EMTEC INC/NJ - 10-K - Management's Discussion and Analysis of Financial Condition and Results of Operations

(Edgar Glimpses Via Acquire Media NewsEdge) Reference is made to the "Risk Factors" outlined in Item 1A for a discussion of important factors that could cause actual results to differ from expectations and any of our forward-looking statements contained herein. The following discussion as of August 31, 2012 and 2011 should be read in conjunction with our audited consolidated financial statements and accompanying notes, which are contained elsewhere in this Report.

Overview of Emtec Emtec, Inc., a Delaware corporation, was formed on January 17, 2001 and is an information technology ("IT") services provider. We provide consulting, application services and infrastructure services to commercial and public sector clients. The Company's client base is comprised of commercial businesses, school districts, and departments of the U.S. and Canada's federal, state/provincial and local governments.

Over the last two years, we have concentrated our sales efforts on growing our consulting and outsourcing services to our clients; we go to market through specific industry segments, commonly called "verticals," "industry verticals" or "vertical markets", and through specific organizational functional expertise.

Our primary business objective is to become a leading provider of high quality IT application services and innovative consulting for our clients, while continuing to provide a range of managed infrastructure support.

We service our clients on their premises or in our delivery centers in the U.S., Canada and India.

Our consulting and outsourcing services can be subject to inflationary pressures and, in order to stay competitive, we typically need to increase the wages of our consultants. Generally, rate increases to our clients lag behind such wage increases due to the long term nature of contracts with some of our clients.

While the economy in general has suffered since 2008, IT unemployment is lower than other job functions across the U.S. This is from a lack of qualified technical resources and the U.S. government's tightening of immigration limits.

While we are ultimately focused on growing revenue, the Company has been in a transition period over the last several years. We have been moving away from lower gross margin revenue that requires significant scale to maintain profitability, towards higher gross margin recurring revenue that requires significantly less overhead. As such, we have concentrated our focus on improving overall gross profit, gross margins and operating profit.

Factors that may affect gross profits in the future include billing rates, utilization rates of our consultants, and pay and benefits for our consultants.

In addition, the mix of services we provide can affect gross margins; domestically-based long-term, recurring revenue outsourcing contracts tend to have lower margins than project based consulting engagements. In addition, increasing use of offshore resources for maintenance and support will have the effect of decreasing our revenues while increasing our gross margins.

Our procurement services business is typically a low margin, high overhead business. The procurement services we provide for our clients have historically not been adversely affected by inflation. Technological advances or competition within the IT industry have generally caused the prices of the products we sell to decline as well as the product life-cycles tend to be shorter. With continuing downward pressure on prices, we have taken the approach that we favor growth of product lines with higher gross margins, and larger and fewer transactions. Except in our Federal segment we are not currently focused in growth of our product sales. Rather, we view these sales to be ancillary to our core service relationships with our clients. Our clients purchase products through us because we provide a particular knowledge of the appropriate configuration, because they have outsourced the deployment of these products to us, or because we have simplified the purchasing process through an agreement that provides ease of use and volume pricing incentives.

27 -------------------------------------------------------------------------------- Factors that may affect procurement services gross profits in the future include changes in product margins, volume incentive rebates and other incentives offered by various manufacturers, the mix of products sold, the mix of client type and the decision to aggressively price certain products.

Factors that may in the future have a negative impact on our selling, general and administrative expenses for both types of services include costs associated with marketing and selling activities, potential merger and acquisition related costs, technological improvement costs, compliance costs associated with SEC rules and increases in our insurance costs.

During 2012, we decided to re-segment our business. We have two reporting segments, Federal and Commercial, State, Local and Education ("CSLED"), each having its own independent sales force. Our Federal segment sells our portfolio of services to the various agencies of the U.S federal government. The federal government uses a variety of master contracts (or "contract vehicles") and seldom purchases services and products directly without using a prime vendor listed under the contract. Thus, there is a concentrated sales effort on obtaining the rights to sell as a prime vendor under these contracts. Once the contract vehicle has been awarded, the Company largely competes against a limited number of other awardees. In addition, the federal government reserves a certain amount of business under these contracts for companies in various special interest groups' categories such as small businesses; women owned businesses and service disabled veteran owned businesses. Emtec partners and subcontracts with a number of these firms in order meet the government's' requirements under the contracts and contract vehicles. Further, many of the awardees of contract vehicles do not have a complete portfolio of services. Accordingly, they seek out to partner with companies, such as Emtec, who can provide specific expertise in which the federal government may be looking for on a bid. Therefore, even though the Company may not be a vendor under a contract vehicle, they still may be a subcontractor to a prime vendor. Emtec is a prime vendor and a designated subcontractor to prime vendors under numerous of these contract vehicles.

The sales cycle for a procurement service transaction for the Federal segment is typically very short-term in nature and very cyclical with the majority of sales orders being placed immediately before the end of the U.S. government's fiscal year in September. Thus our Federal segment typically has a strong fiscal first quarter as these products are delivered during the months of October and November. By contrast, the sales cycle for a consulting and outsourcing customer is an extremely elongated sale cycle. However, once the sale is made, the contract typically lasts from 3-8 years and provides a very predictable stream of revenue.

Within our CSLED segment, we have our "Commercial" operating segment and our "State, Local and Education" ("SLED") operating segment. This segment has one sales force that serves the entire CSLED segment. While the SLED and Commercial businesses can differ in their sales process, we have observed enough evidence of the relationships between many of our Commercial and SLED clients, and the projects tend to be similar in nature with large 3-5 year outsourcing contracts and shorter 6-9 month project based contracts. In addition, our procurement sales in both of these business units are sold typically as part of a larger consulting and outsourcing contract and are a service we provide as part of our relationship. The motivation of the sales teams in this segment is not focused primarily on procurement sales but rather on consulting and outsourcing services, and, when needed, responding to the client when the client needs the product as part of our ongoing outsourcing relationship or executes a product rollout.

28--------------------------------------------------------------------------------Quarterly Financial Summary We believe that as we add to the portfolio of services we are offering, our revenues will experience less quarterly fluctuations. Some of the contracts we are now in the process of negotiating with federal government agencies require services and products to be delivered throughout the year as opposed to the historical cyclical delivery timing we have experienced. In addition, we have diversified our revenue base through the businesses we have acquired. These businesses typically deliver long-term services to a variety of clients. Therefore, the revenues from these acquired businesses have not fluctuated as much quarter-to-quarter as has our historical business. We expect to continue to develop new practices and acquire companies which may not have significant seasonal fluctuations. Accordingly, we expect our revenues not to fluctuate as much quarter to quarter in the future as they have in the past.

In 2012, we rebounded from a difficult year for our Federal segment in 2011 due to budgetary crises in 2011. After a solid first quarter, we decided that the business could not withstand another significant downturn in the Federal segment. With the fiscal cliff looming in January 2013, we cut back on non-performing sales personnel in the Federal segment and reduced other operational overhead. This restructuring allowed the Federal segment to be significantly more profitable during the second, third, and fourth quarters of 2012. We believe we currently have a more productive sales team in place and more efficient operations associated with our Federal segment. In addition, our sales team has been selling longer term projects that include a combination of procurement and consulting and outsourcing which we believe may lead to a more predictable and more evenly distributed base of revenue for 2013.

During the fourth quarter of 2011 and the first three quarters of 2012, we were affected by a significant slowdown in our SLED business. One of our clients had delayed a number of projects dues to a delay in receiving tax revenues that are specifically designed to purchase IT services and systems. During the fourth quarter of 2012, this business returned to its normal run-rate. This slowdown was partially offset by new contracts in our Commercial business; however we also invested in sales talent and practice management in Commercial in 2012 to position the Company for future growth. The table below does not identify the effects of significant non-cash charges which are identified in our quarterly statements and in other sections of this document for the full year ended August 31 2012. Readers of this document should refer to those documents and items in order to get a better understanding of the Company's performance.

Year ended August 31, 2012 (In thousands, except share amounts) First Second Third Fourth Fiscal Quarter Quarter Quarter Quarter 2012 Revenue $ 72,030 $ 47,725 $ 50,699 $ 54,119 $ 224,573 Gross Profit $ 11,896 $ 8,481 $ 9,060 $ 8,584 $ 38,021 Net Income (Loss) $ 455 $ (2,736 ) $ (926 ) $ (9,216 ) $ (12,423 ) Net Income (Loss) per share: $ 0.05 $ (0.17 ) $ (0.06 ) $ (0.55 ) $ (0.74 ) Basic and Diluted 29-------------------------------------------------------------------------------- Year ended August 31, 2011 (In thousands, except share amounts) First Second Third Fourth Fiscal Quarter Quarter Quarter Quarter 2011 Revenue $ 76,869 $ 46,130 $ 44,859 $ 44,289 $ 212,147 Gross Profit $ 10,547 $ 7,750 $ 7,807 $ 6,963 $ 33,067 Net Income (Loss) $ 729 $ (427 ) $ (812 ) $ (3,740 ) $ (4,250 ) Net Income (Loss) per share: $ 0.05 $ (0.03 ) $ (0.05 ) $ (0.24 ) $ (0.27 ) Basic and Diluted The consolidated quarterly financial information for the year ended August 31, 2011 includes the accounts and transactions of Dinero, Covelix and Emerging with respective acquisition dates of February 3, 2011, March 1, 2011 and August 15, 2011.

30--------------------------------------------------------------------------------Overview of Consolidated Financial Statements Presented Herein The consolidated financial information for the year ended August 31, 2011 includes the accounts and transactions of Dinero, Covelix, and Emerging as of the respective acquisition dates of February 3, 2011, March 1, 2011 and August 15, 2011.

EMTEC, INC.

CONSOLIDATED STATEMENTS OF OPERATIONS (In thousands) Years Ended August 31, 2012 2011 Change % Revenues Consulting and outsourcing $ 103,438 $ 74,538 $ 28,900 38.8 % Procurement services 121,135 137,609 (16,474 ) (12.0 )% Total Revenues 224,573 212,147 12,426 5.9 % Cost of Revenues Cost of consulting and outsourcing 80,132 55,695 24,437 43.9 % Cost of procurement services 106,420 123,385 (16,965 ) (13.7 )% Total Cost of Revenues 186,552 179,080 7,472 4.2 % Gross Profit Consulting and outsourcing 23,306 18,843 4,463 23.7 % Consulting and outsourcing % 22.5 % 25.3 % Procurement services 14,715 14,224 491 3.5 % Procurement services % 12.1 % 10.3 % Total Gross Profit 38,021 33,067 4,954 15.0 % Total Gross Profit % 16.9 % 15.6 % Operating expenses: Selling, general, and administrative expenses 32,467 33,346 (879 ) (2.6 )% Retention bonuses to former owners of acquired entities 884 1,040 (156 ) (15.0 )% Non cash operating expenses Stock-based compensation 420 514 (94 ) (18.3 )% Warrant liability adjustment 890 57 833 1461.4 % Earnout liability adjustment 557 - 557 - Impairment of identifiable intangible assets 4,132 - 4,132 - Impairment of goodwill 5,295 200 5,095 2547.5 % Depreciation and amortization 5,304 3,387 1,917 56.6 % Total operating expenses 49,949 38,544 11,405 29.6 % Percent of revenues 22.2 % 18.2 % Operating loss (11,928 ) (5,477 ) (6,451 ) 117.8 % Percent of revenues (5.3 )% (2.6 )% Other expense (income): Interest income - other (102 ) (23 ) (79 ) 343.5 % Interest expense 3,298 1,110 2,188 197.1 % Other (117 ) 57 (174 ) (305.3 )% Loss before income tax benefit (15,007 ) (6,621 ) (8,386 ) 126.7 % Income tax benefit (2,584 ) (2,371 ) (213 ) 9.0 % Net loss $ (12,423 ) $ (4,250 ) $ (8,173 ) 192.3 % Percent of revenues (5.5 )% (2.0 )% 31--------------------------------------------------------------------------------Consolidated Results of Operations Overview During the year ended August 31, 2012, the Company lowered the six year projections for all business units used in our goodwill and intangible asset impairment testing. The projections were lowered due to the uncertainty surrounding the impending fiscal cliff. In the past, we had forecasted with the assumption that the President and Congress would have come to an agreement prior to January 1, 2013. Since 2011, it has become far less likely that the fiscal cliff will be avoided, so we reduced our projections and assumed a decline in economic activity. While we do not project negative cash flows for any of our business units nor do we believe we will default on any of the debt covenants due to the strength of our education backlog and our continuing cost reductions, the impact of a reduction in these projections resulted in goodwill impairment of $4.8 million in our CSLED segment (driven by a reduction in revenue growth projections in the commercial unit) and a write-down of $521,000 in our federal segment.

In addition, customer relationships in our CSLED segment were written down by approximately $4.0 million. In 2011, parts of the staffing business were still growing and others seemed to have stabilized; however, the Company was still not generating significant cash flow from the staffing business so it was restructured to focus on cash generation rather than new sales growth. As a result, the staffing business returned to profitability but numerous clients were lost as we focused on rate improvement. To a lesser extent, the customer intangible write-downs were the continued reduction of customers which the Company had in its legacy procurement (VAR) commercial business which has also gone through a significant restructuring to improve profitability.

Readers should note that these write downs have no effect on the operating cash flows for 2012 or anything Management has mentioned in this analysis on the outlook for 2013. Management believes it has sufficient cash flows to meet its obligations in 2013, as well as continue with its future growth plans. Readers are encouraged to read the footnotes to the financial statements for further review of these write-downs.

Management examines numerous measures when analyzing the results of our operations. Our objective is to grow the overall revenues, gross profit margins and continuous operating cash flows of the Company.

As we diversify our business and grow our consulting and outsourcing services revenues, and in particular our applications services revenues, we expect gross margins to increase. However, due to changes in types of services, we may occasionally see a decline in our services gross margin which may lead to a decline in our overall gross margin.

We measure our selling costs as a percentage of gross profits and sales compensation for the associates of the Company is derived from gross profit. We expect that our growth will lead to selling costs increasing, but as our revenues grow we expect our selling costs to grow less quickly than our gross profit, thereby decreasing selling costs as a percentage of total gross profits.

We expect as we grow our general and administrative costs will decrease as a percentage of revenue. In the past, we have invested, from time to time, in additional selling, general and administrative costs in order to be able to grow our revenue more quickly based on market conditions. In addition, we may experience an increase in our overall selling, general and administrative costs prior to being able to rationalize some of the costs (for example after an acquisition, we may not experience overhead synergies immediately).

We currently categorize our revenues and costs of services into "Procurement Services" and "Consulting and Outsourcing." We have made these categorizations in order to analyze our growth in IT professional services as a percentage of overall revenues. We have divided our business into two reporting segments. Our Federal segment sells our portfolio of services to the various agencies of the U.S. federal government. Our CSLED segment sells our portfolio of services to clients in the Commercial and SLED business units.

Total revenue for fiscal 2012 increased 5.9% or $12.4 million as compared to fiscal 2011. This increase was primarily the result of the full year effect of the 2011 acquisitions that was partially off-set by project delays from our education clients.

The aggregate gross profit increased by $4.9 million for fiscal 2012 as compared to fiscal 2011. The increase is due to higher revenues and a shift in the Company's revenue mix from lower margin procurement services to higher margin consulting and outsourcing services. For fiscal 2012, the aggregate gross margin increased to 16.9% as compared to 15.6% for fiscal 2011. This increase is primarily attributable to higher gross margins from procurement services revenue partially off-set by lower gross margin in consulting and outsourcing related to underutilized staff due to project delays from our education clients.

We have itemized our operating expenses in order to present a more accurate picture of our ongoing costs. Our selling, general and administrative expenses include ongoing costs of our sales force and our administrative overhead. Selling, general and administrative expenses decreased by approximately $879,000 from fiscal 2011 to fiscal 2012. This decrease is primarily the result of our ongoing cost cutting efforts including a $4.0 million cost cutting project in the fourth quarter of fiscal 2011 and an additional $3.6 million in reductions in 2012. The decrease was offset by a $6.7 million increase from the effect of reporting a full year of selling, general and administrative expenses on our 2011 acquisitions.

As part of the consideration we give to acquire companies, we often include bonuses which may either be in the form of retention or performance incentives. Often these bonuses are awarded to the second layer of management within the acquired companies and to a lesser extent the former owners of the acquired companies. Since these bonuses are in lieu of purchase consideration, we separate them out in segment comparative income statements. During fiscal 2012, we expensed $884,000 for these bonuses which was a $156,000 decrease over the amount expensed in fiscal 2011. Unless we acquire new companies, these amounts will continue to decrease.

32 -------------------------------------------------------------------------------- Stock based compensation records the expense of any stock consideration awarded to management. We believe providing management with stock-based compensation properly motivates management to increase the value of the stock over time and allows us to retain key management. It also allows the Company to increase the operating cash flows of the Company instead of paying out large cash awards for performance. Stock based compensation decreased by approximately $94,000 in fiscal 2012. This was primarily because stock based compensation is amortized over the vesting period. In fiscal 2011, executive management bonuses were less than they had typically been in prior years and there were no stock awards paid as part of executive management bonuses. Accordingly, the amortization that would typically occur over the one year vesting of these awards did not occur in fiscal 2012. The remaining amortization in fiscal 2012 is for awards with longer vesting periods.

As explained in Note 13 to our financial statements, the Company has issued various warrants. These warrants are marked to market each quarter. The warrant expense or income for the year actually represents the opposite effect of an increase in the Company's stock. As the stock price increases, the Company records an expense, and as it decreases it records income related to these warrants. The warrant liability adjustment for fiscal 2012 was $890,000 versus $57,000 in fiscal 2011. This is primarily the result of the increase in the Company's stock price and the increase in number of warrants due to the issuance of warrants as a result of the Company's subordinated debt issuances in the fourth quarter of fiscal 2011 and the second quarter of fiscal 2012.

The Company recorded $557,000 in earn out liability adjustments in fiscal 2012. This non-cash charge which has been expensed represents an increase in the probability of the earn out liability being paid and the effect of the time value of money since the earn outs are closer to being paid. This increase in the liability from expense was offset by actual earn out payments in fiscal 2012.

In the fourth quarter of fiscal 2012, the Company recorded impairment charges of $5.3 million associated with goodwill and $4.1 million associated with identifiable intangible assets.

As discussed earlier, during the year ended August 31, 2012, the Company lowered the six year projections for all business units used in our goodwill and intangible asset impairment testing. The projections were lowered due to the uncertainty surrounding the impending fiscal cliff. In the past, we had forecasted with the assumption that the President and Congress would have come to an agreement prior to January 1, 2013. Since 2011, it has become far less likely that the fiscal cliff will be avoided, so we reduced our projections and assumed a decline in economic activity. While we do not project negative cash flows for any of our business units nor do we believe we will default on any of the debt covenants due to the strength of our education backlog and our continuing cost reductions, the impact of a reduction in these projections resulted in goodwill impairment of $4.8 million in our CSLED segment (driven by a reduction in revenue growth projections in the commercial unit) and a write-down of $521,000 in our federal segment.

In addition, customer relationships in our CSLED segment were written down by approximately $4.0 million. In 2011, parts of the staffing business were still growing and others seemed to have stabilized; however, the company was still not making a great deal of cash flow from the staffing business so it was restructured to focus on cash generation rather than new sales growth. As a result, the staffing business returned to profitability but numerous clients were lost as we focused on rate improvement. To a lesser extent, the customer intangible write-downs were the continued reduction of customers which the Company had in its legacy procurement (VAR) commercial business which has also gone through a significant restructuring to improve profitability.

Depreciation and amortization increased by $1.9 million in 2012. This was a result of the increased depreciation and intangible amortization from the Company's 2011 acquisitions, as well as increased depreciation from the Company's fiscal 2011 SAP implementation.

The operating loss increased by 117.8% to $11.9 million for fiscal 2012 as compared to $5.5 million for fiscal 2011. The increase in operating loss is mainly due to the increase in non-cash operating expenses of $12.4 million related to warrant liability adjustment, earn out liability adjustment, impairment of goodwill and intangible assets and increase in depreciation and amortization, as discussed above. Other expense (income), net, increased $1.9 million to $3.1 million for fiscal 2012 as compared to $1.1 million for fiscal 2011 related to additional interest expense. The increase in interest expense is a result of the subordinated debt the Company issued in August 2011 and December 2011, as well as the amortization of deferred financing costs associated with the subordinated debt issuance and the Company's new PNC Credit Facility commencing December 2011.

We have divided our business into three segments as of June 1, 2012 · Federal - provides IT consulting services, outsourcing services, and procurement services to the various agencies of the U.S. federal government.

· Commercial, State & Local and Education ("CSLED") - provides IT consulting services, outsourcing services, and procurement services to clients in the commercial, state & local and education sectors.

· Corporate- Provides operational support to the segments and generates no revenue or gross profit.

The results of each segment are discussed below 33 --------------------------------------------------------------------------------Results of Operations - Federal The following discussion and analysis provides information that management believes is relevant to an assessment and understanding of our Results of Operations for the fiscal years ended August 31, 2012 and 2011.

FEDERAL STATEMENTS OF OPERATIONS (In thousands) Years Ended August 31, 2012 2011 Change % Revenues Consulting and outsourcing $ 12,524 $ 11,140 $ 1,384 12.4 % Procurement services 75,471 76,729 (1,258 ) (1.6 )% Total Revenues 87,996 87,869 126 0.1 % Cost of Revenues Cost of consulting and outsourcing 9,907 8,547 1,360 15.9 % Cost of procurement services 66,807 68,966 (2,159 ) (3.1 )% Total Cost of Revenues 76,713 77,513 (800 ) (1.0 )% Gross Profit Consulting and outsourcing 2,618 2,593 25 1.0 % Consulting and outsourcing % 20.9 % 23.3 % Procurement services 8,665 7,763 901 11.6 % Procurement services % 11.5 % 10.1 % Total Gross Profit 11,282 10,356 926 8.9 % Total Gross Profit % 12.8 % 11.8 % Operating expenses: Selling, general, and administrative expenses 5,331 8,313 (2,981 ) (35.9 )% Retention bonuses to former owners of acquired entities 133 604 (471 ) (78.0 )% Non cash operating expenses Earnout liability adjustment 513 - 513 - Impairment of identifiable intangible assets 102 - 102 - Impairment of goodwill 521 - 521 - Depreciation and amortization 934 867 66 7.7 % Total operating expenses $ 7,534 $ 9,784 $ (2,250 ) (23.0 )% Percent of revenues 9 % 11 % Operating income $ 3,748 $ 572 $ 3,176 555.2 % Percent of revenues 4.3 % 0.7 % Comparison of Years Ended August 31, 2012 and 2011 - Federal Revenues - Federal Our Federal segment's total revenue increased by $126,000. Our consulting and outsourcing revenue increased by $1.4 million, or 12.2% to $12.5 million for the year ended August 31, 2012 as compared to $11.1 million for the year ended August 31, 2011, which was offset by a $1.2 million decrease in our procurement business. The increase in our consulting and outsourcing revenue is primarily attributable to the focus of our Federal segment sales force on selling long-term engagements which have higher margins than our procurement business.

Gross Profit - Federal Aggregate gross profit for our Federal segment increased $926,000, or 8.9%, to $11.3 million for the year ended August 31, 2012 as compared to $10.4 million for the year ended August 31, 2011. This increase was related to an increased gross profit from procurement services revenue. Although procurement services revenues slightly decreased for the year ended August 31, 2012, we targeted our sales efforts on higher margin procurement services revenues during fiscal 2012. Our consulting and outsourcing gross profit was relatively flat during 2012. The gross margin in consulting and outsourcing decreased from 23.3% to 20.9%. While revenues increased for consulting and outsourcing, we lost a higher margin outsourcing arrangement in our federal application services business and had several new consulting projects which were shorter term in duration and had a lower margin.

34-------------------------------------------------------------------------------- Overall measured as a percentage of revenues, the gross margin for the Federal segment increased to 12.8% of revenues for the year ended August 31, 2012 from 11.8% for the year ended August 31, 2011. This increase is primarily related to obtaining higher margin procurement service revenues during fiscal 2012 and offset by the lower margin consulting and outsourcing revenue as described above.

Operating Expenses - Federal Selling, general and administrative expenses decreased by $3.0 million to $5.3 million in fiscal 2012 from $8.3 million in fiscal 2011. This decrease was primarily the result of the Company's cost cutting initiative in the fourth quarter of fiscal 2011 and additional cost cutting in the sales personnel in fiscal 2012.

Retention bonuses decreased by $471,000 from fiscal 2011 to fiscal 2012. The retention bonuses are associated with the Company's acquisition of SDI in fiscal 2010.

Non-cash expenses include the earn out liability adjustment of $513,000 associated with the increased likelihood of SDI achieving their earn outs and impairment charges of $623,000. The impairment charges were the result of lower forecasts due to the impending fiscal cliff.

Operating Income - Federal Operating income for our Federal segment increased $3.2 million, or 552.2%, to $3.7 million for the year ended August 31, 2012, compared to $572,000 for the year ended August 31, 2011. This increase is primarily related to the decrease in selling, general and administrative expenses, a decrease in retention bonuses and the increase in gross profit associated with procurement services each discussed above. However, this increase was offset by a $1.2 million increase in non-cash operating expenses.

For purposes of this discussion, other expenses, including interest, are covered in our corporate segment.

Results of Operations - CSLED The following discussion and analysis provides information that management believes is relevant to an assessment and understanding of our Results of Operations for the fiscal years ended August 31, 2012 and 2011 for our CSLED segment.

35 -------------------------------------------------------------------------------- CSLED STATEMENTS OF OPERATIONS (In thousands) Years Ended August 31, 2012 2011 Change % Revenues Consulting and outsourcing $ 90,914 $ 63,398 $ 27,516 43.4 % Procurement services 45,664 60,880 (15,216 ) (25.0 )% Total Revenues 136,577 124,278 12,300 9.9 % Cost of Revenues Cost of consulting and outsourcing 70,225 47,148 23,077 48.9 % Cost of procurement services 39,614 54,419 (14,805 ) (27.2 )% Total Cost of Revenues 109,839 101,567 8,272 8.1 % Gross Profit Consulting and outsourcing 20,688 16,250 4,438 27.3 % Consulting and outsourcing % 22.8 % 25.6 % Procurement services 6,050 6,460 (410 ) (6.4 )% Procurement services % 13.2 % 10.6 % Total Gross Profit 26,738 22,711 4,028 17.7 % Total Gross Profit % 19.6 % 18.3 % Operating expenses: Selling, general, and administrative expenses 13,512 12,355 1,157 9.4 % Retention bonuses to former owners of acquired entities 751 436 315 72.2 % Non cash operating expenses Stock-based compensation 140 - 140 - Earnout liability adjustment 44 - 44 - Impairment of identifiable intangible assets 4,030 - 4,030 - Impairment of goodwill 4,773 200 4,573 2286.6 % Depreciation and amortization 3,205 1,726 1,479 85.7 % Total operating expenses $ 26,456 $ 14,717 $ 11,738 79.8 % Percent of revenues 19 % 12 % Operating income $ 283 $ 7,993 $ (7,711 ) (96.5 )% Percent of revenues 0.2 % 6.4 % Comparison of Years Ended August 31, 2012 and 2011 - CSLED Revenues - CSLED Our CSLED segment's total revenues increased $12.3 million, or 9.9%, to $136.6 million for the year ended August 31, 2012 as compared to $124.3 million for the year ended August 31, 2011. The increase in CSLED total revenue was primarily attributable to an increase in consulting and outsourcing revenue partially offset by a decline in procurement services revenue. Without the impact of the fiscal 2011 acquisitions of Dinero (acquired on February 3, 2011), Covelix (acquired on March 1, 2011), and Emerging (acquired on August 15, 2011), CSLED's revenue would have decreased $31.0 million, or 22.7%, to $105.5 million for the year ended August 31, 2012, compared to $119.0 million for the year ended August 31, 2011. The majority of this decrease can be attributed to timing delays from our education clients and a decline in our staffing practice.

Consulting and outsourcing revenue increased $27.5 million, or 43.4%, to $90.9 million for the year ended August 31, 2012 as compared to $63.4 million for the year ended August 31, 2011. This increase is primarily attributable to acquisitions in fiscal 2011 and the increase in new commercial outsourcing contracts and new state and local projects, which was partially off-set by a decline in revenue from our education clients.

36 -------------------------------------------------------------------------------- Procurement services revenue decreased $15.2 million, or 25.0%, to $45.7 million for the year ended August 31, 2012 as compared to $60.9 million for the year ended August 31, 2011. A substantial portion of the procurement services revenue decline is related to timing delays from our education clients.

Our CSLED segment revenues, by client type, are comprised of the following (in thousands): For the Year Ended Aug 31, 2012 Aug 31, 2011 Commercial Companies $ 83,360 61.0 % $ 58,304 46.9 % Education and other 45,959 33.7 % 59,829 48.1 % State and Local Governments 5,218 3.8 % 3,384 2.7 % Canadian Government Agencies 2,040 1.5 % 2,761 2.2 % Total Revenues $ 136,577 100.0 % $ 124,278 100.0 % For the years ended August 31, 2012 and August 31, 2011, revenues from commercial clients represented approximately 61.0% and 46.9% of our total CSLED segment revenues, respectively. The increase in fiscal 2012 revenues is related to the acquisitions in fiscal 2011 as well as several new multiyear contracts the Company won in the first quarter of fiscal 2012. These increases were offset by continued declines in our staffing business. We have restructured our staffing business by reducing our sales efforts in this business as the return on our selling costs have continued to decrease. This restructuring has resulted in a decline in revenues but an increase in profitability in the staffing practices. We expect the decline in revenues to continue into 2013. However we believe over the long-term, this business will contribute more to the bottom line based on the restructuring.

For the year ended August 31, 2012, revenues from our education business decreased by approximately $13.9 million compared with the year ended August 31, 2011. The majority of this decrease can be attributed to timing delays from our education clients.

Our State and Local government business revenues increased by approximately $1.8 million from 2011 to 2012. This increase is primarily due to new projects infrastructure services in state and local governments in the Northeast.

Gross Profit - CSLED Aggregate gross profit for our CSLED segment increased $4.0 million, or 17.7%, to $26.7 million for the year ended August 31, 2012 as compared to $22.7 million for the year ended August 31, 2011. Our acquisitions in fiscal 2011, new commercial outsourcing contracts and new state and local projects provided the majority of the increase in consulting and outsourcing gross profit, though this increase was offset in part by under-utilized personnel in our education business due to the timing delays in new projects discussed above. The increase in gross profit was also affected by declining revenues in our staffing practice and a decrease in gross margins in the staffing practice due to changes in compensation in the staffing practice and increased immigration costs. Procurement services gross profit decreased slightly between the two periods.

Measured as a percentage of revenues, the gross margin for the CSLED segment increased to 19.6% of revenues for the year ended August 31, 2012 from 18.3% for the year ended August 31, 2011. This increase can be attributed to a difference in the mix of revenues and consulting and outsourcing increased from 51.0% of total revenues to 66.6% of total revenues. In addition, procurement services margins also increased. These increases were offset by a decrease in our consulting and outsourcing gross margins caused by non-utilized staff during the education project delays.

37--------------------------------------------------------------------------------Operating Expenses - CSLED Selling general and administrative expenses increased by approximately $1.2 million. This increase includes $6.7 million of additional selling, general and administrative costs from our fiscal 2011 acquisitions and is offset by our cost cutting efforts in fiscal 2011 and fiscal 2012 and consolidation of back office personnel of acquired companies into our corporate shared services functions.

Retention and performance bonuses to acquired companies increased by approximately $315,000 as a result of payments made to the companies acquired in fiscal 2011.

Non-cash operating expenses for fiscal 2012 totaled $12.2 million versus $1.9 million in fiscal 2011, an increase of $10.3 million. The increase over fiscal 2011 includes $140,000 in stock based compensation, $44,000 in an earn out liability adjustment, $8.8 million in impairment of goodwill and intangibles, and an increase in depreciation and amortization. The impairment charge is the result of us lowering our forecasts for our commercial unit in our 6 year projections due to the impeding fiscal cliff. The impairment of customer intangibles is from a decline in our staffing business. In 2011, parts of the staffing business were still growing and others seemed to have stabilized, however the Company was still not generating significant cash flow from the staffing business so it was restructured to focus on cash generation rather than new sales growth. As a result, the staffing business returned to profitability but numerous clients were lost as we focused on rate improvement. To a lesser extent the customer intangible write-downs were the continued reduction of customers which the Company had in its legacy procurement (VAR) commercial business which has also gone through a significant restructuring to improve profitability.

The increase in depreciation and amortization includes increased intangible amortization due to the newly acquired companies in fiscal 2011.

Operating Income - CSLED Operating income for the CSLED segment decreased $7.7 million, or 96.5%, to $283,000 for the year ended August 31, 2012, compared to $8.0 million for the year ended August 31, 2011. This decrease is primarily related due to the items discussed above of which $10.3 million are non-cash expenses.

Results of Operations - Corporate Years Ended August 31, 2012 2011 Change % Operating expenses: Selling, general, and administrative expenses $ 13,623 $ 12,678 $ 945 7.5 % Stock-based compensation 280 514 (234 ) (45.6 )% Warrant liability adjustment 890 57 833 1461.6 % Depreciation and amortization 1,165 793 373 47.0 % Total operating expenses $ 15,958 $ 14,042 $ 1,916 13.6 % Operating Expenses - Corporate Our Corporate segment provides operational support to the Federal and CSLED segments and generates no revenue or gross profit. As we acquire new companies, we consolidate the back office functions into our corporate shared services groups and, therefore, we will see an increase in these costs as we shift costs out of the operating segments and into corporate. It is then our goal, once systems and processes have been harmonized, to move these costs to the environment that provides high quality service at a lower cost.

During fiscal 2012, our corporate costs increased $1.9 million from $14.0 million to $16.0 million. Of this amount, approximately $500,000 is from increases in our executive management costs. The remainder of the increase is from moving various costs out of the segments and into corporate where they can be controlled more easily. For example, we moved approximately $600,000 in costs from our 2011 acquisitions into shared services that were not included in the operating segments in fiscal 2011 and approximately $300,000 in rent was moved into corporate in fiscal 2012. We increased costs in shared services that supported our growth such as recruiting and marketing, and we decreased costs in other administrative areas such as accounting and order processing.

38 --------------------------------------------------------------------------------Noncash operating expenses increased by approximately $972,000 in 2012. This includes an $833,000 increase in the warrant liability expense, $234,000 decrease in stock-based expense and a $373,000 increase in depreciation and amortization.

Recently Issued Accounting Standards Intangibles - Goodwill and Other In December 2010, the Financial Accounting Standards Board ("FASB") issued Accounting Standards Update ("ASU") 2010-28, Intangibles - Goodwill and Other (Topic 350): When to Perform Step 2 of the Goodwill Impairment Test for Reporting Units with Zero or Negative Carrying Amounts. ASU 2010-28 modifies Step 1 of the goodwill impairment test for reporting units with zero or negative carrying amounts. For those reporting units, an entity is required to perform Step 2 of the goodwill impairment test if it is more likely than not that a goodwill impairment exists. In determining whether it is more likely than not that a goodwill impairment exists, an entity must consider whether there are any adverse qualitative factors indicating an impairment may exist. ASU 2010-28 is effective for fiscal years, and interim periods within those years, beginning December 15, 2010.

Business Combinations In December 2010, the FASB issued ASU 2010-29, Business Combinations (Topic 805): Disclosure of Supplementary Pro Forma Information for Business Combinations. ASU 2010-29 requires that if a public entity presents comparative financial statements, the entity should disclose revenue and earnings of the combined entity as though the business combination(s) that occurred during the current year had occurred as of the beginning of the comparable prior annual reporting period only. This ASU also expands the supplemental pro forma adjustments to include a description of the nature and amount of material, nonrecurring pro forma adjustments directly attributable to the business combination included in the reported pro forma revenue and earnings. ASU 2010-29 is effective prospectively for business combinations for which the acquisition date is on or after the first annual reporting period beginning on or after December 15, 2010. The adoption of ASU 2010-29, which will be applied to future acquisitions, will expand existing disclosure requirements.

Fair Value Measurement In May 2011, the FASB issued ASU 2011-04, Fair Value Measurement (Topic 820): Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRS. ASU 2011-04 sets forth common requirements for measuring fair value and for disclosing information about fair value measurements in accordance with U.S. generally accepted accounting principles and International Financial Reporting Standards. ASU 2011-04 is effective prospectively. For public entities, ASU 2011-04 is effective during interim and annual periods beginning after December 15, 2011. The adoption of ASU 2011-04 did not have a material impact on the Company's financial position, results of operations or cash flows.

39--------------------------------------------------------------------------------Comprehensive Income In June 2011, the FASB issued ASU 2011-05, Comprehensive Income (Topic 220): Presentation of Comprehensive Income. ASU 2011-05 states that an entity has the option to present the total of comprehensive income, the components of net income, and the components of other comprehensive income either in a single continuous statement of comprehensive income or in two separate but consecutive statements. In both choices, an entity is required to present each component of net income along with total net income, each component of other comprehensive income along with a total for other comprehensive income, and a total amount for comprehensive income. ASU 2011-05 eliminates the option to present the components of other comprehensive income as part of the statement of changes in stockholders' equity. ASU 2011-05 is effective retrospectively and is effective for fiscal years, and interim periods with those years, beginning after December 15, 2011. The adoption of ASU 2011-05 did not have a material impact on the Company's financial position, results of operations or cash flows. The Company currently presents comprehensive income or loss as a separate statement within its consolidated financial statements.

Intangibles - Goodwill and Other In September 2011, the FASB issued ASU 2011-08, Intangibles - Goodwill and Other (Topic 350): Testing Goodwill for Impairment. ASU 2011-08 permits an entity to first assess qualitative factors to determine whether it is more likely than not that the fair value of a reporting unit is less than its carrying amount as a basis for determining whether it is necessary to perform the two-step goodwill impairment test described in ASC Topic 350. The more-likely-than-not threshold is defined as having a likelihood of more than 50 percent. ASU 2011-08 is effective for annual and interim goodwill impairment tests performed for fiscal years beginning after December 15, 2011. Early adoption is permitted, including for annual and interim goodwill impairment tests performed as of a date before September 15, 2011, if an entity's financial statements for the most recent annual or interim period have not yet been issued. The adoption of ASU 2011-08 is not expected to have a material impact on the Company's financial position, results of operations or cash flows.

In July 2012, the FASB issued ASU 2012-02, Intangibles - Goodwill and Other (Topic 350): Testing Indefinite-Lived Intangible Assets for Impairment. ASU 2012-02 permits an entity to first assess qualitative factors to determine whether the existence of events and circumstances indicates that it is more likely than not that the indefinite-lived intangible asset is impaired. If, after assessing the totality of events and circumstances, an entity concludes that it is not more likely than not that the indefinite-lived intangible asset is impaired, then the entity is not required to take further action. ASU 2012-02 is effective for annual and interim impairment tests performed for fiscal years beginning after September 15, 2012. Early adoption is permitted, including for annual and interim impairment tests performed as of a date before July 27, 2012, if a public entity's financial statements for the most recent annual or interim period have not yet been issued or, for nonpublic entities, have not yet been made available for issuance. The adoption of ASU 2012-02 is not expected to have a material impact on the Company's financial position, results of operations or cash flows.

Offsetting Assets and Liabilities In December 2011, the FASB issued ASU 2011-11, Balance Sheet (Topic 210): Disclosures about Offsetting Assets and Liabilities. ASU 2011-11 requires an entity to disclose information about offsetting and related arrangements to enable users of its financial statements to understand the effect of those arrangements on its financial position. ASU 2011-11 is effective for annual reporting periods beginning on or after January 1, 2013 and interim periods within those annual periods. The adoption of ASU 2011-11 may expand existing disclosure requirements, which the Company is currently evaluating.

40 --------------------------------------------------------------------------------Liquidity and Capital Resources The Company incurred significant operating losses for fiscal 2012 and 2011. In addition, the Company had a working capital deficit at August 31, 2012 and 2011, and is dependent on its line of credit to finance working capital needs. The operating loss for fiscal 2012 was related to non-cash charges and the Company had sufficient cash flow from operations and availability under its line of credit to support all its cash needs in 2012. The operating loss for fiscal 2011 can be attributed primarily to reduced procurement revenues from the Federal business associated with the federal debt and budget crisis in 2011 and certain non-cash charges including a warrant liability adjustment and an earn out liability adjustment. We managed our liquidity in 2011 through a cost reduction initiative that we implemented in the fourth quarter of fiscal 2011 and which continued into fiscal year 2012.

The U.S. government agencies we service are historically slow in making payments of our procurement sales. This delay in payments caused the Company to experience large working capital fluctuations and increased working capital requirements during the periods of peak government deliveries. As a result, at times, we need to pay our vendors more quickly than we receive payments from the government, which leads to increases in our borrowing under our line of credit and a decline in liquidity. Management took steps to improve the liquidity by increasing our long-term borrowings over short-term borrowings. We obtained subordinated financing of $10 million in the fourth quarter of 2011, of which approximately $2 million was used to pay down short-term borrowings under our line of credit. We also obtained subordinated financing of $3 million in December 2011, of which approximately $2.5 million was used to pay down our line of credit. In addition, management is taking further steps to improve the collection process with our government clients. There can be no guarantee, however, that these efforts will be successful.

The Company believes that its existing resources together with available borrowings under its PNC Credit Facility, the annualized cost savings from the cost reduction initiative described above, and expected cash flow from operations will provide sufficient liquidity for at least the next 12 months.

Net cash provided by operations was $1.7 million for the year ended August 31, 2012 as compared to $1.6 million for the year ended August 31, 2011. Although we generated a significant operating net loss for fiscal 2012, this operating loss included a significant amount of non-cash charges totaling $16.6 million, these included depreciation and amortization, deferred income tax benefit, stock-based compensation, earn out liability adjustment, warrant liability adjustment and impairment charges for goodwill and identifiable intangible assets this compares to noncash charges of $4.2 million for the year ended August 31, 2012. In fiscal 2011, the operating losses were also offset by cash flow from working capital changes of approximately $2.2 million.

Net cash paid for acquisitions during fiscal 2012 and 2011 was $-0- and $8.2 million, respectively. Additionally, we made earn out payments of $500,000 during fiscal each of fiscal 2012 and 2011 associated with prior acquisitions. Purchases of property and equipment for fiscal 2012 and 2011 were $800,000 and $2.5 million, respectively. The decrease in purchases for fiscal 2012 was primarily related to the purchase and installation of the Company's new ERP system, totaling approximately $1.7 million, during fiscal 2011.

Net cash used in financing activities for fiscal 2012 was $2.4 million as compared to net cash from financing activities of $11.0 million for fiscal 2011. The large difference between periods is primarily related to the decrease in proceeds from the issuance of subordinated debt and changes in the Company's working capital line of credit. For fiscal 2012, the Company issued $3.0 million of subordinated debt and paid down $5.2 million of its working capital line of credit and $161,000 of its capital lease obligation resulting in a reduction of debt of $2.4 million. In fiscal 2011, the Company issued $10 million of subordinated debt and borrowed $1.2 million from its line of credit and paid down $174,000 of its capital lease obligation, resulting in a debt increase of $11.0 million. In fiscal 2011 the proceeds of the debt increase were used to fund the acquisitions, operating losses, and our SAP implementation.

41 -------------------------------------------------------------------------------- We are a net borrower; consequently, we believe our cash balance must be viewed along with the available balance on our line of credit. Cash at August 31, 2012 of $1.8 million represented a decrease of approximately $2.2 million from cash of $4.0 million at August 31, 2011. This decrease is primarily related to partial repayment of our line of credit.

PNC Credit Facility On December 30, 2011, Emtec NJ, Emtec LLC, Emtec Federal, EGS LLC, Luceo, eBAS, Aveeva, EIS-US, KOAN-IT US, SDI, Dinero, Covelix and Emerging (collectively the "Borrower") entered into a Revolving Credit and Security Agreement (the "PNC Loan Agreement") with PNC Bank, National Association, as lender and agent ("PNC"). The PNC Loan Agreement provides for a senior secured revolving credit facility in an amount not to exceed (i) $30.0 million for period from February 1 through August 31 each year during the term of the facility and (ii) $45.0 million for the period from September 1 through January 31 each year during the term of the facility (the "PNC Credit Facility"). The PNC Credit Facility also includes a $7.0 million sublimit for the issuance of letters of credit. The proceeds of the PNC Credit Facility were used to refinance all of the Borrower's outstanding indebtedness under its then existing senior credit facility with De Lage Landen Financial Services, Inc. ("DLL") pursuant to which DLL provided a revolving credit loan and floorplan loan (the "DLL Credit Facility"), to pay off all indebtedness of EIS-Canada under a loan agreement with De Lage Landen Financial Services Canada Inc. ("DLL Canada") pursuant to which DLL Canada provided EIS-Canada with a revolving credit line of C$5 million, to pay related costs and expenses and for working capital and other general corporate purposes. The PNC Loan Agreement will remain in effect until December 29, 2014, unless sooner terminated by the Borrower or PNC.

On March 20, 2012, the Borrower and EIS -Canada entered into a First Amendment and Joinder to Loan Documents with PNC, pursuant to which PNC agreed to make certain amendments to the PNC Loan Agreement and the Other Documents (as such term is defined in the PNC Loan Agreement and together with the PNC Loan Agreement, the "PNC Loan Documents"), including (1) joining EIS -Canada to the PNC Loan Documents, (2) amending the definition of EBITDA to revise certain add-backs and deductions thereto and (3) revising the covenants and representations and warranties included in the PNC Loan Agreement to include certain customary covenants and representations and warranties relating to EIS -Canada.

As of August 31, 2012, the Company determined it was in compliance with its financial covenants under the PNC Credit Facility.

The Company had a balance of $12.0 million outstanding under the revolving portion of the PNC Credit Facility and $300,000 in letters of credit at August 31, 2012. At August 31, 2011, the Company had a balance of $17.2 million outstanding under the revolving portion of the DLL Credit Facility, and a balance of $1.0 million (included in the Company's accounts payable) outstanding plus $2.2 million in open approvals under the floorplan portion of the DLL Credit Facility. Net availability was $4.2 million under the revolving portion of the PNC Credit Facility as of August 31, 2012 and $4.9 million under the revolving portion of the DLL Credit Facility as of August 31, 2011.

On December 14, 2012, the Borrower entered into a Third Amendment to Loan Documents (the "Third Amendment") with PNC, pursuant to which PNC has agreed to make certain amendments to the PNC Loan Agreement. The modifications provided for in the Third Amendment, among other things, (1) amend the definition of "Formula Amount" to reduce the percentage of outstanding trade letters of credit for inventory purchases used to calculate amounts available for borrowing under the Loan Agreement, (2) amend the definition of "EBITDA" for fiscal quarters ended on or prior to August 31, 2012 to add back intangible asset impairment charges and goodwill impairment charges relating to acquisitions not to exceed $10,000,000 in the aggregate, (3) change the point in time with respect to which the fixed charge ration covenant relating to earn out payments is calculated and (4) provide the consent of PNC and the lenders to a release of a security interest in certain receivables.

42 --------------------------------------------------------------------------------Subordinated Debt On December 30, 2011, the Borrower entered into an Amended and Restated Subordinated Loan Agreement (the "Subordinated Loan Agreement") with Peachtree and NewSpring (collectively the "Investors") pursuant to which: (i) Peachtree provided an additional subordinated term loan in an original principal amount of $3.0 million (ii) NewSpring was appointed as collateral agent, (iii) the Investors waived any event of default arising from (a) the Borrower failing to meet the Total Funded Senior Debt to Pro Forma Adjusted EBITDA Ratio covenant (as set forth in that certain Subordinated Loan Agreement, dated August 15, 2011, between the Borrower and NewSpring (the "Original Subordinated Loan Agreement")) for the trailing twelve months ending November 30, 2011 and (b) the Borrower failing to comply with the covenant in the Original Subordinated Loan Agreement prohibiting a Borrower name change without notice to, or the consent of, NewSpring, and (iv) the Investors agreed to make certain other amendments to the Subordinated Loan Agreement, including amending the Total Funded Senior Debt to Pro Forma Adjusted EBITDA Ratio covenant to provide that the Company and its consolidated subsidiaries shall maintain as of the last business day of the fiscal quarters ending on February 28, 2012 and May 31, 2012, a ratio of Total Funded Senior Debt on such date to Pro Forma Adjusted EBITDA (as such terms are defined in the Subordinated Loan Agreement) on a trailing twelve months basis for such period of not less 4.0 to 1.0 for the fiscal quarter ending on February 28, 2012 and of not less than 3.75 to 1.0 for the fiscal quarter ending on May 31, 2012.

On August 29, 2012, the Borrower entered into Amendment No. 2 (the "Amendment") to the Subordinated Loan Agreement with the Investors, pursuant to which the Investors have agreed to make certain modifications to the Subordinated Loan Agreement.

The modifications provided for in the Amendment, among other things, (1) amend the definition of "Fixed Charge Coverage Ratio" to allow the Borrower to fully offset the amount of cash taxes paid by any tax refunds received, (2) amend and restate the requirements under the financial ratios and covenants in their entirety as follows: (a) require the Borrower to maintain: (i) as of the last Business Day (as defined in the Subordinated Loan Agreement ) of the fiscal quarter ending August 31, 2012, a ratio of Total Funded Senior Debt on such date to Pro Forma Adjusted EBITDA on a trailing 12 months basis for such period of not greater than 4.5 to 1.0, (ii) thereafter as of the last Business Day of each fiscal quarter ending on February 28th, May 31st and August 31st of each fiscal year, a ratio of Total Funded Senior Debt on such date to Pro Forma Adjusted EBITDA on a trailing 12 months basis for such period of not greater than 3.75 to 1.0, (c) eliminate the requirement for the Borrower to test of the last Business Day of each fiscal quarter ending on November 30th of each fiscal year, a ratio of Total Funded Senior Debt on such date to Pro Forma Adjusted EBITDA on a trailing 12 months basis for such period and (d) require the Borrower to maintain, as of the last Business Day of each fiscal quarter on a trailing 12 months basis, a Fixed Charge Coverage Ratio of not less than 1.25 to 1.0.

As of August 31, 2012, the Company has determined it was in compliance with its financial covenants under the Subordinated Loan Agreement with NewSpring and Peachtree.

Capital Expenditures Capital expenditures of approximately $800,000 during the year ended August 31, 2012 related primarily to the purchase of computer equipment for internal use and furniture and fixtures.

In January 2011, we entered into a capital lease for computer equipment and related software with a value of $468,000. The term of the lease is 36 months and the monthly lease payment is $14,000. In March 2012, we entered into a capital lease for computer equipment with a value of $64,000. The term of the lease is 36 months and the monthly lease payment is $2,000.

43 --------------------------------------------------------------------------------Contractual Obligations The following are our long-term contractual obligations for leases, debt and other long-term liabilities as of August 31, 2012.

Payments due by period: (in thousands) Less than 1 More than 5 Contractual Obligations: Total year* 1-3 years 4-5 years years Subordinated Debt $ 13,000 $ - $ - $ 13,000 $ - Operating Lease Obligations 6,704 1,889 2,632 1,304 879 Capital Lease Obligations 274 85 189 - - Contingent Acquisition Liabilities ** 4,821 1,449 3,372 - - Total $ 24,799 $ 3,423 $ 6,193 $ 14,304 $ 879 * This does not include the total PNC Credit Facility in the amount of $12.0 million that is classified as current liability on our consolidated balance sheet at August 31, 2012.

** Recorded in accordance with fair value accounting as of August 31, 2012.

Liquidity We anticipate that our primary sources of liquidity in fiscal year 2013 will be cash generated from operations, trade vendor credit and cash available to us under our PNC Credit Facility. Our future financial performance will depend on our ability to continue to reduce and manage operating expenses as well as our ability to grow revenues. Any loss of clients, whether due to price competition or technological advances, will have an adverse effect on our revenues. Our future financial performance could be negatively affected by unforeseen factors and unplanned expenses. See "Forward Looking Statements" and "Risk Factors." We have no arrangements or other relationships with unconsolidated entities or other persons that are reasonably likely to materially affect liquidity or the availability of or requirements for capital resources.

We believe that funds generated from operations, trade vendor credit and bank borrowings should be sufficient to meet our current operating cash requirements through at least the next twelve months. However, there can be no assurance that all of the aforementioned sources of cash can be realized. Our non-cash expenses, including 2012 write downs, have no effect on the operating cash flows for 2012 or anything Management has mentioned in this analysis on the outlook for 2013. Management believes it has sufficient cash flows to pay down its obligations in 2013, as well as continue with its future growth plans.

Critical Accounting Policies Our financial statements are prepared in accordance with accounting principles that are generally accepted in the U.S. The methods, estimates, and judgments we use in applying our most critical accounting policies have a significant impact on the results we report in our financial statements. The SEC has defined critical accounting policies as policies that involve critical accounting estimates that require (i) management to make assumptions that are highly uncertain at the time the estimate is made, and (ii) different estimates that could have been reasonably used for the current period, or changes in the estimates that are reasonably likely to occur from period to period, which would have a material impact on the presentation of our financial condition, changes in financial condition or in result of operations. Based on this definition, our most critical policies include revenue recognition, business combinations, allowance for doubtful accounts, inventory valuation reserve, the assessment of recoverability of long-lived assets, the assessment of recoverability of goodwill and intangible assets, rebates and income taxes.

44 --------------------------------------------------------------------------------Revenue Recognition We are an IT services provider delivering consulting, staffing, application services and infrastructure solutions to commercial, education, federal, state and local government clients. Our specific practices include IT consulting, communications, data management, enterprise computing, managed services, business service management solutions, training, storage and data center planning and development and staff augmentation solutions.

It is impracticable for us to report the revenues from external clients for each of our products and services or each group of similar products and services offered. Our revenue recognition policy is as follows: Consulting and outsourcing revenue includes time billings based upon billable hours charged to clients, fixed price short-term projects, and hardware maintenance contracts. These contracts generally are task specific and do not involve multiple deliverables. Revenues from time billings are recognized as services are delivered. Revenues from short-term fixed price projects are recognized using the proportionate performance method by determining the level of service performed based upon the amount of labor cost incurred on the project versus the total labor costs to perform the project because this is the most readily reliable measure of output. Revenues from hardware maintenance contracts are recognized ratably over the contract period.

We recognize revenue from the sales of products when risk of loss and title passes, which is upon client acceptance.

Procurement revenue represents sales of computer hardware and pre-packaged software. These arrangements often include software installations, configurations and imaging, along with delivery and set-up of hardware. We follow the criteria contained in FASB Accounting Standards Codification ("ASC") 605-25, Revenue Recognition, Multiple-Element Arrangements, in recognizing revenue associated with these transactions. We perform software installations, configurations and imaging services at our locations prior to the delivery of the product. Some client arrangements include "set-up" services performed at client locations where our personnel perform the routine tasks of removing the equipment from boxes and setting up the equipment at client workstations by plugging in all necessary connections. This service is usually performed the same day as delivery. Revenue is recognized on the date of acceptance, except as follows: · In some instances, the "set-up" service is performed after date of delivery. We recognize revenue for the "hardware" component at date of delivery when the amount of revenue allocable to this component is not contingent upon the completion of "set-up" services and, therefore, our client has agreed that the transaction is complete as to the "hardware" component. In instances where our client does not accept delivery until "set-up" services are completed, we defer all revenue in the transaction until client acceptance occurs.

· There are occasions when a client requests a transaction on a "bill and hold" basis. We follow the ASC 605-25 criteria and recognize revenue from these sales prior to date of physical delivery only when all the criteria of ASC 605-25 are met. We do not modify our normal billing and credit terms for these clients. The client is invoiced at the date of revenue recognition when all of the criteria have been met. Bill and hold transactions were not material for the years ended August 31, 2012 and 2011.

45--------------------------------------------------------------------------------· Revenue is recognized net of client returns. We have experienced minimal client returns. Since some eligible products must be returned to us within 30 days from the date of the invoice, we reduce the procurement revenue and cost of goods in each accounting period based on the actual returns that occurred in the next 30 days after the close of the accounting period.

· We recognize revenue from sale arrangements that contain both procurement revenue and services and consulting revenue in accordance with ASC 605-25 based on the relative fair value of the individual components. The relative fair value of individual components is based on historical sales of the components sold separately.

· Revenues from the sale of third party manufacturer warranties and manufacturer support service contracts where the manufacturer is responsible for fulfilling the service requirements of the client are recognized immediately on their contract sale date. Manufacturer support service contracts contain cancellation privileges that allow our clients to terminate a contract with 90 days' written notice. In this event, the client is entitled to a pro-rated refund based on the remaining term of the contract, and we would owe the manufacturer a pro-rated refund of the cost of the contract. However, we have experienced no client cancellations of any significance during our most recent 3-year history and we do not expect cancellations of any significance in the future. As the Company is not obligated to perform these services, we determined it is more appropriate to recognize the net amount of the revenue and related payments as net revenue at the time of sale, pursuant to the guidelines of ASC 605-45, Revenue Recognition, Principal Agent Considerations.

Revenue from the sale of warranties and support service contracts is recognized on a straight-line basis over the term of the contract, in accordance with ASC 605-20, Revenue Recognition, Services.

Business Combinations The Company follows applicable sections of ASC 805, Business Combinations, which address accounting for business combinations using the acquisition method of accounting (previously referred to as the purchase method). Among the significant changes, this standard requires a redefining of the measurement date of a business combination, expensing direct transaction costs as incurred, capitalizing in-process research and development costs as an intangible asset and recording a liability for contingent consideration at the measurement date with subsequent re-measurements recorded as general and administrative expense. This standard also requires costs for business restructuring and exit activities related to the acquired company to be included in the post-combination financial results of operations and also provides guidance for the recognition and measurement of contingent assets and liabilities in a business combination.

The Company's business acquisitions have historically been made at prices above the fair value of the acquired net assets, resulting in goodwill, based on our expectations of synergies of combining the businesses. These synergies include elimination of redundant facilities, functions and staffing; use of our existing commercial infrastructure to expand sales of the acquired businesses' products; and use of the commercial infrastructure of the acquired businesses to cost-effectively expand procurement sales.

46 -------------------------------------------------------------------------------- Significant judgment is required in estimating the fair value of intangible assets and in assigning their respective useful lives. The fair value estimates are based on available historical information and on future expectations and assumptions deemed reasonable by management, but are inherently uncertain.

The Company generally employs the income method to estimate the fair value of intangible assets, which is based on forecasts of the expected future cash flows attributable to the respective assets. Significant estimates and assumptions inherent in the valuations reflect a consideration of other marketplace participants, and include the amount and timing of future cash flows (including expected growth rates and profitability), the underlying product/service life cycles, economic barriers to entry and the discount rate applied to the cash flows. Unanticipated market or macroeconomic events and circumstances may occur, which could affect the accuracy or validity of the estimates and assumptions.

Allocation of the purchase price for acquisitions is based on estimates of the fair value of the net assets acquired and, for acquisitions completed within the past year, is subject to adjustment upon finalization of the purchase price allocation. The estimated useful lives of the individual categories of intangible assets were based on the nature of the applicable intangible asset and the expected future cash flows to be derived from the intangible asset.

Amortization of intangible assets with finite lives is recognized over the shorter of the respective lives of the agreement or the period of time the assets are expected to contribute to future cash flows. We amortize our finite-lived intangible assets on patterns in which the economic benefits are expected to be realized.

Allowance For Doubtful Accounts We maintain an allowance for doubtful accounts for estimated losses resulting from the inability of our clients to make required payments. We base our estimates on the aging of our accounts receivable balances and our historical write-off experience, net of recoveries. If the financial condition of our clients were to deteriorate, additional allowances may be required. We believe the accounting estimate related to the allowance for doubtful accounts is a "critical accounting estimate" because changes in it can significantly affect net income.

Inventory Valuation Inventory is stated at the lower of average cost or market. Inventory is entirely finished goods purchased for resale and consists of computer hardware, computer software, computer peripherals and related supplies. We provide an inventory reserve for products we determine are obsolete or where salability has deteriorated based on management's review of products and sales.

Long-Lived Assets Long-lived assets, including definite-lived intangible assets and property and equipment, are tested for recoverability whenever events or changes in circumstances indicate that their carrying amount may not be recoverable in accordance with ASC 360, Property, Plant and Equipment. Recoverability of long-lived assets is assessed by a comparison of the carrying amount to the estimated undiscounted future net cash flows expected to result from the use of the assets and their eventual disposition. If estimated undiscounted future net cash flows are less than the carrying amount, the asset is considered impaired and a loss would be recognized based on the amount by which the carrying value exceeds the fair value of the asset.

47 --------------------------------------------------------------------------------Goodwill and Intangible Assets Goodwill represents costs in excess of fair values assigned to the underlying net assets of acquired companies. In accordance with ASC 350, Intangibles - Goodwill and Other, goodwill is not amortized but tested for impairment annually, or more frequently if events or changes in circumstances indicate that the asset might be impaired. The Company has set an annual impairment testing date of June 1. The impairment determination is made at the reporting unit level and consists of two steps. First, the Company determines the fair value of the reporting unit and compares it to its carrying amount. Second, if the carrying amount of the reporting unit exceeds its fair value, an impairment loss is recognized for any excess of the carrying amount of the reporting unit's goodwill over the implied fair value of that goodwill. The implied fair value of goodwill is determined by allocating the fair value of the reporting unit in a manner similar to a purchase price allocation, in accordance with ASC 805, Business Combinations. The residual fair value after this allocation is the implied fair value of the reporting unit goodwill. The Company's policy is to perform its annual impairment testing for all reporting units as of June 1. An impairment charge will be recognized only when the implied fair value of a reporting unit, including goodwill, is less than its carrying amount.

Definite-lived intangible assets are tested for recoverability whenever events or changes in circumstances indicate that their carrying amount may not be recoverable in accordance with ASC 360, Property, Plant and Equipment. Recoverability of definite-lived intangible assets is assessed by a comparison of the carrying amount to the estimated undiscounted future net cash flows expected to result from the use of the assets and their eventual disposition. If estimated undiscounted future net cash flows are less than the carrying amount, the asset is considered impaired and a loss would be recognized based on the amount by which the carrying value exceeds the fair value of the asset.

Rebates Rebates received on purchased products are recorded in the accompanying consolidated statements of operations as a reduction of the cost of revenues, in accordance with ASC 605-50, Revenue Recognition, Customer Payments and Incentives.

Income Taxes Income taxes are accounted for under an asset and liability approach that requires the recognition of deferred tax assets and liabilities for the expected future tax consequences of events that have been recognized in our financial statements or tax returns. In estimating future tax consequences, we generally consider all expected future events other than the enactment of changes in tax laws or rates. A valuation allowance is recognized if, on weight of available evidence, it is more likely than not that some portion or all of the deferred tax assets will not be realized.

Off-Balance Sheet Arrangements We do not have any material off-balance sheet arrangements.

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