[July 29, 2011] WPCS INTERNATIONAL INC - 10-K - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Tweet (Edgar Glimpses Via Acquire Media NewsEdge) This Management's Discussion and Analysis of Financial Condition and Results of Operations includes a number of forward-looking statements that reflect Management's current views with respect to future events and financial performance. You can identify these statements by forward-looking words such as "may" "will," "expect," "anticipate," "believe," "estimate" and "continue," or similar words. Those statements include statements regarding the intent, belief or current expectations of us and members of its management team as well as the assumptions on which such statements are based. Prospective investors are cautioned that any such forward-looking statements are not guarantees of future performance and involve risk and uncertainties, and that actual results may differ materially from those contemplated by such forward-looking statements. Readers are urged to carefully review and consider the various disclosures made by us in this report and in our other reports filed with the Securities and Exchange Commission. Important factors currently known to Management could cause actual results to differ materially from those in forward-looking statements. We undertake no obligation to update or revise forward-looking statements to reflect changed assumptions, the occurrence of unanticipated events or changes in the future operating results over time. We believe that its assumptions are based upon reasonable data derived from and known about our business and operations and the business and operations of the Company. No assurances are made that actual results of operations or the results of our future activities will not differ materially from its assumptions. Factors that could cause differences include, but are not limited to, expected market demand for the Company's services, fluctuations in pricing for materials, and competition. Business Overview and Recent Developments We are a global provider of design-build engineering services for communications infrastructure, with over 500 employees in 10 operation centers on three continents. We provide our engineering capabilities including wireless communication, specialty construction and electrical power to a diversified customer base in the public services, healthcare, energy and corporate enterprise markets worldwide. Wireless Communication Throughout the community or around the world, in remote and urban locations, wireless networks provide the connections that keep information flowing. The design and deployment of a wireless network solution requires an in-depth knowledge of radio frequency engineering so that wireless networks are free from interference with other signals and amplified sufficiently to carry data, voice or video with speed and accuracy. We have extensive experience and methodologies that are well suited to address these challenges for our customers. We are capable of designing wireless networks and providing the technology integration necessary to meet goals for enhanced communication, increased productivity and reduced costs. We have the engineering expertise to utilize all facets of wireless technology or combination of various technologies to develop a cost effective network for a customer's wireless communication requirements. This includes Wi-Fi networks, point-to-point systems, mesh networks, microwave systems, cellular networks, in-building systems and two-way communication systems. Specialty Construction We offer specialty construction services for building design including the design and integration of mechanical, electrical, hydraulic and life safety systems in an environmentally safe manner. We work through all phases of the building design and construction to evaluate the design for cost, flexibility, efficiency, productivity and overall environmental impact. Next, we have established capabilities in transportation infrastructure. In the developing world, urbanization has created increased mobility, placing great demands on transportation infrastructure. Governments are responding by making the construction of safe, efficient roads a priority. New systems are needed for traffic monitoring, traffic signaling, video surveillance and smart message signs to communicate information advisories. We are providing design-build engineering services for these technologically advanced systems. Lastly, as world economies are growing, standards of living are improving and energy supplies are dwindling. It is a scenario that has accelerated the search for new energy sources and better ways of delivery existing supply. We are contributing in both of these critical areas. We design and deploy renewable energy solutions in wind and solar power. Through a unique combination of scientific, geologic, engineering and construction expertise, we offer solutions in site design, solar installation, meteorological towers and wind turbine installation. In addition, we support energy companies as they maximize the efficiency of their energy supply infrastructure, by providing a range of services from pipeline trenching to the deployment of wireless solutions. 20 --------------------------------------------------------------------------------Electrical Power Electrical power transmission and distribution networks built years ago often cannot fulfill the growing technological needs of today's end users. We provide complete electrical contracting services to help commercial and industrial facilities of all types and sizes to upgrade their power systems. Our capabilities include power transmission, switchgear, underground utilities, outside plant, instrumentation and controls. We provide an integrated approach to project coordination that creates cost-effective solutions. In addition, corporations, government entities, healthcare organizations and educational institutions depend on the reliability and accuracy of voice, data and video communications. However, the potential for this new technology cannot be realized without the right electrical infrastructure to support the convergence of technology. In this regard, we create integrated building systems, including the installation of advanced structured cabling systems and electrical networks. We support the integration of telecommunications, fire protection, security and HVAC in an environmentally safe manner and design for future growth by building in additional capacity for expansion as new capabilities are added. For the fiscal year ended April 30, 2011, wireless communication represented approximately 28.9% of our total revenue, specialty construction represented approximately 13.0% of our total revenue and electrical power represented approximately 58.1% of our revenue. For the fiscal year ended April 30, 2010, wireless communication represented approximately 28.5% of our total revenue, specialty construction represented approximately 14.2% of our total revenue and electrical power represented approximately 57.3% of our revenue. Industry Trends We focus on markets such as public services, healthcare, energy and international which continue to show strong growth potential, and we continue to bid and be awarded projects in these markets. · Public services. We provide communications infrastructure for public services which includes police, fire, emergency dispatch, utilities, education, military and transportation infrastructure. We believe there is an active market for communications infrastructure in the public service sector due to the need to replace out-dated equipment with new technology. During fiscal 2011, we experienced a decrease in public services revenue compared to fiscal 2010 due to what we consider as a temporary slowdown in spending on public services projects. We believe that the public services sector will continue to benefit from the American Recovery and Reinvestment Act of 2009 (ARRA), which has made funding available for state and local municipalities nationwide, and we are currently performing work on certain projects that have been funded with ARRA funds. Of the $787 billion in total funding, according to the latest report from a July 2010 article by The New York Times, approximately $32 billion has been allocated for communications infrastructure projects to be completed over the next several years which fit our service capabilities. · Healthcare. We provide communications infrastructure for hospitals and medical centers. In the healthcare market, according to the latest report in October 2008 from Market Research, the aging population and the need to reduce labor costs through the implementation of advanced communications technology is driving projected expenditures of $3 billion per year over the next few years. · Energy. We provide communications infrastructure for petrochemical, natural gas, electric utilities and alternative energy. The need to deliver basic energy more efficiently and to create new energy sources is driving the growth in energy construction. This creates opportunities to upgrade and deploy new communications technology which creates the demand for communications infrastructure. According to a July 2010 article by The New York Times, the ARRA legislation has allocated approximately $36 billion in funding for energy and conservation projects over the next few years which fit our service capabilities. · International. We provide communications infrastructure internationally for a variety of companies and government entities. China is spending on building its internal infrastructure and Australia is upgrading their infrastructure. Both China and Australia have experienced positive GDP growth rates. Our international revenue continues to grow, representing approximately 17% of consolidated revenue for the year ended April 30, 2011, compared to 9% of consolidated revenue for the year ended April 30, 2010. 21--------------------------------------------------------------------------------Current Operating Trends and Financial Highlights Management currently considers the following events, trends and uncertainties to be important in understanding our results of operations and financial condition during the current fiscal year: · In regards to our fiscal year 2011 financial performance, as with many companies in our industry, we have experienced difficult economic conditions and competitive gross margin pressure resulting in lower revenue and gross margins compared to fiscal 2010. In addition, we experienced significant losses on certain projects which adversely impacted our financial results for fiscal year 2011. As a result, for the fiscal year ended April 30, 2011, we reported a net loss of approximately $37 million, which includes non-cash charges of approximately $33.5 million for the impairment of goodwill and $869,000 for the impairment of customer lists in certain of our reporting units as a result of the carrying value of these intangible assets exceeding the respective fair values. The non-cash charges have no impact on our operations or cash flows. The net loss also includes $624,000 of one-time costs associated with exploring strategic alternatives, including the possible sale of our company. During fiscal 2011, we implemented management changes and implemented cost reduction strategies to improve our future operations and reduce future operating expenses. Although the economy has not yet fully recovered and will continue to present challenges for our business, we expect we will return to profitability in fiscal 2012. The markets we serve in public services, healthcare, and energy continue to afford opportunities to grow our business; · Two of our most important economic indicators for measuring our future revenue producing capability and demand for our services continue to be our backlog and bid list. Our backlog of unfilled orders was approximately $45 million at April 30, 2011, compared to backlog of $32 million at January 31, 2011 and backlog of $49 million at April 30, 2010. Our bid list, which represents project bids under proposal for new and existing customers, was approximately $147 million at April 30, 2011, compared to approximately $131 million at April 30, 2010. We believe our bid list at April 30, 2011 represents a normal bid level and we expect our bid list to remain in a range of $125 million to $175 million. We continue to bid and be awarded projects in the public service, healthcare and renewable energy markets. We believe there is an active market for communications infrastructure in the public services sector that will allow us to continue to grow this market. In the healthcare market, we continue to receive bid requests and complete new projects, as the primary drivers in this market continue to be the need to provide healthcare infrastructure for an aging population and to cut costs in delivering healthcare. The ARRA legislation also provides $32 billion for healthcare infrastructure spending. In the energy market, we continue to receive bid requests and complete new projects as oil, gas, water and electric utility companies continue to upgrade their communications infrastructure, while in renewable energy the growth in wind and solar power development is expected to continue. The ARRA legislation also provides $36 billion for energy infrastructure spending. Our opportunity to obtain work related to the ARRA legislation depends on the timing of funding allocations and our ability to receive bid requests and be awarded new projects; however, we believe that our experience in performing work in each of these sectors will result in continued bid activity in the near future while ARRA funding continues to be made available; · We believe our design-build engineering focus for public services, healthcare, energy and corporate enterprise infrastructure will create additional opportunities both domestically and internationally. We believe that the ability to provide comprehensive communications infrastructure services including wireless communication, specialty construction and electrical power gives us a competitive advantage. We expect an increase in backlog in the future as a result of the current level of bid activity for communication infrastructure services in both project opportunities generated from the ARRA legislation and general projects from our diversified customer base; · We continue to focus on expanding our international presence in China and Australia, and we believe that these markets have not been impacted as much by recent economic conditions. In China, our focus is primarily in the energy market, and in Australia primarily on the corporate enterprise market. During the third fiscal quarter, the flooding in Australia contributed to temporary delays in completing projects, however, we believe that there are future opportunities to grow our revenue in this market with the rebuilding that has commenced. Our international revenue continues to grow, representing 17.4% of consolidated revenue for the year ended April 30, 2011, compared to 9% of consolidated revenue for the year ended April 30, 2010; and · In regards to strategic development, our internal focus is on organic growth opportunities. We have engaged an investment bank to assist us in exploring strategic alternatives, including the consideration of a possible sale of our company. As a result of exploring strategic initiatives, effective June 1, 2011, we executed the non-binding letter of intent to be acquired by Multiband for $3.20 per share in cash. 22--------------------------------------------------------------------------------Results of Operations for the Fiscal Year Ended April 30, 2011 Compared to Fiscal Year Ended April 30, 2010 The consolidated financial statements in this Annual Report on Form 10-K includes the accounts of WPCS International Incorporated (WPCS) and its wholly and majority-owned subsidiaries, as follows, collectively referred to as "we", "us" or the "Company". Domestic operations include WPCS Incorporated, WPCS International - Suisun City, Inc. (Suisun City Operations), WPCS International - St. Louis, Inc. (St. Louis Operations), WPCS International - Lakewood, Inc. (Lakewood Operations), WPCS International - Hartford, Inc. (Hartford Operations), WPCS International - Sarasota, Inc. (Sarasota Operations), WPCS International - Trenton, Inc. (Trenton Operations), WPCS International - Seattle, Inc. (Seattle Operations), and WPCS International - Portland, Inc. (Portland Operations). International operations include WPCS Asia Limited, Taian AGS Pipeline Construction Co. Ltd. (China Operations), and WPCS Australia Pty Ltd, WPCS International - Brisbane, Pty Ltd., WPCS International - Brendale, Pty Ltd., and The Pride Group (QLD) Pty Ltd. (Pride), (collectively the Australia Operations). Consolidated results for the years ended April 30, 2011 and 2010 were as follows. Years Ended April 30, 2011 2010 REVENUE $ 96,836,728 100.0 % $ 105,769,432 100.0 % COSTS AND EXPENSES: Cost of revenue 78,910,135 81.5 % 77,930,126 73.7 % Selling, general and administrative expenses 24,920,538 25.7 % 23,454,081 22.2 % Depreciation and amortization 2,754,961 2.8 % 2,729,882 2.6 % Goodwill and intangible assets impairment 34,370,285 35.6 % - 0.0 % Change in fair value of acquisition-related contingent consideration 217,571 0.2 % 125,092 0.1 % Total costs and expenses 141,173,490 145.8 % 104,239,181 98.6 % OPERATING (LOSS) INCOME (44,336,762 ) (45.8 %) 1,530,251 1.4 % OTHER EXPENSE (INCOME): Interest expense 655,944 0.6 % 397,765 0.4 % Interest income (48,364 ) 0.0 % (15,849 ) 0.0 % (LOSS) INCOME BEFORE INCOME TAX ( BENEFIT) PROVISION (44,944,342 ) (46.4 %) 1,148,335 1.0 % Income tax (benefit) provision (7,938,430 ) (8.1 %) 576,226 0.5 % CONSOLIDATED NET (LOSS) INCOME (37,005,912 ) (38.3 %) 572,109 0.5 % Net loss attributable to noncontrolling interest (174,491 ) 0.2 % (282,292 ) (0.3 %) NET (LOSS) INCOME ATTRIBUTABLE TO WPCS $ (36,831,421 ) (38.1 %) $ 854,401 0.8 % 23 --------------------------------------------------------------------------------Revenue Revenue for the year ended April 30, 2011 was approximately $96,837,000, as compared to $105,769,000 for the year ended April 30, 2010. The decrease in revenue for the year was primarily attributable to what we believe was a temporary slowdown in spending for public services projects at the state and local government level, resulting in reductions, delays or postponements of these projects in all three segments of our business. This decrease was partially offset by an increase in revenue from the acquisition of Pride. For the years ended April 30, 2011 and 2010, there were no customers which comprised more than 10% of total revenue. Wireless communication segment revenue for the years ended April 30, 2011 and 2010 was approximately $27,979,000 or 28.9% and $30,163,000 or 28.5% of total revenue, respectively. The decrease in revenue was due primarily to reductions, delays or postponements of projects at the state and local government level for public services projects. Specialty construction segment revenue for the years ended April 30, 2011 and 2010 was approximately $12,630,000 or 13.0% and $15,050,000 or 14.2% of total revenue, respectively. The decrease in revenue was due primarily to a decrease in revenue from existing operations from the timing and completion of work on certain larger projects last year. The decrease in organic growth is due to a project award of approximately $11.7 million for the School District of Philadelphia which was completed in the second quarter of fiscal 2011, and had commenced in the third quarter of fiscal 2010. Electrical power segment revenue for the years ended April 30, 2011 and 2010 was approximately $56,227,000 or 58.1% and $60,556,000 or 57.3% of total revenue, respectively. The decrease in revenue was due primarily to a decrease in revenue from existing operations. Current economic conditions have negatively affected the public services sector and our electrical power segment in California, with general spending slowed at the state and local government level, and secondarily from the timing and completion of less work on certain larger projects in fiscal year 2011 compared to the prior year. This decrease was partially offset by an increase in revenue from the acquisition of Pride. Cost of Revenue Cost of revenue consists of direct costs on contracts, materials, direct labor, third party subcontractor services, union benefits and other overhead costs. Our cost of revenue was approximately $78,910,000 or 81.5% of revenue for the year ended April 30, 2011, compared to $77,930,000 or 73.7% for the prior year. The dollar increase in our total cost of revenue is due to significant cost overruns on two projects in our Suisun City operations center and one project in our Portland operations center, and competitive pressure on work performed in the public services sector. The 7.8% increase in cost of revenue as a percentage of revenue is due to the blend of project revenue attributable to our existing operations and recent acquisition, and the project cost overruns described above. Historically, over the past three fiscal years, our cost of revenue as a percentage of revenue was ranged from approximately 73% to 82%. The cost of revenue percentage is expected to vary depending on our mix of project revenue. However, we expect our future consolidated cost of revenue to be lower as a percentage of revenue compared to fiscal 2011, as we have recorded the job losses related to these significant project cost overruns described above, and implemented changes to prevent such significant costs overruns in the future, and as a result such losses are not expected to recur or continue in fiscal 2012. Wireless communication segment cost of revenue and cost of revenue as a percentage of revenue for the years ended April 30, 2011 and 2010 was approximately $20,962,000 and 74.9% and $22,696,000 and 75.2%, respectively. The dollar decrease in our cost of revenue is due to the corresponding decrease in revenue during the year ended April 30, 2011. The slight decrease in cost of revenue as a percentage of revenue was due primarily to the revenue blend attributable to our existing operations. Specialty construction segment cost of revenue and cost of revenue as a percentage of revenue for the years ended April 30, 2011 and 2010 was approximately $9,255,000 and 73.3% and $10,732,000 and 71.3%, respectively. As discussed above, the dollar decrease in our total cost of revenue is due to the corresponding decrease in revenue during the year ended April 30, 2011. The increase as a percentage of revenue is due primarily to the blend of project revenue attributable to our existing operations. Electrical power segment cost of revenue and cost of revenue as a percentage of revenue for the years ended April 30, 2011 and 2010 was approximately $48,693,000 and 86.6% and $44,502,000 and 73.5%, respectively. The dollar increase in our total cost of revenue is primarily due to the cost overruns on the two projects in Suisun City and one project in Portland referred to above. The increase as a percentage of revenue is due primarily to additional loss accruals for the same project cost overruns described above, and from the lower gross margin earned on electrical power work performed in the public services sector as a result of increased competitive pressure. Current economic conditions have negatively affected the public services sector and our electrical power segment in California, with general spending slowed at the state and local government level due to a decrease in tax revenue and credit impediments. Unfortunately we have experienced higher costs of revenue in this sector due to increased competitive pressure for remaining public service bids, with California being more adversely impacted from competition than the other operations in this segment. We expect our future electrical power segment cost of revenue to be lower as a percentage of revenue compared to fiscal 2011, as we have recorded the job losses related to these significant project cost overruns described above, and implemented changes to prevent such significant cost overruns in the future, and as a result such losses are not expected to recur or continue in fiscal 2012. 24--------------------------------------------------------------------------------Selling, General and Administrative Expenses For the year ended April 30, 2011, total selling, general and administrative expenses were approximately $24,921,000, or 25.7% of total revenue compared to $23,454,000, or 22.2% of revenue for the prior year. The dollar increase in the selling, general and administrative expenses is due primarily to the reserves for bad debt and secondarily to the acquisition of Pride. Included in selling, general and administrative expenses for the year ended April 30, 2011 are $13,869,000 for salaries, commissions, payroll taxes and other employee benefits. The $136,000 increase in salaries and payroll taxes compared to the prior year is due primarily to the increase in headcount as a result of the acquisition of Pride, partially offset by a decrease in the administrative overhead headcount from the consolidation of certain operations. Professional fees were $2,020,000, which is primarily related to the accounting, legal and investor relation fees. The net $518,000 increase in professional fees compared to the prior year is due primarily to $624,000 of investment banking services from a third party in connection with pursuing strategic alternatives, offset by lower professional fees for other services elsewhere. Insurance costs were $2,309,000 and rent for office facilities was $1,073,000. Automobile and other travel expenses were $1,606,000 and telecommunication expenses were $540,000. Other selling, general and administrative expenses totaled $3,504,000. For the year ended April 30, 2011, total selling, general and administrative expenses for the wireless communication, specialty construction and electrical power segments were approximately $6,914,000, $3,190,000 and $10,941,000, respectively, with the balance of approximately $3,876,000 pertaining to corporate expenses. For the year ended April 30, 2010, total selling, general and administrative expenses were approximately $23,454,000, or 22.2% of total revenue. Included in selling, general and administrative expenses for the year ended April 30, 2010 are $13,733,000 for salaries, commissions, payroll taxes and other employee benefits. Professional fees were $1,502,000, which include accounting, legal and investor relation fees. Insurance costs were $2,486,000 and rent for office facilities was $1,087,000. Automobile and other travel expenses were $1,955,000 and telecommunication expenses were $607,000. Other selling, general and administrative expenses totaled $2,084,000. For the year ended April 30, 2010, total selling, general and administrative expenses for the wireless communication, specialty construction and electrical power segments were approximately $6,573,000, $2,295,000 and $11,194,000, respectively, with the balance of $3,392,000 pertaining to corporate expenses. Depreciation and Amortization For the years ended April 30, 2011 and 2010, depreciation was approximately $2,185,000 and $2,064,000, respectively. The increase in depreciation is due to the purchase of property and equipment and the acquisition of fixed assets from Pride. The amortization of customer lists and backlog for the year ended April 30, 2011 was $570,000 as compared to $666,000 for the same period of the prior year. The net decrease in amortization was due primarily to certain customer lists and backlog being fully amortized in the current year compared to the prior year. All customer lists are amortized over a period of three to nine years from the date of their acquisitions. Backlog is amortized over a period of one to three years from the date of acquisition based on the expected completion period of the related contracts. Goodwill and Intangible Assets Impairment For the fiscal year ended April 30, 2011, we recorded a total goodwill impairment charge of $33,501,509. Based on a combination of factors that occurred in the second quarter of fiscal 2011, including the operating results and the transition of the former management team in our Suisun City reporting unit, management concluded that an interim goodwill impairment triggering event had occurred, and accordingly performed a testing of the carrying value of $7.9 million of goodwill for the Suisun City reporting unit. After this testing, management concluded that the carrying value of the Suisun City reporting unit exceeded the fair value of this reporting unit. The implied fair value of the goodwill of the Suisun City reporting unit was calculated by allocating the fair values of substantially all of its individual assets, liabilities and identified intangible assets as if Suisun City had been acquired in a business combination. As a result, we recorded a non-cash goodwill impairment charge of $6.9 million for Suisun City. As previously discussed, we entered into a non-binding letter of intent to be acquired by Multiband at a cash price of $3.20 per common share for our outstanding common stock, or a market capitalization of approximately $22.3 million, which was significantly less than our book value. We considered the significant difference between the market capitalization and book value an indicator that the aggregate fair value of its reporting units may be less than the carrying amounts in performing its annual step one test for goodwill impairment. As a result, we determined that, except for the carrying value of Pride, included within the Australia Operations reporting unit, the carrying value of all other reporting units exceeded its respective fair values, or failing the first step of the goodwill impairment test. As a result, we recorded an additional estimated non-cash goodwill impairment charge of $26,601,509 in the fourth quarter of the year ended April 30, 2011. At April 30, 2011, we determined that the customer lists for certain of the Australia operations, Portland, Sarasota and Suisun City reporting units were impaired due to projected future operating performance. As a result, we recorded an impairment charge related to these customer lists of $868,777. 25 --------------------------------------------------------------------------------This impairment charge is a non-cash charge that does not impact our consolidated cash flows. Change in Fair Value of Acquisition-Related Contingent Consideration For the years ended April 30, 2011 and 2010, the change in fair value of acquisition-related contingent consideration was approximately $218,000 and $125,000, respectively. The change in fair value of acquisition-related contingent consideration is due to the non-cash expense recorded in the fiscal 2011 income statement for the change in present value of the expected future payments of acquisition-related contingent consideration related to the Pride acquisition. Interest Expense and Interest Income For the years ended April 30, 2011 and 2010, interest expense was approximately $656,000 and $398,000, respectively. The increase in interest expense is due primarily to the payment of additional fees related to the forbearance agreement and amendment, and amortization of remaining debt issuance costs due to the classification of the outstanding borrowings as short term liabilities compared to the year ended April 30, 2010. For the years ended April 30, 2011 and 2010, interest income was approximately $48,000 and $16,000, respectively. The increase in interest earned is due principally to an increase in interest income in our Australia Operations compared to the same period in the prior year. Net (Loss) Income Attributable to WPCS The net loss attributable to WPCS was approximately $36,831,000 for the year ended April 30, 2011. Net loss was net of Federal and state income tax benefit of approximately $7,938,000. The decrease in the effective tax rate was due to permanent differences, including the $21,595,858 of goodwill impairment charges and the $217,570 non cash expense resulting from the increase in the fair value of the acquisition-related contingent consideration not deductible for tax purposes, and federal income taxes due on state income tax refunds received. In addition, the rate increase is due to the difference between U.S. and foreign income tax rates, as foreign pre-tax losses provided less consolidated income tax benefit due to lower income tax rates than if tax-effected in the U.S. The net income attributable to WPCS was approximately $854,000 for the year ended April 30, 2010. Net income was net of Federal and state income tax expense of approximately $576,000. Liquidity and Capital Resources At April 30, 2011, we had working capital of approximately $14,774,000, which consisted of current assets of approximately $39,369,000 and current liabilities of $24,595,000. Management believes that through a combination of internally available funds, operating expense management and future operating income, we have sufficient capital to meet our liquidity and capital resources requirements for the next twelve months. Our cash and cash equivalents balance at April 30, 2011 of $4,879,000 included $907,000 of cash in our Australia Operations associated with our permanent reinvestment strategy. We do not believe that indefinite reinvestment of these funds offshore impairs our ability to meet our domestic debt or working capital obligations. Our working capital needs are influenced by our level of operations, and generally increase with higher levels of revenue. Our sources of cash in the last several years have come from operating activities and credit facility borrowings. Our future operating results may be affected by a number of factors including our success in bidding on future contracts and our continued ability to manage our controllable operating costs effectively. To the extent we grow by future acquisitions that involve consideration other than stock, our cash requirements may increase. Our capital requirements depend on numerous factors, including the market for our services, the resources we devote to developing, marketing, selling and supporting our business, and the timing and extent of establishing additional markets and other factors. Operating activities provided approximately $112,000 in cash for the year ended April 30, 2011. The sources of cash from operating activities total approximately $7,747,000, comprised of a $2,584,000 decrease in accounts receivable, a $4,211,000 decrease in costs and estimated earnings in excess of billings on uncompleted contracts, a $474,000 decrease in inventory, a $173,000 increase in billings in excess of costs and estimated earnings on uncompleted contracts, a $275,000 increase in deferred revenue and a $30,000 decrease in other assets. The uses of cash from operating activities total approximately $7,635,000, comprised of an approximately $4,546,000 net loss (excluding approximately $32,460,000 in net non-cash charges), a $699,000 increase in prepaid expenses and other current assets, a $941,000 decrease in accounts payable and accrued expenses and $1,449,000 from the fluctuations in income taxes payable and prepaid taxes. Working capital provided cash of approximately $4,658,000 in fiscal 2011 versus utilizing cash of approximately $1,102,000 in fiscal 2010. Working capital components provided cash in fiscal 2011 primarily from net collections of accounts receivable and lower costs in excess of billings. 26-------------------------------------------------------------------------------- Our investing activities utilized approximately $2,216,000 in cash during the year ended April 30, 2011, which consisted of approximately $1,194,000 paid for property and equipment, and approximately $1,022,000, we paid for the first contingent consideration earn out payment related to the acquisition of Pride. Our financing activities provided cash of approximately $1,182,000 during the year ended April 30, 2011. Financing activities included the additional borrowings under lines of credit of $1,374,000, offset by the repayment of loan payables and capital lease obligations of approximately $149,000, and $43,000 in repayments to joint venture partner. Bank of America Loan Agreement and Default On April 10, 2010, we renewed our loan agreement (Loan Agreement) with Bank of America, N.A. (BOA), for three years under terms similar to the prior loan agreement with BOA, including the same customary covenants. The Loan Agreement provides for a revolving line of credit in an amount not to exceed $15,000,000, together with a letter of credit facility not to exceed $2,000,000. We also entered into a security agreement with BOA, pursuant to which we granted a security interest to BOA in all of our domestic assets and 65% of the capital stock of our Australia Operations. The Loan Agreement contains customary covenants, including but not limited to (i) funded debt to tangible net worth and (ii) minimum interest coverage ratio. At April 30, 2011, outstanding borrowings were $7,000,000 under the Loan Agreement. For each of the quarters during fiscal 2011 and as of and for the year ended April 30, 2011, we were in default of the financial covenants under the Loan Agreement due to the operating losses incurred during this fiscal year. In the first quarter of fiscal 2011, we obtained a waiver for this non-compliance from BOA. However, as a result of the non-compliance with the financial covenants at the completion of our second fiscal quarter of 2011, on December 22, 2010 we executed the terms of a forbearance agreement with BOA (the Forbearance Agreement). On March 28, 2011 but effective February 28, 2011, we entered into a first amendment (the Forbearance Amendment) of the Forbearance Agreement. Under the terms of the Forbearance Amendment, BOA agreed not to exercise its rights or remedies against us as a result of these events of default until the earlier of (a) September 30, 2011 or (b) an event of termination under the Forbearance Agreement. During the term of the Forbearance Amendment, the available funds pursuant to the Loan Agreement will be limited to the lesser of (a) $7,000,000 or (b) a lower threshold based on the aggregate sum of (i) 70% of eligible accounts receivable (as defined in the Forbearance Agreement) which are not more than 90 days past original invoice date, plus (ii) 30% percent of eligible inventory (as defined in the Forbearance Agreement). Borrowings on the line of credit bear interest at BOA's prime rate plus two hundred basis points (5.25% at April 30, 2011). In connection with the execution and delivery of the waiver, Forbearance Agreement, and Forbearance Amendment, we paid BOA aggregate waiver and forbearance fees of $85,000. On June 28, 2011, we received a letter dated June 27, 2011 (the "Notice") from counsel to BOA pursuant to which BOA alleged that certain events of default considered to be events of termination under the Forbearance Agreement have occurred under the Loan Agreement (including the Forbearance Agreement), including failures to (i) provide a compliance certificate pursuant to section 8.2(f) of the Loan Agreement, (ii) maintain EBITDA on a quarterly basis of not less than $425,000 for the quarter ending April 30, 2011 pursuant to section 8.3 of the Loan Agreement, (iii) maintain, on a consolidated basis, a Funded Debt to Tangible Net Worth Ratio of not more than 1.00 to 1.00 as of April 30, 2011 pursuant to section 8.4 of the Loan Agreement, (iv) maintain, on a consolidated basis, an Interest Coverage Ratio, on a quarterly (and not a rolling four-quarter) basis, of at least 3.00 to 1.00 for the quarter ending April 30, 2011 pursuant to section 8.5 of the Loan Agreement, (v) maintain, on a consolidated basis, a Funded Debt to EBITDA Ratio on a quarterly basis of not more than 21.0 to 1.0 for the quarter ending April 30, 2011 pursuant to section 8.25 of the Loan Agreement, and (vi) maintain, on a consolidated basis, a Basic Fixed Charge Ratio of not less than 1.20 to 1.00 as of the April 30, 2011 quarter end pursuant to section 2(d)(iii) of the Forbearance Amendment. We have determined that we are in default of the financial covenants set forth in items (ii), (iv) and (vi) above based on our financial results for the year ended April 30, 2011. As a result of these defaults, BOA is entitled to exercise its rights and remedies pursuant to the Loan Agreement. BOA has advised us that it has reserved all of its available rights and/or remedies as a result of the defaults, including the right to stop making additional credit available to us, but BOA is evaluating its options and has not decided to take or forebear from taking any action at this time as a result of the events of default. Furthermore, BOA has not declared any and all of our obligations to be immediately due and payable, which totaled $5,560,977 at July 27, 2011. While we and BOA have commenced discussions concerning the Loan Agreement and the events of default, there can be no assurance that we and BOA will come to any agreement regarding repayment, future forbearance terms, waiver and/or modification of the Loan Agreement and/or the default of the financial covenants. 27 -------------------------------------------------------------------------------- For fiscal 2012, we expect a return to profitability. The return to profitability includes expected increases in revenue due to existing backlog and bids, revenue enhancements as well as revenue recognition on projects that were delayed from 2011. In addition, we have made management changes in the Suisun City operation, and have reduced selling, general and administrative costs through cost efficiency measures throughout the Company. Each of these activities is expected to return us to profitability in fiscal 2012. Our ability to continue as a going concern is dependent on the success of these actions. There can be no assurance that we will be successful in accomplishing our objectives. Although BOA has not demanded current payment on the amounts outstanding, at the same time we are managing our business for a return to profitability in fiscal 2012, we are also currently seeking alternatives to replace the Loan Agreement. Effective June 1, 2011, we executed a non-binding letter of intent to be acquired by Multiband. Currently, we anticipate that if the acquisition by Multiband is consummated, the Loan Agreement will be repaid by Multiband. In the event that the acquisition by Multiband does not close or the Loan Agreement is called prior to acquisition, we would seek alternative debt financing and we have already conducted discussions with other senior lenders to replace the Loan Agreement. We may not be successful in obtaining alternative debt financing or additional sources may not be available on acceptable terms. If the Loan Agreement is called and we were unable to obtain alternative debt financing, we would need to use our existing cash and cash equivalents. In the alternative, we could raise additional funds from a sale of common stock. On April 15, 2010 we filed a registration statement on Form S-3 using a "shelf" registration process. Under this shelf registration process, we may offer up to 2,314,088 shares of our common stock, from time to time, in amounts and at prices and terms that we will determine at the time of the offering. Each share of our common stock automatically includes one right to purchase one one-thousandth of a share of Series D Junior Participating Preferred Stock, par value $0.0001 per share, which becomes exercisable pursuant to the terms and conditions set forth in a Rights Plan Agreement with Interwest Transfer Co., Inc., as amended from time to time. If we sell any securities, the net proceeds will be added to our general corporate funds and may be used for general corporate purposes. To date, no shares of our common stock have been issued under this shelf registration statement and we may not be successful in issuing additional common stock on acceptable terms or at all. Other Short-Term Commitments The China Operations has outstanding loans due within the next twelve months to our joint venture partner, Taian Gas Group (TGG), of approximately $3,416,000. We expect for TGG to renew any remaining unpaid loan balances in its continued support of the China Operations consistent with historical practice. On November 4, 2009, we acquired Pride. The purchase price represents an amount up to $3,408,913 of which $1,975,429 was paid upon closing. Additional purchase price is paid by us to the former Pride shareholders based upon the achievement of earnings before interest and taxes (EBIT) targets for each of the twelve month periods ending October 31, 2010 and 2011, respectively. In fiscal 2011, we made the first contingent consideration payment of $1,022,003 (including currency exchange) to the former Pride shareholders as the Pride actual EBIT of $1,467,729 for the first twelve month period ended October 31, 2010 exceeded the EBIT target amount of $1,103,386 (the Target Amount). We will pay another $919,488 if Pride's EBIT for the twelve month period ending October 31, 2011 equals or exceeds the Target Amount. In the event that Pride's EBIT is less than the Target Amount for either measurement period, such $919,488 payment will be reduced by the percentage of the shortfall between the actual EBIT and the Target Amount. Following the first year contingent payment, and the recording of $217,570 of additional non-cash expense during fiscal 2011 for the change in the fair value of the contingent consideration from the present value of the future payments of this obligation, the fair value of the acquisition-related contingent consideration was $1,008,200 as of April 30, 2011. This additional expense is not deductible for income tax purposes. We determined the fair value of the obligation to pay the contingent consideration based on the probability-weighted income approach, using Level 3 measurement as defined in the ASC. The Level 3 measurement is based on significant inputs not observable in the market. These measurements included an estimated discount rate of 18.02%, future revenue growth rate of 10%, EBIT margins ranging from 7.5% to 13.32%, and weighted probability of EBIT achievement ranging from 0% to 100%. Pride is an electrical and security services provider specializing in the commercial and government sectors and focuses on low voltage security installations, alarm systems, video surveillance and access controls. The acquisition of Pride provides further international expansion into Australia. Backlog As of April 30, 2011, we had a backlog of unfilled orders of approximately $45.3 million compared to approximately $48.6 million at April 30, 2010. We define backlog as the value of work-in-hand to be provided for customers as of a specific date where the following conditions are met (with the exception of engineering change orders): (i) the price of the work to be done is fixed; (ii) the scope of the work to be done is fixed, both in definition and amount; and (iii) there is an executed written contract, purchase order, agreement or other documentary evidence which represents a firm commitment by the customer to pay us for the work to be performed. These backlog amounts are based on contract values and purchase orders and may not result in actual receipt of revenue in the originally anticipated period or at all. We have experienced variances in the realization of our backlog because of project delays or cancellations resulting from external market factors and economic factors beyond our control and we may experience such delays or cancellations in the future. Backlog does not include new firm commitments which may be awarded to us by our customers from time to time in future periods. These new project awards could be started and completed in this same future period. Accordingly, our backlog does not necessarily represent the total revenue that could be earned by us in future periods. 28--------------------------------------------------------------------------------Off-Balance Sheet Arrangements We have no off-balance sheet arrangements other than operating lease commitments. Critical Accounting Policies Financial Reporting Release No. 60, published by the SEC, recommends that all companies include a discussion of critical accounting policies used in the preparation of their financial statements. While all these significant accounting policies impact our financial condition and results of operations, we view certain of these policies as critical. Policies determined to be critical are those policies that have the most significant impact on our consolidated financial statements and require management to use a greater degree of judgment and estimates. Actual results may differ from those estimates. We believe that given current facts and circumstances, it is unlikely that applying any other reasonable judgments or estimate methodologies would cause a material effect on our consolidated results of operations, financial position or liquidity for the periods presented in this report. The accounting policies identified as critical are as follows: Use of Estimates In preparing financial statements in conformity with accounting principles generally accepted in the United States of America, management is required to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements and revenue and expenses during the reporting period. The most significant estimates relate to revenue recognition based on the estimation of percentage of completion on uncompleted contracts, valuation of inventory, allowance for doubtful accounts, realization of deferred tax assets, amortization methods and estimated lives of customer lists, acquisition-related contingent consideration and estimates of the fair value of reporting units and discounted cash flows used in determining whether goodwill has been impaired. Actual results could differ from those estimates. Accounts Receivable Accounts receivable are due within contractual payment terms and are stated at amounts due from customers net of an allowance for doubtful accounts. Credit is extended based on evaluation of a customer's financial condition. Accounts outstanding longer than the contractual payment terms are considered past due. The Company determines its allowance by considering a number of factors, including the length of time trade accounts receivable are past due, the Company's previous loss history, the customer's current ability to pay its obligation to the Company, and the condition of the general economy and the industry as a whole. The Company writes off accounts receivable when they become uncollectible against the allowance for doubtful accounts, and payment subsequently received on such receivables are credited to the allowance for doubtful accounts. Goodwill and Other Long-lived Assets We assess the impairment of long-lived assets whenever events or changes in circumstances indicate that their carrying value may not be recoverable from the estimated future cash flows expected to result from their use and eventual disposition. Our long-lived assets subject to this evaluation include property and equipment and amortizable intangible assets. We assess the impairment of goodwill annually as of April 30 and whenever events or changes in circumstances indicate that it is more likely than not that an impairment loss has been incurred. Intangible assets other than goodwill are reviewed for impairment whenever events or changes in circumstances indicate that the carrying value may not be fully recoverable. We are required to make judgments and assumptions in identifying those events or changes in circumstances that may trigger impairment. Some of the factors we consider include a significant decrease in the market value of an asset, significant changes in the extent or manner for which the asset is being used or in its physical condition, a significant change, delay or departure in our business strategy related to the asset, significant negative changes in the business climate, industry or economic condition, or current period operating losses, or negative cash flow combined with a history of similar losses or a forecast that indicates continuing losses associated with the use of an asset. 29 -------------------------------------------------------------------------------- Based on a combination of factors that occurred in the second quarter of fiscal 2011, including the operating results and the transition of the former management team in our Suisun City reporting unit, management concluded that an interim goodwill impairment triggering event had occurred, and accordingly performed a testing of the carrying value of $7.9 million of goodwill for the Suisun City reporting unit. After this testing, management concluded that the carrying value of the Suisun City reporting unit exceeded the fair value of this reporting unit. The implied fair value of the goodwill of the Suisun City reporting unit was calculated by allocating the fair values of substantially all of its individual assets, liabilities and identified intangible assets as if Suisun City had been acquired in a business combination. As a result, we recorded a non-cash goodwill impairment charge of $6.9 million for Suisun City. As further described in Note 16 of the consolidated financial statements, we entered into a non-binding letter of intent to be acquired for $3.20 in cash per each share for our outstanding common stock, or a market capitalization of approximately $22.3 million, which was significantly less than our book value. We considered the significant difference between the market capitalization and book value an indicator that the aggregate fair value of its reporting units may be less than the carrying amounts in performing its annual step one test for goodwill impairment. As a result, we determined that, except for the carrying value of Pride, included within the Australia Operations reporting unit, the carrying value of all other reporting units exceeded its respective fair values, thus failing the first step of the goodwill impairment test. Accordingly, we performed the second step of the goodwill impairment analysis and determined the estimated fair value of the impaired reporting units' goodwill using Level 3 measurement as defined in the ASC. The Level 3 measurements were based on significant inputs for each reporting unit not observable in the market using a discounted cash flow valuation technique, which includes an estimated discount rate range of 15.5% to 17.3%, future short and long term revenue growth rates ranging from using 0% to 3%, gross margins ranging from 10% to 35%, and selling general and administrative expenses at 5% to 29% of revenue. As a result, we recorded estimated non-cash goodwill impairment charges of $26,601,509 in the fourth quarter of the year ended April 30, 2011. The second step of the goodwill impairment testing is not yet completed, which we expect to complete in the first fiscal quarter of 2012, and includes calculating an implied fair value of the goodwill of the reporting units by allocating the fair values of substantially all of the individual assets, liabilities and identified intangible assets, as if each reporting unit had been acquired in a business combination. At April 30, 2011, we determined that the customer lists for certain of the Australia operations, Portland, Sarasota, St. Louis and Suisun City reporting units were impaired due to projected future operating performance. Using a discounted cash flow valuation technique, we determined that the carrying value of these customer lists exceeded the fair value. As a result, we recorded impairment charges regarding these customer lists of $868,777. Deferred Income Taxes We determine deferred tax liabilities and assets at the end of each period based on the future tax consequences that can be attributed to net operating loss carryovers and differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases, using the tax rate expected to be in effect when the taxes are actually paid or recovered. The recognition of deferred tax assets is reduced by a valuation allowance if it is more likely than not that the tax benefits will not be realized. The ultimate realization of deferred tax assets depends upon the generation of future taxable income during the periods in which those temporary differences become deductible. We consider past performance, expected future taxable income and prudent and feasible tax planning strategies in assessing the amount of the valuation allowance. Our forecast of expected future taxable income is based over such future periods that we believe can be reasonably estimated. Changes in market conditions that differ materially from our current expectations and changes in future tax laws in the U.S. may cause us to change our judgments of future taxable income. These changes, if any, may require us to adjust our existing tax valuation allowance higher or lower than the amount we have recorded. At April 30, 2011, we have net operating loss carryforwards for federal tax purposes approximating $3,804,000 expiring through 2031. We also have net operating losses for state tax purposes approximating $12,811,000 expiring through 2031. We evaluated the carryforward of these state losses by each operation, and determined that our WPCS, Hartford, Portland and Sarasota Operations are not expected to generate substantial profits in the near future. Due to the uncertainty of recognizing a tax benefit on these losses, we have provided a valuation allowance against approximately $10,679,000 of state losses at April 30, 2011. In addition, we provided a valuation allowance against deferred tax assets related to the future deduction of the amortization of goodwill, customer lists and stock compensation expense of $4,030,000, for a total valuation allowance of approximately $1,221,800 at April 30, 2011. The future use of some or all of such carried forward losses may be limited by Sec. 382 of the Internal Revenue Code in the event of an ownership change, such as the Multiband transaction described above. We expect to carryback the Federal loss of $3,877,019 to offset profits reported on the tax returns for fiscal year 2009 and fiscal year 2010, resulting in a Federal tax refund of $1,185,000 and release of foreign tax credit of $132,800. The $132,800 foreign tax credit expires in 2014. Due to the uncertainty of our receiving any foreign income in the future, we have provided for a full valuation allowance against the foreign tax credit. 30 --------------------------------------------------------------------------------Revenue Recognition We generate our revenue by providing design-build engineering services for communications infrastructure. Our engineering services report revenue pursuant to customer contracts that span varying periods of time. We report revenue from contracts when persuasive evidence of an arrangement exists, fees are fixed or determinable, and collection is reasonably assured. We record revenue and profit from long-term contracts on a percentage-of-completion basis, measured by the percentage of contract costs incurred to date to the estimated total costs for each contract. Contracts in process are valued at cost plus accrued profits less earned revenues and progress payments on uncompleted contracts. Contract costs include direct materials, direct labor, third party subcontractor services and those indirect costs related to contract performance. Contracts are generally considered substantially complete when engineering is completed and/or site construction is completed. We have numerous contracts that are in various stages of completion. Such contracts require estimates to determine the appropriate cost and revenue recognition. Cost estimates are reviewed monthly on a contract-by-contract basis, and are revised periodically throughout the life of the contract such that adjustments to profit resulting from revisions are made cumulative to the date of the revision. Significant management judgments and estimates, including the estimated cost to complete projects, which determines the project's percent complete, must be made and used in connection with the revenue recognized in the accounting period. Current estimates may be revised as additional information becomes available. If estimates of costs to complete long-term contracts indicate a loss, provision is made currently for the total loss anticipated. For the year ended April 30, 2011, we have provided aggregate loss provisions of approximately $946,000 related to anticipated losses on long-term contracts. The length of our contracts varies. Assets and liabilities related to long-term contracts are included in current assets and current liabilities as they will be liquidated in the normal course of contract completion, although this may require more than one year. We also recognize certain revenue from short-term contracts when equipment is delivered or the services have been provided to the customer. For maintenance contracts, revenue is recognized ratably over the service period. Recently Issued Accounting Pronouncements No recently issued accounting pronouncement issued or effective after the end of the fiscal year is expected to have a material impact on our consolidated financial statements. [ Back To TMCnet.com's Homepage ]