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AMERICAN ELECTRIC TECHNOLOGIES INC - 10-Q - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (in thousands, except share, per share and percentages)(Edgar Glimpses Via Acquire Media NewsEdge) The following discussion should be read in conjunction with the financial statements and notes thereto included elsewhere in this Form 10-Q and the financial statements in the 2011 Annual Report on Form 10-K filed on March 30, 2012. Historical results and percentage relationships set forth in the condensed consolidated statements of operations and cash flows, including trends that might appear, are not necessarily indicative of future operations or cash flows. FORWARD-LOOKING STATEMENTS Except for historical and factual information, this document contains "forward-looking statements" within the meaning of the Private Securities Litigation Reform Act of 1995. These forward-looking statements include statements that address activities, events or developments that we expect, believe or anticipate will or may occur in the future, such as predictions of future financial performance. All forward-looking statements are based on assumptions made by us based on our experience and perception of historical trends, current conditions, expected future developments and other factors we believe are appropriate under the circumstances. These statements, including statements regarding our capital needs, business strategy, expectations and intentions, are subject to numerous risks and uncertainties, many of which are beyond our control, including our ability to maintain key products' sales or effectively react to other risks including those discussed in Part I, Item 1A, Risk Factors, of our 2011 Annual Report on Form 10-K filed on March 30, 2012. We urge you to consider that statements that use the terms "believe," "do not believe," "anticipate," "expect," "plan," "estimate," "intend" and similar expressions are intended to identify forward-looking statements. No forward-looking statement can be guaranteed, and actual results may differ materially from those projected. We undertake no obligation to publicly update any forward-looking statement, whether as a result of new information, future events or otherwise. BUSINESS American Electric Technologies, Inc. is a leading global supplier of power delivery solutions to the energy industry. AETI offers M&I Electric™ power distribution and control products, electrical services, and E&I Construction services, as well as American Access Technologies zone enclosures, and Omega Metals custom fabrication services. South Coast Electric Systems L.L.C. a subsidiary, services U.S. Gulf Coast marine vessel customers. We report our business in three segments: Technical Products and Services ("TP&S"), Electrical and Instrumentation Construction ("E&I") and American Access Technologies ("AAT"). Foreign Joint Ventures We have interests in three joint ventures outside of the United States which are accounted for on the equity method: • BOMAY Electric Industries Company, Ltd. ("BOMAY"), in which the Company holds a 40% interest, BOMCO. (a subsidiary of China National Petroleum Corporation) holds a 51% interest, and AA Energies, Inc., holds a 9% interest; • M&I Electric Far East, Ltd. ("MIEFE"), in which the Company holds a 41% interest, MIEFE's general manager holds an 8% interest and, Oakwell Engineering, Ltd., of Singapore, holds a 51% interest, and; • AETI Alliance Group do Brazil Sistemas E Servicos Em Energia LTDA. ("AAG"), in which the Company holds a 49% interest and, Five Stars De Macae Servicos De Petroleo LTDA., of Brazil, holds a 51% interest. Industry Conditions Our power delivery products which support the various segments of the energy industry are capital intensive and cyclical in nature. The U.S. upstream, midstream and downstream oil & gas markets continues to favorably impact the demand for our technical products and services. Our products through our joint ventures in China, Singapore and Brazil continue to experience favorable market conditions related to the energy demands in these countries. Our industrial markets remain weak. As the company previously announced, we decided in the first quarter 2012 to exit the water and wastewater construction markets as we complete our existing backlog which is expected to be substantially completed by December 31, 2012. TP&S The TP&S segment has three main components: power distribution equipment, power conversion equipment and electrical services. 13-------------------------------------------------------------------------------- Table of Contents Our power distribution equipment group designs, manufactures, markets and provides products designed to distribute the flow of electricity for energy projects and protect electrical equipment such as motors, transformers and cables. The main products offered by this group include low and medium voltage ANSI ("American National Standards Institute") certified and IEC ("International Electrotechnical Commission") certified switchgear for generator control and power distribution applications. We also manufacture complimentary equipment including motor control centers (MCCs), bus duct, and the power control rooms that the power distribution equipment is located within for customer projects. Our power distribution solutions are primarily sold into the upstream, midstream and downstream oil & gas, the power generation and distribution markets, and the marine vessel and industrial markets. The Company provides switchgear for power generation applications up to 38,000 volts. We have recently expanded our offerings into the renewable energy marketplace with the introduction of the world's first switchgear designed for wind farm deployment, which includes our arc-mitigation technology. Arc-mitigation technology enables power system operators to significantly reduce the risk from arc-flash explosions and the resulting downtime and liability exposure. Our power conversion group provides products that convert AC and DC power into usable power using a variety of technologies. We provide analog (Hill Hays) DC drives, digital SCR drives, AC variable frequency drives (also known as "VFDs"), inverters, converters, programmable logic control ("PLC") based automation systems, and human machine interface ("HMI") systems. Our analog DC drives, digital SCR drives and AC VFDs are used in a variety of applications including land and offshore drilling, marine propulsion and pipeline applications. The Company has recently introduced a line of wind converter products that convert the AC power produced by wind turbine generators to DC, then inverts the power back to AC for delivery to the electrical grid. We also offer our ISIS™ solution, a 1 and 1.5 MW fully integrated solar farm power station designed to integrate all of the power conversion and power distribution equipment of the solar farm. ISIS™ is the world's first 1000V, 1MW solar inverter to be tested by TUV Rhineland, a nationally recognized test laboratory, to UL 1741 standards. Our power distribution and power conversion products are built for application voltages from 480 volts to 40,000 volts and are used in a wide variety of industries. We have the technical expertise to provide these services in compliance with a number of applicable industry standards such as NEMA ("National Electrical Manufacturers Association"), ANSI ("American National Standards Institute"), IEC ("International Electrotechnical Commission"), ABS ("American Bureau of Shipping"), USCG ("United States Coast Guard"), Lloyd's Register, a provider of marine certification services, and DNV ("Det Norske Veritas"), a leading certifying body/registrar for management systems certification services standards. Our electrical services group includes both technical services and power services. Technical services include global start-up and service of AETI power conversion systems, electrical equipment retrofits and upgrades. Our power services group provides electrical infrastructure start-up and commissioning, preventative maintenance, and emergency repair services to industrial, marine and renewable projects globally. Our team of trained technicians maintains substations up to 500KV. We also offer in-shop services including refurbishment and repair services for circuit breakers and switchgear. E&I The E&I segment provides a full range of electrical and instrumentation construction and installation services to the oil & gas, power generation and distribution and marine and industrial markets.. The segment's services include new construction as well as electrical and instrumentation turnarounds, upgrades, maintenance, and renovation projects. Applications include installation of switchgear, AC and DC motors, drives, motor controls, lighting systems, and high voltage cable. The company also provides projects that include complete electrical system rig-ups, modifications, start-ups and testing for offshore drilling rigs, and production platforms, marine (vessels) etc. In the first quarter 2012, we decided to complete the existing backlog related to the water and wastewater construction sector of the industrial market and exit that market sector based on its continued weakness and lack of strategic alignment. AAT The AAT segment manufactures and markets zone cabling enclosures and custom formed metal products for a variety of industrial markets. The zone cabling product line provides state-of-the-art flexible cabling and wireless solutions for the high-speed communication networks found throughout office buildings, hospitals, schools, industrial complexes and government buildings. Our patented enclosures mount in ceilings, walls, raised floors, and certain modular furniture to facilitate the routing of telecommunications network cabling, fiber optics and wireless solutions in a streamlined, flexible, and cost effective fashion. AAT also operates a precision sheet metal fabrication and assembly operation and provides services such as precision "CNC" ("Computer Numerical Controlled") punching, laser cutting, bending, assembling, painting, powder coating and silk screening to a diverse client base including engineering, technology and electronics companies, primarily in the Southeast. The Company has facilities and sales offices in Texas, Mississippi and Florida. We have minority interests in foreign joint ventures which have facilities in Singapore; Xian, China; and Macae, Rio De Janeiro, Brazil. 14-------------------------------------------------------------------------------- Table of Contents CRITICAL ACCOUNTING POLICIES AND ESTIMATES We have adopted various critical accounting policies that govern the application of accounting principles generally accepted in the United States of America ("U.S. GAAP") in the preparation of our condensed consolidated financial statements. The preparation of financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Although these estimates are based on management's knowledge of current events and actions it may undertake in the future, they may ultimately differ from actual results. Certain accounting policies involve significant estimates and assumptions by us that have a material impact on our financial condition or operating performance. Management believes the following critical accounting policies reflect the most significant estimates and assumptions used in the preparation of our condensed consolidated financial statements. We do not have off-balance sheet arrangements, financings, or other relationships with unconsolidated entities or other persons, also known as "special purpose entities", nor do we have any "variable interest entities". Inventory Valuation - Inventories are stated at the lower of cost or market, with material being accounted for using the average cost method. Inventory costs for finished goods and work-in-process include direct material, direct labor, production overhead and outside services. TP&S and E&I indirect overhead is apportioned to work-in-process based on direct labor incurred. AAT production overhead, including indirect labor, is allocated to finished goods and work-in-process based on material consumption, which is an estimate that could be subject to change in the near term as additional information is obtained and as our operating environment changes. Allowance for Obsolete and Slow-Moving Inventory - We regularly review the value of inventory on hand using specific aging categories, and record a provision for obsolete and slow-moving inventory based on historical usage and estimated future usage. As actual future demand or market conditions may vary from those projected, adjustments to our inventory reserve may be required. Allowance for Doubtful Accounts - We maintain an allowance for doubtful accounts for estimated losses resulting from the failure of our customers to make required payments. The estimate is based on management's assessment of the collectability of specific customer accounts and includes consideration for credit worthiness and financial condition of those specific customers. We also review historical experience with the customer, the general economic environment and the aging of our receivables. We record an allowance to reduce receivables to the amount that we reasonably believe to be collectible. Based on our assessment, we believe our allowance for doubtful accounts is adequate. Revenue Recognition - We report earnings from fixed-price and modified fixed-price long-term contracts on the percentage-of-completion method. Earnings are accrued based on the ratio of costs incurred to total estimated costs. However, for TP&S, we have determined that labor incurred provides an improved measure of percentage-of-completion. Costs include direct material, direct labor, and job related overhead. Losses expected to be incurred on contracts are charged to operations in the period such losses are determined. A contract is considered complete when all costs except insignificant items have been incurred and the facility has been accepted by the customer. Revenue from non-time and material jobs of a short-term nature (typically less than one month) is recognized on the completed-contract method after considering the attributes of such contracts. This method is used because these contracts are typically completed in a short period of time and the financial position and results of operations do not vary materially from those which would result from use of the percentage-of-completion method. The asset, "Work-in-process," which is included in inventories, represents the cost of labor, material, and overhead on jobs accounted for under the completed-contract method. For contracts accounted for under the percentage-of-completion method, the asset, "Costs and estimated earnings in excess of billings on uncompleted contracts," represents revenue recognized in excess of amounts billed and the liability, "Billings in excess of costs and estimated earnings on uncompleted contracts," represents billings in excess of revenue recognized. Foreign Currency Gains and Losses - Foreign currency translations are included as a separate component of comprehensive income. We have determined the local currency of our foreign joint ventures to be the functional currency. In accordance with ASC 830, the assets and liabilities of the foreign equity investees, denominated in foreign currency, are translated into United States Dollars at exchange rates in effect at the condensed consolidated balance sheet date and revenue and expenses are translated at the average exchange rate for the period. Related translation adjustments are reported as comprehensive income which is a separate component of stockholders' equity, whereas gains and losses resulting from foreign currency transactions are included in results of operations. Federal Income Taxes - The liability method is used in accounting for federal income taxes. Under this method, deferred tax assets and liabilities are determined based on differences between the financial reporting and tax basis of assets and liabilities and are measured using the enacted tax rates and laws that will be in effect when the differences are expected to reverse. The realizability of deferred tax assets are evaluated annually and a valuation allowance is provided if it is more likely than not that the deferred tax assets will not give rise to future benefits in the Company's tax returns. 15-------------------------------------------------------------------------------- Table of Contents Contingencies - We record an estimated loss from a loss contingency when information indicates that it is probable that an asset has been impaired or a liability has been incurred and the amount of loss can be reasonably estimated. Contingencies are often resolved over long time periods, are based on unique facts and circumstances, and are inherently uncertain. We regularly evaluate current information available to us to determine whether such accruals should be adjusted or other disclosures related to contingencies are required. We are a party to a number of legal proceedings in the normal course of our business for which we have made appropriate provisions where we believe an ultimate loss is probable. The ultimate resolution of these matters, individually or in the aggregate, is not likely to have a material impact on the Company's financial position or results of operations. Equity Income from Foreign Joint Ventures' Operations - We account for our investments in foreign joint ventures' operations using the equity method of accounting. Under the equity method, the Company's share of the joint ventures' operations' earnings or loss is recognized in the condensed consolidated statements of operations as equity income (loss) from foreign joint ventures' operations. Joint venture income increases the carrying value of the joint venture investment and joint venture losses, as well as dividends received from the joint ventures, reduce the carrying value of the investment. Carrying Value of Joint Venture Investments - We evaluate the carrying value of equity method investments as to whether an impairment adjustment may be necessary. In making this evaluation, a variety of quantitative and qualitative factors are considered including national and local economic, political and market conditions, industry trends and prospects, liquidity and capital resources and other pertinent factors. OVERALL RESULTS OF OPERATIONS The Company's management does not separately review and analyze its assets on a segment basis for TP&S, E&I, and AAT and all assets for the segments are recorded within the corporate segment's records. Corporate and other unallocated expenses include compensation costs and other expenses that cannot be meaningfully associated with the individual segments, all other costs, expenses and other income have been allocated to their respective segments. Sales to foreign joint ventures are made on an arms-length basis and intercompany profits, if any, are eliminated in consolidation. See Footnote 5 in Notes to Condensed Consolidated Financial statements for detailed financial information on the foreign joint ventures. 16-------------------------------------------------------------------------------- Table of Contents The following table represents revenue and income (loss) from domestic operations and equity in foreign joint ventures attributable to the business segments for the period indicated (in thousands): Three Months Ended September 30, Nine Months Ended September 30, 2012 2011 2012 2011 Revenue: Technical Products and Services $ 8,903 $ 8,123 $ 27,373 $ 19,907 Electrical and Instrumentation Construction 1,495 3,561 7,102 11,839 American Access Technologies 1,327 2,020 4,554 5,454 $ 11,725 $ 13,704 $ 39,029 $ 37,200 Gross profit: Technical Products and Services $ 1,507 $ 1,487 $ 4,464 $ 2,830 Electrical and Instrumentation Construction 61 214 593 830 American Access Technologies 121 482 577 1,227 $ 1,689 $ 2,183 $ 5,634 $ 4,887 Income (loss) from domestic operations and net equity income from foreign joint ventures' operations: Technical Products and Services $ 1,389 $ 1,140 $ 3,941 $ 1,754 Electrical and Instrumentation Construction 61 214 593 830 American Access Technologies (227 ) 66 (530 ) 55 Corporate and other unallocated expenses (1,100 ) (1,368 ) (3,912 ) (4,460 ) Income (loss) from domestic operations 123 52 92 (1,821 ) Equity income from BOMAY 624 666 2,385 1,343 Equity income (loss) from MIEFE (1 ) 66 19 (72 ) Equity income (loss) from AAG 123 90 167 49 Foreign operations expenses (23 ) (113 ) (246 ) (359 ) Net equity income from foreign joint ventures' operations 723 709 2,325 961 Income (loss) from domestic operations and net equity income from foreign joint ventures' operations $ 846 $ 761 $ 2,417 $ (860 ) Non-GAAP Financial Measures A non- GAAP financial measure is generally defined as one that purports to measure historical or future financial performance, financial position or cash flows, but excludes or includes amounts that would not be so adjusted in the most comparable GAAP measure. In this report, we define and use the non-GAAP financial measure Adjusted EBITDA as set forth below. Adjusted EBITDA Definition of Adjusted EBITDA We define Adjusted EBITDA as follows: Net income (loss) before: • provision (benefit) for income taxes; • non-operating (income) expense items; • depreciation and amortization; • non-cash stock-based compensation expense; • dividends on mandatorily redeemable preferred stock; and • Non-recurring items charged against or included in income(*); * In the first quarter of 2012, we included a $212 expense in cost of sales related primarily to the decision to exit the water/waste water market sector for this segment which was identified as non-recurring. 17 -------------------------------------------------------------------------------- Table of Contents Management's Use of Adjusted EBITDA We use Adjusted EBITDA to assess our overall financial and operating performance. We believe this non-GAAP measure, as we have defined it, is helpful in identifying trends in our day-to-day performance because the items excluded have little or no significance on our day-to-day operations. This measure provides an assessment of controllable expenses and affords management the ability to make decisions which are expected to affiliate meeting current financial goals as well as achieve optimal financial performance. It provides an indicator for management to determine if adjustments to current spending decisions are needed. Adjusted EBITDA provides us with a measure of financial performance, independent of items that are beyond the control of management in the short-term, such as dividends required on preferred stock, depreciation and amortization, taxation and interest expense associated with our capital structure. This metric measures our financial performance based on operational factors that management can impact in the short-term, namely the cost structure or expenses of the organization. Adjusted EBITDA is one of the metrics used by senior management and the board of directors to review the financial performance of the business on a regular basis. Adjusted EBITDA is also used by research analysts and investors to evaluate the performance of and value companies in our industry. Limitations of Adjusted EBITDA Adjusted EBITDA has limitations as an analytical tool. It should not be viewed in isolation or as a substitute for GAAP measures of earnings. Material limitations in making the adjustments to our earnings to calculate Adjusted EBITDA, and using this non-GAAP financial measure as compared to GAAP net income (loss), include: • the cash portion of dividends and interest expense, income tax (benefit) provision and non-recurring charges related to ongoing operations generally represent charges (gains), which may significantly affect our financial results; and • depreciation and amortization, though not directly affecting our current cash position, represent the wear and tear and/or reduction in value of our fixed assets and may be indicative of future needs for capital expenditures. An investor or potential investor may find this item important in evaluating our performance, results of operations and financial position. We use non-GAAP financial measures to supplement our GAAP results in order to provide a more complete understanding of the factors and trends affecting our business. Adjusted EBITDA is not an alternative to net income, income from operations or cash flows provided by or used in operations as calculated and presented in accordance with GAAP. You should not rely on Adjusted EBITDA as a substitute for any such GAAP financial measure. We strongly urge you to review the reconciliation of Adjusted EBITDA to GAAP net income (loss) attributable to common stockholders, along with our condensed consolidated financial statements included herein. We also strongly urge you to not rely on any single financial measure to evaluate our business. In addition, because Adjusted EBITDA is not a measure of financial performance under GAAP and is susceptible to varying calculations, the Adjusted EBITDA measure, as presented in this report, may differ from and may not be comparable to similarly titled measures used by other companies. The table below shows the reconciliation of net income (loss) attributable to common stockholders to Adjusted EBITDA for the three and nine months ended September 30, 2012 and 2011 (dollars in thousands): (Unaudited) Three months ended September 30, Nine months ended September 30, 2012 2011 2012 2011 Net Income (loss) attributable to common stockholders $ 500 $ 359 $ 1,595 $ (690 ) Add: Dividends on mandatorily redeemable preferred stock 85 - 140 - Depreciation and amortization 209 197 676 579 Interest expense and other, net 29 79 116 182 Provision (benefit) for income taxes 232 323 566 (352 ) Non-cash charges: Stock-based compensation 111 88 326 200 Water wastewater charges - - 212 - Adjusted EBITDA $ 1,166 $ 1,046 $ 3,631 $ (81 ) 18 -------------------------------------------------------------------------------- Table of Contents Three Months Ended September 30, 2012 Compared to Three Months Ended September 30, 2011 Consolidated net revenue decreased $1,979, or 14%, to $11,725 for the three months ended September 30, 2012 over the comparable period in 2011. The decrease was primarily attributable to the E&I segment's net revenue decrease of $2,066. The decline was primarily due to the Company's decision in the first quarter 2012 to exit the water/wastewater business as projects are being completed. Consolidated gross profit for the three months ended September 30, 2012, decreased $494 to $1,689 compared to gross profit of $2,183 in the prior year period. The decrease in gross profit is primarily attributable to the AAT segment's net revenue decrease of 34%, resulting in a decrease in gross profit of $361 for the segment coupled with a decrease in the E&I segment gross profit of $153. The TP&S segment's net revenue of $8,903 for the three months ended September 30, 2012 was up $778 and generated gross profit of $1,507 and continues to reflect improvement in the oil and gas market. The E&I segment reported net revenue of $1,495 in the third quarter of 2012, a decrease of $2,066 from the third quarter of 2011. The Company's revenue for the E&I segment will continue to decline due to the decision to exit the water/wastewater business based on the water/wastewater business being non-core to the Company's products coupled with low project margins. The AAT segment reported net revenue of $1,327 in the third quarter of 2012, down $693 from the comparable prior year period. Gross profit decreased $361 to $121 from $482 in the prior year period. The decrease in revenue and gross profit is attributable to a decrease in demand for one of its products because the customer sourced outside of the U.S. The AAT segment is examining continued cost containment for the remainder of the year and marketing efforts to increase revenue. Selling and marketing expenses for the quarter ended September 30, 2012 were $471 compared to the prior period quarter ended September 30, 2011 of $619. The decrease is related to lower sales commissions reflecting a different revenue mix and on reduced sales and marketing related to the Company's renewable energy offerings. General and administrative expenses were down for the quarter ended September 30, 2012 over the same period in 2011 by $256. In the third quarter 2011, the Company incurred expenses related to the E&I segment's legal costs associated with a project in mediation and 2012 reflects costs reductions from 2011 levels. Research and development costs were down $161from the previous period as development of the ISIS solar inverter product was substantially completed. Net equity income from foreign joint ventures increased in the third quarter ended September 30, 2012 by $14 as compared to the third quarter ended September 30, 2011. The increase primarily resulted from reduced foreign operations expenses from a one-time sharing of marketing expenses with foreign partners in 2012. Consolidated net other expense declined due to the lower interest on the $3.5 million reduction in the revolving credit balance in May 2012 resulting from the $5.0 million convertible preferred stock transaction. The effective tax expense (benefit) rates for the three month period ended September 30, 2012 and 2011 were 28% and 47%, respectively. It was determined in the fourth quarter of 2011 that due to the Internal revenue Code's Section 382 limitations on our ability to utilize the net operating losses carry forwards of approximately $9,800 generated by American Access Technologies, Inc. prior to the Company's merger in 2007 and subsequent net operating losses and foreign tax credit carry forwards, a full valuation allowance was warranted in the fourth quarter of 2011. As such, the tax provision on U.S. income generated in 2012 is offset by a reduction of the valuation allowance provided in 2011. The tax provision for 2012 reflects a 34% U.S. tax rate related to the income from the equity in foreign joint ventures' operations, net of dividends received in 2012 for an effective rate of 28% for the period. In the period ended September 30, 2011, the Company recorded a $220 write down of its deferred tax assets related to the IRS's Section 382 net operating loss carry forward limitation resulting from an IRS audit of the Company's December 31, 2008 federal return. After giving effect to the write down of the deferred income taxes of $220, and adjusting for the cumulative effect of the change in the estimated tax rate for fiscal 2011, the effective tax rate for the third quarter 2011 was 47%. Nine Months Ended September 30, 2012 Compared to Nine Months Ended September 30, 2011. Consolidated net revenue increased $1,829 or 5%, to $39,029 for the nine months ended September 30, 2012 over the comparable period in 2011. The TP&S segment recorded a $7,466 or 38% increase in net revenue. This improvement was offset by net revenue declines as compared to 2011 in the E&I segment of $4,737 and in a decrease in the AAT net revenue of $900 as compared to 2011. 19-------------------------------------------------------------------------------- Table of Contents Consolidated gross profit increased $747 to $5,634, or 14% of net revenue as compared to 13% gross profit percentage for the prior nine month period. This increase was mainly attributable to the TP&S segment's increased revenue and improvement in direct margin. This performance reflects the improved conditions in the oil & gas markets. The TP&S segment's net revenue of $ 27,373 generated gross profit of $4,464 for the first nine months ended September 30, 2012 compared to revenue of $19,907 and gross profit of $2,830 for the prior nine month period ended September 30, 2011. This segment's financial improvement reflects the improvement in the oil and gas market. The E&I segment reported net revenue of $7,102 for the nine months ended September 30, 2012, a decrease of $4,737 over the nine months ended September 30, 2011. Gross profit for the E&I segment during the nine months ended September 30, 2012 was $593 compared to $830 in the corresponding prior year period. Gross profit as a percentage of net revenue increased to 8% from 7% in the comparable prior period, however the Company's revenue for the E&I segment will continue to decline through year end 2012 due to the decision to exit the water/wastewater business based on the water/wastewater business being non-core to the Company's products coupled with low project margins. The AAT segment reported revenue of $4,554 for the nine months ended September 30, 2012, down $900 from the comparable prior year period. Gross profit declined by $650 driven substantially by the decrease in revenue from a shift in demand for one of its products because the customer sourced outside of U.S. The AAT segment is examining continued cost containment for the remainder of the year and marketing efforts to increase revenue. Selling and marketing expenses for the nine months ended September 30, 2012 were $1,831 essentially unchanged compared to the prior Nine month period ended September 30, 2011 of $1,844. General and administrative expenses were down for the nine months ended September 30, 2012 over the same period in 2011 by $592 primarily from cost reductions. Research and development costs for the nine months ended September 30, 2012 were down to $36 from $597 in the previous period based on a reduced level of ISIS product development was completed. Net equity income from foreign joint ventures increased for the nine months ended September 30, 2012 by $1,364 as compared to the prior nine month period ended September 30, 2011 primarily from improved BOMAY results. The increase resulted from improved performance at BOMAY by $1,042, MIEFE by $91 and AAG by $118. The BOMAY operations in China continue to reflect a strong demand for its products. Consolidated net other expense for the nine month period was $116, a decrease of $66 from the comparable prior year due to the lower interest on $3,500 reduction in the revolving credit balance subsequent to the $5,000 convertible preferred stock transaction in May 2012. The effective tax expense (benefit) rates for the nine month period ended September 30, 2012 and 2011 were 25% and 34%, respectively. It was determined in the fourth quarter of 2011 that due to the Internal revenue Code's Section 382 limitations on our ability to utilize the net operating losses carry forwards of approximately $9,800 generated by American Access Technologies, Inc. prior to the Company's merger in 2007 and subsequent net operating losses and foreign tax credit carry forwards, a full valuation allowance was warranted in the fourth quarter of 2011. As such, the tax provision on U.S. income generated in 2012 is offset by a reduction of the valuation allowance provided in 2011. The tax provision for 2012 reflects a 34% U.S. tax rate related to the income from the equity in foreign joint ventures' operations, net of dividends paid in 2012, for an effective rate of 25% for 2012. BACKLOG The Company's backlog as of September 30, 2012 was $22.0 million compared to $21.2 million at December 31, 2012. The backlog for the TP&S segment was $19.6 million as of September 30, 2012, an increase of approximately $6.3 million as compared to the backlog at June 30, 2012. The backlog for the E&I water waste/water business of $2.4 million reflects the remaining projects in process and will continue to decline as the Company decided to exit this business in the first quarter 2012. Approximately 50% of this total backlog is expected to be realized as revenue during the remainder of the fiscal year. 20-------------------------------------------------------------------------------- Table of Contents LIQUIDITY AND CAPITAL RESOURCES Notes Payable / Revolving Credit Agreement The Company entered into a credit agreement with JP Morgan Chase Bank, N.A. ("Chase") in October 2007. At September 30, 2012 there was $1,500 and at December 31, 2011 there was $5,000 of borrowings outstanding. There were additional borrowing capacity of $3,500 million and $3,700 million at September 30, 2012 and December 31, 2011, respectively. On August 10, 2012 the $10,000 credit agreement was amended which extended the maturity date to July 1, 2014, modified the financial covenants to a net profitability test of $1 on a trailing six month basis, a 1.0 to 1.0 leverage test of total liabilities to total net worth and eliminated the $6,000 limit on borrowings if the "adjusted net income" became less than $1.00 for any quarter. The current ratio test remained unchanged. The agreement is collateralized by the Company's real estate in Houston and Beaumont, Texas, trade accounts receivable, equipment, inventories, and work-in-process, and the Company's U.S. subsidiaries are guarantors of the borrowings. Under the agreement, the credit facility's interest rate is LIBOR plus 3.25% per annum and a commitment fee of 0.3% per annum of the unused portion of the credit limit each quarter. Additionally, the terms of the agreement contain covenants which provide for customary restrictions and limitations and restriction from paying dividends without prior written consent of the bank. On September 30, 2012 the interest rate was 3.48%. On May 1, 2012, the Company received an amendment from Chase consenting to the payment of the preferred stock dividends and other terms as discussed in the Notes to Condensed Consolidated Financial Statements as Note 10. Mandatorily Redeemable Convertible Preferred Stock. Operating Activities During the Nine months ended September 30, 2012, the Company generated cash flows from operations of $1,153 as compared to a use of cash from operation of $1,066 for the same period in 2011. The increase in cash flow for the 2012 period was primarily due to increased accounts receivable collection of $3,066. Investing Activities During the nine months ended September 30, 2012, the Company generated $7 in cash from investing activities compared to $711 for the comparable period in 2011 primarily as a result of increased capital expenditure. The Company received cash dividends from the BOMAY of $907 and $1,052 in June 2012 and June 2011, respectively. In the first quarter 2012, the Company acquired the net assets of Amnor Technology for cash of $100 plus 44,000 shares of our common stock plus legal costs of $4. Financing Activities During the Nine months ended September 30, 2012, the Company generated $1,175 in cash from financing activities as compared $862 for the comparable period in 2011 The main source of cash in 2012 was from the issuance of the $5.0 million convertible preferred stock transaction. Subsequently, the Company paid $3,500 down on the revolving credit agreement. The Company believes its existing cash, working capital and unused credit facility combined with operating earnings will be sufficient to meet its working capital needs for the next twelve months. The Company continues to review growth opportunities and depending on the cash needs may raise cash in the form of debt, equity, or a combination of both. |