ITEM 1. GENERAL DESCRIPTION OF THE BUSINESS
Halifax Corporation, headquartered in Alexandria, Virginia, is principally focused on providing a comprehensive range of technology services. The Company operates in two principal business segments: technology services and facilities management.
Technology Services includes the integration, systems engineering, installation, maintenance and training for computer systems and communications systems. Other primary services provided include interactive technologies including website design, development and marketing, Internet/Intranet services, multimedia sales and educational tools and year 2000 desktop solutions for enterprise PC hardware and software compliance. Facilities Management includes the management, operations and maintenance support of prisons, waterways, major office complexes and communications sites. Footnote 16 to the accompanying financial statements highlights the Company's industry segments.
The Company's information technology services segment provides a complete array of IT services including but not limited to:
- Seat Management (providing a cradle-to-grave personal computer resource): Needs assessment, planning, procurement, configuration, implementation, training and help desk support. - Networks: Design, implementation and management - Interactive Applications: Web site design, web hosting and e-commerce - Y2K: Assessment, remediation, validation and contingency planning
The Company provides computer maintenance including a full spectrum of repair and upgrade services for a wide range of technologies installed in more than 20,000 locations across the United States. It offers on-site support, depot support, and asset management services. Additionally, the Company engineers, installs and maintains telecommunications systems and networks on a worldwide basis.
The Company's facilities management and outsourcing segment provides complete facilities and maintenance outsourcing capabilities to assist institutional, government and commercial clients in outsourcing facility operations.
While the Company has performed its services in both the national and international marketplaces, the Company continues to concentrate its activities in Virginia, Maryland and Pennsylvania. In this regard, the Company's current strategy is to continue to develop an important presence in the eastern United States, while seeking to provide services nationwide and internationally for selected engagements.
The Company's general business strategy is to secure a prominent position as a leading provider of a broad range of information technology services to address the needs of a marketplace which continues to increase its dependency on technology.
Investment in the Company involves various risks. Additionally, certain of the information contained herein may be deemed to constitute "forward looking statements". Reference is made to Item 7 hereof.
HISTORY
The Company was incorporated in Virginia in 1967 as Halifax Engineering, Inc., the successor to the business begun as a sole proprietorship in 1967. On April 1, 1970, Halifax acquired the Field Service Division of United Industries. This expanded the business base in technical services and field engineering.
On June 30, 1993, the Company acquired the services division of Electronic Associates, Inc. The division expanded the Company's non-federal business and provided an additional service line for simulator operations, maintenance and integration.
On April 1, 1996, the Company completed the acquisition of privately held CMS Automation, Inc. "CMSA", a Richmond, Virginia computer systems integration company. On April 23,1997, the name of CMSA was changed to Halifax Technology Services Company ("HTSC").
On November 25, 1996, the Company, through its wholly owned subsidiary, CMSA, acquired the ongoing computer network integration business of Consolidated Computer Investors, Inc. ("CCI") of Hanover, Maryland. The combined entity name was changed to Halifax Technology Services Company (HTSC), a wholly owned subsidiary of Halifax Corporation. On April 1, 1999, HTSC was merged into Halifax Corporation and began operating as the Technology Services Division of the Company.
The Company maintains its principal executive offices at Halifax Office Park, 5250 Cherokee Avenue, Alexandria, Virginia 22312. Its telephone number is (703) 750-2202 and its internet website is www.hxcorp.com.
RECENT DEVELOPMENTS
Embezzlement Matter
On March 18, 1999, the Company announced that an internal investigation had revealed an apparent material embezzlement by the former controller of one of the Company's subsidiaries. The embezzlement occurred at, and was confined to, the Company's Richmond, VA based Halifax Technology Services Company ("HTSC"). At the time of the embezzlement, HTSC was a wholly owned subsidiary of Halifax Corporation, which resulted from a merger of CMSA (acquired by Halifax on April 1, 1996), and CCI (acquired by Halifax on November 25, 1996). On April 1, 1999, HTSC was merged into Halifax Corporation and is now a division of the Company.
The Company believes that a single individual, the former controller of HTSC, perpetrated the embezzlement. She was immediately terminated, has since been indicted, has pleaded guilty, and currently awaits sentencing. Under the terms of an agreement entered into with the Company, she is cooperating with the Company's recovery efforts.
The embezzlement occurred over a period of nearly four years and aggregated approximately $15.4 million, of which $15 million was embezzled from the Company and $400,000 from CMSA before it was acquired by Halifax. To conceal the embezzlement in the accounting records, the former controller made fraudulent adjustments totaling more than $21 million. Of the $21 million, the $15.0 million embezzled was recorded in the Company's statements of operations and balance sheets after the acquisition, approximately $2.2 million related to amounts reflected in the acquisition date balance sheet, and approximately $3.8 million related to other overstatements of operating results during the three year period subsequent to the CMSA acquisition.
Under the terms of an agreement with the Company, the embezzler has transferred certain assets back to the Company. Some of the recovered assets have been converted into approximately $1.4 million in cash as of August 31, 1999. With an estimated $1.1 million of assets awaiting conversion to cash, the Company estimates approximately $2.5 million will ultimately be recovered from the embezzler. In addition, the full policy amount of $1 million from each of two separate theft insurance polices, or an aggregate of $2 million, has been received to date. Therefore, from these sources, the Company expects a total recovery of $4.5 million (excluding recovery costs) . The Company estimates that, net of recovery costs, approximately $3.5 million will be recovered. At March 31, 1999, the Company had received approximately $670,000 from its recovery efforts and recorded a $2.83 million recovery receivable to recognize its expectation of receiving the estimated $3.5 million of total net recoveries. See Note 4 to the consolidated financial statements.
Due to the corresponding overstatement of taxable income, reported by the Company during the period of the embezzlement, the Company will file for a tax refund of approximately $808,000. The receivable is recorded in "Income Taxes Receivable" in the consolidated financial statements.
The embezzlement had a material effect on the Company's financial statements for fiscal years 1999, 1998 and 1997. In addition to the correction for overstated assets and understated liabilities, the Company recorded an embezzlement loss of approximately $2,593,000, $6,044,000 and $2,892,000 for the fiscal years ended March 31, 1999, 1998 and 1997, respectively. The embezzlement loss recorded in fiscal 1999 is net of the actual and projected net recoveries aggregating $3,500,000.
In addition to the notification and involvement of the appropriate authorities, and the intensive and ongoing investigative efforts, the Company has taken other important steps as a result of the embezzlement. The Board of Directors appointed a special committee of the Board to focus on the recovery of assets taken from the Company and minimization of the damages sustained as a result of the embezzlement.
The employment contract of the HTSC president was not renewed, and he is no longer employed by the Company. Furthermore, new executives have been hired to manage the technology services division and to consolidate the Company's financial and administrative activities. The Company has also transferred key accounting and cash management functions of HTSC to Company headquarters.
FEDERAL GOVERNMENT CONTRACTS
A significant portion of the Company's revenues have historically been derived from contracts or subcontracts with the United States Government. In fiscal years 1999, 1998 and 1997, the Company received revenues from 32, 95 and 183 Government contracts, respectively, which accounted for approximately 45%, 35% and 47%, respectively, of the Company's total revenues. In fiscal 1999 and 1998, the number of contracts does not separately reflect the task orders completed under IDIQ (Indefinite Delivery Indefinite Quantity) contracts compared to 1997. The embezzlement matter did not involve or affect the Company's fulfillment of its Government contracts nor its accounting thereof and its detection did not trigger any termination provisions.
The services of the Company are performed under cost reimbursable, time-and-materials and fixed-price contracts and subcontracts. Under cost reimbursable contracts the Government reimburses the Company for its allowable costs permitted by Government regulations and pays the Company a negotiated fixed fee, incentive fee, award fee or combination thereof. Under time-and-materials contracts, the Company receives a fixed hourly rate intended to cover salary costs attributable to work performed on the contracts and related indirect expenses, as well as a profit margin, and reimbursement for other direct costs. Under fixed-price contracts, the Government pays the Company an agreed-upon price for services rendered. In addition, under certain fixed price contracts, incentive fees are allowed if established performance goals are met or exceeded and penalties are imposed if goals are not attained. Under fixed-price contracts and time-and-materials contracts, the Company bears any risk of increased or unexpected costs that may reduce its profits or cause it to sustain losses.
The Company's Government contracts and subcontracts are subject to termination, reduction or modification as a result of changes in the Government's requirements or budgetary restrictions. When the Company participates as a subcontractor, it is subject to the risk that the primary contractor may fail or become unable to perform the prime contract.
All Government contracts are subject to termination at the convenience of the Government. If a contract were to be terminated for convenience, the Company would be reimbursed for its allowable costs incurred up to the date of termination and would be paid a proportionate amount of the stipulated profits or fees attributable to the work actually performed. Since the inception of the Company's federal Government contracting activities, the Government has only terminated four contracts with the Company for convenience.
Contracts with the Government are generally complex in nature, and require Halifax to comply with numerous Federal regulations regarding discrimination in the hiring of personnel, fringe benefits for employees, safety, safeguarding classified information, responsibility for Government property, fire prevention, equipment maintenance, record keeping and accounting, management qualifications, drug free work place and numerous other matters. The Company has not experienced any material difficulty in complying with applicable federal regulations.
The Company is sensitive to the present climate in the Government with respect to fraud, waste and abuse, and has adopted a Code of Business Ethics and Standards of Conduct and associated Company procedures. In addition, all employees receive training in ethics and associated Company procedures and a hot line has been established to encourage reporting of potential ethical violations.
Under certain circumstances the Government can suspend or debar individuals or firms from obtaining future contracts with the Government for specified periods of time. Any such suspension or debarment could have a material adverse effect upon the Company. The books and records of the Company are subject to audit by the Defense Contract Audit Agency (DCAA), which can result in adjustments to contract costs and fees. Audits by DCAA have been completed for years through fiscal year 1995 with minimal adjustment to the Company's cost accounting records and contract revenue reimbursement.
COMMERCIAL AND STATE/MUNICIPAL GOVERNMENT CONTRACTS
The Company continues to work towards expanding its commercial and state/municipal government business. Commercial revenues are being pursued by targeting non-federal and outsourcing opportunities. The Company's expanding development of computer network solutions, integration and management services follows from its prior acquisition strategy where these basic capabilities were brought into the Company. State/municipal government contracts may expand from privatization opportunities.
The following table reflects the distribution of revenues by type of customer (see Item 7 for further discussion):
TYPE OF CONTRACTS
The following table reflects, by type of contract, the amount of revenues derived for the periods indicated:
ACCOUNTS RECEIVABLE
Trade accounts receivable at March 31, 1999 and 1998 represented 61% and 53% of total assets, respectively. Accounts receivable are comprised of billed receivables and unbilled receivables. Billed receivables represent invoices presented to the Customer. Unbilled receivables represent future payments due from the Customer for which invoices will not be presented until a later period. The reasons that invoices are not presented may be categorized as follows: (1) fee and cost retainage rights of the Government; (2) billable documents in transit; (3) excess of actual direct and indirect costs over amounts currently billable under cost reimbursement contracts to the extent they are expected to be billed and collected; and (4) amounts in excess of billings arising on fixed-price contracts from recognition of revenues under the percentage of completion method.
The financing of receivables requires bank borrowings and the payment of associated interest expense. Interest expense is not reimbursable under Government contracts.
For a summary of the amounts of retainages and unbilled receivables as of March 31, 1999 and 1998, see Note 4 to the consolidated financial statements.
BACKLOG
The Company's funded backlog for services as of March 31, 1999, 1998 and 1997 was $33,000,000, $45,000,000, and $29,000,000, respectively. "Funded" backlog represents commercial orders and Government contracts to the extent that funds have been appropriated by Congress and allotted to the contract by the procuring Government agency. Some of the Company's contract orders provide for potential funding materially in excess of the monies initially provided by the Government. Additional monies are subsequently and periodically authorized in the form of incremental funding documents. The excess of potential future funding over funding provided represents unfunded backlog. A majority of the Company's customer orders or contract awards and extensions for contracts previously awarded are received or occur at various times during the year and may have varying periods of performance. The increased level of funded backlog at March 31, 1998 resulted from the timing of orders received on a digital communication switch contract with the United States Army. Depending upon the volume and timing of orders received on this multi year Indefinite Delivery Indefinite Quantity ("IDIQ") contract, revenue realized may exceed 10% of revenue although no assurances can be given. In fiscal 1999, revenues from this contract amounted to approximately $12.2 million.
As of March 31, 1999, based on total amounts bid on contracts awarded, the Company's five-year potential revenues for work remaining to be performed under existing contracts are approximately $433,000,000. The unfunded portion is $400,000,000 which includes $101,000,000 in options and $299,000,000 in undefinitized work. The realization of these potential revenues is dependent upon a variety of contract contingencies beyond the control of the Company, such as complete funding and the exercise of all existing contract options by the Government and commercial clients. There can be no assurance that such revenues will be realized.
Commercial contracts do not typically have multi-year options, and accordingly, related backlog levels are not significantly increasing in proportion to total revenues.
MARKETING
The Company contracts with the Federal Government, State/Local Governments and commercial entities, each of which requires a different marketing approach. The Federal Government maintains that it buys from companies rather than having companies sell to it, and marketing is more related to keeping abreast of the Government's specified needs versus building markets within the Government for the Company's services. However, the Company conducts a large portion of its business within the commercial and state/local government sectors, and consequently uses traditional marketing approaches to determine commercial customer needs and to enhance the chances that its services will be considered for those needs.
The Company's ability to compete successfully for Government work is largely dependent on recognizing Government requirements and opportunities, the submission of responsive and cost-effective proposals, and a reputation for the successful completion of government contracts. Recognition of Government requirements and opportunities come from inclusion on bidders lists, from participation in activities of professional organizations and from literature published by the Government and other organizations.
Commercial marketing involves the determination of customer needs that match the services offered by the Company, and this is accomplished through individuals who conduct sales calls, attend trade shows, and build a network of customer knowledge and confidence in the Company. Those activities, along with the development of strategic alliances and the reputation the Company has built, represent the normal manner in which the Company's commercial business is obtained.
COMPETITION
The Company has numerous competitors in all areas in which it does business. Some competitors are large diversified firms having substantially greater financial resources and larger technical staffs than the Company, including, in some cases, the manufacturers of the systems being supported. Government in-house capabilities can also be deemed to be competitors of the Company in that they perform certain services which might otherwise be performed by the Company. It is not possible to predict the extent of competition which present or future activities of the Company will encounter because of changing competitive conditions, customer requirements, technological developments and other factors. The principal competitive factors for the type of service business in which the Company is engaged are technology skills, quality, responsiveness, ability to perform within estimated time and expense limits and pricing.
PERSONNEL
On March 31, 1999, the Company had 649 employees of whom 85 were part time. Because of the nature of services provided, many employees are professional or technical personnel with high levels of training and skills, including engineers, and skilled technicians and mechanics. The Company believes its employee relations are excellent. Although many of the Company's personnel are highly specialized and there is a nationwide shortage of certain qualified technical personnel, the Company has not experienced material difficulties obtaining the personnel required to perform under its contracts and generally does not bid on contracts where difficulty may be encountered in hiring personnel. The Company interfaces with labor unions on four of its federal and state/local government contracts. To date, relations with these unions have been excellent. Management believes that the future growth and success of the Company will depend, in part, upon its continued ability to retain and attract highly qualified personnel.
ITEM 2.
ITEM 2. PROPERTIES
On November 6, 1997, the Company sold the twin-building office complex for $5,250,000 and leased back the Company's headquarters building. The transaction generated other income of $1,490,000 of which $715,000 is being amortized over the 12 year lease-back of its headquarters building. The net sale proceeds were applied to the reduction of debt.
The Company is obligated under 14 short-term facility leases connected with its operations.
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS
There are no material pending legal proceedings to which the Company is a party. The Company is engaged in ordinary routine litigation incidental to the Company's business to which the Company is a party.
ITEM 4.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of the security holders in the fourth quarter of fiscal 1999.
PART II
ITEM 5.
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
The Company's Common Stock, par value $0.24, is listed on the American Stock Exchange. Due to the material nature of the embezzlement matter (see Item 1 and Note 2 to the consolidated financial statements), the Company and the American Stock Exchange halted trading of the Company's stock on March 17, 1999, while the Company developed definitive disclosure on the matter. The Company can give no assurances as to when trading may resume.
At September 7, 1999, there were approximately 743 holders of record of the Company's Common Stock as reported by the Company's transfer agent.
The following table sets forth the quarterly range of high and low sales prices on the American Stock Exchange.
In fiscal 1999, the Company paid a cash dividend of $0.05 per share on June 10, 1998, September 10, 1998, December 10, 1998 and March 10, 1999 to shareholders of record on May 20, 1998, August 21, 1998, November 25, 1998 and February 24, 1999, respectively.
In fiscal 1998, the Company paid a cash dividend of $0.05 per share on June 10, 1997, September 10, 1997, December 10, 1997 and March 10, 1998 to shareholders of record on May 27, 1997, August 27, 1997, November 26, 1997 and February 26, 1998, respectively.
In fiscal 1997, the Company paid a cash dividend of $0.043 per share on June 10, 1996 to shareholders of record on May 24, 1996, cash dividends of $0.047 per share on September 10, 1996 and December 10, 1996 to shareholders of record on August 22, 1996 and November 27, 1996, respectively, and a cash dividend of $0.05 per share on March 10, 1997 to shareholders of record on February 21, 1997.
The Company did not declare a cash dividend to be paid in the first quarter of fiscal year 2000 and there is no assurance it will do so in future periods. Amendments, dated June 23, 1999 and September 7, 1999, to the current bank loan agreement prohibit the payout of dividends.
ITEM 6.
ITEM 6. SELECTED FINANCIAL DATA
The following table includes certain selected financial data (fiscal 1998 and 1997 are restated) of the Company for the fiscal years and periods indicated (amounts in thousands except per share data):
ITEM 7.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Certain statements under the caption "Management's Discussion and Analysis of Financial Condition and Results of Operations" and elsewhere in this Annual 10-K Report constitute "forward-looking statements" within the meaning of the United States Private Securities Litigation Reform Act of 1995. Such forward-looking statements involve known
and unknown risks, uncertainties and other factors which may cause the actual results, performance or achievements of the Company, or industry results, to be materially different from any future results, performance, or achievements expressed or implied by such forward-looking statements. Such factors include, among others, the following: general economic and business conditions in the Company's market area, inflation, continuation of favorable banking arrangements, the availability of capital to finance planned growth, ramifications regarding the embezzlement matter changes in government regulations and competition, which may, among other things affect the ability of the Company to implement its business strategy.
Forward-looking statements are intended to apply only at the time they are made. Moreover, whether or not stated in connection with a forward-looking statement, the Company undertakes no obligation to correct or update a forward-looking statement should the Company later become aware that it is not likely to be achieved. If the Company were to update or correct a forward-looking statement, investors and others should not conclude that the Company will make additional updates or corrections thereafter.
Readers are referred to the "Factors that May Affect Future Results" section within this Item 7 of Form 10-K which identifies important risk factors that could cause actual results to differ from those contained in the forward-looking statements.
As more fully discussed in Note 2 to the financial statements, on March 18, 1999, the Company announced that an internal investigation had revealed an apparent material embezzlement by the former controller of one of the Company's subsidiaries. The embezzlement matter had a material effect on the Company's financial statements for fiscal years 1999, 1998 and 1997, and accordingly, the Company's previously reported financial statement for 1998 and 1997 have been restated.
The following discussion should be read in conjunction with the consolidated financial statements and notes thereto. All information is based on the Company's fiscal year ended March 31. (Tabular information: dollars in thousands, except per share amounts).
Revenues
1999 consolidated revenues increased by 11% from 1998, principally due to increased orders delivered on a new digital communications switch contract with the United States Army and the ramping up of a new facilities management contract with HUD.
1998 consolidated revenues decreased modestly (2%) from 1997, primarily because of a large revenue gap created by the completion of a major digital switch contract with the United States Army and the subsequent delay in the award and implementation of a similar but larger contract.
1999 technology services revenues increased 5% from $59.2 million in 1998 to $62.2 million in 1999 primarily due to the increased orders delivered on the new digital communications switch contract. 1998 technology service revenues decreased 2% in 1998 to $59.2 from $60.2 in 1997 primarily because of the gap in revenue between the predecessor digital communications switch contract and its follow on contract.
1999 facilities management revenues increased 34% from $14.6 million in 1998 to $19.6 million in 1999 primarily due to the ramping up of a new facilities management contract with HUD. 1998 facilities management revenues of $14.6 million was consistent with 1997 revenues of $14.9 million.
Operating Costs and Expenses
The Company's 1999 cost of services increased 14%, which was somewhat larger than the comparable revenue increase of 11%. Cost of services for 1999 rose at a more rapid rate than revenue due to lower profit margins permitted by the government on a new digital communications switch contract and a rampup of marketing and service efforts in the technology segment. In addition, the 1999 costs of services reflects a significant provision for inventory obsolescence and shut down costs for the closing of an unprofitable computer maintenance contract. Also the increase in costs as a percentage of revenues in 1999 reflects costs associated with pursuing the higher margin services component of information technology business.
The 1998 cost of services decreased from 1997 in relative proportion to the decrease in revenues from the prior year.
General and administrative expenses (G&A) declined 6% in 1999 from 1998 primarily due to controlling facililty and insurance costs and lower depreciation charges. They increased 4% in 1998 from 1997 primarily because of higher office rental cost after the sale and lease back of the Company's headquarters and increased printing costs.
Operating Income
Operating income decreased by $1,719,000 in 1999 principally due to a sales mix shift within the technology segment which resulted in tighter margins on the new telecommunications switch contract, increased provision for inventory obsolescence and shut-down costs for the closing of an unprofitable computer maintenance contract.
Operating income increased by $939,000 (467%) in 1998 as compared to 1997 as a result of reengineering of the computer maintenance services in the technology segment, and higher margins experienced in the facilities segment on maintenance contracts.
Interest and Other Income or Expense
Interest expense declined 5% in 1999 principally due to a decline in effective interest rates. Interest expense increased 62% in 1998 as compared to 1997 as a result of increases in outstanding borrowings. Other expense in 1999 was related to one-time writeoffs of certain fixed assets. Other income increased by 156% in 1998 as compared to 1997 principally due to gains arising from the sale/leaseback of corporate headquarters.
Embezzlement Loss
Embezzlement losses reflect the cash amounts embezzled from the Company. The embezzlement loss in 1999 is net of $3.5 million of total net recoveries realized and/or anticipated from certain recovered assets (net of recovery costs) and insurance proceeds. For additional discussion, see "Embezzlement Matter" in Item 1 and Note 2 of the consolidated financial statements.
Income Taxes
As a result of the Company's losses, federal and state tax refunds of approximately $808 thousand are anticipated from taxes paid for previous periods and have been recorded as a receivable as of March 31, 1999. In addition, the Company has net operating loss carryforwards amounting to approximately $12,500,000 which expire in 2019. Due to the uncertainty of future realization, the Company has not recorded a net benefit for these operating loss carry forwards in its financial statements.
Factors That May Affect Future Results
The Company's future operating results may be affected by a number of factors including uncertainties relative to national economic conditions, especially as they affect interest rates, industry factors, the Company's ability to successfully increase its business and effectively manage expense margins.
The Company must continue to effectively manage expense margins in relation to revenues by directing new business development towards markets that complement or improve existing service lines. The Company must also continue to emphasize operating efficiencies through cost containment strategies, reengineering efforts and improved service delivery techniques.
The Company serves its customer base by providing consulting, integration, networking, maintenance and installation services. This industry has been characterized by rapid technological advances that have resulted in frequent introduction of new products, product enhancements and aggressive pricing practices, which also impacts pricing of service activities. The Company's operating results could be adversely affected by industry-wide pricing pressures, the ability of the Company to recruit, train and retain personnel integral to the Company's operations and the presence of competitors with greater financial and other resources. Also, the Company's operating results could be adversely impacted should the Company be unable to effectively achieve the revenue growth necessary to provide profitable operating margins in various operations. The Company's plan for growth includes intensified marketing efforts, an expanding commercial sales program, strategic alliances and, where appropriate, acquisitions that expand market share. There can be no assurances these efforts will be successful.
At March 31, 1999, the Company's working capital of $736,000 and current ratio of 1.02 indicate the diminution in the Company's financial strength caused by the embezzlement matter which resulted in the use of cash in operations during the three fiscal years ended March 31, 1999. In October and November 1998 in a series of private placements, the Company issued $2 million of subordinated notes due April 1, 2000 to Research Industries Incorporated, a private investment company and an affiliate of the Company. Cash was also provided through bank borrowings.
In fiscal 1998, the sale of the Company's office complex provided over $4.8 million of cash, net of selling expenses, which was used to retire mortgage debt of $2.5 million and other operating debt as well as pay income taxes on the transaction. In a January 1998 private placement, the Company issued a $2 million 7% Convertible Subordinated Debenture due January 2003 to Research Industries, Incorporated. The net proceeds were applied to reduce the Company's revolving line of credit. Otherwise in 1998, operations required $1,240,000 for working capital needs.
In 1997, the uses of cash in operations of $10,943,000 and investment activities of $4,626,000 reflected the effect of the acquisitions of CMSA and CCI and the insertion of working capital into the two companies including the substitution by the Company of approximately $7.3 million of bank debt at significantly reduced interest rates for prior high-interest rate financing from nonbank sources.
A summary of future minimum lease payments is in Note 10 to the consolidated financial statements. Capital expenditures in 1999 were substantially reduced from prior years to conserve cash and the Company does not expect fiscal year 2000 technology requirements to result in greater capital expenditures than fiscal year 1999. The Company continues to sublease a portion of its headquarters building generating approximately $112,000 annually.
As a direct result of the material nature of the embezzlement matter, the Company was in technical default of its $14.5 million revolving credit agreement and related term notes (aggregating $4.6 million) that were in place at March 31, 1999. In the interim months, the Company entered into a series of forebearence agreements which enabled the borrowing agreement to remain in effect. Effective September 1, 1999, the Company re-negotiated its borrowing agreement to provide funding availability from its current collateral base. The revolving credit agreement availability has been reduced to $12 million subject to borrowing base requirements primarily tied to levels of accounts receivable. At August 31, 1999, the Company had approximately $2.3 million of excess borrowing capacity under the $12 million line of credit.
The bank term notes aggregating $4.6 million at March 31, 1999 have also been renegotiated effective September 1, 1999 to amounts aggregating $3.5 million. Based on the re-negotiated payment terms, the aggregate term notes will be further reduced during fiscal year 2000 based on cash received from embezzlement recoveries, tax refunds and potential asset sales, if any. See Note 6 to the financial statements.
The subordinated debt agreements with an affiliate, which aggregated $4 million at March 31, 1999, are not in default and their terms have remained unchanged, however, the new banking agreement dated September 1, 1999 prohibits the payments of principal or interest through September 15, 2000. See Note 6 to the financial statements.
The Company believes that funds generated from operations, bank borrowings, embezzlement recoveries, tax refunds and investing activities should be sufficient to meet its current operating cash requirements although there can be no assurances that all the aforementioned sources of cash can be realized.
On September 2, 1999, the Company entered into an agreement with a major supplier of digital communications switch hardware for the Company's United States Army contract where approximately $5,500,000 of outstanding accounts payable arising since March 31, 1999 and currently due to the supplier will be paid over 18 months with interest at 8.5%. $506,945 was paid on September 2, 1999 and will be paid on October 1, 1999, $299,965 will be paid on the first day of the next ensuing 15 months and a final payment of $299,974 is due on February 1, 2001.
Year 2000 Compliance
State of Readiness: During fiscal 1999 the Company undertook a formal Year 2000 readiness project assessment of all information technology assets to ensure the compliance of all applications, operating systems and hardware on its PC desktop suites and LAN and WAN server and communications platforms; the compliance of voice and data network software and hardware; to address issues related to non-IT systems in buildings, facilities and equipment which may contain date logic in embedded chips; and to address the compliance of key vendors and other third parties.
The phases of the Project are : (i) inventorying Year 2000 items and assigning priorities, (ii) assessing the Year 2000 compliance of items, (iii) remediating or replacing items that are determined not to be Year 2000 compliant; (iv) testing items for year 2000 compliance, and (v) designing and implementing Year 2000 contingency and business continuity plans. To determine that all IT systems (whether internally developed or purchased) are Year 2000 compliant, each system is tested using a standard testing methodology which includes unit testing, baseline testing, and future date testing. Future date testing includes critical dates near the end of 1999 and into the year 2000, including leap year testing.
The inventory and assessment phases of the Project were completed in mid fiscal 1999. At March 31, 1999, all of the Company's application systems had been remediated and current date tested. Essentially all critical hardware and software was compliant and tested by March 31, 1999. The remaining items will be resolved, tested and remediated by October 1999.
The Company is addressing non-information technology systems readiness through direct contact with our critical supplier chain to validate Year 2000 readiness. As part of the Project, significant service and information providers, external vendors, suppliers, and other third parties (including telecommunication, electrical, security, and HVAC systems), that are believed to be critical to business operations after January 1, 2000, have been identified and contacted. Procedures are being undertaken in an attempt to reasonably ascertain their state of Year 2000 readiness through questionnaires, compliance letters, interviews, on-site visits, and other available means. The Company paid particular attention to suppliers and shippers of the product comprising its hardware inventory.
Cost: The estimated total cost of the Year 2000 Project is approximately $90,000, including $30,000 of internal labor costs devoted to the project. Costs incurred during fiscal 1999 were approximately $62,000, with the remainder of the estimated total being incurred during the first and second quarters of FY 2000.
Risk: The Company believes that its Year 2000 readiness program will prepare the Company for Year 2000 compliance in a timely manner. There can be no assurance, however, that the Company's internal systems or equipment or those external parties on which the Company relies will be Year 2000 compliant in a timely manner or that the Company's or external parties contingency plans will mitigate the effects of any noncompliance. Given the current status of the Company's year 2000 Project, management believes that the most probable worst case scenario could result in short term business interruptions. However, failure by the Company and/or external parties to complete year 2000 readiness work in a timely manner could have a materially adverse effect on the Company's financial position and its results of operations.
Contingency Plans: The Company is developing a Year 2000 Contingency Plan designed to address problems arising from Year 2000 failures of critical third parties and will be directed towards providing alternate sources of supply to the Company.
The Company expects to complete its contingency planning phase for Year 2000 by November 1, 1999.
ITEM 7.a. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company is exposed to market risk from changes in interest rates. Adverse changes in interest rates can have a material effect on the Company's operations.
At March 31, 1999, the Company had $20,225,000 of debt outstanding of which $4,000,000 bears fixed interest rates. If the interest rates charged to the Company on its variable rate debt were to increase significantly, the effect could be materially adverse to future operations.
The Company conducts a limited amount of businesses overseas, principally in Western Europe. At present all transactions are billed and denominated in U.S. dollars and consequently, the Company does not currently have any material exposure to foreign exchange rate fluctuation risk.
ITEM 8.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Financial statements and supplementary data of the Company are attached hereto.
ITEM 9.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
None.
PART III
ITEM 10.
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The following paragraphs set forth the name and age of each executive officer and the members of the Board of Directors of the Company, together with their respective periods of service as officers and directors and other positions with the Company. All directors hold office for one (1) year or until their successors are duly elected and qualified.
DIRECTORS
Arch C. Scurlock, age seventy-nine, presently Chairman of the Board of Directors, has been a Director of the Company since 1973. He had served from 1969 to 1992 as Chairman of the Board of TransTechnology Corporation, a manufacturer of aerospace-defense and other industrial products. Since 1968, he has been President and a Director and controlling shareholder of Research Industries Incorporated, a private investment company.
John J. Reis, age fifty-six, joined the Company on March 1, 1999, as President and Chief Executive Officer, and was elected to the Board of Directors on March 24, 1999. He was President, CEO and Director of NumereX Corporation from 1996 to 1998 and President and CEO of MAXM Systems Corporation, a provider of automation software and services for enterprise wide systems and network management, from 1989 to 1996.
Howard C. Mills, age sixty-five, has been a Director of the Company since October 1984, and he was President and Chief Executive Officer from October 1984 until his retirement on April 16, 1999. He also serves on the Board of the Virginia Tech Corporate Research Center. The Company entered into a consulting agreement with Mr. Mills whereby he will provide certain advisory services to the Company. See Item 11
ITEM 11. EXECUTIVE COMPENSATION
The following table sets forth information on the Chief Executive Officer and the only other officers whose compensation exceeded $100,000 serving at the close of the fiscal year ended March 31, 1999 for services rendered in all capacities during the fiscal years ended March 31, 1999, 1998, and 1997.
SUMMARY COMPENSATION TABLE
(1) Value of Company furnished auto. (2) Amounts contributed to officer under 401(k) plan. (3) Amounts contributed to officer under 401(k) plan, insurance plans, and paid vacation. (4) Amounts contributed to officer under 401(k) plan and living expenses. (5) Mr. Mills retired from the Company effective April 16, 1999. The Company entered into a consulting agreement with Mr. Mills whereby he will provide certain advisory services to the Company. The Agreement is for a term of ten (10) years commencing April 16, 1999 and ending April 15, 2009. Mr. Mills will receive $50,000 per year, payable monthly, in exchange for his services. (6) The Company entered into an Executive Severance Agreement ("Agreement") with Mr. Reis on March 1, 1999. The Agreement provides benefits under certain circumstances including a change in control of the
Company and is automatically renewed from year to year. It confirms that employment is at will and provides for termination without additional compensation in the event of death, resignation, retirement or for cause. Except in connection with a change of control, termination for any other reason results in compensation equal to eighteen (18) months salary. In the event of termination within one (1) year after a change in control or in the event Mr. Reis resigns or retires during the first ninety (90) days after a change in control, he would receive compensation equal to thirty-six (36) months salary subject to statutory limitations.
DIRECTOR COMPENSATION
Except for Howard Mills, who became a Consultant to the Company upon his retirement as President and CEO, directors who are not officers of the Company receive an annual fee of $1,000 and also receive $2,000 and reimbursement of expenses incurred for each meeting of the Board of Directors which they attend. Alvin Nashman also receives $2,000 per month for consulting services provided to the Company.
STOCK OPTION PLANS
The 1984 Incentive Stock Option and Stock Appreciation Rights Plan (the 1984 "Plan") terminated on May 15, 1994. All options expired prior to July 18, 1998 (See Note 8 to the consolidated financial statements).
In 1994, the Company's shareholders approved the 1994 Key Employee Stock Option Plan (the 1994"Plan"). The Company's key employees, including officers, were eligible to participate. Directors who were not officers were not eligible.
At the 1998 Annual Meeting of Shareholders, the shareholders approved amendments to the 1994 Plan which increased to 280,000 the number of shares authorized for issuance pursuant to the 1994 Plan.
The 1994 Plan is administered by a committee selected by the Board and is comprised of not less than three members of the Board. The committee has the sole and absolute discretion to establish from time-to-time the criteria for participation in the 1994 Plan and to select the officers and other key employees to whom options may be granted, to determine all claims for benefits under the 1994 Plan, to impose such conditions and restrictions on options as it determines appropriate, with the consent of the recipient, to cancel options and to substitute new options for previously awarded options which, at the time of such substitution, have an exercise price in excess of fair market value of the underlying shares of Company Common Stock.
The committee also has the sole and absolute discretion to grant options entitling the Participants to purchase shares of Company Common Stock from the Company in such number, at such price and on such terms and subject to such conditions, not inconsistent with the terms of the 1994 Plan, as may be established by the Committee. Due to the broad discretion of the Committee, it is not possible to determine at this time the benefits or amounts that will in the future be received by or allocated to the participants, if any.
Except as otherwise expressly provided in the 1994 Plan, the Committee may designate, at the time of the grant of an Option, the Option as an Incentive Stock Option under Section 422 of the Internal Revenue Code. The Purchase Price of each share of Company Common Stock which may be purchased upon exercise of any Option granted under the 1994 Plan shall be established by the Committee in its discretion, and in the case of Incentive Stock Options, such Purchase Price shall not be less than 100% of the Fair Market Value on the Date of Grant.
Each Option granted under the 1994 Plan shall be exercised by written notice to the Company. The Purchase Price of shares purchased upon exercise of an Option granted under the 1994 Planis required to be paid in full.
No option may be exercised in whole or in part prior to six months from the Date of Grant.
The Board has complete power and authority to amend the 1994 Plan at any time as it deems necessary or appropriate and no approval by the stockholders of the Company or by any other person, committee or entity of any kind is required to make any amendment; provided, however, that the Board shall not, without the affirmative approval of stockholders of the Company, increase the number of shares of Company Common Stock available for
Option grants thereunder or make any other amendment which requires stockholder approval under Rule 16b-3 promulgated under the Securities Exchange Act of 1934 as amended.
In fiscal year 1997, options totaling 105,600 shares were granted to employees at exercise prices ranging from $4.67 to $7.67, the market prices on the dates of issuance.
In fiscal year 1998, options totaling 15,500 shares were granted to employees at exercise prices ranging from $7.56 to $10.25, the market price on the dates of issuance.
In fiscal year 1999, options totaling 87,000 shares were granted to employees at exercise prices ranging from 7.81 to $7.875, the market price on the dates of issuance.
At the September 19, 1997 Annual Meeting of Shareholders, the shareholders approved the new Non-Employee Director Stock Option Plan. The maximum number of shares subject to the plan and approved for issuance is 100,000 shares of the Company's Common Stock either authorized and unissued or shares held in treasury. This number is subject to adjustment in the event of stock splits, stock dividends or other recapitalization of the Company's Common Stock. The Company has registered the shares issuable to the plan with the SEC. The plan will be administered by the Board of Directors in whom the plan vests all powers and authority under the plan.
Under the terms of the plan, each year on the first day of the first month following the Annual Meeting of Shareholders of the Company, each Non-Employee Director who has been elected or reelected as a Board member shall receive an option. This option may be either a first option or subsequent option. At initial election to the Board, a first option shall be granted for 5,000 Common Stock shares. A first option becomes exercisable in installments cumulatively with respect to one sixtieth of the Option Stock per month after the date of grant, so that one hundred percent shall be exercisable five years after the date of grant. Upon each annual reelection as a Board Member, a subsequent option shall be granted of up to a maximum of 2,000 Common Stock shares. A subsequent option becomes exercisable in installments cumulatively with respect to one-twelfth of the optioned stock per month after the date of grant, so that one hundred percent shall be exercisable one year after the date of grant. The total maximum number of shares of Common Stock for which any director shall be granted options under this plan is 13,000. No option or any part of an option shall be exercisable after the expiration of ten years from the date the Option was granted.
In fiscal 1998, options totaling 30,000 shares were granted to non-employee Directors at $10.25 per share, the market price on date of issuance.
In fiscal 1999, options totaling 12,000 shares were granted to non-employee Directors at $7.03 per share, the market price on date of issuance.
See Note 8 to the consolidated financial statements.
ITEM 12.
ITEM 12. Security Ownership of Certain Beneficial Owners and Management
The following table sets forth as of September 7, 1999 (1) the number of shares of the Company's Common Stock owned beneficially by each person who owned of record, or was known by the Company to have owned beneficially, more than 5% of such shares then outstanding, (2) the number of shares owned beneficially by each director and executive officer of the Company, and (3) the number of shares owned beneficially by all officers and directors as a group. Information as to the beneficial ownership is based upon statements furnished to the Company by such persons.
*Less than 1%
(1) Research Industries Incorporated is 93% owned by Arch C. Scurlock, Chairman of the Company's Board of Directors. Dr. Scurlock is also President and a director of Research Industries Incorporated.
(2) Includes 680,300 shares owned by Research Industries Incorporated.
(3) Mr. Grover is also a 5% owner, a director and Executive Vice President and Treasurer of Research Industries Incorporated.
(4) Mr. Ruffner is a director of Research Industries Incorporated.
(5) Includes 450 shares held by Mr. Mills' wife.
(6) Research Industries Incorporated owns $2 million face amount of the Company's 7% Convertible Subordinated Debenture dated January 27, 1998 and $690,000, $310,000, $500,000 and $500,000 face amount of the Company's Promissory Notes dated October 8, 1998, October 13, 1998, November 2, 1998 and November 5, 1998, respectively.
ITEM 13.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Ernest L. Ruffner, Secretary and General Counsel and a Director of the Company, is a member of the law firm of Pompan, Murray, Ruffner & Werfel however, he received no fees therefrom for services to the Company. During the fiscal year ended March 31, 1999, the Company paid $74,250 for legal services to Mr. Ruffner as General Counsel.
Jacob Pompan of Pompan, Murray, Ruffner & Werfel has represented the Company in its government contract affairs since 1984. During the fiscal year ended March 31, 1999, the Company paid $88,247 to the firm for services rendered.
Alvin E. Nashman, a Director of the Company, provides consulting services under an agreement with the Company. During the fiscal year ended March 31, 1999, the Company paid $24,000 for consulting services to Mr. Nashman.
Research Industries, Incorporated, the owner of 680,300 shares or 33.8% of the Company's common stock, owns $2 million face amount of the Company's 7% Convertible Subordinated Debenture dated January 27, 1998 and $690,000, $310,000, $500,000 and $500,000 face amount of the Company's Promissory Notes dated October 8, 1998, October 13, 1998, November 2, 1998 and November 5, 1998, respectively. See Note 6 to the consolidated financial statements for further discussion.
PART IV
ITEM 14.
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(a) The following documents are filed as part of this report:
1. Consolidated Financial Statements
- Report of Independent Auditors - Consolidated Statements of Operations for the years ended March 31, 1999, 1998 and 1997 - Consolidated Balance Sheets as of March 31, 1999 and 1998 - Consolidated Statements of Cash Flows for the years ended March 31, 1999, 1998 and 1997 - Consolidated Statements of Changes in Stockholders' Equity (Deficit) for the years ended March 31, 1999, 1998 and 1997 - Notes to Consolidated Financial Statements
2. Financial Statement Schedule
- Schedule II, Valuation and Qualifying Accounts
All other schedules are omitted since they are not applicable, not required or the required information is included in the consolidated financial statements or notes thereto.
3. Exhibits
3.1 Articles of Incorporation, as amended. (Incorporated by reference to Exhibit 3.1 to Form 10-K for the year ended March 31, 1995.)
3.2 By-laws, as amended. (Incorporated by reference to Exhibit 3.2 to Form 10-K for the year ended March 31, 1995.)
4.1 Loan and Security Agreement dated January 30, 1989 between the Company and Crestar Bank. (Incorporated by reference to Exhibit 4.1 to Form 10-K for the year ended March 31, 1989.)
4.2 First Amendment to Amended and Restated Loan and Security Agreement between the Company and Crestar Bank dated Dec. 11, 1992 and amended and restated revolving note. (Incorporated by reference to Exhibit 4.2 to Form 10-K for the Year ended March 31, 1993.)
4.3 Loan agreement dated June 30, 1993 between the Company and Crestar Bank. (Incorporated by reference to Exhibit 4.3 to Form 10-K for the year ended March 31, 1994.)
4.4 Second Amendment to Amended and Restated Loan and Security Agreement between the Company and Crestar Bank dated November 14, 1994 and amended and restated revolving note. (Incorporated by reference to Exhibit 4.4 to Form 10-K for the year ended March 31, 1995.)
4.5 Fifth Amended and Restated Loan and Security Agreement between the Company and Crestar Bank dated June 25, 1998 and restated notes (Incorporated by reference to Form 8-K dated October 6, 1998.)
4.6 Sixth Amended and Restated Loan and Security Agreement between the Company and Crestar Bank dated September 7, 1999 and restated notes.
10.1 1984 Incentive Stock Option and Stock Appreciation Rights Plan, as amended. (Incorporated by reference to Exhibit 10.3 to the Form 10-K for the year ended March 31, 1989).
10.2 Agreement of purchase and sale with amendments dated June 7, 1992, between the Company and ReCap Inc. for the Halifax Office Complex. (Incorporated by reference to Exhibit 10.5 of the Form 10-K for the year ended March 31, 1992).
10.3 1994 Key Employee Stock Option Plan. (Incorporated by reference to Exhibit 10.3 to Form 10-K for the year ended March 31, 1995).
10.6 John J. Reis Executive Severance Agreement.
22 Subsidiaries of the registrant.
23 Consent of Ernst &Young LLP, Independent Auditors.
(b) Reports on Form 8-K Form 8-K dated March 18, 1999 - Halifax Reports Embezzlement.
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.
HALIFAX CORPORATION
By /s/John J. Reis ---------------- John J. Reis President and Chief Executive Officer Date: 9/8/99
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.
REPORT OF INDEPENDENT AUDITORS
Board of Directors and Stockholders Halifax Corporation
We have audited the accompanying consolidated balance sheets of Halifax Corporation as of March 31, 1999 and 1998, and the related consolidated statements of operations, changes in stockholders' equity (deficit) and cash flows for each of the three years in the period ended March 31, 1999. Our audits also included the financial statement schedule listed in the index at item 14(a)2. These financial statements and schedule are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements and schedule based on our audits.
We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes 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 financial statements referred to above present fairly, in all material respects, the consolidated financial position of Halifax Corporation at March 31, 1999 and 1998, and the consolidated results of its operations and its cash flows for each of the three years in the period ended March 31, 1999, in conformity with generally accepted accounting principles. 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.
/s/Ernst & Young LLP
Washington , D.C. September 7, 1999
HALIFAX CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS FOR THE YEARS ENDED MARCH 31, 1999, 1998 AND 1997
See notes to consolidated financial statements
HALIFAX CORPORATION
CONSOLIDATED BALANCE SHEETS AS OF MARCH 31, 1999 AND 1998
See notes to consolidated financial statements
HALIFAX CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS FOR THE YEARS ENDED MARCH 31, 1999, 1998 AND 1997
See notes to consolidated financial statements
HALIFAX CORPORATION
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY (DEFICIT) FOR THE YEARS ENDED MARCH 31, 1999, 1998, AND 1997
See notes to consolidated financial statements.
HALIFAX CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS FOR THE YEARS ENDED MARCH 31, 1999, 1998 AND 1997
1. SIGNIFICANT ACCOUNTING POLICIES AND BUSINESS ACTIVITY
Business Activity - Halifax Corporation, (the Company) provides Technology Services and Facilities Management for commercial and government activities. These services include the integration, systems engineering, installation, maintenance and training for computer systems, communications systems, and simulation systems; and the management, operations and maintenance support of military bases, prisons, waterways, major office complexes, and communications sites. Revenues from services rendered to the United States Government and the relative percentages of such revenues to total revenues for the years ended March 31, 1999, 1998 and 1997 are $36,816,000 (45%), $25,820,000 (35%), and $35,480,000 (47%), respectively. The reduction in United States Government revenue in fiscal 1998 was primarily a result of reduced deliveries of digital telecommunications switches under long-term contracts.
Principles of Consolidation - The Company's consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries. All significant intercompany transactions are eliminated in consolidation.
Revenue Recognition - On cost type contracts, revenues are recorded as reimbursable costs are incurred and related fixed and award fees are recorded using the percentage of completion method generally using units of delivery as the measurement basis for effort accomplished. On time and materials contracts, revenues are recorded at the contractual rates as labor hours and other direct expenses are incurred. On fixed price contracts, revenues are recorded using the percentage of completion method generally using units of delivery as the measurement basis for effort accomplished. Sales under certain long-term fixed-price contracts which, among other things, provide for the delivery of minimal quantities or require a significant amount of development effort in relation to total contract value, are recorded upon achievement of performance milestones or using the cost-to-cost method of accounting where sales and profits are recorded based on the ratio of costs incurred to estimated total costs at completion. Revenues collected in advance for commercial maintenance contracts are deferred and recognized over the term of the related agreements. For all contracts, recognition is made of any anticipated losses when identified. Disputes involving amounts owed the Company by customers arise in the normal course of the Company's business. These disputes are primarily due to changes in contract specifications and disagreements over the interpretation of contract provisions. Any amounts due related to such disputes are recorded at the lesser of their estimated net realizable value or actual costs incurred. Claims against the Company are recognized when the loss is considered probable and reasonably determinable in amount. Revenue on sales of information technology hardware is realized upon delivery to the customer.
Use of Estimates - The preparation of financial statements in conformity with generally accepted accounting principles requires management 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 financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
Property and Equipment - Property and equipment is stated at cost. Depreciation is provided using the straight-line method over the estimated useful lives of the related assets.
Inventory - Inventory consists principally of spare computer parts and computer and computer peripheral hardware and software in the process of delivery upon resale to customers. All inventories are valued at the lower of cost or market on the first-in first-out basis. These inventories are recorded on the consolidated balance sheet net of allowances for inventory valuation of $1,500,000 and $356,000 at March 31, 1999 and 1998, respectively.
Accounts Receivable and Inventories - Receivables and inventories are primarily attributable to long-term contracts or programs in progress for which the related operating cycles are longer than one year. In accordance with industry practice, these items are included in current assets.
Income Taxes - Deferred taxes are provided on all temporary differences measured using enacted tax rates expected to be in effect during the periods in which the temporary differences reverse.
Goodwill - Goodwill in acquired companies, described in Note 3, is being amortized using the straight-line method over periods ranging from 10 to 25 years. Accumulated amortization was $1,159,000 and $905,000 as of March 31, 1999 and 1998, respectively (See Note 3). Management periodically reviews the appropriateness of the carrying value of goodwill.
Earnings Per Common Share - The computation of basic earnings per share is based on the weighted average number of shares outstanding during the period. Due to the net loss in each period, the computation of diluted earnings per share is based on the weighted average number of shares outstanding during the period and does not include dilutive common stock equivalents.
New Accounting Pronouncements - In 1997, the Financial Accounting Standards Board issued SFAS No. 131, "Disclosures about Segments of an Enterprise and Related Information." SFAS No. 131 establishes standards for the way in which publicly-held companies report financial and descriptive information about their operating segments in financial statements for both interim and annual periods, and requires additional disclosures with respect to products and services, geographic areas of operation and major customers. The Statement is effective for fiscal years beginning after December 15, 1997. The Company adopted the provisions of this standard in fiscal year 1999. (See Note 16)
2. EMBEZZLEMENT MATTER AND RESTATEMENT OF 1998 AND 1997 CONSOLIDATED FINANCIAL STATEMENTS
Embezzlement Matter
On March 18, 1999, the Company announced that an internal investigation had revealed an apparent material embezzlement by the former controller of one of the Company's subsidiaries. The embezzlement occurred at, and was confined to, the Company's Richmond, VA based Halifax Technology Services Company ("HTSC"). At the time of the embezzlement, HTSC was a wholly owned subsidiary of Halifax Corporation, which resulted from a merger of CMSA (acquired by Halifax on April 1, 1996), and CCI (acquired by Halifax on November 25, 1996). On April 1, 1999, HTSC was merged into Halifax Corporation and is now a division of the Company.
The Company believes that a single individual, the former controller of HTSC, perpetrated the embezzlement. She was immediately terminated, has since been indicted, has pleaded guilty, and currently awaits sentencing. Under the terms of an agreement entered into with the Company, she is cooperating with the Company's recovery efforts.
The embezzlement occurred over a period of nearly four years and aggregated approximately $15.4 million, of which $15 million was embezzled from the Company and $400,000 from CMSA before it was acquired by Halifax. To conceal the embezzlement in the accounting records, the former controller made fraudulent adjustments totaling more
than $21 million. Of the $21 million, the $15.0 million embezzled was recorded in the Company's statements of operations and balance sheets after the acquisition, approximately $2.2 million related to amounts reflected in the acquisition date balance sheet, and approximately $3.8 million related to other overstatements of operating results during the three year period subsequent to the CMSA acquisition.
Under the terms of an agreement with the Company, the embezzler has transferred certain assets back to the Company. Some of the recovered assets have been converted into approximately $1.4 million in cash as of August 31, 1999. With an estimated $1.1 million of assets awaiting conversion to cash, the Company estimates approximately $2.5 million will ultimately be recovered from the embezzler. In addition, the full policy amount of $1 million from each of two separate theft insurance polices, or an aggregate of $2 million, has been received to date. Therefore, from these sources, the Company expects a total recovery of $4.5 million (excluding recovery costs) . The Company estimates that, net of recovery costs, approximately $3.5 million will be recovered. At March 31, 1999, the Company had received approximately $670,000 from its recovery efforts and recorded a $2.83 million recovery receivable to recognize its expectation of receiving the estimated $3.5 million of total net recoveries. See Note 4 to the consolidated financial statements.
Due to the corresponding overstatement of taxable income, reported by the Company during the period of the embezzlement, the Company will file for a tax refund of approximately $808,000. The receivable is recorded in "Income Taxes Receivable" in the consolidated financial statements.
The embezzlement had a material effect on the Company's financial statements for fiscal years 1999, 1998 and 1997. In addition to the correction for overstated assets and understated liabilities, the Company recorded an embezzlement loss of approximately $2,593,000, $6,044,000 and $2,892,000 for the fiscal years ended March 31, 1999, 1998 and 1997, respectively. The embezzlement loss recorded in fiscal 1999 is net of the actual and projected net recoveries aggregating $3,500,000.
In addition to the notification and involvement of the appropriate authorities, and the intensive and ongoing investigative efforts, the Company has taken other important steps as a result of the embezzlement. The Board of Directors appointed a special committee of the Board to focus on the recovery of assets taken from the Company and minimization of the damages sustained as a result of the embezzlement.
The employment contract of the HTSC president was not renewed, and he is no longer employed by the Company. Furthermore, new executives have been hired to manage the technology services division and to consolidate the Company's financial and administrative activities. The Company has also transferred key accounting and cash management functions of HTSC to Company headquarters.
The Company's fiscal 1998 and 1997 financial statements have been restated to reflect corrections due to the embezzlement. The effect of the restatement on results of operations and balance sheets for fiscal 1998 and 1997 is as follows:
3. ACQUISITIONS
CMS Automation, Inc. (CMSA) and Consolidated Computer Investors, Inc. (CCI)
On April 1, 1996, the Company completed the acquisition of CMS Automation, Inc. (CMSA), a private Richmond, VA based computer network integration and solutions company Financial consideration was in the Company's stock with an assumption of debt. There was an initial payment of approximately 209,400 shares valued at approximately $978,000 from Treasury Stock representing approximately 12% of Halifax's outstanding shares at closing. The Company assumed secured debt totaling approximately $5,085,000. 1,550 additional shares were paid out in fiscal 1998 as additional consideration. On November 25, 1996, the Company through its wholly-owned subsidiary, CMSA, acquired the ongoing computer network integration business of Consolidated Computer Investors, Inc. ("CCI") of Hanover, Maryland through an asset purchase. The Company paid $114,000 in cash and assumed secured debt totaling $1,680,000. On April 23, 1997, CMSA was renamed Halifax Technology Services Company (HTSC) and on April 1, 1999 became a division of the Company.
On June 30, 1993, the Company purchased substantially all of the assets and liabilities of the Field Services Division of Electronics Associates, Inc. (EAI) which was primarily engaged in the maintenance of electronic equipment and software for an initial purchase price of approximately $2.4 million. Additional payments of $1,000,000 were paid over the next 3 years as certain revenue objectives were achieved. The Company paid $200,000 relating to this requirement in 1994 and $400,000 in both 1995 and 1996.
The Company's change in focus to its technology services segment over the last three fiscal years is intended to secure a prominent future as a leading provider of a broad range of information technology services to technology dependent companies and other users of technology. The purchased assets and ongoing lines of business of HTSC have provided the impetus for this thrust and contributed over $70 million of revenue beginning with their purchase in fiscal 1997. Because the high-technology and services orientation of the HTSC lines of business have a higher rate of change and evolution, the goodwill of approximately $2,968,000 is being amortized over 20 years beginning in fiscal 1997. The fiscal 1994 acquisition of Electronic Associates, Inc., which provided complementary technology capability in the maintenance of electronic and computer equipment and software, resulted in approximately $2,235,000 of goodwill which is being amortized over 25 years.
4. ACCOUNTS RECEIVABLE
Trade Accounts receivable consist of:
Embezzlement recoveries receivable represents the difference between the estimated $3.5 million of total net recoveries and $672 thousand of cash received at March 31, 1999.
Retainages are generally billable upon acceptance of work by customers or completion of contract audits by the Government. It is anticipated that the accounts receivable balance at March 31, 1999 will be substantially collected within one year.
5. PROPERTY AND EQUIPMENT
Property and equipment consists of:
6. LONG-TERM DEBT AND MORTGAGE NOTE PAYABLE
Advances under the revolving credit agreement and term loan facilities are collateralized by a first priority security interest in all of the Company's assets except for the computer resale inventory of HTSC. Additionally, advances under the CMSA and CCI acquisition term loan facilities were secured by the acquired assets. The banking agreement also contains financial covenants and financial reporting covenants. $6,440,000 of the revolving credit agreement has been excluded from current liabilities because the Company anticipates it would remain outstanding for an uninterrupted period extending beyond one year from the balance sheet date.
The Company signed a new banking agreement on September 1, 1999 which refinances the Company's bank debt as presented at March 31, 1999. The new debt continues to consist of a revolving line of credit ($12,000,000 revised facility) and two term loans ($1,000,000 and $2,500,000 revised facilities), however the principal reduction and interest rate provisions of the term loans have been revised as have the interest rate provisions. Standard closing and unused balance fees are included. The revised facilities make $15,500,000 of credit available to the Company. This agreement expires on September 8, 2000. All assets of the Company remain as collateral in accordance with the prior agreement. Financial covenants have been revised to require only prospective operational performance objectives including minimum quarterly net income of $100,000 beginning September 30, 1999 and quarterly increases in tangible net worth of $150,000.
The new agreement prohibits the payment of dividends or distributions as well as the payment of principal or interest on Subordinated Debt. Interest expense on Subordinated Debt is accrued on a current basis.
In connection with the new banking agreement, the revolving credit agreement was reduced from a maximum credit line of $14,500,000 to $12,000,000. Amounts available are determined by applying stated percentages to the Company's eligible billed and unbilled accounts receivable. Interest now accrues at LIBOR plus 4.25%.
The Tier III Term Note principal balance was reduced by $125,000 at closing which reduced the outstanding principal balance on that date to $1,000,000. Interest is payable monthly on the principal at LIBOR plus 5.55%.
The Tier II Term Note facility remains $2,500,000. The principal balance is to be reduced by $125,000 on December 15, 1999 and by $500,000 quarterly beginning March 15, 2000. Any unpaid balance is due September 15, 2000. Interest is payable monthly on the principal at LIBOR plus 4.65%.
The Company is required to make certain additional term note balance reductions from the future proceeds of various embezzlement recoveries, tax refunds and potential asset sales if any. In addition the Company is required to pay quarterly fees on outstanding term note credit facilities. Such fees will range from .35% to .45%.
The aggregate annual maturities of long-term debt, based on the terms of the new banking agreement, (excluding any debt reductions related to proceeds from the above specified non-operational events) are as follows:
The carrying value of total debt approximates fair market value at March 31, 1999 and 1998.
7. ACCOUNTS PAYABLE AND ACCRUED EXPENSES
Accounts payable and accrued expenses consist of:
On September 2, 1999, the Company entered into an agreement with a major supplier of digital communications switch hardware for the Company's United States Army contract where approximately $5,500,000 of outstanding accounts payable arising since March 31, 1999 and currently due to the supplier will be paid over 18 months with interest at 8.5%. $506,945 was paid on September 2, 1999 and will be paid on October 1, 1999, $299,965 will be paid on the first day of the next ensuing 15 months and a final payment of $299,974 is due on February 1, 2001.
8. COMMON STOCK
Stock Options - Under the Company's 1984 Stock Option and Stock Appreciation Rights Plan (as amended), options to purchase shares of the Company's common stock were granted to officers and key employees at a price not less than the fair market value of the stock at the date of grant. Any grants of options or stock appreciation rights under the plan were limited to a maximum of 165,000 shares of the Company's common stock. Options and/or stock appreciation rights expired five years after the date of grant. The 1984 plan terminated May 15, 1994. All options under this plan had been exercised or terminated by July 18, 1998. On September 16, 1994 the shareholders approved the new Key Employee Stock Option Plan ("1994 Plan"). The maximum number of shares of the Company's common stock subject to the 1994 Plan and approved for issuance is 280,000 shares either authorized and unissued or
shares held in treasury. This number is subject to adjustment in the event of stock splits, stock dividends or other recapitalization of the Company's common stock.
A summary of options activity is as follows:
All stock-based incentive awards granted in 1999, 1998 and 1997 under the 1994 Plan were stock options which have 5 year terms and vest at the end of the third and fourth years. All awards granted in 1999 and 1998 under the Non-Employee Directors Stock Options Plan were stock options which have 5 year terms and vest in installments cumulatively with respect to one-sixtieth of that option stock per month after the date of grant. Exercise prices of all options awarded in all years under all plans were equal to the market price of the stock on the date of grant. Proforma information regarding net earnings and earnings per share as required by SFAS No. 123 has been determined as if the Company had accounted for its employee stock options under the fair value method. The fair value for these options was estimated at the date of grant using a Black-Scholes option pricing model with the following weighted-average assumptions for 1999, 1998 and 1997: risk-free interest rate of 5.36%, 5.99% and 6.16% respectively, dividend yield of 2%, 2% and 2% respectively, volatility factor related to the expected market price of the Company's common stock of .262, and weighted-average expected option life of five years. The weighted average fair value of options granted during 1999, 1998 and 1997 were $2.35, $2.66 and $1.57, respectively.
For purposes of proforma disclosures, the options' estimated fair values are amortized to expense over the options' vesting periods. The Corporation's proforma information for the years ended March 31, is as follows:
9. EMPLOYEE 401(K) RETIREMENT PLAN
The Company sponsors a 401(k) retirement plan covering substantially all non-union employees with more than 3 months of service. The plan provides that the Company will contribute an amount equal to 50% of a participant contribution up to 4% of salary, and at the Company's discretion, additional amounts based upon the profitability of the Company. The Company's contributions were $230,000 in 1999, $199,000 in 1998 and $191,000 in 1997. The Company has an Employee Stock Purchase Plan under which all employees of the Company are eligible to contribute funds for the purchase of the Company's common stock on the open market at market value. Under the Plan, the Company agrees to pay all brokerage commissions associated with such purchases.
10. INCOME TAXES
Deferred tax assets and liabilities on the balance sheets reflect the net tax effect of temporary differences between carrying amounts of assets and liabilities for financial statement purposes and the amounts used for income tax purposes. The deferred tax assets and liabilities are classified on the balance sheets as current or non current based on the classification of the related assets and liabilities.
The components of income tax expense are as follows for the years ended March 31:
The components of the Company's deferred tax assets and liabilities consist of the following at March 31:
Due to the uncertainty of future realization, the Company has not recorded a net benefit for these operating loss carryforwards and other deferred tax assets in its fiscal 1999 financial statements. As of March 31, 1998, a valuation allowance was also provided against the net deferred tax asset except to the extent taxes paid for the years ended March 31, 1997 and 1998 are recoverable through the carryback of the Company's net operating loss arising in the year ended March 31, 1999. The change in the valuation allowance of $2,034,000 results primarily from the increase in the net operating loss carryforward due to the embezzlement loss and the reclassification of the defered tax asset as of March 31, 1998 into a current tax receivable as of March 31, 1999.
The differences between the provision for income taxes at the expected statutory rate and those shown in the consolidated statements of operations are as follows for the years ended March 31:
The Company has a $12.5 million net operating loss carryover virtually all of which expires in fiscal 2019. As a part of the restatement of the financial statements , tax assets, tax liabilities and tax provisions were also
restated which resulted in an adjustment of $243,000 to the March 31, 1996 retained earnings. The $808,000 income tax receivable at March 31, 1999 consists of net operating loss carryback refunds of $682,000 and $126,000 of estimated tax payments made in fiscal 1999.
11. LEASING ACTIVITY
The Company is obligated under operating leases for office space and certain equipment. The following are future minimum lease payments under operating leases as of March 31, 1999.
Total rent expense under operating leases was $1,188,000, $954,000 and $411,000 for the years ended March 31, 1999, 1998 and 1997, respectively. The Company sold its office complex on November 6, 1997 and leased back its headquarter's building for 12 years which resulted in increased rental expense and future minimum lease payments since fiscal 1997. Aggregate future minimum rentals to be received under noncancelable subleases as of March 31, 1999 are $8,000.
12. RELATED PARTY TRANSACTIONS
During the years ended March 31, 1999, 1998 and 1997, the Company paid $74,250, $62,000 and $77,000, respectively, for legal services to a Board member serving as General Counsel; $88,247, $9,096 and $4,651, respectively, to a law firm in which the same Board member is a partner; and $24,000, $24,000 and $22,000, respectively, for consulting services to another Board member.
Research Industries, Incorporated, the owner of 680,300 shares or 33.8% of the Company's common stock, owns $2 million face amount of the Company's 7% Convertible Subordinated Debenture dated January 27, 1998 and $690,000, $310,000, $500,000 and $500,000 face amount of the Company's Promissory Notes dated October 8, 1998, October 13, 1998, November 2, 1998 and November 5, 1998, respectively. Interest expense on the subordinated debt totaled $222,000 and $37,000 for 1999 and 1998, respectively. See Note 6 .
13. COMMITMENTS AND CONTINGENCIES
The Company's contracts with the U.S. Government are subject to cost audit by Government authorities. Such audits have been completed through fiscal years ended March 31, 1995. It is not possible to predict the outcome of future audits but it is the opinion of the Company's management that liabilities, if any, arising from such audits would not have a material adverse effect on the Company's consolidated financial position or results of operations.
Upon the death of certain former officers and at the option of their estates, the Company is committed to purchase 54,112 of their shares of the Company's common stock at current book value. At March 31, 1999, the book value of the Company was a deficit and therefore, the Company had no obligation.
There are no material pending legal proceedings to which the Company is a party. The Company is engaged in ordinary routine litigation incidental to the Company's business to which the Company is a party.
14. SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION
The Company paid the following amounts for interest and income taxes during the years ended March 31:
15. EARNINGS PER SHARE
The following table sets forth the computation of basic and diluted earnings per share:
*Because of losses, no effect is given to dilutive securities.
16. INFORMATION ON INDUSTRY SEGMENTS AND RELATED INFORMATION
The Company operates in two principal business segments: technology services and facilities management.
Technology Services includes the integration, systems engineering, installation, maintenance and training for computer systems and communications systems. Other primary services provided include interactive technologies including website design, development and marketing, Internet/Intranet services, multimedia sales and educational tools and Year 2000 desktop solutions for enterprise PC hardware and software compliance.
Facilities Management includes the management, operations and maintenance support of prisons, waterways, major office complexes and communications sites.
Halifax Corporation
SCHEDULE II, VALUATION AND QUALIFYING ACCOUNTS
March 31, 1999
INDEX TO EXHIBITS
Exhibit Number
4.6 Sixth Amended and Restated Loan and Security Agreement between the Company and Crestar Bank dated September 7, 1999 and restated notes
10.6 John J. Reis Executive Severance Agreement
23 Consent of Ernst & Young LLP, Independent Auditors