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ICLD > SEC Filings for ICLD > Form 10-K/A on 16-Oct-2013All Recent SEC Filings

Show all filings for INTERCLOUD SYSTEMS, INC.

Form 10-K/A for INTERCLOUD SYSTEMS, INC.


16-Oct-2013

Annual Report


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

This management's discussion and analysis of financial condition and results of operations contains certain statements that are forward-looking in nature relating to our business, future events or our future financial performance. Prospective investors are cautioned that such statements involve risks and uncertainties and that actual events or results may differ materially from the statements made in such forward-looking statements. In evaluating such statements, prospective investors should specifically consider the various factors identified in this report, including the matters set forth under Item 1A "Risk Factors," which could cause actual results to differ from those indicated by such forward-looking statements.

Overview

We were incorporated in 1999, but functioned as a development stage company with limited activities through December 2009. In January 2010, we acquired Digital Comm, Inc. ("Digital"), a provider of specialty contracting services primarily in the installation of fiber optic telephone cable. Until September 2012, substantially all of our revenue came from our specialty contracting services. In the year ending December 31, 2012, primarily as a result of our acquisition of ADEX, approximately 39% of our revenue was derived from specialty contracting services, with the remaining 61% coming from our telecommunications staffing services.


We operate in one reportable segment as a specialty contractor and staffing service, providing engineering, construction, maintenance and installation services to telecommunications providers and underground facility locating services, as well as related staffing services to various utilities, including telecommunications providers, and other construction and maintenance services to electric and gas utilities and others. All of our operating divisions have been aggregated into one reporting segment due to their similar economic characteristics, products, production methods and distribution methods.

Our revenue increased from $2.8 million for the year ended December 31, 2011 to $17.2 million for the year ended December 31, 2012. Our net loss attributable to common stockholders decreased from $6.4 million for the year ended December 31, 2011 to $2.1 million for the year ended December 31, 2012. As of December 31, 2012, our accumulated deficit was $12.5 million. A significant portion of our services are performed under master service agreements and other arrangements with customers that extend for periods of one or more years. We are currently party to numerous master service agreements, and typically have multiple agreements with each of our customers. Master service agreements generally contain customer-specified service requirements, such as discrete pricing for individual tasks. To the extent that such contracts specify exclusivity, there are often a number of exceptions, including the ability of the customer to issue work orders valued above a specified dollar amount to other service providers, perform work with the customer's own employees and use other service providers when jointly placing facilities with another utility. In most cases, a customer may terminate an agreement for convenience with written notice. The remainder of our services are provided pursuant to contracts for specific projects. Long-term contracts relate to specific projects with terms in excess of one year from the contract date. Short-term contracts for specific projects are generally of three to four months in duration.

During 2012, the majority of our revenue and expenses came from our acquired companies. Of the $17.2 million in total revenues in the year ended December 31, 2012, $16.7 million came from the companies we acquired in 2011 and 2012.

Cost of revenues from the companies acquired in the years ended December 31, 2011 and 2012, accounted for $11.0 million of our $12.1 million cost of revenues during the year ended December 31, 2012.

Gross profit from the companies acquired in the years ended December 31, 2011 and 2012, accounted for $5.0 million of our $5.2 million gross profit during the year ended December 31, 2012.

Operating expenses, including salaries and wages and depreciation and amortization from the companies acquired in the years ended December 31, 2011 and 2012, accounted for $4.2 million of our $7.9 million of operating expenses during the year ended December 31, 2012.

The following table summarizes our revenues from multi-year master service agreements and other long-term contracts, as a percentage of contract revenues:

                                                   Year ended December 31,
                                                   2012               2011
         Multi-year master service agreements           60 %               59 %
         Total long-term contracts                      60 %               59 %

The percentage of revenue from long-term contracts varies between periods, depending on the mix of work performed under our contracts.

A significant portion of our revenue is derived from several large customers. The following table reflects the percentage of total revenue from those customers that contributed at least 10% to our total revenue in the years ended December 31, 2012 and 2011:

                                                  Year ended December 31,
                                                 2012                   2011
      Verizon Communications, Inc.                       7 %                 56 %
      Ericsson, Inc.                                    38    %               -
      Danella Construction                                 *                 17 %
      Nexlink                                           14    %               -



* Represented less than 5% of the total revenues during the period.

Telecommunications providers and enterprise customers continue to seek and outsource solutions in order to reduce their investment in capital equipment, provide flexibility in workforce sizing and expand product offerings without large increases in incremental hiring. As a result, we believe there is significant opportunity to expand both our United States and international telecommunications solutions services and staffing services capabilities. As we continue to expand our presence in the marketplace, we will target those customers going through new network deployments and wireless service upgrades.


We expect to continue to increase our gross margins on our specialty contracting services by leveraging our single-source end-to-end network to efficiently provide a full spectrum of telecommunications contracting and staffing services to our customers. We believe this will alleviate some of the inefficiencies typically present in our industry, which result, in part, from the highly-fragmented nature of the telecommunications industry, limited access to skilled labor and the difficulty of managing multiple specialty-service providers to address our customers' needs. As a result, we believe we can provide superior service to our customers and eliminate certain redundancies and costs for them. We believe our ability to address a wide range of end-to-end solutions network, infrastructure and project staffing service needs for our telecommunications industry clients is a key competitive advantage. Our ability to offer diverse technical capabilities (including design, engineering, construction, deployment, and installation and integration services) allows customers to turn to a single source for these specific specialty services, as well as to entrust us with the execution of entire turn-key solutions.

As a result of our recent acquisitions, we have become a multi-faceted company with an international presence. We believe this platform will allow us to leverage our corporate and other fixed costs and capture gross margin benefits. Our platform is highly scalable. We typically hire workers to staff projects on a project-by-project basis and our other operating expenses are primarily fixed. Accordingly, we are generally able to deploy personnel to infrastructure projects in the United States and beyond without incremental increases in operating costs, allowing us to achieve greater margins. We believe this business model enables us to staff our business efficiently to meet changes in demand.

Finally, given the worldwide popularity of telecommunications and wireless products and services, we will selectively pursue international expansion, which we believe represents a compelling opportunity for additional long-term growth.

Our planned expansion will place increased demands on our operational, managerial, administrative and other resources. Managing our growth effectively will require us to continue to enhance our operations management systems, financial and management controls and information systems and to hire, train and retain skilled telecommunications personnel. The timing and amount of investments in our expansion could affect the comparability of our results of operations in future periods.

Our recent acquisitions and planned acquisitions have been timed with the additions to our management team of skilled professionals with deep industry knowledge and a strong track record of execution. Our senior management team brings an average of over 25 years of individual experience across a broad range of disciplines. We believe our senior management team is a key driver of our success and is well-positioned to execute our strategy.

Factors Affecting Our Performance

Changes in Demand for Data Capacity and Reliability.

The telecommunications industry has undergone and continues to undergo significant changes due to advances in technology, increased competition as telephone and cable companies converge, the growing consumer demand for enhanced and bundled services and increased governmental broadband stimulus funding. As a result of these factors, the networks of our customers increasingly face demands for more capacity and greater reliability. Telecommunications providers continue to outsource a significant portion of their engineering, construction and maintenance requirements in order to reduce their investment in capital equipment, provide flexibility in workforce sizing, expand product offerings without large increases in incremental hiring and focus on those competencies they consider core to their business success. These factors drive customer demand for our services.

Telecommunications network operators are increasingly relying on the deployment of fiber optic cable technology deeper into their networks and closer to consumers in order to respond to demands for capacity, reliability and product bundles of voice, video and high-speed data services. Fiber deployments have enabled an increasing number of cable companies to offer voice services in addition to their traditional video and data services. These voice services require the installation of customer premise equipment and, at times, the upgrade of in-home wiring. Additionally, fiber deployments are also facilitating the provisioning of video services by local telephone companies in addition to their traditional voice and high-speed data services. Several large telephone companies have pursued fiber-to-the-premise and fiber-to-the-node initiatives to compete actively with cable operators. These long-term initiatives and the likelihood that other telephone companies will pursue similar strategies present opportunities for us.

Cable companies are continuing to target the provision of data and voice services to residential customers and have expanded their service offerings to business customers. Often times, these services are provided over fiber-optic cables using "metro Ethernet" technology. The commercial geographies that cable companies are targeting for network deployments generally require incremental fiber optic cable deployment and, as a result, require the type of engineering and construction services that we provide.

The proliferation of smart phones and other wireless data devices has driven demand for mobile broadband. This demand and other advances in technology have prompted wireless carriers to upgrade their networks. Wireless carriers are actively increasing spending on their networks to respond to the explosion in wireless data traffic, upgrade network technologies to improve performance and efficiency and consolidate disparate technology platforms. These customer initiatives present long-term opportunities for us for the wireless services we provide. Further, the demand for mobile broadband has increased bandwidth requirements on the wired networks of our customers. As the demand for mobile broadband grows, the amount of cellular traffic that must be "backhauled" over customers' fiber and coaxial networks increases and, as a result, carriers are accelerating the deployment of fiber optic cables to cellular sites. These trends are increasing the demand for the types of services we provide.


Our Ability to Recruit, Manage and Retain High Quality Telecommunications Personnel.

The shortage of skilled labor in the telecommunications industry and the difficulties in recruiting and retaining skilled personnel can frequently limit the ability of specialty contractors to bid for and complete certain contracts. In September 2012, we acquired ADEX, a telecommunications staffing firm. Through ADEX, we manage a database of more than 70,000 telecom personnel, which we use to locate and deploy skilled workers for projects. We believe our access to a skilled labor pool gives us a competitive edge over our competitors as we continue to expand. However, our ability to continue to take advantage of this labor pool will depend, in part, on our ability to successfully integrate ADEX into our business.

Our Ability to Integrate Our Acquired Businesses and Expand Internationally.

We completed five acquisitions since August 2011 and plan to consummate additional acquisitions in the near term. Our success will depend, in part, on our ability to successfully integrate these businesses into our global telecommunications platform. In addition, we believe international expansion represents a compelling opportunity for additional growth over the long-term because of the worldwide need for telecommunications infrastructure. As of December 31, 2012, our operations in Puerto Rico have generated $887,000 in revenue. We plan to expand our global presence either by expanding our current operations or by acquiring subsidiaries with international platforms.

Our Ability to Expand and Diversify Our Customer Base.

Our customers for specialty contracting services consist of leading telephone, wireless, cable television and data companies. Ericsson Inc. is our principal telecommunications staffing services customer. Historically, our revenue has been significantly concentrated in a small number of customers. Although we still operate at a net loss, our revenue in recent years has increased as we have acquired additional subsidiaries and diversified our customer base and revenue streams. The percentage of our revenue attributable to our top 10 customers, as well as key customers that contributed at least 10% of our revenue in at least one of the years specified in the following table, were as follows:

      Customer:                                   Year ended December 31,
                                                 2012                   2011
      Top 10 customers, aggregate                       77 %                 97 %
      Customer:
      Verizon Communications, Inc.                       7 %                 56 %
      Danella Construction                                 *                 17 %
      Nexlink                                           14 %                  -
      Ericsson, Inc.                                    33 %                  -



* Represented less than 5% of the total revenues during the period.

Business Unit Transitions.

In the year ended December 31, 2011, 100% of our revenue came from our specialty contracting services. In the year ended December 31, 2012, approximately 39% of our revenue came from our specialty contracting services, and the remaining 61% come from our telecommunications staffing services. This change in focus is primarily attributable to our acquisition of ADEX in September 2012. Due to the shift of our business focus from exclusively providing specialty contracting services to also providing professional staffing services, we have expanded our customer base.

In addition, we have acquired four other companies since August 2011, and each of these acquisitions has either enhanced certain of our existing business units or allowed us to gain market share in new lines of business. For example, our acquisition of T N S in September 2012 extended the geographic reach of our structured cabling and digital antenna system services. Our proposed acquisition of IPC will allow us to improve our systems integration capabilities. Our proposed acquisition of Telco will further expand our professional staffing business and our access to skilled labor.

We expect these acquisitions to facilitate geographic diversification that should protect against regional cyclicality. We believe our diverse platform of services, capabilities, customers and geographies will enable us to grow as the market continues to evolve.

The table below summarizes the revenues for each of our product lines for the years ended December 31, 2012 and 2011.

                                                  Year ended December 31,
                                                     2012           2011
         Revenue from:
         Specialty contracting services         $  6,658,388     $ 2,812,210
         Telecommunications staffing services     10,577,197               -
         As a percentage of total revenue:
         Specialty contracting services                   39 %           100 %
         Telecommunications staffing services             61 %             0 %


With our acquisition of ADEX in September 2012, we believe our revenue generated from telecommunications staffing services will continue to increase as a percentage of our overall revenue.

Impact of Pending and Recently-Completed Acquisitions

We have grown significantly and expanded our service offerings and geographic reach through a series of strategic acquisitions. Since January 1, 2011, we have completed five acquisitions. We expect to regularly review opportunities, and periodically to engage in discussions, regarding possible additional acquisitions. Our ability to sustain our growth and maintain our competitive position may be affected by our ability to identify, acquire and successfully integrate companies.

We intend to operate all of the companies we acquire in a decentralized model in which the management of the companies will remain responsible for daily operations while our senior management will utilize their deep industry expertise and strategic contacts to develop and implement growth strategies and leverage top-line and operating synergies among the companies, as well as provide overall general and administrative functions.

In November 2012, we executed definitive agreements to acquire Telco and IPC, which acquisitions which we intend to complete within 90 days of the date of this report. After the completion of the Telco and IPC acquisitions and reflecting the consolidation of these entities in our results of operations, we expect our revenues, cost of revenues and operating expenses will increase substantially. Accordingly, our future results of operations may differ significantly from those described in this report. The impact of the pending acquisitions is not reflected in this "Management's Discussion and Analysis of Financial Condition and Results of Operations" section and the impact of a completed acquisition is only included from the period commencing on the acquisition date. The unaudited pro forma combined condensed financial information included in this report is not intended to represent what our results of operations would have been if the acquisitions had occurred on January 1, 2012 or to project our results of operations for any future period. Since we and each of these entities were not under common control or management for any period presented, the unaudited pro forma combined condensed financial results may not be comparable to, or indicative of, future performance.

General Economic Conditions.

Within the context of a slowly-growing economy and the current volatility in the credit and equity markets, we believe the latest trends and developments support our steady industry outlook. We will continue to closely monitor the effects that changes in economic and market conditions may have on our customers and our business and we will continue to manage those areas of the business we can control.

Components of Results of Operations

Revenue.

In the year ended December 31, 2011, we derived virtually all of our revenue from our specialty contracting services. In the year ended December 31, 2012, we derived approximately 39% of our revenue from our specialty contracting services and approximately 61% of our revenue from our telecommunications staffing and training services.

Cost of Revenues.

Cost of revenues in the year ended December 31, 2012 was 70% of revenues as compared to 66% in the year ended December 31, 2011, primarily due to lower margins in our telecommunications staffing business. Cost of revenues in the telecommunications staffing business was 71% of revenues in the year ended December 31, 2012. We are trying to increase efficiency in the year ending December 31, 2013 and will focus our efforts on improving margins. Cost of revenues includes all direct costs of providing services under our contracts, including costs for direct labor provided by employees, services by independent subcontractors, operation of capital equipment (excluding depreciation and amortization), direct materials, insurance claims and other direct costs.

We retain the risk of loss, up to certain limits, for claims related to automobile liability, general liability, workers' compensation, employee group health and location damages. We are sometimes subject to claims for damages resulting from property and other damages arising in connection with our specialty contracting services. A change in claims experience or actuarial assumptions related to these risks could materially affect our results of operations.

For a majority of the contract services we perform, our customers provide all required materials while we provide the necessary personnel, tools and equipment. Materials supplied by our customers, for which the customer retains financial and performance risk, are not included in our revenue or costs of revenues. We expect cost of revenue to continue to increase if we succeed in continuing to grow our revenue.


General and Administrative Costs.

General and administrative costs include all of our corporate costs, as well as costs of our subsidiaries' management personnel and administrative overhead. These costs primarily consist of employee compensation and related expenses, including legal, consulting and professional fees, information technology and development costs, provision for or recoveries of bad debt expense and other costs that are not directly related to performance of our services under customer contracts. Our senior management, including the senior managers of our subsidiaries, perform substantially all of our sales and marketing functions as part of their management responsibilities and, accordingly, we have not incurred material sales and marketing expenses. Information technology and development costs included in general and administrative expenses are primarily incurred to support and to enhance our operating efficiency. We expect these expenses to continue to generally increase as we expand our operations, but expect that such expenses as a percentage of revenues will decrease if we succeed in increasing revenues. Between January 1, 2012 and December 31, 2012, we increased our workforce by 346 employees, primarily as a result of the acquisitions of ADEX and its affiliated entities, T N S and ERFS, which will increase ongoing headcount-related expenses.

Fair Value of Embedded Derivatives.

We used the Black-Scholes option-pricing model to determine the fair value of the derivative liability related to warrants and the put and effective price of future equity offerings of equity-linked financial instruments. We derived the fair value of warrants using the common stock price, the exercise price of the warrants, the risk-free interest rate, the historical volatility and our dividend yield. We do not have sufficient historical data to use our historical volatility; therefore the expected volatility is based on the historical volatility of comparable companies. We developed scenarios to take into account estimated probabilities of future outcomes. The fair value of the warrant liabilities is classified as Level 3 within our fair value hierarchy.

On August 6, 2010, we issued to UTA Capital LLC warrants to purchase 16% of our common stock on a fully-diluted basis, which were exercisable at $18.75 per share and provided for cashless exercise. Such warrants were cancelled in September 2012 in consideration of the issuance of 215,099 shares of our common stock. In connection with the preparation of our financial statements for the year ended December 31, 2011, we evaluated the anti-dilution provisions of such warrants and deemed their impact to be immaterial. The relative fair value of such warrants was calculated using the Black-Scholes Option pricing model. This amount, totaling approximately $872,311, was recorded as a derivative liability and debt discount and charged to interest expense over the life of the related promissory note. The warrants issued to UTA Capital LLC did not meet the criteria to be classified as equity in accordance with ASC 815-40-15-7D and were classified as derivative liabilities at fair value and marked to market because they were not indexed to our stock as the settlement amount was not fixed due to the variability of the number of shares issuable pursuant to such warrants. The derivative liability associated with this debt was revalued each reporting period and the increase or decrease was recorded to our consolidated statement of operations under the caption "change in fair value of derivative instruments."

On February 14, 2011, we entered into an extension and modification agreement with UTA Capital LLC in connection with our outstanding note payable to UTA Capital LLC, which had a balance of $775,000 at December 31, 2010. The modification agreement provided for an extension of the original maturity date of the note from August 6, 2011 to September 30, 2011. In exchange for consenting to the modification agreement, UTA Capital LLC was issued 10,257 shares of our common stock, which had a fair value of $153,850 and was recorded as a debt discount. Additionally, as additional consideration for our failure to satisfy a certain covenant in the agreement, UTA Capital LLC was issued 4,000 shares of our common stock, which shares were recorded as a penalty paid to the lender and recorded as an expense. As of December 31, 2011, these two additional . . .

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