FORM 10-Q

 

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 

x

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the quarterly period ended September 30, 2007

 

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 0-23585.

 

 

SM&A

(Exact name of registrant as specified in its charter)

 

Delaware

 

33-0080929

(State or other jurisdiction of incorporation or organization)

 

(I.R.S. Employer Identification No.)

 

 

 

4695 MacArthur Court, 8th Floor, Newport Beach, California

 

92660

(Address of principal executive offices)

 

(Zip Code)

 

(949) 975-1550

(Registrant’s telephone number, including area code)

 

Not applicable

(Former name, former address and former fiscal year, if changed since last report)

 

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 is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of accelerated filer and large accelerated filer in Rule 12b-2 of the Exchange Act. (Check one):

 

Large accelerated filer o     Accelerated filer x     Non-accelerated filer o

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

 

Yes o     No x

 

The registrant had 18,949,575 shares of common stock, $0.0001 par value, outstanding as of September 30, 2007

 

 



 

SM&A

 

INDEX

 

PART I. FINANCIAL INFORMATION

 

 

Cautionary Statement Related to Forward Looking Statements

 

 

How to Obtain SM&A SEC Filings

 

 

Item 1.

Financial Statements:

 

Condensed Consolidated Balance Sheets

 

Condensed Consolidated Statements of Income

 

Condensed Consolidated Statements of Cash Flows

 

Notes to Condensed Consolidated Financial Statements

Item 2.

Management’s Discussion and Analysis of Financial Condition and Results of Operations

Item 3.

Quantitative and Qualitative Disclosures About Market Risk

Item 4.

Controls and Procedures

 

 

PART II. OTHER INFORMATION

 

 

Item 1.

Legal Proceedings

Item 2.

Unregistered Sales of Equity Securities and Use of Proceeds

Item 3.

Defaults Upon Senior Securities

Item 4.

Submission of Matters to a Vote of Security Holders

Item 5.

Other Information

Item 6.

Exhibits

 

 

Signatures

 

2



 

CAUTIONARY STATEMENT RELATED TO FORWARD LOOKING STATEMENTS

 

This Quarterly Report on Form 10-Q includes certain forward-looking statements as defined within Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended, relating to revenue, revenue composition, earnings, projected plans, performance, contract procurement, demand trends, future expense levels, trends in average headcount and gross margins, and the level of expected capital expenditures. Such forward-looking statements are based on the beliefs of, estimates made by, and information currently available to SM&A management and are subject to certain risks, uncertainties and assumptions. Any statements contained herein (including without limitation statements to the effect that the Company or management “estimates,” “expects,” “anticipates,” “plans,” “believes,” “projects,” “continues,” “may,” “will,” “could,” or “would” or statements concerning “potential” or “opportunity” or variations thereof or comparable terminology or the negative thereof) that are not statements of historical fact should be construed as forward-looking statements. The actual results of SM&A may vary materially from those expected or anticipated in these forward-looking statements. The realization of such forward-looking statements may be impacted by certain important unanticipated factors including those discussed in “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” at pages 12-15. Because of these and other factors that may affect SM&A’s operating results, past performance should not be considered as an indicator of future performance, and investors should not use historical results to anticipate results or trends in future periods. The Company undertakes no obligation to publicly release the results of any revisions to these forward-looking statements that may be made to reflect events or circumstances after the date hereof or to reflect the occurrence of unanticipated events. Readers should carefully review the risk factors described in this and other documents that SM&A files from time to time with the Securities and Exchange Commission (“SEC”), including subsequent Current Reports on Form 8-K, Quarterly Reports on Form 10-Q and Annual Reports on Form 10-K.

 

HOW TO OBTAIN SM&A SEC FILINGS

 

All reports filed by SM&A with the SEC are available free of charge via EDGAR through the SEC website at www.sec.gov. In addition, the public may read and copy materials filed by the Company with the SEC at the SEC’s public reference room located at 450 Fifth St., N.W., Washington, D.C. 20549. SM&A also provides copies of its Forms 8-K, 10-K, 10-Q, Proxy and Annual Report at no charge to investors upon request and makes electronic copies of its most recently filed reports available through its website at www.smawins.com as soon as reasonably practicable after filing such material with the SEC.

 

3



 

SM&A

CONDENSED CONSOLIDATED BALANCE SHEETS

(in thousands)

 

 

 

September 30,
2007

 

December 31,
2006

 

 

 

(unaudited)

 

 

 

ASSETS

 

 

 

 

 

Current assets:

 

 

 

 

 

Cash and cash equivalents

 

$

2,776

 

$

15,143

 

Investments

 

6,520

 

 

Accounts receivable, net

 

24,849

 

15,759

 

Prepaid expenses and other current assets

 

1,341

 

871

 

Total current assets

 

35,486

 

31,773

 

Fixed assets, net

 

3,644

 

3,446

 

Goodwill

 

6,183

 

 

Intangibles, net

 

2,003

 

 

Other assets

 

890

 

407

 

 

 

$

48,206

 

$

35,626

 

LIABILITIES AND STOCKHOLDERS’ EQUITY

 

 

 

 

 

 

 

 

 

 

 

Current liabilities:

 

 

 

 

 

Accounts payable

 

$

1,836

 

$

1,232

 

Accrued compensation and related benefits

 

4,516

 

2,112

 

Other current liabilities

 

70

 

42

 

Total current liabilities

 

6,422

 

3,386

 

Other liabilities

 

906

 

644

 

Total liabilities

 

7,328

 

4,030

 

 

 

 

 

 

 

Commitments, contingencies and subsequent events

 

 

 

 

 

 

 

 

 

 

 

Stockholders’ equity:

 

 

 

 

 

Preferred stock

 

 

 

Common stock

 

2

 

2

 

Additional paid-in capital

 

44,728

 

39,893

 

Treasury stock

 

(1,506

)

(664

)

Accumulated deficit

 

(2,346

)

(7,635

)

Total stockholders’ equity

 

40,878

 

31,596

 

 

 

$

48,206

 

$

35,626

 

 

See accompanying notes to condensed consolidated financial statements

 

4



 

SM&A

CONDENSED CONSOLIDATED STATEMENTS OF INCOME

(in thousands, except per share data)

(UNAUDITED)

 

 

 

Three Months Ended
September 30,

 

Nine Months Ended
September 30,

 

 

 

2007

 

2006

 

2007

 

2006

 

 

 

 

 

 

 

 

 

 

 

Revenue

 

$

25,059

 

$

17,025

 

$

74,251

 

$

53,017

 

Cost of revenue

 

14,941

 

10,645

 

45,021

 

31,487

 

Gross margin

 

10,118

 

6,380

 

29,230

 

21,530

 

 

 

 

 

 

 

 

 

 

 

Selling, general and administrative expenses

 

7,095

 

5,859

 

20,620

 

17,272

 

Operating income

 

3,023

 

521

 

8,610

 

4,258

 

 

 

 

 

 

 

 

 

 

 

Interest income, net

 

80

 

158

 

301

 

602

 

Income before income taxes

 

3,103

 

679

 

8,911

 

4,860

 

 

 

 

 

 

 

 

 

 

 

Income tax expense

 

1,268

 

261

 

3,622

 

1,983

 

 

 

 

 

 

 

 

 

 

 

Net income

 

$

1,835

 

$

418

 

$

5,289

 

$

2,877

 

 

 

 

 

 

 

 

 

 

 

Net income per share:

 

 

 

 

 

 

 

 

 

Basic

 

$

0.10

 

$

0.02

 

$

0.28

 

$

0.15

 

Diluted

 

$

0.10

 

$

0.02

 

$

0.28

 

$

0.15

 

 

 

 

 

 

 

 

 

 

 

Shares used in calculating net income per share:

 

 

 

 

 

 

 

 

 

Basic

 

18,874

 

18,730

 

18,758

 

19,235

 

Diluted

 

19,021

 

18,910

 

18,930

 

19,419

 

 

See accompanying notes to condensed consolidated financial statements

 

5



 

SM&A

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(in thousands)

(UNAUDITED)

 

 

 

Nine Months Ended
September 30,

 

 

 

2007

 

2006

 

 

 

 

 

 

 

CASH FLOWS FROM OPERATING ACTIVITIES:

 

 

 

 

 

Net income

 

$

5,289

 

$

2,877

 

Adjustments to reconcile net income to net cash provided by (used in) operating activities:

 

 

 

 

 

Depreciation and amortization

 

907

 

639

 

Stock-based compensation expense

 

1,335

 

942

 

Excess tax benefits from stock-based compensation

 

(118

)

 

Deferred income taxes

 

(291

)

(202

)

Changes in operating assets and liabilities, net of business acquisitions:

 

 

 

 

 

Accounts receivable

 

(6,272

)

(6,280

)

Prepaid expenses and other current assets

 

(451

)

339

 

Accounts payable

 

(847

)

237

 

Accrued compensation and related benefits

 

1,696

 

935

 

Other liabilities

 

386

 

15

 

Net cash provided by (used in) operating activities

 

1,634

 

(498

)

 

 

 

 

 

 

CASH FLOWS FROM INVESTING ACTIVITIES:

 

 

 

 

 

Purchases of fixed assets

 

(944

)

(1,281

)

Proceeds from the sale of fixed assets

 

18

 

 

Purchases of marketable securities

 

(16,520

)

 

Proceeds from sale of marketable securities

 

10,000

 

4,950

 

Cost of acquisitions, net of cash acquired

 

(6,455

)

 

Net cash (used in) provided by investing activities

 

(13,901

)

3,669

 

 

 

 

 

 

 

CASH FLOWS FROM FINANCING ACTIVITIES:

 

 

 

 

 

Proceeds from issuance of common stock

 

666

 

409

 

Excess tax benefits from stock-based compensation

 

118

 

3

 

Payment for repurchase of shares

 

(842

)

(7,262

)

Net cash used in financing activities

 

(58

)

(6,850

)

 

 

 

 

 

 

Net decrease in cash and cash equivalents from continued operations

 

(12,325

)

(3,679

)

Net cash used in discontinued operations by operating activities

 

(42

)

(266

)

Net decrease in cash and cash equivalents

 

(12,367

)

(3,945

)

Cash and cash equivalents at beginning of period

 

15,143

 

19,103

 

Cash and cash equivalents at end of period

 

$

2,776

 

$

15,158

 

 

 

 

 

 

 

SUPPLEMENTAL INFORMATION—CASH PAID FOR:

 

 

 

 

 

Income taxes

 

$

4,057

 

$

1,727

 

Interest

 

$

10

 

$

 

 

 

 

 

 

 

SUPPLEMENTAL DISCLOSURE OF NON-CASH TRANSACTIONS:

 

 

 

 

 

Common stock issued for acquisitions

 

$

2,716

 

$

 

Common stock issued to an employee

 

$

50

 

$

 

Assets acquired under a capital lease

 

$

160

 

$

 

 

See accompanying notes to condensed consolidated financial statements

 

6



 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

For the Three and Nine Months Ended September 30, 2007 and 2006

(UNAUDITED)

 

Note 1.   Basis of Presentation and Significant Accounting Policies

 

The condensed consolidated financial statements included herein are unaudited; such financial statements contain all normal recurring accruals and adjustments that, in the opinion of management, are necessary to present fairly the consolidated financial position of SM&A at September 30, 2007, the consolidated results of operations for the three and nine months ended September 30, 2007 and 2006, and cash flows for the nine months ended September 30, 2007 and 2006. Comprehensive income is equivalent to net income for the three and nine month periods ended September 30, 2007 and 2006, respectively.

 

Accounting measurements at interim dates inherently involve greater reliance on estimates than at year-end. The results of operations for the three and nine months ended September 30, 2007 are not necessarily indicative of the results to be expected for the full fiscal year.

 

The accompanying unaudited condensed consolidated financial statements do not include footnotes and certain financial presentations normally required under generally accepted accounting principles. Therefore, these financial statements should be read in conjunction with our audited consolidated financial statements and notes thereto for the year ended December 31, 2006, included in our Annual Report on Form 10-K/A filed with the Securities and Exchange Commission (“SEC”) on March 16, 2007.

 

Significant Accounting Policies

 

Goodwill. Goodwill represents the excess of purchase consideration over the fair value of assets acquired less liabilities assumed in a business acquisition. The Company accounts for its goodwill in accordance with the provisions of Statement of Financial Accounting Standards No. 142, “Goodwill and Other Intangible Assets.” Under these rules, goodwill and other intangible assets deemed to have indefinite useful lives are not amortized but are subject to impairment tests at least annually, or more frequently if circumstances occur that indicate impairment may have occurred.

 

Note 2.   Net Income Per Share

 

The following table illustrates the number of shares used in the computation of basic and diluted net income per share (in thousands):

 

 

 

Three Months Ended
September 30,

 

Nine Months Ended
September 30,

 

 

 

2007

 

2006

 

2007

 

2006

 

Denominator for basic income per share: weighted-average shares outstanding during the period

 

18,874

 

18,730

 

18,758

 

19,235

 

Incremental shares attributable to dilutive outstanding stock options

 

147

 

180

 

172

 

184

 

Denominator for diluted income per share

 

19,021

 

18,910

 

18,930

 

19,419

 

 

Anti-dilutive shares excluded from the foregoing reconciliation are 1,657,628, 1,384,952, 1,534,628 and 1,320,250 for the three and nine months ended September 30, 2007 and 2006, respectively.

 

Note 3.   Investments in Marketable Securities

 

During the nine months ended September 30, 2007, the Company purchased short-term state issued securities for $16.5 million and sold $10.0 million of its marketable securities for investment activities.  There were no realized gains or losses upon disposal.  For the three and nine months ended September 30, 2007 and 2006, our interest income on these investments was approximately $69,000 and $18,000 and $144,000 and $97,000, respectively.

 

7



 

Note 4.   Stock-Based Compensation

 

The fair value of each stock option is estimated on the date of grant using the Black-Scholes option pricing model with the following weighted-average assumptions for the three and nine months ended September 30, 2007 and 2006, respectively:

 

 

 

Three Months Ended
September 30,

 

Nine Months Ended
September 30,

 

 

 

2007

 

2006

 

2007

 

2006

 

Stock price volatility

 

42.00

%

77.75

%

59.02

%

77.14

%

Risk-free interest rate

 

4.40

%

4.66

%

4.65

%

4.86

%

Expected life (in years)

 

3.58

 

3.21

 

3.73

 

3.13

 

Forfeiture rate

 

10.45

%

11.81

%

9.84

%

12.19

%

Stock dividend yield

 

N/A

 

N/A

 

N/A

 

N/A

 

Weighted-average fair value per option granted

 

$

2.58

 

$

3.50

 

$

3.11

 

$

4.20

 

 

The following table summarizes stock option activity for the nine months ended September 30, 2007:

 

 

 

Shares

 

Weighted-
Average
Exercise Price

 

Weighted-
Average
Fair Value of
Options Granted

 

Aggregate
Intrinsic
Value

 

Outstanding at December 31, 2006

 

1,851,787

 

$

7.43

 

 

 

 

 

Granted

 

962,610

 

6.65

 

$

3.11

 

 

 

Exercised

 

(103,137

)

2.66

 

 

 

 

 

Cancelled, Forfeited or Expired

 

(259,250

)

7.26

 

 

 

 

 

Outstanding at September 30, 2007

 

2,452,010

 

$

7.35

 

 

 

$

18,010,938

 

Exercisable at September 30, 2007

 

1,248,710

 

$

7.78

 

 

 

$

9,714,112

 

 

The total intrinsic value of options exercised during the nine months ended September 30, 2007 and 2006 was $463,000 and $38,000, respectively.

 

The Company recorded $436,000 and $313,000 and $1.3 million and $942,000 in stock-based compensation expense before income tax benefit for stock options in its results of operations for the three and nine months ended September 30, 2007 and 2006, respectively. As of September 30, 2007, there was $3.5 million of total unrecognized compensation cost related to unvested awards which will be amortized to expense over the weighted-average period of 4.0 years.

 

The Company received $274,000 and $10,000 in cash from option exercises during the nine months ended September 30, 2007 and 2006, respectively. The Company also received $390,000 and $399,000 from the purchase of shares under the ESPP during the nine months ended September 30, 2007 and 2006, respectively. Upon the exercise of options and stock purchase shares granted under the ESPP, the Company issues new common stock from its authorized shares.

 

Note 5.   Acquisitions

 

Project Planning, Incorporated.

 

On February 9, 2007, the Company purchased Project Planning, Incorporated (“PPI”), a provider of consulting, education, and implementation and support services for enterprise project management solutions based in Andover, Massachusetts. The acquisition was made pursuant to a Stock Purchase Agreement dated February 9, 2007. The aggregate purchase price could be up to $15.0 million, which consists of $13.0 million in cash and 333,333 shares of common stock of the Company valued at $6.64 per share. At closing, the Company paid $4.5 million of the cash portion of the purchase price and delivered to the seller 333,333 shares of the Company’s common stock. The Company could pay up to an additional $9.5 million of the remaining cash portion of the purchase price over a three year period upon satisfaction of certain revenue goals.

 

The acquisition was accounted for using the purchase method of accounting whereby the total purchase price, including transaction expenses, was allocated to tangible and intangible assets acquired based on estimated fair market values, with the remainder classified as goodwill. The estimated fair market values were obtained by an independent third party valuation provider. Net tangible assets were valued at their respective historical carrying amounts as these approximate fair values.

 

8



 

The Company acquired identifiable intangible assets of $1.2 million.  Of the identifiable intangibles acquired, $1.1 million has been assigned to customer relationships and $30,000 to non-compete agreements. The acquired intangibles have been assigned definite lives and are subject to amortization, as described in the table below.

 

Intangible Asset Category

 

Amortization Period

Customer relationships

 

6 years

Non-compete agreements

 

3 years

 

The following details the allocation of the purchase price for the acquisition:

 

Cash and cash equivalents

 

$

345

 

Accounts receivable, no allowance

 

1,786

 

Fixed assets, net

 

41

 

Other assets

 

144

 

Assumed liabilities

 

(708

)

Customer relationships

 

1,130

 

Non-compete agreements

 

30

 

Goodwill

 

4,288

 

 

 

$

7,056

 

 

The following represents a summary of the purchase price consideration:

 

Cash

 

$

4,465

 

Issuance of common stock (333,333 shares at $6.64 per share)

 

2,213

 

Other direct acquisition costs

 

378

 

 

 

$

7,056

 

 

Performance Management Associates, Inc.

 

On September 14, 2007, the Company acquired Performance Management Associates, Inc. (“PMA”), an Earned Value Management System (“EVMS”) consulting provider. EVMS is an important project management technique that incorporates cost, scheduling and technical performance measurements to provide an outlook on how a project is progressing and to point out potential issues. The acquisition was made pursuant to a Stock Purchase Agreement dated September 14, 2007. The aggregate purchase price could be up to $5.0 million, which consists of $4.5 million in cash and 80,671 shares of common stock of the Company valued at $6.24 per share. At closing, the Company paid approximately $2.0 million of the $2.5 million cash portion of the purchase price holding back $500,000, which is included in accounts payable, and delivered to the seller 80,671 shares of the Company’s common stock. The Company could pay up to an additional $2.0 million of the remaining cash portion of the purchase price over a three year period upon satisfaction of certain retention, revenue and profit targets.

 

The acquisition was accounted for using the purchase method of accounting whereby the total purchase price, including transaction expenses, was allocated to tangible and intangible assets acquired based on estimated fair market values, with the remainder classified as goodwill. The estimated fair market values were obtained by an independent third party valuation provider. Net tangible assets were valued at their respective historical carrying amounts as these approximate fair values.

 

As part of the purchase, the Company acquired identifiable intangible assets of $981,000.  Of the identifiable intangibles acquired, $962,000 has been assigned to customer relationships and $19,000 to non-compete agreements. The acquired intangibles have been assigned definite lives and are subject to amortization, as described in the table below.

 

Intangible Asset Category

 

Amortization Period

Customer relationships

 

4 years

Non-compete agreements

 

3 years

 

9



 

The following details the preliminary allocation of the purchase price for the acquisition:

 

Cash and cash equivalents

 

$

720

 

Accounts receivable, no allowance

 

1,032

 

Other assets

 

13

 

Assumed liabilities

 

(1,461

)

Customer relationships

 

962

 

Non-compete agreements

 

19

 

Goodwill

 

1,895

 

 

 

$

3,180

 

 

The following represents a preliminary summary of the purchase price consideration:

 

Cash

 

$

2,405

 

Issuance of common stock (80,671 shares at $6.24 per share)

 

503

 

Other direct acquisition costs

 

272

 

 

 

$

3,180

 

 

Unaudited Pro Forma Financial Information

 

The pro forma combined results set forth below are not necessarily indicative of the results that actually would have occurred if the acquisitions of PPI and PMA had been completed as of the beginning of 2006 or 2007, nor are they necessarily indicative of future consolidated results. The following presents the unaudited pro forma combined results of operations of the Company with the acquisitions (in thousands, except for share information).

 

 

 

Three Months Ended
September 30,

 

Nine Months Ended
September 30,

 

 

 

2007

 

2006

 

2007

 

2006

 

Revenue

 

$

25,973

 

$

20,273

 

$

78,579

 

$

61,869

 

Net income

 

$

1,824

 

$

974

 

$

5,256

 

$

4,426

 

Pro forma net income per common share:

 

 

 

 

 

 

 

 

 

Basic

 

$

0.10

 

$

0.05

 

$

0.28

 

$

0.23

 

Diluted

 

$

0.10

 

$

0.05

 

$

0.28

 

$

0.22

 

 

Note 6.   Intangible Assets and Goodwill

 

Intangible Assets

 

Intangible assets consist of amounts related to the 2007 acquisitions, consisting of PPI and PMA. Intangible assets at September 30, 2007 consisted of the following (in thousands):

 

 

 

Amount

 

Weighted
Average
Amortization
Period

 

Client relationships

 

$

2,092

 

4.9

 

Non-compete agreements

 

49

 

3.0

 

 

 

2,141

 

 

 

Less: accumulated amortization

 

(138

)

 

 

Intangible assets, net

 

$

2,003

 

 

 

 

10



 

The total expected future amortization related to intangible assets are as follows for the years ended December 31:

 

(in thousands)

 

Total

 

Non-Compete
Agreements

 

Customer
Relationships

 

2007

 

$

112

 

$

5

 

$

107

 

2008

 

445

 

16

 

429

 

2009

 

445

 

16

 

429

 

2010

 

434

 

5

 

429

 

2011

 

359

 

 

359

 

Thereafter

 

208

 

 

208

 

Totals

 

$

2,003

 

$

42

 

$

1,961

 

 

The Company recorded amortization expense related to the acquired amortizable intangibles of $61,000 and $138,000 during the three and nine months ended September 30, 2007, respectively. The Company had no amortizable intangibles in 2006.

 

Goodwill

 

A summary of goodwill as of September 30, 2007 is as follows (in thousands):

 

 

 

Total

 

Balance as of January 1, 2007

 

$

 

Acquisition of PPI

 

4,288

 

Acquisition of PMA

 

1,895

 

Balance as of September 30, 2007

 

$

6,183

 

 

Note 7.   Credit Facility

 

The Company has a revolving credit agreement which allows for borrowings up to $10.0 million at the prime rate minus one half of one percent (-0.50%) per annum or LIBOR plus two and one quarter percent (2.25%) per annum. The revolving credit agreement is renewable annually on April 30th of each year. Borrowings under the revolving credit agreement are unsecured. The agreement requires the Company to comply with certain financial covenants pertaining to its tangible net worth, ratio of total liabilities to tangible net worth, and ratio of current assets to current liabilities (as defined in the agreement). The agreement also contains certain negative covenants which, among other things, restrict the Company’s ability to incur additional indebtedness of more than $1.0 million in excess of the $10.0 million limit set forth in the credit agreement and make capital expenditures in excess of $3.0 million without the prior written approval of the lender. At September 30, 2007, the Company was in compliance with its covenants and had no outstanding borrowings under the line of credit. The bank had issued a letter of credit for $64,000 and $9.9 million was available.

 

11



 

Note 8.   Stockholders’ Equity

 

The Company’s Board of Directors (“Board”) has previously authorized a plan to repurchase up to $30.0 million of the Company’s common stock. For the nine months ended September 30, 2007 and 2006, the Company repurchased 139,417 shares at a total cost of $842,000 and 1,153,900 shares at a total cost of $7.3 million, respectively. Since the inception of the share repurchase plan, the Company has repurchased 3,354,860 shares at a total cost of $24.2 million. The Company intends to repurchase shares from time to time, at prevailing prices, in the open market. The share repurchase plan may be suspended or discontinued at any time. Shares repurchased under the plan prior to our reincorporation in the state of Delaware were cancelled. After the date of reincorporation (November 30, 2006), the shares are included in treasury shares.

 

A roll-forward of the Company’s stockholders equity for the nine months ended September 30, 2007 is presented below (in thousands, except share data):

 

 

 

Nine Months Ended September 30, 2007

 

 

 

Common
Shares

 

Common
Stock and
Additional
Paid-In
Capital

 

Treasury
Stock

 

Accumulated
Deficit

 

Stockholders’
Equity

 

Balances at December 31, 2006

 

18,502,827

 

$

39,895

 

$

(664

)

$

(7,635

)

$

31,596

 

Proceeds from the issuance of common stock

 

172,161

 

716

 

 

 

716

 

Excess tax benefits from stock-based compensation

 

 

118

 

 

 

118

 

Stock-based compensation expense

 

 

1,285

 

 

 

1,285

 

Repurchased treasury shares

 

(139,417

)

 

(842

)

 

(842

)

Common stock issued for acquisitions

 

414,004

 

2,716

 

 

 

2,716

 

Net income

 

 

 

 

5,289

 

5,289

 

Balances at December 31, 2006

 

18,949,575

 

$

44,730

 

$

(1,506

)

$

(2,346

)

$

40,878

 

 

Note 9.   Commitment and Contingencies

 

The Company entered into employment agreements with its Chief Executive Officer and its President and Chief Operating Officer and into benefit agreements with other executives of the Company (collectively “Agreements”). Under the terms of each of the Agreements, the Company may be obligated to pay a severance payment ranging from six months to one year of the respective employee’s base salary, depending on the date of termination, if the employment is terminated by the Company without cause. In addition, the Agreements have a change of control provisions that may require the Company to pay up to twelve months of current annual base salary and up to eighteen months of health and life insurance benefits.

 

Note 10.  Subsequent Event

 

On November 5, 2007, the Company announced that Mr. Handy, the Company’s Senior Vice President, Chief Financial Officer and Corporate Secretary has put in his resignation from the Company effective November 9, 2007. The Company is actively seeking a replacement and has engaged a national retained search firm for help. In the interim, Dan Hart, Vice President and Controller, will assume the duties of Mr. Handy.

 

12



 

Item 2.   Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

SM&A is the world’s leading provider of competition management (business capture and proposal development) services, and a leading provider of program services (post-award risk mitigation and profit maximizing) services. Under these two service lines, our approximately 350 employees and consultants provide strategy, proposal management, program management, systems engineering, program planning, and other high-value technical support to major industrial customers in the defense, homeland security, aerospace, information technology, and engineering sectors. Since 1982, we have managed more than 1,000 proposals worth more than $340 billion for our clients and have achieved an 85% win rate on awarded contracts.

 

Results of Operations

 

Three Months Ended September 30, 2007 Compared to Three Months Ended September 30, 2006

 

The following table sets forth certain historical operating results (in millions):

 

 

 

Three Months Ended September 30,

 

 

 

2007

 

2006

 

Change

 

 

 

$

 

%

 

$

 

%

 

$

 

%

 

Revenue

 

25.1

 

100.0

 

17.0

 

100.0

 

8.1

 

47.6

 

Cost of revenue

 

15.0

 

59.6

 

10.6

 

62.4

 

4.4

 

41.5

 

Gross margin

 

10.1

 

40.4

 

6.4

 

37.6

 

3.7

 

57.8

 

Selling, general and administrative expenses

 

7.1

 

28.3

 

5.9

 

34.7

 

1.2

 

20.3

 

Operating income

 

3.0

 

12.0

 

0.5

 

2.9

 

2.5

 

500.0

 

Interest income, net

 

0.1

 

0.4

 

0.2

 

1.2

 

(0.1

)

(50.0

)

Income tax expense

 

1.3

 

5.2

 

0.3

 

1.8

 

1.0

 

333.3

 

Net income

 

1.8

 

7.2

 

0.4

 

2.4

 

1.4

 

350.0

 

 

Revenue. Revenue increased $8.1 million, or 47.6%, to $25.1 million for the three months ended September 30, 2007 compared to $17.0 million for the same period of the prior year. The acquisitions completed in fiscal 2007 contributed $2.7 million or 10.8% of total revenue for the three months ended September 30, 2007. The increase in our revenue was realized across all of our service lines and market verticals. The following table is provided to display our revenue results compared to the same period of the prior year.

 

For the three months ended September 30,
(in millions)

 

2007

 

2006

 

% Growth

 

Revenues by Market Vertical

 

 

 

 

 

 

 

Aerospace and Defense (A&D)

 

$

18.1

 

$

12.7

 

43

%

Non Aerospace and Defense (SIIT)

 

7.0

 

4.3

 

63

%

Total

 

$

25.1

 

$

17.0

 

48

%

 

 

 

 

 

 

 

 

Revenues by Service Line

 

 

 

 

 

 

 

Competition Management

 

$

13.6

 

$

9.8

 

39

%

Program Services

 

11.5

 

7.2

 

60

%

Total

 

$

25.1

 

$

17.0

 

48

%

 

Starting in 2006, our focus on expanding our Program Services offerings led to two acquisitions in fiscal 2007. These acquisitions, along with our latest solution offerings, have generated consistent sequential quarterly revenue growth. Our growth has also been generated by our Account Executives’ ability to build valued long term relationships with our clients. Our clients repeatedly engage us for our services as they understand how valuable we are in helping them both win and execute on their competitively awarded programs.

 

Gross Margin. Gross margin increased $3.7 million, or 57.8%, to $10.1 million for the three months ended September 30, 2007 compared to $6.4 million for the same period of the prior year. The increase in gross margin dollars is due to the increase in sales as discussed above and an improvement in our gross margin as a percentage of revenue. As a percentage of revenue, gross margin increased to 40.4% for the three months ended September 30, 2007 compared to 37.6% for the same period of the prior year. The increase was due to an increase in the level of success fees earned and revenue mix. We recorded success fees of $439,000 and $103,000 for the three months ended September 30, 2007 and 2006, respectively. We expect our gross margins to be approximately 39.0% to 40.0% for fiscal year 2007.

 

13



 

Selling, General and Administrative Expenses. Selling, general and administrative expenses (“SG&A”) consist principally of salary and benefit costs for executive, sales and administrative personnel, stock-based compensation, depreciation and amortization, training and recruiting, professional services and other general corporate activities.

 

On July 18, 2007, the Board of Directors accepted the resignation of Cynthia A. Davis as Chief Executive Officer and as a Director, and the Company and Ms. Davis entered into a separation agreement including a mutual release of claims and a payment of $475,000 by the Company. Cathy L. McCarthy was elected as President and Chief Executive Officer following the resignation of Ms. Davis and entered into an employment agreement with the Company, and was granted 200,000 stock options vesting quarterly over four years. Ms. McCarthy was also elected to the Board of Directors. The expense associated with this transition, which includes a payment of $475,000 to Ms. Davis and legal and professional fees of approximately $125,000, are included in SG&A for the three months ended September 30, 2007.

 

The following table is provided to display our SG&A results segregating these areas of cost for comparison purposes:

 

For the three months ended September 30,
(in millions)

 

2007

 

2006

 

% Growth

 

SG&A before stock based compensation, acquisitions, and management transition expenses

 

$

5.6

 

$

5.6

 

0

%

Stock based compensation expense

 

0.4

 

0.3

 

33

%

Acquisitions SG&A

 

0.5

 

 

100

%

Management transition expenses

 

0.6

 

 

100

%

Total SG&A

 

$

7.1

 

$

5.9

 

20

%

 

Excluding stock based compensation expense, acquisitions, and management transition expenses, SG&A was consistent with the prior year and as a percentage of revenue decreased to 22.3% for the three months ended September 30, 2007, as compared to 32.9% for the same period of the prior year.

 

Operating Income. Operating income increased $2.5 million, or 500.0% to $3.0 million for the three months ended September 30, 2007, compared to approximately $500,000 for the same period of the prior year. As a percentage of revenue, operating income increased to 12.0% for the three months ended September 30, 2007, as compared to 2.9% for the same period of the prior year. Operating income increased due to the increase in sales and gross profit offset by an increase in SG&A as discussed above.

 

Income Tax Expense. Our effective income tax rates for the three months ended September 30, 2007 and 2006 were 40.9% and 38.4%, respectively.

 

14



 

Nine Months Ended September 30, 2007 Compared to Nine Months Ended September 30, 2006

 

The following table sets forth certain historical operating results (in millions):

 

 

 

Nine Months Ended September 30,

 

 

 

2007

 

2006

 

Change

 

 

 

$

 

%

 

$

 

%

 

$

 

%

 

Revenue

 

74.2

 

100.0

 

53.0

 

100.0

 

21.2

 

40.0

 

Cost of revenue

 

45.0

 

60.6

 

31.5

 

59.4

 

13.5

 

42.9

 

Gross margin

 

29.2

 

39.4

 

21.5

 

40.6

 

7.7

 

35.8

 

Selling, general and administrative expenses

 

20.6

 

27.8

 

17.3

 

32.6

 

3.3

 

19.1

 

Operating income

 

8.6

 

11.6

 

4.2

 

7.9

 

4.4

 

104.8

 

Interest income, net

 

0.3

 

0.4

 

0.6

 

1.1

 

(0.3

)

(50.0

)

Income tax expense

 

3.6

 

4.9

 

2.0

 

3.8

 

1.6

 

80.0

 

Net income

 

5.3

 

7.1

 

2.8

 

5.3

 

2.5

 

89.3

 

 

Revenue. Revenue increased $21.2 million, or 40.0%, to $74.2 million for the nine months ended September 30, 2007 compared to $53.0 million for the same period of the prior year. The acquisitions we completed in fiscal 2007 contributed $5.8 million or 7.8% of total revenue for the nine months ended September 30, 2007. The increase in our revenue was realized across all of our service lines and our traditional aerospace and defense vertical. The following table is provided to display our revenue results compared to the same period of the prior year.

 

For the nine months ended September 30,
(in millions)

 

2007

 

2006

 

% Growth

 

Revenues by Market Vertical

 

 

 

 

 

 

 

Aerospace and Defense (A&D)

 

$

58.0

 

$

39.0

 

49

%

Non Aerospace and Defense (SIIT)

 

16.2

 

14.0

 

16

%

Total

 

$

74.2

 

$

53.0

 

40

%

 

 

 

 

 

 

 

 

Revenues by Service Line

 

 

 

 

 

 

 

Competition Management

 

$

42.9

 

$

33.0

 

30

%

Program Services

 

31.3

 

20.0

 

57

%

Total

 

$

74.2

 

$

53.0

 

40

%

 

Starting in 2006, our focus on expanding our Program Services offerings led to two acquisitions in fiscal 2007. These acquisitions, along with our latest solution offerings, have generated consistent sequential quarterly revenue growth. Our growth has also been generated by our Account Executives’ ability to build valued long term relationships with our clients. Our clients repeatedly engage us for our services as they understand how valuable we are in helping them both win and execute on their competitively awarded programs.

 

Gross Margin. Gross margin increased $7.7 million, or 35.8%, to $29.2 million for the nine months ended September 30, 2007 compared to $21.5 million for the same period of the prior year. The increase in gross margin dollars is due to the increase in sales as discussed above offset by a decrease in gross margin as a percentage of revenue. As a percentage of revenue, gross margin decreased to 39.4% for the nine months ended September 30, 2007 compared to 40.6% for the same period of the prior year. The decline was due to a reduction in the level of success fees earned and revenue mix. We recorded success fees of $557,000 and $910,000 for the nine months ended September 30, 2007 and 2006, respectively. We expect our gross margins to be approximately 39.0% to 40.0% for fiscal year 2007.

 

Selling, General and Administrative Expenses. Selling, general and administrative expenses consist principally of salary and benefit costs for executive, sales and administrative personnel, stock-based employee compensation, depreciation and amortization, training and recruiting, professional services and other general corporate activities.

 

On March 31, 2007, the Company’s Chairman and Chief Executive Officer, Steven S. Myers, retired and on April 1, 2007, was replaced by Cynthia Davis as Chief Executive Officer. Ms. Davis was also elected to the Board of Directors. A current board member, Dwight Hanger, replaced Mr. Myers as Chairman of the Board. The expense associated with this transition, which includes a retirement payment of $500,000 and legal and professional fees of approximately $200,000, are included in SG&A for the nine months ended September 30, 2007.

 

15



 

Subsequently, effective July 18, 2007, the Board of Directors accepted the resignation of Cynthia A. Davis as Chief Executive Officer and as a Director, and the Company and Ms. Davis entered into a separation agreement including a mutual release of claims and a payment of $475,000 by the Company. Cathy L. McCarthy was elected as President and Chief Executive Officer following the resignation of Ms. Davis and entered into an employment agreement with the Company, and was granted 200,000 stock options vesting quarterly over four years. The expense associated with this transition, which includes a payment of $475,000 to Ms. Davis and legal and professional fees of approximately $125,000, are included in SG&A for the nine months ended September 30, 2007.

 

The following table is provided to display our SG&A results segregating these areas of cost for comparison purposes:

 

For the nine months ended September 30,
(in millions)

 

2007

 

2006

 

% Growth

 

SG&A before stock based compensation, acquisitions, and management transition expenses

 

$

16.8

 

$

16.4

 

2

%

Stock based compensation expense

 

1.3

 

0.9

 

44

%

Acquisitions SG&A

 

1.2

 

 

100

%

Management transition expenses

 

1.3

 

 

100

%

Total SG&A

 

$

20.6

 

$

17.3

 

19

%

 

SG&A expenses increased $3.3 million, or 19.1%, to $20.6 million for the nine months ended September 30, 2007, as compared to $17.3 million for the same period of the prior year. Excluding stock based compensation, acquisitions, and management transition related expenses, SG&A as a percentage of revenue decreased to 22.6% for the nine months ended September 30, 2007, as compared to 30.9% for the same period of the prior year. The current period increase of approximately $400,000, excluding the items noted in the table above, was due to increased recruiting and training expenses associated with our strong revenue growth.

 

Operating Income. Operating income increased $4.4 million, or 104.8% to $8.6 million for the nine months ended September 30, 2007, compared to $4.2 million for the same period of the prior year. As a percentage of revenue, operating income increased to 11.6% for the nine months ended September 30, 2007, as compared to 7.9% for the same period of the prior year. Operating income primarily increased due to the increase in sales offset by a decrease in gross profit as a percentage of sales and an increase in selling, general and administrative expenses, as discussed above.

 

Income Tax Expense. Our effective income tax rates for the nine months ended September 30, 2007 and 2006 were 40.6% and 40.8%, respectively.

 

Capital Resources and Liquidity

 

Our working capital increased to $29.1 million at September 30, 2007 from $28.4 million at December 31, 2006. In addition, our cash and cash equivalents plus investments decreased to $9.3 million at September 30, 2007, from $15.1 million at December 31, 2006. The decrease in cash and cash equivalents plus investments was due to the funds used for acquisitions of approximately $6.0 million, our share buyback activity in which the Company repurchased $842,000 of common shares during the nine months ended September 30, 2007, and the increase in the number of day’s sales outstanding (“DSO”). Periodically, when our larger client’s contracts are under renewal we are authorized to continue providing our services while the extended contract is being processed. This process can take two to three months to finalize at which time we invoice all unbilled amounts. Our clients will typically pay the balances within 60 days upon receipt of our invoices. As the majority of these renewals have been completed, we expect to reduce our DSO’s to approximately our historical average DSO of 70 days before the end of this fiscal year.

 

We believe we have sufficient working capital available under the line of credit and that cash generated by continuing operations will be sufficient to fund operations for at least the next twelve months.

 

16



 

Item 3.   Quantitative and Qualitative Disclosures About Market Risk

 

The Company currently has no instruments that are sensitive to market risk.

 

Item 4.   Controls and Procedures

 

Evaluation of Disclosure Controls and Procedures

 

Our management, with the participation of our principal executive officer and principal financial officer, has evaluated the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended) as of the end of the period covered by this quarterly report on Form 10-Q. Based on this evaluation, our principal executive officer and principal financial officer concluded that these disclosure controls and procedures are effective and designed to ensure that the information required to be disclosed in our reports filed or submitted under the Securities Exchange Act of 1934 is recorded, processed, summarized, and reported within the requisite time periods.

 

While the Company’s disclosure controls and procedures provide reasonable assurance that the appropriate information will be available on a timely basis, this assurance is subject to limitations inherent in any control system, no matter how well designed and administered.

 

Changes in Internal Controls

 

There was no change in our internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Securities Exchange Act of 1934, as amended) identified in connection with the evaluation of our internal control performed during our last fiscal quarter that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

 

17



 

PART II - OTHER INFORMATION

 

Item 1.   Legal Proceedings

 

We are involved in routine litigation incidental to the conduct of our business. There are currently no material pending litigation proceedings to which we are a party or to which any of our property is subject.

 

Item 2.   Unregistered Sales of Equity Securities and Use of Proceeds

 

Issuance of Unregistered Securities

 

As previously disclosed in the Current Report on Form 8-K filed by the Company on September 19, 2007, the Company issued 80,671 shares of its common stock to the stockholders of PMA on September 14, 2007, as partial consideration in the amount of approximately $500,000 for the acquisition by the Company of all of the outstanding capital stock of PMA from those stockholders. The issuance of these shares of common stock was made in reliance on the exemption from registration provided by Section 4(2) of the Securities Act of 1933.

 

Issuer Purchases of Equity Securities

 

Information about securities purchased under the Company’s share repurchase program is incorporated by reference to Note 8 to the condensed consolidated financial statements.

 

Period

 

Total Number
of Shares
Purchased

 

Average
Price Paid
Per Share

 

Total Number
of Shares
Purchased as
Part of a
Publicly
Announced
Plan

 

Approximate
Dollar Value of
Shares That
May Yet Be
Purchased
Under The Plan

 

Beginning balance at January 1, 2007

 

3,215,443

 

$

7.27

 

3,215,443

 

$

6,639,411

 

January 2007

 

139,417

 

6.04

 

3,354,860

 

5,797,093

 

February 2007

 

 

 

 

 

March 2007

 

 

 

 

 

April 2007

 

 

 

 

 

May 2007

 

 

 

 

 

June 2007

 

 

 

 

 

July 2007

 

 

 

 

 

August 2007

 

 

 

 

 

September 2007

 

 

 

 

 

Total as of September 30, 2007

 

3,354,860

 

$

7.21

 

3,354,860

 

$

5,797,093

 

 

Item 3.  Defaults Upon Senior Securities

 

Not Applicable.

 

Item 4.  Submission of Matters to a Vote of Security Holders

 

None.

 

Item 5.  Other Information

 

None.

 

18



 

Item 6.   Exhibits

 

INDEX TO EXHIBITS

 

Exhibits (numbered in accordance with item 601 of Regulation S-K).

 

2.1           Stock Purchase Agreement, by and among Project Planning Inc., Richard Bowe, its Shareholder, and SM&A.

Filed on February 12, 2007 as Exhibit 99.2 to the registrant’s Current Report on Form 8-K and incorporated herein by reference.

 

2.2           Stock Purchase Agreement, by and among Performance Management Associates, Inc., James A. Wrisley and Paulette Wrisley, its Shareholders, and SM&A.

Filed on September 19, 2007 as Exhibit 10.1 to the registrant’s Current Report on Form 8-K and incorporated herein by reference.

 

3.1           Amended and Restated Articles of Incorporation, a California corporation.

Filed on March 15, 2002 as Exhibit 3.1 to the registrant’s Annual Report on Form 10-K and incorporated herein by reference.

 

3.2           Amended and Restated Bylaws of the Registrant, a California corporation.

Filed on May 3, 2002 as Exhibit 3.2 to the registrant’s Quarterly Report on Form 10-Q and incorporated herein by reference.

 

3.3           Certificate of Incorporation of SM&A, a Delaware corporation.

Filed on December 6, 2006 as Exhibit 3.1 to the registrant’s Current Report on Form 8-K and incorporated herein by reference.

 

3.4           Bylaws of SM&A, a Delaware corporation.

Filed on December 6, 2006 as Exhibit 3.3 to the registrant’s Current Report on Form 8-K and incorporated herein by reference.

 

3.5           Agreement and Plan of Merger, between SM&A, a California corporation, and SM&A, a Delaware corporation.

Filed on December 6, 2006 as Exhibit 2.1 to the registrant’s Current Report on Form 8-K and incorporated herein by reference.

 

10.3         Employment Agreement of Cathy L. McCarthy

Filed on July 23, 2007 as Exhibit 10.1 to the registrant’s Current Report on Form 8-K and incorporated herein by reference.

 

10.5         Separation Agreement of Cynthia A. Davis.

Filed on July 23, 2007 as Exhibit 10.2 to the registrant’s Current Report on Form 8-K and incorporated herein by reference.

 

10.7         Employment Agreement of James A. Wrisley.

Filed on September 19, 2007 as Exhibit 10.2 to the registrant’s Current Report on Form 8-K and incorporated herein by reference.

 

31.1         Certificate of Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

Filed herewith.

 

31.2         Certificate of Chief Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

Filed herewith.

 

32            Certification of Chief Executive Officer and Chief Financial Officer Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

Filed herewith.

 

19



 

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.

 

 

SM&A

 

 

(Registrant)

 

 

 

 

Dated: November 7, 2007

/s/ STEVE D. HANDY

 

 

Steve D. Handy

 

Senior Vice President, Chief Financial Officer

 

and Secretary

 

 

 

 

Dated: November 7, 2007

/s/ CATHY McCARTHY

 

 

Cathy McCarthy

 

President and Chief Executive Officer

 

20