|
83,753 | (33,830 | ) | |||||
|
Accounts
payable
|
(1,071,013 | ) | (106,119 | ) | ||||
|
Discount
on note payable
|
- | (32,081 | ) | |||||
|
Accrued
expenses
|
(613,001 | ) | (301,603 | ) | ||||
|
Unearned
revenue
|
(96,469 | ) | (8,612 | ) | ||||
|
Net
cash provided by (used in) operating activities
|
(2,360,017 | ) | (1,577,795 | ) | ||||
|
Cash
Flows from Investing activities
|
||||||||
|
Proceeds
from sale of equipment
|
- | 90,882 | ||||||
|
Proceeds
from sale of discontinued operations
|
- | 150,000 | ||||||
|
Proceeds
from sale of leased assets
|
- | 332,958 | ||||||
|
Purchase
of property and equipment
|
(424,641 | ) | (9,805 | ) | ||||
|
Net
cash provided by (used in) investing activities
|
(424,641 | ) | 564,035 | |||||
|
Cash
Flows from Financing activities
|
||||||||
|
Proceeds
from note payable
|
- | 250,000 | ||||||
|
Proceeds
from issuance of common stock
|
- | 87,500 | ||||||
|
Proceeds
from exercise of common stock options
|
244,912 | - | ||||||
|
Payments
on notes payable
|
(12,843 | ) | (15,441 | ) | ||||
|
Net
cash provided by (used in) financing activities
|
232,069 | 322,059 | ||||||
|
Net
increase (decrease) in cash and cash equivalents
|
(1,870,303 | ) | (691,701 | ) | ||||
|
Cash
and cash equivalents at beginning of year
|
2,622,654 | 752,351 | ||||||
|
Cash
and cash equivalents at end of year
|
$ | 752,351 | $ | 60,650 | ||||
|
Supplemental
disclosure of cash flows information
|
||||||||
|
Interest
paid
|
$ | 18,370 | $ | 79,159 | ||||
|
Income
taxes paid
|
- | - | ||||||
|
Supplemental
disclosure of non-cash investing and financing activities
|
||||||||
|
Discount
on note payable
|
- | $ | 85,575 | |||||
|
Common
stock issued for services
|
- | $ | 35,000 | |||||
See accompanying
footnotes.
F-5
1. Organization
Founded
in 1987, SteelCloud, Inc. (referred to herein as the “Company,” or “SteelCloud”)
is a developer of mobility appliance software solutions primarily for the
Research In Motion® (“RIM”) BlackBerry market. SteelCloud designs and
integrates its software into specialized server appliances targeted at
Department of Defense (“DoD”), public sector, commercial, and remote hosting
customers. Until July 2009, SteelCloud offered computer
integration solutions for the federal marketplace and Independent Software
Vendors. In July 2009, SteelCloud entered into an Asset Purchase
Agreement with NCS Technologies, Inc., a Virginia corporation (“NCS”), pursuant
to which SteelCloud agreed to sell to NCS, and NCS agreed to purchase, all of
SteelCloud’s right, title and interest in and to the assets relating to our
computer integration business. Further, in July 2009
SteelCloud’s management and Board of Directors determined to shift the focus of
our operations, resources and investments to our BlackBerry-related technologies
and products.
SteelCloud
was originally incorporated as Dunn Computer Operating Company on July 27,
1987 under the laws of the Commonwealth of Virginia. On February 26,
1998, Dunn Computer Corporation ("Dunn") was formed and incorporated in the
Commonwealth of Virginia to become a holding company for several entities
including Dunn Computer Operating Company. The Company's subsidiary
is International Data Products ("IDP"), acquired in May 1998. On May
15, 2001, the shareholders approved an amendment to the Company’s articles of
incorporation to change the corporate name from Dunn Computer Corporation to
SteelCloud, Inc. On December 31, 2003, Dunn was merged with
and into SteelCloud. On February 17, 2004, the Company acquired the
assets of Asgard Holding, LLC ("Asgard"). In July of 2006, as part of
its restructuring efforts, the Company closed its sales office and ceased all of
its operations in Florida. The Company’s former subsidiaries, Puerto
Rico Industrial Manufacturing Operations Acquisition Corporation (“PRIMO”), and
STMS Corporation (“STMS”), are inactive.
The
accompanying financial statements include the accounts of SteelCloud and its
subsidiaries, International Data Products Corporation (“IDP”), Puerto Rico
Industrial Manufacturing Operations Acquisition Corporation (“PRIMO”), and STMS
Corporation (“STMS”). All intercompany accounts and activity have
been eliminated in the consolidation process.
Going
Concern
SteelCloud
has had recurring annual operating losses since its fiscal year ended October
31, 2004. SteelCloud expects that such losses may continue at least
through its fiscal year ending October 31, 2010. The report of
SteelCloud’s independent registered public accounting firm on SteelCloud’s
consolidated financial statements for the fiscal year ended October 31, 2009
contains an explanatory paragraph regarding SteelCloud’s ability to continue as
a going concern based upon its history of net losses, net working capital
deficit and uncertainty regarding its ability to satisfy its obligations as they
come due in the near term.
is
dependent upon available cash and operating cash flow to meet its capital
needs. SteelCloud is considering all strategic options to improve its
liquidity and provide it with working capital to fund its continuing business
operations, including equity offerings, asset sales or debt; however, there can
be no assurance that SteelCloud will be successful in negotiating financing on
terms agreeable to it or at all. If adequate funds are not available
or are not available on acceptable terms, SteelCloud will likely not be able to
take advantage of unanticipated opportunities, develop or enhance services or
products, respond to competitive pressures, or continue as a going
concern. There are no assurances that SteelCloud will be successful
in raising working capital as needed. Further, there are no
assurances that SteelCloud will have sufficient funds to execute its business
plan, pay its operating expenses and obligations as they become due or generate
positive operating results or continue as a going concern.
F-6
2. Sale
of Integration Business
On July
10, 2009, SteelCloud entered into an Asset Purchase Agreement (the “Agreement”)
with NCS Technologies, Inc., a Virginia corporation (“NCS”), pursuant to which
SteelCloud agreed to sell to NCS, and NCS agreed to purchase from SteelCloud,
all of SteelCloud’s right, title and interest in and to the assets relating to
SteelCloud’s computer integration business. The purchase price
was $475,000 of which $150,000 was paid as a deposit and the remaining $325,000
is an earn-out amount, which is payable from and to the extent of revenue NCS
receives during the three-year period after the closing date from certain
existing and prospective clients, at a rate equal to 15% of the net sales price
received by NCS from such clients. Any payments by NCS to us are due
on or before the 10th
business day following the month in which NCS receives the payments from the
client(s).
SteelCloud
has classified the integration business as discontinued operations for the
twelve month period ending October 31, 2009 as well as all comparative periods
presented. Certain amounts have been reclassified in order to conform
to current period presentation.
3. Significant
Accounting Policies
The
preparation of the consolidated financial statements in conformity with
accounting principles generally accepted in the United States of America
requires the Company to make estimates and assumptions that affect the reported
amounts of assets and liabilities and disclosure of contingent assets and
liabilities at the date of the consolidated financial statements and the
reported amounts of revenues and expenses during the reporting
period. Actual results could differ from those
estimates.
Revenue
Recognition
The
Company recognizes revenue when all four basic criteria are met: (1) persuasive
evidence of an arrangement exists; (2) delivery has occurred or services
rendered; (3) the fee is fixed and determinable: and (4) collectability is
reasonably assured.
In the
event the Company enters into a multiple element arrangement and there are
undelivered elements as of the balance sheet date, the Company assesses whether
the elements are separable and have determinable fair value in determining the
amount of revenue to record.
The
Company collects and remits sales and property taxes on products and services
that it purchases and sells under its contracts with customers, and reports such
amounts under the net method in its consolidated statements of
operations. Accordingly, there are no sales and property taxes
included in gross revenue.
The
Company derives its revenue from the following sources: product revenue,
information technology support services, software license as a reseller and
support revenue and software training and implementation revenue.
For
product sales where title transfers upon shipment and risk of loss transfers to
the customer, the Company generally recognizes revenue at the time of
shipment. For product sales where title and risk of loss transfers
upon destination, the Company generally recognizes revenue when products reach
their destination. Revenue from hardware leased to customers under
operating lease arrangements is recognized over the contract
term. When product and installation services that are not essential
to the functionality of the product are sold as part of a bundled agreement, the
fair value of the installation services, based on the price charged for the
services when sold separately, is deferred and recognized when the services are
performed. The products sold are generally covered by a warranty for
periods ranging from one to three years. The Company previously
accrued an estimated warranty reserve in the period of sale to provide for
estimated costs to provide warranty services; as part of the agreement with Dell
to produce the Company’s appliance hardware, SteelCloud currently purchases an
on-site three year warranty from Dell with each unit. This warranty
is transferred to the appliance end user and warranty service is provided
directly to the customer by Dell.
F-7
When the Company acts as a reseller, the Company monitors the terms of each new transaction to assess whether ASC 605-45, “Reporting Revenue Gross as a Principal versus Net as an Agent” applies to its financial reporting for such transaction. In accordance with this standard, the Company recognizes revenue associated with the resale of service contracts on a gross basis.
In
October 2008 the Company began delivering its appliance solution specifically
developed for Blackberry Enterprise Servers (“BES”). The software
does not require significant modification and customization
services. The Company does not have vendor-specific objective
evidence (“VSOE”) of fair value for its software. Accordingly, when
the software is sold in conjunction with the Company’s hardware, software
revenue is recognized upon delivery of the hardware.
For
services revenue under time and material contracts, the Company recognizes
revenue as services are provided based on the hours of service at stated
contractual rates.
The
Company is a value-added solution provider for certain software
products. When resold software licenses, and related maintenance,
customization and training services are all provided together to an individual
customer the Company recognizes revenue for the arrangement after the Company
has delivered the software license and the customer has approved all
implementation and training services provided. In instances where the
Company only resells the software license and maintenance to the customer, the
Company recognizes revenue after the customer has acknowledged and accepted
delivery of the software. The software manufacturer is responsible
for providing software maintenance. Accordingly, revenue from
maintenance contracts is recognized upon delivery or acceptance, as the Company
has no future obligation to provide the maintenance services and no right of
return exists.
The
Company incurs shipping and handling costs, which are recorded in cost of
revenues.
Deferred
revenue includes amounts received from customers for which revenue has not been
recognized. This generally results from certain customer contracts,
ISV releases, warranties, hardware maintenance and support, and consulting
services. The deferred revenue associated with customer contracts and
ISV releases represents payments received for milestones achieved prior to
recognition of revenue. This revenue will be recognized as products
are shipped. Revenues from warranties and hardware maintenance and
support are recognized ratably over the service term selected by the
customer. Deferred service revenues from consulting are recognized as
the services are performed.
Significant
Customers
During
fiscal year 2009, contracts with two federal government customers, represented
approximately $775,000 of SteelCloud’s net revenues or 51% of total net
revenues, respectively, for the fiscal year 2009. Given the nature of
the products offered by us as well as the delivery schedules established by
SteelCloud’s partners, revenue and accounts receivable concentration by any
single customer will fluctuate from year to year. Future revenues and
results of operations could be adversely affected should these customers reduce
their purchases, eliminate product lines or choose not to continue to buy
products and services from us.
Equity-Based
Compensation
Share-based
compensation cost is measured at the grant date, based on the fair value of the
award, and is recognized over the employee’s requisite service
period. The fair value of the Company’s stock options and employee
stock purchase plan (“ESPP”) awards are estimated using a Black-Scholes option
valuation model. This model requires the input of highly subjective
assumptions and elections, including expected stock price volatility and the
estimated life of each award. The fair value of equity-based awards
is amortized over the vesting period of the award and the Company has elected to
use the straight-line method for amortizing its stock option and ESPP
awards. Compensation costs for all awards granted after the date of
adoption and the unvested portion of previously granted awards outstanding are
measured at their estimated fair value.
F-8
Other
Equity-Based Compensation
The
Company accounts for equity instruments issued in exchange for the receipt of
goods or services from other than employees and non-employee directors at the
estimated fair market value of the consideration received or the estimated fair
value of the equity instruments issued, whichever is more reliably
measurable. The value of equity instruments issued for consideration
other than employee services is determined on the earlier of a performance
commitment or completion of performance by the provider of goods or
services. Stock-based compensation recognized under SFAS No. 123 and
EITF 96-18 for services from non-employees was $55,550 and $47,288 during the
fiscal years ended October 31, 2008 and 2009, respectively.
Income
Taxes
The
Company recognizes deferred tax liabilities and assets for the expected future
tax consequences of temporary differences between the carrying amounts and the
tax bases of certain assets and liabilities. A valuation allowance is
established, as necessary, to reduce deferred income tax assets to an amount
expected to be realized in future periods. The Company determines its
valuation allowance by weighing all positive and negative evidence including
past operating results and forecasts of future taxable income. In
assessing the amount of the valuation allowance as of October 31, 2008 and 2009,
the Company considered, in particular, its forecasted operations for the
upcoming fiscal year, current backlog of orders, including those recently
received, and other significant opportunities currently in its sales and
marketing pipeline with a high probability of generating
revenues. Based upon this review, the Company will continue to fully
reserve for all deferred tax assets as of October 31, 2009.
SteelCloud
accounts for uncertainty in income taxes using a more-likely-than-not
recognition threshold based on the technical merits of the tax position
taken. Tax positions that meet the more-likely-than-not recognition
threshold should be measured as the largest amount of the tax benefits,
determined on a cumulative probability basis, which is more likely than not to
be realized upon effective settlement in the financial
statements. The Company’s accounting policy is to recognize
interest and penalties related to income tax matters in general and
administrative expense.
Inventory
Inventory
consists of materials and components used in the assembly of the Company’s
products or maintained to support maintenance and warranty obligations and are
stated at the lower of cost or market using actual costs on a first-in,
first-out basis. The Company maintains a perpetual inventory system
and continuously records the quantity on-hand and actual cost for each product,
including purchased components, subassemblies and finished goods. The
Company maintains the integrity of perpetual inventory records through periodic
physical counts of quantities on hand. Finished goods are reported as
inventory until the point of title transfer to the
customer. Generally, title transfer is documented in the terms of
sale. When the terms of sale do not specify, the Company assumes
title transfers when it completes physical transfer of the products to the
freight carrier unless other customer practices prevail.
The
Company periodically evaluates its inventory obsolescence reserve to ensure
inventory is recorded at its net realizable value. The Company’s
policy is to assess the valuation of all inventories, including manufacturing
raw materials, work-in-process, finished goods and spare parts in each reporting
period. Inherent in managements estimates of excess and obsolete
inventory are management’s forecasts related to the Company’s future
manufacturing schedules, customer demand, technological and/or market
obsolescence and possible alternative uses. If future customer demand
or market conditions are less favorable than the Company’s projections,
additional inventory write-downs may be required, and would be reflected in cost
of sales in the period the revision is made. For the fiscal year
ending 2008 and 2009 the Company incurred charges to expense of $186,000 and
$72,000, respectively, associated with excess and obsolete inventory cost
adjustments.
F-9
Warranty
As
part of the agreement with Dell to produce the Company’s appliance hardware,
SteelCloud purchases an on-site three year warranty from Dell with each
unit. This warranty is transferred to the appliance end user and
warranty service is provided directly to the customer by Dell.
Warranty
and service support for BlackBerry software is provided directly to the user by
RIM as part of the software license agreement. End users contact RIM
directly for support.
SteelCloud
periodically monitors the performance and cost of warranty activities for other
technology that SteelCloud develops.
Research
and Product Development Expenses
The
Company expenses research and product development costs as
incurred. These costs consist primarily of labor charges associated
with development of the Company’s commercial and federal integrator
products. These research and development expenses amounted to
approximately $234,000 and $233,000 during fiscal 2008 and 2009,
respectively. The Company invests in intellectual property in the
form of proprietary products such as SteelWorks®.
Cash
and Cash Equivalents
The
Company maintains demand deposit accounts with principally one financial
institution. At times deposits may exceed federally insured limits,
but management does not consider this a significant concentration of credit risk
based on the strength of the financial institution. The Company
considers all highly liquid investments with a maturity of three months or less
at the time of purchase to be cash equivalents.
Accounts
Receivable
Accounts
receivable are recorded at the invoice amount at the time of sale. The
Company continually monitors the collectability of its trade receivables based
on a combination of factors. The Company maintains reserves for possible credit
losses based upon these evaluations. As of October 31, 2009 and 2008, the
allowance for doubtful accounts was $0 and $36,000, respectively.
Financial
Instruments and Concentration of Credit Risk
The
carrying value of the Company’s financial instruments including cash and cash
equivalents, accounts receivable, accounts payable, accrued liabilities, notes
payable and its line of credit approximates fair value. Financial
instruments that potentially subject the Company to concentrations of credit
risk consist primarily of cash and accounts receivable. The cash is
held by high credit quality financial institutions. For accounts
receivable, the Company performs ongoing credit evaluations of its customers’
financial condition and generally does not require collateral. The
Company maintains reserves for possible credit losses. As of October
31, 2008 and 2009, the Company had allowance for doubtful account balances of
approximately $36,000 and $0, respectively.
Advertising
Expenses
The
Company expenses advertising costs as incurred. Advertising costs
consisted of expenditures for tradeshows, website maintenance, radio
advertisements, and other charges associated with the dissemination of important
Company news and product features to the public. Advertising expense
amounted to approximately $298,000 and $122,000 during fiscal 2008 and 2009,
respectively.
F-10
Earnings
Per Share
The
Company presents basic and fully diluted earnings per share. Basic
earnings per share is based on the weighted average shares outstanding during
the period. Diluted earnings per share increases the shares used in
the basic share calculation by the dilutive effect on net income from continuing
operations of stock options and warrants. The dilutive weighted
average number of common shares outstanding excluded potential common shares
from stock options of approximately 352,000 and 584,000 for the fiscal years
ending October 31, 2008 and 2009, respectively. These shares were
excluded from the earnings per share calculation due to their antidilutive
effect resulting from the loss from operations.
Recent
Pronouncements
In
September 2009, Financial Accounting Standards Board (“FASB”) issued ASC 605-25,
Revenue Recognition -
Multiple-Deliverable Revenue Arrangements, formerly Emerging Issues Task
Force (EITF) 00-21. This guidance
addresses how to separate deliverables and how to measure and allocate
consideration to one or more units of accounting. Specifically, the guidance
requires that consideration be allocated among multiple deliverables based on
relative selling prices. The guidance establishes a selling price hierarchy of
(1) vendor-specific objective evidence, (2) third-party evidence and
(3) estimated selling price. This guidance is effective for annual periods
beginning after December 15, 2009 but may be early adopted as of the
beginning of an annual period. The Company is currently evaluating the effect
that this guidance will have on its financial position and results of
operations.
In June 2009, the FASB issued
SFAS No. 168, The FASB
Accounting Standards Codification and the Hierarchy of Generally Accepted
Accounting Principles – a replacement of FASB Statement No. 162, now referred to as ASC
105-10, Generally
Accepted Accounting Principles. The FASB Accounting
Standards Codification (“Codification”) will become the source of authoritative
U.S. generally accepted accounting principles (“GAAP”) recognized by FASB to be
applied by nongovernmental entities. Rules and interpretive releases of the
Securities and Exchange Commission (“SEC”) under authority of federal securities
laws are also sources of authoritative GAAP for SEC registrants. On the
effective date of this statement, the Codification will supersede all
then-existing non-SEC accounting and reporting standards. All other
non-grandfathered non-SEC accounting literature not included in the Codification
will become non-authoritative. This statement is effective for financial
statements issued for interim and annual periods ending after September 30,
2009. The adoption of this statement did not have a material effect on the
Company’s financial statements.
In June
2009, the FASB issued SFAS No. 165, later codified in ASC
855-10, Subsequent
Events. ASC 855-10 establishes general standards of for the evaluation,
recognition and disclosure of events and transactions that occur after the
balance sheet date. Although there is new terminology, the standard is based on
the same principles as those that currently exist in the auditing standards. The
standard, which includes a new required disclosure of the date through which an
entity has evaluated subsequent events, is effective for interim or annual
periods ending after June 15, 2009. The adoption of ASC 855-10 did not
have a material effect on the Company’s financial statements.
In April
2009, the FASB issued FASB Staff Position No. 107-1 and APB Opinion
No. 28-1 (FSP 107-1 and APB 28-1), later codified in ASC
825-10-65-1, Interim
Disclosures about Fair Value of Financial Instruments. FSP 107-1 and
APB 28-1 require fair value disclosures in both interim, as well as annual,
financial statements in order to provide more timely information about the
effects of current market conditions on financial instruments. FSP 107-1 and
APB 28-1 became effective for the Company in the quarter ended July 31,
2009, and their adoption did not have a material impact on the Company's
financial statements.
In June
2008, the EITF ratified EITF Issue No. 07-5, Determining Whether an Instrument
(or Embedded Feature) Is Indexed to an Entity’s Own Stock, now referred
to as ASC 815-40-15. ASC 815-40-15 provides guidance in assessing whether
derivative instruments meet the criteria in paragraph 11(a) of
SFAS No. 133, Accounting for Derivative
Instruments and Hedging Activities, now referred to as ASC 815, for being
considered indexed to an entity’s own common stock. ASC 815-40-15 is effective
for fiscal years beginning after December 15, 2008. The adoption of this
statement is not expected to have a material effect on the Company’s financial
statements.
F-11
In April
2008, the FASB issued FSP FAS 142-3, Determination of the Useful Life of
Intangible Assets, now referred to as FASB ASC 350-30-65-1. It amends the
factors that should be considered in developing renewal or extension assumptions
used to determine the useful life of a recognized intangible asset under
SFAS No. 142, Goodwill and Intangible
Assets, now referred to as ASC 350. ASC 350-30-65-1 is effective for
fiscal years beginning after December 15, 2008 and may not be adopted
early. The adoption of this statement is not expected to have a material effect
on the Company's financial statements.
In March
2008, the FASB issued SFAS No. 161, Disclosures about Derivative
Instruments and Hedging Activities – an amendment to FASB Statement No. 133,
now referred to as ASC 815. ASC 815 is intended to
improve financial standards for derivative instruments and hedging activities by
requiring enhanced disclosures to enable investors to better understand their
effects on an entity's financial position, financial performance, and cash
flows. Entities are required to provide enhanced disclosures about: (a) how and
why an entity uses derivative instruments; (b) how derivative instruments and
related hedged items are accounted for under SFAS No. 133 and its related
interpretations; and (c) how derivative instruments and related hedged items
affect an entity’s financial position, financial performance, and cash flows.
ASC 815 is effective for financial statements issued for fiscal years
beginning after November 15, 2008, with early adoption encouraged. The adoption
of this statement is not expected to have a material effect on the Company's
financial statements.
In
December 2007, the FASB issued SFAS No.141R, Business Combinations, now
referred to as ASC 805.
ASC 805 establishes principles and requirements for how the acquirer of a
business recognizes and measures in its financial statements the identifiable
assets acquired, the liabilities assumed, and any noncontrolling interest in the
acquiree. The statement also provides guidance for recognizing and measuring the
goodwill acquired in the business combination and determines what information to
disclose to enable users of the financial statements to evaluate and financial
effects of the business combination. The guidance will become effective
for the fiscal year beginning after December 15, 2008. The adoption of this
statement is not expected to have a material effect on the Company's
consolidated financial statements, unless the Company enters into a material
business combination transaction. The Company is in the process of evaluating
the effect, if any, the adoption of ASC 805 will have on its financial
statements, if the Company undertakes an acquisition.
In
December 2007, the FASB issued SFAS No. 160, Noncontrolling Interests in
Consolidated Financial Statements – an amendment of ARB No. 51, now
referred to as ASC 810. ASC 810 establishes accounting and reporting standards
for the noncontrolling interest in a subsidiary and for the deconsolidation of a
subsidiary. The guidance will become effective for the fiscal year beginning
after December 15, 2008. The Company is in the process of evaluating the effect,
if any, the adoption of ASC 810 will have on its financial
statements.
4. Inventories
Inventories
consisted of the following:
|
Years ended October 31,
|
||||||||
|
2008
|
2009
|
|||||||
|
Raw
materials
|
$ | 344,898 | $ | 6,259 | ||||
|
Work
in process
|
- | - | ||||||
|
Finished
goods
|
177,022 | 4,328 | ||||||
| $ | 521,920 | $ | 10,587 | |||||
F-12
5. Property
and Equipment and Equipment on Lease
Property
and equipment, including leasehold improvements, are stated at
cost. Property and equipment are depreciated using the straight-line
method over the estimated useful lives ranging from one to five
years. Furniture and fixtures are depreciated over an estimated
useful life of five years. Leasehold improvements are amortized over
the related lease term.
Any
tenant allowances have been recorded as deferred rent and will be recognized as
a reduction in rent expense over the applicable lease term.
Property
and equipment consisted of the following:
|
Years ended October 31,
|
||||||||
|
2008
|
2009
|
|||||||
|
Computer
and office equipment
|
$ | 296,215 | $ | 154,325 | ||||
|
Furniture
and fixtures
|
38,530 | 28,503 | ||||||
|
Leasehold
improvements
|
941,617 | 279,972 | ||||||
|
Other
|
112,668 | 1,959 | ||||||
| 1,389,030 | 464,759 | |||||||
|
Less
accumulated depreciation and amortization
|
(762,590 | ) | (298,005 | ) | ||||
| $ | 626,440 | $ | 166,754 | |||||
During
the fourth quarter of the fiscal year ended October 31, 2009, the Company
recorded an impairment charge against discontinued operations on its leasehold
improvements of approximately $276,000. This charge should have been
recorded in the third quarter of fiscal 2009 due to the triggering event of the
sale of the computer network business which would have required an impairment
analysis on the remaining assets related to that business. There was
no impact to any other prior periods. The Company evaluated the error
on both a quantitative and qualitative basis under the guidance of "SEC Staff
Accounting Bulletin: No. 99 - Materiality". The Company determined
that the impact of this error did not affect the trend of net losses, cash
flows, or liquidity and therefore was not material to either the third quarter
or fourth quarter financial statements. Accordingly the Company has
not restated the interim financial statements for the third quarter of fiscal
year 2009.
The
Company owned equipment that was at customer sites under multiple operating
lease agreements. The cumulative cost of the equipment was $987,741
at October 31, 2008. This equipment lease was sold in April of 2009
for approximately $61,000, resulting in a loss on sale of approximately
$281,000, which was recorded under discontinued operations. The
Company depreciates its leased property and equipment assets over the lesser of
the related lease term or the useful life of the leased asset. The
related cumulative accumulated depreciation on the equipment was $545,642 in
October 31, 2008. This lease was sold in April of 2009, and
accordingly there is no accumulated depreciation on the equipment ending October
31, 2009.
6. Notes
Payable
On July
1, 2009, the Company entered into a Business Loan and Security Agreement (the
“Agreement”) with Caledonia Capital Corporation, a Delaware corporation (the
“Lender”) pursuant to which the Lender agreed to lend to SteelCloud $250,000 in
the form of a Secured Promissory Note (the “Note”) which was issued on July 1,
2009 (the “Issuance Date”). The Note bears interest at a rate of 15%
per annum, and is payable in quarterly installments commencing three months
after the Issuance Date, or October 1, 2009. The principal amount of
the Note was due and payable in full on December 29, 2009 (The “Maturity
Date”. There are no penalties for early prepayment of the
Note.
On
December 29, 2009, the Company entered into an Allonge to Note (the "Allonge")
with the Lender. The Allonge amends the terms of the Agreement by, among other
things, (a) increasing the annual interest rate of the Note to 20%, (b)
providing that accrued interest under the Note shall be payable in monthly
installments commencing on February 1, 2010, and continuing on the first
business day of each successive month, (c) paying an extension fee of $25,000
and (d) extending the Maturity Date of the Note to March 31,
2010.
F-13
Additionally,
in the event that the Company receives investments from one or more investors in
one or more transactions in an aggregate amount in excess of $750,000, whether
in the form of cash, negotiable or non-negotiable instruments or any form of
payment in exchange for the issuance of any certificated or non-certificated
security of the Company, whether in the form of debt or equity (an “Equity
Raise”), at any time between the Issuance Date and the Maturity Date, then, the
Company shall be required, within five (5) business days after the Equity Raise
first exceeds $750,000, to curtail the accrued interest and outstanding
principal balance of the Note by an amount equal to the amount by which the
Equity Raise then exceeds $750,000 (but in no event by more than the then
outstanding principal balance and interest accrued on the Note). Until delivery
of such funds to the Lender, all such funds shall be deemed held in trust by the
Company for and on behalf of the Lender. All funds that the Company
delivers to the Lender from the Equity Raise shall be deemed prepayments of the
Note.
Pursuant
to the Agreement and the Note, the Company’s obligations thereunder are secured
by a first priority lien in and to all of the Company’s intellectual property
rights, title and interest in and to the SteelWorks® Mobile integrated server
appliance software.
As an
inducement to the Lender to make the loan to the Company, the Company issued to
the Lender a warrant to purchase up to 625,000 shares of the Company’s common
stock, par value $0.001 per share. The Warrant is exercisable for
four years at an exercise price of $0.15 per share. The Company
determined the fair value of these warrants utilizing the Black-Sholes
Model. The fair value of these warrants at issuance date was
approximately $130,000.
The loan
amount of $250,000 was allocated between the note payable and warrants based
upon their relative fair values. The difference between the face amount of the
note of $250,000 and the note payable amount of $164,425 recorded at date of
execution represents the debt discount of $85,575 which will be amortized over
the life of the note. To determine the fair value of the warrants,
management used the Black-Scholes Model which includes assumptions on the period
end stock price, historical stock volatility, risk free interest rate and term
of warrants.
The fair
value of the loan at October 31, 2009 approximates its carrying value due to its
short-term maturity.
Notes
payable consisted of the following:
|
Years ended October 31,
|
||||||||
|
2008
|
2009
|
|||||||
|
Secured
Promissory Note
|
$ | - | $ | 217,919 | ||||
|
Asset
loans, bearing interest at annual interest rates from 0.0% to 4.9% due in
aggregate monthly payments of $676, $348 and $359, that expired
in July 2009, July 2008 and July 2008, respectively, secured by certain
assets of the Company
|
15,441 | - | ||||||
|
Less
current portion
|
7,538 | 217,919 | ||||||
|
Notes
payable, long-term
|
$ | 7,903 | $ | - | ||||
F-14
7. Commitments
Operating
Leases
The
Company’s current corporate office is located in Herndon, Virginia and consists
of approximately 24,000 square feet of office, manufacturing and warehouse space
held under one lease. In February 2009, the Company entered into a
lease amendment with the landlord of this facility whereby the lease, which was
originally scheduled to expire on August 31, 2014, was amended to provide for
(i) the extension of the lease term for a period of one (1) year and four (4)
months ending on December 31, 2015, and (ii) certain other modifications,
including a reduction in SteelCloud’s rent cash payments by approximately
$60,000 and $34,000 for the fiscal years 2009 and 2010,
respectively. SteelCloud’s monthly straight-line rent expense will be
approximately $21,000 a month for the remainder of the lease.
In May
2009, the Company entered into a Stipulation/Consent Order with CRP (the
“Stipulation”), pursuant to an Affidavit and Statement of Account (the
“Affidavit”), stating, as declared by a general manager of Jones Lang LaSalle, a
property management company and agent for CRP Holdings A-1, LLC (“CRP”), the
landlord of 14040 Park Center Road, Suite 210, Herndon, Virginia 20171 (the
“Premises”), the Company’s previous corporate office, that CRP, as landlord, was
seeking a judgment against the Company for: (i) possession of the Premises, and
(ii) monetary damages for nonpayment of rent due under a sublease. In
the Stipulation the Company acknowledged that the balance due for rent and
additional rent for the Premises was $168,637.96, together with attorney’s fees
and court expenses of $7,041.00 through May 22, 2009 (the “Judgment
Amount”). Pursuant to the Stipulation, the Company paid $30,000 (the
“Forbearance Payment”) on May 22, 2009 toward the Judgment Amount. In
May 2009, the Company vacated the premises. CRP agreed to stay
enforcement of the Judgment Amount until the earlier of (a) SteelCloud’s receipt
of capital in the amount of at least $500,000, or (b) May 31,
2010. The matter was returned to the court’s files pending
SteelCloud’s compliance with the terms of the Stipulation.
The
Company recognizes rent holiday periods, scheduled rent increases and tenant
improvement allowances on a straight-line basis over the lease term beginning
with the commencement date of the lease. Rent expense under these
leases, which is recorded on a straight-line basis over the life of each lease,
was approximately $526,000 and $440,000 for the years ended October 31,
2008, and 2009, respectively.
Additionally,
the Company leases office equipment under non-cancelable operating leases which
expired in September of 2009. Total rental expense was $19,000 and
$18,000 for the years ended October 31, 2008, and 2009,
respectively.
Future
minimum lease expenditures under all non-cancelable operating leases at October
31, 2009 are as follows:
|
2010
|
256,728 | |||
|
2011
|
256,728 | |||
|
2012
|
256,728 | |||
|
2013
|
256,728 | |||
|
2014
|
256,728 | |||
|
2015
and beyond
|
299,514 | |||
|
Total
|
$ | 1,583,154 |
F-15
8. Employment
Agreements
The
Company has employment agreements for two key executives. Mr. Hajost,
the Company’s Chief Executive Officer has an executive retention agreement which
obligates the Company to escalating severance payments of up to one year’s
salary in the event Mr. Hajost is terminated without cause, or terminates his
employment with good cause. Mr. Murphy, the Company’s former Chief
Financial Officer, had an amended employment agreement with a term of 3 years,
expiring October 2010 and automatically renewed for additional one-year terms
unless terminated by either the Company or the employee. Effective
November 30, 2009, Mr. Murphy resigned his positions as Chief Financial Officer
and Executive Vice President of the Company and this employment agreement was
terminated
The
aggregate annual minimum commitment under the agreement on October 31, 2009
attributed to Mr. Hajost was $100,000. Due to Mr. Murphy’s
resignation, the Company has no annual minimum commitment under his prior
agreement.
9. Stockholders’
Equity
Stock
On June
15, 2009, the Company sold an aggregate of 350,000 shares of its common
stock, to its seven directors, for aggregate cash proceeds of $87,500.
The shares of common stock were sold at $0.25 per share, or $.01 higher
than the closing price of the common stock on the date of
sale.
On
October 23, 2009, the Company issued 109,375 shares of its common stock to a law
firm, of which one of the Company’s directors is a member, in conversion of
legal fees due. These legal fees were converted at $0.32 per share,
the closing price of our stock on October 23, 2009.
Warrants
On
September 14, 2007, the Company issued 100,000 warrants in exchange for investor
relations services valued at approximately $56,000. The warrants were
issued at an exercise price of $1.28 and expire on September 14,
2012. The fair value of the warrants was estimated in four equal
tranches over a four-month vesting period using the Black- Scholes Option
pricing fair value model which resulted in a fair value of $0.62. On
August 24, 2009, the investor relations firm terminated its right to these
100,000 warrants, and in exchange SteelCloud issued to them 115,000 warrants at
an exercise price of $0.20 and vesting immediately. The fair value of
the warrants was estimated using the Black-Scholes Option pricing fair value
model which resulted in a fair value of $0.074.
The
Company recognized $56,000 of sales and marketing expense associated with the
issuance of warrants in exchange for services during the fiscal year ended
October 31, 2008.
As
discussed in Note 6, as an inducement to Caledonia Capital Corporation (the
“Lender”) to make a loan to the Company, the Company issued to the Lender a
warrant to purchase up to 625,000 shares of the Company’s common stock, par
value $0.001 per share. The loan amount of $250,000 was allocated
between the note payable and warrants based upon their respective fair
values. The difference between the face amount of the note of
$250,000 and the note payable amount of $164,425 recorded at the date of
execution represents the debt discount of $85,575 which will be amortized over
the life of the note. The Warrant is exercisable for four years at an
exercise price of $0.15 per share. The Company determined the fair
value of these warrants utilizing the Black-Sholes method. The fair
value of these warrants at issuance date was approximately
$130,000.
F-16
As
discussed above, the Company sold shares of our common stock to our seven
directors. Each share of common stock was accompanied by one warrant
to purchase one additional share of common stock. These warrants are
exercisable for five years from the date of issuance at an exercise price of
$0.25 per share. The seven directors entered into lock-up
agreements with us, restricting their ability to exercise these warrants until
such time as we received shareholder approval for the issuance of these
warrants. We received shareholder approval for the issuance of these
warrants on October 23, 2009.
10. Stock
Based Compensation
Share-based
compensation cost is measured at the grant date, based on the fair value of the
award, and is recognized over the employee’s requisite service
period. Stock-based compensation expense for the year ended October
31, 2008 and 2009 increased the Company’s basic and diluted loss per share by
approximately $0.03 and $0.03, respectfully. The estimated fair value
of the Company’s stock-based awards is amortized on a straight-line basis over
the awards’ vesting period.
A summary
of the total stock-based compensation expense for the fiscal years ended October
31, 2008 and 2009 is as follows:
|
Years ended October 31,
|
||||||||
|
Stock
based expense allocation
|
2008
|
2009
|
||||||
|
Cost
of revenue
|
$ | 24,000 | $ | - | ||||
|
General
and administrative
|
294,000 | 199,000 | ||||||
|
Selling
and marketing
|
29,000 | 6,000 | ||||||
|
Research
and development
|
21,000 | 22,000 | ||||||
|
Severance
and restructuring
|
- | - | ||||||
|
Total
stock compensation
|
$ | 368,000 | $ | 227,000 | ||||
Stock
Options
In
January 1997, the Company adopted the 1997 Stock Option Plan (the “1997
Option Plan”). Under the 1997 Option Plan, options to purchase a
maximum of 2,650,000 shares of the Company’s common stock (subject to
adjustments in the event of stock splits, stock dividends, recapitalizations and
other capital adjustments) may be granted to employees, officers and directors
of the Company and certain other persons who provide services to the
Company. In addition, the Company established the 2002 Stock Option
Plan (the “2002 Option Plan”) in May 2002, which permits the Company to grant up
to 750,000 options to employees, officers and directors of the Company and
certain other persons who provide services to the Company under that
Plan. In May 2004, the Company’s shareholders approved an amendment
to the Company’s 2002 Stock Option Plan to increase the number of options
available under the plan from 750,000 to 1,500,000. In May 2007, the
Company’s shareholders approved the 2007 Stock Option Plan which permits the
Company to grant up to 1,500,000 options to employees, officers and directors of
the Company. In May 2008, the Company’s shareholders approved an
amendment to the Company’s 2007 Stock Option Plan creating the Amended 2007
Stock Option and Restricted Stock Plan (the “2007 Option and Restricted Stock
Plan”). The 2007 Stock Option and Restricted Stock Plan permits the
Company to issue restricted stock awards to employees, officers and directors of
the Company in addition to stock option awards.
Stock
options are generally granted with an exercise price equal to the fair market
value of its common stock at the date of grant. The options vest
ratably over a stated period of time not to exceed four years. The
contractual terms of the options are five or ten years.
F-17
A summary
of the Company’s stock option activity as of October 31, 2008 and 2009 is
presented below:
|
Fiscal Year ended October 31, 2008
|
||||||||||||
|
Shares
|
Weighted-
Average
Exercise
Price
|
Weighted-
Average
Remaining
Contractual
Term (years)
|
||||||||||
|
Outstanding
at October 31, 2007
|
1,786,000 | $ | 1.13 | 3.17 | ||||||||
|
Exercisable
at October 31, 2007
|
686,625 | $ | 1.60 | 2.33 | ||||||||
|
Options
granted
|
1,015,000 | $ | 1.26 | |||||||||
|
Options
exercised
|
196,290 | $ | 0.62 | |||||||||
|
Options
canceled or expired
|
622,210 | $ | 1.13 | |||||||||
|
Outstanding
at October 31, 2008
|
1,982,500 | $ | 1.24 | 3.42 | ||||||||
|
Exercisable
at October 31, 2008
|
879,584 | $ | 1.36 | 2.51 | ||||||||
|
Fiscal Year ended October 31, 2009
|
||||||||||||
|
Shares
|
Weighted-
Average
Exercise
Price
|
Weighted-
Average
Remaining
Contractual
Term (years)
|
||||||||||
|
Outstanding
at October 31, 2008
|
1,982,500 | $ | 1.24 | 3.42 | ||||||||
|
Exercisable
at October 31, 2008
|
879,584 | $ | 1.36 | 2.51 | ||||||||
|
Options
granted
|
450,000 | $ | 0.24 | |||||||||
|
Options
exercised
|
- | $ | - | |||||||||
|
Options
canceled or expired
|
1,180,000 | $ | 1.29 | |||||||||
|
Outstanding
at October 31, 2009
|
1,252,500 | $ | 0.83 | 3.04 | ||||||||
|
Exercisable
at October 31, 2009
|
862,500 | $ | 1.08 | 2.49 | ||||||||
The total
options outstanding do not include 600,000 non-qualified options granted to the
former IDP stockholders that are not included in the Option Plan as these
options expired in April 2008.
The
aggregate intrinsic value of options exercised during the fiscal year ended
October 31, 2008 was approximately $93,000. There were no options
exercised during the fiscal year ended October 31, 2009. The
intrinsic value of a stock option is the amount by which the market value of the
underlying stock exceeds the exercise price of the option. The
intrinsic value for options outstanding or options exercisable for year ended
October 31, 2009 was $15,000 and $7,500 respectively.
The fair
value of each option grant is estimated on the date of the grant using the
Black-Scholes option-pricing fair value model. This model is
calculated based on exercise price, an expected annual dividend yield of 0% and
several subjective assumptions, including the expected term and expected stock
price volatility over the expected term. The weighted-average
grant-date fair value of options granted during the fiscal years ended October
31, 2008 and 2009 was $0.51 and $0.12, respectively.
The fair
value of the Company’s Stock Option awards granted during the fiscal years ended
October 31, 2008 and 2009 were estimated based upon the following
assumptions:
F-18
|
Years ended October 31,
|
||||||
|
2008
|
2009
|
|||||
|
Expected
term (years)1
|
3.3
to 3.7
|
3.0
to 3.2
|
||||
|
Expected
stock price volatility2
|
57.6%
to 60.1%
|
75.2%
to 80.4%
|
||||
|
Weighted
average volatility2
|
58.80%
|
76.91%
|
||||
|
Risk-free
interest rate3
|
2.03%
to 2.92%
|
1.40%
to 1.46%
|
||||
______________________________
1 - Expected
term. For awards granted prior
to January 1, 2008, expected
term for the stock option awards was calculated based upon the simplified method
set out in the SEC Staff Accounting Bulletin No. 107 (“ SAB
107”). For awards granted after January 1, 2008 the Company continued
to use the simplified method set out in SAB 107 for grants with two-year and
three-year graded vesting for which it lacked sufficient historical share option
exercise data in accordance with SEC Staff Accounting Bulletin No.
110. Expected term for grants of one year cliff vesting stock option
awards was calculated based upon historical share option exercises for which the
Company did have sufficient historical data.
2 - Expected stock
price volatility. Expected stock price volatility for Stock
Option awards is calculated using the weighted average of the Company’s
historical volatility over the expected term of the award.
3 - Risk-free
interest rate. The risk-free interest rate is calculated based
on the U.S Treasury yield curve on the grant date and the expected term of the
award.
The
Company modified the stock option agreement of one employee in fiscal year
2009. Using the Black-Scholes fair-value pricing model, the fair
value of the stock option agreement prior to modification was approximately
$133,000 and the fair value subsequent to modification was approximately
$164,000. As a result of the modification the Company recorded $44,000 of
stock-based compensation expense which was recorded as general and
administrative expense.
A summary
of the Company’s outstanding stock options at October 31, 2009 is as
follows:
|
Options Outstanding
|
Options Exercisable
|
|||||||||||||||||||
|
Range of Exercise Prices
|
Number
Outstanding
|
Weighted
Average
Exercise
Price
|
Average
Remaining
Contractual
Life
|
Number
Outstanding
|
Weighted
Average
Exercise
Price
|
|||||||||||||||
|
$0.55-$1.75
|
1,137,500 | $ | 0.68 | 3.28 | 747,500 | $ | 0.88 | |||||||||||||
|
$1.76-$4.50
|
115,000 | $ | 2.40 | 0.65 | 115,000 | $ | 2.40 | |||||||||||||
|
$0.55-$4.50
|
1,252,500 | $ | 0.83 | 3.04 | 862,500 | $ | 1.08 | |||||||||||||
A summary
of the status of the Company’s nonvested shares as of October 31, 2008 and 2009,
and changes during the fiscal year ended October 31, 2008, is presented
below:
|
Fiscal Year Ended October 31, 2008
|
||||||||
|
Shares
|
Weighted-
Average
Grant-Date
Fair Value
|
|||||||
|
Nonvested
at October 31, 2007
|
1,099,375 | $ | 0.46 | |||||
|
Options
granted
|
1,015,000 | $ | 0.51 | |||||
|
Options
vested
|
(606,459 | ) | $ | 0.51 | ||||
|
Options
forfeited
|
(405,000 | ) | $ | 0.36 | ||||
|
Nonvested
at October 31, 2008
|
1,102,916 | $ | 0.52 | |||||
F-19
|
Fiscal Year Ended October 31, 2009
|
||||||||
|
Shares
|
Weighted-
Average
Grant-Date
Fair Value
|
|||||||
|
Nonvested
at October 31, 2007
|
1,102,916 | $ | 0.52 | |||||
|
Options
granted
|
450,000 | $ | 0.12 | |||||
|
Options
vested
|
(492,500 | ) | $ | 0.39 | ||||
|
Options
forfeited
|
(670,416 | ) | $ | 0.56 | ||||
|
Nonvested
at October 31, 2008
|
390,000 | $ | 0.15 | |||||
The
Company recognized approximately $364,000 and $86,000 of stock-based
compensation expense associated with stock option awards in the fiscal years
ended October 31, 2008 and 2009, respectively. As of October 31,
2009, unrecognized compensation expense related to nonvested stock options was
$15,000 which is expected to be recognized through January 2012 over a weighted
average period of 1.03 years. The total fair value of shares vested
during the years ended October 31, 2008 and 2009 was approximately $309,000 and
$194,000 respectively.
Employee
Stock Purchase Plan – No Participation
In
August, 1998, the Board adopted an Employee Stock Purchase Plan (“ESPP”) whereby
employees may purchase Company stock through a payroll deduction
plan. The purchase price of the stock is the lower of 85% of the fair
market value on the first or last day of the applicable six month offering
period. All employees, including officers but not directors, are
eligible to participate in this plan. Executive officers whose stock
ownership of the Company exceeds five percent of the outstanding common stock
are not eligible to participate in this plan. In May 2007, the
Company’s shareholders approved an amendment to the ESPP that increased the
number of shares available for issuance from 300,000 to 600,000.
The fair
value of each ESPP award is estimated on the date of the grant using the
Black-Scholes option-pricing fair value model. This model is
calculated based on exercise price, an expected annual dividend yield of 0%, the
expected term and a subjective assumption, expected stock price volatility over
the expected term. The Company did not grant any ESPP awards in the
fiscal year ended October 31, 2009. The fair value of the Company’s
ESPP awards granted during the fiscal year ended October 31, 2008was estimated
based upon the following assumptions:
|
Fiscal Year Ended
October 31, 2008
|
||||
|
Expected
term (years)1
|
0.50 | |||
|
Expected
stock price volatility2
|
64.6 | % | ||
|
Risk-free
interest rate3
|
1.53 | % | ||
______________________________
1 - Expected
term. Expected term for ESPP awards is equal to the vesting
period of the award.
2 - Expected stock
price volatility. Expected stock price volatility for ESPP
awards is calculated using the weighted average of the Company’s historical
volatility over the expected term of the award.
3 - Risk-free
interest rate. The risk-free interest rate is calculated based
on the U.S. Treasury yield curve on the grant date and the expected term of the
award.
F-20
The
Company did not recognize any stock-based compensation expense associated with
ESPP awards in the fiscal year ended October 31, 2009. As of October
31, 2009, there was not any unrecognized compensation cost related to ESPP
awards.
Restricted
Stock Awards
Restricted
stock awards are issued pursuant to the Company’s 2007 Stock Option and
Restricted Stock Plan. The Company’s restricted stock grants are
accounted for as equity awards. The expense is based on the price of
the Company’s common stock, and is recognized on a straight-line basis over the
requisite service period. The Company’s restricted stock agreements
do not contain any post-vesting restrictions. The restricted stock
award grants vest ratably over a two to three year period.
A summary
of the Company’s restricted stock award activity as of October 31, 2008 and
2009, and changes during the year then ended are as follows:
|
Fiscal Year Ended October 31, 2008
|
|||||||||||
|
Shares
|
Weighted-
Average
Price/Share
|
Intrinsic
Value
|
|||||||||
|
Nonvested
at October 31, 2007
|
180,000 | $ | 1.22 | ||||||||
|
Granted
|
- | $ | - | ||||||||
|
Vested
and issued
|
- | $ | - | ||||||||
|
Cancelled
|
(113,334 | ) | $ | 1.24 | |||||||
|
Nonvested
at October 31, 2008
|
66,666 | $ | 1.20 |
$
|
39,332
|
||||||
|
Fiscal Year Ended October 31, 2009
|
|||||||||||
|
Shares
|
Weighted-
Average
Price/Share
|
Intrinsic
Value
|
|||||||||
|
Nonvested
at October 31, 2007
|
66,666 | $ | 1.20 | ||||||||
|
Granted
|
546,000 | $ | 0.34 | ||||||||
|
Vested
and issued
|
395,750 | $ | 0.34 | ||||||||
|
Cancelled
|
(147,916 | ) | $ | 0.78 | |||||||
|
Nonvested
at October 31, 2008
|
69,000 | $ | 0.23 |
$
|
17,940
|
||||||
The
Company recognized $142,000 of stock-based compensation expense associated with
restricted stock awards in the fiscal year ended October 31,
2009. The Company did not recognize any stock-based compensation
expense associated with restricted stock awards in the fiscal year ended October
31, 2008. As of October 31, 2009, unrecognized compensation expense
related to nonvested restricted stock awards was $21,000 which is expected to be
recognized through February 2010 over a weighted average period of 0.18
years.
F-21
11.
Income
Taxes
The
provision for income taxes from continuing operations consists of the
following:
|
Years ended October 31,
|
||||||||
|
2008
|
2009
|
|||||||
|
Current:
|
||||||||
|
Federal
|
$ | (367,253 | ) | $ | - | |||
|
State
|
(30,615 | ) | - | |||||
|
Deferred:
|
||||||||
|
Federal
|
- | - | ||||||
|
State
|
- | - | ||||||
|
Total
Benefit for income taxes
|
$ | (397,868 | ) | $ | - | |||
The
provision for income taxes for discontinued operations consists of the
following:
|
Years ended October 31,
|
||||||||
|
2008
|
2009
|
|||||||
|
Current:
|
||||||||
|
Federal
|
$ | 367,253 | $ | - | ||||
|
State
|
30,615 | - | ||||||
|
Deferred:
|
||||||||
|
Federal
|
- | - | ||||||
|
State
|
- | - | ||||||
|
Total
Provision for income taxes
|
$ | 397,868 | $ | - | ||||
F-22
Deferred
income taxes reflect the net tax effects of temporary differences between the
carrying amounts of assets and liabilities for financial reporting purposes and
the amounts used for income tax purposes.
Components
of the Company’s net deferred tax asset balance are as follows:
|
Years Ended October 31,
|
||||||||
|
2008
|
2009
|
|||||||
|
Deferred
tax assets:
|
||||||||
|
Current
portion:
|
||||||||
|
Accrued
expenses
|
$ | 61,390 | $ | 19,217 | ||||
|
Asset
reserves
|
72,156 | - | ||||||
|
Other
|
31,674 | 4,086 | ||||||
|
Total
current portion
|
165,220 | 23,303 | ||||||
|
Long
term portion:
|
||||||||
|
Net
operating loss carryforwards
|
16,318,196 | 17,685,269 | ||||||
|
Deferred
rent
|
58,768 | 93,196 | ||||||
|
Stock
compensation
|
83,890 | 133,524 | ||||||
|
Investment
reserve
|
55,252 | 55,228 | ||||||
|
Depreciation
|
153,128 | 226,747 | ||||||
|
Intangibles
|
757,560 | 683,362 | ||||||
|
Total
long term portion
|
17,426,794 | 18,877,326 | ||||||
|
Deferred
tax credit:
|
||||||||
|
Valuation
allowance
|
(17,525,032 | ) | (18,867,153 | ) | ||||
|
Total
deferred tax asset
|
$ | 66,982 | $ | 33,476 | ||||
|
Deferred
tax liabilities:
|
||||||||
|
Current
portion:
|
||||||||
|
Change
in accounting method
|
(33,491 | ) | (33,476 | ) | ||||
|
Long
term portion:
|
||||||||
|
Change
in accounting method
|
(33,491 | ) | - | |||||
|
Total
deferred tax liability
|
$ | (66,982 | ) | $ | (33,476 | ) | ||
|
Net
deferred tax asset
|
$ | - | $ | - | ||||
As of
October 31, 2009, the Company had approximately $48.1 million in pretax net
operating loss carryforwards reported on its tax returns, which expire between
2011 and 2028. Of this amount, approximately 132,000 is unrecognized
in the financial statement related to stock-based compensation that has not yet
provided a benefit due to the Company’s net operating loss
position. The use of the net operating loss carryforwards may be
subject to limitation under the rules regarding a change of ownership as
determined by the Internal Revenue Service. The effects of potential ownership
changes, if any, have not been analyzed by the Company.
As of
October 31, 2009, the Company has recorded a valuation allowance of
approximately $18.9 million against the total deferred tax asset of $18.9
million. The portion of the valuation allowance for which
subsequently recognized benefits will increase stockholders’ equity was $0.3
million. In assessing the amount of the valuation allowance as of
October 31, 2009, SteelCloud considered, in particular, SteelCloud’s forecasted
operations for the next fiscal year, taking into account SteelCloud’s year to
date results of operations, current backlog of orders, including those recently
received, and other significant opportunities currently in SteelCloud’s sales
and marketing pipeline with a high probability of generating
revenues. Based upon this review, management determined that it is
not more likely than not its net deferred tax assets will be realized and has
provided a valuation allowance against all deferred tax assets as of October 31,
2009.
F-23
The
reconciliation of income tax from the federal statutory rate of 34%
is:
|
Years ended October 31,
|
||||||||
|
2008
|
2009
|
|||||||
|
Tax
at statutory rates:
|
$ | (1,305,504 | ) | $ | (999,858 | ) | ||
|
Non-deductible
(income) expenses, net
|
8,866 | 3,245 | ||||||
|
Stock
based compensation
|
73,784 | 4,525 | ||||||
|
Valuation
allowance
|
911,323 | 1,049,116 | ||||||
|
State
income tax, net of federal benefit
|
(108,831 | ) | (82,892 | ) | ||||
|
Change
in state tax rates
|
(73,201 | ) | 7,426 | |||||
|
True-up
of net-operating loss
|
87,985 | (1,113 | ) | |||||
|
Other
|
7,710 | 19,551 | ||||||
| $ | (397,868 | ) | $ | - | ||||
The
Company conducts business in the U.S. and is subject to U.S.
taxes. As a result of its business activities, the Company files tax
returns that are subject to examination by the respective federal and state tax
authorities. For income tax returns filed by the Company, the Company
is no longer subject to U.S. federal, or state tax examination by tax
authorities for years before the tax year ended October 31, 2006, although
significant net operating loss carryforward tax attributes that were generated
prior to the tax year ended October 31, 2006 may still be adjusted upon
examination by tax authorities if they either have been or will be
utilized.
As of
November 1, 2008, the Company had a total unrecognized tax benefit of $61
thousand, of which $12 thousand related to tax positions taken in prior years
that did not meet the more-likely-than-not recognition threshold, and $41
thousand related to stock compensation deductions.
The
change in the Company’s unrecognized tax benefits are shown in the table
below:
|
Years
ended October 31,
|
||||||||
|
2008
|
2009
|
|||||||
|
Balance
at November 1
|
$ | 615,674 | $ | 61,145 | ||||
|
Additions
related to current year tax positions
|
50,971 | - | ||||||
|
Additions
related to current year windfall tax benefits not
recognized
|
48,697 | - | ||||||
|
Reduction
for tax positions related to the current year
|
- | |||||||
|
Additions
for tax positions of prior years
|
54 | - | ||||||
|
Reductions
for tax positions of prior years
|
- | |||||||
|
The
amounts of decreases in the unrecognized tax benefits relating to
settlements with taxing authorities
|
(654,251 | ) | - | |||||
|
Expiration
of the statute of limitations for the assessment of taxes
|
- | |||||||
|
Balance
at October 31, 2009
|
$ | 61,145 | $ | 61,145 | ||||
The
Company has a valuation allowance against the full amount of its net deferred
tax assets and therefore, the amount of unrecognized tax benefits that, if
recognized, would impact the effective tax rate is zero. The Company
does not expect its unrecognized tax benefit liability to change significantly
over the next 12 months. The Company’s accounting policy is to
recognize interest and penalties related to income tax matters in general and
administrative expense. The Company has $0 accrued for interest and
penalties as of October 31, 2008 and 2009.
F-24
12.
Earnings Per Share
Basic net
income per share is computed by dividing net income by the weighted-average
number of common shares outstanding during the period. Diluted net
income per share is computed, using the treasury stock method, as though all
potential common shares that are dilutive were outstanding during the
period. The following table provides a reconciliation of the
numerators and denominators of the basic and diluted computations for net (loss)
per share.
|
Years ended October 31,
|
||||||||
|
2008
|
2009
|
|||||||
|
Numerator:
|
||||||||
|
Net
income (loss) from continuing operations
|
$ | (3,838,716 | ) | $ | (2,940,864 | ) | ||
|
Net
income (loss) from discontinued operations
|
$ | 1,080,154 | $ | (795,698 | ) | |||
|
Net
income (loss)
|
$ | (2,759,562 | ) | $ | (3,736,562 | ) | ||
|
Denominator:
|
||||||||
|
Denominator
for basic earnings per share- weighted-average shares
|
14,493,215 | 15,032,286 | ||||||
|
Effect
of dilutive securities:
|
||||||||
|
Employee
stock options
|
271,575 | 20,182 | ||||||
|
Warrants
|
56,186 | 365,644 | ||||||
|
Restricted
stock
|
24,160 | 197,705 | ||||||
|
Dilutive
potential common shares
|
351,920 | 583,531 | ||||||
|
Denominator
for diluted earnings per share - adjusted weighted-average shares and
assumed conversions
|
14,493,215 | 15,615,817 | ||||||
|
(Loss)
per share from continuing operations, basic and diluted
|
$ | (0.26 | ) | $ | (0.19 | ) | ||
|
Income
(loss) per share from discontinued operations, basic and
diluted
|
$ | 0.07 | $ | (0.05 | ) | |||
|
(Loss)
per share, basic and diluted
|
$ | (0.19 | ) | $ | (0.24 | ) | ||
13.
Retirement Plans
401(k)
Plans
The
Company maintains a 401(k) (the “Plan”) for all current
employees. Under the Plan, employees are eligible to participate the
first calendar day of the month following their first day of service and
attaining the age of 18. Employees could defer up to $16,500 of
compensation in calendar year 2009. Employee contributions are
subject to Internal Revenue Service limitations. All employees who
contributed to the Plan are eligible to share in discretionary Company matching
contributions. The Company match is equal to 25% of employee
contributions up to 6% of an employee’s annual compensation. Company
contributions vest over 5 years. In fiscal 2008 and 2009, the Company
contributed approximately $72,000 and $23,000 to the participants of the 401(k),
respectively.
F-25
14.
Segment Reporting
The
Company is organized on the basis of products and services. The
Company’s chief operating decision maker is the Company’s Chief Executive
Officer. While the Chief Executive Officer is apprised of a variety
of financial metrics and information, the Chief Executive Officer makes
decisions regarding how to allocate resources and assess performance based on a
single operating segment.
15.
Related Party Transactions.
An
individual who is a director is also a founding member of Gersten Savage LLP,
who provides legal services to the Company. During the fiscal years ended
October 31, 2008 and 2009, the Company paid Gersten Savage LLP approximately
$93,000 and $169,000, respectively, in legal fees. In addition, on
October 23, 2009, we issued 109,375 shares of our common stock to Gersten Savage
LLP in conversion of legal fees due them. These legal fees were
converted at $0.32 per share, the closing price of our stock on October 23,
2009.
16.
Commitments and Contingencies
The
Company has accrued approximately $50,000 pertaining to non-income taxes and
related interest and penalties that would have resulted from the failure to file
the associated returns. The Company intends to file the necessary
returns to resolve the contingency.
17.
Subsequent
Events
Subsequent
events are current as of February 5, 2010.
Operations
lease
On
February 2, 2010, SteelCloud entered into a Lease Agreement (the “February
Lease”) with Merritt-AB5, LLC (the “Landlord”), pursuant to which SteelCloud
will rent approximately 3,461 square feet in the property located at 20110
Ashbrook Place, Suite 130, Ashburn, Virginia 20147 (the “Premises”) for its
operations facility. The term of the February Lease is for one year
beginning on the later to occur of (i) February 15, 2010, (ii) the date the
Landlord completes certain work on the premises, or (iii) the date when we
occupy the Premises (the “Term”). The Term may be extended for two
additional successive one year periods. The monthly rate is $6,489.38, or
$77,872.50 for the first year, inclusive of operating expenses. If we
determine to extend the term, the monthly rent for the second year will be
$6,684.06 or $80,208.68 per year, and the monthly rent for the third year will
be $6,884.58 or $82,614.94 per year.
Sale
of Portion of Consulting Business
On
January 11, 2010, SteelCloud entered into a Purchase and Sale Agreement (the
“Agreement”) with Global Technology Partners, Inc., a Maryland Corporation (the
“Purchaser”).
Pursuant
to the Agreement, on January 15, 2010, SteelCloud sold to the Purchaser a
portion of its consulting business, consisting of certain consulting contracts
and related agreements, and assign all of its rights to employment and
independent contractor contracts for certain of its contractors and employees
engaged in the consulting business (the “Assets”). As consideration
for the sale of the Assets, the Purchaser agreed to pay a base price of one
hundred forty thousand dollars ($140,000) (the “Base Price”) of which (a)
seventy thousand dollars ($70,000) was paid upon the execution of the Agreement,
and (b) seventy thousand dollars ($70,000) was paid on January 15, 2010;
however, this payment may be forfeited to Purchaser if a novation is not
approved by the government and certain payments due to Purchaser from the Assets
are not made to Purchaser. In addition to the Base Price, the
Agreement provides for contingent payments in the amount of (a) one hundred
thousand dollars ($100,000) in the event certain payments are made pursuant to
certain of the Assets, and (b) twenty percent (20%) of the gross margin from all
revenue generated from the Assets for the period beginning from January 11, 2010
and ending on January 11, 2011.
F-26
Pursuant
to the Agreement, the parties agreed to cooperate in obtaining novations of all
governmental contracts included in the Assets. SteelCloud agreed to
guarantee payment of all liabilities and the performance of all obligations that
Purchaser assumed under any governmental contracts included in the
Assets.
The
Agreement contains standard representations and warranties for a transaction of
this type. The terms of the transaction were the result of arm’s length
negotiations between SteelCloud and the Purchaser. Prior to the
completion of the transaction, neither SteelCloud nor any of its affiliates or
officers, directors or their associates had any material relationship with the
Purchaser, other than in respect of the Agreement and the transactions
contemplated therein and related thereto.
In
connection with the Agreement, SteelCloud obtained a Release of Lien (the
“Release”) from Caledonia Capital Corporation (“Caledonia”), pursuant to which
Caledonia released and waived its interest in the Assets, including any
receivables due thereunder, which SteelCloud pledged and assigned as collateral
security under the Line of Credit and Security Agreement dated November 3, 2009,
by and between SteelCloud and Caledonia (the “Line of Credit”).
NASDAQ Stock Market
Delisting
On
January 5, 2010, the Company received notice from The NASDAQ Stock Market
("NASDAQ") indicating that the NASDAQ Hearings Panel determined to delist the
Company’s securities from NASDAQ and trading in the Company’s securities would
be suspended effective as of the open of trading on Thursday, January 7, 2010.
As previously reported by the Company, on October 8, 2009, the NASDAQ Hearings
Panel gave SteelCloud until January 4, 2010 to comply with NASDAQ Listing Rule
5550(b) (formerly known as Market Place Rule 4310(c)(3)), which required that
the Company maintain a minimum of (a) $2,500,000 in stockholder's equity, (b)
$35,000,000 market value of listed Securities, or (c) $500,000 of net income
from continuing operations. the Company was unable to gain compliance with
NASDAQ Listing Rule 5550(b) by the January 4, 2010 deadline. The Company does
not intend to take any further action to appeal NASDAQ's decision. Accordingly,
trading of the Company’s common stock was suspended at the opening of business
on January 7, 2010, and NASDAQ will file a Form 25-NSE with the SEC as soon as
all applicable appeal periods have lapsed.
Allonge
to Business Loan
On
December 29, 2009, the Company entered into an Allonge to Note (the "Allonge")
with Caledonia Capital Corporation, a Delaware Corporation (the "Lender"). The
Allonge amends the terms of the Business Loan and Security Agreement dated July
1, 2009 (the "Agreement"), pursuant to which the Lender agreed to lend to the
Company $250,000 in the form of a Secured Promissory Note (the "Note") issued on
July 1, 2009. The Note originally provided for a maturity date of December 29,
2009 (the "Maturity Date") and an annual interest rate of 15%. The Allonge
amends the Note by, among other things, (a) increasing the annual interest rate
of the Note to 20%, (b) providing that accrued interest under the Note shall be
payable in monthly installments commencing on February 1, 2010, and continuing
on the first business day of each successive month, (c) paying an extension fee
of $25,000 and (d) extending the Maturity Date of the Note to March 31, 2010.
There are no penalties for early prepayment of the Note.
F-27
Line
of Credit
On
November 3, 2009, the Company entered into a Line of Credit and Security
Agreement (the "Agreement") with Caledonia Capital Corporation, a Delaware
corporation (the "Lender") pursuant to which the Lender agreed to extend to the
Company a revolving line of credit in the amount of $150,000, in the form of a
Revolving Line of Credit Promissory Note (the "Note"). The Note bears interest
at a rate of 15% per annum, and is payable in monthly installments commencing 30
days after SteelCloud issued the Note (November 3, 2009). The principal amount
of the Note, together with interest accrued and unpaid thereon and all other
sums due, shall be due and payable in full upon the earlier to occur of (a)
March 31, 2010, or (b) the date the Company shall have raised a total of not
less than $1,000,000 in capital invested in the equity of the Company which is
accompanied by the Company issuing shares of stock which were not trading in the
public markets prior to the date of the Note ("New Equity Capital"). There are
no penalties for early prepayment of the Note. The Note is a
revolving line of credit note. Principal advances may be made, from time to
time, by the Lender up to the principal amount of the Note, and principal
payments may be made, from time to time by the Company to reduce the principal
balance owing pursuant to the Note.
Pursuant
to the Agreement and the Note, the Company's obligations thereunder are secured
by a lien in and to all of the Company’s rights, title and interest in and to
its furniture, fixtures, equipment, supplies, receivables, intangibles, and
inventory, together with all present and future substitutions, replacements and
accessories thereto and all present and future proceeds and products thereof, in
any form whatsoever (the "Collateral").
Pursuant
to the Agreement, in the event that (a) the Company shall fail to pay when due
any principal, interest or other sum owing on any of the obligations described
in the Agreement when due; or (b) the Company shall fail to perform any other
covenant or agreement in the Agreement, in the Warrant or in any of the other
loan documents and such default continues uncorrected for a period of thirty
(30) days after written notice of such default from Lender to the Company; or
(c) if any warranty or representation of the Company made to the Lender shall be
untrue or misleading in any material respect; or (d) if a trustee or receiver is
appointed for the Company or for all or a substantial part of the Company's
assets; or if the Company makes a general assignment for the benefit of
creditors; or if the Company files for bankruptcy; or if an involuntary
bankruptcy petition is filed against the Company and such petition is not
dismissed within forty-five (45) days after the filing of the same; or (e) If
any property of the Company pledged or hypothecated to Lender, or any deposit
account held by Lender, is levied upon or attached or further encumbered, or
garnished or the Collateral shall otherwise be impaired and same is not removed
within thirty (30) days after written notice thereof from Lender to the Company,
as determined by Lender; or (f) if there occurs any material adverse change in
the financial condition of the Company or value of the Collateral, as determined
by Lender; or (g) if a final judgment is entered against the Company, and the
same is not discharged, appealed (provided such appeal stays such judgment) or
satisfied within thirty (30) calendar days; or (h) if the Company is liquidated
or dissolved; or (i) a default shall occur under that certain Note in the
original principal amount of $250,000 from the Company to Lender dated July 1,
2009, then the Lender may, without any further notice or demand, (1) declare any
or all of the obligations not already due to be immediately due and payable; (2)
enforce, by any proceedings or otherwise, any of the obligations; (3) take
exclusive possession of any or all of the Collateral, (4) enforce any liens or
security interests securing the obligations; (5) demand, compromise, collect,
sue for and receive any money or property at any time due, (6) endorse the
Company name on any promissory notes or other instruments, checks, drafts, money
orders or other items of payment constituting Collateral, or collections or
other proceeds of Collateral, that may come into Lender's possession or control
from time to time; and/or (7) terminate, or cease extending credit under, any or
all outstanding commitments or credit accommodations of Lender to the
Company.
As an
inducement to the Lender to make a loan under the Agreement, the Company shall
issue to the Lender a warrant (the "Warrant") to purchase 2.5 shares of the
Company's common stock, par value $0.001 per share ("Common Stock") for every
dollar the Company borrows pursuant to the Agreement. The Warrant is exercisable
for four years at an exercise price of $0.25 per share. The exercise price may
be adjusted in the event of any stock dividend, stock split, stock combination,
reclassification or similar transaction. Additionally, the Company's Board of
Directors (the "Board") has the discretion to reduce the then-current exercise
price to any amount at any time during the term of the Warrant for any period of
time the Board deems appropriate. The Company has agreed to prepare and file a
registration statement for the purposes of registering the resale of the shares
of Common Stock underlying the Warrant, commencing on or about December 31,
2009.
F-28