Item
2. Management's Discussion and Analysis of Financial Condition and
Results of Operations
Cautionary
Statement Regarding Forward-Looking Statements
This
Form 10-Q contains forward-looking statements regarding our
business, customer prospects, or other factors that may affect
future earnings or financial results that are subject to the safe
harbor created by the Private Securities Litigation Reform Act of
1995. Such statements involve risks and uncertainties which could
cause actual results to vary materially from those expressed in the
forward-looking statements. Investors should read and understand
the risk factors detailed in our Annual Report on Form 10-K for the
fiscal year ended December 31, 2017 (“2017 10-K”) and
in other filings with the Securities and Exchange
Commission.
We
operate in a rapidly changing environment that involves a number of
risks, some of which are beyond our control. This list highlights
some of the risks which may affect future operating results. These
are the risks and uncertainties we believe are most important for
you to consider. Additional risks and uncertainties, not presently
known to us, which we currently deem immaterial or which are
similar to those faced by other companies in our industry or
business in general, may also impair our business operations. If
any of the following risks or uncertainties actually occurs, our
business, financial condition and operating results would likely
suffer. These risks include, among others, the
following:
●
changes in the
funding priorities of the U.S. federal government;
●
changes in the way
the U.S. federal government contracts with businesses;
●
terms specific to
U.S. federal government contracts;
●
our failure to keep
pace with a changing technological environment;
●
intense competition
from other companies;
●
inaccuracy in our
estimates of the cost of services and the timeline for completion
of contracts;
●
non-performance by
our subcontractors and suppliers;
●
our dependence on
third-party software and software maintenance
suppliers;
●
fluctuations in our
results of operations and the resulting impact on our stock
price;
●
the limited public
market for our common stock; and
●
our forward-looking
statements and projections may prove to be inaccurate.
In some
cases, you can identify forward-looking statements by terms such as
“may,” “will,” “should,”
“could,” “would,” “expect,”
“plans,” “anticipates,”
“believes,” “estimates,”
“projects,” “predicts,”
“intends,” “potential” and similar
expressions intended to identify forward-looking statements. These
statements reflect our current views with respect to future events
and are based on assumptions and subject to risks and
uncertainties. Given these uncertainties, you should not place
undue reliance on these forward-looking statements. We discuss many
of these risks in greater detail under the heading “Risk
Factors” in Item 1A of our 2017 10-K. Also, these
forward-looking statements represent our estimates and assumptions
only as of the date of this report. Except as required by law, we
assume no obligation to update any forward-looking statements after
the date of this report.
Our Business
Founded
in 1979, IAI is in the business of modernizing client information
systems, developing and maintaining information technology systems
and programs, developing Section 508-compliant electronic forms and
smart forms, and performing consulting services to government and
commercial organizations. We have performed software modernization
and electronic forms conversion projects for over 100 commercial
and government customers, including, but not limited to, Computer
Sciences Corporation, IBM, Computer Associates, Sprint, Citibank,
U.S. Department of Homeland Security, U.S. Treasury Department,
U.S. Department of Agriculture, U.S. Department of Education, U.S.
Department of Energy, U.S. Army, U.S. Air Force, U.S. Department of
Veterans Affairs, and the Federal Deposit Insurance Corporation,
and the U.S. Small Business Administration. Today, we primarily
apply our technology, services and experience to legacy software
migration and modernization for commercial companies and government
agencies, and to developing web-based solutions for agencies of the
U.S.
federal government.
IAI
also provides services through its GSA IT Schedule 70 contracts
(47QTCA18D0080) and maintains Reseller and/or Solution Partner
relationships with firms such as Adobe Systems, Micro Focus, and
Heirloom Computing (additional information on IAI may be viewed at
its website located at www.infoa.com).
Information Analysis Incorporated
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Form
10-Q Third Quarter 2018
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IAI
has earned an ISO 9001:2015 Management System certificate for the
provisioning and management of certain services and product
delivery to its customers. Many government agencies are now
requiring this certification as a basis for participating in
designated contract solicitations. ISO 9001:2015 is a process-based
certification recognizing organizations that can link business
objectives with operating effectiveness and institutionalize
continual improvement in its operations. In order to achieve and
maintain certification, IAI is required to demonstrate through
external audit our ability to consistently provide products and
services that meet customer and applicable statutory and regulatory
requirements set forth in the referenced ISO 9001:2015 standard.
Companies that achieve such certification have demonstrated
effective implementation of documentation and records management,
top management’s commitment to their customers, establishment
of clear policy, good planning and implementation, good resource
management, efficient process control, as well as measurement and
analysis.
In the three months ended September 30, 2018, our
prime contracts with U.S. government agencies generated 71.3% of
our revenue, subcontracts under federal procurements generated
24.7% of our revenue, and 4.0% of our
revenue came from
commercial contracts. The terms of these contracts and subcontracts
vary from single transactions to five years. Within this group of
prime contracts with U.S. government agencies, one software sale
generated 15.5% of our revenue and one other contract generated
13.6% of our revenue. One subcontract generated 20.4% of our
revenue.
In the
three months ended September 30, 2017, our prime contracts with
U.S. government agencies generated 67.4% of our revenue,
subcontracts under federal procurements generated 27.7% of our
revenue, and 4.9% of our revenue came from commercial contracts.
The terms of these contracts and subcontracts varied from single
transactions to five years. Within this group of prime contracts
with U.S. government agencies, one software sale generated 23.9% of
our revenue and one other contract generated 12.0% of our revenue.
One subcontract generated 22.0% of our revenue.
In the nine months ended September 30, 2018, our
prime contracts with U.S. government agencies generated 72.0% of
our revenue, subcontracts under federal procurements generated
24.3% of our revenue, and 3.7% of our
revenue came from
commercial contracts. The terms of these contracts and subcontracts
vary from single transactions to five years. Within this group of
prime contracts with U.S. government agencies, one software sale
generated 24.3% of our revenue and one other contract generated
13.1% of our revenue. One subcontract generated 20.2% of our
revenue.
In the
nine months ended September 30, 2017, our prime contracts with U.S.
government agencies generated 72.2% of our revenue, subcontracts
under federal procurements generated 22.1% of our revenue, and 5.7%
of our revenue came from commercial contracts. The terms of these
contracts and subcontracts varied from single transactions to five
years. Within this group of prime contracts with U.S. government
agencies, two software sales contracts generated 20.4% and 10.2% of
our revenue, respectively, and one professional fees contract
generated 12.0% of our revenue. One subcontract generated 16.6% of
our revenue.
At
September 30, 2018, balances related to one subcontract under a
federal procurement represented 42.5% of our outstanding accounts
receivable, and balances related to two prime contracts represented
11.9% and 10.6% of our outstanding accounts receivable,
respectively.
At
September 30, 2017, balances related to that same subcontract under
a federal procurement represented 22.8% of our outstanding accounts
receivable, and balances related to two prime contracts represented
33.3% and 12.2% of our outstanding accounts receivable,
respectively.
We sold
third-party software and maintenance contracts under agreements
with one major supplier. These sales accounted for 51.1% of total
revenue in the third quarter of 2018 and 49.3% of revenue in the
third quarter of 2017, and 53.5% of total revenue in the first nine
months of 2018 and 55.5% of revenue in the first nine months of
2017.
Information Analysis Incorporated
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Form
10-Q Third Quarter 2018
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Three
Months Ended September 30, 2018 versus Three Months Ended September
30, 2017
Revenue
Our
revenues in the third quarter of 2018 were $2,418,677 compared to
$2,731,794 in the corresponding quarter in 2017, a decrease of
$313,117, or (11.5%). Professional fee revenue was $1,111,358 in
the third quarter of 2018 versus $1,385,257 in the corresponding
quarter in 2017, a decrease of $273,899, or (19.8%), and software
revenue was $1,307,319 in the third quarter of 2018 versus
$1,346,537 in the third quarter of 2017, a decrease of $39,218, or
(2.9%). Revenue from professional fees decreased due primarily to
the completion or expirations of certain contracts since the third
quarter of 2017, as well as variations in the levels of activity on
several other continuing contracts. The decrease in our software
revenue in 2018 versus the same period in 2017 is due to the
non-recurring nature of many of our software sales transactions.
Software sales and associated margins are subject to considerable
fluctuation from period to period, based on the product mix sold
and referral fees earned.
Gross Profit
Gross
profit was $569,106, or 23.5% of revenue in the third quarter of
2018 versus $635,891, or 23.3% of revenue in the third quarter of
2017. For the quarter ended September 30, 2018, $536,158 of the
gross profit was attributable to professional fees at a gross
profit percentage of 48.2%, and $32,948 of the gross profit was
attributable to software sales at a gross profit percentage of
2.5%. In the same quarter in 2017, we reported gross profit for
professional fees of $608,853, or 44.0%, of professional fee
revenue, and gross profit of $27,038, or 2.0% of software sales.
Gross profit from professional fees decreased primarily due to the
completion or expirations of certain contracts, and fluctuations in
activity on continuing contracts, since the third quarter of 2017.
Gross profit on software sales increased due to fluctuations in the
mix of products sold. Software product sales and associated margins
are subject to considerable fluctuation from period to period,
based on the product mix sold and referral fees
earned.
Selling, General and Administrative Expenses
Selling, general
and administrative expenses, exclusive of sales commissions, were
$409,761, or 16.9% of revenues, in the third quarter of 2018 versus
$386,929, or 14.2% of revenues, in the third quarter of 2017. These
expenses increased $22,832, or 5.9%, from the third quarter of
2017. These increases are from increases in the costs of
non-billable labor and the fringe benefits associated with that
labor.
Commissions expense
was $134,255, or 5.6% of revenues, in the third quarter of 2018
versus $140,963, or 5.2% of revenues, in the third quarter of 2017.
Commissions are driven by varying factors and are earned at varying
rates for each salesperson.
Net income
Net
income for the three months ended September 30, 2018, was $27,964,
or 1.2% of revenue, versus net income of $110,284, or 4.0% of
revenue, for the same period in 2017.
Nine
months Ended September 30, 2018 versus Nine months Ended September
30, 2017
Revenue
Our
revenues in the first nine months of 2018 were $7,520,972 compared
to $8,269,558 in the corresponding quarter in 2017, a decrease of
$748,586, or (9.1%). Professional fee revenue was $3,429,153 in the
first nine months of 2018 versus $3,676,730 in the corresponding
period in 2017, a decrease of $247,577, or (6.7%), and software
revenue was $4,091,819 in the first nine months of 2018 versus
$4,592,828 in the first nine months of 2017, a decrease of
$501,009, or (10.9%). Revenue from professional fees decreased due
primarily to the completion or expirations of certain contracts
since the third quarter of 2017, as well as variations in the
levels of activity on several other continuing contracts. The
decrease in our software revenue in 2018 versus the same period in
2017 is due to the non-recurring nature of many of our software
sales transactions. Software sales and associated margins are
subject to considerable fluctuation from period to period, based on
the product mix sold and referral fees earned.
Information Analysis Incorporated
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Form
10-Q Third Quarter 2018
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Gross Profit
Gross
profit was $1,674,881, or 22.3% of revenue in the first nine months
of 2018 versus $1,773,076, or 21.4% of revenue in the first nine
months of 2017. For the nine months ended September 30, 2018,
$1,600,611 of the gross profit was attributable to professional
fees at a gross profit percentage of 46.7%, and $74,270 of the
gross profit was attributable to software sales at a gross profit
percentage of 1.8%. In the same period in 2017, we reported gross
profit for professional fees of $1,686,347, or 45.9%, of
professional fee revenue, and gross profit of $86,729, or 1.9% of
software sales. Gross profit from professional fees decreased
primarily due to the completion or expirations of certain contracts
since the third quarter of 2017. Gross profit on software sales
decreased due to the non-recurring nature of many of our software
sales transactions and to decreases in referral fees earned.
Software product sales and associated margins are subject to
considerable fluctuation from period to period, based on the
product mix sold and referral fees earned.
Selling, General and Administrative Expenses
Selling, general
and administrative expenses, exclusive of sales commissions, were
$1,319,790, or 17.5% of revenues, in the first nine months of 2018
versus $1,231,863, or 14.9% of revenues, in the first nine months
of 2017. These expenses increased $87,927, or 7.1%, from the first
nine months of 2017. These increases are from increases in
non-billable labor and the fringe benefits associated with that
labor, costs of issuing incentive stock options to certain key
employees, the cost of maintaining our ISO 9001 certification,
costs associated with bids and proposals, and severance payments
for former employees.
Commissions expense
was $374,815, or 5.0% of revenues, in the first nine months of 2018
versus $380,267, or 4.6% of revenues, in the first nine months of
2017. Commissions are driven by varying factors and are earned at
varying rates for each salesperson.
Net (loss) income
Net
loss for the nine months ended September 30, 2018, was ($11,194),
or (0.1%) of revenue, versus net income of $167,386, or 2.0% of
revenue, for the same period in 2017.
Liquidity
and Capital Resources
Our
cash and cash equivalents balance, when combined with our cash flow
from operations during the first nine months of 2018, were
sufficient to provide financing for our operations. Our net cash
used in the combination of our operating and investing activities
in the first nine months of 2018 was $677,819. This net cash, when
subtracted from a beginning balance of $2,731,510, yielded cash and
cash equivalents of $2,053,691 as of September 30, 2018. Accounts
receivable and contract assets increased $549,083. Prepaid expenses
and other current assets increased $97,637 due primarily to
unrecognized expenses related to maintenance contracts on software
sales, which are recognized over the terms of the maintenance
contracts. Commissions payable decreased $125,019 due to payouts of
existing commissions payable balances occurring faster than new
commissions were earned.
We have
a revolving line of credit with a bank providing for demand or
short-term borrowings of up to $1,000,000. The line expires on May
31, 2020. As of September 30, 2018, no amounts were outstanding
under this line of credit. We did not borrow against this line of
credit in the last twelve months.
Given
our current cash position and operating plan, we anticipate that we
will be able to meet our cash requirements for at least twelve
months from the date of filing of this Form 10-Q.
We
presently lease our corporate offices on a contractual basis with
certain timeframe commitments and obligations. We believe that our
existing offices will be sufficient to meet our foreseeable
facility requirement. Should we need additional space to
accommodate increased activities, management believes we can secure
such additional space on reasonable terms.
We have
no material commitments for capital expenditures.
We have
no off-balance sheet arrangements.
Information Analysis Incorporated
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Form
10-Q Third Quarter 2018
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Item
4
.
Controls
and Procedures
Disclosure Controls and Procedures
Our
management, under the supervision and with the participation of our
Chief Executive Officer and Chief Financial Officer, and people
performing similar functions, has evaluated the effectiveness of
the design and operation of our disclosure controls and procedures
(as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange
Act), as of September 30, 2018 (the “Evaluation Date”).
Based upon this evaluation, our Chief Executive Officer and Chief
Financial Officer have concluded that, as of the Evaluation Date,
our disclosure controls and procedures are effective to ensure that
information required to be disclosed by us in the reports that we
file or submit under the Exchange Act (i) is recorded, processed,
summarized and reported within the time periods specified in the
Securities and Exchange Commission’s rules and forms, and
(ii) is accumulated and communicated to management, including our
Chief Executive Officer and Chief Financial Officer, to allow
timely decisions regarding required disclosure
.
Changes in Internal Controls over Financial Reporting
There
were no changes in the Company’s internal control over
financial reporting during the quarter ended September 30, 2018,
that have materially affected, or are reasonably likely to
materially affect, our internal control over financial
reporting.
Inherent Limitations on Effectiveness of Controls
Because
of the inherent limitations in all control systems, no control
system can provide absolute assurance that all control issues and
instances of fraud, if any, within a company have been detected.
These inherent limitations include the realities that judgments in
decision making can be faulty and that breakdowns can occur because
of simple error or mistake. Additionally, controls can be
circumvented by the individual acts of a person, by collusion of
two or more people or by management override of the control. The
design of any system of controls also is based in part upon certain
assumptions about the likelihood of future events, and there can be
no assurance that any design will succeed in achieving its stated
goals under all potential future conditions. Because of the
inherent limitations in a cost-effective control system,
misstatements due to error or fraud may occur and may not be
detected. Notwithstanding these limitations, we believe that our
disclosure controls and procedures are designed to provide
reasonable assurance of achieving their objectives.
Information Analysis Incorporated
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Form
10-Q Third Quarter 2018
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