UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

 

 

 

 

Form 10-K

 

 

 

 

 

Commission File Number: 000-51456

 

 

 

 

180 CONNECT INC.

(Exact Name of Registrant as Specified in its Charter)

 

6501 E. Belleview Avenue

Englewood, Colorado 80111

(Address of principal executive offices)

 

Registrant’s Telephone Number:

(303) 395-6000

 

Securities registered pursuant to Section 12(g) of the Act:

 

Common Stock, par value $0.0001 per share

 

Units, each consisting of one share of Common Stock and two Warrants

 

Warrants, exercisable for Common Stock at an exercise price of $5.00 per share

 

 

 

 

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.  Yes o     No þ

 

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.  Yes o     No þ

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes þ     No o

 

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  þ

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

 

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act).  Yes o     No þ

 

The aggregate market value of the common stock, par value $0.0001 per share, held by non-affiliates of the Registrant, computed by reference to the closing price of such stock on March 27, 2008 was $18,957,026.

 

As of March 27, 2008, there were 23,751,648 shares of the Registrant’s Common Stock issued and outstanding which excludes 1,768,504 exchangeable shares and 500,000 shares of common stock held in the Company’s treasury.

 

 

180 CONNECT INC.
FORM 10-K
FOR THE FISCAL YEAR ENDED DECEMBER 31, 2007
INDEX

 

 

 

Corporate Overview

 

We were organized as a Delaware blank check company in April 2005 under the name Ad.Venture Partners, Inc. (“AVP”) for the purpose of acquiring, through a merger, capital stock exchange, asset acquisition or other similar business combination, one or more operating businesses in the technology, media or telecommunications industries. On August 24, 2007, we completed the Arrangement (the “Arrangement”) with 180 Connect Inc., a corporation organized under the laws of Canada (“180 Connect (Canada)”), whereupon 180 Connect (Canada) became our indirect, wholly-owned subsidiary and we changed our name to 180 Connect Inc.

 

As used in this annual report, “we,” “us,” “our,” “180 Connect Inc.,” the “Company” and words of similar import refer to the consolidated business of 180 Connect Inc. (formerly known as Ad.Venture Partners, Inc.).

 

Industry Trends

 

Our industry is comprised of national, regional and local companies that provide services to meet the following needs:

 

 

The 180 Connect Solution

 

We employ a flexible, highly skilled workforce to provide technical support services to the home entertainment, communications, enterprise data and home integration service industries. By providing such services, we allow our customers to focus on their core competencies and product offerings.

 

We train, equip and employ technicians in each of our more than 85 operating locations to ensure the timely completion of our services and to provide ongoing direct contact with our customers and their subscribers. Our customers, which are home entertainment, communications and data providers and municipalities, engage us to respond to requests received from their subscribers by assigning a service request, or work order, to us. We typically receive work orders within twenty-four hours of the carrier’s

receipt of a service request, which are then assigned to a technician. The technician is then dispatched to the subscriber’s location and completes the service request. Technicians typically require one to three hours to complete a service request, depending upon the type of service required. Upon completion, the technician contacts us and/or the customer and closes the work order. In addition, engineering and design services are also completed based on the receipt of work orders from our customers.

 

We provide our customers with the resources of a national organization combined with the accessibility and flexibility of a local technical support services provider. We are recognized as a leading provider of technical support services, which we believe is due to our focus on the following factors:

 

 

Our Business

 

We provide installation, integration and fulfillment services to the home entertainment, communications and home integration service industries. The principal market for our services is the United States. Our customers include providers of satellite, cable and broadband media services as well as home builders, developers and municipalities.

 

Consolidation in the media and communications industry has created national carriers, many of whom provide an integrated suite of advanced video, data and voice services to residential and commercial subscribers. Many of these national carriers made the strategic decision to outsource the majority of the physical implementation of their services, leading to the creation of a large and highly competitive technical support services industry, of which we are a member.

 

We have evolved through a combination of internal growth and acquisitions. With a staff of more than 4,000 skilled technicians and 750 support personnel based in over 85 operating locations in 22 states, we provide technical support services at our customer’s subscribers’ homes and businesses across the United States and parts of Canada. This infrastructure allows us to provide consistent service and utilize our expertise and resources to deploy increasingly complex technologies over large networks in a cost efficient manner.

 

Satellite Services

 

We are one of the largest services providers for DIRECTV. We have the non-exclusive right to provide services in the installation and maintenance of DIRECTV system hardware in 22 states at specified rates per service pursuant to the terms and conditions of our agreements with DIRECTV. There is no minimum

amount of services or compensation guaranteed to us under these agreements. The agreements have a term of four years, and automatically renew for consecutive one-year terms thereafter unless either party gives notice to terminate at least ninety days prior to the expiration of the then-current term. The agreements may also be terminated by either party without cause upon 180-days prior notice. We are restricted under the agreements from performing installations or providing services to competitors of DIRECTV in the same markets where we provide services to DIRECTV, without DIRECTV’s consent. DIRECTV accounted for 84%, 84% and 86% of our consolidated revenues for the years ended December 31, 2007, December 31, 2006 and December 31, 2005, respectively. A 2007 study by J.D. Power and Associates recognized DIRECTV for achieving one of the highest levels of customer satisfaction in many of its markets. We believe that the training and performance of our technicians contributed to DIRECTV’s high level of customer satisfaction.

 

Cable Services

 

Our cable services division is a substantial provider of technical resources for major cable operators such as Time Warner Inc. (“Time Warner”), Cox Communications, Cablevision Systems Corp. (“Cablevision”), Brighthouse Networks, Wide open West (“WoW”) in the United States and Rogers Communications Inc. (“Rogers Communications”) in Canada. We have over 500 technicians operating from 12 branches who perform voice, video and data installations, upgrades and maintenance services for our cable customers.

 

Network Services

 

180 Connect Network Services provides a “One Source Solution” for fiber network and communication services. We provide a fully integrated, turnkey solution that includes a complete range of network design, integration, installation, maintenance, project management and 24/7 network monitoring and technical support services for telecommunication networks that include: Fiber-to-the-premise, wireless, advanced copper and LAN/WAN/MAN networks for municipal and city governments and public and private development projects.

 

Home Services

 

180 Connect Home Services is a leading low-voltage system and lifestyle-technology integrator that provides installation, sales and service to builders and residential developers. We focus on superior customer service and on building long-term business relationships with our customers. Our product and service offerings include structured wiring, security system installation, home theater and broadband, whole-house audio and central vacuum deployment throughout the home.

 

Outlook

 

We believe substantial growth opportunities exist for a limited number of national technical support service providers due to:

 

 

The key components of our expansion strategy are the continued focus on margin improvement, growth opportunities within the existing branch operating network and identifying, acquiring and integrating strategic acquisitions to increase geographic coverage and extend service offerings to include complementary product lines that can be offered from our existing network of branch operations. Our operating model, combined with its size and focus and management depth and experience allows us to leverage organic growth and acquisition opportunities that complement and enhance our current operations.

 

Seasonality

 

We need working capital to support seasonal variations in our business. Our customers’ subscriber growth, and thus the revenue earned by us, tends to be higher in the third and fourth quarters of the year. We generally experience seasonal working capital needs from approximately January through June. See “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operation — Seasonality.”

 

Safety and Insurance/Risk Management

 

We are committed to ensuring that our employees perform their work safely. We regularly communicate with our employees to reinforce that commitment and to instill safe work habits. We review all accidents and claims for our operations, examine trends and implement changes in procedures to address safety issues. Claims arising in our business generally include workers’ compensation claims, various general liability and damage claims, and claims related to vehicle accidents, including personal injury and property damage. We self insure against the risk of loss arising form our operations up to certain deductible limits. Any amounts exceeding the maximum amounts are covered by our umbrella insurance policy. See “Item 1A. Risk Factors — Our actual losses may exceed our insurance expense estimates,” “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operation — Insurance Premium Deposits” and “Note 2 of Notes to Consolidated Financial Statements — Significant Accounting Policies, Insurance Premium Deposits.”

 

Competition

 

Our industry is highly competitive and highly fragmented. We often compete with a number of companies in markets where we operate, ranging from small local independent companies to large national firms. Under our contractual agreement with DirecTV, they are able to increase the number of markets we serve or the amount of work we do within those markets, decrease the number of markets or the volume of work, or enter the markets themselves. Historically they have not provided fulfillment services themselves, but they have publicly expressed an interest in doing so in the future.

 

Relatively few significant barriers to entry exist in the markets in which we operate and, as a result, any organization that has adequate financial resources and access to technical expertise may become a competitor. Some of our customers employ personnel to perform infrastructure services of the type we provide. We compete based upon our industry experience, technical expertise, financial and operational resources, nationwide and Canadian presence, industry reputation and customer service. While we believe our customers consider a number of factors when selecting a service provider, most of their work is awarded through a bid process. Consequently, price is often a principal factor in determining which service provider is selected.

 

Availability of Filings

 

We make all of our reports filed under the Securities Exchange Act of 1934, as amended (the “Exchange Act”) available, free of charge, on our web site at www.180connect.net, as soon as reasonably practicable after electronically filing with the Securities and Exchange Commission (the “SEC”). The information on or accessible through our website is not part of this Annual Report on Form 10-K. Further, a copy of this Annual Report on Form 10-K is located at the SEC’s Public Reference Room at 100 F Street, NE, Washington, DC 20549. Information on the operation of the Public Reference

Room can be obtained by calling the SEC at 1-800-SEC-0330. The SEC maintains an internet site that contains reports, proxy and information statements and other information regarding our filings at www.sec.gov.

 

Item 1A.  Risk Factors

 

Risks Related to Our Business and Industry

 

We have a history of operating losses and may not be able to achieve profitability.

 

We began operating our business in 2000 through the acquisition of certain assets relating to the cable and satellite industries. We had a loss from continuing operations of $22.9 million for the year ended December 31, 2007, of which approximately $12.0 million was related to the Arrangement. Our net losses from continuing operations were $8.8 million and $5.2 million for the years ending December 31, 2006 and December 31, 2005, respectively. If we are not profitable in the future, we may require additional sources of financing to meet ongoing requirements. We may continue to incur losses and remain unprofitable in the future.

 

We rely on one key customer for a substantial percentage of our revenue.

 

DIRECTV accounted for 84%, 84% and 86% of our consolidated revenues for the years ended December 31, 2007, December 31, 2006 and December 31, 2005, respectively. We are materially dependent on this customer and the loss of this customer or a substantial reduction in the level of services provided to this customer would have a material adverse affect on us and the market price and value of our common shares. A number of factors impact the services that this customer or any of our other customers may require. Industry consolidation, technological developments, economic cycles, and internal budgetary constraints all affect the demand for our services. Our contract with DIRECTV does not afford us the exclusive right to provide our services to DIRECTV’s customers in the territories we serve, and the contract may be terminated by either party upon 180 days’ notice. Our contract with DIRECTV does not permit us to perform services for competitors of DIRECTV in the same markets where we perform services for DIRECTV without DIRECTV’s consent. In addition, our contract with DIRECTV can be cancelled on short notice and DIRECTV is generally not obligated to purchase additional services from us.

 

Historically, DIRECTV has not provided fulfillment services itself; rather it has relied on companies such as 180 Connect (generally referred to by DIRECTV as ’Home Service Providers’ or ’HSPs’) to complete the fulfillment. Recently, DIRECTV has indicated an interest in bringing some portion of their fulfillment services in-house. If it were to do so at any significant scale, this could have a material impact on our financial results and future prospects.

 

If we are unable to retain trained personnel, we may be unable to provide adequate service.

 

Our ability to provide quality service and to meet the demand for our services depends upon our ability to retain an adequate number of trained personnel. We operate in an industry characterized by highly competitive labor markets and, similar to many of our competitors, we experience high employee turnover. It is possible that our labor expenses would increase due to a shortage in the supply of skilled field technicians and subcontractors and our efforts to reduce employee turnover. Additionally, labor expenses may increase if we are required to rely more extensively on overtime for our technicians to meet the demands for our services or if our employees unionize. We cannot be certain that we will be able to improve our employee retention rates or maintain an adequate skilled labor force necessary to operate efficiently and to support our growth strategy. Failure to do so could impair our ability to operate efficiently and to retain current customers and attract prospective customers which would cause our business to suffer materially. Additionally, the industry in which we operate is characterized by significant changes in technology. New technologies may replace existing technologies for transmission of video, data and voice. In order to remain competitive, we must continue to train our technicians to keep pace with technological developments in the industry. If we are unable to provide our technicians with adequate

training in a timely manner, we may not be able to retain customers or attract new customers and our financial situation could be adversely affected.

 

Higher fuel prices would increase our cost of doing business, and we may not be able to pass along the added costs to customers.

 

The price of fuel fluctuates based on events outside of our control. Most of our contracts do not allow us to adjust our pricing and therefore we have limited ability to pass higher fuel costs to customers. Higher fuel costs may negatively impact our financial condition and results of operations.

 

We depend on key employees for management and operations.

 

We are dependent upon the retention of certain key executives and employees. Our future success will depend upon our ability to attract and retain additional qualified personnel to identify, investigate and negotiate future acquisitions and manage, oversee and staff acquired operations.

 

We are subject to litigation and other disputes which may lead to litigation.

 

We are subject to various actual and potential claims, proceedings and lawsuits which may arise in the ordinary course of business as well as four class action lawsuits in federal court in Washington, California, and Oregon brought by current and former employees alleging violations of state wage and hour laws. Claimants can seek large damage awards and these claims can involve potentially significant defense costs. We provide reserves for those claims based on our current information and legal advice. However, such reserves may be inadequate to cover our losses relating to these claims and lawsuits and an adverse decision in a lawsuit could have a material impact on our financial condition and results of operations. See Item 3 of Part I of this Form 10-K for a description of the legal proceedings involving us and our subsidiaries.

 

Our actual losses may exceed our insurance expense estimates.

 

We maintain a self-insurance program for casualty coverage, including workers compensation, automobile and general liability coverage. As part of the self-insurance program, we are required to pay up to $500,000 for each individual workers compensation claim and up to $350,000 for each auto liability claim. The aggregate limit is $29,295,000 for all workers compensation and automobile liability claims. We are required to pay up to $500,000 for each general liability claim for the period ended April 30, 2008. We estimate, on an annual basis, our potential liability for property and casualty claims, including workers compensation, automobile and general liability claims incurred within a particular policy year. These estimates take into account policy loss limits and future anticipated payouts on an individual claim basis and form the basis of our annual insurance expense. We generally accrue for liability for losses over a twelve-month period based on our then current estimate of losses. In some cases, we may be required to make further accruals and payments where actual losses in prior periods exceed estimated amounts. If our estimates of potential liability prove to be inaccurate, we could experience a reduction in our profitability and liquidity and a weakening of our financial condition.

 

We are subject to competition and may not be able to maintain our position within the industry.

 

We face competition from other providers of installation services and may not be able to maintain or strengthen our competitive position within the industry. There are a number of factors that determine the level of competitive intensity in our industry. First, there are relatively few barriers to entry into the markets in which we operate. Therefore, any entity that has sufficient financial resources and access to technical expertise may become a competitor. Second, competitors may have lower cost structures, which they are able to pass along to customers in the form of lower rates. Third, some of our existing or potential customers may themselves perform some of the same services we perform. If we are unable to maintain or enhance our competitive position and the quality of our service offering, our business, operating results

and financial condition may be adversely affected. There can be no assurance that we will be able to compete successfully against our current or future competitors.

 

Our revenue and liquidity are subject to seasonal fluctuations.

 

Our customers’ subscriber growth, and thus our revenue, tends to be higher in the third and fourth quarters of the year. While subscriber activity is subject to seasonal fluctuations, it may also be affected by competition and varying amounts of promotional activity undertaken by our customers. Additionally, actual work order volume for any quarter may be lower than the quarterly projections provided to us by our customers resulting in increased levels of inventory and a decrease in revenue and liquidity. There can be no assurance that we would have sufficient liquidity or be able to obtain additional financing on satisfactory terms, or at all, in the event a shortfall was to occur in the future.

 

Our revolving credit facility (the ’Revolver”) requires a lockbox arrangement, which provides for all receipts to be swept daily to reduce borrowings outstanding under the credit facility. This arrangement, combined with the existence of a subjective acceleration clause in the revolving credit facility, requires that the borrowings under the Revolver be classified a current liability on the balance sheet in accordance with the Financial Accounting Standards Board (“FASB”) Emerging Issues Task Force Issue No. 95-22, “Balance Sheet Classification of Borrowings Outstanding under Revolving Credit Agreements that Include Both a Subjective Acceleration Clause and a Lock-Box Arrangement” (“EITF 95-22”). There can be no assurance that we would have sufficient liquidity or be able to obtain additional financing on satisfactory terms, or at all, in the event the debt repayment was accelerated.

 

Consolidation of broadband carriers could result in a reduction of our customer base.

 

From time to time, the home entertainment and communications, cable, telecommunications, satellite and wireless industries have experienced significant consolidation activity. Consolidation among our customers could have the effect of reducing the number of our current or prospective customers, which could lead to increased dependence on a smaller number of customers or the loss of customers who elect to use a competitor.

 

We have not and do not expect to pay cash dividends which may cause the price of our common stock to decline.

 

We have never paid a cash dividend on our common stock and do not anticipate paying any cash dividends in the foreseeable future. We intend to retain future cash earnings, if any, for reinvestment in the development and expansion of our business. A decision to pay cash dividends in the future will be made by our Board of Directors and will be dependent on our financial condition, results of operations, capital requirements and any other factors our Board of Directors decides is relevant. As a result, an investor will only recognize an economic gain on an investment in our common stock from an appreciation in the price of such common stock.

 

Failure to successfully manage organic growth or growth through acquisitions could negatively impact our business.

 

If we are unable to successfully manage our internal growth, our revenue, profitability, operating results and financial condition may be adversely affected. In addition, anticipated cost savings may not materialize, and we may experience operating losses. Our financial success could also be impaired by the following risks if future acquisitions are not integrated successfully:

 

 

 

No assurance can be given that our systems and procedures will be adequate to support or integrate the expansion of operations resulting from organic growth or an acquisition.

 

Risks Related to Our Common Stock

 

The price of our common stock is volatile and may be less than what you originally paid for your shares of common stock.

 

The price of our common stock is volatile, and may fluctuate due to factors such as:

 

 

The communication and broadcast services industry has been highly unpredictable and volatile. The market for common stock of companies in this industry may be equally volatile. Our common stock may trade at prices lower than what you originally paid for your shares.

 

The exercise of our outstanding convertible securities will result in a dilution of our current shareholders’ voting power and an increase in the number of shares eligible for future resale in the public market which may negatively impact the market price of our shares.

 

As of March 27, 2008, we have outstanding the following securities:

 

 

Exercise of these warrants and options will dilute our existing shareholders’ voting interest, and would lead to an increase in the number of shares eligible for resale in the public market. Sales of substantial numbers of such shares in the public market could adversely affect the market price of our shares.

 

Our common stock is traded on the OTC Bulletin Board, which may make it more difficult for shareholders to dispose of or to obtain accurate quotations as to the value of our common stock.

 

Our common stock is quoted on the OTC Bulletin Board. As a result, there may be no or only a limited public market for our common stock and you may find it more difficult to dispose of, or to obtain accurate quotations as to the market value of, our common stock. In addition, the “penny stock” regulations of the SEC might apply to transactions in the common stock. A “penny stock” generally includes any over-the-counter equity security that has a market price of less than $5.00 per share. The SEC regulations require the delivery, prior to any transaction in a penny stock, of a disclosure schedule prescribed by the SEC relating to the penny stock. A broker-dealer effecting transactions in penny stocks must make disclosures, including disclosure of commissions, and provide monthly statements to the customer with information on the limited market in penny stocks. These requirements may discourage broker-dealers from effecting transactions in penny stocks. If the penny stock regulations were to become applicable to transactions in shares of our common stock, they could adversely affect your ability to sell or otherwise dispose of your shares.

 

 

None.

 

 

Our corporate headquarters consist of an 18,500 square foot leased facility located in Englewood, Colorado. As of December 31, 2007, our operations were conducted from over 85 locations in 22 states. No individual facilities are material to our operations as most of our services are performed on the customers’ premises. In addition, suitable alternative branch locations are available in substantially all areas where we currently conduct business. We also own property and equipment that, at December 31, 2007, had a net book value of $34.9 million. This property and equipment includes vans, tools, computers, office and other equipment. Our equipment is acquired from various third-party vendors, none of which we depend upon, and we did not experience any difficulties in obtaining desired equipment.

 

 

We and our subsidiaries, Ironwood Communications, Inc. (“Ironwood”) and Mountain Center, Inc. (“Mountain”) are party to four class action lawsuits in federal court in Washington, California and Oregon brought by current and former employees alleging violations of state wage and hour laws. A class has been certified in the Washington class action pending in federal court in Seattle, and a trial is scheduled for November 2008. A motion to certify a class has been filed in the Oregon case pending in federal court in Portland, but there has been no decision yet on that motion. The two California class actions are coordinated for discovery purposes before the same federal court judge in the Central District of California (Riverside). No class certification motion has been filed in either California case, which are both in early stages of discovery.

 

In December 2006, thirteen technicians (the “Complainants”) employed at our Farmingdale, New York location filed harassment, discrimination and retaliation charges against us with the Equal Employment Opportunity Commission (the “EEOC”) alleging that we violated Title VII of the Civil Rights Act of 1964. In September 2007, the EEOC issued a probable cause finding with respect to an alleged discriminatory incident, the occurrence of which we did not dispute. In our defense, we submitted evidence showing that we promptly hired a neutral third party to investigate the complained-of incident, that the incident was not racially motivated and that notwithstanding the investigator’s findings, the Company promptly discharged

the employee responsible for the incident. Notwithstanding, the EEOC made a per se finding holding us responsible for the conduct of the employee responsible for committing the complained-of incident and concluded that we engaged in unlawful discriminatory practices. The EEOC determined that all other complaints of discrimination, harassment and retaliation, including any discriminatory employment practices, were unfounded and, thus, dismissed. Thereafter, in December 2007, after failure to reach a settlement, the Complainants filed a federal lawsuit against us in connection with their claims to the EEOC. The complaint purports to bring claims under Title VII, the Civil Rights Act of 1871, the 1991 Civil Rights Act, and the New York State Executive Law Section 290. In January 2008, we filed an answer to the complaint denying each of the Complainants allegations.

 

We intend to vigorously contest each of these claims.  Other than with respect to the Washington class action, no reserves have been recorded for these cases as we are unable to estimate the amounts of probable and reasonably estimable losses. Any reserves we have recorded may be inadequate to cover our losses relating to these claims and lawsuits and an adverse decision in a lawsuit could have a material impact on our financial condition and results of operations.

 

In addition to the foregoing, we are subject to a number of individual employment-related lawsuits. No reserve has been recorded for these cases as we are unable to estimate the amount of probable and reasonably estimable losses. These lawsuits are not expected to have a material impact on our results of operations, financial position or liquidity.

 

 

No matters were submitted to a vote of our security holders during the fourth quarter of 2007.

 

 

Market Information.  Our units, which consist of one share of our common stock, par value $0.0001 per share, and two warrants, each to purchase an additional share of common stock, are quoted on the OTC Bulletin Board under the symbol “CNCTU.” Our common stock is quoted separately on the OTC Bulletin Board under the symbol “CNCT.” Our publicly-traded warrants are listed separately on the OTC Bulletin Board under the symbol “CNCTW.” Prior to August 24, 2007, our units, common stock and warrants were quoted on the OTC Bulletin Board under the symbols “AVPAU,” “AVPA” and “AVPAW,” respectively.

 

The following tables set forth, for the calendar quarter indicated, the quarterly high and low closing prices of our units, common stock and warrants, respectively, as quoted on the OTC Bulletin Board.

 

 

 

 

Holders.  As of March 27, 2008, there were approximately 30 shareholders of record of our common stock.

 

Dividends.  We have never paid any cash dividends and do not anticipate paying any cash dividends in the foreseeable future. Our board of directors regularly evaluates our dividend policy based on our financial condition, profitability, cash flow, capital requirements, and the outlook for our business. We currently intend to retain any future earnings for reinvestment and acquisitions.

 

Unregistered Securities Sold.

 

On November 9, 2007, the Company issued Magnetar Capital Master Fund, Ltd’s (“Magnetar”) a warrant to purchase 356,952 shares of common stock of the Company at an exercise price of $0.01 per share in full satisfaction of amounts owing by the Company to Magnetar in connection with Magnetar’s agreement to vote the shares it held in AVP in favor of the Arrangement at the August 24, 2007 AVP shareholders meeting. Such warrant has a five year term and was valued at $800,000 on November 9, 2007. In connection with such issuance, the Company withheld 90,559 shares underlying the warrant in order to satisfy U.S. tax withholding requirements and remitted $202,961 to the Internal Revenue Service on behalf of Magnetar. Accordingly, the warrant is exercisable for 266,393 shares.

 

The following table sets forth certain selected financial data for the fiscal years ended December 31, 2007, December 31, 2006, December 31, 2005, December 25, 2004, and December 27, 2003. Subsequent to December 31, 2005, we changed our year end accounting period from a 52/53 week year to a calendar year basis. The following selected financial data should be read together with our consolidated financial statements and notes thereto as well as “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations.”

 

 

 

 

Overview

 

This Management’s Discussion and Analysis (“MD&A”) should be read in conjunction with the accompanying audited consolidated financial statements for the year ended December 31, 2007 and the related notes thereto.

 

Certain information included herein is forward-looking and based upon assumptions and anticipated results that are subject to risks and uncertainties. Should one or more of these uncertainties materialize or should the underlying assumptions and estimates prove incorrect, actual results may vary significantly from those expected. Reference should be made to the section entitled “Forward-Looking Statements”. Reference should also be made to Item 1A, “Risk Factors”, of this Annual Report on Form 10-K.

 

We generate substantially all of our revenue in the United States for which we receive payment in U.S. dollars. We prepare our consolidated financial statements in U.S. dollars and in conformity with U.S. generally acceptable accounting principles (“GAAP”). Unless otherwise indicated, all dollar amounts in this MD&A are expressed in U.S. dollars. References to “$” and “US$” are to U.S. dollars.

 

Certain amounts have been reclassified from the consolidated financial statements previously presented to account for discontinued operations and the reclassification of the Revolver portion of long-term debt to current.

 

Introduction

 

We provide installation, integration and fulfillment services to the home entertainment, communications and home integration service industries. The principal market for our services is the United States. Our customers include providers of satellite, cable and broadband media services as well as home builders, developers and municipalities.

 

Trends and Uncertainties in our Business

 

DIRECTV

 

Historically, DIRECTV has not provided fulfillment services itself; rather it has relied on companies such as 180 Connect (generally referred to by DIRECTV as ’Home Service Providers’ or ’HSPs’) to complete the fulfillment. Recently, DIRECTV has indicated an interest in bringing some portion of their fulfillment services in-house. If it were to do so at any significant scale, this could have a material impact on our financial results and future prospects.

 

Labor Class Action Proceedings

 

We are subject to various actual and potential claims, proceedings and lawsuits which may arise in the ordinary course of business as well as four class action lawsuits in federal court in Washington, California, and Oregon brought by current and former employees alleging violations of state wage and hour laws. Claimants can seek large damage awards and these claims can involve potentially significant defense costs. Any reserves we have recorded may be inadequate to cover our losses relating to these claims and lawsuits and an adverse decision in a lawsuit could have a material impact on our financial condition and results of operations.

 

Rising Fuel Costs

 

The price of fuel fluctuates based on events outside of our control. Most of our contracts do not allow us to adjust our pricing and therefore we have limited ability to pass higher fuel costs to our customers. Higher fuel costs may negatively impact our financial condition and results of operations.

2007 Significant Operating Events

 

Consummation of the Plan of Arrangement

 

On August 24, 2007, the Arrangement was consummated.  Because the consummation of the Arrangement resulted in more than 50% of our voting securities being held by the shareholders of 180 Connect (Canada), the Arrangement has been accounted for under the reverse acquisition application of the equity recapitalization method of accounting in accordance with GAAP for accounting and financial reporting purposes. Under this method of accounting, AVP was treated as the “acquired” company for financial reporting purposes. In accordance with guidance applicable to these circumstances, the Arrangement is considered to be a capital transaction in substance. Accordingly, for accounting purposes, the Arrangement was treated as the equivalent of 180 Connect (Canada) issuing stock for the net monetary assets of AVP, accompanied by a recapitalization. The net monetary assets of AVP were recorded at their fair value, essentially equivalent to historical costs, with no goodwill or other intangible assets recorded. The accumulated deficit of 180 Connect (Canada) has been carried forward after the closing of the Arrangement. Operations prior to the closing for all periods presented are those of 180 Connect (Canada). All common shares, warrants, options and earning per share amounts related to transactions and periods prior to August 24, 2007 have been restated in these financial statements to reflect the 0.6 exchange ratio applied to 180 Connect (Canada)’s equity instruments.

 

Exercise and Redemption of Convertible Debentures

 

On March 22, 2006, 180 Connect (Canada) completed a private placement with a group of qualified, accredited institutional investors of $10,686,101 of convertible debentures and warrants (Note 13). During the second quarter of 2007, one of the convertible debenture holders exercised its option to convert in total $2,024,785 of principal under the convertible debenture into 510,000 common shares.

 

The consummation of the Arrangement constituted an event of default under 180 Connect (Canada)’s convertible debentures. In the third quarter of 2007, the convertible debenture holders exercised their right to redeem the convertible debentures in full. We paid the holders of the convertible debentures $10,393,577, which included outstanding principal and a 20% redemption premium, excluding accrued but unpaid interest.

 

Reduction of Letter of Credit

 

During 2007, as a result of a reduction in our insurance obligations, we negotiated a reduction in our required letter of credit (“LOC”). The LOC requirement, which is collateralized with our restricted cash, was reduced by $6.3 million. This reduction in our restricted cash balance was offset by a $2.0 million increase in restricted cash as collateral for bonds on projects currently in progress by our network services operation.

 

On March 19, 2008, as a result of the reduction in our insurance obligations, we negotiated a reduction in our LOC requirement by approximately $2.0 million.

 

Seasonality

 

We need working capital to support seasonal variations in our business. Our customers’ subscriber growth, and thus the revenue earned by us, tends to be higher in the third and fourth quarters of the year. We generally experience seasonal working capital needs from approximately January through June. The following chart sets forth our revenue distribution by quarter for fiscal years 2005 through 2007.

 

Significant Accounting Policies

 

Critical Accounting Estimates

 

The preparation of consolidated financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenue and expense during the reporting periods. The most significant assumptions made by management in the preparation of our consolidated financial statements include: (i) provisions for credit adjustments and doubtful accounts to reflect credit exposures and unrecoverable amounts; (ii) valuation allowances and impairment assessments for various assets, including customer contracts and goodwill; (iii) the useful life and residual value of property, plant and equipment; (iv) deferred income taxes; (v) accruals related to liabilities arising from legal claims; and (vi) periodic estimates of ultimate liabilities related to losses associated with workers’ compensation and employment liability, business automotive liability and general liability insurance claims. Actual results could differ as a result of revisions to estimates and assumptions which may have a material impact on financial results of future periods. The policies described below are considered to be critical accounting estimates, as they require significant estimation or judgment. For additional information see Note 2, “Significant Accounting Policies,” of our consolidated financial statements included in Item 8.

 

Reserves

 

The majority of our revenues are earned from executing work orders received from our customers. We are required to make an estimate of an appropriate reserve on our receivables. We consider factors such as the number of days the account is past due, the status of an account with respect to our past collection history, our historical charge backs as well as penalties and changes in business circumstances. The estimated reserve required is a matter of judgment and the actual loss eventually sustained may be more or less than the estimate depending on events which have yet to occur and which are uncertain including future business and economic conditions. Conditions causing deterioration or improvement in the aging of accounts and collections or deterioration or improvement of customer service will increase or decrease reserve expense.

 

Other Intangible Assets

 

The intangible assets consist primarily of customer contracts acquired from acquisitions. Intangible assets are evaluated for impairment whenever events or changes in circumstances indicate the carrying value of an asset may not be recoverable. Such an asset is considered impaired if the carrying amount of the asset grouping including the intangible asset exceeds the sum of the undiscounted cash flows expected to result from the use and ultimate disposition of the assets. If such assets are considered to be impaired, the impairment to be recognized is the amount by which the carrying amount of the assets exceeds fair value determined using a discounted cash flow model. While our cash flow assumptions and estimated useful lives are consistent with our business plans, significant judgment is involved in determining cash flows including growth, profitability projections and earnings multiples.

 

The acquired companies had existing contracts with their customers at the time of the acquisition. These contracts required us to provide installation and other services over a period of time in a specific geographic area on an exclusive basis for our customers. These contracts were recognized apart from goodwill as these assets resulted from contractual or other legal rights and these assets are capable of being separated or divided from the acquired enterprise. As such, a value was assigned to the future benefits to be realized from these exclusive contractual agreements with our customers. We amortize these contracts over a ten year period.

 

The fair value of the customer contracts was initially determined by a third-party valuation company at the time of acquisition of the entities to which the customer contracts were related. The valuation company used the excess earnings approach to value the customer relationships by projecting revenue and expenses attributable to the current customer relationship. The customer contracts were assigned a

ten year life based upon existing terms of the customer contracts, the likely renewal periods for customer contracts and barriers to entry for competitors that would make it unlikely that our customers could find replacement service providers. Customer contracts are amortized ratably over the life of the customer contract.

 

We test customer contracts for recoverability when events or changes in circumstances indicate that their carrying amount may not be recoverable. Indicators of impairment would include loss of customers, declining revenues or the closure of branches. Recoverability is assessed based on the carrying amount of the assets and their net recoverable value, which is generally determined based on undiscounted cash flows expected to result from the use and the eventual disposal of the assets. An impairment loss is recognized to write the assets down to their fair value.

 

When a contract is being tested for impairment, uncertainties and risks inherent in the assumptions included in the future cash flows include the revenue growth projection and expense estimates. Management believes that the growth rate and expense estimate assumptions used in the calculations of future cash flows are reasonable.

 

Significant judgments in this area involve determining whether a triggering event has occurred and the determination of the cash flows for the assets involved and, when necessary, the discount rate to be applied in determining fair value. As of December 31, 2007, there were no events or circumstances that indicated that an impairment may have occurred. Management prepared a sensitivity analysis whereby the estimated revenues and expenses were changed by 5% and noted that the results of the analysis would not have resulted in the impairment of customer contracts.

 

Goodwill

 

Prior to January 1, 2002, amounts allocated to goodwill were amortized over five years. Subsequent to January 1, 2002, we test for impairment on an annual basis or more frequently if events or changes in circumstances indicate that the asset might have been impaired. We assess the recoverability of the carrying value of our goodwill on an annual basis. As part of our annual evaluation, we consider several factors including operating results and trends, closure of branch operations, changes in client relationships and general economic conditions. The assumptions about future cash flows and growth rates are based on our budget and business plans and varying growth rate assumptions for periods beyond the long-term business plan period. Significant changes in these factors could result in an impairment of goodwill.

 

We assess goodwill for impairment at the satellite, cable and home integration lines of our business. Discrete financial information is available and reviewed by operating managers for each component. To test for goodwill impairment, we use the two-step impairment process. The first impairment test is to compare the fair value of the component with its carrying amount, including goodwill, in order to identify a potential impairment. Fair value is calculated using a discounted cash flow model where the estimated future cash flows are discounted by the weighted average cost of capital. When the fair value of a component exceeds its carrying amount, goodwill of the component is considered not to be impaired and the second step of calculating the impairment is unnecessary. If step one of the test is not met, an impairment loss is recorded for the carrying amount of the goodwill exceeding the implied fair value of that goodwill.

 

Uncertainties and risks inherent in the assumptions included in the future cash flows include revenue growth projection and expense estimates and the discount rate used. The assumptions used to calculate future cash flows are based on management’s best estimates but are subject to changes as they are based on forward-looking information. Management believes that the assumptions used in the calculations of future cash flows are reasonable as the revenue growth rate selected by management for use in the discounted cash flow model is lower than the actual revenue growth rate for each component for the last two fiscal years and the expense estimates include projected increases year over year.

 

As of December 31, 2007, there have been no events or circumstances that would indicate impairment has occurred. Management prepared a sensitivity analysis whereby the estimated revenues and

expenses were changed by 5% and noted that the results of the analysis would not have resulted in the impairment of goodwill. At the date of the last impairment test for each reporting unit, the fair value exceeded the carrying value by more than 10%.

 

Leases

 

Leases have been classified as either capital or operating leases. Leases which transfer substantially all of the benefits and risks incidental to the ownership of assets are accounted for as if there were an acquisition of an asset and incurrence of an obligation at the inception of the lease and are accounted for as capital leases. All other leases are accounted for as operating leases wherein rental payments are expensed as incurred.

 

If at inception a lease meets one or more of the following four criteria, the lease is considered a capital lease.

 

 

In 2005, we entered into agreements with third party leasing companies to lease over 2,200 vehicles pursuant to our fleet expansion program. As of December 31, 2007, we have approximately 3,000 vehicles included as capital lease obligations in the consolidated financial statements.

 

Income Taxes

 

We account for income taxes in accordance with SFAS No. 109, “Accounting for Income Taxes”. SFAS 109 requires deferred tax assets and liabilities to be recognized for temporary differences between the tax basis and financial reporting basis of assets and liabilities, computed at the expected tax rates for the periods in which the assets or liabilities will be realized, as well as for the expected tax benefit of net operating loss and tax credit carryforwards. We have recorded a valuation allowance against all of our United States and foreign net deferred tax assets in jurisdictions where we have incurred significant losses. We have in accordance with SFAS 109 evaluated the recoverability of our net deferred tax assets and concluded that it was more likely than not that all of net deferred tax assets would not be realized and recorded a valuation allowance accordingly. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income during the period in which those deferred tax assets become deductible, the timing and amount of which is uncertain. We assess the recoverability of our net deferred tax assets on a quarterly basis. If we determine that it is more likely than not that we will realize a portion or

all of our remaining net deferred tax assets, some portion or all of the valuation allowance will be reversed with a corresponding reduction in income tax expense in such period.

 

We have significant taxable losses available to be carried forward into future years. However, due to the uncertainty of realization of these losses and other deferred tax assets, we have recorded a valuation allowance against all of those assets. We do not foresee any significant tax expense except to our Canadian subsidiary, Wirecomm Systems, Inc. which has taxable income and has exhausted most of its deferred tax assets. Proper accrual has therefore been made for the Canadian tax liability.

 

The majority of the Company’s U.S. operations are included in a federal consolidated tax return under Section 1501 of the Internal Revenue Code and therefore, most of our U.S. tax losses are available for future use subject to Section 172 and Section 382 limitations. The Company has not completed an analysis of limitations on the future ability to use net operating losses under Section 382. Such limitations could significantly impact the amount of the Company’s net operating loss carryforward available to offset future taxable income. Due to a restructuring completed by the Company in December, 2007, certain net operating losses might also be limited under the SRLY rules of the internal revenue code.

 

Material changes in valuation allowance during the year are attributable to losses sustained during 2007 by our U.S. subsidiaries. The deferred tax assets for all these losses have been reserved for by a valuation allowance as we do not expect them to be utilized in the near future.

 

Insurance Premium Deposits

 

We maintain a self-insurance program for casualty coverage, including workers compensation, automobile and general liability coverage. Property coverage is insured by a leading insurance carrier in the U.S. The program is administered by a U.S.-based insurance company. As part of the self-insurance program, we are required to pay up to $100,000 in California and $500,000 in all other States, for each individual workers compensation claim, and up to $350,000 for each auto liability claim. The aggregate limit is $29,295,000 for all workers compensation and automobile liability claims. We are required to pay up to $500,000 for each general liability claim incurred during the period ending April 30, 2008. Any amounts exceeding the maximum amounts are covered by our umbrella insurance policy. As is common with these types of insurance programs, we are required to make periodic estimates of our ultimate actuarially determined liability, based on experience, claims filed and an estimate of claims incurred but not yet reported. These estimates take into account policy loss limits and future anticipated payouts on an individual claims basis. We make periodic premium payments to the program administrator to cover claim payments as well as associated fixed costs.

 

We calculate the annual insurance cost using actuarial estimates provided by third party service providers at the beginning of the plan year. For the plan years prior to May 1, 2004 and for the plan year starting on May 1, 2006, we are required to pre-pay the full estimated costs of insurance for the plan year. The accounting for those periods was to record a prepaid asset for the payments made in advance of the plan year. The prepaid asset was then amortized on a pro rata basis each month during which the coverage was provided. For the plan years beginning on May 1, 2004 and May 1, 2005, we entered into an agreement with our insurance carrier which required us to pay the fixed costs associated with the insurance plan up-front, and pay the actual claim amounts as they were settled by putting in place necessary collateral in the form of letters of credit.

 

Commitments and Contingencies

 

We are subject to various claims and contingencies related to lawsuits, taxes and commitments under contractual and other commercial obligations. We recognize liabilities for contingencies and commitments when a loss is probable and capable of being estimated. Significant changes in our assumptions as to the likelihood and estimates of the amount of a loss could result in recognition of an additional liability.

Relationship with DIRECTV

 

DIRECTV revenue is recognized when the work orders are closed. Our agreements with DIRECTV include mechanisms whereby the amount due to us from DIRECTV may be reduced for certain reasons. These reasons include a failure to complete a work order as defined within the agreements, amounts paid to us in error or credits issued to DIRECTV customers that were the result of poor services provided by us. Based on historical amounts for actual chargebacks, we calculate and record a chargeback estimate and record this as a monthly expense and reserve against service revenue. For the year ended December 31, 2007, $5.7 million in chargebacks (1.5% of revenue) was deducted from revenue as compared to $5.0 million (1.5% of revenue) in 2006.

 

We recognize revenue from our role as a commissioned sales agent regarding DIRECTV’s direct broadcast services. Sales for the year ended December 31, 2007 were $1.2 million versus $1.0 million recorded in the year ended December 31, 2006. Direct contribution margin (“DCM”) recognized from this revenue activity was $0.4 million for each of the years ended December 31, 2007 and 2006.

 

Included in the DCM for the year ended December 31, 2006 is the effect of approximately $1.1 million of excess equipment costs resulting partially from inventory write-offs and from the usage of more expensive equipment in the installation process which was not reimbursed. The write-offs are included as a direct cost as they represent inventory shrinkage due to poor inventory management practices.

 

Financial Review

 

Revenue from continuing operations is generated from providing installation, integration, fulfillment and long-term maintenance and support services to the home entertainment, communications and home integration service industries. Our services are engaged by our customers pursuant to ongoing contracts and on a project-by-project basis.

 

Direct cost of revenue is comprised primarily of direct labor costs including amounts paid to our extensive labor force of technicians and third party subcontractors. Also included in direct costs are materials, supplies, insurance and costs associated with operating vehicles.

 

General and administrative expenses consist of personnel and related costs associated with our administrative functions, professional fees, office rent and other corporate related expenses.

 

Subsequent to December 31, 2005, we changed our year end accounting period from a 52/53 week year to a calendar year basis. The amounts presented below have been reclassified to reflect the adjustments associated with our discontinued operations. This financial information has been derived principally from our audited consolidated financial statements. This summary financial and operating information should be read in conjunction with our audited consolidated financial statements and the related notes together with the discussion contained herein.

 

Selected Financial Highlights — Year and Quarter Ended December 31, 2007

 

For the twelve months ended December 31, 2007 as compared to the twelve months ended December 31, 2006:

 

Full Year Highlights

 

 

 

 

 

 

Results of Operations

 

Comparison of Years Ended December 31, 2007 and 2006

 

 

 

 

Revenue

 

Revenue for the year ended December 31, 2007 increased to $379.8 million from $331.2 million for the year ended December 31, 2006. This 14.7% increase reflects continued growth in revenue resulting from DIRECTV channeling more work to us through their home services provider network and increased

customer demand resulting from DIRECTV’s initiatives to promote high definition products sales and upgrades as well as growth in our cable operations, home and network services businesses. Work order volume from DIRECTV for the year ended December 31, 2007, increased by 15.3% from the year ended December 31, 2006. In addition to the benefits of this increase in volume, there was also a favorable rate impact realized in the year due to the rate increases initiated in the second quarter of 2007. Different rates are earned for each type of service completed and the mix of services (installations, upgrades and service) impacts both the revenue per call and number of service calls that may be completed. The financial impact of the volume and rate increase, partially offset with the less favorable rate and mix, was $42.4 million for the year ended December 31, 2007.

 

For the year ended December 31, 2007, cable operations continued to grow, particularly in Rogers Communications and Time Warner, which experienced increases of 60% and 24%, respectively, partially offset by a reduction in revenue at certain other cable operations. Overall cable revenues for the year ended December 31, 2007 were 10% greater than in the year ended December 31, 2006. Revenue for our network services business for the year ended December 31, 2007 were 2% greater than in the year ended December 31, 2006, and revenue of our 180 Home business grew by 85% off a relatively small base.

 

Revenue from the majority of our customers is recognized when work orders are closed. Our contracts with our customers also include mechanisms whereby we are not paid for certain work that is not completed within the specifications of the contract. Based upon historical payments, we calculate and estimate a reserve against revenue each month. For the year ended December 31, 2007, $5.7 million (1.5% of revenue) was recorded as a deduction to revenue as compared to $5.0 million (1.5% of revenue) for the year ended December 31, 2006.

 

Direct Contribution Margin

 

DCM, defined as revenue less direct operating expenses, increased by $4.6 million, or 13.4%, from $34.1 million for the year ended December 31, 2006 to $38.7 million for the year ended December 31, 2007. The increase in DCM is primarily due to the revenue growth discussed above and reductions in insurance expense, partially offset by an increase in fuel prices. DCM, as a percentage of revenue DCM decreased from 10.3% in 2006 to 10.2% in 2007.

 

DCM is a non-GAAP measure. The comparable GAAP measure is loss from continuing operations. Loss from continuing operations of $22.9 million in the year ended December 31, 2007 increased by $14.1 million compared to loss from continuing operations of $8.8 million in the year ended December 31, 2006. The following is a reconciliation of DCM to loss from continuing operations, the comparable GAAP measure.

Reconciliation of DCM to Loss from Continuing Operations

 

 

 

 

General and Administrative Expenses, Restructuring Costs and Non-Cash Stock-Based Compensation

 

General and administrative expenses were $19.2 million for the year ended December 31, 2007, a decrease of $0.5 million from the year ended December 31, 2006. General and administrative expenses as a percentage of revenue decreased to 5.0% for the year ended December 31, 2007 from 5.9% for the year ended December 31, 2006. The decrease in general and administrative expenses is primarily due to lower legal and professional fees in 2007. Stock-based compensation was $0.9 million for the year ended December 31, 2007, as a result of the grant of employee stock options, restricted stock units, and share appreciation rights compared to $0.1 million for the year ended December 31, 2006.

 

In addition to the general and administrative expenses above, there were restructuring charges of approximately $0.3 million and $0.9 million for the years ended December 31, 2007 and December 31, 2006, respectively, due to the completion of our relocation of our corporate offices to Denver, Colorado.

 

EBITDA from Continuing Operations

 

EBITDA from continuing operations for the year ended December 31, 2007 increased to $19.3 million from $13.5 million in the year ended December 31, 2006, an increase of $5.8 million or 42.8%. This increase is primarily attributed to an increase in direct contribution margin discussed above. For the year ended December 31, 2007, EBITDA includes $0.9 million in non-cash compensation expense related to our Long-Term Incentive Plan, as well as $0.3 million for restructuring, $0.8 million for costs incurred in

connection with the registration and listing of 180 Connect (Canada)’s shares on a U.S. exchange, which was subsequently abandoned in connection with the Arrangement, and non capitalized costs related to the consummation of the Arrangement.

 

EBITDA is a non-GAAP measure. The comparable GAAP measure is loss from continuing operations. Loss from continuing operations was $22.9 million and $8.8 million for the years ended December 31, 2007 and December 31, 2006, respectively. The following is a reconciliation of EBITDA to loss from continuing operations, the comparable GAAP measure.

 

Reconciliation of EBITDA to Loss from Continuing Operations

 

 

 

 

Depreciation and Amortization of Customer Contracts

 

For the year ended December 31, 2007, depreciation expense of $12.1 million represents a decrease of $1.3 million from the year ended December 31, 2006. This decrease is primarily attributable to the change in useful life of the vehicles from 48 months in 2006 to 60 months in 2007 in order to better reflect the useful life of the asset. Amortization of customer contracts was $3.7 million for the years ended December 31, 2007 and December 31, 2006.

 

Other Income and Expense and Interest and Loan Fees

 

Interest and loan fees were $16.3 million for the year ended December 31, 2007, an increase of $6.2 million over the year ended December 31, 2006. This increase is due in part to a $1.4 million commitment fee and $0.2 million management fee paid to Laurus to secure additional financing to fund working capital prior to the Arrangement. The amortization of deferred financing costs, re-pricing of warrants, accretion attributed to the warrants associated with the convertible debentures and Laurus long-term debt financing also increased interest and loan fees by approximately $4.6 million for the year ended December 31, 2007.

 

During the third quarter of 2006, we recognized a gain of $1.2 million on the extinguishment of debt that we had with a previous lender. The gain was a result of our negotiations with our prior lender reducing the amount of our final payment including any accrued interest to an agreed upon amount below what had previously been recorded by us.

The (gain) loss on sale of investments and assets reflects a $1.4 million increase to the loss from continuing operations for the year ended December 31, 2007 as compared to year ended December 31, 2006. In the first quarter of 2006, we sold our interest in Control F-1 Corporation (“Control F-1”) to Computer Associates International, Inc. and Computer Associates Canada Company for net proceeds of $1.3 million, which was recognized as a pre-tax gain of $1.3 million in the year ended December 31, 2006. The investment had been previously written down to zero in 2004 due to prevailing market conditions. In addition, we had a loss on the disposal of assets of $0.7 million and $0.6 million for the year ended December 31, 2007 and December 31, 2006, respectively.

 

The loss on fair value of derivative liabilities was $5.0 million for the year ended December 31, 2007, compared to a gain on fair value of derivative liabilities of $1.4 million for the year ended December 31, 2006. In the third quarter of 2007, the convertible debt holders redeemed the convertible debt for cash. The loss on the fair market value of the embedded derivatives for the year ended December 31, 2007 was $2.6 million, compared to a gain on the embedded derivatives of $1.3 million in the comparable period in 2006. The gain on the fair value of the convertible debt warrants was $0.9 million for the year ended December 31, 2007 compared to a gain of zero for the year ended December 31, 2006. For the year ended December 31, 2007, the loss on the fair value of the public warrants was $0.6 million as compared to zero for the year ended December 31, 2006. In connection with the Arrangement, two unrelated third parties agreed with180 Connect (Canada) to purchase 400,000 and 100,000 shares, respectively, of AVP and to vote these shares in favor of the Arrangement at the August 24, 2007 AVP shareholders meeting. 180 Connect (Canada) agreed to a make whole formula with these individuals to be settled within 30 days of consummation of the Arrangement. The consummation of the Arrangement resulted in a $2.8 loss on the fair value of derivative liabilities for the year ended December 31, 2007 compared to zero for the year ended December 31, 2006.

 

For the year ended December 31, 2007, we had $3.6 million in other expenses, primarily attributed to bonuses earned by certain of our directors and employees as a result of the consummation of the Arrangement.

 

Income Tax Expense (Benefit)

 

We recorded income tax expense of $0.9 million and an income tax benefit of $1.5 million for the years ended December 31, 2007 and December 31, 2006, respectively.

 

Loss from Continuing Operations

 

Loss from continuing operations for the year ended December 31, 2007 was $22.9 million compared to a loss from continuing operations of $8.8 million for the year ended December 31, 2006 for reasons discuss above.

 

Loss from Discontinued Operations

 

Loss from discontinued operations related to the closure of operations at certain non-profitable branches as well as certain operations where the contracts with the customers were not renewed for the year ended December 31, 2007 was $2.0 million compared to loss from discontinued operations of $5.8 million for the year ended December 31, 2006. The revenue and expenses of these locations have been reclassified as discontinued operations for all periods presented.

 

Net Loss

 

Net loss for the year ended December 31, 2007 was $24.9 million compared to a net loss of $14.6 million for the year ended December 31, 2006.

Results of Operations

 

Comparison of Years Ended December 31, 2006 and 2005

 

 

 

 

Revenue

 

Revenue for the year ended December 31, 2006 increased to $331.2 million from $278.6 million for the year ended December 31, 2005. This 18.9% increase reflects continued growth in revenue resulting from DIRECTV channeling more work through their home services provider network and increased

customer demand resulting from advanced product penetration as well as growth in our cable, digital interiors and network services businesses. Advanced product penetration refers to installations and upgrades that we completed with DVR, HD or an HD/DVR receiver. These increases are due to DIRECTV’s marketing efforts to promote the installation and upgrades. Work order volume from DIRECTV for the year ended December 31, 2006 increased by 20.7% year over year. The benefits of this increase were partially offset by the impact of a less favorable mix. Different rates are earned for each type of service completed and the mix of services (installations, upgrades and service) impact both the revenue per call and number of service calls that may be completed. The financial impact of the volume increase, partially offset with the less favorable rate and mix, was $36.5 million for the year ended December 31, 2006.

 

Throughout 2006 our cable operations continued to grow, adding new operations serving customers such as WoW in Detroit and Time Warner in Greensboro, and expanding current operations for our customers Cablevision, Time Warner and Rogers Communications.

 

Additionally, the New Orleans operation servicing Cox Communication has been completely rebuilt after hurricane Katrina and is operating at pre-Katrina levels. We continued to dedicate resources to supporting growth of our cable business which resulted in a $12.1 million, or 35%, increase in revenue over the prior year.

 

Revenue from the majority of our customers is recognized when work orders are closed. Our contracts with our customers also include mechanisms whereby we are not paid for certain work that is not completed within the specifications of the contract. Based upon historical payments, we calculate and estimate a reserve against revenue each month. For the year ended December 31, 2006, $5.0 million (1.5% of revenue) was recorded as a deduction to revenue as compared to $3.7 million (1.3% of revenue) for the year ended December 31, 2005.

 

Direct Contribution Margin

 

DCM, defined as revenue less direct operating expenses, increased by $10.6 million, or 45.0%, from $23.5 million in the year ended December 31, 2005 to $34.1 million in the year ended December 31, 2006. DCM, as a percentage of revenue, increased to 10.3% in 2006 from 8.4% in 2005.

 

This increase is due to the revenue growth in our satellite and cable businesses as well as the consistently increasing contribution from our network services, retail and 180 Home businesses which accounted for over $2.2 million of the improvement in 2006. We continued rolling out our perpetual inventory system throughout our operations. The rollout was completed in the second quarter of 2007. This system is expected to improve our inventory process and reduce unnecessary costs currently being incurred. The increase of DCM is also a result of the lack of significant start-up operations in the cable business as well as the absence of the effects of Hurricane Katrina, which temporarily closed operations in Louisiana and Texas and resulted in nationwide increases in fuel prices.

 

DCM is a non-GAAP measure. The comparable GAAP measure is loss from continuing operations. Loss from continuing operations of $8.8 million in the year ended December 31, 2006 increased by $3.6 million compared to loss from continuing operations of $5.2 million in the year ended December 31, 2005. See reconciliation of DCM to loss from continuing operations, the comparable GAAP measure.

Reconciliation of DCM to Loss from Continuing Operations

 

 

 

 

General and Administrative Expenses, Restructuring Costs and Stock-Based Compensation

 

General and administrative expenses were $19.7 million for the year ended December 31, 2006, a decrease of $2.0 million or 9.3% from the year ended December 31, 2005. General and administrative expenses as a percentage of revenue decreased from 7.8% for the year ended December 31, 2005 to 5.9% for the year ended December 31, 2006. The decrease in general and administrative expenses is primarily due to lower salary, consulting and travel expenses of approximately $2.3 million, partially offset by certain non-capitalized expenses related to the refinancing of our debt, legal and professional fees related to our U.S. listing costs totaling approximately $1.5 million. Stock-based compensation was $0.1 million for the year ended December 31, 2006, compared to $1.4 million for the year ended December 31, 2005 due to stock compensation related to the 2003 acquisition of the remaining 7% interest in Cable Play Inc.

 

In addition to the general and administrative expenses above is a restructuring charge of approximately $0.9 million for employee severance and related costs associated with the completion of the move of our back office operations and corporate offices to Denver. The comparable period of 2005 reflects a restructuring charge of $1.7 million related to the commencement of our move of our back office operations and corporate offices.

 

EBITDA from Continuing Operations

 

EBITDA from continuing operations for the year ended December 31, 2006 increased to $13.5 million from $0.2 million for the year ended December 31, 2005. This $13.3 million increase is primarily attributed

to the increase in revenue and direct contribution margin discussed above and the full effect of our fleet initiative compared to the four month effect in 2005. The fleet initiative transferred some of the vehicle costs to depreciation and interest; this benefit was partially offset by higher fuel and vehicle insurance costs which are included in EBITDA from continuing operations. Additionally, we continue our efforts to maximize the use of our current resources and operating synergies.

 

EBITDA is a non-GAAP measure. The comparable GAAP measure is loss from continuing operations. Loss from continuing operations was $8.8 million and $5.2 million for the year ended December 31, 2006 and December 31, 2005, respectively.

 

Reconciliation of EBITDA to Loss from Continuing Operations

 

 

 

 

Depreciation, Amortization of Customer Contracts and Impairment of Goodwill and Customer Contracts

 

During the year ended December 31, 2006, depreciation expense of $13.4 million represents an increase of $7.3 million from the similar period in 2005. This increase is primarily attributable to the increase in our vehicle fleet from approximately 750 owned vehicles in 2005, most of which were fully depreciated, to approximately 2,600 owned vehicles. Amortization of customer contracts of $3.7 million in the year ended December 31, 2006 decreased by $0.4 million from 2005 primarily due to the discontinuation and impairment of certain operations during the second half of 2005.

 

Other Income and Expense

 

Interest and loan fees were $10.0 million in 2006 and increased by $6.6 million from 2005, primarily due the completion of the refinancing of our debt and interest related to a private placement of $10.7 million of convertible debentures and warrants completed late in the first quarter of 2006. Interest expense also increased due to the financing related to our newly acquired vehicle fleet. In the first quarter of 2006, we completed our conversion from a privately owned vehicle model to a Company owned vehicle model with the purchase of approximately 2,600 vehicles. These vehicles have been acquired through a capital lease program and are included in the capital lease obligations set forth in our audited consolidated financial statements for the year ended December 31, 2006.

We recognized a gain of $1.2 million on the extinguishment of debt that we had with our previous lender. The gain was a result of our negotiations with that prior lender reducing the amount of our final payment to an agreed upon amount below what had previously been recorded by us.

 

We sold our interest in Control F-1 to Computer Associates International, Inc. and Computer Associates Canada Company in 2006, for net proceeds of $1.3 million, which was recognized as a pre-tax gain of $1.3 million. The investment had been previously written down to zero in 2004 due to prevailing market conditions. In 2006, we also had a loss of $0.3 million on the disposal of assets, and a loss of 0.3 million on the refinancing of vehicles under capital lease. The $6.9 million pre-tax gain on the sale of investments and assets in 2005 was due to the gain on the sale of Guest-Tek of $6.5 million and a $0.4 million gain on the sale of a building.

 

The gain on fair value of derivative liabilities was $1.4 million for the year ended December 31, 2006, primarily due to the gain on the embedded derivatives of $1.3 million compared to zero in 2005.

 

Income Tax Benefit

 

For the year ended December 31, 2006, we recorded a net $1.5 million income tax benefit, which includes a current tax benefit of $0.1 million for state tax liabilities and a deferred tax benefit of $1.6 million to record the amortization of the deferred tax liability associated with certain intangible assets (customer contracts) recognized as part of the acquisition of a U.S. subsidiary and the establishment of a deferred tax asset associated with nondeductible liabilities in the subsidiary.

 

For the year ended December 31, 2005, we recorded a net $2.0 million income tax benefit which consisted of a U.S. federal and state current income tax benefit of $0.5 million, a deferred U.S. federal and state income tax benefit of $2.6 million and a Canadian income tax provision of $1.1 million.

 

Loss from Continuing Operations

 

Loss from continuing operations for the year ended December 31, 2006 was $8.8 million compared to loss from continuing operations of $5.2 million for the comparable period of 2005.

 

Loss from Discontinued Operations

 

Loss from discontinued operations for the year ended December 31, 2006 was $5.8 million compared to loss from discontinued operations of $3.3 million for the year ended December 31, 2005 related to the closure of operations at certain non-profitable branches as well as certain operations where the contracts with the customers were not renewed. The revenue and expenses of these locations have been reclassified as discontinued operations for all periods presented.

 

Net Loss

 

Net loss for the year ended December 31, 2006 was $14.6 million compared to a net loss of $8.5 million for the year ended December 31, 2005.

 

Liquidity and Capital Resources

 

Our primary sources of liquidity are our cash provided by our operating activities and our borrowings under our credit facilities. Cash provided by continuing operations for the year ended December 31, 2007 was $1.5 million.

 

As a result of the Arrangement, we received $37.9 million in proceeds and incurred $7.0 million in issuance costs. The consummation of the Arrangement constituted an event of default under 180 Connect (Canada)’s convertible debentures. In the third quarter of 2007, the holders of the convertible debentures exercised their right to redeem the convertible debentures in full. We paid the holders of the convertible debentures $10,393,577, which included outstanding principal and a 20% redemption premium, excluding accrued but unpaid interest. On August 24, 2007, upon consummation of the Arrangement, we repaid

Laurus $5.0 million principal on the term note. We also used $0.2 million of the merger proceeds to purchase 500,000 shares of treasury stock and $2.8 million in settlement of derivative liabilities. The remaining proceeds will be used to fund working capital and corporate expenses.

 

Our revolving credit facility (the ’Revolver”) requires a lockbox arrangement, which provides for all receipts to be swept daily to reduce borrowings outstanding under the credit facility. This arrangement, combined with the existence of a subjective acceleration clause in the revolving credit facility, requires that the borrowings under the Revolver be classified as a current liability on the balance sheet in accordance with the Financial Accounting Standards Board (“FASB”) Emerging Issues Task Force Issue No. 95-22, “Balance Sheet Classification of Borrowings Outstanding under Revolving Credit Agreements that Include Both a Subjective Acceleration Clause and a Lock-Box Arrangement” (“EITF 95-22”). The amount outstanding under the Revolver was previously classified as long-term debt as of December 31, 2006 and the balance sheet has been restated to correct the classification of the balance due under the Revolver to current portion of long-term debt as of December 31, 2006 increasing the current portion of long-term debt by $20,534,422 to $26,502,096 from the amount previously reported of $5,967,674. The restatement had no impact on previously reported consolidated statements of operations, shareholders’ equity, or cash flows.

 

The acceleration clause could allow the lender to forego additional advances should they determine there has been a material adverse change in the Company’s financial position or prospects reasonably likely to result in a material adverse effect on the Company’s business, condition (financial or otherwise), operations, performance or properties. We believe that no such material adverse change has occurred; further, as of March 27, 2008, our lender had not informed us that any such event had occurred.

 

Agreements with Laurus

 

On August 1, 2006, 180 Connect, Inc., a Nevada corporation and indirect, wholly-owned subsidiary of the company (“180 Connect (NV)”) entered into a Security and Purchase Agreement with Laurus for the refinancing of its long-term debt. The original agreement provided up to $57 million of debt comprised of a $37 million revolving credit and over-advance facility and a $20 million term facility, with an interest rate of prime plus 3% on the revolving credit facility, subject to a minimum interest rate of 10%, an interest rate of prime plus 5% on any over-advance under the revolving credit facility, subject to a minimum interest rate of 11% and an interest rate of prime plus 5% on the term facility, subject to a minimum interest rate of 12%. For the period from August 1, 2006 to July 31, 2007, 180 Connect (NV) was able to draw in excess of the eligible trade receivables and inventory an over advance amount up to $9 million but not to exceed an aggregate amount of $37 million. Availability under the revolving facility fluctuates daily based on receivables. As of March 20, 2008, 180 Connect (NV) had availability of $4.5 million under the revolving facility, and the total balance outstanding thereunder was $23.6 million. Monthly principal repayments on the term loan of $666,667 commenced February 1, 2007, and as of March 20, 2008, the term loan had a principal balance of $5.7 million. Repayment of 180 Connect (NV)’s indebtedness to Laurus is secured by all of its real and personal property.

 

180 Connect (NV) is not subject to any financial covenants with respect to the credit facilities. However, 180 Connect (NV) is subject to other covenants including certain restrictions on it and its subsidiaries with respect to assuming or guaranteeing additional indebtedness, forgiving any indebtedness, issuing any preferred stock, purchasing stock (other than of a subsidiary), making loans other than loans to employees or to its subsidiaries, entering into a merger, consolidation or reorganization, materially changing the nature of its business, changing its accounting practices and disposing of its assets. In addition, the failure to make required payments under the facilities or other indebtedness, the failure to adhere to a covenant or the occurrence of material adverse changes to its business, bankruptcy, certain changes to its ownership or Board of Directors, among other events, could result in an event of default under the facilities. As of December 31, 2007, 180 Connect (NV) was in compliance with the covenants of its credit facilities. 180 Connect (NV) obtained a consent and waiver from Laurus with regards to the Arrangement as it constituted a merger and change of control as defined in Section 13(h)(viii) and 19(l) of the Security and Purchase Agreement, respectively.

In addition, in August 2006, 180 Connect (Canada) issued a warrant to Laurus to purchase up to 1,200,000 common shares for nominal consideration of CDN$0.01 per share. On April 2, 2007, Laurus exercised its right under the warrant to purchase the 1,200,000 common shares. Laurus agreed not to sell any common shares issued upon exercise of the warrant until July 31, 2007. Thereafter, Laurus may, at its election, sell up to 150,000 common shares per calendar quarter (on a cumulative basis) over each of the following eight quarters, subject to applicable securities laws restrictions and limitations.

 

On July 2, 2007, 180 Connect (NV) entered into an amendment agreement with Laurus securing additional interim financing to fund working capital until August 24, 2007. Pursuant to the terms of the agreement, Laurus agreed to provide an additional $8.0 million to 180 Connect (NV) as an increase to the $37.0 million revolving loan, for a total revolving loan of $45.0 million. As part of this agreement, Laurus also agreed to extend the maturity of the existing $9.0 million over-advance letter on a revolving loan from July 31, 2007 until August 24, 2007. At August 24, 2007, 180 Connect (NV) had no outstanding borrowings under either the additional $8.0 million revolving loan or the existing $9.0 million over-advance facility.

 

In connection with the amendment agreement, Howard S. Balter and Ilan M. Slasky, members of our Board of Directors, agreed to provide a limited recourse guaranty for the additional financing Laurus provided to 180 Connect (NV) by placing $7.0 million in a brokerage account pledged to Laurus to be used solely to purchase AVP shares.

 

Laurus also agreed to loan $10.0 million to a special purpose corporation for the purpose of purchasing shares of AVP common stock. The special purpose corporation is a third-party arms-length corporation to both 180 Connect (Canada) and AVP. Neither the special purpose corporation nor Laurus agreed to make any specific amount of purchases or to vote any shares purchased in any specific manner in connection with the Arrangement.

 

As consideration for the guaranty and pledge, 180 Connect (Canada) agreed to reimburse Messrs. Balter and Slasky up to $150,000 for their fees and expenses in connection with the guaranty and pledge.

 

On July 2, 2007, in connection with the amendment to the credit facility, we issued a warrant to Laurus to purchase 600,000 shares of the 180 Connect (Canada)’s common stock at the exercise price of $4.35 per share, the adjusted market price at the time of issue (the “July Warrant”). Thereafter, on August 24, 2007, in connection with consummation of the Arrangement, we issued to Laurus a warrant to purchase 250,000 shares of our common stock at the exercise price of $4.01 per share (the “August Warrant”). Each of the July Warrant and August Warrant has a five year term and is subject to a one-year lock-up. Additionally, Laurus received a $200,000 management fee on the $8.0 million increase to the revolver, and upon consummation of the Arrangement, an additional $1.4 million.

 

During the third quarter of 2007, we entered into a settlement agreement with Laurus with respect to a dispute over an alleged misrepresentation and event of default under the provisions of the Laurus debt agreements that Laurus alleged occurred as a result of the repayment of the convertible dentures after consummation of the Arrangement. Pursuant to the terms of the settlement, we agreed to reduce the exercise price of the warrants issued to Laurus. With respect to the July Warrant, the exercise price for the first 450,000 shares of our common stock exercised by Laurus was reduced from $4.35 to $0.01 per share, and the exercise price of the remaining 150,000 warrants was reduced from $4.35 to $3.00 per share. Laurus has agreed not to sell any of our common shares issuable upon exercise of the July Warrant for a period of twelve months following the date of issuance of the warrants. In addition, the exercise price of the August Warrant was reduced from $4.01 to $3.00 per share.

 

On January 22 and January 30, 2008, pursuant to the Schedule 13D filed by Creative Vistas Inc., Laurus and its affiliates sold 2,674,407 shares of our common stock and their warrant to purchase 450,000 shares of our common stock to Creative Vistas Inc., respectively.

Private Placement

 

On March 22, 2006, 180 Connect (Canada) completed a private placement to a group of institutional investors. For an aggregate purchase price of $10.7 million, the investors purchased convertible debentures and warrants to purchase 942,060 common shares. The convertible debentures accrued interest at a rate of 9.33% per annum, payable quarterly, in arrears, based on a 360-day year. The debentures were to mature on March 22, 2011. In addition, the debentures were to accelerate to maturity upon the occurrence of a default on the debentures by 180 Connect (Canada). The terms of the debentures allowed the investors, at their discretion, to convert all or part of the debentures into its common shares. The aggregate number of common shares to be delivered upon such conversion was approximately 2.7 million shares, subject to adjustment in accordance with the terms of the debentures and subject to additional contractual limitations as described in the debentures. During the second quarter of 2007, one of the institutional investors of the convertible debentures and warrants exercised its option to convert in total $2,024,785 of principal under the 9.33% convertible debentures into 510,000 common shares. The consummation of the Arrangement constituted an event of default under 180 Connect (Canada)’s convertible debentures. In the third quarter of 2007, the lenders exercised their right to redeem the convertible debentures in full. We paid the holders of the convertible debentures $10,393,577, which included outstanding principal and a 20% redemption premium, excluding accrued but unpaid interest.

 

The warrants to purchase 942,060 common shares issued to the investors in the private placement are exercisable until March 21, 2010. The exercise price of the warrants is $4.331; subject to adjustment in accordance with the terms of the warrants (which adjustment is limited and capped as described in the warrants). The warrants may be exercised through a cashless exercise if there is no effective registration statement covering the resale of the underlying shares.

 

Vehicle Leasing Arrangements

 

In 2005, 180 Connect (Canada) entered into agreements with third party leasing companies to lease vehicles pursuant to its fleet expansion program with initial obligations amounting to $39.4 million. As of December 31, 2007, 180 Connect (Canada) has approximately 3,000 vehicles under capital leases with a remaining contractual capital lease obligation of $28.6 million. These vehicles have been recorded as capital leases in the consolidated balance sheets.

 

Cash Flow from Operating Activities

 

For the years ended December 31, 2007 and December 31, 2006, cash provided by operating activities was $1.5 million and $6.3 million, respectively. Inventory increased by $4.4 million in 2007 primarily due to more advanced equipment on hand. Restricted cash provided $4.3 million primarily as a result of a negotiated reduction in our required LOC for insurance obligations. Other changes in non-cash working capital balances related to operations contributed to the remainder of the decrease.

 

For the years ended December 31, 2006 and December 31, 2005, cash provided by (used in) operating activities was $6.3 million and $(15.5) million, respectively. The increase in cash provided by operating activities in 2006 was due to an increase in depreciation, amortization and impairment and amortization of deferred financing costs and accretion of loan discount of $20.3 million. The increase in depreciation, amortization and impairment related, primarily, to the financing of our vehicle leases. The reduction in inventory balances of $4.5 million was the result of improved inventory management and payment terms. The payment terms for equipment purchased from DIRECTV are 30-45 days from the shipment date, depending upon the product type. These terms have a positive affect on operating cash flows because DIRECTV pays us for inventory consumed on average twenty days after it is received. These positive cash flows were offset by an increase in insurance premium deposits of $6.2 million as we increased the collateral related to the renewal of our insurance program. In 2005, accounts receivable increased by $6.5 million and restricted cash increased by $8.7 million as we increased the collateral related to the renewal of our insurance program. An increase in accounts payable and accrued liabilities of

$14.3 million and an increase in inventory of $2.4 million were directly related to our business relationship with DIRECTV.

 

Cash Flow from Investing Activities

 

Our historical investing activities consisted primarily of the purchase of property, plant and equipment and business acquisitions and divestments.

 

For the years ended December 31, 2007 and December 31, 2006, cash used in investing activities was $3.4 million and $1.4 million, respectively, which includes $3.4 million and $2.7 million, respectively, for the purchase of property, plant and equipment. In the year ended December 31 2006, we realized net proceeds of $1.3 million for the sale of our remaining interest in Control F-1.

 

In 2005, cash provided by investing activities was $21.7 million. The increase in cash provided by investing activities during the period was primarily attributable to the sale of short term investments of $16.2 million, proceeds from the sale of the common shares of Guest-Tek of $10.0 million, and $2.0 million on sale of investment in Wal-Mart Stores, offset by capital expenditures of $5.7 million.

 

Cash Flow from Financing Activities

 

Our financing activities have historically consisted primarily of the use of revolving lines of credit, term loans, debentures, capital leases and the issuance of equity. For the years ended December 31, 2007 and December 31, 2006, cash used in financing activities was $0.6 million and $5.3 million, respectively. As a result of the Arrangement, we received $37.9 million in proceeds and incurred $7.0 million in issuance costs. As discussed above, in the third quarter of 2007, the convertible debentures were redeemed in full for 120% of the outstanding principal in the amount of $10.4 million, excluding any accrued interest. In 2007, we paid Laurus $12.3 million principal on the term note which includes $5.0 million principal on the term note upon the consummation of the Arrangement. In 2007, we also purchased 500,000 shares of treasury stock at cost of $0.2 million and made $12.1 million in scheduled vehicle lease payments. The refinancing of approximately 1,020 vehicles with a third-party leasing company under a capital lease resulted in net proceeds of approximately $3.5 million.

 

For the year ended 2006, cash used in financing activities was $5.3 million. In the third quarter of 2006, the refinancing of the long term debt provided $42.1 million used to extinguish 180 Connect (Canada)’s previous debt of $32.9 million plus issuance costs of $3.5 million. In 2006, we completed a private placement of $10.7 million of convertible debentures and warrants. This was offset by the payment of $15.0 million for capital lease obligations primarily related to our new fleet and the repayment of $7.7 million of our long term debt pursuant to agreements with our lenders.

 

In 2005, cash used in financing activities was $15.3 million. Cash flow from financing activities in 2005 was attributable to the repayment of long-term debt of $6.9 million, $5.0 million paid in connection with capital lease financing associated with 180 Connect (Canada)’s new fleet in 2005 and a settlement with the sellers of Mountain Center Inc (“Mountain”) for $2.95 million relating to 180 Connect (Canada)’s purchase of that company. We also paid $1.2 million to repurchase 175,320 shares which was approved by our Board of Directors in 2005.

 

As of December 31, 2007, we did not have any restricted cash invested in asset backed commercial paper. An assumed one percentage point increase or decrease in interest rates would have the effect of increasing or decreasing interest expense by approximately $0.3 million for the year ended December 31, 2007.

 

The working capital deficiency at December 31, 2007 was due, primarily, to the 30-45 day payment terms for inventory purchased from DIRECTV and the approximately 20-day receivable terms from DIRECTV for that inventory when it is installed in the subscriber’s home and the reclassification of our Revolver facility from long term debt to current.

We believe that cash flow from continuing operations and availability under existing credit facilities will be sufficient to meet our short-term and long-term requirements for ongoing operations and planned growth. However, we derive a significant portion of our revenue from a limited number of customers. A decision by a major customer to discontinue, in whole or in part, use of our services in the future may adversely affect our capital resources. Also, there can be no assurance that we would have sufficient liquidity or be able to obtain additional financing on satisfactory terms, or at all, in the event the Revolver repayment was accelerated. See “Risk Factors” in Item 1A of this Annual Report on Form 10-K.

 

Contractual Obligations

 

We have long-term debt obligations, various operating leases and purchase commitments for equipment. The amount of estimated future payments under such agreement is detailed in the following table.

 

 

 

 

Off-Balance Sheet Obligations

 

For the consolidated financial statements presented there were no off-balance sheet transactions entered into. Off-balance sheet obligations include any contractual agreement with an entity not reported on a consolidated basis with us. We did not have any obligations under guaranteed contracts for financing instruments, a retained or contingent interest in assets transferred to an unconsolidated entity, any obligations under derivative interests or any special purpose entity transactions.

 

Forward-Looking Statements

 

This MD&A contains forward-looking statements which reflect management’s expectations regarding our future growth, results of operations, performance and business prospects and opportunities. Statements about our future plans and intentions, results, levels of activity, performance, goals or achievements or other future events constitute forward-looking statements. Wherever possible, words such as “may”, “should”, “could”, “expect”, “plan”, “intend”, “anticipate”, “believe”, “estimate”, “predict” or “potential” or the negative or other variations of these words, or other similar words or phrases, have been used to identify these forward-looking statements. These statements reflect management’s current beliefs and are based on information currently available to management. Forward-looking statements involve significant risk, uncertainties and assumptions. Many factors, including those discussed under Item 1A, “Risk Factors,” of this Annual Report on Form 10-K could cause actual results, performance or achievements to differ materially from the results discussed or implied in the forward-looking statements. These factors should be considered carefully and prospective investors should not place undue reliance on the forward-looking

statements. Although the forward-looking statements contained in this MD&A are based upon what management believes to be reasonable assumptions, we cannot assure investors that actual results will be consistent with these forward-looking statements. These forward-looking statements are made as of the date of this MD&A, and we assume no obligation to update or revise them to reflect new events or circumstances, except as required by law.

 

Non-GAAP Measures

 

The term “Direct Contribution Margin” consists of revenue less direct expenses and excludes general and administrative expense, foreign exchange loss (gain), (gain) loss in sale of investments and assets, depreciation, amortization of customer contracts, interest and loan costs, (gain) loss on change in fair value of derivative liabilities, gain on extinguishment of debt, other expense, and income tax expense (benefit). DCM, as referred to in this discussion and analysis, is a non-GAAP measure which does not have any standardized meaning prescribed by GAAP and is therefore unlikely to be comparable to similar measures presented by other issuers. We believe that this term provides a better assessment of the contribution of the field operations dealing directly with our customers’ subscribers by eliminating: (1) the general and administrative costs that are not part of the direct costs of generating revenue; (2) the charge for customer contracts and depreciation which are non-cash expense items; and (3) (gain) loss on sale of investments and assets, (gain) loss on change in fair value of derivative liabilities, gain on extinguishment of debt, and other expense, which are not considered to be in the normal course of operating activity. Investors should be cautioned, however, that DCM should not be construed as an alternative to loss from continuing operations determined in accordance with GAAP as an indicator of our performance. For a reconciliation of DCM to the comparable GAAP measure, loss from continuing operations, see “Direct Contribution Margin”.

 

The term “EBITDA from continuing operations” refers to loss from continuing operations before deducting depreciation, amortization of customer contracts, (gain) loss in sale of investments and assets, interest and loan fees, (gain) loss on change in fair value of derivative liabilities, gain on extinguishment of debt, other expense, and income tax expense (benefit). EBITDA from continuing operations, as referred to in this MD&A, is a non-GAAP measure which does not have any standardized meaning prescribed by GAAP and is therefore unlikely to be comparable to similar measures presented by other issuers. Management believes that EBITDA from continuing operations provides a better assessment of cash flow from our operations by eliminating: (1) the charge for depreciation, and amortization of customer contracts which are non-cash expense items and (2) (gain) loss on sale of assets, (gain) loss on change in fair market value of derivative liabilities, gain on extinguishment of debt, and other expense, which are not considered to be in the normal course of operating activity. In addition, financial analysts and investors use a multiple of EBITDA from continuing operations for valuing companies within the same sector, in order to eliminate the differences in accounting treatment from one company to the next. Given that we are in a growth stage, we believe the focus on EBITDA from continuing operations gives the investor or reader of our consolidated financial statements and MD&A more insight into the operating capabilities of management and its utilization of our operating assets. Management further believes that EBITDA from continuing operations is also the best metric for measuring our valuation. Investors should be cautioned, however, that EBITDA from continuing operations should not be construed as an alternative to income (loss) from continuing operations determined in accordance with GAAP as an indicator of our performance. For a reconciliation of EBITDA from continuing operations to the comparable GAAP measure, being loss from continuing operations, see “EBITDA from Continuing Operations”.

 

Item 7A.  Quantitative And Qualitative Disclosures About Market Risk

 

We are exposed to market risk related to changes in interest rates and fluctuations in foreign currency rates. Our long-term debt is a variable rate credit facility that exposes us to interest rate risk. The interest rates on our long-term debt range from prime plus 3% to prime plus 5%, subject to a minimum interest rate of 10% to 12%, and are therefore subject to risk relating to interest rate fluctuations. An assumed one percentage point increase or decrease in interest rates would have the effect of increasing interest

expense by approximately $0.3 million. We have Canadian subsidiaries included in our consolidated statements of operations and consolidated balance sheets and we are subject to fluctuations in the exchange rate of the Canadian dollar to the U.S. dollar.

 

 

Our consolidated financial statements and related notes and Reports of Independent Registered Public Accounting Firms follow on subsequent pages of this report Form 10-K.

Report of Independent Registered Public Accounting Firm

 

The Board of Directors and Shareholders of 180 Connect Inc.

 

We have audited the accompanying consolidated balance sheet of 180 Connect Inc. as of December 31, 2007, and the related consolidated statements of operations, shareholders’ equity, comprehensive loss, and cash flows for the year then ended. Our audit also included the 2007 financial statement schedule listed in the Index at Item 15. These financial statements and schedule are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements and schedule based on our audit.

 

We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. We were not engaged to perform an audit of the Company’s internal control over financial reporting. Our audit included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion.

 

In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of 180 Connect Inc. at December 31, 2007, and the consolidated results of their operations and their cash flows for the year then ended, in conformity with U.S. generally accepted accounting principles. Also, in our opinion, the related financial statement schedule, when considered in relation to the basic financial statements taken as a whole, presents fairly in all material respects the information set forth therein.

 

/s/ Ernst & Young LLP

 

Denver, Colorado

March 27, 2008

Report of Independent Registered Public Accounting Firm

 

The Board of Directors and Shareholders of 180 Connect Inc.

 

We have audited the accompanying consolidated balance sheet of 180 Connect Inc. as of December 31, 2006, and the related consolidated statements of operations, shareholders’ equity, comprehensive loss, and cash flows for the years ended December 31, 2006 and 2005. Our audits also included the 2006 and 2005 financial statement schedule listed in the Index at Item 15. These financial statements and schedule are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements and schedule based on our audits.

 

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. We were not engaged to perform an audit of the Company’s internal control over financial reporting. Our audits included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

 

In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of 180 Connect Inc. at December 31, 2006, and the consolidated results of its operations and its cash flows for the years ended December 31, 2006 and 2005 in conformity with U.S. generally accepted accounting principles. Also, in our opinion, the related financial statement schedule, when considered in relation to the basic financial statements taken as a whole, presents fairly in all material respects the information set forth therein.

 

As described in Note 12 the consolidated balance sheet as at December 31, 2006 has been restated.

 

Consolidated Financial Statements

 

 

180 Connect Inc.
Consolidated Balance Sheets

 

 

See accompanying notes

180 Connect Inc.

 

Consolidated Statements of Operations

 

 

 

 

See accompanying notes

180 Connect Inc.

 

Consolidated Statements of Shareholders’ Equity

 

 

180 Connect Inc.

Consolidated Statements of Comprehensive Loss

 

 

See accompanying notes

180 Connect Inc.

 

Consolidated Statements of Cash Flows