Note 2 - General

9 Months Ended

May 31, 2012

Significant Accounting Policies [Text Block]

2.  General

Description of Business

Emtec, Inc., a Delaware corporation (“Emtec”), is an information technology (“IT”) services provider delivering consulting, application services and infrastructure services to public sector and commercial clients.  The Company’s client base is comprised of departments of the United States and Canada’s federal, state/provincial and local governments and schools and commercial businesses throughout the United States and Canada.

Principles of Consolidation

The consolidated financial statements in this report include the accounts of Emtec and its wholly-owned subsidiaries, Emtec, Inc., a New Jersey Corporation (“Emtec NJ”), Emtec Viasub LLC (“Emtec LLC”), Emtec LLC’s wholly-owned subsidiary Emtec Federal, Inc. (“Emtec Federal”), Emtec Global Services LLC (“EGS LLC”), EGS LLC’s wholly-owned subsidiaries Luceo, Inc. (“Luceo”), eBusiness Application Solutions, Inc. (“eBAS”), Aveeva, Inc. (“Aveeva”), Emtec Services Mauritius (“Emtec Mauritius”), Emtec Mauritius’s subsidiary Emtec Software India Private Limited (“Emtec India”) (formerly Aviance Software India Private Limited), Dinero Solutions, LLC (“Dinero”), Covelix, Inc. (“Covelix”), Covelix’s subsidiary Covelix Technologies Private Ltd. (“Covelix India”) and GNUCO, LLC d/b/a Emerging Solutions, LLC (“Emerging”), Emtec Infrastructure Services Corporation (“EIS-US”), and EIS-US’s wholly-owned subsidiaries Emtec Infrastructure Services Canada Corporation (“EIS-Canada”), which is referred to in this report as KOAN-IT, KOAN-IT (US) Corp. (“KOAN-IT (US)”) and Secure Data, Inc. (“SDI”), a subsidiary of Emtec Federal (collectively, the “Company”).   Significant intercompany account balances and transactions have been eliminated in consolidation.

Segment Reporting

The Company divides its operating activity into two operating segments for reporting purposes: Emtec Systems Integration (“ESI”) and Emtec Global Sourcing (“EGS”).  The Company changed the names of these segments in 2010, however historical numbers associated with these segments remain the same.  Our ESI segment provides clients a wide variety of services including outsourced consulting application services and infrastructure consulting and outsourcing.  Our EGS segment provides our clients the opportunity to take advantage of our consulting resources and offshore resources when they are not specifically looking for us to manage their project.  We will continue to reassess our segment reporting structure in accordance with Accounting Standards Codification Topic 280 Segment Reporting.

Reclassifications

Certain reclassifications have been made to prior period balances in order to conform to current presentations.

FASB Accounting Standards Codification and the Hierarchy of Generally Accepted Accounting Principles

The Company identifies the Financial Accounting Standards Board Accounting Standards Codification (“FASB ASC” or “ASC”) as the authoritative source of generally accepted accounting principles in the United States of America (“GAAP”).  Rules and interpretive releases of the SEC under federal securities laws are also sources of authoritative GAAP for SEC registrants.

Accounting Estimates

The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of financial statements and the reported amounts of revenues and expenses during the reporting period, including, but not limited to, receivable valuations, impairment of goodwill and other long-lived assets, income taxes and valuations of put instruments and earnout obligations relating to acquisitions.  Management’s estimates are based on historical experience, facts and circumstances available at the time and various other assumptions that are believed to be reasonable under the circumstances.  The Company reviews these matters and reflects changes in estimates as appropriate.  Actual results could differ materially from those estimates.

Fair Value of Financial Instruments

The fair value of cash and cash equivalents and trade receivables approximates their carrying values due to their short maturities.  The fair value of non-current financial instrument assets and liabilities approximate their carrying value unless otherwise stated.  The carrying value of the PNC Credit Facility approximated its fair value due to its variable interest rate.  In addition, the carrying value of the subordinated debt approximates its fair value as the issuance dates, August 15, 2011 and December 30, 2011, are close in proximity to the May 31, 2012 date of the financial statements.  Furthermore, there have been no changes to the credit markets or the Company’s financial position since the issuance dates that would impact the fair value of the subordinated debt in any material respect.

In accordance with FASB ASC Topic 820 Fair Value Measurement, the estimated fair values of amounts reported in the consolidated financial statements have been determined using available market information and valuation methodologies, as applicable.  Fair value is defined as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date.  Entities are required to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value based upon the following fair value hierarchy:

Level 1 — Quoted prices in active markets for identical assets or liabilities;

Level 2 — Observable inputs other than Level 1 prices, such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities; and

Level 3 — Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities.

The following table summarizes the financial liabilities measured at fair value on a recurring basis as of May 31, 2012 and August 31, 2011 (in thousands):

	Level		May 31, 2012		August 31, 2011
Warrant liability		2	$	2,279	$	1,452
Earn-out liabilities		3	$	4,698	$	4,764

The warrant liabilities were recorded at fair value based on upon valuation models that utilize relevant factors such as expected life, volatility of the Company’s stock price, and the risk free interest rate.

The following table summarizes the changes in earnout liabilities for the nine months ended May 31, 2012 (in thousands):

	Earnout Liabilities
Balance at August 31, 2011	$	4,764
Valuation adjustments		434
Payments		(500	)
Balance at May 31, 2012	$	4,698

The earnout liabilities were recorded at fair value based on valuation models that utilize relevant factors such as expected life and estimated probabilities of the acquired companies achieving the performance targets throughout the earnout periods.  Unobservable inputs used in the valuation of the earnout liabilities included discount rates, ranging from 19% to 21%, and probabilities, ranging from 10% to 95%, associated with the achievement of the earnout targets in future years.

A significant increase (decrease) in the discount rate, in isolation, would result in a significantly lower (higher) fair value measurement, and a significant increase (decrease) in any of the probabilities, in isolation, would result in a significantly higher (lower) fair value measurement.

Financing Costs

Financing costs incurred are amortized over the life of the associated financing arrangements. Amortization expense totaled approximately $97,000 and $-0- for the three months ended May 31, 2012 and 2011, respectively.  During the nine months ended May 31, 2012 and 2011, amortization expense totaled approximately $238,000 and $-0-, respectively.

Goodwill

Goodwill represents costs in excess of fair values assigned to the underlying net assets of acquired companies.  The changes in the carrying amount of goodwill for the nine months ended May 31, 2012 by reportable segment are as follows (in thousands):

	EIS			EGS		Total
Balance at August 31, 2011		16,222			2,386		18,609
Foreign currency translation effect of Canadian goodwill		(56	)		-		(56	)
Adjustment to Covelix goodwill		(94	)		-		(94	)
Adjustment to Dinero goodwill		11			-		11
Balance at May 31, 2012	$	16,083		$	2,386	$	18,470

In accordance with ASC Topic 350 Intangibles - Goodwill and Other, goodwill is not amortized, but rather tested for impairment annually, or more frequently if events or changes in circumstances indicate that the asset might be impaired.  Goodwill is tested for impairment at one level below an operating segment (also known as a reporting unit) in accordance with the guidance of ASC Topic 350. These reporting units are comprised of Systems Division, KOAN-IT, Luceo, eBAS/Aveeva, SDI, Dinero, Covelix and Emerging.  The Company has set an annual impairment testing date of June 1. However, the Company has not yet completed its annual impairment testing as of June 1, 2012.

An impairment charge will be recognized only when the implied fair value of a reporting unit, including goodwill, is less than its carrying amount.  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 Topic 805 Business Combinations.  The residual fair value after this allocation is the implied fair value of the reporting unit goodwill.

The Company’s stock does not trade frequently and thus management believes the inherent value of the Company is not and has not been accurately reflected by the current or historical stock market valuation of the Company.  Accordingly, the Company continues to believe that the income and market-based approaches are the most appropriate valuation methods.

In accordance with ASC Topic 350, the Company performed its annual impairment testing as of June 1, 2011.  Based on this testing and its continued monitoring of market conditions and the operating performance of its reporting units, the Company does not currently believe that there is an indication of goodwill impairment at May 31, 2012.  However, if current market conditions change and the Company’s estimated value(s) under the income and/or market-based approaches is/are affected, then it is possible that the Company could have to take a goodwill impairment charge against earnings in a future period.

Identifiable Intangible Assets

At May 31, 2012 and August 31, 2011, the components of identifiable intangible assets are as follows (in thousands):

	May 31, 2012			August 31, 2011
Customer relationships	$	21,458		$	21,458
Noncompete agreements		2,418			2,418
Software technology		14			14
Trademarks		169			169
Trade names		1,563			1,563
Foreign currency translation adjustment		89			167
		25,711			25,789
Accumulated amortization		(10,198	)		(7,367	)
Foreign currency translation adjustment		(8	)		(16	)
Balance, ending	$	15,505		$	18,406

Customer relationships represent the fair value ascribed to customer relationships purchased from fiscal 2005 through fiscal 2011 through the Company’s acquisitions.  The amounts ascribed to customer relationships are being amortized on a straight-line basis over 5-15 years.

Noncompete agreements represent the value ascribed to covenants not to compete in employment and acquisition agreements entered into with certain members or stockholders of acquired companies.  The amounts ascribed to noncompete agreements are being amortized on a straight-line basis over 3-5 years.

Software technology represents the value ascribed to software developed by an acquired company.  The amount ascribed to software technology is being amortized on a straight-line basis over 3 years.

Trademarks represent the value ascribed to trademarks owned by an acquired company.  The amount ascribed to trademarks is being amortized on a straight-line basis over 5 years.

Trade names represent the value ascribed to trade names owned by various acquired companies.  The amounts ascribed to trade names are being amortized on a straight-line basis over 5 years.

Amortization expense related to intangible assets was $911,000 and $593,000 for the three months ended May 31, 2012 and 2011, respectively.  For the nine months ended May 31, 2012 and 2011, amortization expense was $2.8 million and $1.6 million, respectively.  We currently expect future amortization to be as follows (in thousands):

Years ending August 31,
2012	$	3,688
2013	$	3,640
2014	$	2,991
2015	$	2,860
2016	$	2,413

Long-lived assets, including customer relationships, noncompete agreements, software technology, trademarks and trade names, as well as property and equipment, are tested for recoverability in accordance with ASC Topic 350 Intangibles - Goodwill and Other and ASC Topic 360 Property, Plant and Equipment whenever events or changes in circumstances indicate that their carrying amount may not be recoverable  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.  No impairment of long-lived assets occurred during the three or nine months ended May 31, 2012 or May 31, 2011.

Foreign Currency Translation and Other Comprehensive Income (loss)

The financial statements of the Company’s foreign subsidiaries are translated into U.S. dollars for consolidation and reporting purposes.  The functional currency for the Company’s foreign operations is the local currency.  Current rates of exchange are used to translate assets and liabilities.  Adjustments to translate those statements into U.S. dollars are recorded in accumulated other comprehensive income (loss).

Earnings Per Share

Basic earnings per share amounts are computed by dividing net income available to common stockholders (the numerator) by the weighted average shares outstanding during the period (the denominator).  Shares issued during the period are weighted for the portion of the period that they were outstanding.

The computation of diluted earnings per share is similar to the computation of basic earnings per share, except that the denominator is increased to include the number of additional common shares that would have been outstanding if dilutive options, restricted stock awards and warrants had been exercised as of the end of the period and cash received from the exercise were used to repurchase shares in the open market (the “Treasury Share Method”).  Potentially dilutive shares consist of stock options, restricted stock awards and warrants totaling 2,390,165 shares and 1,706,594 shares for the three month periods ended May 31, 2012 and 2011, respectively, and 3,038,836 shares and 1,382,879 shares for the nine month periods ended May 31, 2012 and  2011, respectively. Diluted shares for the three and nine month periods ended May 31, 2012 and 2011 were not included in the calculation of diluted net loss per share because the effect of the inclusion would be anti-dilutive. In addition, outstanding warrants to purchase 1,401,733 and 1,401,733 common shares as of May 31, 2012 and 2011, respectively, were not included in the computation of diluted earnings per share because the exercise price was greater than the average market price of the Company’s common shares over those periods.

Income Taxes

The Company conducts business in the United States, Canada and India.  With respect to its U.S. operations, the Company files income tax returns in the U.S. federal jurisdiction and various state and local jurisdictions.  The Company accounts for income taxes in accordance with ASC Topic 740 Income Taxes.  The Company files a federal consolidated tax return that includes all U.S. entities.  The Company also files several combined/consolidated state tax returns and several separate state tax returns.  Deferred taxes result from temporary differences, which are the differences between the financial reporting and tax bases of assets and liabilities.  Deferred tax assets are recognized for tax loss carryforwards.  Deferred tax assets are reduced by a valuation allowance when, in the opinion of management, it is more likely than not that some portion or all of the deferred tax assets will not be realized.  Deferred tax assets and liabilities are adjusted for the effects of changes in tax laws and rates on the date of enactment.  Deferred taxes result from timing differences primarily relating to net operating losses, bad debts, inventory reserves, deferred revenue, fixed asset depreciation, compensation expenses and intangible asset amortization.

With a few exceptions, the Company is no longer subject to federal, state or local income tax examinations for tax returns filed for fiscal years 2008 and prior.

Reconciliation of liabilities for unrecognized tax benefits for the nine months ended May 31, 2012 and 2011 (in thousands) are as follows:

	2012		2011
Balance at September 1, 2011 and 2010	$	197	$	212
Unrecognized tax positions of prior periods:
Increase		-		-
Decrease		-		-
Unrecognized tax positions for the three months:
Increase		-		1
Decrease		-		-
Decrease in Unrecognized tax benefits due to settlements		-		-
Decrease in Unrecognized tax benefits due to lapse of statute of limitations		-		-
Balance at May 31, 2012 and 2011	$	197	$	213

	For the Nine Months Ended May 31,
	2012		2011
Total amount of unrecognized tax benefits that, if recognized, would affect the effective tax rate	$	86	$	97
Accrued interest and penalties for unrecognized tax benefits	$	128	$	117
Interest and penalties classified as income tax expense	$	16	$	17