| SYS Item 1A RISK FACTORS 8 Item 1A RISK FACTORS We urge you to consider the following risk factors and all other information contained in this Annual Report on Form 10-K for the fiscal year ended June 30, 2006, and other reports and filings made with the Securities and Exchange Commission in evaluating our business and prospects |
| Risks and uncertainties, in addition to those we describe below, that are not presently known to us or that we currently believe are immaterial may also impair our business operations |
| If any of the following risks occur, our business and financial results could be harmed, and the price of our common stock could decline |
| You should also refer to the other information contained in this Annual Report on Form 10-K, including our consolidated financial statements and related notes |
| Risks Related to Our Business We depend upon a single customer, the US Government, for the majority of our revenues, and a decrease in its demand for our services, or pricing modifications by prime contractors, might harm our operating results |
| Currently, a substantial part of our business is work we do for the US Government |
| Even though the amount of business we receive from this customer is growing and we have negotiated multiple-year contracts that include option and award years, budget changes in Congress or the US Government could have a significant and adverse effect on us |
| In addition, we do not know whether the US Government will exercise each option or award year available on a contract |
| Depending on the contract, we may perform as a prime contractor or as a subcontractor to another prime contractor |
| In cases where we perform as a subcontractor, we may be subject to price modifications required by the prime contractor |
| Such price modifications, if not mitigated by a corresponding reduction of costs, could have a negative impact on our profitability |
| A significant number of our customers are government agencies which are subject to unique political and budgetary constraints and have special contracting requirements that may affect our ability to obtain other new government customers |
| A significant number of our customers are government agencies, principally DoD agencies |
| These agencies often do not set their own budgets and therefore have little control over the amount of money they can spend |
| In addition, these agencies experience political pressure that may dictate the manner in which they spend money |
| Due to political and budgetary processes and other scheduling delays that frequently occur in the contract or bidding process, some government agency orders may be canceled or substantially delayed, and the receipt of revenues or payments may be substantially delayed |
| In addition, future sales to government agencies will depend on our ability to meet government contracting requirements, certain of which may be onerous or impossible to meet, resulting in our inability to obtain particular contracts |
| Common requirements in government contracts include bonding, provisions permitting the purchasing agency to modify or terminate the contract at-will and without penalty and provisions permitting the agency to perform investigations or audits of our business practices |
| The US Government has a program that encourages and sometimes requires large prime contractors to use small businesses |
| The US Government restricts the competition on some contracts to qualifying small businesses |
| Some of our contracts and subcontracts have been awarded based on our eligibility as a small business |
| The definition of a small business depends on the type of product or service being provided |
| The US Government uses North American Industry Classification System (NAICS) codes to classify the small business size standards for all industries |
| One of our primary NAICS codes was for engineering services, and beginning in fiscal year 2005, we no longer qualified as a small business using this code |
| However, we still qualify as a small business using several other NAICS codes |
| In addition, the small business contracts currently held by us do not terminate as a result of our no longer qualifying as a small business under any specific NAICS Code, and any option years on these contracts are also not affected by a change in small business status |
| Nevertheless, it is possible that our future revenues may be adversely impacted by our recent growth and consequent failure to qualify as a small business under certain NAICS codes |
| 8 _________________________________________________________________ Our inability to adequately retain or protect our employees, customer relationships and proprietary technology could harm our ability to compete |
| Our future success and ability to compete depends in part upon our employees and their customer relationships, as well as our proprietary technology and trademarks, which we attempt to protect with a combination of patent, copyright, trademark and trade secret claims, as well as with our confidentiality procedures and employee contract provisions |
| These legal protections afford only limited protection and are time-consuming and expensive to obtain and/or maintain |
| Further, despite our efforts, we may not prevent third parties from soliciting our employees or customers or infringing upon or misappropriating our intellectual property |
| Our employees, customer relationships and intellectual property may not provide us with a competitive advantage adequate to prevent competitors from entering the markets for our products and services |
| Additionally, our competitors could independently develop non-infringing technologies that are competitive with, and equivalent or superior to, our technology |
| Monitoring infringement and/or misappropriation of intellectual property can be difficult, and it is possible that we would not detect an infringement or misappropriation of our proprietary rights |
| Even if we were to detect an infringement or misappropriation of our proprietary rights, litigation to enforce these rights would be costly and would cause us to divert financial and other resources from our normal business operations |
| The departure of certain key personnel could affect the financial condition of SYS due to the loss of their expertise and customer relationships |
| Certain key employees are intimately involved in our business and have day-to-day relationships with critical customers |
| Competition for highly skilled business, product development, technical and other personnel is intense, and we may not be successful in recruiting new personnel or in retaining our existing personnel |
| A failure on our part to retain the services of these key personnel could have a material adverse effect on our operating results and financial condition |
| We do not maintain key man life insurance on any of our employees with the exception of our CEO We face numerous competitors, and as a result, we may not get the business we seek |
| We have many competitors with comparable characteristics and capabilities that compete for the same group of customers |
| Our competitors are competent and experienced and are continuously working to take projects away from us |
| Many of our competitors have greater financial, technical, marketing and other resources than we do |
| Our ability to compete effectively may be adversely affected by the ability of these competitors to devote greater resources to the sale and marketing of their products and services than are available to us |
| We must comply with numerous US Government regulations |
| As a government contractor, we must comply with, and we are affected by, various government regulations |
| Changes in these regulations could affect our operating results, and we could be subject to penalties for failure to comply with them |
| Among the most significant of these regulations are: · The Federal Acquisition Regulations and agency regulations supplemental to the Federal Acquisition Regulations, which comprehensively regulate the formation, administration and performance of government contracts; · the Truth in Negotiations Act, which requires certification and disclosure of all cost and pricing data in connection with certain types of contracts; · government cost accounting standards, which impose accounting requirements that govern our right to reimbursement under certain cost-based government contracts; and · laws, regulations and executive orders restricting the use and dissemination of information classified for national security purposes and the exportation of certain products and technical data |
| Accuracy of indirect billing rates is critical |
| Our provisional indirect billing rates are approved at least annually by the Defense Contract Management Agency (DCMA) after being reviewed by the Defense Contract Audit Agency (DCAA) |
| These rates can differ from our actual indirect rates |
| We budget to have our actual indirect rates as close as possible to our government approved indirect rates at fiscal year end |
| Throughout the year, management assesses how these rates compare to forecasted rates for the year |
| For interim reporting purposes, SYS applies overhead and selling, general and administrative expenses as a percentage of direct contract costs based on annual budgeted indirect expense rates |
| To the extent actual expenses for an interim period are greater than the budgeted rates, the variance is deferred if management believes it is probable that the variance will be absorbed by planned contract activity |
| This probability assessment includes projecting whether future indirect costs will be sufficiently less than the annual budgeted rates or can be absorbed by seeking increased billing rates applied on cost-plus-fee contracts |
| At the end of each interim reporting period, management assesses the recoverability of any amount deferred to determine if any portion should be charged to expense |
| In assessing the recoverability of variances deferred, management takes into consideration estimates of the amount of direct labor and other direct costs to be incurred in future interim periods, the feasibility of modifications for provisional billing rates, and the likelihood that an approved increase in provisional billing rates can be passed along to a customer |
| If assumptions about the probability of recovering deferred variances change, deferred amounts could be expensed and such expenses could have a material adverse effect on the results of operations |
| We rely on subcontractors whose performance could have an adverse impact on our relationships with our customers and our operating results |
| We regularly employ subcontractors to assist us in satisfying our contractual obligations |
| We could have disputes with subcontractors concerning a number of issues, including the quality and timeliness of their work, a decision on our part not to extend task orders or issue new task orders under a subcontract, or our hiring of former personnel of a subcontractor |
| A failure by one or more of our subcontractors to satisfactorily deliver agreed-upon services on a timely basis could materially and adversely impact our ability to perform our obligations as a prime contractor |
| In extreme cases, such subcontractor performance deficiencies could result in the government terminating our contract for default |
| A default termination could expose us to liability for excess costs of procurement by the government and have a material adverse effect on our ability to compete for future contracts and task orders, which in turn could also have a material impact on our results of operations |
| 9 _________________________________________________________________ If we are unable to obtain or maintain security clearances, we may not be able to perform certain work |
| If we cannot obtain the necessary security clearances, we may not be able to perform classified work for the government and our revenues may be adversely affected |
| Certain government contracts require our facilities and some of our employees to maintain security clearances |
| If we lose or are unable to obtain security clearances required for a particular contract, the client can terminate the contract or decide not to renew it upon its expiration |
| As a result, to the extent we cannot obtain the required security clearances for our employees working on a contract, we may not derive the revenue anticipated from that contract |
| Any such reduction in revenue, if not replaced with revenue from other contracts, could seriously harm our operating results |
| Security breaches in sensitive government systems could result in the loss of clients and negative publicity |
| Many of the systems we develop involve managing and protecting information involved in national security and other sensitive government functions |
| A security breach in one of these systems could cause serious harm to our business, could result in negative publicity and could prevent us from having further access to such critically sensitive systems or other similarly sensitive areas for other government clients |
| There are risks associated with our planned growth, such as a possible inability to manage our growth |
| We plan to grow our revenues and profits by adding to our existing customer base through organic growth and by the acquisition of other government services and government or commercial technology related companies |
| Over the past five years we have hired senior management personnel capable of establishing new business units within SYS Rapid expansion through internal growth has required additional capital resources |
| There can be no assurances that such an approach will result in profitability in the future |
| We believe that we can also grow through the acquisition of other government services companies and government or commercial technology related companies that have product offerings which may be sold to both commercial and government customers |
| The acquisition of other companies and growing those businesses is uncertain and contains a variety of business risks, including: integration, cultural differences, the retention of key personnel, competition, protection of intellectual property, industry changes and others |
| We intend to attempt to expand our operations through the acquisition of other companies |
| Acquisitions and attempted acquisitions may place a strain on our limited personnel, financial and other resources |
| Our ability to manage this growth, should it occur, will require expansion of our capabilities and personnel |
| We may not be able to find qualified personnel to fill additional positions or be able to successfully manage a larger organization |
| Further, we intend to finance these transactions through a combination of cash and/or equity and debt financing transactions |
| Our ability to use our stock as an acquisition currency may be limited because the trading volume in our stock has been low, our stock price has been volatile, and our stock may not maintain a price sufficient to support transactions without excessive dilution |
| Our future results could be adversely affected by various significant non-cash charges, which could impair our ability to achieve or maintain profitability in the future |
| We have recorded significant non-cash charges in the past and will incur significant non-cash charges in the future related to the amortization of acquired technology and intangible assets from past acquisitions |
| We may also incur non-cash charges in future periods related to impairments of long-lived assets |
| To achieve profitability in the future, we must grow our revenue sufficiently to cover our business expenses |
| Our failure to achieve profitability in the future could cause our stock price to decline and may lead to additional impairment charges |
| We have very limited funds upon which to rely for adjusting to business variations and for growing new businesses |
| While we are likely to look for new funding to assist in the acquisition of businesses, it is uncertain whether such funding will be available |
| Our substantial reliance on our revolving line of credit facility with Comerica Bank - California imposes certain limitations on us, such as complying with financial covenants |
| If we are to grow and expand our operations, we will need to raise significant amounts of additional capital |
| We may not be successful in raising additional capital, or if we are successful, that we will be able to raise capital on reasonable terms |
| If we do raise additional capital, our existing shareholders may incur substantial and immediate dilution |
| The net loss reported for the fiscal year ended June 30, 2006 may further impact our ability to raise capital |
| We may violate financial covenants under our line of credit which could have a material adverse effect on our liquidity and financial condition |
| SYS must maintain certain financial covenants, including tangible effective net worth, current assets to current liabilities, quarterly net income, ratio of Senior debt to earnings before interest, taxes, depreciation and amortization (EBITDA) and the ratio of cash flow to the current portion of long-term debt |
| As of June 30, 2006 the Company was in technical default of the financial covenants related to minimum quarterly net income, the ratio of cash flow to the current portion of long term debt, and the ratio of Senior debt to EBITDA The lender has granted a waiver of these covenants for the measurement period ended June 30, 2006 |
| On September 27, 2006, the lender amended the terms of the line of credit to eliminate the minimum quarterly net income covenant, current assets to current liabilities covenant and ratio of Senior debt to EBITDA covenant and modify the tangible effective net worth covenant and cash flow coverage ratio covenant |
| We anticipate we will be in compliance with the modified covenants through the expiration date of the credit facility based on our operating budget for fiscal 2007 |
| We intend to renew or replace the credit facility prior to the expiration date |
| If we are not able to remain in compliance with the financial covenants, the lender may require the Company to pay the outstanding balance and cancel the credit facility which would have a material impact on our financial condition, results of operations and cash flows |
| There are a large number of shares that are available for future sale, and the sale of these shares may depress the market price of our common stock |
| As of June 30, 2006, we had issued 15cmam352cmam622 shares of common stock |
| Up to 1cmam924cmam050 shares of common stock were issuable upon the exercise of employee stock options at prices ranging from dlra1dtta23 to dlra4dtta90 per share, 687cmam522 shares were issuable upon the conversion of convertible notes from the February 2004 Offering at dlra2dtta20 per share, 168cmam563 shares were issuable upon the conversion of convertible notes from the acquisition of Polexis at dlra2dtta32 per share, 78cmam400 shares were issuable upon the conversion of the convertible note payable from the Antin acquisition at dlra2dtta50 per share, 868cmam056 shares were issuable upon the conversion of convertible notes from the February 2006 Offering at dlra3dtta60 per share, 313cmam401 shares were issuable upon the exercise of warrants issued in connection with the May 27, 2005 Offering at dlra2dtta50 per share, 50cmam000 shares were issuable upon the exercise of warrants issued in connection with the acquisition of the Lomasoft technology at dlra3dtta85 per share, 100cmam000 shares were conditionally issuable upon the exercise of warrants issued in connection with the acquisition of the Lomasoft technology at dlra3dtta87 per share, 110cmam000 shares were issuable upon the exercise of warrants issued in connection with various transactions at dlra4dtta00 per share, 20cmam000 shares were issuable upon the exercise of warrants issued for services rendered to SmallCap Corporate Advisors, LLC at dlra2dtta44 per share and up to 818cmam750 shares contingently issuable under earn-out provisions in various acquisition transactions |
| Shares issued upon any conversion of our outstanding convertible notes or upon the exercise of outstanding options and warrants could adversely affect the market price of our common stock |
| There is a limited market for our common stock which could impact your ability to sell your shares |
| Our common stock is traded on the American Stock Exchange |
| We cannot predict whether a stronger market will develop |
| There are no analysts currently covering the Company |
| 10 _________________________________________________________________ Future sales of our common stock by existing shareholders under Rule 144 could decrease the trading price of our common stock |
| As of June 30, 2006, a total of 7cmam120cmam981 shares of our outstanding common stock were “restricted securities” and could be sold in the public markets only in compliance with Rule 144 adopted under the Securities Act of 1933 or other applicable exemptions from registration |
| Rule 144 provides that a person holding restricted securities for a period of one year may thereafter sell, in brokerage transactions, an amount not exceeding in any three-month period the greater of either (i) 1prca of the issuer’s outstanding common stock or (ii) the average weekly trading volume in the securities during a period of four calendar weeks immediately preceding the sale |
| Persons who are not affiliated with the issuer and who have held their restricted securities for at least two years are not subject to the volume limitation |
| Possible or actual sales of our common stock by present shareholders under Rule 144 could have a depressive effect on the price of our common stock |
| Our directors, executive officers and affiliated persons beneficially own a significant amount of our stock, and their interests could conflict with yours |
| As of June 30, 2006, our directors, executive officers and affiliated persons beneficially own approximately 34dtta2prca of our common stock, including stock options exercisable within 60 days of June 30, 2006 |
| As a result, our executive officers, directors and affiliated persons will have a significant ability to: · Elect or defeat the election of our directors; · amend or prevent amendment of our articles of incorporation or bylaws; · effect or prevent a merger; sale of assets or other corporate transactions; and · control the outcome of any other matters submitted to the shareholders for vote |
| As a result of their ownership and positions, our directors, executive officers, and affiliated persons, collectively, are able to significantly influence all matters requiring shareholder approval, including the election of directors and approval of significant corporate transactions |
| In addition, sales of significant amounts of shares held by our directors and executive officers and affiliated persons, or the prospect of these sales, could adversely affect the market price of our common stock |
| Management’s stock ownership may discourage a potential acquirer from making a tender offer or otherwise attempting to obtain control of us, which in turn could reduce our stock price or prevent our shareholders from realizing a premium over our stock price |