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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
----------
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the quarterly period ended June 30, 2003
OR
[_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the transition period from__________to__________
Commission file number: 0-32789
EMTEC, INC.
(Exact name of registrant as specified in its charter)
Delaware 87-0273300
(State of incorporation or organization) (I.R.S. Employer Identification No.)
817 East Gate Drive
Mount Laurel, New Jersey 08054
(Address of principal executive offices, including zip code)
(856) 235-2121
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant: (1) has filed all reports
required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [_]
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act). [_]Yes [X] No
As of July 31, 2003, there were outstanding 7,080,498 shares of the
registrant's common stock.
1
EMTEC, INC.
FORM 10-Q FOR THE QUARTER ENDED JUNE 30, 2003
Table of Contents
PART I - FINANCIAL INFORMATION
Item 1 - Financial Statements
Consolidated Balance Sheets
June 30, 2003 (Unaudited) and March 31, 2003 .........................1-2
Consolidated Statements of Operations
Three months ended June 30, 2003 (Unaudited) and 2002 (Unaudited) ......3
Consolidated Statements of Cash Flows
Three months ended June 30, 2003 (Unaudited) and 2002 (Unaudited) ......4
Notes to Consolidated Financial Statements
Three months ended June 30, 2003 and 2002 (Unaudited) ................5-8
Item 2 - Management's Discussion and Analysis of Financial
Condition and Result of Operations ..................................9-17
Item 3 - Quantitative and Qualitative Information About Market Risk ............18
Item 4 - Controls and Procedures ...............................................19
PART II - OTHER INFORMATION
Item 6 - Exhibits and Reports on Form 8-K ......................................20
SIGNATURES .....................................................................21
PART I - FINANCIAL INFORMATION
Item 1. Financial Statements
EMTEC, INC.
CONSOLIDATED BALANCE SHEETS
June 30, March 31,
2003 2003
----------- -----------
(unaudited)
Assets
Current Assets
Cash and cash equivalents $ 1,050,332 $ 1,792,101
Receivables:
Trade, net 17,194,183 14,553,124
Others 500,417 476,682
Inventories 2,954,495 2,881,868
Prepaid expenses 615,176 462,827
Deferred tax assets 34,954 34,954
----------- -----------
Total Current Assets 22,349,557 20,201,556
Property and equipment, net 1,050,216 1,190,851
Investment in geothermal power unit,
less accumulated amortization
of $337,478 and $302,407 601,129 611,519
Deferred tax assets 57,300 105,201
Intangible assets 162,023 176,632
Other assets 48,413 48,825
----------- -----------
Total Assets $24,268,638 $22,334,584
=========== ===========
The accompanying notes are integral parts of these
consolidated financial statements.
1
EMTEC, INC.
CONSOLIDATED BALANCE SHEETS
June 30, March 31,
2003 2003
----------- -----------
(unaudited)
Liabilities and Shareholders' Equity
Current Liabilities
Line of credit $ 8,048,248 $ 8,203,290
Accounts payable 10,330,602 8,199,792
Customer deposits 190,000 488,127
Accrued liabilities 1,433,458 1,474,907
Deferred revenues 1,271,597 1,321,013
----------- -----------
Total Current Liabilities 21,273,905 19,687,129
Deferred revenue 746,410 757,023
Deferred tax liability 51,945 51,945
----------- -----------
Total Liabilities 22,072,260 20,496,097
----------- -----------
Shareholders' Equity
Common stock, $.01 par value; 25,000,000
shares authorized; 7,080,498 shares issued
and outstanding 70,805 70,805
Additional paid-in capital 2,210,805 2,210,805
Accumulated deficit (85,232) (443,123)
----------- -----------
Total Shareholders' Equity 2,196,378 1,838,487
----------- -----------
Total Liabilities and
Shareholders' Equity $24,268,638 $22,334,584
=========== ===========
The accompanying notes are integral parts of these
consolidated financial statements.
2
EMTEC, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(unaudited)
Three Months Ended:
-------------------------
June 30, June 30,
2003 2002
----------- -----------
Revenues:
Procurement services $23,730,729 $15,980,546
Service and consulting 4,702,026 3,683,209
Geothermal 47,585 45,349
----------- -----------
Total Revenues 28,480,340 19,709,104
----------- -----------
Cost of Revenues:
Procurement services 21,691,493 14,061,661
Service and consulting 3,067,780 2,514,540
Geothermal 17,484 17,598
----------- -----------
Total Cost of Revenues 24,776,757 16,593,799
----------- -----------
Gross Profit:
Procurement services 2,039,236 1,918,885
Service and consulting 1,634,246 1,168,669
Geothermal 30,101 27,751
----------- -----------
Total Gross Profit 3,703,583 3,115,305
----------- -----------
Operating Expenses:
Selling, general and
administrative 3,205,245 2,973,914
Interest 99,166 27,136
----------- -----------
Total Operating Expenses 3,304,411 3,001,050
----------- -----------
Income Before Income Tax Expense 399,172 114,255
Income tax expense 41,281 --
----------- -----------
Net Income $ 357,891 $ 114,255
=========== ===========
Net Income Per Share {Basic And Diluted} $ 0.05 $ 0.02
Weighted Average Number Of Shares
Outstanding {Basic And Diluted} 7,080,498 7,080,498
The accompanying notes are integral parts of these
consolidated financial statements.
3
EMTEC, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(unaudited)
Three Months Ended:
-------------------------
June 30, June 30,
2003 2002
----------- -----------
Cash Flows From Operating Activities
Net income for the three months $ 357,891 $ 114,255
Adjustments to Reconcile Net Income To Net
Cash Used In Operating Activities
Depreciation and amortization 192,448 132,085
Deferred income tax 47,901 --
Changes In Operating Assets and Liabilities
Increase in receivables (2,664,794) (5,158,788)
Increase in inventories (72,627) (1,005,386)
Increase in prepaid expenses (152,349) (11,385)
Decrease in other assets 413 1,087
Increase in accounts payable 2,130,810 2,927,080
Decrease in customer deposits (298,127) (245,387)
(Decrease) Increase in accrued liabilities (41,449) 752,434
(Decrease) Increase in deferred revenue (49,415) 270,001
----------- -----------
Net Cash Used In Operating Activities (549,298) (2,224,004)
Cash Flows From Investing Activities
Purchases of equipment (37,426) (423,714)
Cash Flows From Financing Activities
Net (decrease)increase in line of credit (155,045) 1,330,382
----------- -----------
Net Decrease in Cash and Cash Equivalents (741,769) (1,317,336)
Beginning Cash and Cash Equivalents 1,792,101 1,552,666
----------- -----------
Ending Cash and Cash Equivalents $ 1,050,332 $ 235,330
=========== ===========
The accompanying notes are integral parts of these
consolidated financial statements.
4
EMTEC, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
THREE MONTHS ENDED JUNE 30, 2003 AND 2002
(unaudited)
1. Basis of Presentation
The accompanying unaudited consolidated financial statements have been
prepared pursuant to the rules and regulations of the Securities and Exchange
Commission. Accordingly, they do not include all of the information and note
disclosures required by generally accepted accounting principles in the United
States. In the opinion of management, all adjustments (consisting of normal
recurring accruals) considered necessary for a fair presentation have been
included. Quarterly results are not necessarily indicative of results for the
full year. For further information, refer to the annual financial statements and
notes thereto included in the Company's Form 10-K.
2. Stock-Based Compensation
Statement of Financial Accounting Standards No. 123, "Accounting for
Stock-Based Compensation," (SFAS No. 123) encourages, but does not require
companies to record compensation cost for stock-based employee compensation
plans at fair value. The Company has adopted Accounting Principles Board Opinion
No. 25, "Accounting for Stock Issued to Employees" (APB No. 25). APB No. 25
provides that the compensation expense relative to the Company's employee stock
options is measured based on the intrinsic value of the stock option.
Option activity is summarized in the following table:
Options outstanding - April 1, 2003 461,428
Activity for the three months ended June 30, 2003:
Options granted
Options exercised
Options forfeited or expired (10,000)
-------
Options outstanding - June 30, 2003 451,428
=======
3. Line of Credit
On November 21, 2001, the Company entered into a $10.0 million revolving
credit facility with Fleet Capital Corporation, formerly Summit Business Capital
Corporation ("Fleet") under which the Company may borrow on 85% of its eligible
trade receivables. Interest on outstanding loans under the revolving credit
facility with Fleet is charged monthly at a fluctuating rate per annum equal to
0.25% above
5
the prime rate and, at our option, interest on up to 50% of the outstanding
loans may be charged at libor plus 2.75%. The Fleet revolving credit facility is
collateralized by a lien upon and security interest in substantially all of the
Company assets. Since current credit facilities with two of the Company's
primary trade vendors, (GE Access, and Ingram Micro.,) were also collateralized
by substantially all of the Company's assets, Fleet, GE Access and Ingram Micro,
have entered into intercreditor agreements, which provide that as regards to
these vendors, debt obligations to Fleet are accorded priority. The lending
agreement contains financial covenants that require the Company to maintain a
maximum leverage ratio, a minimum debt ratio, a minimum tangible net worth
ratio, and a minimum result of operations. As of June 30, 2003 the Company was
not in compliance with its financial covenant. On November 21, 2001, we also
entered into a Wholesale Financing Security Agreement with IBM. This credit
facility, which is collateralized by a $750,000 letter of credit from Fleet in
favor of IBM, affords us up to a like amount of credit to purchase IBM products
from IBM Global Financing. On January 9, 2002, Fleet also issued a $250,000
letter of credit in favor of its landlord for our New York City office, as a
security deposit for the building lease.
At June 30, 2003, the Company had a $8,048,245 outstanding balance under
the credit facility.
On June 11, 2003 Fleet offered to waive such non-compliance and increase
our credit facility permanently to $12.50 million through November 21, 2005 in
consideration of a cash payment of service fees to Fleet of $50,000 and an
increased interest rate of one percent above prime. The Company is currently
reviewing and negotiating the amended terms of its facility but cannot state
with any certainty the terms upon which the credit facility will be continued or
its duration. The Company and Fleet expect to finalize the amended terms within
the next 30 to 90 days.
On June 17, 2003 Fleet temporarily increased our current credit facility
from $10.0 million to $11.50 million. This increase expired on July 18, 2003. On
July 18, 2003 Fleet extended this temporary increase for additional 30 days.
4. Trade Receivables
The Company provides an allowance for losses on trade receivables based on
a review of the current status of existing receivables and management's
evaluation of periodic aging of the accounts. Trade accounts receivable consists
of the following:
6
- ----------------------------------------------------------------
June 30, 2003 March 31, 2003
- ----------------------------------------------------------------
Trade Receivable $17,456,079 $14,793,971
- ----------------------------------------------------------------
Allowance for doubtful accounts (261,896) (240,847)
- ----------------------------------------------------------------
Trade Receivable, net $17,194,183 $14,553,124
- ----------------------------------------------------------------
5. Inventory
Inventories are stated at lower of cost (first-in, first-out) or market.
Cost is based on standard costs generated principally by the most recent
purchase price. The Company provides an inventory reserve for obsolescence and
deterioration based on management's review of product sales. Inventory is
recorded on the balance sheet net of allowances for inventory valuation of
$518,920 and $471,203 at June 30, 2003 and March 31, 2003, respectively.
6. Acquisitions
On August 31, 2002, the Company acquired all of the customer contracts and
certain assets of Turnkey Computer Systems, Inc. of Clifton, NJ. The purchase
price will be paid over a two-year period and will be based on an earning share
derived from the customer contracts transferred from Turnkey to Emtec. Earnings
share for a given period shall mean 50% of earnings for that period, provided,
that, if for that period earnings is less than $120,000, then the earnings share
for that period shall be the earnings in excess of $60,000. The first earning
share will be calculated at the end of twelve months ended on August 31, 2003.
On August 12, 2002, the Company acquired certain assets of Acentra
Technologies, Inc., including the assignment of the State of New Jersey computer
supply and services contract. The Company paid a net purchase price of $165,607
in cash to be allocated under the purchase method as follows:
Assignment of State of NJ Contract $ 100,000
Inventory 326,798
Equipment 22,715
Advance payment amount from customers (283,906)
---------
Net Purchase Price $ 165,607
=========
7. Major Customers
Two major customers accounted for approximated 56%, and 27% of the
Company's net sales in the quarter ended June 30, 2003 and 2002, respectively.
7
While the Company believes its relationship with these customers will
continue, there can be no assurance that sales to these customers will continue
at all or at the same level.
8. Segment Information
Summarized financial information relating to the Company's operating
segments are as follows:
For the three months ended June 30: 2003 2002
----------- -----------
Revenues
Information Technology $28,432,755 $19,663,755
Geothermal 47,585 45,349
----------- -----------
Total Revenues $28,480,340 $19,709,104
=========== ===========
Operating Profit/(Loss)
Information Technology $ 382,149 $ 96,039
Geothermal 17,023 18,216
----------- -----------
Net Segment Operating
Income/(Loss) $ 399,172 $ 114,255
Income Tax Expense 41,281 --
----------- -----------
Net Income $ 357,891 $ 114,255
=========== ===========
8
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
The following discussion and analysis should be read in conjunction with,
and is qualified in its entirety by, the unaudited financial statements,
including the notes thereto, appearing elsewhere in this quarterly report on
Form, 10-Q.
Critical Accounting Policies
Management's Discussion and Analysis of Financial Condition and Results of
Operations discusses our consolidated financial statements, which have been
prepared in accordance with accounting principles generally accepted in the
United States of America. The methods, estimates, and judgments we use in
applying our most critical accounting policies have a significant impact on the
results we report in our financial statements. The Securities and Exchange
Commission has defined critical accounting policies as policies that involve
critical accounting estimates that require (i) management to make assumptions
that are highly uncertain at the time the estimate is made, and (ii) different
estimates that could have been reasonably used for the current period, or
changes in the estimates that are reasonably likely to occur from period to
period, which would have a material impact on the presentation of our financial
condition, changes in financial condition or in result of operations. Based on
this definition, our most critical policies include: revenue recognition,
allowance for doubtful accounts, inventory valuation reserve, the assessment of
recoverability of long-lived assets, the assessment of recoverability of
goodwill and intangible assets, and valuation of deferred tax assets.
o Revenue Recognition
We recognize revenues based upon Staff Accounting Bulletin #101 (SAB 101).
SAB 101 states that revenue recognition cannot occur until the earnings process
is complete, evidenced by an agreement between us and the customer, there has
been delivery and acceptance, collectibility is probable, and pricing is fixed
and determinable. If significant obligations remain after delivery, revenue is
deferred until such obligations are fulfilled. Procurement services represent
sales of computer hardware and prepackaged software. Revenue from consulting and
support service contracts are recognized ratably over the contract or service
period. Revenues from manufacturer support service contracts where the
manufacturer is responsible for fulfilling the service requirements of the
customer are recognized immediately on their contract date. These contracts
contain cancellation privileges that allow our customer to terminate a contract
with 90 days written notice. In this event, the customer is entitled to a
pro-rated refund based on the remaining term of the contract and we would owe
the manufacturer a pro-rated refund of the cost of the contract. However, we
have experienced no customer cancellations of any significance during our most
recent 3-year history and do not expect cancellations of any significance in the
future. We believe that net revenue reporting for manufacturer support service
contracts is more appropriate. Thus starting the fiscal year ended March 31,
2003, we have adopted net revenue reporting for manufacturer support service
contracts and to conform to the current presentation, have reclassified contract
costs from prior periods as an offset to revenue.
9
o Trade Receivables
We maintain allowance for doubtful accounts for estimated losses resulting
from the inability of our customers to make required payments. We base our
estimates on the aging of our accounts receivable balances and our historical
write-off experience, net of recoveries. If the financial condition of our
customers were to deteriorate, additional allowances may be required. We believe
the accounting estimate related to the allowance for doubtful accounts is a
"critical accounting estimate" because changes in it can significantly affect
net income.
o Inventories
Inventories are stated at the lower of cost (first-in, first-out) or
market. Cost is based on standard costs generated principally by the most recent
purchase prices. We provide an inventory reserve for obsolescence and
deterioration based on management's review of the current status of the excess
inventory, its age, and net realizable value based upon assumptions about future
demand and market condition.
o Property and Equipment
We estimate the useful lives of property and equipment in order to
determine the amount of depreciation and amortization expense to be recorded
during any reporting period. The majority of our equipment is depreciated over
three years. The estimated useful lives are based on the historical experience
with similar assets as well as taking into account anticipated technological or
other changes. If technological changes were to occur more rapidly than
anticipated or in a different form than anticipated, the useful lives assigned
to these assets may need to be shortened, resulting in the recognition of
increased depreciation and amortization in future periods. We review for
impairment when events or circumstances indicate that the carrying amounts may
not be recoverable over the remaining lives of the assets. In assessing
impairments, we follow the provisions of Statement of Financial Accounting
Standard No. 144 "Accounting for the Impairment or Disposal of Long-Lived
Assets," utilizing cash flows which takes into account management's estimates of
future operations.
o Goodwill and Intangible Assets
We have adopted Statement of Financial Accounting Standards No. 141
"Business Combinations" and No. 142 "Goodwill and Other Intangible Assets". As a
result, amortization of goodwill was discontinued. We performed the initial
goodwill impairment test as of April 1, 2002 and another impairment test as of
March 31, 2003. Based on the impairment test performed as of March 31, 2003, the
goodwill of $254,894 associated with the acquisition of Devise Associates, Inc.,
was determined to be fully impaired and charged to earnings in fiscal year ended
March 31, 2003. This determination was based upon the operating and cash flow
losses of this business unit since the January 9, 2002 acquisition date and
budgeted fiscal 2004 operating and cash flow losses for this business unit. We
found no impairment of the remaining goodwill of $112,996 as of March 31, 2003.
We were assigned a contract to supply computer hardware and services to the
State of New Jersey in the August 12, 2002 acquisition of Acentra Technologies,
Inc. This contract was
10
valued at $100,000 in the acquisition. Amortization expense of $13,636 was
expensed in the current period based upon the current contract term that ends at
May 2004. The contract is subject to annual renewals. The net carrying value for
this contract amounted to $50,000 at June 30, 2003.
o Income Taxes
Income taxes are accounted for under an asset and liability approach that
requires the recognition of deferred tax assets and liabilities for the expected
future tax consequences of events that have been recognized in Emtec's financial
statements or tax returns. In estimating future tax consequences, Emtec
generally considers all expected future events other than the enactment of
changes in tax laws or rates. A valuation allowance is recognized if, on weight
of available evidence, it is more likely than not that some portion or all the
deferred tax assets will not be realized. We continue to be conservative in
accounting for income taxes by recording significant valuation allowances for
deferred tax assets due to the high degree of uncertainty that exists regarding
future operating results.
Results of Operations
Three Months Ended June 30, 2003 Compared to Three Months Ended June 30, 2002.
Total Revenues
Total revenues for our IT business, which includes services and consulting
revenue, and procurement revenues, increased by 44.59% or $8.77 million, to
$28.43 million for the quarter ended June 30, 2003, compared to $19.67 million
for the quarter ended June 30, 2002. This increase is primarily attributable to
acquisitions of Acentra Technologies, Inc. in August 2002 and Turnkey Computer
Systems, Inc. in August 2002. IT revenue associated with these acquisitions
equaled $10.43 million for the quarter ended June 30, 2003. Without these
acquisitions, revenues associated with our IT business would have decreased by
8.43% or $1.66 million for the quarter ended June 30, 2003. This decrease is
mainly due to a slow-down in the economy.
Services and consulting revenue increased by 27.66%, or $1.02 million, to
$4.70 million for the quarter ended June 30, 2003 compared to $3.68 million for
the quarter ended June 30, 2002. This increase is also attributable to
acquisitions of Acentra Technologies Inc., and Turnkey Computer Systems, Inc.
Services and consulting revenue associated with these acquisitions equaled $2.02
million for the quarter ended June 30, 2003. Without these acquisitions,
services and consulting revenue would have decreased by 27.18% or $1.00 million,
to $2.68 million for the quarter ended June 30, 2003. This decrease is mainly
due to a decrease in our manufacturers support services contracts revenues. Net
revenues associated with manufacturers support services contracts revenue
decreased by 80.27%, or $857,266, to $210,679 for the quarter ended June 30,
2003 compared to $1.07 million for the quarter ended June 30, 2002. This
decrease in manufacturers support services contracts revenue is mainly due a
sale that occurred in May 2002 of $580,000 to one customer, which may be renewed
in December 2003. The remaining decrease is due to a slow-down in the economy.
11
Procurement revenues also increased by 48.50%, or $7.75 million, to $23.73
million for the quarter ended June 30, 2003. This increase is the net result of
the acquisitions of Acentra Technologies, Inc. and Turnkey Computer Systems,
Inc. of approximately $8.40 million recorded in the quarter ended June 30, 2003.
Without these acquisitions, procurement revenue would have decreased by 4.07%,
or $649,817 for the quarter ended June 30, 2003.
Geothermal Revenues increased by 4.93%, or $2,236. to $47,585 for the
quarter ended June 30, 2003. This increase is mainly attributable to higher
production of steam during this quarter.
Gross Profit
Our aggregate gross profit for IT business increased by 18.98%, or
$585,925, to $3.67 million for the quarter ended June 30, 2003. This increase is
mainly attributable to a 44.59% increase in our IT revenues. Measured as a
percentage of our total revenues for IT business, our overall gross profit
margin decreased to 12.92% of total revenues for the quarter ended June 30, 2003
from 15.70% for the quarter ended June 30, 2002. This decrease is mainly due to
lower gross profit margin from our procurement revenues.
Gross profit for product sales increased by 6.27%, or $120,351, to $2.04
million for the quarter ended June 30, 2003 as compared with $1.92 million for
the quarter ended June 30, 2002. This increase is mainly attributable to a
48.50% increase in product revenue. Measured as a percentage of procurement
revenues, our gross profit margin decreased to 8.59% of procurement revenue for
the quarter ended June 30, 2003 from 12.01% for the quarter ended June 30, 2002.
This decrease is mainly due to continued downward pricing pressure on product
sales.
Gross profit for service and consulting increased by 39.84%, or $465,574,
to $1.63 million for the quarter ended June 30, 2003 as compared with $1.17
million for the quarter ended June 30, 2002. This increase is mainly
attributable to a 27.66% increase in services and consulting revenues. Measured
as a percentage of services and consulting revenues, our gross margin
attributable to services and consulting revenue increased to 34.76% of services
and consulting revenue for the quarter ended June 30, 2003 from 31.73% for the
quarter ended June 30, 2002. This increase is attributable to higher billing
rates (total revenue generated divided by total billable hours available during
the period) and utilization rates (billable hours divided by paid hours) of
engineers during this quarter.
The geothermal gross profit of $30,101 for the quarter ended June 30, 2003
increased by 8.47%, or $2,350 attributable to higher production of steam coupled
with lower operating expenses for the quarter.
Sales, General, and Administrative Expenses
Sales, general and administrative expenses increased by 7.78%, or $231,328,
to $3.21 million for the quarter ended June 30, 2003. Without the acquisitions
of Acentra Technologies, Inc. and Turnkey Computer Systems, Inc., our sales,
general and administrative expenses would have been decreased by approximately
18.49 %, or $549,000, to $2.42 million for the quarter ended June 30, 2003
compared with $2.97 million for the quarter ended June 30, 2002. This decrease
is mainly attributable to the following:
12
1. Elimination of non-productive sales staff.
2. Reduction in sales commission compensation plans. and
3. Eliminated duplication of non-essential administrative support
services.
Interest expense
Interest expense increased by 265.44%, or $72,030, to $99,166 the quarter
ended June 30, 2003 as compared with $27,136 for the quarter ended June 30,
2002. This increase is mainly due to a higher balance on our line of credit, and
higher days sales outstanding during the period.
Income Taxes
Income tax expense for the quarter ended June 30, 2003 was $41,281. For the
quarter ended June 30, 2003, we recognized a deferred income tax expense of
$47,901 that is partially offset by an income tax refund of $6,620.
Factors That May Affect Future Results
Our future operating results may be affected by a number of factors
including uncertainties relative to national economic conditions, especially as
they affect interest rates, business insurance industry factors, our ability to
successfully increase business, and effectively manage expense margins.
Since our inception, we have funded our operations primarily from
borrowings under our credit facility. We are currently in default under our
credit facility, which could result in a demand for immediate repayment. Revised
terms of our indebtedness could materially limit our financial and operating
flexibility.
We must continue to effectively manage expenses in relation to revenues by
directing new business development towards markets that complement or improve
our existing service lines. Management must also continue to emphasize operating
efficiencies through cost containment strategies, reengineering efforts, and
improved service delivery techniques. The most significant cost relating to the
services component of our business is personnel expense, which consists of
salaries, benefits, and payroll related expenses. Thus, the financial
performance of our service business is based primarily upon billing margins
(billable hourly rates less the costs to us of service personnel on an hourly
basis) and utilization rates (billable hours divided by paid hours). The future
success of the services component of our business will depend in large part upon
our ability to maintain high utilization rates at profitable billing margins.
The competition for quality technical personnel has continued to intensify,
resulting in increased personnel costs. This intense competition has caused our
billing margins to be lower than they might otherwise have been. Our utilization
rates for service personnel likely will also be adversely affected during
periods of rapid and concentrated hiring.
13
Emtec is a system integrator focused on providing technology solutions that
enables our customers to effectively use and manage their data to grow their
business. Our areas of specialization in IT services include remote network
monitoring, help desk, network design, enterprise backup and storage
consolidation, and network security. While we have offered IT services to our
customers since 1983, our major emphasis on IT consulting and services began in
1995 and we started focusing on our new managed services and network security
during the fiscal year 2002. We have invested approximately $710,000 for the
purchase of computer hardware, software, and consulting services for our Network
Operations Center to enhance our offerings in Managed Services. Currently our
recurring managed services revenues equal approximately $35,000 a month. We have
limited experience in developing, marketing, or providing these services. We
cannot assure that we will be able to successfully market such services to
either new or existing customers, that our services will achieve market
acceptance, or that we will be able to effectively hire, integrate, and manage
additional technical personnel to enable us to perform these services to our
customers' expectations This industry has been characterized by rapid
technological advances that have resulted in frequent introductions of new
products, product enhancements and aggressive pricing practices, which also
impacts pricing of service activities. Our operating results could be adversely
affected by industry-wide pricing pressures, the ability to recruit, train and
retain personnel integral to our operations and the presence of competitors with
greater financial and other resources. Also, our operating results could be
adversely impacted should our company be unable to effectively achieve the
revenue growth necessary to provide profitable operating margins in various
operations. Our plan for growth includes marketing efforts, acquisitions that
expand market share. There can be no assurances these efforts will be
successful, or if successful the timing thereof.
Liquidity and Capital Resources
Cash and cash equivalents at June 30, 2003 of $1,050,332 represented a
decrease of $741,769 from $1,792,101 at March 31, 2003. We are a net borrower;
consequently, we believe our cash and cash equivalents balance must be viewed
along with the available balance on our line of credit.
Since our inception, we have funded our operations primarily from
borrowings under our credit facility. On November 21, 2001, we entered into a
$10.0 million revolving credit facility with Fleet Capital Corporation, formerly
Summit Business Capital Corporation ("Fleet"). Interest on outstanding loans
under our revolving credit facility with Fleet is charged monthly at a
fluctuating rate per annum equal to 0.25% above the Prime Rate and, at our
option, interest on up to 50% of the outstanding loans may be charged at LIBOR
plus 2.75%. Our Fleet revolving credit facility is collateralized by a lien upon
and security interest in substantially all of our assets. As our current credit
facilities with two of our primary trade vendors, GE Access, and Ingram Micro,
were also collateralized by substantially all of our assets, we, Fleet, GE
Access and Ingram Micro, have entered into intercreditor agreements, which
provide that as regards to these vendors, our obligations to Fleet are accorded
priority. On November 21, 2001, we also entered into a Wholesale Financing
Security Agreement with IBM. This credit facility, which is collateralized by a
$750,000 letter of credit from Fleet in favor of IBM, affords us up to a like
amount of credit to purchase IBM products from IBM Global Financing. On January
9, 2002, Fleet also issued a $250,000 letter of credit in favor of Vandergrand
Properties Co., L.P., our
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landlord for our New York City office, as a security deposit for the building
lease. At June 30, 2003, we had an $8.05 million outstanding loan balance under
the credit facility.
Our lending agreement with Fleet contains financial covenants that require
us to maintain a minimum leverage ratio, minimum debt service coverage ratio,
minimum tangible net worth, and prohibits quarterly losses. As of June 30, 2003,
Emtec was not in compliance with some of its covenants. The following table
quantifies Emtec's non-compliance with its financial covenants with Fleet.
- ---------------------------------------------------------------------------------
Actual As of
Covenants Required 6/30/2003
- ---------------------------------------------------------------------------------
Leverage Ratio Not to exceed 11.0 : 1.0 11.11 : 1.0
- ---------------------------------------------------------------------------------
Debt Service Coverage Ratio Not to be less than 1.20 : 1.0 1.63 : 1.0
- ---------------------------------------------------------------------------------
Tangible Net Worth Not to be less than $1,842,000 $1,985,545
- ---------------------------------------------------------------------------------
Prohibition on Losses No Quarterly Losses Allowed in Quarterly Loss of
excess of $150,000 $(767,026) as of
December 31, 2002.
- ---------------------------------------------------------------------------------
On June 11, 2003 Fleet offered to waive such non-compliance and increase
our credit facility permanently to $12.50 million through November 21, 2005 in
consideration of a cash payment to Fleet of $50,000 and increased interest rate
of one percent above prime. Emtec is currently reviewing and negotiating the
amended terms of its facility but cannot state with any certainty the terms upon
which the credit facility will be continued or its duration. Emtec and Fleet
expect to finalize the amended terms within next 30 to 90 days. If we are
unsuccessful in reaching an agreement with Fleet, Fleet may immediately call for
a repayment of the outstanding borrowings under the Credit Facility. This action
of Fleet could force us to find a substitute lender at a higher cost and/or
could adversely affect our day to day business.
On June 17, 2003 Fleet temporarily increased our current credit facility
from $10.0 million to $11.50 million. This increase expired on July 18, 2003. On
July 18, 2003 Fleet extended this temporary increase for additional 30 days.
At June 30, 2003, our credit facilities with our primary trade vendors, GE
Access, Ingram Micro, and Tech Data were as follows: 1) Our credit Line with GE
Access was $4.0 million, no interest charged, with an outstanding principal
balance of $2.06 million. 2) Our credit line with Ingram Micro was $6.5 million
this includes a temporary increase of $4.0 million which expires on September
30, 2003, at an 18% APR interest rate after 30 days from the date of the
invoice, with an outstanding principal balance of $5.29 million, ($2.66 million
on the main account and $2.62 million on the temporary account). 3) Our credit
line with Tech Data was $2.0 million, no interest charged, with an outstanding
balance of $1.43 million. Under these credit lines, we are obligated to pay each
invoice within 30 days from the date of such invoice.
15
Capital expenditures of $37,425 during three months ended June 30, 2003,
were primarily for the purchase of computer equipment for internal use.
Emtec has no arrangements or other relationships with unconsolidated
entities or other persons that are reasonably likely to materially affect
liquidity or the availability of or requirements for capital resources.
We believe that our available funds, together with existing and anticipated
credit facilities, as discussed above, will be adequate to satisfy our current
and planned operations for at least the next 12 months. If we are unsuccessful
in reaching an agreement with Fleet, Fleet may immediately call for a repayment
of the outstanding borrowings under the Credit Facility. This action of Fleet
could force us to find a substitute lender at a higher cost and/or could
adversely affect our day-to-day business.
Recently Issued Accounting Standards
In June 2001, the FASB issued two new statements: SFAS No. 141, "Business
Combinations," and SFAS No. 142, "Goodwill and Other intangible Assets."
Effective April 1, 2002, Emtec adopted SFAS No. 141 that requires business
combinations entered into after June 30, 2001 to be accounted for using the
purchase method of accounting. Specifically identifiable intangible assets,
other than goodwill, are to be amortized over their estimated useful economic
life.
SFAS No. 142 requires that goodwill not be amortized, but should be tested
for impairment at least annually. SFAS No. 142 is effective for fiscal years
beginning after December 15, 2001 and applies to goodwill and other intangible
assets, regardless of when those assets were initially recognized. Effective
April 1, 2002, Emtec adopted SFAS No. 142 and in connection with its adoption,
discontinued the amortization of goodwill and reviewed the estimated useful
lives of previously recorded identifiable intangible assets. Emtec follows the
two-step process prescribed in SFAS 142 to test its goodwill for impairment. The
first step is a screen for potential impairment, while the second step measures
the amount of the impairment, if any. Under the guidelines of SFAS No. 142,
Emtec is required to perform an impairment test at least on an annual basis.
Emtec performed its initial goodwill impairment test as of April 1, 2002 and
another impairment test as of March 31, 2003. Based on the impairment test
performed on March 31, 2003 the goodwill of $254,894 associated with the
acquisitions of Devise Associates, Inc. was impaired.
In August 2001, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standards No. 144 ("SFAS 144"), "Accounting for the
Impairment or Disposal of Long-Lived Assets." SFAS 144 addresses the financial
accounting and reporting for the impairment or disposal of long-lived assets.
SFAS 144 supersedes SFAS 121 but retains the fundamental provisions of SFAS 121
for (I) recognition/measurement of impairment of long-lived assets to be held
and used and (II) measurement of long-lived assets to be disposed of by sale.
SFAS 144 also supersedes the accounting and reporting provisions of Accounting
Principles Board's No. 30 ("APB 30"). "Reporting the Results of Operations-
Reporting the
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Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual and
Infrequently Occurring Events and Transactions, "for segments of a business to
be disposed of but retains APB 30's requirement to report discontinued
operations separately from continuing operations and extends that reporting to a
component of an entity that either has been disposed of or is classified as held
for sale. SFAS 144 is effective for fiscal years beginning after December 15,
2001. Emtec adopted the provisions of SFAS 144 effective April 1, 2002.
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Item 3. Quantitative and Qualitative Information About Market Risk
We do not engage in trading market risk sensitive instruments and do not
purchase hedging instruments or "other than trading" instruments that are likely
to expose us to market risk, whether interest rate, foreign currency exchange,
commodity price or equity price risk. We have issued no debt instruments,
entered into no forward or future contracts, purchased no options and entered
into no swaps. Our primary market risk exposures are those of interest rate
fluctuations. A change in interest rates would affect the rate at which we could
borrow funds under our revolving credit facility. Our balance on the line of
credit at June 30, 2003 was approximately $8.00 million. Assuming no material
increase or decrease in such balance, a one percent change in the interest rate
would change our interest expense by approximately $80,000 annually.
18
Item 4. Controls and Procedures
Our management carried out an evaluation, with the participation of our
Chief Executive Officer and Chief Financial Officer, of the effectiveness of our
disclosure controls and procedures as of June 30, 2003. Based upon that
evaluation, our Chief Executive Officer and Chief Financial Officer concluded
that our disclosure controls and procedures were effective to ensure that
information required to be disclosed by us in reports that we file or submit
under the Securities Exchange Act of 1934 is recorded, processed, summarized and
reported, within the time periods specified in the rules and forms of the
Securities and Exchange Commission.
There has not been any change in our internal control over financial
reporting in connection with the evaluation required by Rule 15d-15(d) under the
Exchange Act that occurred during the quarte ended June 30, 2003 that has
materially affected, or is reasonably likely to materially affect, our internal
control over financial reporting.
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PART II - OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits:
Exhibit 31 - Rule 13a-14(a)/15-d-14(a) Certifications
Exhibit 32 Section 1350 Certifications
(b) Reports on Form 8-K filed during the quarter ended June 30, 2003:
None
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this Report to be signed on its behalf by the
undersigned thereunto duly authorized
EMTEC, INC.
By: /s/ JOHN P. HOWLETT
---------------------------------
John P. Howlett
Chairman, and Chief
Executive Officer
(Principal Executive Officer)
By: /s/ SAM BHATT
---------------------------------
Sam Bhatt
Vice President - Finance
(Principal Financial and
Accounting Officer)
Date: August 14, 2003
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STATEMENT OF DIFFERENCES
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The section symbol shall be expressed as............................... 'SS'