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PRXG > SEC Filings for PRXG > Form 10-K on 1-Apr-2013All Recent SEC Filings

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Form 10-K for PERNIX GROUP, INC.


1-Apr-2013

Annual Report


ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

You are cautioned that this Annual Report on Form 10-K and, in particular, the "Management's Discussion and Analysis of Financial Condition and Results of Operations", contains forward-looking statements concerning future operations and performance of the Company within the meaning of the Private Securities Litigation Reform Act of 1995. You should not place undue influence on these forward-looking statements. Forward-looking statements are subject to market, operating and economic risks and uncertainties that may cause the Company's actual results in future periods to be materially different from any future performance suggested herein. Factors that may cause such differences include, among others: increased competition, increased costs, changes in general market conditions, changes in the regulatory environment, changes in anticipated levels of government spending on infrastructure, and changes in loan relationships or sources of financing, political instability or violence. Such forward-looking statements are made pursuant to the Safe Harbor Provisions of the Private Securities Litigation Reform Act of 1995.

The Company effected an elective accounting quasi-reorganization as of September 30, 2012, which eliminated its accumulated deficit in retained earnings and accumulated other comprehensive income against additional paid-in-capital. The consolidated balance sheet as of December 31, 2012 gives effect to adjustments to the fair value of assets and liabilities that are necessary when adopting "fresh-start" reporting. As a result, the consolidated balance sheet as of December 31, 2012 is presented on a different basis of accounting and, therefore, is not comparable to the prior period.

In this report, we use the terms "Pernix Group", "PGI", "the Company", 'we", "us", and "our" to refer to Pernix Group, Inc. and its consolidated subsidiaries. Unless otherwise noted, references to years are for calendar years.

Executive Summary

The Company recognized pretax income from continuing operations attributable to Pernix Group, Inc. of $3.4 million and $0.1 million for 2012 and 2011, respectively, reflecting the growth in our construction business and the positive impact of the restructuring of our operations through the 2012 disposition of TransRadio and TCNMI. The loss on these discontinued operations was $3.7 million and $2.1 million during 2012 and 2011, respectively. In order to curtail the negative impact of these losses on Pernix and to enable the Pernix management team to focus its efforts on the strategic plan initiatives to grow the core construction and power businesses, Pernix completed the sales of TransRadio and TCNMI in March and October of 2012, respectively.

Included in the 2011 results is the $5.3 million benefit from the release of a portion of the Company's income tax valuation allowance against its deferred tax assets arising principally from net operating loss carryforwards. Of the $5.3 million, $4.0 million was related to continuing operations and $1.3 million was related to discontinued TCNMI operations. The valuation allowance release was based on our assessment that it is more likely than not that we will realize our domestic deferred tax assets and a portion of TCNMI's deferred tax assets.

Adjusting to exclude the net impact of the 2011 initial release of the income tax valuation and the losses of the discontinued operations of TransRadio and TCNMI, we recognized net income attributable to Pernix Group of $3.8 million ($0.43 basic and diluted earnings per share) in 2012 and net loss of $0.1 million, ($0.01 basic and diluted per share) for 2011, as explained and reconciled in the table below.

Net income and basic earnings per share attributable to Pernix Group, Inc. reconciliation:

                                                      For the          For the
                                                    Year Ended       Year Ended
                                                     December         December
     (in thousands, except per share data)           31, 2012         31, 2011

     Net income attributable to Common           $                $
     Stockholders of Pernix Group, Inc.                     422            1,823
     Plus:
     Losses attributable to TransRadio and
     TCNMI sold in 2012                                   3,663            2,067
     Less:
     Net impact of 2011 initial income tax
     valuation allowance release continuing
     operations                                               -            3,966
     Income from all other sources               $        4,085   $         (76)

     Basic earnings (loss) per share             $                $
     attributable to Pernix Group, Inc.                    0.43           (0.01)
     Diluted earnings (loss) per share           $                $
     attributable to Pernix Group, Inc.                    0.43           (0.01)

     Basic weighted shares outstanding                9,403,697        9,403,697
     Diluted weighted shares outstanding              9,418,704        9,429,647

During 2012, we delivered strong performance. Our construction backlog remained relatively stable in 2012 at $67.9 million as of December 31, 2012 compared to $71.0 million at December 31, 2011 after having grown from $2.2 million as of the end of 2010. The backlog reflects new contract awards totaling $111.7 million net of completed work totaling $114.8 million during 2012. Our construction segment benefitted from an increased need to provide secure facilities for U.S. Government personnel caused by instability in certain foreign countries. Our Power segment subsidiary, Vanuatu Utilities and Infrastructure (VUI), continued to benefit from managing the power facilities on Vanuatu under a Memorandum of Understanding (MOU) during 2012. VUI contributed $1.0 million of pretax income during 2012 compared to $1.7 million during 2011. The decrease in revenue during 2012 reflects the stabilization of operations, as 2011 reflects the initial year of activity. VUI is currently awaiting a decision by the Government of Vanuatu regarding the appointment of a concessionaire for the long term concession deed. We anticipate VUI being awarded the long term concession based on the tenuous relationship between the previous concessionaire and the Government of Vanuatu coupled with the positive reviews VUI has received from the Utilities Regulatory Authority of Vanuatu for work performed under the MOU. The decrease in VUI income was largely offset by the improved performance of TFL as it contributed $0.5 million toward income from continuing operations in 2012 compared with breakeven performance in 2011 when it incurred the financial impact of the August 2011 engine failure at one of our power plants in Fiji. In light of these recent and notable successes in the construction and power segments coupled with the 2012 sale of TransRadio and TCNMI, management implemented "fresh start" accounting through a quasi-reorganization as of September 30, 2012.

As the U.S. and global markets recover from the recession, industry experts predict that construction in emerging markets will make up more than half of the global construction market by the end of this decade. In light of its experience, Pernix is uniquely qualified to perform in emerging markets which can be more remote and logistically challenging environments. The combination of growing demand to supplement or replace aging power generation equipment, growing demand for power in non-OECD countries and demand to improve power efficiency through the use of new power technologies presents a wealth of opportunities for construction and distribution of power. Pernix Group's power segment is well positioned to pursue these opportunities which are expected to be smaller in size and fit well with our agile organizational structure.

Our revenue is dependent on our ability to attract and retain qualified and productive employees, identify business opportunities, allocate our labor resources to profitable markets, align with strategic partners, secure new contracts

and renew existing client agreements. Moreover, as a professional services company, maintaining the high quality of the work generated by our employees is integral to our revenue generation.

Our costs consist primarily of the compensation we pay to our employees, including salaries, fringe benefits, the costs of hiring subcontractors and other project-related expenses, the costs associated with maintaining and operating diesel power plants (fuel related costs) and sales, general and administrative costs.

Critical Accounting Policies and Estimates

Our financial statements are presented in accordance with accounting principles generally accepted in the United States of America (GAAP). Highlighted below are the accounting policies that management considers significant to understanding the operations of our business.


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Basis of Presentation

The consolidated financial statements include the accounts of all majority-owned subsidiaries and material joint ventures in which the Company is the primary beneficiary. All inter-company accounts have been eliminated in consolidation. The Company effected an elective accounting quasi-reorganization as of September 30, 2012, which eliminated its accumulated deficit in retained earnings and accumulated other comprehensive income against additional paid-in-capital. The consolidated balance sheet as of December 31, 2012 reflects the adjustments to fair value of assets and liabilities that were recorded in connection with the implementation of the quasi-reorganization and subsequent amortization thereof.
As a result, the consolidated balance sheets as of December 31, 2012 are presented on a different basis of accounting and, therefore, are not comparable to the prior period. In addition, certain reclassifications were made to prior years' amounts to conform to the 2012 presentation, including the retroactive reclassification of 2011 results of TransRadio and TCNMI operations to discontinued operations presentation in the consolidated statement of income. See Notes 1, 2 and 8 in our notes to our consolidated financial statements.

Revenue Recognition

We offer our services through two operating business segments: General Construction and Power Generation Services which are supported by the Corporate segment. Prior to March 28, 2012, the Company also operated the RF Transmitter Design, Installation and Service segment. Revenue recognition for each of the non-corporate segments is described by segment below.

General Construction Revenue. Revenue from construction contracts is recognized using the percentage-of-completion method of accounting based upon costs incurred and estimated total projected costs. Our current projects with the United States Government are design/build contracts with fixed contract prices and include provisions of termination for convenience by the party contracting with us. Such provisions also allow payment to us for the work performed through the date of termination.

Revenues recognized under the percentage-of-completion method require applying a percentage (actual costs incurred through the reporting date divided by the total estimated costs to complete the project) to the fixed contract price. The Company only uses approved contract changes in its revenue recognition calculation. This method of revenue recognition requires that we estimate future costs to complete a project. Estimating future costs requires judgment of the value and timing of material, labor, scheduling, product deliveries, contractual performance standards, liability claims, impact of change orders, contract disputes as well as productivity. In addition, sometimes clients, vendors and subcontractors will present claims against us for recovery of costs they incurred in excess of what they expected to incur, or for which they believe they are not contractually responsible. In turn, we may also present claims to our clients, vendors and subcontractors for costs that we believe were not our responsibility or may be beyond our scope of work. The Company will include costs associated with these claims in its financial information when such costs can be reliably identified and estimated. Similarly, the Company will include in revenue amounts equal to costs for claims, where the outcome is probable that the claim will be found in the favor of

the Company. Our estimates, assumptions and judgments are continually evaluated based on known information and experience. However, the actual amounts could be significantly different from our estimates. Costs and estimated earnings in excess of amounts billed to customers are recognized as an asset. Amounts billed in excess of costs and estimated earnings are recognized as a liability. The Company will record a provision for losses when estimated costs exceed estimated revenues. To mitigate risks associated with cost overruns, the Company consistently employs fixed price contracts with our subcontractors and no "provisional pricing" subcontracts are allowed. In addition, our subcontractors generally manage procurement and as such are liable for procurement related risk including price risk.

Cost of Construction Revenue. Cost of construction revenue consists of direct costs on contracts, including labor and materials, amounts payable to subcontractors, direct overhead costs, equipment expense (primarily depreciation, maintenance, and repairs), interest associated with construction projects, and insurance costs. The Company records a portion of depreciation in cost of revenue. Contracts frequently extend over a period of more than one year. Revisions in cost and profit estimates during construction are recognized in the accounting period in which the facts that require the revision become known. Losses on contracts are provided for in total when determined, regardless of


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the degree of project completion. Claims for additional contract revenue are recognized in the period when it is probable that the claim will result in additional revenue and the amount can be reasonably estimated.

Power Generation Service Revenue. The Company receives a combination of fixed and variable monthly payments as compensation for its production of power. The variable payments are recognized based upon power produced and billed to the customer as earned during each accounting period.

RF Transmitter Design, Installation and Service Revenue. Any revenues associated with TransRadio contracts are included in the loss from discontinued operations for the years ended December 31, 2012 and 2011. See Note 8 in the notes to our consolidated financial statements. Contracts for TransRadio products and services generally contain customer-specified acceptance provisions. The Company evaluates customer acceptance by demonstrating objectively that the criteria specified in the contract acceptance provisions are satisfied and recognizes revenue on these contracts when the objective evidence and customer acceptance are demonstrated. Certain contracts include prepayments, which are recorded as a liability until the customer acceptance is received, at which time the prepayments are recorded as revenue. Certain TransRadio contracts require training services separate from acceptance of provisions and are generally provided after the delivery of the product to the customer. These services are a separate element of the contract that is accounted for as revenue is earned. The amount attributable to services is based on the fair value of the services in the marketplace and is typically stipulated separately with the customer.

Claims Recognition

Claims are amounts in excess of the agreed contract price (or amounts not included in the original contract price) that we seek to collect from customers or others for delays, errors in specifications and designs, contract terminations, change orders in dispute or unapproved as to both scope and price or other causes of unanticipated additional costs. The Company records contract revenue related to claims only if it is probable that the claim will result in additional contract revenue and if the amount can be reliably estimated. In such cases, the Company records revenue only to the extent that contract costs relating to the claim have been incurred. The amounts recorded, if material, are disclosed in the notes to the financial statements. Costs attributable to claims are treated as costs of contract performance as incurred.

Unbilled Accounts Receivable and Billings in Excess of Costs on Uncompleted Contracts

Unbilled accounts receivable represents the contract revenue recognized to date using the percentage-of-completion accounting method but not yet invoiced to the client due to contract terms or the timing of the accounting invoicing cycle. Billings in excess of costs on uncompleted contracts represent the billings to date, as allowed under the terms of a contract, but not yet recognized as contract revenue using the percentage-of-completion accounting method.

Stock Based Compensation

In December 2011, the Company's shareholders and board of directors approved the 2012 Incentive Stock Option Plan that provides for the issuance of qualified stock options to employees. In connection with the annual shareholder meeting held on November 12, 2012, the shareholders approved a long term incentive plan for non-employee directors (the "LTIP") and consultants. The plan allows various types of awards including stock options, stock awards, restricted stock units and other types of awards. As of December 31, 2012, 152,500 awards were outstanding and unvested under the ISOP and no awards were granted or outstanding under the LTIP.

We recognize the expense associated with stock option awards over the period during which an employee is required to provide services in exchange for the award, known as the requisite service period (usually the vesting period). The related option awards are classified as equity and as such are valued at the grant date and are not subject to remeasurement. Estimates are revised if subsequent information indicates that forfeitures will differ from previous estimates, and the cumulative effect on compensation cost of a change in the estimated forfeitures is recognized in the period of the change. The option valuation was performed using a fair value Black Scholes model. The fair value is net of any amount that an employee pays (or becomes obligated to pay) for that instrument when it is granted. Option valuation models require the input of highly subjective assumptions, and changes in the assumptions can materially affect fair value estimates. Judgment is required in estimating stock price volatility, forfeiture rates,


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expected dividends, and expected terms that options remain outstanding. During 2012 and 2011 the compensation expense related to the stock options was less than $0.1 million and zero, respectively.

See Note 20 in the notes to our consolidated financial statements for additional information pertaining to the stock based compensation plans.

Income Taxes

Valuation Allowance. Deferred income taxes are provided on the liability method whereby deferred tax assets and liabilities are established for the difference between the financial reporting and income tax basis of assets and liabilities, as well as operating loss and tax credit carry forwards. Deferred tax assets and liabilities are adjusted for the effects of changes in tax laws and rates on the date of enactment of such changes to laws and rates. In accordance with the quasi-reorganization requirements tax benefits realized in periods after the quasi-reorganization that were not recognized at the date of the quasi-reorganization will be recorded directly to equity.

Deferred tax assets are reduced by a valuation allowance when, in our opinion, it is more likely than not that some portion or all of the deferred tax assets may not be realized. Whether a deferred tax asset may be realized requires considerable judgment by us. In considering the need for a valuation allowance, we consider a number of factors including the future reversal of existing temporary differences, future taxable income exclusive of reversing temporary differences and carry forwards, taxable income in carry-back years if carry-back is permitted under tax law, and prudent and feasible tax planning strategies that would normally be taken by management, in the absence of the desire to realize the deferred tax asset. Whether a deferred tax asset will ultimately be realized is also dependent on varying factors, including, but not limited to, changes in tax laws and audits by tax jurisdictions in which we operate.

We review the need for a valuation allowance at least quarterly. If we determine we will not realize all or part of our deferred tax asset in the future, we will record an additional valuation allowance. Conversely, if a valuation allowance exists and we determine that all or part of the net deferred tax asset is more likely than not to be realized, then the amount of the valuation allowance will be reduced. This adjustment will increase or decrease income tax expense in the period of such determination. As noted above, the valuation allowance was partially released during the fourth quarter of 2011 resulting in a $5.3 million tax benefit. The valuation allowance adjustment in 2012 resulted in an income tax expense of $0.6 million during 2012. As of December 31, 2012, our deferred tax assets total $28.1 million net of a valuation allowance of $23.2 million ($4.9 million net) on a post quasi-reorganization basis. The valuation allowance incorporates a full reserve on the deferred tax asset generated by the October 12, 2012, sale of TCNMI by the Company that resulted in a taxable loss of $51.7 million. The federal and state deferred tax assets arising from this loss on sale of TCNMI approximates $22.5 million and is fully reserved for through the valuation allowance resulting in a zero net impact on our deferred tax assets, net as of December 31, 2012.

Undistributed Non-U.S. Earnings. The results of our operations outside of the United States are consolidated for financial reporting; however, earnings from investments in non-U.S. operations are included in domestic U.S. taxable income only when actually or constructively received. No U.S. Federal or State deferred taxes have been provided on the undistributed earnings of non-U.S. operations of approximately $1.6 million in 2012 because we plan to permanently reinvest these earnings overseas. If we were to repatriate these earnings, additional taxes would be due at that time. However, these additional U.S. taxes may be offset in part by the use of foreign tax credits. There is no intention to repatriate amounts earned by TFL prior to November 2012; thus, no U.S. tax liability is recorded for historic TFL income. U.S. Tax liabilities are recorded from our earnings due to operations in Vanuatu as there are no income taxes in Vanuatu and Pernix Group periodically repatriates these earnings.

Foreign Currency Translation

The Company's functional currency is the U.S. dollar. Results of operations for foreign entities are translated to US dollars using the average exchange rates during the period. Assets and liabilities for foreign entities are translated using the exchange rates in effect as of the date of the balance sheet. Resulting translation adjustments are recorded


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as a foreign currency translation adjustment into other accumulated comprehensive income/(loss) in stockholders' equity.

The Company uses forward exchange contracts from time to time to mitigate foreign currency risk. The Company limits exposure to foreign currency fluctuations in most of its contracts through provisions that require client payments in currencies corresponding to the currency in which costs are incurred. The Company did not employ any such contracts, nor were any such contracts outstanding during 2012 or 2011.

Results of Operations

Results of Operations for the calendar year ended December 31, 2012 compared to the calendar year ended December 31, 2011

Revenues

Total revenues more than doubled, increasing $62.0 million for the fiscal year ended December 31, 2012 compared to the prior year. This increase is primarily attributable to the $63.0 million increase in construction revenue reflecting the Company's significant strides in the past several years in business development efforts and leveraging its significant experience in bidding, winning and executing government contracts with its strategic partners.

General Construction - Specifically, the revenue is largely attributable to the Containerized Housing Units (CHU) IDIQ program in Iraq, which began in 2011. The Sather and Shield projects generated $111.2 million of revenue during 2012 compared to $47.4 million during 2011. The projects advanced from 1% and 51% complete to 56% and 99% complete during 2012, respectively. In addition, during 2012 the Company received a full notice to proceed with construction on the Niamey, Niger rehabilitation project, thereby generating $3.2 million of income in 2012 compared to $0.3 million of income during 2011 when the Company only had a limited notice to proceed. During 2012, the progress on the Niger project advanced from 1% complete to 14% complete. The Shield project is expected to be complete during 2013 and the Sather and Niger contracts are expected to be completed in 2013 and early 2014, respectively. The work on the Sather contract awarded in January 2012 commenced in early 2012 as such, no revenue was recorded on this contract in 2011.The increases in construction revenue driven by the CHU program and Niger project were partially offset by the $3.3 million decrease in revenue from the U.S. Embassy project in Fiji. The Fijian embassy project consisted of two contracts, the Suva new embassy construction project and the Suva cleared access area fit-out project, both of which reached substantial completion, (99.4% and 97%) as of December 31, 2011, respectively.

Service fees (Including Other Revenue)- Total Power Generation revenue decreased $1.1 million in 2012 compared to 2011. The decrease reflects the $0.6 million reduction in the Vanuatu management fee for the operation of the Vanuatu power plant under the Memo of Understanding (MOU). This year over year fee reduction reflects that the VUI operations were at steady state during 2012 compared to start-up mode in 2011. The remaining $0.5 million decrease in power generation revenue reflects the reduction in TFL's diesel power generation as Fiji's Electric Authority shifted to a higher mix of hydro relative to diesel power during 2012. TCNMI was sold during 2012 and the operations of TCNMI are reflected as discontinued operations in our consolidated statement of income.

Costs and Expenses

General Construction Costs -( including Construction Costs - Related Party). Total construction costs, including construction costs - related party, increased $54.3 million from 2011 to $102.3 million for 2012 compared to 2011, primarily reflecting the costs on the Iraq CHU projects and related modifications and settlement negotiations and the Niger contract activity. This increase was partially offset by a $1.5 million decrease in costs related to the Fiji Embassy contracts.

Operations and Maintenance Costs - Power Generation Plant. Operations and maintenance costs - power generation plant decreased $1.0 million (25%) to $2.9 million in 2012, resulting from lower 2012 maintenance


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expense. The higher level of 2011 expenses for planned maintenance and unplanned . . .

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