5. Warrants
On August 2, 2010, the Company entered into a letter agreement (the “Letter Agreement”) with DARR Westwood LLC (the “Investor”), pursuant to which, among other things, (a) the Investor agreed (i) to certain transfer restrictions on shares of Common Stock owned by the Investor, which are described below, and (ii) to transfer to the Company for cancellation the existing warrant owned by the Investor to purchase 8% of the outstanding Common Stock on a fully diluted basis, and (b) the Company issued to the Investor a warrant (the “Warrant”) to purchase up to an aggregate of 1,401,733 shares of common stock, par value $.01 per share, of the Company (“Common Stock”) at an exercise price of $2.11 per share. The Investor’s sole member is Dinesh R. Desai, the Company’s Chairman, Chief Executive Officer and President. For further information on Warrants, refer to the annual financial statements and notes thereto included in the Company’s Quarterly Report on Form 10-K for the year ended August 31, 2010.
The Warrant entitles the Investor to purchase 1,401,733 shares of Common Stock at $2.11 per share and expires on August 2, 2015. The Warrant also contains provisions for cashless exercise and weighted average anti-dilution protection for subsequent issuances or deemed issuances of Common Stock by the Company for consideration per share less than the per share exercise price of the Warrant in effect immediately prior to such issuance or deemed issuance. In connection with this issuance of warrants and compliance with ASC Topic 815, “Derivates and Hedging,” the Company recorded a liability on August 2, 2010 of $916,000. At May 31, 2011 and August 31, 2010, the net liability recorded on the balance sheet was $432,000 and $910,000, respectively. The Company recorded (income) expense on its consolidated results of operations of ($49,000) and $-0- for three months ended May 31, 2011 and 2010 and ($478,000) and $-0- for the nine months ended May 31, 2011 and 2010, respectively, as a result of adjusting the warrant liability to fair value. As a result of the Company’s stock being thinly traded, there may continue to be adjustments associated with fair valuing the warrant liability in future periods.
6. Line of Credit
The Company, Emtec NJ, Emtec LLC, Emtec Federal, EGS LLC, Luceo, eBAS, Aveeva EIS-US, KOAN-IT US, SDI, Dinero and Covelix (collectively, the “Borrower”), have a Loan and Security Agreement with De Lage Landen Financial Services, Inc. (the “Lender”) pursuant to which the Lender provides the Borrower with a revolving credit loan and floor plan loan (the “Credit Facility”). The Credit Facility provides for aggregate borrowings of the lesser of $32.0 million or 85% of Borrower’s eligible accounts receivable, plus 100% of unsold inventory financed by the Lender and 40% of all other unsold inventory. The floor plan loan portion of the Credit Facility is for the purchase of inventory from approved vendors and for other business purposes. The Credit Facility subjects the Borrower to mandatory repayments upon the occurrence of certain events as set forth in the Credit Facility.
On December 5, 2008, the Borrower entered into a First Amendment and Joinder to Loan and Security Agreement and Schedule to Loan and Security Agreement (the “First Amendment”) with the Lender, pursuant to which the Lender extended the term of the loans issued to the Borrower under the Loan and Security Agreement from December 7, 2008 until December 7, 2010 and made certain other amendments to the Loan and Security Agreement, including the following:
|
|
·
|
The First Amendment changed the base rate of interest to the three month (90 day) LIBOR rate from the previous base rate of the “Prime Rate.”
|
|
|
·
|
The First Amendment changed the interest rate for revolving credit loans to the base rate plus 3.25% from the previous interest rate for revolving credit loans which was the base rate minus 0.5%, and changed the interest rate for floorplan loans, if applicable, to 6.25% in excess of the base rate from the previous interest rate for floorplan loans of 2.5% in excess of the base rate.
|
|
|
·
|
The First Amendment amended the Schedule to Loan and Security Agreement to provide that the Borrower must pay the Lender a floorplan annual volume commitment fee if the aggregate amount of all floorplan loans does not equal or exceed $60.0 million in a 12-month period from December 1st through November 30th. The floorplan commitment fee is equal to the amount that the floorplan usage during such 12-month period is less than $60.0 million multiplied by 1%. If the Borrower terminates the Credit Facility during a 12-month period, the Borrower shall be required to pay the Lender a prorated portion of the annual volume commitment fee.
|
On December 7, 2010, the Borrower entered into a Second Amendment and Joinder to Loan and Security Agreement and Schedule to Loan and Security Agreement (the “Second Amendment”) with the Lender, pursuant to which the Lender has agreed to extend the term of the Credit Facility from December 7, 2010 until December 7, 2012 and to make certain other amendments to the Credit Facility, including the following:
|
|
·
|
The Second Amendment changed the total facility amount by temporarily increasing it to $40.6 million. This amendment was effective until January 31, 2011, at which time the total facility amount returned to its previous level of $32.0 million.
|
|
|
·
|
The Second Amendment added and clarified certain covenants in the Credit Facility including the following:
|
|
|
o
|
Changing the Positive Net Income covenant to add back to Net Income certain non-cash charges;
|
|
|
o
|
Providing that Borrower shall maintain a ratio of EBITDA to Interest Paid (as such terms are defined in the Credit Facility) of 3.50 to 1.00 as of the end of each fiscal quarter measured on a trailing twelve month basis; and
|
|
|
o
|
Changing the Capital Expense covenant to increase the limitation on capital expenditures to $2,750,000 in any rolling four fiscal quarter period and to provide that business acquisition costs are not considered capital expenditures for this purpose.
|
In addition, by executing the Second Amendment, EIS-US, KOAN-IT US and SDI each joined the Credit Documents as a Borrower and granted the Lender a security interest in all of their respective assets, including inventory, equipment, fixtures, accounts, chattel paper, instruments, deposit accounts, documents, general intangibles, letter of credits rights, and all judgments, claims and insurance policies. EIS-US pledged 100% of the outstanding shares of its domestic subsidiary, KOAN-IT US, and 65% of the outstanding shares of the Company’s Canadian subsidiary, Emtec Infrastructure Services Canada Corporation. Emtec Federal, Inc. pledged 100% of the outstanding shares of its domestic subsidiary, SDI, and the Company pledged 100% of the outstanding shares of its domestic subsidiary, EIS-US.
On March 11, 2011, the Borrower entered into a Third Amendment and Joinder to Loan and Security Agreement and Schedule to Loan and Security Agreement (the “Third Amendment”) with the Lender, pursuant to which Dinero and Covelix each joined the Credit Documents as a Borrower and granted the Lender a security interest in all of their respective assets, including inventory, equipment, fixtures, accounts, chattel paper, instruments, deposit accounts, documents, general intangibles, letter of credits rights, and all judgments, claims and insurance policies.
On June 23, 2011, EIS-Canada and De Lage Landen Financial Services Canada Inc. (the “Canadian Lender”) entered into a Loan Agreement (the “Canadian Loan Agreement”) and Schedule to Loan Agreement (the “Canadian Schedule,” together with the Canadian Loan Agreement, the “Canadian Credit Documents”) pursuant to which the Canadian Lender has agreed to provide EIS-Canada with a revolving credit line of $5 million (Canadian dollars) (the “Canadian Credit Facility”). The Canadian Credit Facility is subject to certain mandatory repayments upon the occurrence of certain events as set forth in the Canadian Credit Documents.
Borrowings under the Canadian Credit Facility will bear interest at an annual rate equal to the rate of interest announced by The Toronto-Dominion Bank as the Canadian prime rate plus 1.75% for revolving credit loans.
To secure the payment of the obligations under the Canadian Credit Facility, EIS-Canada entered into a General Security Agreement, dated June 23, 2011, with the Canadian Lender (the “Canadian Security Agreement”), pursuant to which EIS-Canada granted to the Canadian Lender a security interest in all of EIS-Canada’s interests in certain of its undertakings, personal property and real property.
The Canadian Credit Documents contain certain customary covenants, including among other things:
|
|
·
|
Affirmative covenants requiring EIS-Canada to maintain its legal existence and provide certain notices to the Canadian Lender; and
|
|
|
·
|
Restrictive covenants including limitations on other indebtedness, liens, fundamental changes, asset sales, capital expenditures, the issuance of capital stock, investments, and transactions with affiliates.
|
The Canadian Credit Documents contain certain customary representations and warranties and events of default, including failure to pay interest, principal or fees, any material inaccuracy of any representation and warranty, bankruptcy and insolvency events. Certain of the events of default are subject to exceptions and materiality qualifiers.
The Company had balances of $14.5 million and $16.0 million outstanding under the revolving portion of the Credit Facility, and balances of $974,000 and $3.4 million (included in the Company’s accounts payable) outstanding plus $723,000 and $723,000 in open approvals under the floor plan portion of the Credit Facility at May 31, 2011 and August 31, 2010, respectively. Net availability per our Lender was $1.3 million and $6.8 million under the revolving portion of the Credit Facility as of May 31, 2011 and August 31, 2010, respectively.
On June 23, 2011, the Borrower entered into a Fourth Amendment to Loan and Security Agreement and Schedule to Loan and Security Agreement (the “Fourth Amendment”) with the Lender, pursuant to which the Lender has agreed to make certain amendments to the Loan and Security Agreement and the Schedules to the Loan and Security Agreement including (1) recognizing the Canadian Credit Facility and acknowledging the Borrowers’ agreement to guarantee EIS-Canada’s obligations under that facility and (2) amending the total facility amount under the Credit Documents to provide that the total facility plus the aggregate amount outstanding under the Canadian Credit Facility shall not exceed $32,000,000 (US dollars).
As of May 31, 2011, the Company determined that it was in compliance with its financial covenants under the Facility.
7. Concentration of Credit Risk
Financial instruments that potentially subject the Company to a concentration of credit risk consist principally of accounts receivable.
The Company’s revenues, by client type, consist of the following (in thousands):
| |
|
For the Three Months Ended
|
|
| |
|
May 31, 2011
|
|
|
May 31, 2010
|
|
|
Departments of the U.S. Government
|
|
$ |
12,036 |
|
|
|
26.8 |
% |
|
$ |
22,457 |
|
|
|
42.0 |
% |
|
Canadian Government Agencies
|
|
|
991 |
|
|
|
2.2 |
% |
|
|
760 |
|
|
|
1.4 |
% |
|
State and Local Governments
|
|
|
2,465 |
|
|
|
5.5 |
% |
|
|
1,026 |
|
|
|
1.9 |
% |
|
Commercial Companies
|
|
|
14,673 |
|
|
|
32.7 |
% |
|
|
12,977 |
|
|
|
24.3 |
% |
|
Education and other
|
|
|
14,694 |
|
|
|
32.8 |
% |
|
|
16,287 |
|
|
|
30.4 |
% |
|
Total Revenues
|
|
$ |
44,859 |
|
|
|
100.0 |
% |
|
$ |
53,506 |
|
|
|
100.0 |
% |
| |
|
For the Nine Months Ended
|
|
| |
|
May 31, 2011
|
|
|
May 31, 2010
|
|
|
Departments of the U.S. Government
|
|
$ |
72,124 |
|
|
|
43.0 |
% |
|
$ |
79,373 |
|
|
|
48.6 |
% |
|
Canadian Government Agencies
|
|
|
2,301 |
|
|
|
1.4 |
% |
|
|
1,480 |
|
|
|
0.9 |
% |
|
State and Local Governments
|
|
|
4,720 |
|
|
|
2.8 |
% |
|
|
3,162 |
|
|
|
1.9 |
% |
|
Commercial Companies
|
|
|
40,921 |
|
|
|
24.4 |
% |
|
|
38,462 |
|
|
|
23.6 |
% |
|
Education and other
|
|
|
47,792 |
|
|
|
28.4 |
% |
|
|
40,710 |
|
|
|
24.9 |
% |
|
Total Revenues
|
|
$ |
167,858 |
|
|
|
100.0 |
% |
|
$ |
163,187 |
|
|
|
100.0 |
% |
The Company reviews a client’s credit history before extending credit. The Company does not require collateral or other security to support credit sales. The Company provides an allowance for doubtful accounts based on the credit risk of specific clients, historical experience and other identified risks. Trade receivables are carried at original invoice less an estimate made for doubtful receivables, based on review by management of all outstanding amounts on a periodic basis. Trade receivables are considered delinquent when payment is not received within standard terms of sale, and are charged-off against the allowance for doubtful accounts when management determines that recovery is unlikely and ceases its collection efforts.
The trade account receivables consist of the following (in thousands):
| |
|
May 31,
|
|
|
August 31,
|
|
| |
|
2011
|
|
|
2010
|
|
|
Trade receivables
|
|
$ |
24,032 |
|
|
$ |
36,628 |
|
|
Allowance for doubtful accounts
|
|
|
(504 |
) |
|
|
(366 |
) |
|
Trade receivables, net
|
|
$ |
23,528 |
|
|
$ |
36,262 |
|
Trade receivables include $2.4 million and $2.2 million of unbilled revenue as of May 31, 2011 and August 31, 2010, respectively.
Sales to major customers, representing at least 10% of total revenue for a period, of the Company, consist of the following (in thousands):
| |
|
For the Three Months Ended
|
|
| |
|
May 31, 2011
|
|
|
May 31, 2010
|
|
|
School District #1
|
|
$ |
10,005 |
|
|
|
22.3 |
% |
|
$ |
11,062 |
|
|
|
20.7 |
% |
|
School District #2
|
|
|
4,403 |
|
|
|
9.8 |
% |
|
|
5,814 |
|
|
|
10.9 |
% |
|
All Other Customers
|
|
|
30,451 |
|
|
|
67.9 |
% |
|
|
36,630 |
|
|
|
68.4 |
% |
|
Total Revenues
|
|
$ |
44,859 |
|
|
|
100.0 |
% |
|
$ |
53,506 |
|
|
|
100.0 |
% |
| |
|
For the Nine Months Ended
|
|
| |
|
May 31, 2011
|
|
|
May 31, 2010
|
|
|
School District #1
|
|
$ |
37,409 |
|
|
|
22.3 |
% |
|
$ |
26,715 |
|
|
|
16.4 |
% |
|
Department of the U.S. Government
|
|
|
17,286 |
|
|
|
10.3 |
% |
|
|
6,132 |
|
|
|
3.8 |
% |
|
All Other Customers
|
|
|
113,163 |
|
|
|
67.4 |
% |
|
|
130,340 |
|
|
|
79.8 |
% |
|
Total Revenues
|
|
$ |
167,858 |
|
|
|
100.0 |
% |
|
$ |
163,187 |
|
|
|
100.0 |
% |
Trade receivables due from an education client in the southeastern United States and one of the departments of the U.S. Government accounted for approximately 11.6% and 0.1%, respectively, of the Company’s trade receivables as of May 31, 2011. The same clients accounted for approximately 18.2% and 1.3%, respectively of the Company’s trade receivable as of August 31, 2010.
8. Inventories
Inventories are stated at the lower of average cost or market. Inventories consist of finished goods purchased for resale, including computer hardware, computer software, computer peripherals and related supplies. At May 31, 2011 and August 31, 2010, inventories consisted of the following (in thousands):
| |
|
May 31,
|
|
|
August 31,
|
|
| |
|
2011
|
|
|
2010
|
|
|
Hardware, software, accessories and parts
|
|
$ |
1,851 |
|
|
$ |
1,759 |
|
|
Inventory reserve
|
|
|
(212 |
) |
|
|
(244 |
) |
|
Net inventories
|
|
$ |
1,639 |
|
|
$ |
1,515 |
|
9. Accrued Liabilities
At May 31, 2011 and August 31, 2010, accrued liabilities consisted of the following (in thousands):
| |
|
May 31, 2011
|
|
|
August 31, 2010
|
|
|
Accrued payroll
|
|
$ |
2,822 |
|
|
$ |
4,156 |
|
|
Accrued commissions
|
|
|
220 |
|
|
|
389 |
|
|
Accrued state sales taxes
|
|
|
68 |
|
|
|
84 |
|
|
Accrued third-party service fees
|
|
|
12 |
|
|
|
181 |
|
|
Other accrued expenses
|
|
|
4,676 |
|
|
|
3,217 |
|
| |
|
$ |
7,798 |
|
|
$ |
8,027 |
|
10. Related Party Transactions
The Company leases warehouse and office space from related parties. The aggregate expense for these lease arrangements during the three months ended May 31, 2011 and 2010 was $194,000 and $162,000, respectively. During the nine months ended May 31, 2011 and 2010, the aggregate expense for these lease arrangements was $582,000 and $473,000, respectively.
11. Legal Proceedings
In December 2007, the Company received a subpoena issued by the General Services Administration Office of Inspector General (“OIG”), as part of an ongoing, industry-wide investigation. The Company produced documents and data in response to the subpoena to the OIG during 2008. In October 2010, the Company learned that it had been named as a defendant in a qui tam case alleging violations of the Trade Agreements Act. This case, designated United States ex rel. Folliard v. Synnex Corporation et al., was filed under seal in the United States District Court for the District of Columbia. Qui tam lawsuits typically remain under seal (hence, usually unknown to the defendant) for some time while the government decides whether or not to intervene on behalf of a private qui tam plaintiff (known as a relator) and take the lead in the litigation. These lawsuits can involve significant monetary damages and penalties and award bounties to private plaintiffs who successfully bring the suits. The United States government declined to intervene in the matter on May 27, 2010. Nonetheless, the Company can provide no assurance that the government will not intervene in this case in the future or in any other qui tam suit against the Company in the future. The Company filed a motion to dismiss the lawsuit on December 10, 2010. At this time, the Company is unable to predict the timing and outcome of this matter.
In addition, the Company is occasionally involved in various lawsuits, claims, and administrative proceedings arising in the normal course of business. Except as set forth above, the Company believes that any liability or loss associated with such matters, individually or in the aggregate, will not have a material adverse effect on the Company’s financial condition or results of operations.
12. Segment Information
The Company provides segment financial information in accordance with ASC Topic 280, “Segment Reporting.” The Company’s business activities are divided into two business segments, EIS and EGS. EIS consists of the Systems Division, which includes Emtec NJ, Emtec LLC, Emtec Federal and the business service management solutions offered by the ITSM practice, the Oracle practice, and the Federal applications business. EGS is the Company’s enterprise applications services solutions and training business including its ERP and Application Development practice and its Business Analysis and Quality Assurance Practice. The accounting policies of our segments are the same as those described in Note 2 and there are no material intersegment transactions.
Summarized financial information relating to the Company’s operating segments is as follows (in thousands):
| |
|
(Unaudited)
|
|
|
|
|
| |
|
May 31 ,
|
|
|
August 31,
|
|
| |
|
2011
|
|
|
2010
|
|
|
Identifiable Assets:
|
|
|
|
|
|
|
|
EIS
|
|
$ |
56,336 |
|
|
$ |
61,501 |
|
|
EGS
|
|
|
11,893 |
|
|
|
12,771 |
|
|
Total Assets
|
|
$ |
68,229 |
|
|
$ |
74,272 |
|
| |
|
For the Three Months Ended
|
|
|
For the Nine Months Ended
|
|
| |
|
May 31,
|
|
|
May 31,
|
|
| |
|
(Unaudited)
|
|
|
(Unaudited)
|
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
2011
|
|
|
2010
|
|
|
2011
|
|
|
2010
|
|
|
Revenues
|
|
|
|
|
|
|
|
|
|
|
|
|
|
EIS
|
|
$ |
37,136 |
|
|
$ |
45,791 |
|
|
$ |
145,647 |
|
|
$ |
140,800 |
|
|
EGS
|
|
|
7,723 |
|
|
|
7,715 |
|
|
|
22,211 |
|
|
|
22,387 |
|
|
Total Revenue
|
|
$ |
44,859 |
|
|
$ |
53,506 |
|
|
$ |
167,858 |
|
|
$ |
163,187 |
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gross profit
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
EIS
|
|
$ |
6,661 |
|
|
$ |
6,736 |
|
|
$ |
22,320 |
|
|
$ |
20,619 |
|
|
EGS
|
|
|
1,146 |
|
|
|
1,345 |
|
|
|
3,783 |
|
|
|
3,910 |
|
|
Gross profit
|
|
$ |
7,807 |
|
|
$ |
8,081 |
|
|
$ |
26,103 |
|
|
$ |
24,529 |
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Depreciation and amortization
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
EIS
|
|
$ |
620 |
|
|
$ |
371 |
|
|
$ |
1,602 |
|
|
$ |
1,082 |
|
|
EGS
|
|
|
236 |
|
|
|
180 |
|
|
|
694 |
|
|
|
636 |
|
|
Depreciation and amortization
|
|
$ |
856 |
|
|
$ |
551 |
|
|
$ |
2,296 |
|
|
$ |
1,718 |
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating income (loss)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
EIS
|
|
$ |
(997 |
) |
|
$ |
371 |
|
|
$ |
(284 |
) |
|
$ |
1,609 |
|
|
EGS
|
|
|
(172 |
) |
|
|
(246 |
) |
|
|
(63 |
) |
|
|
(233 |
) |
|
Operating income (loss)
|
|
$ |
(1,169 |
) |
|
$ |
125 |
|
|
$ |
(347 |
) |
|
$ |
1,376 |
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest and other expense
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
EIS
|
|
$ |
120 |
|
|
$ |
66 |
|
|
$ |
361 |
|
|
$ |
238 |
|
|
EGS
|
|
|
55 |
|
|
|
51 |
|
|
|
160 |
|
|
|
160 |
|
|
Interest and other expense
|
|
$ |
175 |
|
|
$ |
117 |
|
|
$ |
521 |
|
|
$ |
398 |
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income tax expense (benefit)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
EIS
|
|
$ |
(480 |
) |
|
$ |
138 |
|
|
$ |
(398 |
) |
|
$ |
573 |
|
|
EGS
|
|
|
(52 |
) |
|
|
(95 |
) |
|
|
43 |
|
|
|
(117 |
) |
|
Income tax expense (benefit)
|
|
$ |
(532 |
) |
|
$ |
43 |
|
|
$ |
(355 |
) |
|
$ |
456 |
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income (loss)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
EIS
|
|
$ |
(637 |
) |
|
$ |
167 |
|
|
$ |
(247 |
) |
|
$ |
798 |
|
|
EGS
|
|
|
(175 |
) |
|
|
(202 |
) |
|
|
(266 |
) |
|
|
(276 |
) |
|
Net income (loss)
|
|
$ |
(812 |
) |
|
$ |
(35 |
) |
|
$ |
(513 |
) |
|
$ |
522 |
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Capital expenditures
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
EIS
|
|
$ |
1,499 |
|
|
$ |
296 |
|
|
$ |
2,192 |
|
|
$ |
502 |
|
|
EGS
|
|
|
94 |
|
|
|
16 |
|
|
|
101 |
|
|
|
61 |
|
|
Capital expenditures
|
|
$ |
1,593 |
|
|
$ |
312 |
|
|
$ |
2,293 |
|
|
$ |
563 |
|
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
The following discussion and analysis should be read in conjunction with, and is qualified in its entirety by, the unaudited financial statements, including the notes thereto, appearing elsewhere in this Quarterly Report on Form 10-Q.
Cautionary Statement Regarding Forward-Looking Statements
You should carefully review the information contained in this Quarterly Report on Form 10-Q and in other reports or documents that we file from time to time with the Securities and Exchange Commission (the “SEC”). In addition to historical information, this Quarterly Report on Form 10-Q contains our beliefs regarding future events and our future financial performance. In some cases, you can identify those so-called “forward-looking statements” by words such as “may,” “will,” “should,” expects,” “plans,” “anticipates,” “believes,” “estimates,” “predicts,” “potential,” or “continue” or the negative of those words and other comparable words. You should be aware that those statements are only our predictions. Actual events or results may differ materially. We undertake no obligation to publicly release any revisions to forward-looking statements after the date of this report. In evaluating those statements, you should specifically consider various factors, including the risk factors discussed in our Annual Report on Form 10-K for the year ended August 31, 2010 and other reports or documents that we file from time to time with the SEC. All forward-looking statements attributable to us or a person acting on our behalf are expressly qualified in their entirety by this cautionary statement.
Assumptions relating to budgeting, marketing, and other management decisions are subjective in many respects and thus susceptible to interpretations and periodic revisions based on actual experience and business developments, the impact of which may cause us to alter our marketing, capital expenditure or other budgets, which may in turn affect our business, financial position, results of operations and cash flows.
Overview of Emtec
We are an IT services provider and we deliver consulting, application services, and infrastructure services to public sector and commercial clients. The Company’s client base is comprised of departments of the United States and Canada’s federal, state/provincial and local governments, schools, and commercial businesses throughout the United States and Canada.
Consolidated Statements of Operations for the Three Months Ended May 31, 2011 compared with the Three Months Ended May 31, 2010.
|
EMTEC, INC.
|
|
|
CONSOLIDATED STATEMENTS OF OPERATIONS
|
|
|
(In thousands)
|
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
Three Months Ended May 31,
|
|
|
|
|
|
|
|
| |
|
2011
|
|
|
2010
|
|
|
Change
|
|
|
%
|
|
|
Revenues
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Procurement services
|
|
$ |
24,652 |
|
|
$ |
39,536 |
|
|
$ |
(14,884 |
) |
|
|
(37.6 |
)% |
|
Service and consulting
|
|
|
20,207 |
|
|
|
13,970 |
|
|
|
6,237 |
|
|
|
44.6 |
% |
|
Total Revenues
|
|
|
44,859 |
|
|
|
53,506 |
|
|
|
(8,647 |
) |
|
|
(16.2 |
)% |
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cost of Sales
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cost of procurement services
|
|
|
21,980 |
|
|
|
35,140 |
|
|
|
(13,160 |
) |
|
|
(37.5 |
)% |
|
Cost of service and consulting
|
|
|
15,072 |
|
|
|
10,285 |
|
|
|
4,787 |
|
|
|
46.5 |
% |
|
Total Cost of Sales
|
|
|
37,052 |
|
|
|
45,425 |
|
|
|
(8,373 |
) |
|
|
(18.4 |
)% |
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gross Profit
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Procurement services
|
|
|
2,672 |
|
|
|
4,396 |
|
|
|
(1,724 |
) |
|
|
(39.2 |
)% |
|
Procurement services %
|
|
|
10.8 |
% |
|
|
11.1 |
% |
|
|
|
|
|
|
|
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Service and consulting
|
|
|
5,135 |
|
|
|
3,685 |
|
|
|
1,450 |
|
|
|
39.3 |
% |
|
Service and consulting %
|
|
|
25.4 |
% |
|
|
26.4 |
% |
|
|
|
|
|
|
|
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total Gross Profit
|
|
|
7,807 |
|
|
|
8,081 |
|
|
|
(274 |
) |
|
|
(3.4 |
)% |
|
Total Gross Profit %
|
|
|
17.4 |
% |
|
|
15.1 |
% |
|
|
|
|
|
|
|
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating expenses:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Selling, general, and administrative expenses
|
|
|
8,025 |
|
|
|
7,287 |
|
|
|
738 |
|
|
|
10.1 |
% |
|
Stock-based compensation
|
|
|
144 |
|
|
|
118 |
|
|
|
26 |
|
|
|
22.0 |
% |
|
Warrant liability adjustment
|
|
|
(49 |
) |
|
|
- |
|
|
|
(49 |
) |
|
|
N/A |
|
|
Depreciation and amortization
|
|
|
856 |
|
|
|
551 |
|
|
|
305 |
|
|
|
55.4 |
% |
|
Total operating expenses
|
|
|
8,976 |
|
|
|
7,956 |
|
|
|
1,020 |
|
|
|
12.8 |
% |
|
Percent of revenues
|
|
|
20.0 |
% |
|
|
14.9 |
% |
|
|
|
|
|
|
|
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating income (loss)
|
|
|
(1,169 |
) |
|
|
125 |
|
|
|
(1,294 |
) |
|
|
(1035.2 |
)% |
|
Percent of revenues
|
|
|
-2.6 |
% |
|
|
0.2 |
% |
|
|
|
|
|
|
|
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Other expense (income):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest income – other
|
|
|
(7 |
) |
|
|
(3 |
) |
|
|
(4 |
) |
|
|
(133.3 |
)% |
|
Interest expense
|
|
|
184 |
|
|
|
124 |
|
|
|
60 |
|
|
|
48.4 |
% |
|
Other
|
|
|
(2 |
) |
|
|
(4 |
) |
|
|
2 |
|
|
NM
|
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income (loss) before income tax expense (benefit)
|
|
|
(1,344 |
) |
|
|
8 |
|
|
|
(1,352 |
) |
|
|
(16900.0 |
)% |
|
Income tax expense (benefit)
|
|
|
(532 |
) |
|
|
43 |
|
|
|
(575 |
) |
|
|
(1337.2 |
)% |
|
Net loss
|
|
$ |
(812 |
) |
|
$ |
(35 |
) |
|
$ |
(777 |
) |
|
|
2220.0 |
% |
|
Percent of revenues
|
|
|
-1.8 |
% |
|
|
-0.1 |
% |
|
|
|
|
|
|
|
|
Selling, General and Administrative Expenses - EGS
EGS division’s selling, general and administrative expenses decreased $330,000, or 23.4%, to $1.1 million for the three months ended May 31, 2011, compared to $1.4 million for the three months ended May 31, 2010. Approximately $230,000 of the decrease is the result of a reduction in acquisition-related and retention bonuses paid. The balance of the decrease can be attributed to reductions in various expense categories including marketing expense, commission expense and salaries.
Depreciation and Amortization - EGS
EGS division’s depreciation and amortization expense increased $56,000, or 31.1.0%, to $236,000 for the three months ended May 31, 2011, compared to $180,000 for the three months ended May 31, 2010.
Operating loss -EGS
Operating loss for our EGS division for the three months ended May 31, 2011 was $171,000, compared to operating loss of $246,000 for the three months ended May 31, 2010. The reduction in the operating loss is the result of the decreases described in the Gross Profit and Selling, General and Administrative sections above.
Interest expense -EGS
Interest expense for our EGS division for the three months ended May 31, 2011 increased by 5.6%, or $3,000, to $57,000, compared to interest expense of $54,000 for the three months ended May 31, 2010.
Benefit for income taxes -EGS
We recorded an income tax benefit of $52,000 for the three months ended May 31, 2011, compared to income tax benefit of $95,000 for the three months ended May 31, 2010. The effective tax benefit rate was 23.0% for the three months ended May 31, 2011, compared to tax benefit rate of 32.0% for the three months ended May 31, 2010. The lower effective tax benefit for the three months ended May 31, 2011 is the result of the Company’s tax loss for the period reducing tax expense in unitary tax states that EGS has a filing requirement.
Consolidated Statements of Income for the Nine Months Ended May 31, 2011 compared with the Nine Months Ended May 31, 2010.
|
EMTEC, INC.
|
|
CONSOLIDATED STATEMENTS OF OPERATIONS
|
|
(In thousands)
|
| |
| |
|
Nine Months Ended May 31,
|
|
|
|
|
|
|
|
| |
|
2011
|
|
|
2010
|
|
|
Change
|
|
|
%
|
|
|
Revenues
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Procurement services
|
|
$ |
113,389 |
|
|
$ |
122,193 |
|
|
$ |
(8,804 |
) |
|
|
(7.2 |
)% |
|
Service and consulting
|
|
|
54,469 |
|
|
|
40,994 |
|
|
|
13,475 |
|
|
|
32.9 |
% |
|
Total Revenues
|
|
|
167,858 |
|
|
|
163,187 |
|
|
|
4,671 |
|
|
|
2.9 |
% |
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cost of Sales
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cost of procurement services
|
|
|
101,742 |
|
|
|
109,348 |
|
|
|
(7,606 |
) |
|
|
(7.0 |
)% |
|
Service and consulting
|
|
|
40,013 |
|
|
|
29,310 |
|
|
|
10,703 |
|
|
|
36.5 |
% |
|
Total Cost of Sales
|
|
|
141,755 |
|
|
|
138,658 |
|
|
|
3,097 |
|
|
|
2.2 |
% |
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gross Profit
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Procurement services
|
|
|
11,647 |
|
|
|
12,845 |
|
|
|
(1,198 |
) |
|
|
(9.3 |
)% |
|
Procurement services %
|
|
|
10.3 |
% |
|
|
10.5 |
% |
|
|
|
|
|
|
|
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Service and consulting
|
|
|
14,456 |
|
|
|
11,684 |
|
|
|
2,772 |
|
|
|
23.7 |
% |
|
Service and consulting %
|
|
|
26.5 |
% |
|
|
28.5 |
% |
|
|
|
|
|
|
|
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total Gross Profit
|
|
|
26,103 |
|
|
|
24,529 |
|
|
|
1,574 |
|
|
|
6.4 |
% |
|
Total Gross Profit %
|
|
|
15.6 |
% |
|
|
15.0 |
% |
|
|
|
|
|
|
|
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating expenses:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Selling, general, and administrative expenses
|
|
|
24,195 |
|
|
|
21,043 |
|
|
|
3,152 |
|
|
|
15.0 |
% |
|
Stock-based compensation
|
|
|
437 |
|
|
|
392 |
|
|
|
45 |
|
|
|
11.4 |
% |
|
Warrant liability adjustment
|
|
|
(478 |
) |
|
|
- |
|
|
|
(478 |
) |
|
|
N/A |
|
|
Depreciation and amortization
|
|
|
2,296 |
|
|
|
1,718 |
|
|
|
578 |
|
|
|
33.6 |
% |
|
Total operating expenses
|
|
|
26,450 |
|
|
|
23,153 |
|
|
|
3,297 |
|
|
|
14.2 |
% |
|
Percent of revenues
|
|
|
15.8 |
% |
|
|
14.2 |
% |
|
|
|
|
|
|
|
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating income (loss)
|
|
|
(347 |
) |
|
|
1,376 |
|
|
|
(1,723 |
) |
|
|
(125.2 |
)% |
|
Percent of revenues
|
|
|
-0.2 |
% |
|
|
0.8 |
% |
|
|
|
|
|
|
|
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Other expense (income):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest income – other
|
|
|
(14 |
) |
|
|
(18 |
) |
|
|
4 |
|
|
|
(22.2 |
)% |
|
Interest expense
|
|
|
521 |
|
|
|
428 |
|
|
|
93 |
|
|
|
21.7 |
% |
|
Other
|
|
|
14 |
|
|
|
(12 |
) |
|
|
26 |
|
|
|
(216.7 |
)% |
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income (loss) before income tax expense (benefit)
|
|
|
(868 |
) |
|
|
978 |
|
|
|
(1,846 |
) |
|
|
(188.8 |
)% |
|
Income tax expense (benefit)
|
|
|
(355 |
) |
|
|
456 |
|
|
|
(811 |
) |
|
|
(177.9 |
)% |
|
Net income (loss)
|
|
$ |
(513 |
) |
|
$ |
522 |
|
|
$ |
(1,035 |
) |
|
|
(198.3 |
)% |
|
Percent of revenues
|
|
|
-0.3 |
% |
|
|
0.3 |
% |
|
|
|
|
|
|
|
|
Results of Operations -EIS
The following discussion and analysis provides information that management believes is relevant to an assessment and understanding of our EIS Results of Operations for the nine months ended May 31, 2011 and 2010.
|
EIS
|
|
|
STATEMENTS OF OPERATIONS
|
|
|
(In thousands)
|
|
| |
|
| |
|
Nine Months Ended May 31,
|
|
|
|
|
|
|
|
| |
|
2011
|
|
|
2010
|
|
|
Change
|
|
|
%
|
|
|
Revenues
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Procurement services
|
|
$ |
113,389 |
|
|
$ |
122,193 |
|
|
$ |
(8,804 |
) |
|
|
(7.2 |
)% |
|
Service and consulting
|
|
|
32,258 |
|
|
|
18,607 |
|
|
|
13,651 |
|
|
|
73.4 |
% |
|
Total Revenues
|
|
|
145,647 |
|
|
|
140,800 |
|
|
|
4,847 |
|
|
|
3.4 |
% |
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cost of Sales
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cost of procurement services
|
|
|
101,742 |
|
|
|
109,348 |
|
|
|
(7,606 |
) |
|
|
(7.0 |
)% |
|
Service and consulting
|
|
|
21,585 |
|
|
|
10,833 |
|
|
|
10,752 |
|
|
|
99.3 |
% |
|
Total Cost of Sales
|
|
|
123,327 |
|
|
|
120,181 |
|
|
|
3,146 |
|
|
|
2.6 |
% |
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gross Profit
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Procurement services
|
|
|
11,647 |
|
|
|
12,845 |
|
|
|
(1,198 |
) |
|
|
(9.3 |
)% |
|
Procurement services %
|
|
|
10.3 |
% |
|
|
10.5 |
% |
|
|
|
|
|
|
|
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Service and consulting
|
|
|
10,673 |
|
|
|
7,774 |
|
|
|
2,899 |
|
|
|
37.3 |
% |
|
Service and consulting %
|
|
|
33.1 |
% |
|
|
41.8 |
% |
|
|
|
|
|
|
|
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total Gross Profit
|
|
|
22,320 |
|
|
|
20,619 |
|
|
|
1,701 |
|
|
|
8.2 |
% |
|
Total Gross Profit %
|
|
|
15.3 |
% |
|
|
14.6 |
% |
|
|
|
|
|
|
|
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating expenses:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Selling, general, and administrative expenses
|
|
|
21,043 |
|
|
|
17,536 |
|
|
|
3,507 |
|
|
|
20.0 |
% |
|
Stock-based compensation
|
|
|
437 |
|
|
|
392 |
|
|
|
45 |
|
|
|
11.5 |
% |
|
Warrant liability adjustment
|
|
|
(478 |
) |
|
|
- |
|
|
|
(478 |
) |
|
|
N/A |
|
|
Depreciation and amortization
|
|
|
1,602 |
|
|
|
1,082 |
|
|
|
520 |
|
|
|
48.1 |
% |
|
Total operating expenses
|
|
|
22,604 |
|
|
|
19,010 |
|
|
|
3,594 |
|
|
|
18.9 |
% |
|
Percent of revenues
|
|
|
15.5 |
% |
|
|
13.5 |
% |
|
|
|
|
|
|
|
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating income (loss)
|
|
|
(284 |
) |
|
|
1,609 |
|
|
|
(1,893 |
) |
|
|
(117.7 |
)% |
|
Percent of revenues
|
|
|
(0.2 |
)% |
|
|
1.1 |
% |
|
|
|
|
|
|
|
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Other expense (income):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest income – other
|
|
|
(13 |
) |
|
|
(18 |
) |
|
|
5 |
|
|
|
(27.8 |
)% |
|
Interest expense
|
|
|
358 |
|
|
|
261 |
|
|
|
97 |
|
|
|
37.2 |
% |
|
Other
|
|
|
16 |
|
|
|
(5 |
) |
|
|
21 |
|
|
|
(420.0 |
)% |
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income (loss) before income tax expense (benefit)
|
|
|
(645 |
) |
|
|
1,371 |
|
|
|
(2,016 |
) |
|
|
(147.0 |
)% |
|
Income tax expense (benefit)
|
|
|
(398 |
) |
|
|
573 |
|
|
|
(971 |
) |
|
|
(169.5 |
)% |
|
Net income (loss)
|
|
$ |
(247 |
) |
|
$ |
798 |
|
|
$ |
(1,045 |
) |
|
|
(131.0 |
)% |
|
Percent of revenues
|
|
|
(0.2 |
)% |
|
|
0.6 |
% |
|
|
|
|
|
|
|
|
Comparison of the Nine months Ended May 31, 2011 and 2010 - EIS
Revenues - EIS
EIS division’s total revenues increased $4.9 million, or 3.4%, to $145.6 million for the nine months ended May 31, 2011, compared to $140.8 million for the nine months ended May 31, 2010. Without the impact of the recent acquisitions of SDI, Dinero and Covelix, total 2011 revenues for the nine months ended May 31, 2011 would have decreased by $7.1 million to $138.5 million.
Procurement services revenue decreased $8.8 million, or 7.2%, to $113.4 million for the nine months ended May 31, 2011, compared to $122.2 million for the nine months ended May 31, 2010. This decrease was related to a reduction in spending by U.S. governmental agencies. See Item 1A-Risk Factors.
Service and consulting revenue increased $13.7 million, or 73.4%, to $32.3 million for the nine months ended May 31, 2011, compared to $18.6 million for the nine months ended May 31, 2010. This increase is mainly attributable to recent acquisitions and organic growth of service and consulting revenue.
Our EIS division’s revenues, by client type, are comprised of the following (in thousands):
| |
|
For the Nine Months Ended
|
|
| |
|
May 31, 2011
|
|
|
May 31, 2010
|
|
|
Departments of the U.S. Government
|
|
$ |
72,124 |
|
|
|
49.6 |
% |
|
$ |
79,373 |
|
|
|
56.4 |
% |
|
Canadian Government Agencies
|
|
|
2,300 |
|
|
|
1.6 |
% |
|
|
1,480 |
|
|
|
1.1 |
% |
|
State and Local Governments
|
|
|
4,720 |
|
|
|
3.2 |
% |
|
|
3,162 |
|
|
|
2.2 |
% |
|
Commercial Companies
|
|
|
18,711 |
|
|
|
12.8 |
% |
|
|
16,075 |
|
|
|
11.4 |
% |
|
Education and other
|
|
|
47,792 |
|
|
|
32.8 |
% |
|
|
40,710 |
|
|
|
28.9 |
% |
|
Total Revenues
|
|
$ |
145,647 |
|
|
|
100.0 |
% |
|
$ |
140,800 |
|
|
|
100.0 |
% |
During the quarter ended May 31, 2011 and 2010, U.S. governmental department- and agency-related revenues represented approximately 49.6% and 56.4% of total EIS revenues, respectively. These clients include the Department of Defense, Department of Justice, Department of Homeland Security, Department of Health and Human Services, Department of Agriculture and Department of Commerce. Revenues from various civilian and military U.S. governmental departments and agencies decreased by approximately $7.2 million, or 9.1%, to $72.1 million during the nine months ended May 31, 2011 compared to $79.4 million for the nine months ended May 31, 2010.
Revenues from state and local governments increased $1.6 million or 49.3% to $4.7 million for the nine months ended May 31, 2011. However, the state and local government business remains uncertain due to the tight budgetary pressures within governmental agencies, primarily in the State of New Jersey. Until tax revenues increase in state and local governments, we do not anticipate a significant amount of growth from these clients.
Revenues from commercial clients increased $2.6 million for the nine months ended May 31, 2011, from $16.1 million to $18.7 million. We have made investments to reposition our sales force to sell more services, long-term projects and managed services to our commercial clients. We expect to see continued growth in the commercial sector as the economy continues its recovery and we are able to offer our clients a wider range of services.
During the nine months ended May 31, 2011, revenues from our education business increased by approximately $7.1 million compared with the nine months ended May 31, 2010. This increase is attributable primarily to timing of various projects in the school districts we serve.
Gross profit – EIS
Aggregate gross profit for our EIS division increased $1.7 million, or 8.2%, to $22.3 million for the nine months ended May 31, 2011, compared to $20.6 million for the nine months ended May 31, 2010. This increase is primarily related to an increase in our higher margin service and consulting revenues as well as our recent acquisitions that primarily generated service and consulting revenue.
Measured as a percentage of revenues, our gross profit margin for our EIS division increased to 15.3% of our EIS division’s revenues for the nine months ended May 31, 2011 from 14.6% for the nine months ended May 31, 2010.
Selling, general and administrative expenses - EIS
Corporate expenses are primarily recorded in our EIS segment. Selling, general and administrative expenses for our EIS division increased by $3.5 million, or 20.0% to $21.0 million for the nine months ended May 31, 2011, compared to $17.5 million for the nine months ended May 31, 2010.
If the recent acquisitions were excluded from selling, general and administrative expenses for the nine months ended May 31, 2011, the increase in selling, general and administrative expenses for the period would have been $1.7 million. The balance of the increase is related to investments in sales personnel and sales managers to expand our Federal, Education and Commercial revenue, merger and acquisition expenses associated with recent acquisitions completed in February and March 2011 and increased management information systems costs in conjunction with improving our IT systems to manage a larger IT services business. Management has continued to invest in infrastructure and resources to build a much larger IT Services platform.
Stock-based compensation
Stock-based compensation for our EIS division increased by $45,000, or 11.5% to $437,000 for the nine months ended May 31, 2011, compared to $392,000 for the nine months ended May 31, 2010.
Warrant liability adjustment
Warrant liability adjustment for our EIS division was $(478,000) for the nine months ended May 31, 2011, compared to $-0- for the nine months ended May 31, 2010. This adjustment relates to the stock warrants issued to our majority stockholder in August 2010. This warrant will continue to be “marked-to-market” each reporting period, which could result in large fluctuations in income or expense on the statement of operations in future periods related to this non-cash charge.
Depreciation and amortization - EIS
Depreciation and amortization expense for our EIS division increased by 48.1%, or $520,000, to $1.6 million for the nine months ended May 31, 2011, compared to $1.1 million for the nine months ended May 31, 2010. The increase for the nine months ended May 31, 2011 is primarily attributable to the amortization of intangible assets in connection with the acquisitions of SDI, Dinero and Covelix.
Operating income (loss) - EIS
The EIS division experienced an operating loss of $284,000 for the nine months ended May 31, 2011, compared to an operating income of $1.6 million for the nine months ended May 31, 2010. This operating loss for the nine months ended May 31, 2011 is mainly attributable to an increase in overall operating expenses as discussed in the “Selling, general and administrative expenses - EIS” section above that was partially offset by revenue and gross profit increases as discussed in the “Revenue – EIS” and “Gross profit – EIS” sections above.
Interest expense - EIS
Interest expense for the EIS division increased by 37.2%, or $97,000, to $358,000 for the nine months ended May 31, 2011, compared to $261,000 for the nine months ended May 31, 2010. This increase is primarily attributable to higher balances on the Credit Facility.
Income tax expense (benefit) - EIS
We recorded an income tax benefit of $398,000 for the nine months ended May 31, 2011, compared to an income tax expense of $573,000 for the nine months ended May 31, 2010. The effective benefit rate was 61.8% for the nine months ended May 31, 2011, compared to an effective tax rate of 41.8% for the nine months ended May 31, 2010. The higher effective benefit rate in the nine months ended May 31, 2011 was primarily the result of the warrant liability adjustment that was partially offset by other permanent differences.
Results of Operations –EGS
The following discussion and analysis provides information that management believes is relevant to an assessment and understanding of our EGS Results of Operations for the nine months ended May 31, 2011 and 2010.
|
EGS
|
|
|
STATEMENTS OF OPERATIONS
|
|
|
(In thousands)
|
|
| |
|
| |
|
Nine Months Ended May 31,
|
|
|
|
|
|
|
|
| |
|
2011
|
|
|
2010
|
|
|
Change
|
|
|
%
|
|
|
Revenues
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Service and consulting
|
|
$ |
22,211 |
|
|
$ |
22,387 |
|
|
$ |
(176 |
) |
|
|
(0.8 |
)% |
|
Total Revenues
|
|
|
22,211 |
|
|
|
22,387 |
|
|
|
(176 |
) |
|
|
(0.8 |
)% |
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cost of Sales
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cost of service and consulting
|
|
|
18,428 |
|
|
|
18,477 |
|
|
|
(49 |
) |
|
|
(0.3 |
)% |
|
Total Cost of Sales
|
|
|
18,428 |
|
|
|
18,477 |
|
|
|
(49 |
) |
|
|
(0.3 |
)% |
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gross Profit
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Service and consulting
|
|
|
3,783 |
|
|
|
3,910 |
|
|
|
(127 |
) |
|
|
(3.2 |
)% |
|
Service and consulting %
|
|
|
17.0 |
% |
|
|
17.5 |
% |
|
|
|
|
|
|
|
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total Gross Profit
|
|
|
3,783 |
|
|
|
3,910 |
|
|
|
(127 |
) |
|
|
(3.2 |
)% |
|
Total Gross Profit %
|
|
|
17.0 |
% |
|
|
17.5 |
% |
|
|
|
|
|
|
|
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating expenses:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Selling, general, and administrative expenses
|
|
|
3,152 |
|
|
|
3,507 |
|
|
|
(355 |
) |
|
|
(10.1 |
)% |
|
Depreciation and amortization
|
|
|
694 |
|
|
|
636 |
|
|
|
58 |
|
|
|
9.1 |
% |
|
Total operating expenses
|
|
|
3,846 |
|
|
|
4,143 |
|
|
|
(297 |
) |
|
|
(7.2 |
)% |
|
Percent of revenues
|
|
|
17.3 |
% |
|
|
18.5 |
% |
|
|
|
|
|
|
|
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating loss
|
|
|
(63 |
) |
|
|
(233 |
) |
|
|
170 |
|
|
|
(73.0 |
)% |
|
Percent of revenues
|
|
|
(0.3 |
)% |
|
|
(-1.0 |
)% |
|
|
|
|
|
|
|
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Other expense (income):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest income – other
|
|
|
(1 |
) |
|
|
- |
|
|
|
(1 |
) |
|
|
N/A |
|
|
Interest expense
|
|
|
163 |
|
|
|
167 |
|
|
|
(4 |
) |
|
|
(2.4 |
)% |
|
Other
|
|
|
(2 |
) |
|
|
(7 |
) |
|
|
5 |
|
|
|
(71.4 |
)% |
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Loss before income tax expense (benefit)
|
|
|
(223 |
) |
|
|
(393 |
) |
|
|
170 |
|
|
|
(43.3 |
)% |
|
Income tax expense (benefit)
|
|
|
43 |
|
|
|
(117 |
) |
|
|
160 |
|
|
|
(136.8 |
)% |
|
Net loss
|
|
$ |
(266 |
) |
|
$ |
(276 |
) |
|
$ |
10 |
|
|
|
(3.6 |
)% |
|
Percent of revenues
|
|
|
(1.2 |
)% |
|
|
(1.2 |
)% |
|
|
|
|
|
|
|
|
Comparison of the Nine Months Ended May 31, 2011 and 2010 - EGS
Revenues - EGS
EGS revenue consists of its ERP and Application Development practice and its Business Analysis and Quality Assurance practice. EGS division’s total revenues decreased $176,000, or 0.8%, to $22.2 million for the nine months ended May 31, 2011, compared to $22.4 million for the nine months ended May 31, 2010. This decrease was caused by a 0.4% decrease in hours billed and a 0.1% decrease in the average hourly billing rate during the nine months ended May 31, 2011 compared with the corresponding period in 2010. The decrease in billable hours and rate is mainly due to decreases in our Business Analysis and Quality Assurance practices. Most of the clients EGS serves are commercial clients and we believe that this decrease in commercial business is primarily attributed to the current general economic downturn.
Gross Profit - EGS
EGS division’s gross profit decreased $127,000, or 3.2%, to $3.8 million for the nine months ended May 31, 2011, compared to $3.9 million for the nine months ended May 31, 2010.
Measured as percentages of revenues, our gross profit margin for the EGS division decreased to 17.0% for the nine months ended May 31, 2011 from 17.5% for the nine months ended May 31, 2010. We believe this decrease is mainly due to the decreased billing rate per hour that resulted from pricing pressure from our commercial clients.
Selling, General and Administrative Expenses - EGS
EGS division’s selling, general and administrative expenses decreased 355,000, or 10.1%, to $3.2 million, for the nine months ended May 31, 2011, compared to $3.5 million for the nine months ended May 31, 2010. Approximately $230,000 of the decrease is the result of a reduction in acquisition-related and retention bonuses paid. The balance of the decrease can be attributed to reductions in various expense categories including marketing expense, commission expense and salaries.
Depreciation and Amortization - EGS
EGS division’s depreciation and amortization expense increased $58,000, or 9.1%, to $694,000 for the nine months ended May 31, 2011, compared to $636,000 for the nine months ended May 31, 2010.
Operating loss -EGS
Operating loss for our EGS division for the nine months ended May 31, 2011 was $63,000 compared to operating loss of $233,000 for the nine months ended May 31, 2010. The reduction in the operating loss is the result of the decreases described in the Gross Profit and Selling, General and Administrative sections above.
Interest expense -EGS
Interest expense for our EGS division for the nine months ended May 31, 2011 decreased by 2.4%, or $4,000, to $163,000, compared to interest expense of $167,000 for the nine months ended May 31, 2010.
Provision (benefit) for income taxes -EGS
We recorded an income tax expense of $43,000 for the nine months ended May 31, 2011, compared to income tax benefit of $117,000 for the nine months ended May 31, 2010. The effective tax benefit rate was 19.3% for the nine months ended May 31, 2011, compared to tax benefit rate of 29.7% for the nine months ended May 31, 2010.
Recently Issued Accounting Standards
Revenue Recognition
In October 2009, the FASB issued Accounting Standards Update (“ASU”) 2009-13, “Revenue Recognition (Topic 605):Multiple Deliverable Revenue Arrangements,” which amends ASC Topic 605 “Revenue Recognition,” to permit companies to allocate revenue in multiple-element arrangements based on an element’s estimated selling price if vendor-specific or other third-party evidence of value is not available. ASU 2009-13 was effective prospectively for revenue arrangements entered into or materially modified in fiscal years beginning on or after June 15, 2010. The adoption of this ASU has not had a material impact on the Company’s financial position, results of operation or cash flows.
Accounts Receivable
In July 2010, the FASB issued ASU 2010-20, “Disclosures about the Credit Quality of Financing Receivables and the Allowance for Credit Losses.” ASU 2010-20 requires more robust and disaggregated disclosures about the credit quality of financing receivables and allowances for credit losses, including disclosure about credit quality indicators, past due information and modifications of finance receivables. The disclosures as of the end of a reporting period are effective for interim and annual reporting periods ending on and after December 15, 2010. The disclosures about activity that occurs during a reporting period was effective for interim and annual reporting periods beginning on or after December 15, 2010. The adoption of this ASU has not had a material impact on the Company’s financial position, results of operation or cash flows.
Intangibles – Goodwill and Other
In December 2010, the FASB issued ASU 2010-28, “Goodwill and Other (Topic 350): When to Perform Step 2 of the Goodwill Impairment Test for Reporting Units with Zero or Negative Carrying Amounts.” ASU 2010-28 modifies Step 1 of the goodwill impairment test for reporting units with zero or negative carrying amounts. For those reporting units, an entity is required to perform Step 2 of the goodwill impairment test if it is more likely than not that a goodwill impairment exists. In determining whether it is more likely than not that a goodwill impairment exists, an entity must consider whether there are any adverse qualitative factors indicating an impairment may exist. ASU 2010-28 is effective for fiscal years, and interim periods within those years, beginning December 15, 2010. The adoption of this ASU has not had a material impact on the Company’s financial position, results of operation or cash flows.
Business Combinations
In December 2010, the FASB issued ASU 2010-29, “Business Combinations (Topic 805): Disclosure of Supplementary Pro Forma Information for Business Combinations.” ASU 2010-29 requires that if a public entity presents comparative financial statements, the entity should disclose revenue and earnings of the combined entity as though the business combination(s) that occurred during the current year had occurred as of the beginning of the comparable prior annual reporting period only. This ASU also expands the supplemental pro forma adjustments to include a description of the nature and amount of material, nonrecurring pro forma adjustments directly attributable to the business combination included in the reported pro forma revenue and earnings. ASU 2010-29 is effective prospectively for business combinations for which the acquisition date is on or after the first annual reporting period beginning on or after December 15, 2010. The adoption of this ASU is not expected to have a material impact on the Company’s financial position, results of operations or cash flows. The adoption of this guidance may expand the existing disclosure requirements, which the Company is currently evaluating.
Comprehensive Income
In June 2011, the FASB issued ASU 2011-05, “Comprehensive Income (Topic 220): Presentation of Comprehensive Income.” ASU 2011-05 states that an entity has the option to present the total of comprehensive income, the components of net income, and the components of other comprehensive income either in a single continuous statement of comprehensive income or in two separate but consecutive statements. In both choices, an entity is required to present each component of net income along with total net income, each component of other comprehensive income along with a total for other comprehensive income, and a total amount for comprehensive income. This ASU eliminates the option to present the components of other comprehensive income as part of the statement of changes in stockholders' equity. ASU 2011-05 is effective retrospectively and is effective for fiscal years, and interim periods with those years, beginning after December 15, 2011. The adoption of this ASU is not expected to have a material impact on the Company’s financial position, results of operations or cash flows. The adoption of this guidance may expand the existing disclosure requirements, which the Company is currently evaluating.
Liquidity and Capital Resources
Cash at May 31, 2011 of $2.9 million represented an increase of approximately $500,000 from cash of $2.4 million at August 31, 2010. We are a net borrower; consequently, we believe our cash balance must be viewed along with the available balance on our line of credit. Net availability per our Lender was $1.3 million and $6.8 million under the revolving portion of the Credit Facility as of May 31, 2011 and August 31, 2010, respectively. Borrowings under our line of credit at May 31, 2011 decreased to $14.5 million from $16.0 million at August 31, 2010.
The decline in the Federal market has negatively affected our operations. While management believes that the decline is temporary and spending in the Federal market is increasing, the Company has taken steps to adjust for a long term reduction in government spending. These steps include a reduction in spending on under-utilized assets, planned cost reductions and seeking alternative sources of liquidity for the Company. See Item 1A-Risk Factors.
The Company, Emtec NJ, Emtec LLC, Emtec Federal, EGS LLC, Luceo, eBAS, Aveeva EIS-US, KOAN-IT US, SDI, Dinero and Covelix (collectively, the “Borrower”), have a Loan and Security Agreement with De Lage Landen Financial Services, Inc. (the “Lender”) pursuant to which the Lender provides the Borrower with a revolving credit loan and floor plan loan (the “Credit Facility”). The Credit Facility provides for aggregate borrowings of the lesser of $32.0 million or 85% of Borrower’s eligible accounts receivable, plus 100% of unsold inventory financed by the Lender and 40% of all other unsold inventory. The floor plan loan portion of the Credit Facility is for the purchase of inventory from approved vendors and for other business purposes. The Credit Facility subjects the Borrower to mandatory repayments upon the occurrence of certain events as set forth in the Credit Facility.
On December 5, 2008, the Borrower entered into a First Amendment and Joinder to Loan and Security Agreement and Schedule to Loan and Security Agreement (the “First Amendment”) with the Lender, pursuant to which the Lender extended the term of the loans issued to the Borrower under the Loan and Security Agreement from December 7, 2008 until December 7, 2010 and made certain other amendments to the Loan and Security Agreement, including the following:
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The First Amendment changed the interest rate for revolving credit loans to the base rate plus 3.25% from the previous interest rate for revolving credit loans which was the base rate minus 0.5%, and changed the interest rate for floorplan loans, if applicable, to 6.25% in excess of the base rate from the previous interest rate for floorplan loans of 2.5% in excess of the base rate.
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The First Amendment amended the Schedule to Loan and Security Agreement to provide that the Borrower must pay the Lender a floorplan annual volume commitment fee if the aggregate amount of all floorplan loans does not equal or exceed $60.0 million in a 12-month period from December 1st through November 30th. The floorplan commitment fee is equal to the amount that the floorplan usage during such 12-month period is less than $60.0 million multiplied by 1%. If the Borrower terminates the Credit Facility during a 12-month period, the Borrower shall be required to pay the Lender a prorated portion of the annual volume commitment fee.
On December 7, 2010, the Borrower entered into a Second Amendment and Joinder to Loan and Security Agreement and Schedule to Loan and Security Agreement (the “Second Amendment”) with the Lender, pursuant to which the Lender has agreed to extend the term of the Credit Facility from December 7, 2010 until December 7, 2012 and to make certain other amendments to the Credit Facility, including the following:
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The Second Amendment changed the total facility amount by temporarily increasing it to $40.6 million. This amendment was effective until January 31, 2011, at which time the total facility amount returned to its previous level of $32.0 million.
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Changing the Positive Net Income covenant to add back to Net Income certain non-cash charges;
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Providing that Borrower shall maintain a ratio of EBITDA to Interest Paid (as such terms are defined in the Credit Facility) of 3.50 to 1.00 as of the end of each fiscal quarter measured on a trailing twelve month basis; and
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Changing the Capital Expense covenant to increase the limitation on capital expenditures to $2,750,000 in any rolling four fiscal quarter period and to provide that business acquisition costs are not considered capital expenditures for this purpose.
In addition, by executing the Second Amendment, EIS-US, KOAN-IT US and SDI each joined the Credit Documents as a Borrower and granted the Lender a security interest in all of their respective assets, including inventory, equipment, fixtures, accounts, chattel paper, instruments, deposit accounts, documents, general intangibles, letter of credits rights, and all judgments, claims and insurance policies. EIS-US pledged 100% of the outstanding shares of its domestic subsidiary, KOAN-IT US, and 65% of the outstanding shares of the Company's Canadian subsidiary, Emtec Infrastructure Services Canada Corporation. Emtec Federal, Inc. pledged 100% of the outstanding shares of its domestic subsidiary, SDI, and the Company pledged 100% of the outstanding shares of its domestic subsidiary, EIS-US.
For detailed information on terms of the Credit Facility, refer to Note 6 – Line of Credit, of the Consolidated Financial Statements in this Quarterly Report on the Form 10-Q for the three months ended May 31, 2011, or the annual financial statements and notes thereto included in the Company’s Annual Report on Form 10-K for the fiscal year ended August 31, 2010.
On March 11, 2011, the Borrower entered into a Third Amendment and Joinder to Loan and Security Agreement and Schedule to Loan and Security Agreement (the “Third Amendment”) with the Lender, pursuant to which Dinero and Covelix each joined the Credit Documents as a Borrower and granted the Lender a security interest in all of their respective assets, including inventory, equipment, fixtures, accounts, chattel paper, instruments, deposit accounts, documents, general intangibles, letter of credits rights, and all judgments, claims and insurance policies.
On June 23, 2011, EIS-Canada and De Lage Landen Financial Services Canada Inc. (the “Canadian Lender”) entered into a Loan Agreement (the “Canadian Loan Agreement”) and Schedule to Loan Agreement (the “Canadian Schedule,” together with the Canadian Loan Agreement, the “Canadian Credit Documents”) pursuant to which the Canadian Lender has agreed to provide EIS-Canada with a revolving credit line of $5 million (Canadian dollars) (the “Canadian Credit Facility”). The Canadian Credit Facility is subject to certain mandatory repayments upon the occurrence of certain events as set forth in the Canadian Credit Documents.
Borrowings under the Canadian Credit Facility will bear interest at an annual rate equal to the rate of interest announced by The Toronto-Dominion Bank as the Canadian prime rate plus 1.75% for revolving credit loans.
To secure the payment of the obligations under the Canadian Credit Facility, EIS-Canada entered into a General Security Agreement, dated June 23, 2011, with the Canadian Lender (the “Canadian Security Agreement”), pursuant to which EIS-Canada granted to the Canadian Lender a security interest in all of EIS-Canada’s interests in certain of its undertakings, personal property and real property.
The Canadian Credit Documents contain certain customary covenants, including among other things:
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Restrictive covenants including limitations on other indebtedness, liens, fundamental changes, asset sales, capital expenditures, the issuance of capital stock, investments, and transactions with affiliates.
The Canadian Credit Documents contain certain customary representations and warranties and events of default, including failure to pay interest, principal or fees, any material inaccuracy of any representation and warranty, bankruptcy and insolvency events. Certain of the events of default are subject to exceptions and materiality qualifiers.
On June 23, 2011, the Borrower entered into a Fourth Amendment to Loan and Security Agreement and Schedule to Loan and Security Agreement (the “Fourth Amendment”) with the Lender, pursuant to which the Lender has agreed to make certain amendments to the Loan and Security Agreement and the Schedules to the Loan and Security Agreement including (1) recognizing the Canadian Credit Facility and acknowledging the Borrowers’ agreement to guarantee EIS-Canada’s obligations under that facility and (2) amending the total facility amount under the Credit Documents to provide that the total facility plus the aggregate amount outstanding under the Canadian Credit Facility shall not exceed $32,000,000 (US dollars).
The Company had balances of $14.5 million and $16.0 million outstanding under the revolving portion of the Credit Facility, and balances of $974,000 and $3.4 million (included in the Company’s accounts payable) outstanding plus $723,000 and $723,000 in open approvals under the floor plan portion of the Credit Facility at May 31, 2011 and August 31, 2010, respectively.
As of May 31, 2011, the Company determined that it was in compliance with its financial covenants under the Facility.
As of May 31, 2011, we had open term credit facilities with our primary trade vendors, including aggregators and manufacturers, of approximately $20.9 million with outstanding principal of approximately $11.2 million. Under these lines, we are typically obligated to pay each invoice within 30-45 days from the date of such invoice. These credit lines could be reduced or eliminated without notice and this action could have a material adverse affect on our business, result of operations and financial condition.
Capital expenditures of approximately $2.3 million during the nine months ended May 31, 2011 related primarily to the purchase of computer equipment for internal use and furniture and fixtures and an increased investment in IT infrastructure.
In January 2011, we entered into a capital lease for computer equipment and related software with a value of $468,000. The term of the lease is for 36 months and the monthly lease payment is $14,000.
We anticipate that our primary sources of liquidity in fiscal year 2011 will be cash generated from operations, trade vendor credit and cash available to us under our Credit Facility. Our future financial performance will depend on our ability to continue to reduce and manage operating expenses as well as our ability to grow revenues. Any loss of clients, whether due to economic factors, price competition or technological advances, will have an adverse affect on our revenues. Our future financial performance could be negatively affected by unforeseen factors and unplanned expenses.
We believe that funds generated from current operations, trade vendor credit and bank borrowings should be sufficient to meet our current operating cash requirements through the next twelve months. However, there can be no assurance that all of the aforementioned sources of cash can be realized.
Critical Accounting Policies
Our financial statements are prepared in accordance with accounting principles that are generally accepted in the United States. The methods, estimates, and judgments we use in applying our most critical accounting policies have a significant impact on the results we report in our financial statements. The SEC has defined critical accounting policies as policies that involve critical accounting estimates that require (i) management to make assumptions that are highly uncertain at the time the estimate is made, and (ii) different estimates that could have been reasonably used for the current period, or changes in the estimates that are reasonably likely to occur from period to period, which would have a material impact on the presentation of our financial condition, changes in financial condition or in result of operations. Based on this definition, our most critical policies include revenue recognition, allowance for doubtful accounts, inventory valuation reserve, the assessment of recoverability of long-lived assets, the assessment of recoverability of goodwill and intangible assets, rebates and income taxes.
Revenue Recognition
We are an IT Services provider delivering consulting, staffing, application services and infrastructure solutions to commercial, federal, education, state and local government clients. Our specific practices include IT consulting, communications, data management, enterprise computing, managed services, business service management solutions, training, storage and data center planning and development and staff augmentation solutions.
It is impracticable for us to report the revenues from external customers for each of our products and services or each group of similar products and services offered. Our revenue recognition policy is as follows:
We recognize revenue from the sales of products when risk of loss and title passes, which is upon client acceptance.
Product revenue represents sales of computer hardware and pre-packaged software. These arrangements often include software installations, configurations and imaging, along with delivery and set-up of hardware. We follow the criteria contained in the ASC in recognizing revenue associated with these transactions. We perform software installations, configurations and imaging services at our locations prior to the delivery of the product. Some client arrangements include “set-up” services performed at client locations where our personnel perform the routine tasks of removing the equipment from boxes, and setting up the equipment at client workstations by plugging in all necessary connections. This service is usually performed the same day as delivery. Revenue is recognized on the date of acceptance, except as follows:
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In some instances, the “set-up” service is performed after date of delivery. We recognize revenue for the “hardware” component at date of delivery when the amount of revenue allocable to this component is not contingent upon the completion of “set-up” services and, therefore, our client has agreed that the transaction is complete as to the “hardware” component. In instances where our client does not accept delivery until “set-up” services are completed, we defer all revenue in the transaction until client acceptance occurs.
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There are occasions when a client requests a transaction on a “bill and hold” basis. We follow the ASC criteria and recognize revenue from these sales prior to date of physical delivery only when all the criteria of ASC are met. We do not modify our normal billing and credit terms for these clients. The client is invoiced at the date of revenue recognition when all of the criteria have been met. For the periods ended May 31, 2011 and 2010, we did not have any bill and hold transactions.
We have experienced minimal client returns. Since some eligible products must be returned to us within 30 days from the date of the invoice, we reduce the product revenue and cost of goods in each accounting period based on the actual returns that occurred in the next 30 days after the close of the accounting period.
Revenue from the sale of warranties and support service contracts is recognized on a straight-line basis over the term of the contract.
We recognize revenue from sale arrangements that contain both procurement revenue and services and consulting revenue based on the relative fair value of the individual components. The relative fair value of individual components is based on historical sales of the components sold separately.
Revenues from the sale of third party manufacturer warranties and manufacturer support service contracts where the manufacturer is responsible for fulfilling the service requirements of the client are recognized immediately on their contract sale date. Manufacturer support service contracts contain cancellation privileges that allow our clients to terminate a contract with 90 days’ written notice. In this event, the client is entitled to a pro-rated refund based on the remaining term of the contract, and we would owe the manufacturer a pro-rated refund of the cost of the contract. However, we have experienced no client cancellations of any significance during our most recent 3-year history and we do not expect cancellations of any significance in the future. As the Company is not obligated to perform these services, we determined it is more appropriate to recognize the net amount of the revenue and related payments as net revenue at the time of sale.
Services and consulting revenue includes time billings based upon billable hours charged to clients, fixed price short-term projects, and hardware maintenance contracts. These contracts generally are task specific and do not involve multiple deliverables. Revenues from time billings are recognized as services are delivered. Revenues from short-term fixed price projects are recognized using the proportionate performance method by determining the level of service performed based upon the amount of labor cost incurred on the project versus the total labor costs to perform the project because labor is the most readily reliable measure of output. Revenues from hardware maintenance contracts are recognized ratably over the contract period.
Trade Receivables
We maintain an allowance for doubtful accounts for estimated losses resulting from the inability of our clients to make required payments. We base our estimates on the aging of our accounts receivable balances and our historical write-off experience, net of recoveries. If the financial condition of our clients were to deteriorate, additional allowances may be required. We believe the accounting estimate related to the allowance for doubtful accounts is a “critical accounting estimate” because changes in it can significantly affect net income.
Inventories
Inventory is stated at the lower of average cost or market. Inventory is entirely finished goods purchased for resale and consists of computer hardware, computer software, computer peripherals and related supplies. We provide an inventory reserve for products we determine are obsolete or where salability has deteriorated based on management’s review of products and sales.
Goodwill and Intangible Assets
Goodwill represents costs in excess of fair values assigned to the underlying net assets of acquired companies. In accordance with ASC Topic 350, “Intangibles-Goodwill and Other,” goodwill is not amortized but tested for impairment annually, or more frequently if events or changes in circumstances indicate that the asset might be impaired. The impairment determination is made at the reporting unit level and consists of two steps. First, the Company determines the fair value of the reporting unit and compares it to its carrying amount. Second, if the carrying amount of the reporting unit exceeds its fair value, an impairment loss is recognized for any excess of the carrying amount of the reporting unit’s goodwill over the implied fair value of that goodwill. The implied fair value of goodwill is determined by allocating the fair value of the reporting unit in a manner similar to a purchase price allocation, in accordance with ASC Topic 805, “Business Combinations.” The residual fair value after this allocation is the implied fair value of the reporting unit goodwill. The Company’s policy is to perform its annual impairment testing for all reporting units as of June 1.
Intangible assets are tested for recoverability whenever events or changes in circumstances indicate that their carrying amount may not be recoverable in accordance with FASB ASC Topic 360 “Property, Plant and Equipment.” Recoverability of definite-lived intangible assets is assessed by a comparison of the carrying amount to the estimated undiscounted future net cash flows expected to result from the use of the assets and their eventual disposition. If estimated undiscounted future net cash flows are less than the carrying amount, the asset is considered impaired and a loss would be recognized based on the amount by which the carrying value exceeds the fair value of the asset.
Rebates
Rebates are recorded when earned in the accompanying consolidated statements of operations as a reduction of the cost of revenues.
Income Taxes
Income taxes are accounted for under an asset and liability approach that requires the recognition of deferred tax assets and liabilities for the expected future tax consequences of events that have been recognized in our financial statements or tax returns. In estimating future tax consequences, we generally consider all expected future events other than the enactment of changes in tax laws or rates. A valuation allowance is recognized if, on weight of available evidence, it is more likely than not that some portion or all of the deferred tax assets will not be realized.
Item 3. Quantitative and Qualitative Information About Market Risk
Not Applicable.
Item 4. Controls and Procedures
Our management carried out an evaluation, with the participation of our Chief Executive Officer and Chief Financial Officer, of the effectiveness of our disclosure controls and procedures (as defined in Rule 13a-15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”)) as of May 31, 2011. Based upon that evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures including the accumulation and communication of disclosures to the Company’s Chief Executive Officer and Chief Financial Officer as appropriate to allow timely decision regarding required disclosure, were effective to provide reasonable assurance that information required to be disclosed by us in reports that we file or submit under the Exchange Act are recorded, processed, summarized and reported, within the time periods specified in the rules and forms of the SEC. It should be noted that the design of any system of controls 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 the stated goals under all potential future conditions, regardless of how remote.
There has not been any change in our internal control over financial reporting in connection with the evaluation required by Rule 13a-15(d) under the Exchange Act that occurred during the quarter ended May 31, 2011 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
PART II – OTHER INFORMATION
Item 1. Legal Proceedings
In December 2007, the Company received a subpoena issued by the General Services Administration Office of Inspector General (“OIG”), as part of an ongoing, industry-wide investigation. The Company produced documents and data in response to the subpoena to the OIG during 2008. In October 2010, the Company learned that it had been named as a defendant in a qui tam case alleging violations of the Trade Agreements Act. This case, designated United States ex rel. Folliard v. Synnex Corporation et al., was filed under seal in the United States District Court for the District of Columbia. Qui tam lawsuits typically remain under seal (hence, usually unknown to the defendant) for some time while the government decides whether or not to intervene on behalf of a private qui tam plaintiff (known as a relator) and take the lead in the litigation. These lawsuits can involve significant monetary damages and penalties and award bounties to private plaintiffs who successfully bring the suits. The United States government declined to intervene in the matter on May 27, 2010. Nonetheless, the Company can provide no assurance that the government will not intervene in this case in the future or in any other qui tam suit against the Company in the future. The Company filed a motion to dismiss the lawsuit on December 10, 2010. At this time, the Company is unable to predict the timing and outcome of this matter.
In addition, the Company is occasionally involved in various lawsuits, claims, and administrative proceedings arising in the normal course of business. Except as set forth above, the Company believes that any liability or loss associated with such matters, individually or in the aggregate, will not have a material adverse effect on the Company’s financial condition or results of operations.
Item 1A. Risk Factors
Other than with respect to the risk factors set forth below, there have been no material changes from the risk factors disclosed in the “Risk Factors” section of the Company’s Annual Report on Form 10-K for the fiscal year ended August 31, 2010.
Our revenues are derived from a few major clients, the loss of any of which could cause our results of operations to be adversely affected.
A large portion of our revenues are drawn from various civilian and military U.S. governmental departments and agencies. These clients include the Department of Defense, Department of Justice, Department of Homeland Security, Department of Health and Human Services, Department of Agriculture, Department of Commerce and the GSA. During the nine months ended May 31, 2011 and 2010, U.S. governmental department and agency related sales accounted for approximately 43.0% and 48.6% of our total revenues, respectively.
Either of the following additional risk factors could have a material negative impact on our business:
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due to our dependence on governments demand for IT products, a material decline in overall sales to the government as a whole, or to a certain key agency thereof, could have a material adverse effect on our results of operations.
Adverse changes in U.S. federal government fiscal spending could have a negative effect on our sales, gross margin, and cash flow.
Changes in U.S. federal government spending policies or budget priorities could directly affect our financial performance. Among the factors that could materially harm our business are:
These or other factors could cause U.S. federal government agencies and departments to reduce their purchases under contracts, to exercise their right to terminate contracts, or not to exercise options to renew contracts, any of which would cause us to lose future revenue.
Failure to comply with the financial covenants under our credit facility would allow our lender to call for repayment of our outstanding borrowings.
Our credit facility contains certain financial covenants. As of May 31, 2011, the Company was in compliance with all of its financial covenants and the Company had $14.5 million outstanding under the revolving portion of the credit facility, and balances of $974,000 (included in the Company’s accounts payable) plus $723,000 in open approvals under the floor plan portion of the credit facility. As of May 31, 2011, net availability was $1.3 million under the revolving portion of the credit facility. There can be no assurance that we will be in compliance with all of our financial covenants in the future and that the lender will not immediately call for repayment of the outstanding borrowings under the credit facility in the event we are not in compliance with any of the financial covenants.
If we experience an event of default under our Credit Facility, then all amounts due there under will become immediately due and payable, which will have a material adverse effect on our business and financial condition.
At May 31, 2011, our Credit Facility provides for aggregate borrowings of the lesser of $32.0 million or 85% of our eligible accounts receivable plus 100% of unsold inventory financed by the Lender and 40% of all other unsold inventory. The floor plan loan portion of the Credit Facility is for the purchase of inventory from approved vendors and for other business purposes. If an event of default under our Credit Facility occurs because our outstanding borrowings exceed the borrowing base or for any other reason, then the entire balance outstanding under the Credit Facility will become immediately due and payable. We will not be able to repay this balance unless we raise significant capital by selling assets or issuing debt or equity securities, which we may not be able to do on terms acceptable to us, if at all. If the balance outstanding under our Credit Facility becomes immediately due and payable and we are unable to raise significant capital or obtain from the Lender a waiver and an agreement to forbear, then we will not be able to satisfy our obligations to the Lender, they may proceed to foreclose on the collateral and our business and financial condition will be materially and adversely affected.
Implementation of new ERP System
We are currently implementing a new enterprise resource planning ("ERP") system which will be fully installed in the fourth quarter of fiscal 2011. Implementation of a new ERP system will typically involve changes to an entity's overall internal control environment, which we currently have in process. Any unforseen difficulties in the implementation of our new ERP system could adversely impact our system of internal controls and have a material adverse effect on our business and results of operations.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
On March 1, 2011, EGS LLC, a wholly-owned subsidiary of the Company, acquired all of the issued and outstanding stock of Covelix for cash plus the right to receive future contingent earnout payments. In connection with the acquisition, the Company issued 187,500 shares of restricted common stock on March 1, 2011 to the former shareholders of Covelix. One-half of the shares vested on March 1, 2011 and the remaining shares vest evenly over a two-year period. The securities were sold only to an “accredited investor,” as such term is defined in the Securities Act of 1933, as amended (the “Securities Act”), were not registered under the Securities Act or the securities laws of any state, and were offered and sold in reliance on the exemption from registration afforded by Section 4(2) under the Securities Act and corresponding provisions of state securities law, which exempt transactions by an issuer not involving any public offering. The securities were offered for investment purposes only and not for the purpose of resale or distribution, and the transfer thereof was restricted under the terms of the Purchase Agreement.
Item 3. Defaults Upon Senior Securities
Not Applicable.
Item 4. (Removed and Reserved)
Item 5. Other Information
Not Applicable.
Item 6. Exhibits
Exhibit 31.1 - Rule 13a-14(a)/15d-14(a) Certification of Dinesh R. Desai, Principal Executive Officer, of Emtec, Inc. dated July xx, 2011.
Exhibit 31.2 - Rule 13a-14(a)/15d-14(a) Certification of Gregory P. Chandler, Principal Financial Officer, of Emtec, Inc. dated July xx, 2011.
Exhibit 32.1 - Section 1350 Certificate of Dinesh R. Desai, Principal Executive Officer, of Emtec, Inc. dated July xx, 2011.
Exhibit 32.2 - Section 1350 Certificate of Gregory P. Chandler, Principal Financial Officer, of Emtec, Inc. dated July xx, 2011.
Exhibit 99.1 - Third Amendment and Joinder to Loan Security Agreement and Schedule to Loan and Security Agreement and Second Amendment to Collateral Pledge Agreement dated March 9, 2011. (1)
(1) Previously filed as an exhibit to Registrant’s Form 10-Q for the period ending February 28, 2011, filed on April 14, 2011 and incorporated herein by reference.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this Report to be signed on its behalf by the undersigned thereunto duly authorized.
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EMTEC, INC.
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By: |
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Dinesh R. Desai
Chairman and Chief
Executive Officer
(Principal Executive Officer)
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By: |
/s/ GREGORY P. CHANDLER
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Gregory P. Chandler
Chief Financial Officer
(Principal Financial Officer)
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Date: July 15, 2011
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