-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, JDw8s0YTf1NbtcmEnObl4d6ojLXZKhyfM5enEoUFcBtGzEavL9AEbdFFhDfS7zeN BNS7au9y7PpPzmeq1cdlkg== 0000881975-99-000001.txt : 19990402 0000881975-99-000001.hdr.sgml : 19990402 ACCESSION NUMBER: 0000881975-99-000001 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 2 CONFORMED PERIOD OF REPORT: 19980930 FILED AS OF DATE: 19990331 FILER: COMPANY DATA: COMPANY CONFORMED NAME: CTA INCORPORATED CENTRAL INDEX KEY: 0000881975 STANDARD INDUSTRIAL CLASSIFICATION: SERVICES-COMPUTER PROGRAMMING SERVICES [7371] IRS NUMBER: 840797618 STATE OF INCORPORATION: CO FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K SEC ACT: SEC FILE NUMBER: 033-44510 FILM NUMBER: 99579491 BUSINESS ADDRESS: STREET 1: 6116 EXECUTIVE BLVD STREET 2: STE 800 CITY: ROCKVILLE STATE: MD ZIP: 20852 BUSINESS PHONE: 3018161200 MAIL ADDRESS: STREET 1: 6116 EXECUTIVE BLVD STREET 2: STE 800 CITY: ROCKVILLE STATE: MD ZIP: 20852 10-K 1 SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-K (Mark One) [ X ] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 [FEE REQUIRED] For the fiscal year ended December 31, 1998 or [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 [NO FEE REQUIRED] COMMISSION FILE NUMBER 333-64373 COMPUTER TECHNOLOGY ASSOCIATES, INC. (Exact name of registrant as specified in its charter) COLORADO 84-0797618 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 6903 ROCKLEDGE DRIVE, BETHESDA, MD 20817 (Address of principal executive offices) (Zip Code) Registrant's telephone number, including area code (301) 581-3200 Securities registered pursuant to Section 12(b) of the Act: NONE Securities registered pursuant to Section 12(g) of the Act: NONE Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.[ X ] Yes[ ] No Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of the registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [ X ] As of FEBRUARY 28, 1999, there were outstanding 8,584,095 shares of the registrant's common stock, par value $.01, which is the only class of common or voting stock of the registrant. The aggregate market value of the common stock held by non-affiliates of the registrant as of that date was $9,917,232 as determined by independent appraisal. COMPUTER TECHNOLOGY ASSOCIATES, INC. ANNUAL REPORT ON FORM 10-K FOR THE YEAR ENDED DECEMBER 31, 1998 TABLE OF CONTENTS PART I PAGE ITEM 1 BUSINESS 1 ITEM 2. PROPERTIES 8 ITEM 3. LEGAL PROCEEDINGS 9 ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS 9 PART II ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS 10 ITEM 6. SELECTED FINANCIAL DATA 14 ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS 16 ITEM 7A. QUALITATIVE AND QUANTITATIVE DISCLOSURES ABOUT MARKET RISK 22 ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA 22 ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE 23 PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT 24 ITEM 11. EXECUTIVE COMPENSATION 26 ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT 28 ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS 29 PART IV ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K 31 SIGNATURES PART I ITEM 1. BUSINESS CTA provides rapid development and deployment of advanced information technology ("IT") solutions for complex enterprise requirements. The Company's offerings include project management consulting, network engineering, embedded IT systems engineering, Enterprise Resource Planning ("ERP") installation and integration, data warehousing and data base migrations, electronic commerce, client-server and other web based applications development and legacy system modernization. CTA's mission is to provide for rapid, low risk installation and integration of complex information technology through the use of a disciplined incremental implementation approach. In addition to its strong technical and program management capabilities, the Company has established a reputation for consistently high levels of customer satisfaction based on a combination of service, quality and value. The Company's current business strategy includes developing an international client base which is balanced across both government and commercial sectors of the IT services market. COMPANY HISTORY The Company was founded in 1979 as Computer Technology Associates Inc., specializing in consulting services related to the evaluation of computer systems embedded in larger systems such as spacecraft, missiles and aircraft. In the mid-1980's, the Company's consulting business expanded into systems integration of avionics, command and control, and other decision support systems. Originally qualified to receive small business related support from the federal government, the Company established major relationships with U.S. military operations at the Defense Department's Cheyenne Mountain Complex, the Naval Air Warfare Center, Weapons Division, NASA's Goddard Space Flight Center and the Air Force's Consolidated Space Operations Center. In 1992, the Company ended its eligibility for government programs that assist small businesses, with the last significant contract awarded under these programs completed in early 1996. Since 1992, the Company has replaced contracts awarded under these assistance programs with contracts awarded under full and open competition. The share of IT revenues derived from competitive awards grew from 19% in 1992 to 100% in 1997. In the 1990's, the Company targeted U.S. government IT contracts that allowed it to broaden the Company's base of skills to include a number of business oriented IT disciplines equally applicable to the federal civil agency and state government IT markets. The Company then established strategic alliances with certain specialized software companies that enabled it to enter the commercial IT market and win contracts with commercial customers such as Cessna, Reynolds Metals and Allied-Signal. In 1992, the Company acquired a 79% interest in CTA Space Systems ("CTASS") to expand its business from providing IT services related to space systems to providing full turn-key space systems. In 1994, CTA acquired the remaining minority interest in CTASS. CTASS pioneered small satellite-based store-and-forward technology, which it originally developed to interrogate dispersed buoys equipped with acoustic sensors. In 1994, the Company entered the commercial GEO communications satellite market with CTASS' award of the contract for the Indostar turn-key direct-to-home ("DTH") system from PT MediaCitra Indostar. The contract provided for the Company to build a small, three-axis stabilized commercial communications satellite, which was launched in 1997, and a complete facility in Jakarta, Indonesia including broadcast and subscriber management software, communications uplinking systems and hardware/software systems for spacecraft telemetry, tracking and control. In late 1997, the Company sold CTASS and certain related businesses to Orbital Sciences Corporation in order to focus on its core IT business. See Note 2 of Notes to Consolidated Financial Statements. CORPORATE ORGANIZATION Following the sale of the Space and Telecommunications business, the Company organized into Federal and Commercial operating units. These business units focused on specific client groups, namely, federal, state and local government and commercial clients. Subsequently, management determined that to better focus the provision of services to our clients, an organization consisting of Software Engineering and Systems Engineering groups would be more appropriate. Accordingly, the Company's Software Engineering Group focuses on the installation and integration of ERP software, software migration and conversions, e-commerce implementation and Year 2000 services. The Company's Systems Engineering Group focuses on complex embedded computer systems and project management and engineering consulting. INFORMATION TECHNOLOGY SERVICES The Company believes that it possesses a level of IT technical and project management experience and expertise that allows it to offer rapid, high value, solutions to a range of client IT requirements. The Company's principal business focus is in the areas of 1) legacy information system modernization, including Year 2000 compliance upgrades, 2) electronic commerce implementations and other web based applications including the engineering and implementation of secure and highly reliable computer and network systems, 3) network integration and application development, 4) the development, migration and maintenance of large scale databases, 5) the installation and integration of ERP software, and 6) a range of IT services associated with complex embedded computer systems. The Company is currently planning to focus the provision of these services across a wide range of vertical markets. The Company believes that it is one of the industry leaders in the rapidly growing market for federal, state and commercial Year 2000 compliance upgrades based on its combination of direct Year 2000 conversion experience, use of automated tools and its ability to offer its customers solutions to both their embedded and non-embedded Year 2000 compliance requirements. The Company expects that it will continue to receive revenues from additional Year 2000 engagements during the next 18 months. However, these engagements and related revenues are expected to peak prior to calendar year 2000 as customers address their needs. Thereafter, the Company expects that revenues derived from year 2000 engagements will steadily decline. The Company believes that current Year 2000 related business will be replaced with legacy system modernization projects including web based applications and client-server conversions. INFORMATION TECHNOLOGY SERVICES--BUSINESS STRATEGY The principal strategies that the Company is pursuing to expand its IT services business include: INCREASING PENETRATION OF EXISTING CUSTOMER BASE. The Company focuses heavily on achieving consistently high levels of customer satisfaction and technical excellence. Due to its long-term incumbent position as a key systems integrator for some of the nation's largest and most complex information systems, the Company has gained a unique and profound understanding of those systems. The Company believes this knowledge provides it with a substantial advantage in terms of cost, technical expertise and demonstrated past performance in competing for future work related to these systems. The Company believes that its Year 2000 conversion initiative will result in similar competitive advantages with respect to a wide range of new customers. PENETRATING NEW MARKETS BY LEVERAGING CORE COMPETENCIES. The Company seeks out and exploits opportunities to market to new customers the expertise it has gained in past IT assignments. The Company's experience in federal government, state government and commercial Year 2000 compliance projects has proven to be a key factor differentiating the Company in competitive bidding situations with new customers. The Company plans to use such engagements to establish relationships with an expanded base of customers that can be used for marketing the Company's expertise in additional areas such as legacy system modernization, data base migrations, and web enabled applications development. ESTABLISHING MARKETING ALLIANCES TO OFFER COMPLETE SOLUTIONS. The Company has established, and will continue to establish, marketing alliances with software product and tool providers which allow the Company to offer turn-key solutions for such applications as Enterprise Resource Planning and electronic commerce. ACQUIRING STRATEGIC IT SERVICES BUSINESSES. The Company intends to pursue acquisitions that will expand the Company's commercial IT services customer base and provide specialized capabilities and skills that enhance the Company's penetration of the commercial IT services market. INFORMATION TECHNOLOGY SERVICES--CONTRACTS AND PROGRAMS Certain of the Company's significant IT contracts and programs are described below. Total contract values include both realized (earned and recorded) and unrealized (to be earned and recorded in future periods) revenues. Government contracts are typically funded annually and there are no assurances that funding will continue beyond the current fiscal year or, if they are funded beyond the current fiscal year, for how many additional years. U.S. GOVERNMENT--DOD RANGE SYSTEMS MANAGEMENT. In 1993, the Company was awarded the Range Instrumentation Development ("RID") contract, pursuant to which the Company supports a wide variety of aircraft range system activities for the Naval Air Warfare Center ("NAWC") located at China Lake, California, including software development, test and evaluation, system integration and fabrication of electronic threat simulators. The RID contract is a cost-plus-award-fee contract, has a total value of $88 million and work under this contact is scheduled to be completed in December 1999. AVIONICS SYSTEMS INTEGRATION. The Company participates in the design, development, fabrication, modification and testing of hardware for the NAWC, performing a wide range of support activities. These activities include systems engineering, systems analysis, software development, configuration management, verification and validation, maintenance and operation services for various naval aircraft and the development and maintenance of large-scale hybrid simulators (which integrate computer simulations with actual aircraft avionics). The Company has performed this work since its first NAWC contract, awarded in 1985. In 1995, this contract was recompeted under a program reserved for small businesses and the Company successfully teamed with a small business contractor, which was awarded the prime contract. The current NAWC contract is a cost-plus-award-fee contract, has a total value to CTA of $33 million and is scheduled for completion in March 2000. INFORMATION SYSTEMS SECURITY. The Company, as a subcontractor to SAIC, is a member of the team awarded the Center for Information Systems Security contract in 1995 by the Defense Information Systems Agency. Under this five-year omnibus security engineering contract, the Company will continue to provide technical support to information systems security activities within the DOD and other U.S. government departments and agencies. Activities under this contract include designing and implementing the measures necessary to detect, document and counter a wide range of threats to on-line and stored information. The Information Systems Security contract is a time-and-materials contract, has a total value to CTA of $8 million and is scheduled for completion in July 2000. In addition, the Company's clients for information system security services include the Department of Treasury, General Services Administration, Defense Finance and Accounting Service as well as several commercial companies. MEDICAL INFORMATION SYSTEMS. The Company is providing medical information systems expertise to the DOD Department of Health Affairs Consolidated Health Care System. This second generation medical information system implements the most advanced technology available in the industry today. Its goal is a paperless, globally accessible electronic patient record system that provides authorized medical professionals with vital patient medical histories in near real time, regardless of where the patient data may have been collected or stored, or where the patient may be physically located when medical attention is required. This technology not only enables more accurate record keeping but also reduces the response time required to obtain medical information from days or weeks to literally seconds. This contract is a cost-plus-fixed-fee contract, has a total value of $30 million and is scheduled for completion in March 2001. U.S. GOVERNMENT--CIVILIAN AGENCIES FEDERAL AVIATION ADMINISTRATION ("FAA"). For the FAA, the Company provides services related to the design, development, integration and test of the U.S. air traffic control ("ATC") system and has been supporting the FAA automation programs since 1982. Currently, the Company is performing on the following programs for the FAA: (i) providing engineering support to the FAA as a subcontractor to TRW under the AUA Technical Assistance contract in implementing its programs to replace the ATC system. This contract is a time-and-materials contract, has a total value to CTA of $40 million and is scheduled for completion in December 2002. (ii) providing support to the FAA as a subcontractor to TRW under the ASD SETA contract for the overall architectural design and evolution of the National Airspace System. This contract is a time-and-materials contract, has a total value to CTA of $17 million and is scheduled for completion in September 2001. (iii) assisting the FAA, as a subcontractor to TRW under the Weather Technical Assistance contract in the areas of program engineering, hardware and software engineering, program and project management, system test and evaluation, system implementation and human factors. This contract is a cost-plus-fixed-fee contract, has a total value to CTA of $3 million and is scheduled for completion in March 2000. (iv) providing engineering and management support services to the FAA as a subcontractor to SRC under the ANN Technical Assistance contract. This contract is a cost-plus-award-fee contract, has a total value to CTA of $5 million and is scheduled for completion in September 2000. DEPARTMENT OF JUSTICE. In February 1994, the Department of Justice ("DOJ") awarded the Company a contract to assist the FBI in its program to streamline, consolidate and automate its Criminal Justice Information System, which serves over 80,000 law enforcement users. Under this seven-year contract, the Company is assisting the FBI in virtually every aspect of the engineering process, from procurement of new information systems to the re-engineering of the processes that this system supports. The DOJ contract is a combined fixed-price and cost-plus contract, has a total value of $40 million and is scheduled for completion in September 2001. TREASURY DEPARTMENT. Under a contract awarded in 1995, the Company provides system engineering and technical analysis support to the Treasury Department, primarily for the Internal Revenue Service's computer-based information processing system modernization effort. The Company's support functions include engineering services and telecommunication and security services. In the longer term, the Company will be developing and assessing advanced user interface concepts, technologies and prototypes (such as hypertext and speech recognition) and assessing and recommending tools and environments to support future software development. This contract is a time-and-materials contract, has a total value of $40 million and is scheduled for completion in June 2000. GENERAL SERVICES ADMINISTRATION. The Company provides support for the Federal Supply Service's central offices, its eleven regional offices and its various commodity centers and depots. The Company provides applications software and database maintenance and upgrades, network administration, mainframe to client-server conversions and implementation of electronic commerce applications. The Company's current Federal Supply Service contract is a follow-on contract to the original Federal Supply Service contract that was awarded to the Company in 1992. The current contract has a total value of $31 million and is scheduled for completion in September 2001. STATE GOVERNMENT AND COMMERCIAL YEAR 2000 CONVERSION. The Company is a leading provider of Year 2000 compliance services to both commercial clients and state and local governments. The Company currently has contracts to provide such services to 14 commercial clients centered in the Financial Services and Process Manufacturing vertical markets and 12 state and local governments. These contracts incorporate a wide range of services including IT inventory assessment, code remediation, testing, auditing of third party-vendor remediated systems and embedded systems compliance evaluations. The Company's historical, positive performance track record has fostered significant financial confidence within the customer base that has resulted in multi-year contractual awards that range from $1 - $5 million for its commercial customers to $1 - $25 million for its state and local government customers. IT SYSTEMS ENGINEERING. In June of 1996, the Company was awarded a contract by USAA, a San Antonio, Texas-based, provider of insurance, banking and investment services to provide technical and engineering support to the USAA Information Technology Division. The Company's functions include (i) project management support, including resource forecasting and tracking and scheduling, (ii) systems engineering, including configuration management, systems requirements management and test planning and execution, (iii) procurement support, including the development of procurement strategies, evaluation criteria and requests for proposals and (iv) development of cost estimates for USAA procurement. The USAA contract is a time-and-materials contract, and is scheduled for completion in March 2000. EMERGING COMMERCIAL OFFERINGS & PROGRAMS. In keeping with its stated strategy to leverage Year 2000 contracts, the Company has staffed its Year 2000 projects with senior business and systems professionals whose experience profiles go far beyond those required to perform general Year 2000 assessments and remediation. By incorporating a high-level skill set with a proven methodology, customers have yielded an experience-enhanced view of their current IT portfolios that not only accelerates Year 2000 remediation, but also provides for cost-effective alternatives for contingency planning, platform consolidation, systems maintenance and ERP integration. As a result, nearly all the Company's commercial clients and a third of the state and local government clients have requested assistance with non-Year 2000 IT systems efforts. In order to better leverage this opportunity, the Company has combined its service capabilities into three primary offerings: Platform Conversions and Migrations, Application Integration and ERP enhancement. Platform Conversions and Migrations focus on the transformation of code and data. Projects of this type may be driven by customer requirements for system consolidation, by "orphaned" (vendor abandoned) systems that are still considered to be mission critical or by clients who need to modify their systems to handle Euro-Currency transactions. Application Integration is directed toward the linkage of legacy mainframe and client/server platforms. ERP enhancement consists of a combined product and service offering that facilitates the integration of disparate ERP systems within the corporate enterprise. The Company is utilizing these offerings to enhance its competitive positioning within its installed base and to create a compelling rationale for new clients to consider working with CTA. For its Financial clients, the company has targeted these offerings at this market's high demand for data mining and customer portfolio management systems. These systems provide a comprehensive view of customer product and service purchases, customer portfolio profitability and customer activity trends. This offering is currently in the planning stages at USAA, a San Antonio, Texas-based provider of insurance, as a natural extension to the current contract with USAA for IT engineering services. For the Company's process manufacturing clients, these offerings allow for the successful implementation of a hybrid ERP system; where new investments in packaged ERP systems (i.e., manufacturing, financial, inventory) and existing investments in viable legacy systems (i.e., order processing, sales management, distribution) provide for the framework of a unified system structure. The Company is currently initiating these offerings at Dannon Foods and Centocor Pharmaceuticals. For its State and local clients, the Company's offerings provide a pathway for migration from maintenance-intensive, sunset (obsolete) systems to advanced open-systems technology. State and local government also have the need for ERP-type systems, particularly in the areas of human resources services and financial management. These initiatives are often hampered by the government's ability to sustain expertise in aging legacy environments and hire and maintain technical staff in a highly competitive marketplace. With the addition of selective systems outsourcing as an adjunct to the standard IT Systems Engineering offering, the Company has created a comprehensive program consisting of Year 2000 compliance, sunset system maintenance support, phased platform migration and ERP system support. Selective state agencies in California, Connecticut, Kansas and Texas are reviewing these options as a natural extension to their current Year 2000 contracts with CTA. INFORMATION TECHNOLOGY SERVICES--COMPETITION The IT services industry in which the Company operates is highly fragmented with no single company or small group of companies in a dominant position. The Company's competitors include large, diversified firms with substantially greater financial resources and larger technical staffs than the Company, such as BDM, Cap Gemini, CSC, EDS, IBM, Lockheed Martin, PRC, SAIC, as well as firms that receive preferences under government programs for small businesses. The firms that compete with the Company include consulting firms, computer services firms, applications software companies and accounting firms, as well as the computer service arms of computer manufacturing companies and defense and aerospace firms. In addition, the internal staffs of client organizations, non-profit federal contract research centers and universities are, in effect, competitors of the Company. The primary competitive factors in the information technology industry include technical, management and marketing competence, as well as price. The Company competes for commercial work by identification of unique market niches in which the Company believes it has superior technical service capability. TYPES OF CONTRACTS GENERAL. The Company's services are provided primarily through three types of contracts: fixed-price, time-and-material and cost-reimbursable contracts. Fixed-price contracts require the Company to perform services under the contract at a stipulated price. Time-and-material contracts reimburse the Company for the number of labor hours expended at established hourly rates negotiated in the contract and the cost of materials incurred. Cost-reimbursable contracts reimburse the Company for all actual costs incurred in performing the contract, to the extent that such costs are within a specified maximum and allowable under the terms of the contract, plus a fee or profit. The following table shows the approximate percentage of revenue by contract type recognized by the Company's continuing operations during the indicated periods:
YEAR ENDED DECEMBER 31, TYPE OF CONTRACT 1996 1997 1998 Fixed-price 11% 14% 24% Time-and-materials 53% 54% 47% Cost-reimbursable 36% 32% 29% 100% 100% 100% Total
GOVERNMENT CONTRACT REQUIREMENTS. Many of the government programs in which the Company participates as a contractor or subcontractor may extend for several years, but they are normally funded on an annual basis. The Company's U.S. government contracts and subcontracts are subject to modification, curtailment and termination in the event of changes in government funding. Accordingly, all of the Company's contracts and subcontracts involving the U.S. government may be terminated at any time by the U.S. government, without cause, for the convenience of the U.S. government. If a U.S. government contract is terminated for convenience, the Company would be entitled to receive compensation for the services provided or costs incurred at the time of termination and a negotiated amount of the profit on the contract. Among the factors that could materially adversely affect the Company's U.S. government contracting business are budgetary constraints, changes in fiscal policies or available funding, reduction of defense or aerospace spending, changes in U.S. government programs or requirements, curtailment of the U.S. government's use of technology services firms, the adoption of new laws or regulations, technological developments and general economic conditions. In addition, increased competition and U.S. government budget constraints in the defense area, and in areas not related to defense, may limit future growth in Company revenues from U.S. government agencies and contractors. The Company's costs and revenues under government contracts are subject to adjustment as a result of annual audits performed by the DCAA on behalf of the DOD. Audits of the Company by the DCAA and other agencies have been completed for all years through 1996 without material adjustment. BACKLOG As the Company has evolved from Federal government contractor to commercial IT services provider, the concept of backlog has become less important. In the commercial marketplace, nearly all of the Company's orders are terminable by either the customer or the Company on short notice. Government contracts are generally multi-year awards subject to annual funding appropriations and termination for convenience by the government customer. The Government's ability to select multiple winners under IDIQ contracts, as well as its right to limit orders to any particular awardee, mean that there is no assurance that contract backlog will result in actual orders to the Company. Accordingly, the Company does not believe that backlog is material to its business. The Company's backlog represents an estimate of the remaining future revenues from existing signed contracts and contracts that have been awarded but not yet signed. Using the best available information, the Company estimates backlog on a quarterly basis. Changes in the backlog calculation from quarter to quarter result from: (a) additions for future revenues from the execution of new contracts or extension or renewal of existing contracts; (b) reductions for revenues earned from fulfilling contracts during the most recent quarter; (c) reductions from the early terminations of contracts; and (d) adjustments to estimates of previously included contracts. The Company's backlog at December 31, 1998 was approximately $148 million. EMPLOYEES At December 31, 1998, the Company had 774 employees, approximately 80 percent of whom are IT professionals and 20 percent in management and support positions. The Company also utilizes the services of independent contractors and as of December 31, 1998 had approximately 175 independent contractors working on client engagements. None of the Company's employees are represented by a labor union and the Company believes its relations with its employees to be good. The Company must compete against other employers for the acquisition of high quality, professional staff members. The Company cannot assure the retention of current staff or that replacement staff will be available at equal cost. Competitors of the Company may be able to attract or retain employees more successfully than the Company based on levels of benefits, demographics and other factors. The Company also regularly utilizes the services of consultants as an integral part of its work on specific projects. The Company is not materially dependent upon the services of any individual consultant or consulting firm. ITEM 2. PROPERTIES The Company leases approximately 23,000 square feet at its corporate headquarters in Bethesda, Maryland under a lease expiring in 2005. In addition, the Company has principal leased facilities in Ridgecrest, California and Colorado Springs, Colorado. The Company believes that these properties are adequate to serve the Company's present business operations. ITEM 3. LEGAL PROCEEDINGS The Company is currently involved in certain legal proceedings incidental to the ordinary course of its business. The Company does not believe that any liabilities relating to the legal proceedings to which it is a party are likely to be, individually or in the aggregate, material to its consolidated financial position or results of operations. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS None PART II ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS There is no established public trading market for the stock of the Company or its subsidiaries. However, the Company has maintained a limited market ("Limited Market") as described below to provide liquidity for its Common Stock. THE LIMITED MARKET Since its inception, the Company has pursued a policy of remaining essentially employee owned and, therefore, there has never been a public market for the Common Stock. Prior to September 1992, the Company has offered to repurchase shares from shareholders on several occasions primarily for contribution to the Company's Employee Stock Ownership Plan ("ESOP"). In order to provide liquidity for its shareholders, however, the Company established a Limited Market through an agreement with Capitol Securities Management, Inc. ("Capitol") whereby Capitol maintains the Limited Market. From September 1992 through December 1998, the Company has conducted six trades in the Limited Market, one each in 1992, 1993, 1995 and 1998 and two in 1994. There were no trades conducted in 1996 or 1997. It is anticipated that the Limited Market will continue to permit existing shareholders to sell shares of Common Stock on at least one predetermined date each year (the "Trade Date"). Such sales will be made at the prevailing Formula Price, or such other price as may be determined by the Board of Directors with the advice of an independent appraiser, to employees, consultants and directors of the Company. In addition, the Company will be authorized, but not obligated, to purchase shares of Common Stock in the Limited Market to satisfy its requirements (including for sale to the trustees of the Company's ESOP), but only if and to the extent that the number of shares offered for sale by shareholders exceeds the number of shares sought to be purchased by authorized buyers. In the event that the aggregate number of shares offered for sale by the sellers is greater than the aggregate number of shares sought to be purchased by authorized buyers and the Company, offers to sell will be treated in the following manner: Offers to sell 1,000 shares or less of Common Stock or up to the first 1,000 shares if more than 1,000 shares of Common Stock are offered by any seller will be accepted first. Offers to sell shares in excess of 1,000 shares of Common Stock will be accepted on a pro-rata basis based on the number of shares owned by those shareholders wanting to sell shares. If, however, there are insufficient purchase orders to support the primary allocation of 1,000 shares of Common Stock or less per seller, then the purchase orders will be allocated equally among each of the proposed sellers up to each seller's total number of shares offered for sale. Subject to applicable legal or contractual restrictions and the availability of funds, the Company currently intends to purchase sufficient shares on each Trade Date so that each shareholder wishing to sell shares will be able to sell at least 1,000 shares. Such restrictions include those contained in the Colorado Business Corporation Act, which prohibit a corporation from purchasing its outstanding shares if, as a result of such purchase, (i) the corporation would not be able to pay its debts as they become due in the usual course of business or (ii) the corporation's total assets would be less than its total liabilities plus any amount necessary, if the corporation were to be dissolved at the time of the distribution, to satisfy any preferential payments upon dissolution of shareholders holding a class of stock being repurchased by the corporation. The Company's current credit agreement also restricts the Company from purchasing Common Stock if doing so would cause it to violate one of the financial covenants in the credit agreement. These financial covenants include requirements to preserve a certain fixed charge coverage ratio, earnings before interest and taxes to interest expense ratio and total outstanding debt to accounts receivable ratio. In addition, the Company may enter into other contracts in the future which restrict its ability to repurchase its outstanding Common Stock. To the extent that the aggregate number of shares sought to be purchased exceeds the aggregate number of shares offered for sale, the Company may, but is not obligated to, sell authorized but unissued shares of Common Stock in the Limited Market. If the number of purchase orders exceeds the number of sell orders plus any shares sold by the Company, the aggregate number of shares offered for sale will be allocated, pro rata, among the purchasers based upon the total number of shares each has subscribed for. All sellers in the Limited Market, other than the Company, pay Capitol a commission generally equal to 1.5 percent of the proceeds from such sales. No commission is paid by purchasers in the Limited Market. Prior to each Trade Date, Capitol will receive sell orders from shareholders and buy orders from authorized purchasers and the Company. On each Trade Date, Capitol will match sellers and buyers of the Company's Common Stock (including, to the extent applicable, the Company) according to the proration rules described above. Capitol will then forward payments to sellers, minus the commission, and will issue in book-entry form, the shares of Common Stock to the purchasers. Capitol will not buy or sell shares of Common Stock for its own account or as an agent for the Company. Each shareholder of the Company who elects to purchase or sell Common Stock has an account established with Capitol. On the day after each Trade Date, a confirmation of purchases or sales is generated for each shareholder showing price per share, number of shares, commission paid, net dollars transacted and settlement date. The purchase price for Common Stock purchased on a Trade date must generally be received by Capitol within three business days following such date. While the Company established the Limited Market to attempt to provide liquidity to shareholders, there can be no assurance that there will be sufficient liquidity to permit shareholders to resell their shares in the Limited Market. THE FORMULA The purchase price of the shares of Common Stock in the Limited Market will be at the formula price described below (the "Formula Price"). The Formula Price is established by the Board of Directors of the Company based on the performance of the Company as measured by certain factors listed below as well as certain other factors also listed below which are determined based on the recommendation of an independent appraiser. The Formula Price will be redetermined at least annually. The price is determined according to the following formula (the "Formula"): the price per share is equal to the product of (i) a number representing one minus the discount for the limited liquidity of the stock ("D") and (ii) a fraction, the denominator of which is the number of outstanding shares and share equivalents ("Wi") and the numerator of which is the sum of (A) a number which is the product of 2.25 and the book value of the Company at the end of the applicable period ("BV") and (B) a number which is the product of (a) 11.34 ("K") and (b) a number equal to the product of (I) a market index ("MI") based on certain comparable companies, (II) the after tax profits from operations for the last 12 month period ("P") and (III) a fraction, the denominator of which is 2 and the numerator of which is the sum of (A) the change in contract margin ("CM"), which is a number equal to the contract margin for the last 12 months divided by the contract margin for the prior 12 month period, where contract margin is the contract fee as a percentage of contract cost adjusted for program reserves and allowances and (B) the change in revenue growth ("R"), which is a number equal to a fraction, the numerator of which is revenue for the last 12 months and the denominator of which is the revenue for the prior 12 month period times the change in the consumer price index for that period. The Formula Price of the Common Stock expressed as an equation, is as follows: {Formula Price = D} The "discount factor" is a number which is intended to reflect the discount for the limited liquidity of the Common Stock and the "market index" is a number which is intended to reflect existing securities market conditions. Both of these factors are established annually by the Board of Directors based upon the recommendation of an independent appraisal firm. The 11.34 multiplier is a constant representing the factor necessary to equalize the initial stock price calculated by the Formula to the appraised price for the Common Stock on the date the Formula was adopted. The remainder of the factors will be based on the Company's historical financial data. PROCEDURES FOR DETERMINING FORMULA PRICE The Formula is used to determine the offering price at which the Common Stock will be sold and will trade in the Limited Market, except in the circumstances set forth below. The present Formula was adopted by the Board of Directors on September 14, 1998, following a determination by the Board of Directors that the prior formula was not resulting in a fair market value for the Common Stock. The Board of Directors believes the current Formula results in a fair market value for the Common Stock within a broad range of financial criteria. In redetermining the current Formula, net income for the trailing twelve months was adjusted for all factors associated with the sale of the Company's Space and Telecommunications business having a financial impact on continuing operations in 1997. The adjusted net income for use in the Formula at June 30, 1998 was $2,482,000. Annually, the Company provides audited financial statements and other data as requested by the independent appraiser. The independent appraiser analyzes that data and recommends two factors of the Formula: the Market Index ("MI") and the Discount Factor ("D"). Based on this recommendation, the Board of Directors determines the Formula Price. The Board of Directors also obtains an appraisal of the current fair market value of the Common Stock from the independent appraiser in order to confirm that the Formula has resulted in a price which falls within an acceptable range of values for the fair market value of the Common Stock. In those circumstances when the Board of Directors determines the Formula has not resulted in a fair market value for the Common Stock, the Company establishes a price for the Common Stock within the range established by the independent appraisal. The price of $5.05 per share at June 30, 1997 and at December 31, 1997 was based solely on an independent appraisal as were all share prices prior to the adoption of the Formula. Such appraisal is required on an annual basis for purposes of valuing the assets contained in the Company's ESOP and for determining the price at which the ESOP may purchase shares of Common Stock. PRICE RANGE OF COMMON STOCK The following table sets forth the price per share (after giving effect for all years presented for a 2 for 1 split of the Company's common stock in February 1998) at which the Common Stock was valued by the Board of Directors based on an appraisal performed by the Company's independent appraiser, Legg Mason Wood Walker, Inc., for the last twelve years. The 1992, 1993, both 1994 and 1995 appraisal prices were also the prices at which shares were sold in the Limited Market for each of the following periods ending on the dates set forth below.
EFFECTIVE DATE OF APPRAISAL PRICE PER SHARE December 31, 1998 $7.800 June 30, 1998 $5.840 December 31, 1997 $5.050 June 30, 1997 $5.050 December 31, 1995 $4.745 December 31, 1994 $4.695 June 30, 1994 $4.485 December 31, 1993 $4.364 December 31, 1992 $3.583 December 31, 1991 $3.002 December 31, 1990 $2.088 December 31, 1989 $2.050 December 31, 1988 $2.015 December 31, 1987 $1.400 December 31, 1986 $0.888
Report of Independent Appraiser Since 1986, Legg Mason Wood Walker, Inc. ("Legg Mason") has been engaged by the Company to act as the independent appraiser for the Company with respect to the Common Stock. Legg Mason was selected because it is a nationally recognized investment banking firm that has extensive experience in the valuation of securities of all types, including closely-held and seldom traded securities. In connection with the Board's determination of the Formula Price, Legg Mason recommends to the Board of Directors (i) the discount factor ("D") to reflect the limited liquidity of the Company's Common Stock and (ii) the market index ("MI") to reflect existing securities market conditions. Legg Mason also provides to the Board of Directors an assessment as to whether the Formula Price calculated is within a range which Legg Mason considers reasonable. Legg Mason makes these determinations based on its own analysis after reviewing and analyzing numerous factors including, without limitation, (i) the Company's annual and quarterly reports, (ii) interviews with management regarding the Company's business, earnings, cash flow, assets and prospects, (iii) contract backlog data and contract profiles prepared by Company management, (iv) data regarding the financial performance and market valuation of selected public companies deemed by Legg Mason to be comparable to the Company and (v) data relating to recent merger and acquisition activity of selected public companies deemed by Legg Mason to be comparable to the Company. DIVISION OF MARKET REGULATION Section 5 of the Securities Exchange Act of 1934 (the "Exchange Act") generally prohibits operation of an "exchange" to effect any transaction in a security, or to report any such transaction, unless the exchange is either (i) registered as a national securities exchange under Section 6 of the Exchange Act or (ii) exempted from such registration because, in the opinion of the Commission, the limited volume of the transactions effected on such exchange does not make it necessary, appropriate or in the public interest to require such registration. The Limited market is not registered as an exchange under the Exchange Act. The Company has had discussions with the staff of the Division of Market Regulation concerning the operation of the Limited Market in compliance with the Exchange Act. While the Commission has not formally indicated to the Company any specific concerns regarding the operation of the Limited Market it may do so in the future. If the Commission requires the Limited Market to register as an exchange or otherwise raises concerns regarding operation of the Limited Market, there can be no assurance that the Company will be able to continue operation of the Limited Market. HOLDERS OF COMMON STOCK As of February 28, 1999, there were approximately 270 common stockholders of the Company. DIVIDENDS It is the current policy of the Company to retain all earnings to provide funds for the Company's growth. Therefore, the Company has no current intention of paying cash dividends on the Common Stock. The Company has not made any distributions to its shareholders since 1988. The Company's bank credit agreement requires advance approval by the bank for the Company to pay any dividends. ITEM 6. SELECTED FINANCIAL DATA The following selected consolidated financial data for each of the years in the five year period ended December 31, 1998 and as of December 31, 1994, 1995, 1996, 1997 and 1998 have been derived from the consolidated financial statements of the Company. The consolidated financial statements for each of the five years ended December 31, 1994 through 1998 have been audited by Ernst & Young LLP, independent auditors. The data (in thousands, except for per share data) should be read in conjunction with the consolidated financial statements, related notes, and other financial information included elsewhere in this document.
1994 1995 1996 1997 1998 Income Statement Data: Contract revenues $107,471 $105,224 $96,246 $92,239 $117,184 Cost of contract 90,102 96,633 87,644 78,530 91,747 revenues Selling, general and administrative 6,723 4,117 5,431 9,622 15,585 expenses Other expenses 833 (292) 2,447 3,668 3,040 Operating profit 9,813 4,766 724 419 6,812 Interest expense 907 850 969 1,589 1,195 Income (loss) before income taxes 8,906 3,916 (245) (1,170) 5,617 Provision (benefit) for income taxes 3,830 1,567 (80) (500) 2,225 Income (loss) from continuing 5,076 2,349 (165) (670) 3,392 operations Income (loss) from discontinued operations, net of (617) (403) (10,872) 648 (2,482) income taxes(1)(2) Net income (loss) $4,459 $1,946 $(11,037) $ (22) $ 910 Basic earnings (loss) per share: Continuing $0.53 $0.27 $(0.02) $(0.07) $ 0.39 operations Discontinued (0.06) (0.05) (1.22) 0.07 (0.29) operations Earnings (loss) per $0.47 $0.22 $(1.24) $ 0.00 $ 0.10 share Diluted earnings (loss) per share: Continuing $0.50 $0.25 $(0.02) $(0.07) $ 0.38 operations Discontinued (0.06) (0.04) (1.22) 0.07 (0.28) operations Earnings (loss) per share-diluted $0.44 $0.21 $(1.24) $ 0.00 $ 0.10 Weighted average number of shares 9,567 8,863 8,875 9,092 8,694 outstanding Diluted average number of shares 10,092 9,418 8,875 9,092 8,815 outstanding
DECEMBER 31, 1994 1995 1996 1997 1998 Balance Sheet Data: Cash and cash $ 3,902 $ 235 $ 16 $ $ equivalents - - Working capital 20,638 19,713 13,721 12,588 12,242 Total assets 89,816 91,530 92,690 45,288 57,348 Short-term debt 15,750 17,074 28,335 9,112 17,890 Long-term debt 17,765 17,431 18,510 3,333 3,802 Total stockholders' 27,950 28,773 17,793 15,810 15,734 equity
(1) During 1997, the Company sold its Space and Telecommunications Systems and its Mobile Information and Communications Services businesses to Orbital Sciences Corporation. Results of operations have been restated to exclude revenues and expenses of discontinued operations from captions applicable to continuing operations. See Note 2 to the Consolidated Financial Statements. (2) During 1995, the Company discontinued the operations of its Simulation Systems Division, which manufactured aircraft flight simulators for sale or lease, and sold its assets to a company principally owned by one of the Company's principal stockholders. Results of operations have been restated to exclude revenues and expenses of discontinued operations from captions applicable to continuing operations. See "Certain Transactions" and Note 2 to the Consolidated Financial Statements. ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS FORWARD LOOKING STATEMENTS This filing may contain "forward-looking" statements, as that term is defined in the Private Securities Litigation Reform Act of 1995. Such statements include, but are not limited to, statements concerning expectations of the Company's future performance in terms of revenue and earnings. There can be no assurance that actual results will not differ materially from those projected or suggested in such forward-looking statements. Factors which could cause a material difference in results include, but are not limited to, the following: regional and national economic conditions; changes in interest rates; changes in government spending policies and/or decisions concerning specific programs; individual business decisions of customers and clients; developments in technology; competitive factors and pricing pressures; changes in government laws and regulations; acts of God; and the Company's ability to achieve the objectives of its business plans. The following discussion and analysis should be read in conjunction with the consolidated financial statements and notes thereto included elsewhere in this document. OVERVIEW Computer Technology Associates, Inc. (the "Company," formerly CTA INCORPORATED) provides information technology services to Federal, State and commercial markets including Year 2000 services, network design and implementation, mainframe to client-server conversions, software language upgrades, database development and maintenance, electronic data interchange and automated enterprise management technologies. During 1996, the Company completed a five year prime contract with the U.S. Navy and, although it was ineligible to rebid this contract as the prime contractor, is now a major subcontractor receiving approximately 45% of the total contract revenues. During 1997, the Company sold the Advanced Information Systems division and several systems engineering contracts ended. As a result, the Company's revenues from systems engineering services, principally to the Federal government, have declined from $105 million, or 100% of contract revenues, in 1995 to $74 million, or 64% of contract revenues, in 1998. Since 1997, the Company has focused its marketing efforts on software engineering, primarily Year 2000 services, for State and local governments and commercial entities in order to increase such revenues. Also during 1997, the Company disposed of its Space and Telecommunications Systems and its Mobile Information and Communications Services businesses. In 1998, the Company realigned its corporate organization to further refine its focus on the rapidly growing market for commercial and governmental IT services creating the CTA Systems Engineering Group and the CTA Software Engineering Group. RESULTS OF OPERATIONS The following tables set forth certain items in the Company's Statements of Operations as a percentage of contract revenues:
YEAR ENDED DECEMBER 31, 1996 1997 1998 Contract revenues: Systems Engineering 95.5% 79.6% 62.8% Software Engineering 4.5 20.4 37.2 Total contract revenues 100.0 100.0 100.0 Cost of contract revenues 91.1 85.2 78.3 Selling, general and administrative expenses 5.6 10.4 13.3 Supplemental ESOP contribution 0.0 3.2 0.9 Other expenses 2.5 0.8 1.7 Operating profit 0.8 0.4 5.8 Interest expense 1.0 1.7 1.0 Income (loss) before income taxes (0.2) (1.3) 4.8 Provision (benefit) for income taxes (0.0) (0.6) 1.9 Income (loss) from continuing operations (0.2) (0.7) 2.9 Income (loss) from discontinued operations, (11.3) 0.7 (2.1) net of income taxes Net income (loss) (11.5)% (0.0)% 0.8%
The following tables set forth certain items in the Company's Statements of Operations by operating segment:
Year ended December 31, 1996 1997 1998 (In thousands of dollars) Contract revenues: Systems Engineering $91,953 $73,464 $73,579 Software Engineering 4,293 18,775 43,605 $96,246 $92,239 $117,184 Operating profit: Systems Engineering $2,442 $2,933 $5,259 Software Engineering 729 1,154 4,593 Other expenses (2,447) (3,668) (3,040) $ 724 $ 419 $ 6,812
1998 COMPARED WITH 1997 CONTRACT REVENUES. Contract revenues increased 27% to $117.2 million in 1998 from $92.2 million in 1997 as a result of a 132% increase in software engineering contract revenues. Systems engineering contract revenues increased to $73.6 million in 1998 from $73.5 million in 1997. Decreases in revenues on the General Services Administration ("GSA") Eastern Zone contract, which ended in the third quarter of 1997, and on the Technical Engineering and Management Support IV ("TEMS IV") program at Hanscom Air Force Base, which is winding down, and smaller decreases in other Federal programs, were partially offset by increases in contract revenues on embedded systems Year 2000 contracts and on GSA Schedule contracts. Software engineering contract revenues increased to $43.6 million in 1998 from $18.8 million in 1997. The increase is primarily attributable to new Year 2000 conversion contracts with the States of Michigan and Texas and commercial companies such as Wells Fargo Bank and Norrell. Commercial contract revenues from both systems engineering and software engineering services increased to $50.7 million, or 43% of total contract revenues, in 1998 from $18.8 million, or 20% of total contract revenues, in 1997. COST OF CONTRACT REVENUES. Cost of contract revenues increased 16.8% to $91.7 million, or 78.3% of contract revenues, in 1998, from $78.5 million, or 85.2% of contract revenues, in 1997. This decrease in cost of contract revenues as a percentage of contract revenues resulted primarily from the increase of higher margin commercial contracts as a percentage of overall contract revenues. SG&A. Selling, general and administrative expenses ("SG&A") increased to $15.6 million, or 13.3% of contract revenues, in 1998, from $9.6 million, or 10.4% of contract revenues, in 1997. The increase in SG&A reflects the Company's continued investment in infrastructure and in the initiatives required to implement the Company's marketing strategies and increased focus on commercial markets. SUPPLEMENTAL ESOP CONTRIBUTION. During 1998, the Board of Directors elected to make a supplemental contribution of approximately $1.1 million to the Company's employee stock ownership plan (ESOP). OTHER EXPENSES. Other expenses increased to $2.1 million in 1998 from $0.7 million in 1997 due to additional reserves and write-downs of certain contract receivables. OPERATING PROFIT. As a result of the foregoing, the Company had an operating profit of $6.8 million in 1998 and an operating profit of $0.4 million in 1997. LOSS FROM DISCONTINUED OPERATIONS. The loss from discontinued operations for 1998 reflects an adjustment of $2.1 million for the final settlement of the sales price of the Company's Space and Telecommunications business, which was sold in the third quarter of 1997, and a binding arbitration award of $2.0 million to a former employee of that business. The amounts are presented net of income tax benefit in the Consolidated Statements of Operations. 1997 COMPARED WITH 1996 CONTRACT REVENUES. Contract revenues decreased 4.2% to $92.2 million in 1997 from $96.2 million in 1996. Software engineering contract revenues increased 337% to $18.8 million in 1997 from $4.3 million in 1996. Such increase resulted primarily from the Company's Year 2000 Century date Change conversion contracts. The Company performed such services in 1997 for the States of Nebraska, Kansas, Iowa and others as well as Cessna Aircraft and Virginia Tech. A new systems engineering contract in 1997, providing program management and integration for the Assistant Secretary of Defense for Health Affairs, generated revenues of $7.1 million. Another new program, the Defense Enterprise Integration Services (DEIS) subcontract to Computer Sciences Corporation (CSC) generated revenues of $4.1 million in 1997. Contract revenues on the Company's contact with the GSA's Federal Supply Service increased 65% from $6.5 million in 1996 to $10.8 million in 1997. These increases in contract revenues were offset by decreases in revenues from the TEMS IV program at Hanscom Air Force Base of $10.4 million in 1997 compared to 1996 as the program winds down. Revenues on the Naval Air Weapons Center (NAWC) contract at China Lake, California decreased in 1997 by $5.2 million compared to 1996. In the first quarter of 1996, the Company completed its five- year contract with the NAWC, the last of the Company's significant contracts awarded during its period of eligibility for small business awards which ended in 1992. Although it was ineligible to rebid for this contract as the prime contractor, the Company is a major subcontractor to the small business prime contractor who was awarded the NAWC follow-on contract, from which the Company receives approximately 45% of the contract revenues. Contract revenues on the NAWC subcontract increased by $0.3 million in 1997 compared to 1996. Contract revenues in 1997 decreased by $2.0 million on the Range Instrumentation Development contract and by $1.3 million on the AUA technical assistance contract. Contracts which ended in 1997, such as the Systems Engineering Analysis contract with NASA and the GSA Eastern Zone contract contributed to the decline in revenues, as did the sale of the Advanced Information Systems division. Contracts which ended in 1996, such as the Air Force Warning System integration contract, also contributed to the overall decline in contract revenues in 1997. The Company revised its estimates of the full contract value and profitability of its Eastern Zone contract with the GSA, resulting in a reduction in revenues and operating profit in 1996 of $2.6 million, reflecting the Company's current estimate of the contract's profit at completion. The Eastern Zone contract incurred significant start-up costs related to the establishment of nine new facilities required for contract performance and to difficulties encountered in cost-effective staffing of the personnel required under the contract. The use of subcontract personnel to fill critical positions resulted in cost overruns. The Company initially expected that future contract performance over the full contract term at originally anticipated staffing levels would result in profit sufficient to offset early program losses. However, revenues on the contract were not sufficient to offset these losses. The Company has submitted claims against the U.S. government seeking recovery of $1.5 million of the overrun. The Company has recorded these claims as an unbilled receivable, against which it has certain reserves which it deems adequate. COST OF CONTRACT REVENUES. Cost of contract revenues decreased 10.4% to $78.5 million, or 85.2% of contract revenues, in 1997 from $87.6 million, or 91.1% of contract revenues, in 1996. The decrease in cost of contract revenues as a percentage of contract revenues resulted primarily from the effect of changes in the estimated contract value and profitability of the Eastern Zone contract in 1996. Without giving effect to the reduction in revenues due to the Eastern Zone contract, the cost of contract revenues as a percentage of contract revenues for 1996 was 88.7%. The decrease in cost of contract revenues in 1997 would have been even more significant were it not for the indirect cost impact of $0.9 million related to the sale of the Space and Telecommunications business and one-time start-up costs of $1.0 million related to certain software engineering contracts. SG&A. Selling, general and administrative expenses ("SG&A") for 1997 increased 77.2% to $9.6 million, or 10.4% of contract revenues, from $5.4 million, or 5.6% of contract revenues, in 1996. Higher costs and reduced revenues accounted for the increase in SG&A as a percentage of contract revenues in 1997. The increase in SG&A reflects the Company's continued investment in infrastructure and in the initiatives required to implement the Company's marketing strategies and increased focus on commercial markets as well as the indirect cost impact of $0.3 million related to the sale of the Space and Telecommunications business. SUPPLEMENTAL ESOP CONTRIBUTION. During 1997, the Board of Directors elected to make a supplemental contribution of approximately $3.0 million to the Company's ESOP out of the proceeds from the sale of the Space and Telecommunications business to allow the employees to share in the Company's future potential performance, if any. The Board authorized the supplemental contribution after the sale had closed and the Company's new bank credit facility was in place. OTHER EXPENSES. Other expenses decreased to $0.7 million in 1997 from $2.4 million in 1996. The decrease is due primarily to the write-off in the fourth quarter of 1996 of capitalized software costs of $0.8 million and $0.9 million related to the Company's unsuccessful initial public offering. OPERATING PROFIT (LOSS). As a result of the foregoing, the Company had an operating profit of $0.4 million in 1997 compared to an operating profit of $0.7 million in 1996. INTEREST EXPENSE. Interest expense increased to $1.6 million in 1997 from $1.0 million in 1996 due to the payment of additional interest on the subordinated debt as a result of the sale of the Space and Telecommunications Systems business to Orbital. Interest expense allocated to discontinued operations was $2.1 million in 1997 and $3.3 million in 1996. INCOME (LOSS) FROM DISCONTINUED OPERATIONS. The income from discontinued operations in 1997 was $0.6 million, net of tax benefits of $1.4 million, compared to a loss from discontinued operations of $10.9 million, net of tax benefits of $5.6 million in 1996. The income in 1997 includes a gain on the sale of the segments to Orbital Sciences Corporation of $3.9 million. The loss in 1996 includes a charge of $6.4 million from the write-off of the Company's investment in GEMnet and a charge of $2.8 million for additional reserves due to schedule delays on the Indostar program. During 1996, the Company had been in discussions with certain international companies to continue the GEMnet program after the 1995 launch failure. These discussions did not produce a viable solution and as a result the Company decided to terminate the program and write-off its remaining investment. LIQUIDITY AND CAPITAL RESOURCES The Company's net income (loss) was $0.9 million, ($0.02 million), and ($11.0 million) 1998, 1997 and 1996, respectively. Its cash flow provided by (used in) operating activities was $(1.8 million), $(10.2 million), and $(5.5 million) in 1998, 1997 and 1996, respectively. The principal factors accounting for the provision (use) of cash in operating activities in 1998 were $2.3 million in losses on disposal of segments and sale of assets, $1.5 million of depreciation and amortization expense, $1.1 million in other non-cash expenses and changes in working capital accounts using $7.6 million of cash. The principal factors accounting for the provision (use) of cash in operating activities in 1997 were $(3.9 million) non-cash gain on disposal of segments, $2.8 million of depreciation and amortization expense, ($3.6 million) payment of previously accrued interest, and changes in working capital accounts using $5.6 million of cash. The principal factors accounting for the provision (use) of cash in operating activities in 1996 was the net loss of $11.0 million and an increase in accounts receivable and other net assets of $6.6 million, offset by $5.6 million of depreciation and amortization expense and the $6.4 million write-off of the investment in GEMnet. Cash provided by (used in) investing activities totaled $(4.5 million), $14.4 million, and $(6.2 million) in 1998, 1997 and 1996, respectively. Additions to furniture and equipment were $2.4 million, $3.6 million, and $6.5 million in 1998, 1997 and 1996, respectively. Proceeds from the sale of segments provided $18 million in 1997 and an adjustment to the sales price of the segments in 1998 used $2.1 million. Cash provided by (used in) financing activities was $6.2 million, $(4.2 million), and $11.5 million in 1998, 1997 and 1996, respectively. Financing was primarily provided by borrowings under the credit facility and offset by the repayment of long-term debt and the purchase of treasury stock. The Company's net borrowings (payments) under the credit facility were $8.8 million, $(3.7 million), and $12.0 million for 1998, 1997 and 1996, respectively. The 1997 amount is net of $5 million proceeds from a new three-year term loan. Repayment of long-term debt was $1.7 million in 1998 and $0.5 million in 1997. Net purchases of treasury stock were $1.0 million, $0.1 million, and $0.5 million in 1998, 1997 and 1996, respectively. In November 1997, the Company entered into a three-year agreement with a bank for a revolving credit facility, which was amended in 1998, providing the availability to borrow up to $18 million, which includes a facility for letters of credit up to $4 million, and which also provides a $5 million term facility. At December 31, 1998, there was $16.2 million outstanding under the revolving credit facility and $3.3 million outstanding under the term facility, to be repaid in equal quarterly payments. Borrowings under the credit facility are secured by substantially all of the Company's assets and bear interest at either the lender's prime rate or LIBOR plus 1.5% to 2.25% (based on the Company's ratio of total funded debt to earnings before interest, taxes, depreciation and amortization) at the Company's discretion. The weighted average rate in effect for short-term borrowings at December 31, 1998 was approximately 7.5%. Under the agreement, the Company pays an annual commitment fee on the unused credit line and an annual administration fee on the total revolving credit line. The credit facility requires advance approval by the bank for the Company to pay cash dividends. The agreement also includes financial covenants which require the Company to maintain certain financial ratios such as a fixed charge coverage ratio, earnings before interest and taxes to interest expense ratio and total outstanding debt to accounts receivable ratio. The agreement also requires the Company to obtain the consent of the bank prior to making aggregate capital expenditures for itself and its subsidiaries of greater than $2.5 million per year. The Company believes it is in compliance with all of the financial covenants. In January 1998, the Company completed the $2.0 million tender offer accrued for as of December 31, 1997. The Company believes that cash flow from operations and available bank borrowings will provide adequate funds for continued operations for the next twelve months. OTHER MATTERS The Company has assigned certain individuals to identify and correct Year 2000 compliance issues. Information technology ("IT") systems with non- compliant code are expected to be modified or replaced with systems that are Year 2000 compliant. The individuals are also responsible for investigating the readiness of suppliers, customers and other third parties along with the development of contingency plans where necessary. All IT systems have been inventoried and assessed for compliance, and detailed plans are in place for required system modifications or replacements. Systems conversion and testing activities are underway with approximately two-thirds of the systems already compliant. IT systems are expected to be fully compliant by the end of the third quarter of 1999. Inventories and assessments of non-IT systems have been completed. Progress of the Year 2000 compliance program is continuously being monitored by senior management. The Company has identified critical suppliers, customers and other third parties and has surveyed their Year 2000 remediation programs. Risk assessments and contingency plans, where necessary, will be finalized in the third quarter of 1999. Incremental costs directly related to Year 2000 issues are estimated to be $650,000 to be incurred between 1998 and 1999 of which $420,000 (or 65%) has been spent to date. Approximately 10% of the total estimated spending represents costs to modify existing systems. Costs incurred prior to 1998 were immaterial. This estimate assumes that the Company will not incur significant Year 2000 related costs on behalf of suppliers, customers or other third parties. The Company's most likely potential risk is the inability of some customers to order and pay on a timely basis. Contingency plans for Year 2000-related interruptions are being developed and will include, but not be limited to, the development of emergency backup and recovery procedures, remediation of existing systems parallel with installation of new systems and identification of alternate suppliers. All plans are expected to be completed by the end of the third quarter of 1999. The Company's Year 2000 efforts are ongoing and its overall plan, as well as the consideration of contingency plans, will continue to evolve as new information becomes available. While the Company anticipates no major interruption of its business activities, that will be dependent in part, upon the ability of third parties to properly remediate their IT and non-IT systems in a timely manner. Although the Company has implemented the actions described above to address third party issues, it has no ability to influence the compliance actions of such parties. Accordingly, while the Company believes its actions in this regard should have the effect of reducing Year 2000 risks, it is unable to eliminate them or estimate the ultimate effect Year 2000 risks will have on the Company's operating results. ITEM 7A. QUALITATIVE AND QUANTITATIVE DISCLOSURES ABOUT MARKET RISK The market risk inherent in the Company's financial instruments and positions represents the potential loss arising from adverse changes in interest rates. At December 31, 1998 and 1997 the principal amount of the Company's aggregate outstanding variable rate indebtedness was $19.5 million and $12.4 million, respectively. A hypothetical 10% adverse change in interest rates would have had an annualized unfavorable impact of approximately $146,000 and $95,000, respectively, on the Company's earnings and cash flows based upon these year- end debt levels. ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA The information required by this item is included under Item 14(a) of this document. ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE None PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT The following table sets forth certain information regarding the directors and executive officers of the Company as of December 31, 1998:
NAME AGE POSITION C.E. Velez 58 President, Chief Executive Officer and Chairman of the Board Gregory H. Wagner 50 Executive Vice President, Chief Financial Officer and Treasurer Terry J. 55 President, Systems Engineering Group Piddington Sy Inwentarz 47 President, Software Engineering Group Harvey D. 68 Director Kushner(1) David R. Mackie 60 Director (1) Raymond V. 65 Director McMillan (1) George W. 72 Director Morgenthaler(1) James M. Papada, 50 Director III(1) Arturo 68 Director Silvestrini(1)
___________ (1) Member of the Compensation Committee and the Audit Committee of the Board of Directors. ___________ Dr. C.E. "Tom" Velez, a founder of the Company, has been President and Chairman of the Board since the Company's organization in 1979. Prior to founding the Company, Dr. Velez was employed by Martin Marietta Aerospace for three years as Director, Software Engineering Research and Development, and was previously employed at the NASA Goddard Space Flight Center for 12 years in various positions including Chief of the Systems Development and Analysis Branch. Gregory H. Wagner has been Executive Vice President and Chief Financial Officer and Treasurer of the Company since November 1992. From 1988 to 1992, he was Vice President of Finance of the Company. Mr. Wagner was previously employed with Martin Marietta Aerospace for ten years in various positions, most recently as Director of Business Management. Terry J. Piddington has been President of the Company's Systems Engineering Group since October 1997 and before that had been Executive Vice President of the Company since February 1987. From 1985 to 1987, he was a Vice President of the Company's Systems Engineering Services Division. Sy Inwentarz has been President of the Company's Software Engineering Group since March 1998. From 1996 until he joined the Company, he was a Managing Principal with IBM Global Services. From 1992 to 1996 he was a Vice President of Computer Horizons Corp., a business solutions software supplier. Prior to 1992, he held various positions with Hewlett-Packard and American Hoechst. Harvey D. Kushner has been a Director of the Company since July 1989. Mr. Kushner formed Kushner Management Planning Corporation in 1988 which is a professional services firm advising in management, business and technology development. From 1987 to 1988, he was an officer of Atlantic Research Corporation. Prior to 1987, Mr. Kushner had been employed by the ORI Group for 33 years, having served as Chairman of the Board of Directors, Chief Executive Officer, and President for 20 years. David R. Mackie has been a Director of the Company since 1997. Since 1985 he has been an independent consultant and is currently a Partner in Diplomatic Resolutions, Inc. Prior to 1985, he held various positions with Tandem Computers, where he was one of the co-founders, and Hewlett-Packard. Raymond V. McMillan has been a Director of the Company since August 1996 and President of Information Technology Services from April 1996 to his retirement in October 1997 and before that had been Executive Vice President of the Company since February 1991. From 1988 to 1991, he was a Vice President of the Company. From 1984 to 1987, he was a Brigadier General in the Air Force responsible for management of the integration and test of the DOD's Integrated Tactical Warning and Attack Assessment System. George W. Morgenthaler has been a Director of the Company since August 1991. From 1986 to the present, he has served on the faculty of the University of Colorado at Boulder as Professor, Aerospace Engineering Sciences. He previously served four years as Department Chairman and Associate Dean of the College of Engineering and Applied Science. From 1960 to 1986, he was with Martin Marietta; his last position was as Vice President of Energy, Technology and Special Products. He is on the Board of Directors of Dynamic Materials Corp., a NASDAQ company. James M. Papada, III has been a Director of the Company since August 1996. Since prior to 1991, he has been a senior partner in the corporate depart- ment of the law firm of Stradley, Ronon, Stevens & Young, a limited liability partnership in Philadelphia, Pennsylvania, specializing in merger and acquisition transactions. He is also the Chairman of the Board of Technitrol, Inc., a multi-national, diversified manufacturing company listed on the New York Stock Exchange. He is also a Director of ParaChem Southern, Inc., a manufacturer of specialty chemical products and GlassTech, Inc., a manufacturer of glass tempering and bending systems. From February 1983 until December 1987, Mr.Papada was President and Chief Operating Officer of Hordis Brothers, Inc., a privately held glass fabricator. Arturo Silvestrini has been a Director of the Company since August 1991. From November 1991 to December 1996, he was President and CEO of Earth Observation Satellite Corporation. From 1965 to 1991, he was with Computer Sciences Corporation (CSC), as President of various Divisions, Deputy to the President of CSC Systems Group and as Senior Vice President for European operations. Executive officers are reviewed annually by the Board of Directors and serve at the pleasure of the Board. ITEM 11. EXECUTIVE COMPENSATION The following table sets forth information regarding the compensation for 1998, 1997 and 1996 of the Company's Chief Executive Officer and the three other most highly compensated executive officers in 1998 (the "Executive Officer Group") for services rendered in all capacities to the Company. The Company has no other executive officers. SUMMARY COMPENSATION TABLE
LONG-TERM COMPENSATION ANNUAL COMPENSATION Other Restricted Option All Other NAME AND PRINCIPAL Salary Bonus Annual Stock Awards Compensation POSITION(S) YEAR ($) ($) Compensation Awards ($) (#) ($)(2) ($)(1) C.E. Velez 1998 308,000 145,673 2,052 -- 22,895 17,915 President, Chief 1997 280,000 130,220 2,090 -- -- 14,480 Executive Officer 1996 276,743 -- 1,870 -- 59,010 5,700 and Chairman of the Board Gregory H. 1998 187,000 88,494 954 -- 13,900 32,411 Wagner 1997 170,000 112,455 927 -- -- 32,461 Executive Vice 1996 167,900 -- 856 -- 85,828 5,700 President, Chief Financial Officer and Treasurer Terry J. 1998 180,000 75,634 1,548 -- 12,828 24,131 Piddington- 1997 155,000 25,033 1,396 -- -- 14,028 President, Systems 1996 153,350 -- 1,221 -- 32,666 5,700 Engineering Group Sy Inwentarz (3) 1998 161,826 93,399 696 -- 150,000 15,217 President, 1997 -- -- -- -- -- -- Software 1996 -- -- -- -- -- -- Engineering Group
___________ (1) Represents long term disability premiums and group life insurance premiums for amounts in excess of $50,000. (2) Includes amounts of the Company's contributions allocated to participants' accounts pursuant to the Company's 401(k) plan and ESOP, other relocation reimbursements and miscellaneous cash payments pursuant to the Company's cafeteria plan. (3) Mr. Inwentarz joined the Company in March 1998 at an annual salary of $225,000. OPTION GRANTS DURING 1998 The following table sets forth information concerning the stock options granted during fiscal 1998 to each member of the Executive Officer Group.
% of Number of Total Shares Options Underlying Granted Grant Date Options to Exercise Expiration Present NAME GRANTED Employees Price DATE Value ($) (#) in ($/SH) (1) Fiscal YEAR C.E. Velez 17,909 2.0% $5.05 2/12/05 $42,623 4,986 0.6 5.05 5/14/05 11,867 Gregory H. 10,873 1.2 5.05 2/12/05 25,878 Wagner 3,027 0.3 5.05 5/14/05 7,204 Terry J. 9,914 1.1 5.05 2/12/05 23,595 Piddington 2,914 0.3 5.05 5/14/05 6,935 Sy Inwentarz 150,000 16.5 5.05 3/24/05 357,000
(1) The Company uses the Black-Scholes model to estimate the fair values of options, assuming a risk-free interest rate equal to the ninety-day U.S. Treasury Bill rate, expected lives of five to ten years, an expected volatility factor of .197 and no expected dividends. FISCAL YEAR-END OPTION VALUES The following table sets forth information concerning the exercise of stock options during fiscal 1998 and the number and value of unexercised stock options held at year-end by each member of the Executive Officer Group.
Number of Value of Securities Unexercised Shares Underlying In-the-Money Acquired Value Unexercised Options at NAME on Realized($) Options at FY-End FY-End ($)(1) Exercise(#) (#) Exercisable/ Exercisable/ UNEXERCISABLE UNEXERCISABLE C.E. Velez -- -- 39,340/42,565 120,184/123,052 Gregory H. -- -- 73,884/25,844 225,715/74,714 Wagner Terry J. -- -- 21,776/23,718 66,525/68,546 Piddington Sy -- -- -- /150,000 -- /412,500 Inwentarz
___________ (1) There was no public trading market for the Common Stock on December 31, 1998. Accordingly, solely for purposes of this table, the values in this column have been calculated on the basis of an estimated market price of $7.80 per share, less the aggregate exercise price of the options. ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT The following table sets forth certain information with regard to the benefi- cial ownership of the Common Stock as of December 31, 1998 by (i) each person known by the Company to own beneficially more than 5% of the outstan- ding shares of Common Stock, (ii) each director, each executive officer and each member of the Executive Officer Group and (iii) all current direc- tors and executive officers of the Company as a group:
Shares Percent NAME AND ADDRESS OF BENEFICIAL Beneficially Beneficially OWNER(1)(2) OWNED (1) OWNED(3) 5% Stockholders: C.E. Velez 4,681,420 (4) 50.4% ESOP 1,615,318 17.4 B.A. Claussen 883,752 (5) 9.5 Directors and executive officers: C.E. Velez 4,681,420 (4) 50.4% Terry J. Piddington 443,903 (6) 4.8 Raymond V. McMillan 230,346 (7) 2.5 Gregory H. Wagner 192,212 (8) 2.1 George W. Morgenthaler 20,705 (9) * Harvey D. Kushner 18,195 (10) * James M. Papada, III 7,755 (11) * Arturo Silvestrini 3,948 * David R. Mackie 3,373 * Sy Inwentarz - * All current directors and executive officers as a group 5,601,857 60.3% (10 persons as of December 31, (12) 1998)
___________ * Less than 1%. 1. Beneficial ownership as of December 31, 1998 for each person includes shares subject to options held by such person (but not held by any other person) which are exercisable within 60 days after such date. All share amounts are exclusive of shares beneficially owned through the ESOP. Beneficial ownership is determined in accordance with the rules of the SEC and generally includes voting or investment power with respect to securities. 2. The address for each beneficial owner except for Mr. Claussen is c/o Computer Technology Associates, Inc. 6903 Rockledge Drive, Bethesda, Maryland 20817. Mr. Claussen's address is c/o SymSystems, L.L.C., 12508 E. Briarwood Avenue, Englewood, Colorado 80112. (3) The percent beneficially owned is based on 8,584,095 shares of Common Stock deemed outstanding as of December 31, 1998 and non-qualified options to purchase 705,744 shares of Common Stock which are currently exercisable within 60 days after such date. (4) Includes non-qualified options to purchase 39,340 shares of Common Stock . (5) Includes non-qualified options to purchase 200,000 shares of Common. (6) Includes non-qualified options to purchase 21,776 shares of Common Stock. (7) Includes non-qualified options to purchase 199,988 shares of Common Stock. (8) Includes non-qualified options to purchase 73,884 shares of Common Stock.. (9) Includes non-qualified options to purchase 1,354 shares of Common Stock. (1) Includes non-qualified options to purchase 5,646 shares of Common Stock. (2) Includes non-qualified options to purchase 630 shares of Common Stock. (3) Includes non-qualified options to purchase 342,618 shares of Common Stock. ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS During 1995, the Company discontinued the operations of its Simulation Systems Division, which manufactured aircraft flight simulators for sale or lease. The assets of the division consisted primarily of a cockpit flight simulator and various fixed assets, which had an aggregate value of $3.1 million, net of accumulated depreciation. These assets were sold on September 1, 1995 to a company principally owned by Mr. Claussen, one of the Company's principal stockholders, for two notes secured by the assets with an aggregate principal amount of $2.2 million, bearing interest at the Company's borrowing rate which has ranged between 6.00% and 7.75% per annum, and a 15% minority interest in the entity purchasing the division, which has been assigned a value of $0.2 million. In August 1998, the Company received $0.2 million in cash on the $1.8 million note and forgave the balance (which was charged against the Company's allowance for doubtful accounts). The other note was repaid from the Company's common stock held by Mr. Claussen and the Company's minority interest reduced to 10.6%. In March 1991, the Company made a loan to Mr. Claussen of $368,623 for the purchase of his new residence. The interest rate on this loan varied from 4.69% to 7.75% per annum and equaled the interest rate on the Company's revolving line of credit under the Credit Facility. Mr. Claussen paid all outstanding principal and accrued interest on the loan in January 1996. In connection with Mr. Claussen's resignation as an officer and director of the Company, during December 1996 he entered into an Employee Separation and Non-Competition Agreement (the "Separation Agreement") with the Company whereby, in consideration for Mr. Claussen's agreement to not compete with the Company for a five (5) year period, the Company agreed: (i) to allow Mr. Claussen to retain his outstanding stock options in the Company until November 28, 2003 and (ii) to pay Mr. Claussen $175,000 per year for a period of five years. At the same time, Mr. Claussen and Dr. Velez agreed to terminate the Buy-Sell Agreement which had formerly restricted the transfer of their shares in the Company. Mr. Claussen then executed a Stock Restric- tion Agreement with respect to his Common Stock on the same terms as the Stock Restriction Agreements signed by all other shareholders of the Company. The Company also entered into a Consulting Agreement with Mr. Claussen during December 1996 for a five (5) year term, whereby Mr. Claussen agreed to provide consulting services to the Company, including with respect to the procurement for the Company of commercial and international business. During the term of the Consulting Agreement, the Company is required to pay Mr. Claussen a fee equal to one percent (1%) of (i) the gross revenues derived by the Company from contracts secured primarily through Mr. Claussen's efforts and which will generate greater than $5 million of aggregate revenue for the Company. The Company has not paid any fees to Mr. Claussen under the Consulting Agreement. Between May 1993 and July 1995, the Company made loans aggregating $500,000 to Dr. Velez for the purchase and construction of a new residence, evidenced by a revolving promissory note due August 2000 bearing interest at the same rates applicable to the Company under its Credit Facility. Dr. Velez paid all outstanding principal and accrued interest on the loan in November 1997. * PART IV ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K 14(A) CONSOLIDATED FINANCIAL STATEMENTS AND SCHEDULES: PAGE Report of Independent Auditors F-1 Consolidated Balance Sheets F-2 Condolidated Statements of Operations F-4 Consolidated Statements of Stockholders' Equity Consolidated Statements of Cash Flows F-6 Notes to Consolidated Financial Statements F-8 Financial Statement Schedules: Schedule II - Valuation and Qualifying Accounts and Reserves F-24 All other schedules for which provision is made in the applicable accounting regulations of the SEC are not required under the related instructions or are inapplicable and therefore have been omitted. Exhibits: 23(a) Consent of Ernst & Young LLP F-25 23(b) Consent and Report of Legg Mason Wood Walker, Inc. F-26 14(B) REPORTS ON FORM 8-K. There were no reports on Form 8-K filed during the fourth quarter of 1998. 14(C) FINANCIAL DATA SCHEDULE REPORT OF INDEPENDENT AUDITORS The Board of Directors and Shareholders Computer Technology Associates, Inc. We have audited the accompanying consolidated balance sheets of Computer Technology Associates, Inc. (formerly CTA INCORPORATED) and subsidiaries as of December 31, 1998 and 1997, and the related consolidated statements of operations, stockholders' equity, and cash flows for each of the three years in the period ended December 31, 1998. Our audits also included the financial statement schedule listed in the index at Item 14(a). These financial statements and the schedule are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements and the 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 consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of Computer Technology Associates, Inc. and subsidiaries at December 31, 1998 and 1997, and the consolidated results of their operations and their cash flows for each of the three years in the period ended December 31, 1998, 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. February 12, 1999 F-1 COMPUTER TECHNOLOGY ASSOCIATES, INC. Consolidated Balance Sheets
DECEMBER 31 1997 1998 (IN THOUSANDS, EXCEPT FOR SHARE DATA) Assets Current assets: Cash and cash equivalents $ $ - - Accounts receivable (NOTES 1 AND 3) 33,300 48,909 Other current assets (NOTE 4) 1,222 1,145 Recoverable income taxes (NOTE 8) 3,576 - Total current assets 38,098 50,054 Furniture and equipment (NOTES 1 AND 4) 11,110 8,940 Accumulated depreciation and (8,066) (5,192) amortization 3,044 3,748 Other assets (NOTES 1, 4, AND 8) 4,146 3,546 Total assets $45,288 $57,348
SEE ACCOMPANYING NOTES. F-2 COMPUTER TECHNOLOGY ASSOCIATES, INC. Consolidated Balance Sheets
DECEMBER 31 1997 1998 (IN THOUSANDS, EXCEPT FOR SHARE DATA) Liabilities and stockholders' equity Current liabilities: Notes payable - line of credit (NOTE 5) $ 7,445 $16,223 Current portion of long-term debt (NOTE 1,667 1,667 5) Accounts payable 5,788 10,576 Accrued expenses (NOTE 4) 3,156 4,156 Excess of billings over costs and 2,738 1,109 contract prepayments Other current liabilities 270 290 Income taxes payable (NOTE 8) - 19 Accrued tender offer (NOTE 7) 2,019 - Deferred income taxes (NOTE 8) 2,427 3,822 Total current liabilities 25,510 37,812 Long-term debt, less current portion 3,333 1,667 (NOTE 5) Other long-term liabilities (NOTE 6) 635 2,135 Commitments and contingencies (NOTE 11) - - Stockholders' equity (NOTE 7): Preferred stock, $.01 par value, 1,000,000 shares authorized and none issued - - Common stock, $.01 par value, 20,000,000 shares authorized and 10,000,000 issued 100 100 Capital in excess of par value 7,869 7,855 Retained earnings 14,528 15,438 22,497 23,393 Notes receivable from employees (698) (698) (NOTE 10) Treasury stock, at cost (1,248,980 shares in 1997 and 1,415,905 shares in 1998) (5,989) (6,961) Total stockholders' equity 15,810 15,734 Total liabilities and stockholders' equity $45,288 $57,348
SEE ACCOMPANYING NOTES. F-3 COMPUTER TECHNOLOGY ASSOCIATES, INC. Consolidated Statements of Operations
DECEMBER 31 1996 1997 1998 (IN THOUSANDS, EXCEPT FOR SHARE DATA) Contract revenues $ 96,246 $ 92,239 $117,184 Cost of contract revenues 87,644 78,530 91,747 Selling, general and 5,431 9,622 15,585 administrative expenses Supplemental ESOP contribution - 2,958 1,087 (NOTE 6) Other expenses 2,447 710 1,953 Operating profit 724 419 6,812 Interest expense 969 1,589 1,195 Income (loss) before income taxes (245) (1,170) 5,617 Income taxes (benefit) (NOTE 8) (80) (500) 2,225 Income (loss) from continuing (165) (670) 3,392 operations Discontinued operations (NOTE 2): Loss from discontinued operations, (10,872) (3,272) (1,094) net of income taxes Gain (loss) on disposal of segments, - 3,920 (1,388) net of income taxes Income (loss) from discontinued (10,872) 648 (2,482) operations Net income (loss) $(11,037) $ (22) $ 910 Earnings (loss) per share (NOTE 9): Continuing operations $ $ $ (.02) (.07) .39 Discontinued operations .07 (1.22) (.29) Earnings (loss) per share $ (1.24) $ .00 $ .10 Earnings (loss) per share - assuming dilution (NOTE 9): Continuing operations $ (.02) $ (.07) $ .38 Discontinued operations .07 (1.22) (.28) Earnings (loss) per share - Asssuming dilution $(1.24) $ .00 .10
SEE ACCOMPANYING NOTES. F-4 COMPUTER TECHNOLOGY ASSOCIATES, INC. Consolidated Statements of Stockholders' Equity
CAPITAL COMMON IN NOTE STOCK PAR EXCESS RCV SHARES VALUE PAR RETAIN FROM TREASURY STOCK VALUE EARNING EMPL SHARES COST (IN THOUSANDS, EXCEPT FOR SHARE DATA) Balance at January 1, 1996 10,000,000 $100 $8,973 $25,587 $- 1,321,108 $ 5,887 Purchase of treasury - - - - - stock 125,368 590 Sale of treasury stock - - 8 - - (7,826) (28) Exercise of stock - - (1,452) - - (449,340) (1,935) options Compensatory issuance of common stock to - - 7 - - (15,576) (67) employees/directors Issuance of stock for acquisition notes - - 30 - - (79,030) (345) payable Tax benefit of non- qualified stock options - - 377 - - - - exercised Issuance of stock to employees for notes - - - - 698 - - receivable Net loss - - - (11,037) - - - Balance at December 31, 10,000,000 100 7,943 17,550 698 894,704 4,102 1996 Purchase of treasury - - - - - 466,500 2,381 stock (NOTE 7) Exercise of stock - - (191) - - (89,870) (392) options Compensatory issuance of common stock to - - 12 - - (22,354) (102) employees/directors Tax benefit of non- qualified stock options - - 105 - - - - exercised Net loss - - - (22) - - - Balance at December 31, 10,000,000 100 7,869 14,528 698 1,248,980 5,989 1997 Purchase of treasury - - - - - 214,860 1,196 stock Sale of treasury stock - - - - - (17,141) (100) to employees Exercise of stock - - (32) - - (14,000) (61) options Compensatory issuance of common stock to - - 18 - - (16,794) (63) employees/directors Net income - - - 910 - - - Balance at December 31, 10,000,000 $100 $7,855 $15,438 $698 1,415,905 $6,961 1998
SEE ACCOMPANYING NOTES. F-5 COMPUTER TECHNOLOGY ASSOCIATES, INC. Consolidated Statements of Cash Flows
YEAR ENDED DECEMBER 31 1996 1997 1998 (IN THOUSANDS) Operating activities Net income (loss) $(11,037) $ (22) $ 910 Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities: (Gain) loss on disposal of segments - (3,920) 2,100 Loss on sale of assets - - 238 Depreciation and amortization: Furniture and equipment 3,734 2,612 1,911 Capitalized software development costs 1,108 76 - Other noncurrent assets 1,018 390 - Deferred lease incentives (292) (271) (405) Provision for receivable allowances 300 360 1,019 Accrued interest on debt 1,034 (3,590) - Other noncash expenses (8) (224) 81 Changes in assets and liabilities: Accounts receivable (4,106) 901 (16,628) Recoverable income taxes (639) (906) 3,595 Other assets (2,353) 463 (126) GEMnet investment 6,437 - - Accounts payable and accrued expenses 1,595 (5,017) 5,644 Excess of billings over costs and 1,556 (3,180) (1,629) contract prepayments Deferred income taxes, net (3,900) 2,100 1,495 Net cash (used in) operating activities (5,553) (10,228) (1,795) INVESTING ACTIVITIES Investments in furniture and equipment (6,469) (3,584) (2,391) Proceeds from (adjustments to) sale of - 18,000 (2,100) segments Proceeds from sale of assets - - 38 Capitalized computer software (87) - - Other 351 - - Net cash provided by (used in) investing $ (6,205) $ 14,416 $ (4,453) activities
F-6 COMPUTER TECHNOLOGY ASSOCIATES, INC. Consolidated Statements of Cash Flows (continued)
YEAR ENDED DECEMBER 31 1996 1997 1998 (IN THOUSANDS) Financing activities Net borrowings (payments) under bank line of credit agreement $ 12,011 $ (8,684) $ 8,778 Proceeds from term loan - 5,000 - Repayment of long-term debt - (450) (1,666) Repayment of acquisition notes (375) - - Proceeds from deferred lease incentives 315 - - Purchase of treasury stock (458) (104) (993) Sale of treasury stock - - 100 Proceeds from exercise of stock options 10 34 29 Other 36 - - Net cash provided by (used in) financing 11,539 (4,204) 6,248 activities Net decrease in cash and cash equivalents (219) (16) - Cash and cash equivalents at beginning of 235 16 - period Cash and cash equivalents at end of period $ 16 $ - $ - SUPPLEMENTAL INFORMATION Cash paid during the year for: Income taxes $ 226 $ 117 $ 309 Interest $ 2,836 $ 8,807 $ 1,037 Noncash investing and financing activities: Debt assumed by purchaser (NOTE 2) $ - $ 27,000 $ - Purchase of treasury stock (NOTE 7) $ - $ 2,019 $ - Settlement of note receivable for common $ - $ - $ 203 stock Investment in EarthWatch $ 2,038 $ - $ - Conversion of note to common stock $ 375 $ $ - Common stock issued for notes $ 473 $ - $ -
SEE ACCOMPANYING NOTES. F-7 COMPUTER TECHNOLOGY ASSOCIATES, INC. Notes to Consolidated Financial Statements December 31, 1998 1. THE COMPANY AND SIGNIFICANT ACCOUNTING POLICIES Computer Technology Associates, Inc. (the Company, formerly CTA INCORPORATED) provides rapid development and deployment of advanced information technology ("IT") to complex enterprise applications. The Company's offerings include government systems, engineering support, network development and integration, embedded IT systems engineering, object oriented applications development, Enterprise Resource Planning ("ERP") installation and integration, data warehousing and data base migrations, electronic commerce and other web based applications development and legacy system modernization. The Company's mission is to provide for the rapid, on budget, low risk installation and integration of complex information technology. The Company's current business strategy includes developing an international client base which is balanced across both government and commercial sectors of the IT services market. PRINCIPLES OF CONSOLIDATION The consolidated financial statements include the accounts of the Company and its subsidiaries. Significant inter-company accounts and transactions have been eliminated in consolidation. 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 amounts reported in the financial statements and accompanying notes, in particular, estimates of contract cost and revenues used in the earnings recognition process. Actual results could differ from those estimates. An important focus of the Company's efforts to pursue commercial markets is to assist state and local governments and commercial companies address the Year 2000 Issue with their information systems. The Year 2000 Issue arises because many electronic data processing systems will be unable to process year-date data accurately beyond the year 1999. The Company believes it has instituted reasonable contract management practices to control the financial risk of performance on these contracts. CASH AND CASH EQUIVALENTS The Company considers highly liquid investments with original maturities of three months or less to be cash equivalents. FURNITURE AND EQUIPMENT Furniture and equipment are carried at cost. Depreciation is computed based upon accelerated methods using estimated useful lives of three to seven years. Leasehold improvements are amortized on a straight-line basis over the terms of the leases, which range from one to seven years. Purchased computer software used by the Company is amortized on a straight-line basis over a three-year period. F-8 COMPUTER TECHNOLOGY ASSOCIATES, INC. Notes to Consolidated Financial Statements (continued) 1. THE COMPANY AND SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) CONTRACT REVENUES AND RELATED CONTRACT COSTS Revenues result from services performed for the U.S. government and commercial customers under a variety of long-term contracts and subcontracts, some of which provide for reimbursement of costs plus fixed fees and/or award fees, and others which are fixed-price type. Revenues on cost-type contracts are recognized as costs are incurred on the basis of direct costs plus allowable indirect expenses and an allocable portion of a fixed fee. Award fees on cost- type contracts are recognized as earned. Revenues on fixed-price type contracts are recognized using the percentage-of-completion method of accounting, based on contract costs incurred to date compared with total estimated costs at completion or other measures of progress on the contract. Estimated contract revenue at completion includes contract incentive fees at estimated realizable amounts. Revenues from time and materials contracts are recognized based on hours worked at amounts represented by the agreed-upon billing amounts. When adjustments in contract value or estimated costs are determined, any changes from prior estimates are reflected in earnings in the current period. The effect of these adjustments could be material to interim or annual operating results. The Company provides for anticipated losses, if any, on contracts and allowances for receivables during the period in which they are first identified. Contract costs, including indirect costs for cost-type contracts, are subject to audit by government representatives. Such audits have been completed through 1996. Management believes that any adjustments resulting from determinations for subsequent periods and contract close-outs will not have a significant impact on the Company's consolidated financial position or results of operations. STOCK-BASED COMPENSATION The Company has elected to continue accounting for stock-based compensation under Accounting Principles Board Opinion No. 25, "ACCOUNTING FOR STOCK ISSUED TO EMPLOYEES." In addition, the Company has adopted the provisions of Statement of Financial Accounting Standards No. 123, "ACCOUNTING FOR STOCK-BASED COMPENSATION," regarding the required disclosure provisions of the pro forma effect on net earnings and earnings per share. Compensation expense is recognized for stock options and other stock grants to the extent the exercise price is less than the fair market value of the Company's common stock at the date of grant. NEW ACCOUNTING PRONOUNCEMENTS In 1998, the Financial Accounting Standards Board issued SFAS No. 133, ACCOUNTING FOR DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES, which establishes accounting and reporting standards for derivative instruments, including certain derivative instruments embedded in other contracts and for hedging activities. It requires recognition of all derivatives as either assets or liabilities in the statement of financial position at their fair value. SFAS No. 133 is applicable to the Company beginning with its first quarter of fiscal 2000. The impact of this statement on the Company's statement of financial position is not expected to be significant. F-9 COMPUTER TECHNOLOGY ASSOCIATES, INC. Notes to Consolidated Financial Statements (continued) 1. THE COMPANY AND SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) RECLASSIFICATIONS Certain prior year balances have been reclassified to conform with the current period presentation. 2. DISPOSAL OF SEGMENTS In August 1997, the Company sold its Space and Telecommunications Systems and its Mobile Information and Communications Services businesses to Orbital Sciences Corporation in exchange for $18 million in cash and assumption by Orbital of certain liabilities of the Company. In addition, Orbital paid to certain lenders of the Company an aggregate of $27 million in partial satisfaction of the Company's obligations to such lenders. The final purchase price was subject to certain adjustments and was subsequently reduced by $2.1 million in 1998. The consolidated statements of operations exclude sales and expenses of discontinued operations from captions applicable to continuing operations. The discontinued operations include an allocation of interest expense based on the proportion of debt paid by Orbital to the Company's total debt outstanding at the time of the sale. Interest expense allocated to discontinued operations was $2.1 million in 1997 and $3.3 million in 1996. Net sales of the Space and Telecommunications Systems business prior to its disposition were $66.8 million in 1997 and $83.5 million in 1996. There were no sales for the Mobile Information and Communications Services business prior to its disposition. The income (loss) from operations of the disposed businesses was $(3.3) million in 1997 and $(10.9) million in 1996, net of income tax. The operating loss in 1996 includes charges totaling $9.2 million related to lower profitability on a contract and the write-off of the investment in GEMnet. The 1997 gain from disposal of the businesses was $3.9 million, net of income tax. The income tax provision (benefit) related to these discontinued segments was $(1.4) million in 1997 and $(5.6) million in 1996. The loss from discontinued operations for 1998 reflects an adjustment of $2.1 million on the disposal of segments for the final settlement of the sales price to Orbital and a binding arbitration award of $2.0 million to a former employee of that business. The amounts are presented net of income tax benefit in the consolidated statements of operations. During 1997, the Company also sold its Advanced Information Systems (AIS) division for approximately $0.4 million. The net contract revenues of AIS prior to its disposition were $0.9 million in 1997 and $2.9 million in 1996 and are included in continuing operations. In 1995, the Company sold its Simulation Systems Division (SIM) to a former director and a principal stockholder of the Company and other investors in exchange for two notes secured by the assets of the division with an aggregate principal amount of $2.2 million, bearing interest at the Company's borrowing rate and a 15% minority interest in the purchasing entity, valued at $0.2 million. In 1998, the Company received $0.2 million in cash on the $1.8 million note and forgave the balance (which was charged against the Company's allowance for doubtful accounts). The other note was repaid from the Company's common stock held by the former director. In connection with these transactions, the Company's minority interest was reduced to 10.6%. F-10 COMPUTER TECHNOLOGY ASSOCIATES, INC. Notes to Consolidated Financial Statements (continued) 3. ACCOUNTS RECEIVABLE
DECEMBER 31 1997 1998 Accounts receivable: (IN THOUSANDS) U.S. Government: Billed $17,556 $20,746 Unbilled: Contracts in progress 4,659 1,012 Amounts awaiting contractual coverage 4,192 3,505 Revenue awaiting government approval of final indirect rates or contract close- 242 286 out Commercial Customers: Billed 5,646 15,555 Unbilled: Contracts in progress 4,473 10,071 36,768 51,175 Less allowances (3,468) (2,266) $33,300 $48,909
Contracts in progress consist primarily of revenues on long-term contracts that have been recognized under the percentage-of-completion method for accounting purposes but not billed to customers. These amounts generally will be billable upon product delivery or satisfaction of other contract requirements. Amounts awaiting contractual coverage include amounts for which the Company expects to obtain the necessary contract modifications in the normal course of business. At December 31, 1997 and 1998, approximately $2.2 million is related to situations where disputes regarding the extent of contractual coverage have resulted in legal actions or formal claims. The Company has provided allowances that it believes adequately provide for the resolution of these and other matters. The Company expects to realize substantially all billed and unbilled receivables within one year. F-11 COMPUTER TECHNOLOGY ASSOCIATES, INC. Notes to Consolidated Financial Statements (continued) 4. COMPOSITION OF CERTAIN FINANCIAL STATEMENT BALANCES
DECEMBER 31 1997 1998 (IN THOUSANDS) Other current assets: Receivables from employees and $ 76 $ 46 stockholders (NOTE 10) Prepaid expenses 495 584 Other 651 515 $ 1,222 $ 1,145 Furniture and equipment: Data processing equipment $ 7,513 $ 6,545 Office furniture and equipment 2,920 1,848 Leasehold improvements 677 547 11,110 8,940 Accumulated depreciation and amortization (8,066) (5,192) $ 3,044 $ 3,748 Other assets: Intangible pension asset (NOTE 6) $ $ 1,900 - Investment in and notes receivable from SIM 2,218 200 (NOTE 2) Deferred tax asset (NOTE 8) 935 835 Other 993 611 $ 4,146 $ 3,546 Accrued expenses: Salaries and incentives $ 3,106 $ 3,735 Employee benefit plans - 357 Other 50 64 $ 3,156 $ 4,156
F-12 COMPUTER TECHNOLOGY ASSOCIATES, INC. Notes to Consolidated Financial Statements (continued) 5. NOTES PAYABLE AND SUBORDINATED DEBT BANK DEBT In November 1997, the Company entered into a three-year agreement with a bank for a revolving credit facility, which was amended in 1998, providing the availability to borrow up to $18 million, which includes a facility for letters of credit up to $4 million, and which also provides a $5 million term facility. At December 31, 1998 and 1997, there was $16.2 million and $7.4 million, respectively, outstanding under the revolving credit facility and $3.3 million and $5.0 million, respectively, outstanding under the term facility, to be repaid in equal quarterly payments. Borrowings under the credit facility are secured by substantially all of the Company's assets and bear interest at either the lender's prime rate or LIBOR plus 1.5% to 2.25% (based on the Company's ratio of total funded debt to earnings before interest, taxes, depreciation and amortization) at the Company's discretion. The weighted average rate in effect for short-term borrowings at December 31, 1998 and 1997 was approximately 7.5% and 7.7%, respectively. Under the agreement, the Company pays an annual commitment fee on the unused credit line and an annual administration fee on the total revolving credit line. The credit facility requires advance approval by the bank for the Company to pay dividends. The agreement also includes financial covenants which require the Company to maintain certain financial ratios and restricts capital expenditures. SUBORDINATED DEBT In December 1993, the Company entered into a note purchase agreement (the "Notes Agreement") providing for $15 million aggregate principal amount of unsecured, senior subordinated notes (the "Notes"). The Notes bore interest at 12.0% per annum (13.0% effective April 1, 1996), payable quarterly. The Company was required at the election of the holder to repurchase the Notes at the unpaid principal amount, plus accrued interest, at the occurrence of a transaction which resulted in a change in control of ownership of the Company or a "Qualifying Sale" of the Company's common stock as defined by the Notes Agreement. The Notes also provided for payment of contingent interest over and above the 13.0% fixed rate upon the occurrence of a "Qualifying Sale." The sale of the Space and Telecommunications Systems business as described in Note 2 was a "Qualifying Sale." As a result, the subordinated debt was repaid during 1997 along with accrued interest and contingent interest of $5.8 million. F-13 COMPUTER TECHNOLOGY ASSOCIATES, INC. Notes to Consolidated Financial Statements (continued) 6. EMPLOYEE BENEFIT PLANS Substantially all of the Company's employees are eligible to participate in the Company's employee stock ownership plan (ESOP). The ESOP is designed to enable participating employees to share in the growth and prosperity of the Company while providing them with the opportunity to accumulate capital for their future retirement. The ESOP allows only Company contributions, in cash or in common stock, as determined by the Board of Directors, which are recorded as compensation expense. During 1998 and 1997, the Board elected to make supplemental contributions of approximately $1.1 million and $2.9 million, respectively. Contributions are proportionately allocated on the basis of each eligible participant's compensation. Employee vesting in benefits ranges from 40% at the end of two years to 100% at the end of four years. Shares of the Company's common stock which may ultimately be distributed by the ESOP to participants carry certain limited provisions for repurchase by the Company. Through December 31, 1998, no shares of the Company's common stock have been distributed by the ESOP. At December 31, 1997 and 1998, the ESOP owned 1,615,318 shares of the Company's common stock, all of which have been allocated to plan participants. The Company and its subsidiaries maintain a 401(k) savings plan which allows for Company and employee contributions. Employees vest in Company matching contributions immediately. The Company's 401(k) plan owned 140,000 shares of the Company's common stock at December 31, 1997 and 1998. In August 1998, the Company adopted a Supplemental Executive Retirement Plan ("SERP"). Eligibility for participation is determined by the Compensation Committee of the Board of Directors. The SERP will provide normal benefits of sixty percent of average final compensation upon retirement at age sixty-two. The plan is unfunded, however, the Company has purchased corporate owned life insurance to provide for partial funding of the obligations under the Plan. The net periodic cost of the Plan for the period August 1 to December 31, 1998 was comprised of the following (in thousands):
Service cost $ 43 Interest cost 95 Amortization of prior 97 service cost Net periodic benefit $ 235 cost
F-14 COMPUTER TECHNOLOGY ASSOCIATES, INC. Notes to Consolidated Financial Statements (continued) 6. EMPLOYEE BENEFIT PLANS (CONTINUED) Plan activity affecting the benefit obligation during 1998 and the reconciliation of the benefit obligation to accrued pension cost at December 31, 1998 is as follows (in thousands):
Benefit obligation at Plan $3,270 inception Service cost 43 Interest cost 95 Actuarial gain (13) Benefit obligation at year end 3,395 Unrecognized net actuarial gain 13 Unrecognized prior service cost (3,173) Minimum pension liability recorded 1,900 Accrued pension cost $2,135
Accrued pension cost is equal to the Company's accumulated benefit obligation under the Plan. An intangible asset of $1.9 million was recorded during 1998 equal to the minimum pension liability, which represents the difference between the accumulated benefit obligation at December 31, 1998 and the net periodic benefit cost charged to operations. The assumptions used to measure the benefit obligation are a 7% discount rate and a 5% average increase in compensation levels. Amounts charged to expense under the above plans were approximately $2.0 million, $4.2 million and $3.3 million (including the supplemental contributions) for the years ended December 31, 1996, 1997 and 1998, respectively. The Company currently provides no significant other post retirement benefits. 7. COMMON STOCK AND STOCK OPTIONS All of the Company's outstanding shares, except for those held by C.E. Velez, the Company's Chairman and Chief Executive Officer, contain restrictions on transferability. The Company completed a tender offer for 399,946 shares at $5.05 per share on December 31, 1997 which resulted in a corresponding increase of treasury stock. The Board of Directors declared a two-for-one stock split for all shares outstanding on January 15, 1998 which is reflected for all periods presented in these financial statements. F-15 COMPUTER TECHNOLOGY ASSOCIATES, INC. Notes to Consolidated Financial Statements (continued) 7. COMMON STOCK AND STOCK OPTIONS (CONTINUED) In December 1991, the Company adopted the 1991 Stock Option and Purchase Plan which reserves 2,600,000 common shares for the granting of incentive or non- qualified stock options or stock purchase rights through 2001. The Compensation Committee of the Board of Directors is authorized to grant options and purchase rights and to establish the respective terms, subject to certain restrictions. Options generally are for terms of five to ten years and provide for vesting periods of three years. As of December 31, 1998, options for 908,282 shares are available for grant under this plan. The weighted average grant date fair value of an option granted during the years ended December 31, 1996, 1997 and 1998 was $1.91, $1.60 and $2.38, respectively. The Company uses the Black-Scholes model to estimate the fair values of options, assuming a risk-free interest rate equal to the ninety-day U.S. Treasury Bill rate, expected lives of five to ten years, an expected volatility factor of .197 and no expected dividends. The Company recognized no compensation expense for stock option grants during the three years in the period ended December 31, 1998.
NUMBER OF SHARES YEAR ENDED DECEMBER 31, 1996 1997 1998 Options outstanding at beginning of year (weighted average exercise price of $1.90 in 1996, $3.96 in 1997 and 934,450 1,282,126 847,880 $4.08 in 1998) Granted (weighted average exercise price of $4.74 in 1996, $5.05 in 1997 799,016 13,574 906,768 and $5.49 in 1998) Canceled (weighted average exercise price of $2.09 in 1996, $4.61 in 1997 (2,000) (357,950) (48,930) and $4.70 in 1998) Exercised (weighted average exercise price of $1.07 in 1996, $2.24 in 1997 (449,340) (89,870) (14,000) and $2.09 in 1998) Options outstanding at end of year (weighted average exercise price of $3.96 in 1996, $4.08 in 1997 and $4.59 1,282,126 847,880 1,691,718 in 1998) Options exercisable at end of year (weighted average exercise price of $2.48 in 1996, $3.16 in 1997 and $3.76 391,022 462,648 705,035 in 1998)
F-16 COMPUTER TECHNOLOGY ASSOCIATES, INC. Notes to Consolidated Financial Statements (continued) 7. COMMON STOCK AND STOCK OPTIONS (CONTINUED)
RANGE OF EXERCISE PRICES DECEMBER 31, 1998 $2.01-$3.58: Options outstanding: Number of shares 276,000 Weighted average exercise price $2.30 Weighted average remaining contractual life 3.7 (in years) Options exercisable: Number of shares 276,000 Weighted average exercise price $2.30 $4.36-$5.84: Options outstanding: Number of shares 1,415,718 Weighted average exercise price $5.03 Weighted average remaining contractual life 5.1 (in years) Options exercisable: Number of shares 429,035 Weighted average exercise price $4.71
Pro forma compensation expense associated with options granted subsequent to December 31, 1994 generally is recognized over a three year vesting period; therefore, the initial impact of applying SFAS No. 123 on pro forma net income (loss) for 1996 and 1997 is not representative of the impact on pro forma net income in 1998 and future years, when the pro forma effect is fully reflected. The Company's pro forma information follows:
YEAR ENDED DECEMBER 31 1996 1997 1998 (IN THOUSANDS, EXCEPT FOR SHARE DATA) Pro forma income (loss) from $(327) $(964) $2,964 continuing operations Pro forma earnings (loss) per share Basic $(.04) $(.10) $ .34 Diluted $(.04) $(.10) $ .34
F-17 COMPUTER TECHNOLOGY ASSOCIATES, INC. Notes to Consolidated Financial Statements (continued) 8. INCOME TAXES The provision (benefit) for income taxes attributable to continuing operations consisted of the following components:
YEAR ENDED DECEMBER 31 1996 1997 1998 (IN THOUSANDS) Current: Federal $(20) $(2,400) $600 State - (200) 130 (20) (2,600) 730 Deferred: Federal (50) 2,000 1,225 State (10) 100 270 (60) 2,100 1,495 $(80) $ (500) $2,225
Deferred income taxes reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. F-18 COMPUTER TECHNOLOGY ASSOCIATES, INC. Notes to Consolidated Financial Statements (continued) 8. INCOME TAXES (CONTINUED) Significant components of the Company's deferred tax assets and liabilities are as follows:
DECEMBER 31 1997 1998 (IN THOUSANDS) Current deferred tax liabilities: Unbilled receivables $5,425 $5,843 Other 135 118 5,560 5,961 Current deferred tax assets: Contract provisions and 2,482 1,350 allowances Accrued vacation 510 762 Other accruals 141 27 3,133 2,139 Net current deferred tax $2,427 $3,822 liabilities Long-term deferred tax assets: Depreciation $ 400 $ 480 Net operating loss carryforward 350 350 Other 535 355 1,285 1,185 Less: valuation allowance (350) (350) Net long-term deferred tax assets $ 935 $ 835
A reconciliation of income tax expense at the statutory Federal rate to income tax expense related to continuing operations at the Company's effective income tax rate is as follows:
YEAR ENDED DECEMBER 31 1996 1997 1998 (IN THOUSANDS) Federal income taxes at statutory $(83) $(398) $1,910 rate State income taxes, net of Federal (31) (60) 255 tax benefit Other 34 (42) 60 $(80) $(500) $2,225
F-19 COMPUTER TECHNOLOGY ASSOCIATES, INC. Notes to Consolidated Financial Statements (continued) 9. EARNINGS PER SHARE The following table sets forth the computation of basic and diluted earnings per share:
YEAR ENDED DECEMBER 31 1996 1997 1998 (IN THOUSANDS, EXCEPT FOR SHARE DATA) Numerator: Income (loss) from continuing $ (165) $ (670) $3,392 operations Income (loss) from discontinued (10,872) 648 (2,482) operations Net income (loss) for both basic and diluted earnings per share $(11,037) $ (22) $ 910 Denominator: Denominator for basic earnings per share- 8,875,086 9,092,214 8,694,133 Weighted average shares outstanding Dilutive potential common shares: Employee stock options - - 121,333 Denominator for diluted earnings per share- Adjusted weighted average 8,875,086 9,092,214 8,815,466 shares and assumed conversions
Due to a loss from continuing operations in 1996 and 1997, employee stock options are considered anti-dilutive and not included in the denominator for diluted earnings per share. 10. TRANSACTIONS WITH RELATED PARTIES The Company made loans in prior years to certain officers and employees related to the exercise of options to acquire common stock. Unpaid amounts related to the stock exercise price are presented as a reduction of stockholders' equity. The notes are for five years and bear interest at the same rates paid by the Company. The Company made loans in prior years to two of its principal stockholders for relocation costs that include the purchase of new residences. The loans were made in exchange for promissory notes and were secured by deeds of trust on residential property. The loans bore interest at the same rates applicable to the Company's revolving line of credit. The remaining indebtedness of approximately $111,000 on one of these loans was paid in 1996. The remaining outstanding loan of approximately $600,000 was repaid in 1997. F-20 COMPUTER TECHNOLOGY ASSOCIATES, INC. Notes to Consolidated Financial Statements (continued) 11. COMMITMENTS AND CONTINGENCIES OPERATING LEASES The Company has operating leases for all of its office space and various computer and office equipment. Most of the office space leases are on a full service rental basis, but do require the Company to pay increases for maintenance and operating expenses such as taxes, insurance and utilities over a base year, and also include provisions for renewal. Certain of the leases contain provisions for periodic rate escalations to reflect changes in the consumer price index. Total rent expense from continuing operations for the years ended December 31, 1996, 1997 and 1998 was $2.7 million, $2.4 million and $2.2 million, respectively. At December 31, 1998, total future minimum rental commitments under non- cancelable leases are summarized as follows (in thousands):
1999 $1,918 2000 1,713 2001 1,728 2002 1,190 2003 1,042 2004 and 692 after $8,283
LITIGATION In October 1996, a former employee of the Company filed suit against the Company alleging, among other things, breach of contract in connection with a profit sharing agreement. Subsequently, the litigation was stayed by agreement of the parties because the profit sharing agreement called for mandatory and binding arbitration. The arbitration was settled in June 1998 with an award of $2.0 million, which is included in the loss from discontinued operations. The Company is involved in certain other litigation incidental to its business. Management of the Company, after reviewing developments with legal counsel, is of the opinion that the outcome of such matters will not have a material adverse effect on the financial position or future operations of the Company. F-21 COMPUTER TECHNOLOGY ASSOCIATES, INC. Notes to Consolidated Financial Statements (continued) 12. OPERATING SEGMENTS The Company has two principal operating segments: the Systems Engineering Group and the Software Engineering Group. The Systems Engineering Group focuses on information security and complex embedded computer systems and the Software Engineering Group focuses on Year 2000 services and the installation and integration of ERP software. The following table provides certain financial information for each operating segment:
YEAR ENDED DECEMBER 31 1996 1997 1998 (IN MILLIONS) Contract revenues: Systems Engineering $91.9 $73.4 $73.6 Software Engineering 4.3 18.8 43.6 $96.2 $92.2 $117.2 Operating profit: Systems Engineering $ 2.4 $ 3.0 $5.2 Software Engineering 0.7 1.1 4.6 Other expense (2.4) (3.7) (3.0) $ 0.7 $ 0.4 $6.8 Depreciation and amortization expense: Systems Engineering $ 2.4 $ 0.8 $ 0.6 Software Engineering - 0.4 0.9 Discontinued operations 3.2 1.6 - Capital expenditures: Systems Engineering $ 1.0 $ 0.4 $ 1.5 Software Engineering - 1.4 0.9 Discontinued operations 5.5 1.8 - Identifiable assets: Systems Engineering $ 29.8 $ 27.4 $ 27.4 Software Engineering 3.0 12.0 23.8 Discontinued operations 42.8 - - General corporate assets 7.8 5.9 6.2 $ 83.4 $ 45.3 $ 57.4
F-22 COMPUTER TECHNOLOGY ASSOCIATES, INC. Notes to Consolidated Financial Statements (continued) 12. OPERATING SEGMENTS (CONTINUED) The percentage of Systems Engineering contract revenues from U.S. Government customers that comprise 10% or more of total revenues were as follows:
YEAR ENDED DECEMBER 31 1996 1997 1998 Department of Defense 63% 47% 26% General Services Administration 14% 16% 19%
The operating profit in 1996 for the Systems Engineering Group was adversely impacted by a $2.6 million adjustment to the profitability of the General Services Administration - Eastern Zone contract. Other expenses in 1996 include $0.9 million related to an unsuccessful initial public offering. Other expenses in 1998 and 1997 include $1.1 million and $2.9 million, respectively, for supplemental ESOP contributions F-23 SCHEDULE II COMPUTER TECHNOLOGY ASSOCIATES, INC. VALUATION AND QUALIFYING ACCOUNTS AND RESERVES ($000) ALLOWANCE FOR DOUBTFUL ACCOUNTS
Balance, Charged Charged Balance, Beginning to Costs to Other End of DESCRIPTION OF and ACCOUNTS DEDUCTIONS PERIOD PERIOD EXPENSES For the year ended December $2,700 $300 $108 $0 $3,108 31, 1996 For the year ended December $3,108 $600 $94 $334 $3,468 31, 1997 For the year ended December $3,468 $1,019 $325 $2,546 $2,266 31, 1998
F-24 CONSENT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS We consent to the incorporation by reference in the Registration Statement (Form S-8 No. 33- 71128) pertaining to the Defined Contribution 401(k) Retirement Plan of Computer Technology Associates, Inc. (formerly CTA INCORPORATED) and in the related prospectus of our report dated February 12, 1999, with respect to the consolidated financial statements and schedule of Computer Technology Associates, Inc. included in the Annual Report (Form 10-K) for the year ended December 31, 1998. /s/ Ernst & Young LLP Washington, D.C. March 26, 1999 F-25 CONSENT OF LEGG MASON WOOD WALKER, INC., INDEPENDENT APPRAISERS We consent to the incorporation by reference in the Registration Statement (Form S-8 No. 33- 71128) pertaining to the Defined Contribution 401(k) Retirement Plan of Computer Technology Associates, Inc. and in the related prospectus of our report dated February 18, 1999, with respect to the fair market value of minority holdings of Common Stock of Computer Technology Associates, Inc. as of December 31, 1998 included in the Annual Report (Form 10-K) for the year ended December 31, 1998. /s/ Legg Mason Wood Walker, Inc. Baltimore, MD March 26, 1999 F-26 REPORT OF LEGG MASON WOOD WALKER, INC., INDEPENDENT APPRAISERS Board of Directors Computer Technology Associates, Inc. 6903 Rockledge Drive, Suite 800 Bethesda, Maryland 20817 Members of the Board: You have requested our advice with regard to certain factors impacting the formula price of the Common Stock of Computer Technology Associates, Inc. ("CTA" or the "Company") as of December 31, 1998. Specifically, you asked us to provide you with (i) a discount factor to reflect the limited liquidity of CTA Common Stock (the "Discount Factor") (ii) a market index to reflect existing securities market conditions, including their relationship to public companies we have deemed comparable to CTA (the "Market Index") and (iii) our assessment as to whether or not the price produced by the formula for CTA Common Stock as of December 31, 1998 falls within a range we consider reasonable (together, our "Opinion"). In that regard, and pursuant to the terms and conditions of our letter agreement dated February 12, 1999, we are pleased to respond with this letter and related exhibits. In rendering our Opinion we have, among other things: (i) reviewed the Annual Reports to Shareholders and the Annual Reports on Form 10-K for the three years ended December 31, 1998; (ii) reviewed certain interim reports to shareholders and Quarterly Reports on Form 10-Q; (iii) reviewed certain other information relating to the business, earnings, cash flow, assets and prospects of the Company; (iv) reviewed contract backlog data and contract profiles prepared by management; (v) reviewed certain data regarding the financial performance and market valuation of selected public companies we deemed to be engaged in operations similar to those of CTA; (vi) reviewed data relating to recent merger and acquisition activity in relevant industry classifications; and (vii) met with senior management of CTA to discuss the operating performance and future prospects of the Company. We have relied without independent verification on information supplied to us by CTA and its employees, representatives and independent public accountants as well as information available from generally recognized public sources and, accordingly, do not assume responsibility for the accuracy or F-27 completeness of such information. Additionally, we have not made an appraisal of any assets of CTA. Our Opinion herein is necessarily based upon conditions and circumstances as they exist, have been disclosed to us and can be evaluated as of the date hereof. In recommending a 17.5% Discount Factor for the minority holdings of CTA Common Stock we note that while there is no active trading market for the Common Stock, there have been limited treasury stock purchases by the Company, its Employee Stock Option Plan and employees of CTA. Regarding a Market Index, we note that the Company has decided to reset the Market Index to 1.000 as of September 10, 1998. On this date, we note that the Dow Jones Industrial Average closed at 7,615.54 and the S&P 500 Index closed at 980.19. Since September 10, 1998 the Dow Jones Industrial Average has increased to 9,195.47, as of February 17, 1999 and the S&P 500 Index has increased to 1,224.03. Of greater relevance, a composite of commercial information technology stocks increased in value by 11.9% over the same period. Accordingly, we believe the appropriate Market Index is 1.10. Based upon our analyses of the foregoing and upon such other data as we have considered relevant to our analysis, it is our Opinion that (i) the appropriate Discount Factor is 17.5% (ii) the appropriate Market Index is 1.100, and (iii) the formula produced price for CTA Common Stock of $7.80 per share does fall within the range we believe represents fair market value. Very truly yours, LEGG MASON WOOD WALKER, INCORPORATED Baltimore, MD February 18, 1999 By: /S/ SCOTT R.COUSINO Scott R. Cousino Managing Director F-28 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities and Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. Computer Technology Associates, Inc. Date: March 31, 1999 By:/S/ C.E. VELEZ C.E. Velez Chairman of the Board and Chief Executive Officer Pursuant to the requirements of the Securities and Exchange Act of 1934, this report has been signed by the following persons on behalf of the registrant and in the capacities and on the dates indicated. By:/S/ C.E. VELEZ C.E. Velez Chairman of the Board, President, Date: March 31, 1999 By:/S/ GREGORY H. WAGNER Gregory H. Wagner Executive Vice President, Chief Financial Officer, Principal Accounting Officer and Treasurer Date: March 31, 1999 By:/S/ HARVEY D. KUSHNER Harvey D. Kushner Director Date: March 31, 1999 By:/S/ DAVID R. MACKIE David R. Mackie Director Date: March 31, 1999 By: Raymond V. McMillan Director Date: March 31, 1999 By:/S/ GEORGE W. MORGENTHALER George W. Morgenthaler Director Date: March 31, 1999 By: James M. Papada, III Director Date: March 31, 1999 By:/S/ ARTURO SILVESTRINI Arturo Silvestrini Director Date: March 31, 1999 By:/S/ GREGORY H. WAGNER Gregory H. Wagner As Attorney-in-Fact Date: March 31, 1999 EX-27 2 ARTICLE 5 FIN. DATA SCHEDULE FOR THE 1998 10-K
5 1000
12-MOS DEC-31-1998 JAN-01-1998 DEC-31-1998 0 0 51175 2266 0 50054 8940 5192 57348 37812 0 100 0 0 15634 57348 117184 117184 91747 91747 18625 0 1195 5617 2225 3392 (2482) 0 0 910 .10 .10
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