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ICLD > SEC Filings for ICLD > Form 10-K on 8-Apr-2014All Recent SEC Filings

Show all filings for INTERCLOUD SYSTEMS, INC.

Form 10-K for INTERCLOUD SYSTEMS, INC.


8-Apr-2014

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 years ended December 31, 2013 and 2012, primarily as a result of our acquisition of ADEX, approximately 35% and 38%, respectively, of our revenue was derived from specialty contracting services, with the remaining 65% and 62%, respectively, coming from our telecommunications staffing services.

In 2013, we evaluated our reporting segments and determined that we operate in two reportable segments, specialty contracting services and telecommunication staffing services. The telecommunication staffing services segment is comprised of the Adex reporting unit and provides contracted services to provide technical engineering and management solutions to large voice and data communications providers, as specified by their clients. Specialty contracting services revenues are derived from contracted services to provide technical engineering services along with contracting services to commercial and governmental customers. Our operating divisions have been aggregated into the two reporting segments due to their similar economic characteristics, products, production methods and distribution methods. The specialty contracting service segment includes our AW Solutions, TNS, Tropical and RM Engineering reporting units.

Our revenue increased from $17.1 million for the year ended December 31, 2012 to $51.4 million for the year ended December 31, 2013. Our net loss attributable to common stockholders increased from $2.1 million for the year ended December 31, 2012 to $25.4 million for the year ended December 31, 2013. As of December 31, 2013, our stockholders' deficit was $1.7 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 2013 and 2012, the majority of our revenue and expenses was generated by our acquired companies. Of the $51.4 million in total revenues in the year ended December 31, 2013, $45.5 million was generated by the companies we acquired in 2012 and 2013. In 2012, $11.7 million of the total $17.1 million in revenues was generated by companies acquired in 2012.

Cost of revenues of the companies we acquired in the years ended December 31, 2012 and 2013 accounted for $34.2 million of our $37.3 million cost of revenues during the year ended December 31, 2013. In 2012, $8.7 million of the total $12.0 million in cost of revenues was incurred by the companies we acquired in 2012.

Gross profit generated by the companies we acquired in the years ended December 31, 2012 and 2013 accounted for $11.3 million of our $14.1 million gross profit during the year ended December 31, 2013. Gross profit generated by the companies we acquired in 2012 was $3.0 million of the total gross profit of $5.1 million in 2012.

Operating expenses, including salaries and wages and depreciation and amortization, for the companies we acquired in the years ended December 31, 2012 and 2013 accounted for $8.2 million of our $20.5 million of operating expenses during the year ended December 31, 2013. Operating expenses for the companies we acquired in 2012 was $1.9 million of the total $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, 2013 2012 Multi-year master service agreements and long-term contracts 65 % 60 %

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 comes 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, 2013 and 2012:

Year ended December 31,

                    2013               2012
Ericsson, Inc.           41 %               33 %
Nexlink                   0 %               14 %

We are a single-source provider of end-to-end IT and next-generation network solutions to the telecommunications service provider (carrier) and corporate enterprise markets through cloud platforms and professional services. We believe our market advantages center around our cloud-based applications and services portfolio and positioning. As a true infrastructure 2.0 provider, we add value by enabling applications and services while helping to contain costs. Customers now demand a partner that can provide end-to-end IT solutions, that offers a solution that allows the customer to move IT expenditures from capital costs to operating costs, and that offers the customer greater elasticity and the ability to rapidly deploy enterprise applications.

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 by leveraging our single-source end-to-end network to efficiently provide a full spectrum of end-to-end IT and next-generation network solutions and staffing services to our customers. We believe our solutions and services offerings can 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 industry participants have in managing multiple specialty-service providers to address their 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 of 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 those 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 and planned acquisitions have been and will be timed with 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.

Advances in technology architectures have supported the rise of cloud computing, which enables the delivery of a wide variety of cloud-based services, such as platform as a service (PaaS), infrastructure as a service (IaaS), database as a service (DbaaS), and software as a service (SaaS). Today, mission-critical applications can be delivered reliably, securely and cost-effectively to our customers over the internet without the need to purchase supporting hardware, software or ongoing maintenance. The lower total cost of ownership, better functionality and flexibility of cloud applications represent a compelling alternative to traditional on-premise solutions. As a result, enterprises are increasingly adopting cloud services to rapidly deploy and integrate applications without building out their own expensive infrastructure and to minimize the growth of their own IT departments and create business agility by taking advantage of accelerated time-to-market dynamics.

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.

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 IT and 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, an IT and telecommunications staffing firm. Through ADEX, we manage a database of more than 70,000 IT and 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 six acquisitions since January 1, 2012 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 IT and 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 IT and telecommunications infrastructure. As of December 31, 2013, our operations in Puerto Rico have generated $4.1 million in revenue. We plan to expand our global presence either through 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,
                               2013                2012
Top 10 customers, aggregate        74 %                  77 %
Customer:
Nexlink                             * %                  14 %
Ericsson, Inc.                     41 %                  33 %


_________________

* Represented less than 10% of total revenues during the period.

Business Unit Transitions.

In the year ended December 31, 2012, approximately 38% of our revenue came from our specialty contracting services, and the remaining 62% came from our telecommunications staffing services. In the year ended December 31, 2013, approximately 35% of our revenue came from specialty contracting services, and the remaining 65% come from our telecommunications staffing services. The acquisition of ADEX in 2012 enabled us to shift our business focus from exclusively providing specialty contracting services to also providing professional staffing services, which has expanded our customer base.

Since January 1, 2012, we have acquired six other companies, 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 acquisition of AW Solutions in April 2013 broadened our suite of services and added new customers to which we can cross-sell our other services. Our acquisition of IPC in January 2014 improved our systems integration capabilities. Our acquisition of RentVM in February 2014 expanded our cloud and managed services capabilities by providing us a software-defined data center ("SDDC") platform to offer enterprise-grade cloud computing solutions. Our proposed acquisition of VaultLogix will broaden our suite of cloud service offerings by adding VaultLogix's cloud backup services to our wide range of cloud offerings and will add new customers to which we can cross-sell our other services. 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 reportable segments for the years ended December 31, 2013 and 2012.

                                          Year ended December 31,
                                           2013             2012
Revenue from:
Specialty contracting services         $ 18,224,317     $  6,513,763
Telecommunications staffing services   $ 33,183,227     $ 10,575,786
As a percentage of total revenue:
Specialty contracting services                   35 %             38 %
Telecommunications staffing services             65 %             62 %

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, 2012, we have completed six 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 a definitive agreement to acquire Telco, and in March 2014, we executed a definitive agreement to acquire VaultLogix. It is our intention is to complete the VaultLogix acquisition within 90 days of the date of this report, subject to our ability to raise the necessary cash proceeds to complete such acquisition. After the completion of the VaultLogix acquisition and reflecting the consolidation of the companies that we acquired in 2014 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 our 2014 acquisitions and our pending acquisition of VaultLogix is not reflected in this "Management's Discussion and Analysis of Financial Condition and Results of Operations" section. We have not yet determined when we will consummate the acquisition of Telco, if at all. The Telco acquisition also is dependent on our ability to obtain satsifactory financing and there can be no assurance that such financing will be available to us.

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, 2012, we derived approximately 38% of our revenue from our specialty contracting services and approximately 62% of our revenue from our telecommunications staffing and training services. In the year ended December 31, 2013, we derived approximately 35% of our revenue from our specialty contracting services and approximately 65% from our telecommunications staffing and training services.


Cost of Revenues.

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. Cost of revenues in the year ended December 31, 2013 was 73% of revenues as compared to 70% of revenues in the year ended December 31, 2012, primarily due to lower margins in our telecommunications staffing business. Cost of revenues in the telecommunications staffing business was 79% and 78% of revenues in the years ended December 31, 2013 and 2012, respectively. Cost of revenues as a percentage of revenues in the specialty contracting business was 60% and 57% of revenues in the years ended December 31, 2013 and 2012, respectively. We are trying to increase efficiency in the year ending December 31, 2014 and will focus our efforts on improving margins.

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 revenues 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.

Goodwill and Indefintite Lived Intangible Assets

Goodwill was generated through the acquisitions we made during 2011, 2012 and 2013. As the total consideration we paid for our completed acquisitions exceeded the value of the net assets acquired, we recorded goodwill for each of the completed acquisitions (see Note 3. Acquisitions and Deconsolidation of Subsidiary). At the date of acquisition, we performed a valuation to determine the value of the goodwill and intangible assets, along with the allocation of assets and liabilities acquired. The goodwill is attributable to synergies and economies of scale provided to we by the acquired entity.

We perform our annual impairment test at the reportable segment level. The two reporting segments are telecommunication staffing services and specialty contracting services. Telecommunications staffing services is comprised of the ADEX entities, and specialty contracting services is comprised of TNS, Tropical, AW Solutions and RM Engineering. The components within the specialty contracting reportable segment are each considered individual reporting units. These reporting units are aggregated to form one operating segment and reportable segment for financial reporting and for the evaluation of goodwill for impairment. The telecommunications staffing reporting segment consists of one operating segment, which in turn consists of one reporting unit comprised of a single component.

We perform the impairment testing at least annually (at December 31) or at other times if we believe that it is more likely than not that there may be an impairment to the carrying value of its goodwill. If it is more likely than not, that goodwill impairment exists, the second step of the goodwill impairment test should be performed to measure the amount of impairment loss, if any.

We consider the results of an income approach and a market approach in determining the fair value of the reportable segments. We evaluated the forecasted revenue using a discounted cash flow model for each of the reporting segments. We also noted no unusual cost factors that would impact operations based on the nature of the working capital requirements of the components comprising the reportable segments. Current operating results, including any losses, are evaluated by us in the assessment of goodwill and other intangible assets. The estimates and assumptions used in assessing the fair value of the reporting units and the valuation of the underlying assets and liabilities are inherently subject to significant uncertainties. Key assumptions used in the income approach in evaluating goodwill are forecasts for each of the reporting units revenue growth rates along with forecasted discounted free cash flows for each reporting unit, aggregated into each reporting segment. For the market approach, we used the guideline public company method, under which the fair . . .

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