SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-QSB
QUARTERLY REPORT UNDER SECTION 13 OR 15 (d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the Quarter Ended Commission
September 30, 1998 File No. 0-22405
Information Analysis Incorporated
(Exact name of Registrant as specified in its charter)
Virginia 54-1167364
(State or other jurisdiction of (IRS Employer
incorporation or organization) Identification No.)
11240 Waples Mill Road, #400
Fairfax, VA 22030
(Address of principal executive offices) (Zip Code)
(Registrant's telephone number,
including area code) (703) 383-3000
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 Registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes x No
----- -----
State the number of shares outstanding of each of the issuer's classes of common
stock, as of September 30, 1998:
Common Stock, par value $.01, 6,734,173 shares
Transitional small business disclosure format.
Yes No x
----- -----
<PAGE>
INFORMATION ANALYSIS INCORPORATED
FORM 10-QSB
Index
Page
PART I. FINANCIAL INFORMATION Number
Item 1. Financial Statements (Unaudited)
Condensed Consolidated Balance Sheets as of
September 30, 1998 and December 31, 1997 3
Condensed Consolidated Statements of Operations
for the three months and nine months ended
September 30, 1998 and September 30, 1997 4
Condensed Consolidated Statements of Cash Flows
for the three months ended September 30, 1998 and
September 30, 1997 5
Notes to Unaudited Condensed Consolidated
Financial Statements 6
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations 7
PART II OTHER INFORMATION
Item 2. Changes in Securities 10
Item 6. Exhibits and Reports on Form 8-K 10
SIGNATURES 10
2
<PAGE>
Information Analysis Incorporated and Subsidiaries
Consolidated Balance Sheets
<TABLE>
<CAPTION>
As of As of
amounts in thousands September 30, 1998 December 31, 1997
(unaudited) (audited)
<S><C>
ASSETS
Current assets:
Cash and cash equivalents $ 271 $ 364
Accounts receivable, net 6,671 3,128
Employee advances 84 74
Refundable income taxes -- 33
Prepaid expenses 288 53
Other receivables 75 29
------- ------
Total current assets 7,389 3,681
Fixed assets, net 772 781
Equipment under capital leases, net 132 50
Capitalized software, net 6,751 4,431
Goodwill - 12
Other receivables 65 42
Other assets 20 20
------- ------
Total assets $15,129 $9,017
LIABILITIES & STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 2,512 $1,122
Accrued payroll 574 660
Other accrued liabilities 1,396 518
Revolving line of credit 993 600
Current portion of long-term debt 9 104
Current maturities of capital lease obligations 12 23
------- ------
Total current liabilities 5,496 3,027
Long-term debt - -
Capital lease obligations, net of current portion 104 12
------- ------
Total liabilities 5,600 3,039
Common stock, par value $0.01, 15,000,000 shares authorized;
8,238,784 and 7,498,430 shares issued, 6,734,173 and
5,993,819 outstanding at September 30, 1998 and
December 31, 1997, respectively 82 75
Additional paid in capital 12,588 6,518
Retained earnings (deficit) (2,287) 239
Less treasury stock; 1,504,611 shares at cost (854) (854)
------- ------
Total stockholders' equity 9,529 5,977
------- ------
Total liabilities and stockholders' equity $15,129 $9,017
======= ======
</TABLE>
3
<PAGE>
Information Analysis Incorporated
Condensed Consolidated Income Statements
<TABLE>
<CAPTION>
Three months ended September 30,
(in thousands, except per share data; unaudited) 1998 1997
---- ----
<S><C>
Net revenue:
Professional fees $ 2,643 $ 1,643
Software sales 113 173
------- -------
Total revenue 2,756 1,816
Cost of goods sold and services provided:
Cost of professional fees 3,057 1,218
Cost of software sales 397 152
------- -------
Total cost of sales 3,454 1,370
Gross margin (698) 446
Operating expenses:
Sales, general and administrative 1,879 1,085
Research and development 353 61
------- -------
Total operating expenses 2,232 1,146
Operating income (loss) (2,930) (700)
Other income (expense) 15 48
------- -------
Income (loss) before income taxes (2,915) (652)
Provision for income taxes -- --
------- -------
Net income (loss) $(2,915) $ (652)
======= =======
Net income (loss) per share:
Basic $ (0.43) $ (0.11)
======= =======
Diluted $ (0.43) $ (0.11)
======= =======
Shares used in calculating earnings per share:
Basic 6,724,851 5,876,241
Diluted 6,724,851 5,876,241
<CAPTION>
Nine months ended September 30,
(in thousands, except per share data; unaudited) 1998 1997
---- ----
<S><C>
Net revenue:
Professional fees $ 8,023 $ 4,801
Software sales 4,719 365
------- -------
Total revenue 12,742 5,166
Cost of goods sold and services provided:
Cost of professional fees 7,026 3,637
Cost of software sales 2,010 324
------- -------
Total cost of sales 9,036 3,961
Gross margin 3,706 1,205
Operating expenses:
Sales, general and administrative 5,296 2,237
Research and development 1,033 110
------- -------
Total operating expenses 6,329 2,347
Operating income (loss) (2,623) (1,142)
Other income (expense) 98 83
------- -------
Income (loss) before income taxes (2,525) (1,059)
Provision (benefit) for income taxes -- 74
------- -------
Net income (loss) $(2,525) $(1,133)
======= =======
Net income (loss) per share:
Basic $ (0.38) $ (0.20)
======= =======
Diluted $ (0.38) $ (0.20)
======= =======
Shares used in calculating earnings per share:
Basic 6,633,364 5,535,538
Diluted 6,633,364 5,535,538
</TABLE>
4
<PAGE>
Information Analysis Incorporated and Subsidiaries
Consolidated Statement of Cash Flows
<TABLE>
<CAPTION>
For the Nine Months Ended
-----------------------------
September 30,
-------------
1998 1997
amounts in thousands Unaudited Unaudited
--------- ---------
<S><C>
Net income (loss) ($2,525) ($480)
Adjustments to reconcile net loss to
net cash provided by operating activities:
Depreciation 221 93
Amortization 55 44
Software Amortization of Capitalized Software 873 8
Changes in operating assets and liabilities
Accounts receivable (3,543) (260)
Other receivables and prepaid expenses (314) 21
Refundable income taxes 33 2
Deferred income taxes - 72
Accounts payable and accrued expenses 2,114 713
------- -------
Net cash (used) by operating activities (3,086) 213
------- -------
Cash flows from investing activities
Acquisition of furniture and equipment (357) (445)
Increase in capitalized software (3,173) (1,689)
------- -------
Net cash used in investing activities (3,530) (2,134)
------- -------
Cash flows from financing activities
Net borrowed under bank revolving line of credit 393 -
Principal payments on capital leases 80 (11)
Net Proceeds from private placement 5,647 5,000
Proceeds from exercise of warrants 220 -
Proceeds from exercise of incentive stock options 183 227
------- -------
Net cash provided by financing activities 6,523 5,216
------- -------
Net (decrease) increase in cash and cash equivalents (93) 3,295
Cash and cash equivalents at beginning of the period 364 324
Cash and cash equivalents at end of the period $ 271 $ 3,618
======= =======
Supplemental cash flow Information
Interest paid $ 12 $ 12
</TABLE>
5
<PAGE>
PART I
Item 1. Financial Statements.
INFORMATION ANALYSIS, INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Basis of Presentation
The accompanying consolidated financial statements have been prepared by
Information Analysis Incorporated ("IAI" or the "Company"). Financial
information included herein is unaudited, however, in the opinion of management,
all adjustments (which include normal recurring adjustments) considered
necessary for a fair presentation have been made. Certain information and
footnote disclosures normally included in annual financial statements prepared
in accordance with generally accepted accounting principles have been omitted,
but the Company believes that the disclosures made are adequate to make the
information presented not misleading. For more complete financial information,
these financial statements should be read in conjunction with the audited
financial statements and notes thereto for the year ended December 31, 1997
included in the Company's annual report on Form 10-KSB. Results for interim
periods are not necessarily indicative of the results for any other interim
period or for the full fiscal year.
Cautionary Statement Regarding Forward-Looking Statements
This Form 10-QSB contains forward-looking statements regarding the Company's
business, customer prospects, or other factors that may affect future earnings
or financial results that are subject to the safe harbor created by the Private
Securities Litigation Reform Act of 1995. Such statements involve risks and
uncertainties which could cause actual results to vary materially from those
expressed in the forward-looking statements. Investors should read and
understand the risk factors detailed in the Company's 10-KSB for the fiscal year
ended December 31, 1997 and in other filings with the Securities and Exchange
Commission.
Year 2000 Compliance
The Company is committed to ensuring that its software and services are entirely
year 2000 compliant by the end of 1998. To meet this objective, the Company
already has conducted an internal review of software components developed by the
Company.
Year 2000 compliance issues also involve systems that are not directly
involved in the Company's products and services but nonetheless are material to
the conduct of Company's ongoing business. These systems can include alarm
systems, telephone and voicemail systems, customer support tracking systems,
customer billing, accounting and payroll systems, computer equipment, the
operating systems on computer equipment and general office software programs.
Many of these systems are provided to the Company by third party vendors. The
Company plans to seek written confirmations from its primary vendors that those
vendors have developed plans (or are in the process of developing plans) to
address year 2000 issues for the products and services they provide.
Item 2. Management's Discussion and Analysis of Financial Condition or Plan of
Operation.
Overview
Prior to 1997, IAI was primarily dedicated to providing a range of information
technology services, including software applications development, software
conversions, information systems reengineering and systems integration. In 1996,
IAI acquired the rights to a software tool which IAI initially intended to
utilize for systems conversion services as companies seek to migrate from
mainframe legacy systems to more modern-day platforms and environments. After
acquiring the rights to this tool, which IAI named
6
<PAGE>
UNICAST, IAI recognized that the tool's functionality could be extended to
address the Year 2000 problem currently confronting many computer systems. This
problem basically prevents certain software applications from recognizing dates
and executing transactions involving years subsequent to 1999.
In 1997, IAI's efforts were primarily devoted towards transitioning to
a product and services focus centered around UNICAST. As part of this
transition, (i) the Company developed, or commenced the development of, a family
of products to achieve Year 2000 compliance for specific language environments,
(ii) implemented its own "solutions factory" to provide Year 2000 services on an
outsourced basis, (iii) entered into strategic relationships centered around
UNICAST, including a marketing alliance with Computer Associates International,
Inc. ("CA") under which UNICAST is included as part of CA's suite of Year 2000
tools and licensing and other arrangements with other solutions providers
offering to provide, on an outsourced basis, Year 2000 services and (iv)
expanded the Company's infrastructure to meet the anticipated growth which the
Company was projecting for its Year 2000 products and services.
Initially, the Company's intent was to focus upon product sales. The
Company believed, as did others, that substantial revenue could be achieved
through this means. As the Year 2000 market developed, it appeared that many
companies would opt to outsource remediation rather than license software to
undertake remediation internally. Accordingly, the Company deemed it prudent to
expand its services capacity to capture revenue unavailable through product
licensing. Even so, the Company was of the opinion that the UNICAST tool could
facilitate the Company's ability to obtain contracts for Year 2000 remediation
services as well as migration services to convert old systems to modern
platforms. By mid-1998, the Company concluded that industry reports of the
potential size of the Year 2000 market far overstated the actual market. IAI
believed its opportunities were being undermined by a lack of sensitivity of
many companies to appreciate the risks they face by avoiding attaining Year 2000
compliance and by companies electing to primarily rely upon their own internal
resources to remediate their systems.
The Company has seen an increase in its revenues associated with Year
2000 opportunities, but not at the levels it once anticipated. Year 2000-related
revenues rose beginning in the fourth quarter of 1997, when they were
$1,429,000. In the first quarter of 1998, Year 2000 products and services were
$3,081,000; and in the second quarter of 1998, $4,717,000. In the third quarter,
Year 2000 products and revenues fell to $1,347,000, despite a steady increase in
the number of clients served. The Company attributes the decline to several
reasons. First, IAI devoted an unusual level of resources to the completion of
certain fixed-price contracts, preventing the Company from recognizing revenue
from backlogged orders. Second, a portion of a major software sale from a prior
quarter was reversed, depressing third-quarter software sales. Third, IAI's
sales partners failed to achieve forecast levels. The changes in the Company's
business, and the impact these changes caused to operations, as described above,
substantially account for the differences in results of operations between the
three- and nine- months periods. These changes in the Company's business and
operations should be noted when comparing the results of operations between any
respective period in 1998 with a comparable period in 1997.
Three Months Ended September 30, 1998 Versus Three Months Ended September 30,
1997
Revenue
IAI's revenues in the third quarter of fiscal 1998 were $2,756,000,
compared to $1,816,000 in the third quarter of fiscal 1997, an increase of 52%.
Professional services revenues were $2,643,000 versus $1,643,000, an increase of
61%, and product revenues were $113,000 versus $173,000. The increase in
professional services revenue in 1998 is attributable to Year 2000 programs in
1998 that were not materially present in 1997. Software sales in 1998 were for
the Company's UNICAST/2000 remediation tool and for other, third-party software.
Software revenue, which was $838,000 in the third quarter, was adversely
affected by the reversal of a portion of a sale made in a prior quarter,
reducing reported software revenue to $113,000. This reversal was not associated
with any failure on the part of the Company's software to perform but, rather,
was undertaken for business reasons as opposed to legal reasons.
Professional services revenue was lower than anticipated as several
projects required more effort to complete than was planned because of technical
difficulties. Software revenue was substantially lower than anticipated due to
poor sales of the Company's UNICAST/2000 software by third parties.
Going forward, IAI believes Year 2000 revenues will be less than had
been anticipated. The Company believes most remediation projects have been
carried out internally by affected organizations. IAI
7
<PAGE>
expects to continue in the market, but with diminished expectations. In the near
term, the Company sees opportunity for IV&V (Independent Verification and
Validation) projects. Longer term, IAI will increasingly concentrate its
resources on soliciting computer systems migration and modernization business,
and contract IT services. IAI has intensified its internal product sales effort
to offset the disappointing results from third parties. Year 2000 revenues and
earnings are not material to CA, and CA's continuing commitment to its Year 2000
sales and marketing efforts cannot be guaranteed. In the event CA lessened or
discontinued its sales and marketing efforts, IAI would be forced to rely upon
its own efforts and those of other professional services organizations.
Moreover, IAI's revenues may be difficult to predict. IAI expects to
continue to solicit Year 2000 business but, because the Year 2000 market has
little prior history, the sales cycle length and remaining market size cannot be
accurately assessed. IAI's revenues are derived from both products and services.
Customers that choose IAI may elect to buy the Company's products, which would
generate one level of revenue recognizable in one time period; or utilize IAI's
solutions factory, which would generate a different level of revenue
recognizable over a different time period.
Gross margin
Gross margins were ($698,000) in the third quarter of fiscal 1998
versus $446,000 in the third quarter of fiscal 1997. The Company's gross loss on
professional services was $414,000 and, on software sales, the gross loss was
$284,000. Professional services expenses exceeded revenue owing to the Company's
decision to complete certain fixed-price Year 2000 contracts. The cost to
complete these contracts was approximately $900,000 more than the revenue
provided from them. Software gross margin was affected by the Company's decision
to refund the unused portion of a software sale made in a prior quarter,
resulting in the commensurate reversal of $522,000 of gross profit from that
sale. The net result was a gross loss on software sales of $284,000.
Going forward, IAI has announced that future Year 2000 testing
contracts will be bid on a time and materials basis. The Company does not
believe its backlog of orders contains projects with loss potential of the
magnitude experienced in the third quarter. However, the Company does not
anticipate that current customers that have contracted for professional services
on a fixed-price basis will convert to a time-and-materials basis. Accordingly,
the Company cannot guarantee that all current contracts will be completed at a
profit.
Selling, General & Administrative (SG&A)
SG&A was $1,879,000, or 68% of revenues, in the third quarter of 1998
versus $1,085,000, or 60% of revenues, in the third quarter of 1997. The
increase is attributable to the Company's increase in spending for sales,
marketing, and corporate infrastructure. Because the shortfall in software sales
was not known until the final few days of the quarter, the Company was unable to
timely adjust its expense levels during the quarter to the income that would be
realized for the quarter, thereby causing the Company to incur greater SG&A
expense than were warranted. In prior quarters, sales through selling partners
were not made until the final days of the quarter, and were not known until the
beginning of the succeeding quarter.
Research and Development (R&D)
R&D expenditures were $353,000 in the third quarter of fiscal 1998
versus $61,000 in the third quarter of fiscal 1997. The increase is due to
higher software maintenance expenses in 1998. The Company had no Year 2000
software in general release in the third quarter of 1997. In addition to
reported R&D expenditures, IAI capitalized $1,078,000 of software development
costs in the third quarter of 1998, versus $1,221,000 in the third quarter of
1997. The Company anticipates that it will capitalize little or no software in
the fourth quarter of 1998. At the end of the third quarter and beginning of the
fourth quarter, IAI reduced spending on product development in accordance with
lower revenue expectation.
In the fourth quarter of 1998 or in 1999, IAI may elect to accelerate
the amortization of certain UNICAST/2000 products. While certain of the
Company's tools appear to have a useful life approximating the current,
four-year schedule utilized by the Company; other products may have a shorter
useful life based on revised expectations concerning the Year 2000 market. IAI
is evaluating the useful life of its products but has not yet reached any
decision regarding an appropriate amortization period.
8
<PAGE>
Income and loss
The Company reported an operating loss of $2,930,000 in the third
quarter of 1998 compared to a loss of $700,000 in the third quarter of 1997. In
general, the level of loss in 1998 reflected the lower than anticipated revenue
in the quarter, the loss on completion of certain contracts, the reversal of
gross margin on a prior-quarter software sale, and certain termination expenses
incurred in the quarter. Because of the Company's prior history of losses, IAI
did not recognize a tax benefit in the quarter.
Going forward, because IAI's principal selling partner, CA,
acknowledges that a significant percentage of that company's sales are recorded
in the last few days of each quarter, IAI has difficulty accurately predicting
revenue contribution from CA in any given quarter. This, in turn, can impair the
Company's ability to match expense levels to anticipated revenue, with
consequent impact on income.
Nine Months Ended September 30, 1998 Versus Nine Months Ended September 30, 1997
The factors in the preceding section relating to business trends are also
applicable to the nine-month period.
Revenue
IAI's revenues in the first nine months of fiscal 1998 were
$12,742,000, compared to $5,166,000 in the first nine months of fiscal 1997, an
increase of 147%. Professional services revenues were $8,023,000 versus
$4,801,000, an increase of 67%, and product revenues were $4,719,000 versus
$365,000. The increase in revenue in each of the Company's reporting segments is
attributable to Year 2000 programs in 1998 that were not materially present in
1997. Per the discussion above in "Three Months Ended September 30, 1998 Versus
Three Months Ended September 30, 1997", the Company has substantially changed
its business since the first nine months of 1997. See "Overview."
Gross margin
Gross margins were $3,706,000, or 29% of sales, in the first nine
months of fiscal 1998 versus $1,205,000, or 23% of sales, in the first nine
months of fiscal 1997. The improvement in gross margin was attributable to
higher gross margins inherent in software products sales. The 1998 nine-month
figures are not indicative of the much better results achieved through the first
six months of the year.
Selling, General & Administrative
SG&A was $5,296,000, or 42% of revenues, in the first nine months of
1998 versus $2,237,000, or 43% of revenues, in the first nine months of 1997.
The increase is attributable to the Company's increase in spending for sales,
marketing, and corporate infrastructure.
Research and Development
R&D expenditures were $1,033,000 in the first nine months of fiscal
1998 versus $110,000 in the first nine months of fiscal 1997. The increase is
due to higher software maintenance expenses in 1998. The Company had no Year
2000 software in general release in the first nine months of 1997. In addition
to reported R&D expenditures, IAI capitalized $3,182,000 of software development
cost in the first nine months of 1998 and $3,097,000 in the first nine months of
1997.
Income
The Company reported an operating loss of $2,623,000 in the first nine
months of 1998 compared to a loss of $1,142,000 in the first nine months of
1997. The increased loss was a combination of several factors. The Company had
put increased resources into its infrastructure in anticipation of increased
product sales and could not react quickly enough to lower those expenses to
offset lowered revenues of its Year 2000 product suite from third parties. In
addition, the Company underestimated the technical difficulties it would
encounter with several remediation projects.
Liquidity and Capital Resources
Through the first nine months of 1998, the Company financed its operations from
current collections, through proceeds obtained in a private placement in January
1998, which netted $5,647,000, and its line of credit. As
9
<PAGE>
of September 30, 1998, the Company's balance on its line of credit was $993,000.
Cash and cash equivalents at September 30, 1998 were $271,000 compared to
$364,000 at September 30, 1997.
The Company increased the limit on its line of credit to $2,000,000 in June,
1998. The line of credit expires June 17, 1999 at which time it is subject to
renewal. The Company anticipates that the line of credit, coupled with funds
generated from operations and in conjunction with recent cuts in operating
expenses, should be sufficient to meet the Company's operating cash
requirements.
The Company has no material commitments for capital expenditures.
PART II - OTHER INFORMATION
Item 2. Change in Securities.
None.
Item 4. Submission of Matters to a Vote of Security Holders
None.
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibit 27.1, "Financial Data Schedule" is attached.
(b) No reports on Form 8-K were filed for the quarter for which this report
is filed.
SIGNATURES
In accordance with the requirements of the Exchange Act of 1934, the registrant
caused this report to be signed on its behalf by the undersigned thereunto duly
authorized.
Information Analysis Incorporated
_________________________________
(Registrant)
Date: November 13, 1998 By: _______________________________________
Sandor Rosenberg, Chairman of the Board
and President
By: _______________________________________
Richard S. DeRose, Executive Vice President and
Treasurer
INDEX TO EXHIBITS
Exhibit No. Description
27.1 Financial Data Schedule
10
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
REGISTRANT'S 10-QSB AS FOR THE QUARTER ENDED SEPTEMBER 30, 1998 AND IS
QUALIFIED BY REFERENCE TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
<MULTIPLIER> 1
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-END> SEP-30-1998
<CASH> 271
<SECURITIES> 0
<RECEIVABLES> 6,671
<ALLOWANCES> 0
<INVENTORY> 0
<CURRENT-ASSETS> 7,389
<PP&E> 2,687
<DEPRECIATION> 1,783
<TOTAL-ASSETS> 15,129
<CURRENT-LIABILITIES> 5,496
<BONDS> 0
0
0
<COMMON> 82
<OTHER-SE> 9,447
<TOTAL-LIABILITY-AND-EQUITY> 15,129
<SALES> 12,742
<TOTAL-REVENUES> 12,934
<CGS> 9,036
<TOTAL-COSTS> 15,365
<OTHER-EXPENSES> 82
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 12
<INCOME-PRETAX> (2,525)
<INCOME-TAX> 0
<INCOME-CONTINUING> (2,525)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (2,525)
<EPS-PRIMARY> (0.38)
<EPS-DILUTED> (0.38)
</TABLE>
