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WPCS INTERNATIONAL INC - 10-Q - MANAGEMENT'S DISCUSSION AND ANALYSIS
(Edgar Glimpses Via Acquire Media NewsEdge) OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
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 our 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 management's
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 management's 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.
Overview
We are a global provider of design-build engineering services for communications
infrastructure, with over 375 employees in five (5) operations centers on three
continents, following the asset sales of our Hartford and Lakewood Operations
described below. 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.
Recent Developments
On December 4, 2012, we entered into the Purchase Agreement with the Buyers
pursuant to which, we sold an aggregate of (i) $4,000,000 principal amount of
Notes and (ii) Warrants to purchase 15,923,567 shares of our Common Stock to the
Buyers for aggregate gross Financing proceeds of $4,000,000.
Pursuant to the terms of the Notes, we agreed to deposit the initial funds
received from the Financing, minus the Initial Lending Amount of $2,178,516 into
the Lockbox Account controlled by the Collateral Agent, as collateral agent on
behalf of the Buyers. In addition, all payments of our accounts receivable (and
our domestic subsidiaries) shall be deposited into the Lockbox Account. We are
permitted to receive from the Lockbox Account, on a daily basis, such amount of
cash equal to: (A) (i) cash balance in the Lockbox Account plus (ii) 95% of
available qualified accounts receivable minus (iii) $250,000 minus (B) amount of
principal, accrued interest, fees, costs and expenses owed pursuant to the
Notes. The Notes contain certain customary representations and warranties,
affirmative and negative covenants and events of default. The principal covenant
is that we shall maintain a current ratio of not less than 0.6 to 1.0 as of the
last calendar day of each month.
We used the Initial Lending Amount to repay the existing loan of $2,000,000,
plus $78,516 of interest accrued and fees and expenses to Sovereign, which
Credit Agreement was terminated in connection with the Financing, and $100,000
for Buyer legal fees in connection with the Notes.
On July 25, 2012, we and the Hartford and Lakewood Operations entered into the
Asset Purchase Agreement, pursuant to which the Hartford and Lakewood Operations
sold substantially all of their assets and liabilities to two newly-created
subsidiaries of Kavveri for a purchase price of $5.5 million in cash, subject to
adjustment and assumption of their various liabilities. At closing, we received
$4.9 million in cash, and the remaining $600,000 of the purchase price is to be
placed into escrow pursuant to the Asset Purchase Agreement. We used the
proceeds from this sale to repay the full amount outstanding under the Credit
Agreement of $4,022,320 as of July 25, 2012. The difference of $877,680 was
deposited in our operating cash account.
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WPCS INTERNATIONAL INCORPORATED AND SUBSIDIARIES
ITEM 2 - MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The parties agreed to place $350,000 of the purchase price into escrow pending
assignment of certain contracts post-closing, with us receiving those funds upon
successful assignment of the contracts. The remaining $250,000 is to be escrowed
for purposes of satisfying certain adjustments to the purchase price based on a
final net asset valuation to be completed after closing as well as repurchase
obligations of certain delinquent accounts receivable. No later than three days
after the final determination of the net asset valuation, the purchasers are
required to deposit the $600,000 into escrow. On September 4, 2012, Kavveri
provided us with its calculation of the net asset valuation, and claimed that we
owed them $251,868. On October 2, 2012, we provided Kavveri our calculation of
the net asset valuation, and claimed Kavveri owes us $94,493. We are currently
working with Kavveri to resolve the net asset valuation dispute. If the parties
disagree, and if they are unable to come to an agreement, the matter will then
be submitted to one or more independent, nationally-recognized accounting firms
for final determination.
On November 7, 2012, Kavveri submitted to us an aggregate claim for
indemnification of $1,938,288 with regard to (a) delinquent receivables to be
repurchased of $546,077; (b) $916,500 for accounts receivable Kavveri deems are
not collectible in the ordinary course of business, and (c) $475,000 for the
replacement, programming an installation of replacement radios on a project that
was completed by our Hartford Operations and accepted by the customer on or
prior to July 25, 2012. With regard to the delinquent receivables claimed, we
are disputing the amount of the delinquent receivables, and we believe that
after consideration of reserves for uncollectible accounts and other offsets
previously considered in our calculation of the net asset valuation described
above, the total amount of delinquent receivables to be repurchased is less, and
is subject to further reduction based on additional collection of receivables by
Kavveri. Furthermore, with regard to the timing in the Asset Purchase Agreement
for notification to us, we believe that Kavveri missed the deadline to notify us
regarding the repurchase of delinquent receivables, which would eliminate any
repurchase payment owed by us to Kavveri. We believe the remaining two claims
are without merit, and we are currently preparing a response to Kavveri, to
dispute each of these indemnification claims.
All operating results disclosed in this quarterly report only include the
results from continuing operations, and exclude the results for the St. Louis
and Sarasota Operations divested in September 2011, and the Hartford and
Lakewood Operations asset sales, each of which are presented as discontinued
operations. The Sarasota, Lakewood and Hartford Operations were previously
reported in the wireless communications segment and the St. Louis Operation was
reported in the specialty construction segment. We have also combined the
management and operations of the Seattle and Portland Operations for efficiency.
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.
With the divestiture of the Hartford and Lakewood Operations, we expect to
perform less project work in the police, fire, and emergency dispatch markets.
However, we will continue to provide wireless communications services through
our remaining operations in markets such as utilities, education, military and
transportation infrastructure, as part of the services we provide in our other
operations.
Specialty Construction
With the development of communities and industry, pipeline services are an
integral part of the infrastructure process. We have expertise in the
construction and maintenance of pipelines in our China Operations for natural
gas and petroleum transmission. This includes experience in transmission
infrastructure, horizontal directional drilling and rock trenching. In addition,
we offer trenching services for power lines, telecommunications and water lines.
Our services are performed with minimal ground disruption and environmentalimpact.
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WPCS INTERNATIONAL INCORPORATED AND SUBSIDIARIES
ITEM 2 - MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
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 renewable energy, telecommunications, life safety,
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.
As part of the divestiture transactions described above, we reclassified the
reporting units within our reportable segments. As a result, wireless
communications includes the Suisun City and Australia Operations, specialty
construction includes the China Operations, and electrical power includes the
Trenton, Seattle and Portland Operations, for each of the periods presented. For
the six months ended October 31, 2012, wireless communication, specialty
construction and electrical power represented approximately 39.6%, 7.9% and
52.5%, respectively, of our total revenue. For the six months ended October 31,
2011, wireless communication, specialty construction and electrical power
represented approximately 33.8%, 9.3% and 56.9%, respectively, of our totalrevenue.
Industry Trends
We focus on markets such as public services, healthcare, energy and
international which continue to show growth potential.
· Public services. We provide communications infrastructure for public services
which include 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 create cost efficiencies through the
implementation of new communications technology.
· Healthcare. We provide communications infrastructure for hospitals and medical
centers. In the healthcare market, the aging population is resulting in demands
for upgraded and additional hospital infrastructure. New construction and
renovations are occurring for hospitals domestically and internationally. In
addition, there is a need to reduce the cost of delivering healthcare by
implementing new communications technology. Our services include electrical
power, structured cabling, security systems, life safety systems, environmental
controls and communication systems.
· Energy. We provide communications infrastructure for petrochemical, natural gas
and electric utility companies as well as renewable energy systems for various
entities. 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 and design
and build renewable energy solutions.
· 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.
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 financial results in the second quarter and year-to-date for
fiscal 2013, we continue to make significant progress in turning around our
financial performance in our five operations centers for the three and six
months ended October 31, 2012, as compared to the year ended April 30, 2012.
During fiscal 2012, we employed cost reduction strategies, and made management
changes by hiring experienced leadership in Suisun City, especially in the
project management and estimating roles, which we believe has significantly
helped this operation return to EBITDA profitability. In our Trenton Operations,
we have essentially completed the Cooper Project, which was a project we
incurred a loss of approximately $6 million in fiscal 2012, and we are
re-focusing this operation to concentrate on pursuing smaller revenue projects
that can be performed profitably, and cost reduction strategies in order to
return this operation to profitability in fiscal 2013.
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WPCS INTERNATIONAL INCORPORATED AND SUBSIDIARIES
ITEM 2 - MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Excluding our corporate operating expenses, for the three months ended October
31, 2012, the five operation centers generated EBITDA as adjusted of
approximately $1,429,000, compared to an EBITDA as adjusted of $894,000 for the
three months ended October 31, 2011. The second quarter results ended October
31, 2012 includes approximately $ 750,000 of change orders received by the
Trenton Operations related to the Cooper Project. For the six months ended
October 31, 2012, we generated EBITDA as adjusted of approximately $2,124,000,
as compared to EBITDA as adjusted of $2,915,000 for the six months ended October
31, 2011. The six month results ended October 31, 2012 include approximately
$1,486,000 of change orders received by the Trenton Operations related to the
Cooper Project.
We expect to receive additional change orders in the third fiscal quarter from
the Cooper Project for costs incurred and recognized in prior periods, and we
have also submitted a claim for approximately $3.0 million to the Owner for
significant cost overruns as a result of significant delays, disruptions and
construction changes which were beyond our control and required us to perform
additional work. If approved, the additional change orders and claim for the
Cooper Project are expected to generate future operating income for us, as the
costs related to these pending change orders and claim have already been
incurred. All current and future amounts to be paid on the Cooper Project are
assigned and will be paid to Zurich directly.
EBITDA as adjusted is defined as earnings before interest, income taxes
including noncash charges for deferred tax asset valuation allowances, gain or
loss from discontinued operations, acquisition-related contingent earn-out
costs, goodwill impairment, one-time charges related to exploring strategic
alternatives and depreciation and amortization. Management uses EBITDA to assess
the ongoing operating and financial performance of our company. This financial
measure is not in accordance with GAAP and may differ from non-GAAP measures
used by other companies. A reconciliation of EBITDA is as follows.
Three Months Ended Six Months Ended
October 31, October 31, October 31,
2012 2011 2012 2011
NET (LOSS) INCOME ATTRIBUTABLE TO
WPCS, GAAP $ (493,386 ) $ (1,665,328 ) $ 500,315 $ (1,700,005 )
Plus:
Net income attributable to
noncontrolling interest 29,152 44,604 28,605 60,060
Loss from discontinued operations,
net of tax 88,267 285,330 727,559 474,015
Loss (gain) from disposal of
discontinued operations 485,212 1,027,637 (1,839,419 ) 1,027,637Income tax (benefit) provision (72,272 ) (354,384 ) 62,257 57,504
Interest expense 330,135 230,136 455,250 325,929
Interest income (6,161 ) (23,493 ) (15,959 ) (31,969 )
Change in fair value of
acquisition-related contingent
consideration - 40,560 - 83,628
One-time strategic costs - 76,842 - 140,512
Depreciation and amortization 320,066 441,870 681,780 881,043
Consolidated EBITDA as adjusted,
Non-GAAP 681,013 103,774 600,388 1,318,354
Plus:
Corporate operating expenses 747,673 790,574 1,523,416 1,596,638
EBITDA as adjusted of Continuing
Operation Centers, Non-GAAP $ 1,428,686 $ 894,348 $ 2,123,804 $ 2,914,992
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WPCS INTERNATIONAL INCORPORATED AND SUBSIDIARIES
ITEM 2 - MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
In regards to our financial results for the three months ended October 31, 2012,
we generated net income from our continuing operations attributable to WPCS of
approximately $80,000, or $0.01 per diluted common share, compared to a net loss
from continuing operations attributable to WPCS of $352,000 or $0.05 per diluted
common share for the same period in the prior year. For the three months ended
October 31, 2012, we generated a net loss of approximately $493,000, or $0.07
per diluted common share, which includes a loss from discontinued operations for
the Hartford and Lakewood Operations of approximately $573,000, or $0.08 per
diluted common share. This compares to a net loss of $1,665,000, or $0.24 per
diluted common share for the same period in the prior year, which includes a
loss from discontinued operations of approximately $1,313,000, or $0.19 per
diluted common share.
For the six months ended October 31, 2012, we generated net income of
approximately $500,000, or $0.07 per diluted common share, which includes income
from discontinued operations for the Hartford and Lakewood Operations of
approximately $1.1 million or $0.16 per diluted common share. This compares to a
net loss of approximately $1.7 million, or $0.24 per diluted common share, which
includes a loss from discontinued operations of approximately $1.5 million, or
$0.22 per diluted common share for the six months ended October 31, 2011.
Although the economy has not yet fully recovered and will continue to present
challenges for our business, we expect to generate EBITDA as adjusted in the
fiscal year ending April 30, 2013. 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. For comparative purposes our backlog and bid list for prior periods
only includes our continuing operations. Our backlog of unfilled orders was
approximately $28.9 million at October 31, 2012, compared to backlog of $30.8
million at July 31, 2012, and $25.1 million at October 31, 2011.
Our bid list, which represents project bids under proposal for new and existing
customers, was approximately $56.3 million at October 31, 2012, compared to
approximately $61.1 million at July 31, 2012. Our goal is to continue converting
more of these bids into contract awards and to increase our backlog in the
quarters ahead.
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. In regards to strategic development, our focus is on
organic growth opportunities and we feel optimistic about the markets we serve
as evidenced by our new contract awards and customers continuing to seek bids
from us, due to our experience in these markets.
Results of Operations for the Three Months Ended October 31, 2012 Compared to
the Three Months Ended October 31, 2011
Consolidated results for the three months ended October 31, 2012 and 2011 were
as follows:
Three Months Ended
October 31,
2012 2011
REVENUE $ 9,942,161 100.0 % $ 21,754,833 100.0 %
COSTS AND EXPENSES:
Cost of revenue 6,324,209 63.7 % 18,379,347 84.5 %
Selling, general and administrative
expenses 2,936,939 29.5 % 3,348,554 15.4 %
Depreciation and amortization 320,066 3.2 % 441,870 2.0 %
Change in fair value of
acquisition-related contingent
consideration - - 40,560 0.2 %
Total costs and expenses 9,581,214 96.4 % 22,210,331 102.1 %
OPERATING INCOME (LOSS) 360,947 3.6 % (455,498 ) (2.1 )%
OTHER EXPENSE (INCOME):
Interest expense 330,135 3.2 % 230,136 1.1 %
Interest income (6,161 ) - (23,493 ) (0.1 )%
Income (loss) from continuing
operations before income tax benefit 36,973 0.4 % (662,141 ) (3.1 )%
Income tax benefit (72,272 ) (0.7 )% (354,384 ) (1.6 )%
INCOME (LOSS) FROM CONTINUING
OPERATIONS 109,245 1.1 % (307,757 ) (1.5 )%
Discontinued operations
Loss from operations of discontinued
operations, net of tax (88,267 ) (0.9 )% (285,330 ) (1.3 )%
Loss from disposal (485,212 ) (4.9 )% (1,027,637 ) (4.7 )%
Loss from discontinued operations,
net of tax (573,479 ) (5.8 )% (1,312,967 ) (6.0 )%
CONSOLIDATED NET LOSS (464,234 ) (4.7 )% (1,620,724 ) (7.5 )%
Net income attributable to
noncontrolling interest 29,152 0.3 % 44,604 0.2 %
NET LOSS ATTRIBUTABLE TO WPCS $ (493,386 ) (5.0 )% $ (1,665,328 ) (7.7 )%
32
WPCS INTERNATIONAL INCORPORATED AND SUBSIDIARIES
ITEM 2 - MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Revenue
Revenue for the three months ended October 31, 2012 was approximately
$9,942,000, as compared to approximately $21,755,000 for the three months ended
October 31, 2011. The decrease in revenue was due to a number of factors: (1)
the planned strategic change to re-focus the Trenton Operation as a smaller
revenue producing operation that returns to profitability, while the Cooper
Project is completed; and (2) project delays or postponement of new project bid
awards at the state and local government level due to political and economic
climate. For the three months ended October 31, 2012 and 2011, we had one
customer, the Cooper Project, which comprised 12.4% and 16.1% of total revenue,
respectively.
Wireless communication segment revenue for the three months ended October 31,
2012 and 2011 was approximately $4,649,000 or 46.8% and $6,540,000 or 30.1% of
total revenue, respectively. The decrease in revenue was due primarily to
project delays on existing contracts and delays or postponements of new project
bid awards from prior quarters at the state and local government level for
public services projects, the revenue of which is expected to be recognized in
future periods. The increase as a percentage of revenue was due to a change in
segment revenue mix as a result of a reduction of operations in the electrical
power segment.
Specialty construction segment revenue for the three months ended October 31,
2012 and 2011 was approximately $823,000 or 8.3% and $2,443,000 or 11.2% of
total revenue, respectively. The decrease in revenue was primarily attributable
to fewer projects completed in the three months ended October 31, 2012 as
compared to the same period in the prior year for the China Operations. Revenue
in the China Operations is recognized on a completed contract basis.
Electrical power segment revenue for the three months ended October 31, 2012 and
2011 was approximately $4,471,000 or 45.0% and $12,771,000 or 58.7% of total
revenue, respectively. The decrease in revenue was due primarily to the planned
strategic change to re-focus the Trenton Operation as a smaller revenue
producing operation that returns to profitability, while completing the Cooper
Project. The Cooper Project accounted for 27.3% of the total revenue in the
electrical power segment this quarter compared to 27.5% in the same period in
the prior year. The Cooper Project was essentially completed in the second
fiscal quarter. It is not expected that similar future projects will replace the
Cooper Project or other larger electrical projects that were completed in the
prior period, therefore, it is expected that our revenue in the electrical power
segment will not substantially increase in the near future.
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 $6,324,000, or 63.7% of revenue, for the three
months ended October 31, 2012, compared to $18,379,000 or 84.5% for the same
period of the prior year. The dollar decrease in our total cost of revenue is
primarily due to the corresponding decrease in revenue during the three months
ended October 31, 2012. The decrease as a percentage of revenue is due to: (1)
the revenue blend of project work completed during the quarter; (2) the current
period contained a smaller percentage of lower margin work performed by the
Trenton Operations, including the Cooper Project, as compared to the same period
in the prior period; and (3) the current quarter included approximately $750,000
of change order revenue related to the Cooper Project, the costs of which were
incurred or accrued in fiscal 2012.
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WPCS INTERNATIONAL INCORPORATED AND SUBSIDIARIES
ITEM 2 - MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Wireless communication segment cost of revenue and cost of revenue as a
percentage of revenue for the three months ended October 31, 2012 and 2011 was
approximately $3,186,000 and 68.5% and $4,758,000 or 72.7%, respectively. The
dollar decrease in cost of revenue is due to the corresponding decrease in
revenue during the three months ended October 31, 2012. The decrease as a
percentage of revenue is due to the revenue blend of project work performed
during the three months ended October 31, 2012.
Specialty construction segment cost of revenue and cost of revenue as a
percentage of revenue for the three months ended October 31, 2012 and 2011 was
approximately $415,000 and 50.4% and $1,867,000 and 76.4%, respectively. The
dollar decrease in cost of revenue is due to the corresponding decrease in
revenue during the three months ended October 31, 2012 in our China Operations.
The decrease as a percentage of revenue is due to the revenue blend of project
work performed, and less subcontractor cost as compared to the same periodin
the prior year.
Electrical power segment cost of revenue and cost of revenue as a percentage of
revenue for the three months ended October 31, 2012 and 2011 was approximately
$2,724,000 and 60.9% and $11,755,000 and 92.0%, respectively. The dollar
decrease in cost of revenue is due to the corresponding decrease in revenue
during the three months ended October 31, 2012. The decrease as a percentage of
revenue is primarily due to revenue blend of project work performed during the
quarter, as the current quarter included approximately $750,000 of change order
revenue related to the Cooper Project, the costs of which were incurred or
accrued in fiscal 2012. In total, the current period contained a smaller
percentage of lower margin work performed by the Trenton Operations, as compared
to the same period in the prior year.
Selling, General and Administrative Expenses
For the three months ended October 31, 2012, total selling, general and
administrative expenses were approximately $2,937,000, or 29.5% of total revenue
compared to $3,349,000, or 15.4% of revenue, for the prior year. Included in
selling, general and administrative expenses for the three months ended October
31, 2012 are $1,754,000 for salaries, commissions, payroll taxes and other
employee benefits. The $188,000 decrease in salaries and payroll taxes compared
to the prior year is due primarily to the lower salaries from cost reduction
strategies. Professional fees were $279,000, which include on-going accounting,
legal and investor relations fees. The $63,000 decrease in professional fees
compared to the prior year is due primarily to no strategic alternatives costs
due to the conclusion of this effort, and reduced on-going professional service
fees for other services compared to the same period in the prior year. Insurance
costs were $141,000 and rent for office facilities was $119,000. Automobile and
other travel expenses were $283,000 and telecommunication expenses were $57,000.
Other selling, general and administrative expenses totaled $304,000. For the
three months ended October 31, 2012, total selling, general and administrative
expenses for the wireless communication, specialty construction and electrical
power segments were approximately $1,316,000, $98,000 and $775,000,
respectively, with the balance of approximately $748,000 pertaining to corporate
expenses.
For the three months ended October 31, 2011, total selling, general and
administrative expenses were approximately $3,349,000 or 15.4% of total revenue.
Included in selling, general and administrative expenses for the three months
ended October 31, 2011 was $1,942,000 for salaries, commissions, payroll taxes
and other employee benefits. Professional fees were $342,000, which include
accounting, legal and investor relation fees. Insurance costs were $270,000 and
rent for office facilities was $143,000. Automobile and other travel expenses
were $341,000 and telecommunication expenses were $63,000. Other selling,
general and administrative expenses totaled $248,000. For the three months ended
October 31, 2011, total selling, general and administrative expenses for the
wireless communication, specialty construction and electrical power segments
were approximately $1,376,000, $94,000 and $1,088,000, respectively, with the
balance of approximately $791,000 pertaining to corporate expenses.
Depreciation and Amortization
For the three months ended October 31, 2012 and 2011, depreciation was
approximately $289,000 and $402,000, respectively. The decrease in depreciation
is due to the retirement of certain assets. The amortization of customer lists
and backlog for the three months ended October 31, 2012 was $31,000 as compared
to $40,000 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 prior year compared to the current 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 relatedcontracts.
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WPCS INTERNATIONAL INCORPORATED AND SUBSIDIARIES
ITEM 2 - MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Change in Fair Value of Acquisition-Related Contingent Consideration
For the three months ended October 31, 2012 and 2011, the change in fair value
of acquisition-related contingent consideration was $0 and $41,000,
respectively. The change in fair value of acquisition-related contingent
consideration is due to the non-cash expense recorded in the fiscal 2012
statement of operations for the change in present value of future payments of
acquisition-related contingent consideration related to the Pride acquisition.
In connection with the acquisition of Pride on November 1, 2009, during fiscal
2012 we paid additional purchase price of $1,047,732 to the former Pride
shareholders upon the achievement of the earnings before interest and taxes
(EBIT). As a result, the settlement acquisition-related contingent consideration
was completed, and no further expense was recorded.
Interest Expense and Interest Income
For the three months ended October 31, 2012 and 2011, interest expense was
approximately $330,000 and $230,000, respectively. The increase in interest
expense is due principally to an increase in the amortization of debt issuance
costs for Sovereign compared to the same period in the prior year, offset by a
decrease in the total borrowings outstanding under the line of credit with
Sovereign over the course of the three months ended October 31, 2012 compared to
the line of credit with Bank of America N.A. in the same period in the prior
year. As of October 31, 2012, there was approximately $1,034,000 of borrowings
outstanding under the line of credit.
For the three months ended October 31, 2012 and 2011, interest income was
approximately $6,200 and $23,500, respectively. The decrease in interest earned
is due principally to a decrease in interest income in our Australia Operations
compared to the same period in the prior year.
Income Taxes
The actual income tax rate from continuing operations for the three months ended
October 31, 2012 was -195.0% compared to 53.5% for same period in the prior
year. The difference was primarily due to no tax benefit being claimed for
Federal and state losses during the three months ended October 31, 2012.
Loss from Discontinued Operations
As a result of the sale of the assets of the Hartford and Lakewood Operations on
July 25, 2012, we recorded the financial results of these operations as
discontinued operations. For the three months ended October 31, 2012, we
recorded a loss from discontinued operations of approximately $573,000. Included
in the loss from discontinued operations are $485,000 associated with the sale
of the assets of the Hartford and Lakewood Operations.
As a result of the sale of the assets of the Hartford and Lakewood Operations as
described above, and the common stock of the St. Louis and Sarasota Operations
to Multiband on September 1, 2011, we recorded the financial results of these
operations as discontinued operations. For the three months ended October 31,
2011, we recorded a loss from discontinued operations of approximately
$1,313,000, net of tax. Included in the loss from discontinued operations was an
approximate $1,028,000 loss on disposal of the St. Louis and Sarasota
Operations.
Net Loss Attributable to WPCS
The net loss attributable to WPCS was approximately $493,000 for the three
months ended October 31, 2012. The net loss was net of Federal and state income
tax benefits of approximately $72,000.
The net loss attributable to WPCS was approximately $1,665,000 for the three
months ended October 31, 2011. The net loss was net of Federal and state income
tax benefits of approximately $354,000.
35
WPCS INTERNATIONAL INCORPORATED AND SUBSIDIARIES
ITEM 2 - MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Results of Operations for the Six Months Ended October 31, 2012 Compared to the
Six Months Ended October 31, 2011
Consolidated results for the six months ended October 31, 2012 and 2011 were as
follows:
Six Months Ended
October 31,
2012 2011
REVENUE $ 23,386,578 100.0 % $ 40,370,924 100.0 %
COSTS AND EXPENSES:
Cost of revenue 16,838,285 72.0 % 32,586,590 80.7 %
Selling, general and administrative
expenses 5,947,905 25.4 % 6,606,492 16.4 %
Depreciation and amortization 681,780 2.9 % 881,043 2.2 %
Change in fair value of
acquisition-related contingent
consideration - - 83,628 0.2 %
Total costs and expenses 23,467,970 100.3 % 40,157,753 99.5 %
OPERATING (LOSS) INCOME (81,392 ) (0.3 )% 213,171 0.5 %
OTHER EXPENSE (INCOME):
Interest expense 455,250 2.0 % 325,929 0.8 %
Interest income (15,959 ) (0.1 )% (31,969 ) (0.1 )%
Loss from continuing operations
before income tax provision (520,683 ) (2.2 )% (80,789 ) (0.2 )%
Income tax provision 62,257 0.3 % 57,504 0.1 %
LOSS FROM CONTINUING OPERATIONS (582,940 ) (2.5 )% (138,293 ) (0.3 )%
Discontinued operations
Loss from operations of discontinued
operations, net of tax (727,559 ) (3.1 )% (474,015 ) (1.2 )%
Gain (loss) from disposal 1,839,419 7.9 % (1,027,637 ) (2.5 )%
Income (loss) from discontinued
operations, net of tax 1,111,860 4.8 % (1,501,652 ) (3.7 )%
CONSOLIDATED NET INCOME (LOSS) 528,920 2.3 % (1,639,945 ) (4.0 )%
Net income attributable to
noncontrolling interest 28,605 0.1 % 60,060 0.2 %
NET INCOME (LOSS) ATTRIBUTABLE TO
WPCS $ 500,315 2.2 % $ (1,700,005 ) (4.2 )%
Revenue
Revenue for the six months ended October 31, 2012 was approximately $23,387,000,
as compared to approximately $40,371,000 for the six months ended October 31,
2011. The decrease in revenue was due to : (1) the planned strategic change to
re-focus the Trenton Operation as a smaller revenue producing operation that
returns to profitability, while the Cooper Project is completed; and (2) project
delays or postponement of new project bid awards at the state and local
government level due to political and economic climate. For the six months ended
October 31, 2012, we had one customer, the Cooper Project, which comprised 22.9%
of total revenue. For the six months ended October 31, 2011, we had two
customers, the Cooper Project and Irwin & Leighton, Inc. (I&L), which comprised
13.3% and 12.7% of total revenue, respectively.
36
WPCS INTERNATIONAL INCORPORATED AND SUBSIDIARIES
ITEM 2 - MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Wireless communication segment revenue for the six months ended October 31, 2012
and 2011 was approximately $9,265,000 or 39.6% and $13,639,000 or 33.8% of total
revenue, respectively. The decrease in revenue was due primarily to project
delays on existing contracts and delays or postponements of new project bid
awards from prior quarters at the state and local government level for public
services projects, the revenue of which is expected to be recognized in future
periods.
Specialty construction segment revenue for the six months ended October 31, 2012
and 2011 was approximately $1,854,000 or 7.9% and $3,744,000 or 9.3% of total
revenue, respectively. The decrease in revenue was attributable to fewer
projects completed in the six months ended October 31, 2012 as compared to the
same period in the prior year for the China Operations.
Electrical power segment revenue for the six months ended October 31, 2012 and
2011 was approximately $12,269,000 or 52.5% and $22,989,000 or 56.9% of total
revenue, respectively. The decrease in revenue was due primarily to the planned
strategic change to re-focus the Trenton Operation as a smaller revenue
producing operation that returns to profitability, while completing the Cooper
Project. The Cooper Project accounted for 43.6% of total revenue in the
electrical power segment for the six months ended October 31, 2012, compared to
23.3% in the same period in the prior period. It is not expected that similar
future projects will replace the Cooper Project or other larger projects such as
I&L that were completed in the prior period, therefore, it is expected that our
revenue in the electrical power segment will not substantially increase inthe
near future.
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 $16,838,000 or 72.0% of revenue for the six
months ended October 31, 2012, compared to $32,587,000 or 80.7% for the same
period of the prior year. The dollar decrease in our total cost of revenue is
primarily due to the corresponding decrease in revenue for the six months ended
October 31, 2012. The decrease as a percentage of revenue is due to: (1) the
revenue blend of project work completed during the period; (2) the current
period contained a smaller percentage of lower margin work performed by the
Trenton Operations, including the Cooper Project, as compared to the same period
in the prior period; (3) the current period included approximately $1,486,000 of
change order revenue related to the Cooper Project, the costs of which were
incurred or accrued in fiscal 2012.
Wireless communication segment cost of revenue and cost of revenue as a
percentage of revenue for the six months ended October 31, 2012 and 2011 was
approximately $6,406,000 and 69.1% and $9,382,000 and 68.8%, respectively. The
dollar decrease in our cost of revenue is due primarily to the corresponding
decrease in revenue for the six months ended October 31, 2012.
Specialty construction segment cost of revenue and cost of revenue as a
percentage of revenue for the six months ended October 31, 2012 and 2011 was
approximately $1,147,000 and 61.9% and $2,854,000 and 76.2%, respectively. The
dollar decrease in our cost of revenue is due to the corresponding decrease in
revenue for the six months ended October 31, 2012 in our China Operations. The
decrease as a percentage of revenue is due to the revenue blend of project work
performed, and less subcontractor costs as compared to the same period in the
prior year.
Electrical power segment cost of revenue and cost of revenue as a percentage of
revenue for the six months ended October 31, 2012 and 2011 was approximately
$9,285,000 and 75.7% and $20,351,000 and 88.5%, respectively. The dollar
decrease in our cost of revenue is due to the corresponding decrease in revenue
for the six months ended October 31, 2012. The decrease as a percentage of
revenue is primarily due to revenue blend of project work performed during the
quarter, as the current quarter included approximately $1,486, 000 of change
order revenue related to the Cooper Project, the costs of which were incurred or
accrued in fiscal 2012. In total, the current period contained a smaller
percentage of lower margin work performed by the Trenton Operations, as compared
to the same period in the prior year.
37
WPCS INTERNATIONAL INCORPORATED AND SUBSIDIARIES
ITEM 2 - MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Selling, General and Administrative Expenses
For the six months ended October 31, 2012, total selling, general and
administrative expenses were approximately $5,948,000 or 25.4% of total revenue
compared to $6,606,000, or 16.4% of revenue for the same period of the prior
year. Included in selling, general and administrative expenses for the six
months ended October 31, 2012 is $3,485,000 for salaries, commissions, payroll
taxes and other employee benefits. The decrease of $369,000 in salaries and
commissions compared to the prior period is due to lower salaries from cost
reduction strategies, as well as lower commissions and bonuses. Professional
fees were $586,000, which include accounting, legal and investor relation fees.
The decrease of $139,000 in professional fees compared to the prior year is due
primarily to lower strategic alternative costs and other reduced lower
professional service fees for other services compared to the same period in the
prior year. Insurance costs were $387,000 and rent for office facilities was
$251,000. Automobile and other travel expenses were $617,000 and
telecommunication expenses were $106,000. Other selling, general and
administrative expenses totaled $515,000. For the six months ended October 31,
2012, total selling, general and administrative expenses for the wireless
communication, specialty construction and electrical power segments were
approximately $2,661,000, $164,000 and $1,599,000, respectively, with the
balance of approximately $1,524,000 pertaining to corporate expenses.
For the six months ended October 31, 2011, total selling, general and
administrative expenses were approximately $6,606,000, or 16.4% of total
revenue. Included in selling, general and administrative expenses for the six
months ended October 31, 2011 is $3,854,000 for salaries, commissions, payroll
taxes and other employee benefits. Professional fees were $725,000, which
include accounting, legal and investor relation fees, and approximately $141,000
of incremental third party investment banking expenses in connection with
pursuing strategic alternatives. Insurance costs were $446,000 and rent for
office facilities was $298,000. Automobile and other travel expenses were
$671,000 and telecommunication expenses were $128,000. Other selling, general
and administrative expenses totaled $484,000. For the six months ended October
31, 2011, total selling, general and administrative expenses for the wireless
communication, specialty construction and electrical power segments were
approximately $2,824,000, $152,000 and $2,039,000, respectively, with the
balance of approximately $1,591,000 pertaining to corporate expenses.
Depreciation and Amortization
For the six months ended October 31, 2012 and 2011, depreciation was
approximately $615,000 and $800,000, respectively. The net decrease in
depreciation expense is due to new fixed asset additions. The amortization of
customer lists and backlog for the six months ended October 31, 2012 was $66,000
as compared to $81,000 for the same period of the prior year. The decrease in
amortization expense compared to October 31, 2011, was due primarily to certain
customer lists and backlog being fully amortized in the prior year compared to
the current 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.
Change in Fair Value of Acquisition-Related Contingent Consideration
For the six months ended October 31, 2012 and 2011, the change in fair value of
acquisition-related contingent consideration was approximately $0 and $84,000,
respectively. The change in fair value of acquisition-related contingent
consideration is due to the non-cash expense recorded in the fiscal 2012
statement of operations for the change in present value of future payments of
acquisition-related contingent consideration related to the Pride acquisition.
In connection with the acquisition of Pride on November 1, 2009, during fiscal
2012 we paid additional purchase price of $1,047,732 to the former Pride
shareholders upon the achievement of the earnings before interest and taxes
(EBIT). As a result, the settlement acquisition-related contingent consideration
was completed, and no further expense was recorded.
Interest Expense and Interest Income
For the six months ended October 31, 2012 and 2011, interest expense was
approximately $455,000 and $326,000, respectively. The increase in interest
expense is due principally to an increase in the amortization of debt issuance
costs for Sovereign compared to the same period in the prior year, offset by a
decrease in the total borrowings outstanding under lines of credit with Bank of
America N.A. and Sovereign over the course of the six months ended October 31,
2012 compared to the same period in the prior year. As of October 31, 2012,
there was approximately $1,034,000 of borrowings outstanding under the lineof
credit.
For the six months ended October 31, 2012 and 2011, interest income was
approximately $16,000 and $32,000, respectively. The decrease in interest earned
is due principally to a decrease in interest income in our Australia Operations
compared to the same period in the prior year.
38
WPCS INTERNATIONAL INCORPORATED AND SUBSIDIARIES
ITEM 2 - MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Income Taxes
The actual income tax rate from continuing operations for the six months ended
October 31, 2012 was -12.0% compared to -71.2% for same period in the prior
year. The difference was primarily due to no tax benefit being claimed for
federal and state losses during the six months ended October 31, 2012.
Income (Loss) From Discontinued Operations
As a result of the sale of the assets of the Hartford and Lakewood Operations on
July 25, 2012, we recorded the financial results of these operations as
discontinued operations. For the six months ended October 31, 2012, we recorded
an income from discontinued operations of approximately $1,112,000. Included in
the income from discontinued operations are approximately $1,839,000 gain from
disposal and $56,000 of expenses directly related with the sale of the assets of
the Hartford and Lakewood Operations.
As a result of the sale of the assets of the Hartford and Lakewood Operations as
described above, and the common stock of the St. Louis and Sarasota Operations
to Multiband on September 1, 2011, we recorded the financial results of these
operations as discontinued operations. For the six months ended October 31,
2011, we recorded a loss from discontinued operations of approximately
$1,502,000, net of tax. Included in the loss from discontinued operations was an
approximate $1,028,000 loss on disposal of the St. Louis and Sarasota
Operations.
Net Income (Loss) Attributable to WPCS
The net income attributable to WPCS was approximately $500,000 for the six
months ended October 31, 2012. Net income was net of Federal and state income
tax provisions of approximately $62,000.
The loss attributable to WPCS was approximately $1,700,000 for the six months
ended October 31, 2011. Net loss was net of Federal and state income tax
provisions of approximately $58,000.
Liquidity and Capital Resources
At October 31, 2012, we had working capital of approximately $1,266,000, which
consisted of current assets of approximately $15,898,000 and current liabilities
of $14,632,000. This compares to a working capital deficiency of approximately
$1,100,000 at April 30, 2012. The increase in working capital since the fiscal
year ended April 30, 2012 is due primarily to the sale of the assets of the
Hartford and Lakewood Operations on July 25, 2012. We received approximately
$4.9 million in cash from the sale of these assets, and used the proceeds to
repay the full amount then outstanding under the Credit Agreement.
Our cash and cash equivalents balance at October 31, 2012 of $921,000 included
$479,000 of cash in our Australia Operations associated with our permanent
reinvestment strategy. Subject to the working capital needs of Australia, there
is approximately $837,000 of loans due from Australia that could be repaid to us
in the future to help with 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 used approximately $986,000 in cash for the six months
ended October 31, 2012. The sources of cash from operating activities total
approximately $3,318,000, comprised of approximately $529,000 of net income, a
$1,894,000 decrease in accounts receivable, a $63,000 decrease in costs and
estimated earnings in excess of billings on uncompleted contracts, a $159,000
decrease in income taxes receivable and prepaid taxes, a $15,000 decrease in
other assets, and a $658,000 increase in deferred revenue. The uses of cash from
operating activities total approximately $4,304,000, comprised of an
approximately $801,000 in net noncash charges, an $18,000 increase in inventory,
a $156,000 increase in prepaid expenses and other current assets, a $1,753,000
decrease in accounts payable and accrued expenses, and a $1,576,000 decrease in
billings in excess of costs and estimated earnings on uncompleted contracts.
39
WPCS INTERNATIONAL INCORPORATED AND SUBSIDIARIES
ITEM 2 - MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Our investing activities provided cash of approximately $4,324,000 for the six
months ended October 31, 2012. Investing activities include total proceeds of
$4,554,000 from the asset sales of the Hartford and Lakewood Operations, net of
approximately $56,000 of direct transaction costs, and $290,000 of liabilities
paid that were not assumed by Kavveri. The net proceeds of the asset sales were
used to fully repay amounts outstanding under our line of credit with Sovereign
Bank as described under financing activities. These proceeds were offset by the
payment of approximately $230,000 used for acquiring property and equipment
during the six months ended October 31, 2012.
Our financing activities used cash of approximately $3,187,000 for the six
months ended October 31, 2012. Financing activities which used cash include
repayments under the line of credit with Sovereign Bank of approximately
$3,930,000, debt issuance costs paid of $57,000, repayments to joint venture
partner of approximately $2,516,000 and repayments of previous loans payable and
capital lease obligations of approximately $68,000. These financing uses of cash
are offset by additional financing sources including a settlement of $222,000,
relating to a Section 16(b) shareholder derivative lawsuit, borrowings of short
term bank loan for the joint venture of $2,368,000 and other payable due from
Zurich of $794,000.
Sovereign Bank Credit Agreement
On January 27, 2012, we entered into the Credit Agreement with Sovereign, which
was amended May 3, 2012, and again on August 31, 2012. The Credit Agreement, as
amended, provides for a revolving line of credit in an amount not to exceed
$2,000,000 and letters of credit in an amount not to exceed $200,000. Pursuant
to the Credit Agreement, we granted a security interest to Sovereign in all of
our assets. In addition, pursuant to a collateral pledge agreement, we pledged
100% of our ownership in our Subsidiaries and 65% of our ownership in WPCS
Australia Pty Ltd. Borrowings under the Credit Agreement may be used for general
corporate purposes, for permitted acquisitions, for working capital and for
related fees and expenses. The interest rate applicable to revolving loans under
the Credit Agreement is the Prime Rate (3.25%) plus 2.00%, or 5.25%.
On May 3, 2012, we entered into the Amendment to the Credit Agreement with
Sovereign. The Amendment reduced the maximum revolving line of credit in amount
not to exceed $6,500,000. On August 31, 2012, we entered into the Second
Amendment with Sovereign. Pursuant to the terms of the Second Amendment, we are
permitted to borrow under the revolving credit line, under a Borrowing Base
equal to the lesser of (i) $2,000,000 less the letter of credit amount, or (ii)
the sum of (a) 80% of Eligible Accounts Receivable, minus (c) the letter of
credit amount minus (d) such reserves, in such amounts and with respect to such
matters, as Sovereign may deem reasonably proper and necessary from time to time
at its own discretion, which is currently $500,000. As of October 31, 2012, the
total amount of borrowings outstanding under the Credit Agreement was
$1,034,323.
The Credit Agreement contains certain customary representations and warranties,
affirmative and negative covenants, and lockbox arrangements. Principal
covenants include (a) Fixed Charge Coverage Ratio of not less than 1.2 to 1.0,
measured as of April 30, 2012 and as of each fiscal quarter end thereafter, in
each case on a trailing two (2) quarter basis; and (b) Leverage Ratio of not
more than 1.75 to 1.0, measured as of each fiscal quarter end. Due to the
operating losses for the quarters ended April 30, 2012 and July 31, 2012, we did
not meet the Fixed Charge Coverage Ratio of 1.2 to 1.0 for the quarters ended
April 30, 2012, July 31, 2012, and October 31, 2012, and the Leverage Ratio of
1.75 to 1.0 at April 30, 2012, and we are currently in default under the Credit
Agreement. In connection with the Second Amendment, Sovereign reserved all of
its available rights and/or remedies as a result of the defaults of the
financial covenants, including the right to demand repayment of amounts
outstanding or withhold or cease making credit advances under the Credit
Agreement. As more fully described below, on December 5, 2012, the outstanding
borrowings under the Credit Agreement were repaid in full and the Credit
Agreement terminated.
Convertible Debenture Offering
On December 4, 2012, we entered into the Purchase Agreement with the Buyers
pursuant to which, we sold an aggregate of (i) $4,000,000 principal amount of
Notes and (ii) the Warrants to purchase 15,923,567 shares of our Common Stock,
to the Buyers for aggregate Financing gross proceeds of $4,000,000. In
connection with the Financing, (i) we entered into a the Registration Rights
Agreement, (ii) we and our subsidiaries entered into the Security Agreement, and
(iii) our subsidiaries entered into the Guaranty in favor of the collateral
agent for the Buyers. The Closing Date of the Financing was December 5, 2012.
40
WPCS INTERNATIONAL INCORPORATED AND SUBSIDIARIES
ITEM 2 - MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Pursuant to the terms of the Notes, we agreed to deposit the initial funds
received from the Financing, minus the Initial Lending Amount of $2,178,516 into
the Lockbox Account controlled by the Collateral Agent, as collateral agent on
behalf of the Buyers. In addition, all our accounts receivable (and of our
domestic subsidiaries) shall be deposited into the Lockbox Account. We are
permitted to receive from the Lockbox Account, on a daily basis, such amount of
cash equal to: (A) (i) cash balance in the Lockbox Account plus (ii) 95% of
available qualified accounts receivable minus (iii) $250,000 minus (B) amount of
principal, accrued interest, fees, costs and expenses owed pursuant to the
Notes. The Notes contain certain customary representations and warranties,
affirmative and negative covenants, and events of default. The principal
covenant is that we shall maintain a current ratio of not less than 0.6 to 1.0
as of the last calendar day of each month.
We used the Initial Lending Amount to repay the existing loan described above of
$2,000,000, plus $78,516 of interest accrued and fees and expenses to Sovereign,
which Credit Agreement was terminated in connection with the Notes, and $100,000
for Buyer legal expenses in connection with the Notes. In addition, we shall pay
to the Buyers a consulting fee of not more than $5,000 per month during theterm
of the Notes.
The Notes will mature on the eighteen month anniversary of the Closing Date and
will bear interest at the rate of 4% per annum, which will be payable quarterly
in arrears and may be paid, in certain conditions, through the issuance of
shares, at the our discretion.
Pursuant to the Purchase Agreement, we agreed to use our reasonable best efforts
to obtain our Stockholders' Approval at the next annual stockholder meeting of
the issuance of all of the securities issuable pursuant to the Purchase
Agreement. We agreed to seek to obtain Stockholder Approval by March 4, 2013.
If, despite our reasonable best efforts Stockholder Approval is not obtained on
or prior to March 4, 2013, we agreed to cause an additional annual stockholder
meeting to be held annually at which Stockholder Approval will be sought (or if
no Annual Meeting of our stockholders is held in any given year, to seek such
approval at a special meeting of our stockholders in such given year) untilthe
Stockholder Approval Date.
The Notes are initially convertible into shares of Common Stock at a Conversion
Price of $0.3768 per share. The Conversion Price will be adjusted to 85% of the
average of the closing bid prices for the five consecutive trading dates
immediately prior to the following adjustment dates: (1) the earlier of the
effective date of a registration statement or six months after closing (the
First Adjustment); (2) the later of the date that is three months after the
First Adjustment or one year after closing (the Second Adjustment); and (3) the
Stockholder Approval Date. The Warrants are exercisable for a period of five
years from the Closing Date at an Exercise Price of $0.471 per share. The
Exercise Price will be subject to the same adjustments as provided in the Notes
as described above.
If an event of default under the Notes occurs, upon the request of the holder of
the Note, we will be required to redeem all or any portion of the Note
(including all accrued and unpaid interest), in cash, at a price equal to the
greater of (i) up to 125% of the amount being converted, depending on the nature
of the default, and (ii) the product of (a) the number of shares of Common Stock
issuable upon conversion of the Note, times (b) 125% of the highest closing sale
price of the Common Stock during the period beginning on the date immediately
preceding such event of default and ending on the trading day immediately prior
to the trading day that the redemption price is paid by us.
We have the right, at any time after one year from the Closing Date, to redeem
all, but not less than all, of the outstanding Notes, upon not less than 20
trading days nor more than 30 trading days prior written notice. The redemption
price shall equal 120% of the amount of principal and interest being redeemed.
The Buyers are prohibited from converting the Notes and/or exercising the
Warrants and receiving shares of our Common Stock, in the aggregate, such that
the number of shares of Common Stock issued upon such conversions and/or
exercises exceeds 19.9% of the issued and outstanding shares of our Common Stock
as of the Closing Date, unless Stockholder Approval is obtained.
The Buyers agree to restrict their ability to convert the Notes and/or exercise
the Warrants and receive shares of our Common Stock such that the number of
shares of Common Stock held by the Buyer in the aggregate and its affiliates
after such conversion or exercise does not exceed 9.99% of the then issued and
outstanding shares of our Common Stock.
Pursuant to the Registration Rights Agreement, we agreed to file a registration
statement with the SEC, within 30 days following receipt of a request from a
Buyer (or 45 days with respect to an underwritten offering), covering such
shares of common stock issuable upon conversion of the Notes or exercise of the
Warrants, as requested by the Buyers, and have such registration statement
declared effective by the SEC within 90 days thereafter. We also agreed to
notify the Buyers if we at any time propose to register any of our securities
under the Securities Act of 1933, as amended, and of such Buyers' right to
participate in such registration.
41
WPCS INTERNATIONAL INCORPORATED AND SUBSIDIARIES
ITEM 2 - MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Pursuant to the Guaranty, our subsidiaries guaranteed to the collateral agent,
for the benefit of the Buyers, the punctual payment, as and when due and
payable, of all amounts owed by us in respect of the Purchase Agreement, the
Notes and the other transaction documents executed in connection with the
Purchase Agreement.
Pursuant to the Security Agreement, we and our subsidiaries granted, in favor of
the collateral agent for the Buyers, a continuing security interest in all our
personal property and assets, as collateral security for our and the
subsidiaries under the Purchase Agreement, the Notes, the Guaranty and theother
transaction documents.
Hartford and Lakewood Operations Asset Sales
On July 25, 2012, the Company and the Hartford and Lakewood Operations entered
into the Asset Purchase Agreement, pursuant to which the Hartford and Lakewood
Operations sold substantially all of their assets to two newly-created
subsidiaries of Kavveri for a purchase price of $5.5 million in cash, subject to
adjustment, and the assumption of their various liabilities. At closing, we
received $4.9 million in cash, and the remaining $600,000 of the purchase price
is to be placed in escrow pursuant to the Asset Purchase Agreement. We used the
proceeds from this sale to repay the full amount outstanding under the Credit
Agreement of $4,022,320 as of July 25, 2012. The difference of $877,680 was
deposited in our operating cash account.
The parties agreed to place $350,000 of the purchase price into escrow pending
assignment of certain contracts post-closing, with our receiving those funds
upon successful assignment of the contracts. The remaining $250,000 is to be
escrowed for purposes of satisfying certain adjustments to the purchase price
based on a final net asset valuation to be completed after closing as well as
repurchase obligations of certain delinquent accounts receivable. No later than
three days after the final determination of the net asset valuation, the
purchasers are required to deposit the $600,000 into escrow.
On September 4, 2012, Kavveri provided us with its calculation of the net asset
valuation, and claimed that we owed them $251,868. On October 2, 2012, we
provided Kavveri our calculation of the net asset valuation, and claimed Kavveri
owes us $94,493. We are currently working with Kavveri to resolve the net asset
valuation dispute. If the parties disagree, and we are unable to come to an
agreement, the matter will then be submitted to one or more independent,
nationally-recognized accounting firms for final determination.
On November 7, 2012, Kavveri submitted to us an aggregate claim for
indemnification of $1,938,288 with regard to (a) delinquent receivables to be
repurchased of $546,077; (b) $916,500 for accounts receivable Kavveri deems are
not collectible in the ordinary course of business, and (c) $475,000 for the
replacement, programming an installation of replacement radios on a project that
was completed by our Hartford Operations and accepted by the customer on or
prior to July 25, 2012. With regard to the delinquent receivables claimed, we
are disputing the amount of the delinquent receivables, and we believe that
after consideration of reserves for uncollectible accounts and other offsets
previously considered in our calculation of the net asset valuation described
above, the total amount of delinquent receivables to be repurchased is less, and
is subject to further reduction based on additional collection of receivables by
Kavveri. Furthermore, with regard to the timing in the Asset Purchase Agreement
for notification to us, we believe that Kavveri missed the deadline to notify us
regarding the repurchase of delinquent receivables, which would eliminate any
repurchase payment owed by us to Kavveri. We believe the remaining two claims
are without merit, and we are currently preparing a response to Kavveri, to
dispute each of these indemnification claims. We have reflected the estimated
changes in the gain/(loss) from the disposal of these operations in the three
and six months ended October 31, 2012.
Short-Term Commitments with the China Operations
On August 2, 2012, the China Operations entered into a secured loan with the
Bank of China (the Short Term Loan). The Short Term Loan provides for a loan in
the amount of $2,404,545. The proceeds from the Short Term Loan were used to
repay outstanding unsecured loans of $2,404,545 due to its joint venture
partner, Taian Gas Group (TGG). The Short Term Loan has an interest rate of
8.24%, and interest is due on a quarterly basis.
42
WPCS INTERNATIONAL INCORPORATED AND SUBSIDIARIES
ITEM 2 - MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
As of October 31, 2012, the China Operations had outstanding unsecured loans due
the joint venture partner, TGG, totaling $781,268 and is due on demand and
represents interest accrued and working capital loans from TGG to the China
Operations in the normal course of business
Other Payable with Zurich
On July 12, 2012, we executed the Zurich Agreement with Zurich. Under the terms
of the Zurich Agreement, as of October 31, 2012, Zurich advanced us $793,927 for
the payment of labor and labor-related benefits to assist in completing the
Cooper Project. The Cooper Project is a $15.1 million project completed by our
Trenton Operations. Zurich and its affiliate F&D, as surety, have issued certain
performance and payment bonds on behalf of the Owner in regard to our work on
this project. We were required to repay Zurich the financial advances pursuant
to the following repayment schedule: (1) $397,000 on or about August 3, 2012;
and (2) the balance of $396,927 on or about September 7, 2012. As a condition
precedent to the financial advance, we executed two letters held by Zurich: (1)
a letter to the Owner voluntarily terminating its contract for reason of our
default and assigning the contract to Zurich, and (2) a letter of direction to
the Owner. The letters may be forwarded to the Owner in an Event of Default. An
Event of Default under the Zurich Agreement includes: (a) our failure to make
repayments to Zurich in accordance with the repayment schedule; (b) Zurich, at
our request, advances more than $888,000; (c) Zurich pays any of our vendors,
subcontractors, suppliers or material men pursuant to Zurich's obligations under
its payment bond or any other reason; or (d) we use any of the funds advanced by
Zurich for any reason other than the payment of labor and labor benefits
incurred in regard to the Cooper Project. We are in default under the Zurich
Agreement as we have not repaid Zurich the $793,927. As a result, a letter of
direction was sent to the Owner, requesting that all current and future amounts
to be paid on the contract be assigned and paid to Zurich directly.
We are contingently liable to Zurich and its affiliate F&D under the Indemnity
Agreement. Zurich and F&D, as surety, have issued certain performance and
payment bonds on behalf of owners or customers regarding our work on various
projects under the Indemnity Agreement. We agree to indemnify the surety for any
payments made on contracts of suretyship, guaranty or indemnity. As of October
31, 2012, we have approved $4,074,814 of accounts receivable, and $5,672,038 of
accounts payable to be assigned to Zurich and F&D under the Indemnity Agreement,
and reclassified such amounts from consolidated accounts receivable and accounts
payable, respectively, resulting in a net amount owed to Zurich and F&D under
the Indemnity Agreement of $1,597,224. Including the $793,927 owed under the
Zurich Agreement, the net Other Payable owed to Zurich by us is $2,391,151as of
October 31, 2012.
On November 12, 2012, we received a demand notice from Zurich for $3,298,751,
regarding unpaid amounts due under the Zurich Agreement and in regard to claims
asserted against Zurich under the Indemnity Agreement as described above,
without consideration of any offsets for assigned accounts receivable paid or to
be paid. On November 15, 2012, a payment of $2,758,588 was made by the Owner in
partial payment of outstanding assigned accounts receivable amounts due. We are
currently working with on a response to the demand notice, with the expected
response to include directing Zurich to apply $793,927 of the November 15, 2012
payment by the Owner to repay the amounts due under the Financing Agreement,
with the balance applied to partially repay amounts due under the Indemnity
Agreement, and requesting forbearance on the balance of the demand notice.
To date, a total of $3,128,379 of assigned accounts receivable have been paid by
our customers to Zurich, which includes the November 15, 2012 payment of
$2,758,588 described above. To date, a total of $5,570,631 of assigned accounts
payable has been paid by Zurich to our vendors. The remaining accounts and
retention payable properly recorded at October 31, 2012, yet to be approved and
to be assigned in the future under the Indemnity Agreement, is approximately
$338,000, and future billings of customer accounts to be assigned to Zurich is
approximately $836,000, which we expect will reduce the net Other Payable by
$498,000, resulting in a final net Other Payable due Zurich of approximately
$1,893,000. In addition, we have submitted a claim and request for equitable
adjustment to the Owner in the amount of $3,019,813 for significant delays,
disruptions and construction changes that were beyond its control and required
the Company to perform additional work, and if successful in settlement of this
claim, expects to use the proceeds from the claim to repay Zurich the estimated
remaining balance due. There can be no assurance that we will be successful in
settling with the Owner for all or a portion of the submitted claim, and there
can be no assurance that Zurich and the Company will come to any agreement
regarding repayment, future forbearance terms, or waiver or modification of
terms under the Zurich Agreement and Indemnity Agreement, which would have a
serious adverse effect on our business, operations and future prospects.
43
WPCS INTERNATIONAL INCORPORATED AND SUBSIDIARIES
ITEM 2 - MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Going Concern
Our failure to comply with the terms of the Zurich Agreement and Indemnity
Agreement, raise substantial doubt about our ability to continue as a going
concern. Our continuation as a going concern is ultimately dependent upon our
future financial performance and ability to refinance or restructure our credit
facilities, which will be affected by general economic, competitive, and other
factors, many of which are beyond our control. There can be no assurance that
the execution of one or more of the alternatives described above to repay Zurich
will be successful to ensure our continuation as a going concern.
Backlog
As of October 31, 2012, we had a backlog of unfilled orders of approximately
$28.9 million compared to approximately $30.8 million at July 31, 2012. 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 a 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 that 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.
Off-Balance Sheet Arrangements
We have no off-balance sheet arrangements.
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 condensed 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 the calculation of
percentage-of-completion on uncompleted contracts, allowance for doubtful
accounts, valuation of inventory, realization of deferred tax assets,
amortization method and lives of customer lists, acquisition-related contingency
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.
44
WPCS INTERNATIONAL INCORPORATED AND SUBSIDIARIES
ITEM 2 - MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
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 that
are outstanding longer than the contractual payment terms are considered past
due. We determine our allowance by considering a number of factors, including
the length of time trade accounts receivable are past due, our previous loss
history, the customer's current ability to pay its obligation to the us, and the
condition of the general economy and the industry as a whole. We write off
accounts receivable when they become uncollectible, and payments 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.
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.
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.
45
WPCS INTERNATIONAL INCORPORATED AND SUBSIDIARIES
ITEM 2 - MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
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 record revenue and profit from short-term contracts for our China Operations
under the completed contract method, whereas income is recognized only when a
contract is completed or substantially completed. Accordingly, during the period
of performance, billings and costs are accumulated on the balance sheet, but no
revenue or income is recorded before completion or substantial completion of the
work. Our decision is based on the short-term nature of the work performed.
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
In December 2011, the FASB issued ASU No. 2011-11 (ASU 2011-11), Disclosures
about Offsetting Assets and Liabilities where entities are required to disclose
both gross information and net information about both instruments and
transactions eligible for offset in the statement of financial position and
instruments and transactions subject to an agreement similar to a master netting
arrangement. This scope would include derivatives, sale and repurchase
agreements, and reverse sale and repurchase agreements, and securities borrowing
and securities lending arrangements. These disclosures assist users of financial
statements in evaluating the effect or potential effect of netting arrangements
on a company's financial position. We are required to apply the amendments for
annual reporting periods beginning on or after January 1, 2013 (May 1, 2013 for
us). We do not expect the provisions of ASU 2011-11 to have a material impact on
our consolidated financial statements.
46
WPCS INTERNATIONAL INCORPORATED AND SUBSIDIARIES
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