UNITED
STATES


SECURITIES
AND EXCHANGE COMMISSION


WASHINGTON,
DC 20549









FORM
10-Q





QUARTERLY
REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
1934





For the
quarterly period ended February 28, 2010




Commission
file number: 0-32789




EMTEC,
INC.


(Exact
name of registrant as specified in its charter)




Delaware
                (State
      of incorporation or organization)
              87-0273300
                (I.R.S.
      Employer Identification
                No.)





525
Lincoln Drive


5
Greentree Center, Suite 117


Marlton,
New Jersey 08053


(Address
of principal executive offices, including zip code)





(856)
552-4204


(Registrant’s
telephone number, including area code)




Indicate
by check mark whether the registrant: (1) has filed all reports required to
be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.   Yes  x    No   ̈




Indicate
by check mark whether the registrant has submitted electronically and posted on
its corporate Website, if any, every Interactive Data File required to be
submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this
chapter) during the preceding 12 months (or for such shorter period that the
registrant was required to submit and post such files).
Yes    ̈   No   ̈




Indicate
by check mark whether the registrant is a large accelerated filer, an
accelerated filer, a non-accelerated filer or a smaller reporting company (see
the definitions of “large accelerated filer,” “accelerated filer,” and “smaller
reporting company” in Rule 12b-2 of the Exchange Act).  (Check
one)




Large
accelerated filer  ̈  Accelerated
filer   ̈  Non-accelerated
filer   ̈  Smaller
reporting company  x




Indicate
by check mark whether the registrant is a shell company (as defined in
Rule 12b-2 of the Exchange Act). Yes  ̈No x




As of April
5, 2010, there were outstanding 15,742,431 shares of the registrant’s common
stock.








EMTEC,
INC.


FORM
10-Q FOR THE QUARTER ENDED FEBRUARY 28, 2010




Table of
Contents




PART
      I – FINANCIAL INFORMATIONItem
      1 - Financial StatementsCondensed
      Consolidated Balance Sheets
                    1Condensed
      Consolidated Statements of Operations
                    2Condensed
      Consolidated Statements of Cash Flows
                    3Notes
      to Condensed Consolidated Financial Statements
                    4Item
      2  - Management’s Discussion and Analysis of Financial Condition
      and Results of Operations
                    22Item
      3  - Quantitative and Qualitative Disclosures About Market
      Risk
                    49Item
      4T - Controls and Procedures
                    50PART
      II – OTHER INFORMATIONItem
      1 – Legal Proceedings
                    51Item
      4 – Submission of Matters to a Vote by Securities Holders
                    52Item
      6 – Exhibits
                    53SIGNATURES
                    54







PART
I – FINANCIAL INFORMATION


Item
1.          Financial
Statements





EMTEC, INC. AND SUBSIDIARIES


CONDENSED
CONSOLIDATED BALANCE SHEETS


(In
Thousands, Except per Share and Share Data)





February 28, 2010(Unaudited)
                                              
                                              
                                              August 31, 2009AssetsCurrent
      AssetsCash
                                              
                                              $
                                              2,808
                                              
                                              
                                              $
                                              1,713Receivables:Trade,
      less allowance for doubtful accounts
                                              
                                              
                                              20,500
                                              
                                              
                                              
                                              29,463Other
                                              
                                              
                                              2,765
                                              
                                              
                                              
                                              2,184Inventories,
      net
                                              
                                              
                                              3,118
                                              
                                              
                                              
                                              4,410Prepaid
      expenses and other
                                              
                                              
                                              2,871
                                              
                                              
                                              
                                              2,184Deferred
      tax asset - current
                                              
                                              
                                              804
                                              
                                              
                                              
                                              680Total
      current assets
                                              
                                              
                                              32,866
                                              
                                              
                                              
                                              40,634Property
      and equipment, net
                                              
                                              
                                              1,290
                                              
                                              
                                              
                                              1,390Intangible
      assets, net
                                              
                                              
                                              10,467
                                              
                                              
                                              
                                              11,235Goodwill
                                              
                                              
                                              11,446
                                              
                                              
                                              
                                              11,424Deferred
      tax asset- long term
                                              
                                              
                                              427
                                              
                                              
                                              
                                              459Other
      assets
                                              
                                              
                                              128
                                              
                                              
                                              
                                              131Total
      assets
                                              
                                              $
                                              56,624
                                              
                                              
                                              $
                                              65,273Liabilities
      and Stockholders' EquityCurrent
      LiabilitiesLine
      of credit
                                              
                                              $
                                              10,616
                                              
                                              
                                              $
                                              9,035Accounts
      payable
                                              
                                              
                                              17,076
                                              
                                              
                                              
                                              25,390Current
      portion of long term debt - related party
                                              
                                              
                                              170
                                              
                                              
                                              
                                              1,213Income
      taxes payable
                                              
                                              
                                              32
                                              
                                              
                                              
                                              590Accrued
      liabilities
                                              
                                              
                                              5,666
                                              
                                              
                                              
                                              6,723Deferred
      revenue
                                              
                                              
                                              2,125
                                              
                                              
                                              
                                              2,103Total
      current liabilities
                                              
                                              
                                              35,685
                                              
                                              
                                              
                                              45,054Deferred
      tax liability- long term
                                              
                                              
                                              2,653
                                              
                                              
                                              
                                              2,816Accrued
      liabilities
                                              
                                              
                                              178
                                              
                                              
                                              
                                              180Total
      liabilities
                                              
                                              
                                              38,516
                                              
                                              
                                              
                                              48,050Commitments
      and contingenciesStockholders'
      EquityCommon
      stock $0.01 par value; 25,000,000 shares authorized;18,607,020
      and 18,059,679 shares issued and 15,742,431 and
15,195,090,outstanding
      at  February 28, 2010 and August 31, 2009,
      respectively
                                              
                                              
                                              186
                                              
                                              
                                              
                                              181Additional
      paid-in capital
                                              
                                              
                                              21,063
                                              
                                              
                                              
                                              20,794Retained
      earnings
                                              
                                              
                                              2,228
                                              
                                              
                                              
                                              1,671Accumulated
      other comprehensive income
                                              
                                              
                                              227
                                              
                                              
                                              
                                              17323,704
                                              
                                              
                                              
                                              22,819Less:
      treasury stock, at cost, 2,864,589 shares
                                              
                                              
                                              (5,596
                                              )
                                              
                                              
                                              (5,596
                                              )Total
      stockholders' equity
                                              
                                              
                                              18,108
                                              
                                              
                                              
                                              17,223Total
      liabilities and stockholders' equity
                                              
                                              $
                                              56,624
                                              
                                              
                                              $
                                              65,273





The
accompanying notes are integral parts of these consolidated financial
statements.


1





EMTEC,
INC. AND SUBSIDIARIES


CONDENSED
CONSOLIDATED STATEMENTS OF OPERATIONS


(Unaudited)


(In
Thousands, Except per Share and Share Data)





For the Three Months Ended February 28,
                
                
                For the Six Months Ended February 28,2010
                
                
                2009
                
                
                2010
                
                
                2009RevenuesProcurement
      services
                
                $
                23,275
                
                
                $
                29,414
                
                
                $
                82,657
                
                
                $
                85,773Service
      and consulting
                
                
                12,828
                
                
                
                12,547
                
                
                
                27,023
                
                
                
                26,208Total
      Revenues
                
                
                36,103
                
                
                
                41,961
                
                
                
                109,680
                
                
                
                111,981Cost
      of SalesCost
      of procurement services
                
                
                21,036
                
                
                
                26,371
                
                
                
                74,209
                
                
                
                76,763Service
      and consulting
                
                
                9,165
                
                
                
                9,464
                
                
                
                19,025
                
                
                
                20,297Total
      Cost of Sales
                
                
                30,201
                
                
                
                35,835
                
                
                
                93,234
                
                
                
                97,060Gross
      ProfitProcurement
      services
                
                
                2,239
                
                
                
                3,043
                
                
                
                8,448
                
                
                
                9,010Service
      and consulting
                
                
                3,663
                
                
                
                3,083
                
                
                
                7,998
                
                
                
                5,911Total
      Gross Profit
                
                
                5,902
                
                
                
                6,126
                
                
                
                16,446
                
                
                
                14,921Operating
      expenses:Selling,
      general, and administrative expenses
                
                
                6,441
                
                
                
                5,758
                
                
                
                13,719
                
                
                
                11,936Rent
      expense – related parties
                
                
                157
                
                
                
                152
                
                
                
                311
                
                
                
                305Depreciation
      and amortization
                
                
                571
                
                
                
                568
                
                
                
                1,167
                
                
                
                1,102Total
      operating expenses
                
                
                7,169
                
                
                
                6,478
                
                
                
                15,197
                
                
                
                13,343Operating
      income (loss)
                
                
                (1,267
                )
                
                
                (352
                )
                
                
                1,249
                
                
                
                1,578Other
      expense (income):Interest
      income – other
                
                
                (5
                )
                
                
                (6
                )
                
                
                (16
                )
                
                
                (11
                )Interest
      expense
                
                
                159
                
                
                
                270
                
                
                
                303
                
                
                
                524Other
      expense
                
                
                (2
                )
                
                
                -
                
                
                
                (9
                )
                
                
                4Income
      (loss) before income taxes
                
                
                (1,419
                )
                
                
                (616
                )
                
                
                971
                
                
                
                1,061Provision
      for income taxes
                
                
                (569
                )
                
                
                (231
                )
                
                
                413
                
                
                
                440Net
      income (loss)
                
                $
                (850
                )
                
                $
                (385
                )
                
                $
                558
                
                
                $
                621Net
      income (loss) per common shareBasic
      and Diluted
                
                $
                (0.06
                )
                
                $
                (0.03
                )
                
                $
                0.04
                
                
                $
                0.04Weighted
      Average Shares OutstandingBasic
                
                
                15,027,140
                
                
                
                14,629,231
                
                
                
                15,027,140
                
                
                
                14,629,231Diluted
                
                
                15,424,322
                
                
                
                14,629,231
                
                
                
                15,252,454
                
                
                
                14,788,619





The
accompanying notes are integral parts of these consolidated financial
statements.


2





EMTEC,
INC. AND SUBSIDIARIES


CONDENSED
CONSOLIDATED STATEMENTS OF CASH FLOWS


(Unaudited)


(In
Thousands)





For the Six Months Ended February 28,2010
                
                
                2009Cash
      Flows From Operating ActivitiesNet
      income
                
                $
                558
                
                
                $
                621Adjustments
      to Reconcile Net Income to NetCash
      Used In Operating ActivitiesDepreciation
      and amortization
                
                
                345
                
                
                
                402Amortization
      related to intangible assets
                
                
                822
                
                
                
                700Deferred
      income taxes (benefit)
                
                
                (271
                )
                
                
                (162
                )Stock-based
      compensation
                
                
                274
                
                
                
                84Indemnification
      of professional fees
                
                
                -
                
                
                
                (270
                )Changes
      In Operating Assets and LiabilitiesReceivables
                
                
                8,414
                
                
                
                6,721Inventories
                
                
                1,291
                
                
                
                (956
                )Prepaid
      expenses and other assets
                
                
                (653
                )
                
                
                185Accounts
      payable
                
                
                (8,317
                )
                
                
                (7,737
                )Income
      taxes payable
                
                
                (558
                )
                
                
                9Accrued
      liabilities
                
                
                (1,131
                )
                
                
                293Deferred
      revenue
                
                
                (14
                )
                
                
                (313
                )Net
      Cash Provided By (Used In) Operating Activities
                
                
                760
                
                
                
                (423
                )Cash
      Flows From Investing ActivitiesPurchases
      of property and equipment
                
                
                (251
                )
                
                
                (315
                )Acquisition
      of businesses, net of cash acquired
                
                
                -
                
                
                
                (897
                )Goodwill/
      tax settlement
                
                
                -
                
                
                
                (165
                )Net
      Cash Used In Investing Activities
                
                
                (251
                )
                
                
                (1,377
                )Cash
      Flows From Financing ActivitiesNet
      increase  in line of credit
                
                
                1,581
                
                
                
                3,402Repayment
      of debt
                
                
                (1,059
                )
                
                
                (474
                )Net
      Cash Provided By Financing Activities
                
                
                522
                
                
                
                2,928Effect
      of rate changes on cash
                
                
                64
                
                
                
                (51
                )Net
      Increase in Cash
                
                
                1,095
                
                
                
                1,077Beginning
      Cash
                
                
                1,713
                
                
                
                2,025Ending
      Cash
                
                $
                2,808
                
                
                $
                3,102Supplemental
      Disclosure of Cash Flow InformationCash
      paid during the period for:Income
      taxes
                
                $
                1,141
                
                
                $
                209Interest
                
                $
                206
                
                
                $
                146Supplemental
      Schedule of Non Cash Investing and Financing ActivitiesIndemnification
      receivable due from former shareholders settled by the amounts due to
      former shareholders
                
                $
                -
                
                
                $
                631





The
accompanying notes are integral parts of these consolidated financial
statements.


3





EMTEC,
INC


NOTES
TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS





1.  Basis
of Presentation





The
accompanying unaudited condensed consolidated financial statements have been
prepared in accordance with generally accepted accounting principles for interim
financial information and with the instructions to Form 10-Q and Article 8 of
Regulation S-X. Accordingly, they do not include all of the information and note
disclosures required by accounting principles generally accepted in the United
States of America for complete financial statements. In the opinion of
management, all adjustments (consisting of normal recurring adjustments)
considered necessary for a fair presentation have been included in the
accompanying unaudited condensed consolidated financial
statements.  Quarterly results are not necessarily indicative of
results for the full year.For
further information, refer to the annual financial statements and notes thereto
included in the Company's Annual Report on Form 10-K for the fiscal year ended
August 31, 2009.





2.  General





Description of
Business





Emtec,
Inc. a Delaware corporation (the “Company”) established in 1964, is a systems
integrator providing information technology (“IT”) services and products to the
federal, state, local, education and commercial markets. Emtec helps clients
identify and prioritize areas for improvement and then implement process,
technology and business application improvements that reduce cost, improve
service and align the delivery of IT with the needs of their organization. 
The Company’s value-based management methods, coupled with IT technology,
consulting and development services, allow us to address a wide range of
specific client needs, as well as support broader IT transformation
initiatives.  The Company’s client base is comprised of departments of
federal, state and local governments in the United States and Canada, schools
and commercial businesses throughout the United States and
Canada.




Principles of
Consolidation





The
consolidated financial statements include the accounts of the Company 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”), EGS’
wholly-owned subsidiaries Luceo, Inc. (“Luceo”), eBusiness Application
Solutions, Inc. (“eBAS”), Aveeva, Inc. (“Aveeva”), Emtec Services Mauritius
(“Emtec Mauritius”), and Emtec Mauritius’s subsidiary Emtec Software India
Private Limited (“Emtec India”), formerly Aviance Software India Private Limited
(“Aviance”), 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, and KOAN-IT (US)
Corp. (“KOAN-IT (US)”). Significant intercompany account balances and
transactions have been eliminated in consolidation.


4




Segment
Reporting





The
Company divides its operating activity into two operating segments for reporting
purposes: Emtec Infrastructure Services Division (“EIS”) and Emtec Global
Services Division (“EGS”). EIS consists of the Company’s historical business
(“Systems Division”) which includes Emtec NJ, Emtec LLC, Emtec Federal and the
business service management solutions offered by the Information Technology
Service Management (“ITSM”) practice. EGS is the Company’s enterprise
applications services solutions and training business including its Enterprise
Resource Planning (“ERP”) and Application Development practice and its Business
Analysis and Quality Assurance Practice.




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 and inventory
valuations, impairment of goodwill and other long-lived assets and income
taxes.  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.





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 six months ended February 28, 2010, by reportable segments are as
follows (in thousands):





EIS
                    
                    
                    EGS
                    
                    
                    TotalBalance
      at August 31, 2009
                    
                    $
                    9,683
                    
                    
                    $
                    1,741
                    
                    
                    $
                    11,424Foreign
      currency translation effect of Canadian goodwill
                    
                    
                    22
                    
                    
                    
                    -
                    
                    
                    
                    22Balance
      at February 28, 2010
                    
                    $
                    9,705
                    
                    
                    $
                    1,741
                    
                    
                    $
                    11,446





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.  Goodwill is
tested for impairment at one level below an operating segment (also known as a
component) in accordance with the guidance of FASB ASC Topic 350. These
reporting units are comprised of Systems Division, KOAN-IT, Luceo and
eBAS/Aveeva.The Company has set an annual impairment testing
date 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.  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.


5





The
following table presents a summary of the Company’s goodwill by reporting unit
at February 28, 2010, as well as critical assumptions used in the valuation of
the reporting units at June 1, 2009, the Company’s annual testing
date:





GoodwillYears of Cash Flow % By Which Reporting UnitDiscount
                            
                            
                            Terminal
                            
                            
                            before Terminal
                            
                            
                            Fair Value Exceeds itsReporting Unit
                            
                            $'000
                            
                            
                            % of total
                            
                            
                            Rate
                            
                            
                            Growth Rate
                            
                            
                            Value
                            
                            
                            Carrying Value*Systems
      Division
                            
                            
                            8,817
                            
                            
                            
                            77.0
                            %
                            
                            
                            15.6
                            %
                            
                            
                            4.0
                            %
                            
                            
                            10
                            
                            
                            
                            68.8
                            %Luceo
                            
                            
                            1,671
                            
                            
                            
                            14.6
                            %
                            
                            
                            17.5
                            %
                            
                            
                            4.0
                            %
                            
                            
                            10
                            
                            
                            
                            992.3
                            %eBAS/Aveeva
                            
                            
                            70
                            
                            
                            
                            0.6
                            %
                            
                            
                            17.1
                            %
                            
                            
                            4.0
                            
                            
                            
                            10
                            
                            
                            
                            887.7
                            %KOAN-IT
                            
                            
                            888
                            
                            
                            
                            7.8
                            %
                            
                            
                            17.5
                            %
                            
                            
                            4.0
                            %
                            
                            
                            10
                            
                            
                            
                            4652.0
                            %Total
                            
                            
                            11,446
                            
                            
                            
                            100.0
                            %





*
As of June 1, 2009





At the
last annual impairment testing date of June 1, 2009, the Company’s market
capitalization was less than its carrying value.  Since the Company’s
stock does not trade frequently and with the stock price being volatile,
management believes that other valuation methods are more appropriate to reflect
the fair value of the Company.  Accordingly, the Company determined
the fair value of its Systems Division reporting unit using an equally weighted
combination of the discounted cash flow and guideline company valuation
approaches.  For the Company’s remaining reporting units (Luceo,
eBAS/Aveeva and KOAN-IT), fair value was determined using the discounted cash
flow valuation approach, as in the Company’s opinion, this method currently
results in the most accurate calculation of fair value for these reporting
units.    The rationale for relying solely on one valuation
approach for these reporting units was that these reporting units were all
acquired by the Company within the last two years (as of August 31, 2009) and
have relatively brief operating histories from which to base a comparison to
publicly traded companies under the guideline company valuation
approach.





Determining
the fair value of a reporting unit requires judgment and the use of significant
estimates and assumptions. Such estimates and assumptions include revenue growth
rates, operating margins, discount rates, weighted average costs of capital and
views on future market conditions, among others. We believe that the estimates
and assumptions used in our impairment assessments are reasonable and based on
available market information, but variations in any of the assumptions could
result in materially different calculations of fair value and determinations of
whether or not an impairment is indicated. As part of this analysis, the Company
engaged an external valuation firm to review and validate the Company’s
impairment analysis to value its goodwill.





Under the
discounted cash flow method, the Company determined fair value based on the
estimated future cash flows of each reporting unit, discounted to present value
using risk-adjusted  discount rates, which reflect the overall level
of inherent risk of a reporting unit and the rate of return an outside investor
would expect to earn. Cash flow projections are derived from budgeted amounts
and operating forecasts (typically a five-year model) plus an estimate of later
period cash flows, all of which are developed by the Company. Subsequent period
cash flows are developed for each reporting unit using growth rates that the
Company believes are reasonably likely to occur along with a terminal value
derived from the reporting unit’s earnings before interest, taxes, depreciation
and amortization (“EBITDA”).


6




Under the
guideline company approach, the Company determined the estimated fair value of
its Systems Division by comparison to prices paid for similar companies. The
search for guideline companies began with examination of reporting public
companies, which were in similar businesses as the Systems Division. From this
list, we identified companies that were similar to the Systems Division business
characteristics with regard to product offerings, services performed, growth
rates, profitability and size in terms of assets held and volume of
sales.   This approach to value is based on the premise that
prices paid for the stock of one company can provide an indication of what a
willing buyer would pay for the stock of another company sharing similar
characteristics.  More specifically, this approach involves
establishing relationships between the price for shares of similar public
companies and certain benchmarks such as revenues, earnings, earnings before
interest and taxes (“EBIT”) and EBITDA, net income or book value.  In
valuing the Systems Division, the Company utilized the multiples of market value
of capital (“MVC”) divided by revenue and MVC/EBITDA of the selected guideline
companies.  These multiples were applied to the System Division’s
operating results for the twelve months ended May 31, 2009 in order to derive a
fair value under the guideline company approach.





One of
the key assumptions in the five-year budgets, which are the basis of the
discounted cash flow approach, is the projected revenue growth of each reporting
unit.   For each reporting unit, the Company has based its
estimate of projected revenue growth on forecasted revenue growth on a
macro-level (IT industry and overall US economy) and micro-level (purchasing
patterns for specific customers).  For other assumptions in the
five-year forecasts, the Company projected gross profit margins at close to
historical levels, investments in variable selling and management overhead costs
to support revenue growth and increased fixed operating costs at the rate of
inflation.  To the extent forecasted revenue is not met for a
reporting unit, the Company still has the ability to achieve forecasted
profitability (EBITDA) by controlling its cost structure.  Annual
revenue growth for each reporting unit is forecasted to be at a higher level in
the initial five-year operating forecast and is gradually decreased to the
terminal value growth rate for the remaining years under the cash flow
approach.





Key
assumptions in the discounted cash flow approach include the discount rate and
terminal growth rate.  The discount rate, which is specific to each
reporting unit and is used to determine the present value of future debt-free
net cash flow stream, is a blended rate combining required rates of return on
debt and equity instruments with comparable risk characteristics. Using such a
blended rate appropriately reflects the cost of the debt and equity investment
forming the capital of an enterprise, whereas the terminal growth rate at the
end of the discrete projection period is determined by using the Constant Growth
Valuation Model.  The Constant Growth Valuation Model is based on the
assumption that the specific reporting unit will undergo a steady long-term rate
of growth in earnings and that the investor purchasing the business has a
required rate of return he is willing to accept for his
investment.  It assumes a continuing growth in cash flow per annum
into perpetuity (consistent with expected real annual growth rate of Gross
Domestic Product (“GDP”) plus inflation for the foreseeable
future).





In order
to assess the reasonability of its five year budgets, the Company has compared
actual to forecasted operating results for each reporting unit from the date of
the last impairment test (June 1, 2009) through February 28, 2010. On a
reporting unit level, there were some unfavorable variances in actual versus
forecasted results.  However, the Company believes that these
unfavorable variances would not result in a goodwill
impairment.


7





The
Company also examined the sensitivity of the fair values of its Systems Division
reporting unit by reviewing other scenarios relative to the initial assumptions
it used to see if the resulting impact on fair value would have resulted in a
different step one conclusion.  Accordingly, the Company performed
sensitivity analyses based on a more conservative annual revenue growth in years
1–5 of the discounted cash flow approach.  In the first sensitivity
analysis, the Company lowered the revenue growth in years 1- 5 of the discounted
cash flow approach by one-third (holding all other critical assumptions
constant), while in the second sensitivity analysis; the Company lowered the
revenue growth by two-thirds in years 1–5 of the discounted cash flow approach
(holding all other critical assumptions constant).  None of the
outcomes of the sensitivity analyses performed impacted the Company’s step one
conclusion.  It should be noted that Company did not perform
sensitivity analyses on the other reporting units given the relative value of
goodwill and the percentage of the reporting unit’s fair value that was in
excess of its carrying value.





While the
Company has determined the estimated fair values of its reporting units to be
appropriate based on the forecasted level of revenue growth, net income and cash
flows, in the current market environment it is a reasonable possibility that one
of our reporting units may become impaired in future periods as there can be no
assurance that the Company’s estimates and assumptions made for purposes of its
goodwill impairment testing as of June 1, 2009 will prove to be accurate
predictions of the future. Our use of the term "reasonable possibility" refers
to a potential occurrence that is more than remote, but less than probable in
the Company’s judgment. If the Company’s assumptions, including forecasted
revenue growth rates are not achieved, the Company may be required to record
goodwill impairment charges in future periods, whether in connection with our
next annual impairment testing on June 1, 2010 or prior to that, if any
such change constitutes a triggering event outside of the quarter from when the
annual goodwill impairment test is performed.  Potential events and/or
changes in circumstances that could reasonably be expected to negatively impact
the key assumptions and affect the recovery of our goodwill
include:




·
            The
      Company’s revenues are derived from a few major clients, the loss of any
      of which could cause its results of operations to be adversely
      affected.A large portion of the Company’s revenues are
      drawn from various civilian and military U.S. governmental departments and
      agencies and local school districts. The following factors could have a
      material negative impact on the Company’s
  business.




o
            seasonality
      of federal government and education related business makes future
      financial results less predictable;
and




o
            due
      to its dependence on governments and local school districts demand for IT
      products, a material decline in overall sales to the government as a
      whole, or to a certain key agency thereof, and/or the education sector
      could have a material adverse effect on its results of
      operations.




·
            The
      Company’s success in increasing the portion of its revenues derived from
      IT services and consulting.  If the Company is unsuccessful, it
      future results may be adversely affected.The Company’s
      transition from an emphasis on IT product sales to an emphasis on
      providing IT services and consulting has placed significant demands on its
      managerial, administrative and operational resources.  The
      Company’s ability to manage this transition effectively is dependent upon
      its ability to develop and improve operational, financial, and other
      internal systems, as well as its business development capabilities, and to
      attract, train, retain, motivate and manage our employees.  If
      the Company is unable to do so, it ability to effectively deliver and
      support its services may be adversely
affected.


8





·
            The
      Company’s inability to maintain high personnel-utilization rates may
      adversely impact its profit.The most significant cost
      relating to the services component of the Company’s business is personnel
      expense, which consists of salaries, benefits and payroll related
      expenses.  Thus, the financial performance of the Company’s
      service business is based primarily upon billing margins (billable hourly
      rates less the costs to us of service personnel on an hourly basis) and
      utilization rates (billable hours divided by paid hours).  The
      future success of the services component of the Company’s business will
      depend in large part upon our ability to maintain high utilization rates
      at profitable billing margins.





·
              The
      Company’s revenues and expenses are unpredictable. A decrease in revenues
      or increase in expenses could materially adversely affect its operating
      results.The Company’s operating results have been, and
      will continue to be, impacted by changes in technical personnel billing
      and utilization rates.  Moreover, the Company expects that
      downward pricing pressure will persist due to the continued
      commoditization of computer products.  Further, there are
      numerous other factors, which are not within the Company’s control that
      can contribute to fluctuations in our operating results, including the
      following:


o
            patterns
      of capital spending by clients;




o
            the
      timing, size, and mix of product and service orders and
      deliveries;




o
            the
      timing and size of new projects, including projects for new clients;
      and




o
            changes
      in trends affecting the outsourcing of IT
  services.




At
February 28, 2010, Emtec's market capitalization was greater than its total
stockholders' equity. However, the Company’s stock does not trade frequently and
thus management believes the inherent value of the Company is 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.




The
Company does not currently believe that there is an indication of goodwill
impairment at February 28, 2010.  However, if current market
conditions change and the Company’s estimated value under the income and
market-based approaches is affected, then it is possible that the Company may
have to take a goodwill impairment charge against earnings in a future
period.





Identifiable Intangible
Assets





At
February 28, 2010 and August 31, 2009, the components of identifiable intangible
assets are as follows (in thousands):





February 28, 2010
                    
                    
                    August 31, 2009Customer
      relationships
                    
                    $
                    14,098
                    
                    
                    $
                    14,098Noncompete
      agreements
                    
                    
                    398
                    
                    
                    
                    398Trademarks
                    
                    
                    169
                    
                    
                    
                    169Foreign
      currency translation adjustment
                    
                    
                    54
                    
                    
                    
                    -14,719
                    
                    
                    
                    14,665Accumulated
      amortization
                    
                    
                    (4,247
                    )
                    
                    
                    (3,430
                    )Foreign
      currency translation adjustment
                    
                    
                    (5
                    )
                    
                    
                    -Balance,
      ending
                    
                    $
                    10,467
                    
                    
                    $
                    11,235


9


Customer
relationships represent the fair value ascribed to customer relationships
purchased in 2005, the acquisitions of Luceo and eBAS/Aveeva in fiscal 2008 and
the acquisition of KOAN-IT in February 2009.  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 with certain members of Luceo, eBAS/Aveeva
and KOAN-IT’s management entered into at the time of the respective
acquisitions.  The amounts ascribed to noncompete agreements are being
amortized on a straight-line basis over 5 years.





Trademarks
represent the value ascribed to trade name and trademarks owned by
KOAN-IT.  The amounts ascribed to trademarks are being amortized on a
straight-line basis over 5 years.





Amortization
expense related to intangible assets was $414,000 and $355,000, for the three
months ended February 28, 2010 and 2009 respectively, and $822,000 and $700,000
for the six months ended February 28, 2010 and 2009, respectively.  We
currently expect future amortization for the next four years ending August 31,
2010 through 2013 will be approximately $1.6 million per year and for the fiscal
year ending 2014 will be approximately $937,000.





Long-lived
assets, including customer relationships 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 350
“Intangibles- Goodwill and Other” and 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.  No impairment of long-lived assets occurred
during six months ended February 28, 2010 or 2009.





Foreign Currency Translation
and Other Comprehensive Income (loss)





The
financial statements of the Company’s foreign subsidiaries are remeasured 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 remeasure assets and
liabilities.  Adjustments to translate those statements into U.S.
dollars are recorded in accumulated other comprehensive income
(loss).





The
Company’s comprehensive income (loss) (in thousands) is presented in the
following table:





For the Three Months Ended February 28,
                  
                  
                  For the Six Months Ended February 28,2010
                  
                  
                  2009
                  
                  
                  2010
                  
                  
                  2009Net
      Income (loss)
                  
                  $
                  (850
                  )
                  
                  $
                  (385
                  )
                  
                  $
                  558
                  
                  
                  $
                  621Cumulative
      translation adjustment, net of taxes
                  
                  
                  9
                  
                  
                  
                  (37
                  )
                  
                  
                  54
                  
                  
                  
                  (37
                  )Total
      comprehensive income (loss)
                  
                  $
                  (841
                  )
                  
                  $
                  (422
                  )
                  
                  $
                  612
                  
                  
                  $
                  584





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
(the denominator), during the period. Shares issued during the period are
weighted for the portion of the period that they were
outstanding.


10





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. Potentially dilutive shares consist of stock options, restricted
stock awards and warrants totaling 397,182 and 219,842, for the three months
ended February 2010 and 2009, respectively, and 225,314 and 159,388 for the six
months ended February 28, 2010 and 2009, respectively. Diluted shares for the
three months ended February 28, 2010 and 2009 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 1,749,159
and 1,676,069 common shares as of and for the periods ended February 28, 2010
and 2009, 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 and Due to
Former Stockholders





The
Company accounts for income taxes in accordance with ASC 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 are provided based upon a review of the tax
basis of assets and liabilities, whereby deferred tax assets and liabilities are
recognized for temporary differences.  Temporary differences are the
differences between the reported amounts of assets and liabilities and their tax
basis.  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 bad debts, inventory reserves, deferred revenue, fixed asset
depreciation, compensation expenses and intangible asset
amortization.





In
October 2008, the Company settled the August 2003 and April 2004 tax audits of
Emtec Federal, formerly known as Westwood Computer Corporation (“Westwood”),
with the Appeals Office of the IRS.  The settlement agreement resulted in
an additional federal income tax payment of $145,000, which included interest of
$41,000.  The Company has filed 2003 and 2004 amended New Jersey income tax
returns to pay additional New Jersey taxes that resulted from the IRS
settlement.  The accounting to record the settlements of these pre-merger
tax liabilities under ASC 740 resulted in adjustments to goodwill and to
deferred tax assets.  Since the Westwood merger agreement included
indemnification coverage by Westwood’s former stockholders, the Company recorded
a receivable “due from the Westwood former stockholders” of $631,000.  The
$631,000 included pre-merger tax liabilities totaling $361,000 plus associated
professional fees to defend the Company’s tax positions totaling $270,000. 
The $361,000 portion of the Company’s indemnity claim was recorded as a
reduction to goodwill acquired in the April 2004 Westwood merger.  The
remaining $270,000 portion was recorded as a reduction to selling, general and
administrative expenses during the three months ended November 30,
2008.





The “due
from Westwood former stockholders” receivable was satisfied during October 2008,
based on offsetting amounts “due to Westwood former stockholders” totaling
$631,000.  The amounts “due to Westwood former stockholders” represented
funds we held as unclaimed merger consideration.


11





We
conduct business nationally and, as a result, file income tax returns in the U.S
federal jurisdiction and various state and local jurisdictions. With a few
exceptions, we are no longer subject to federal, state or local income tax
examinations for tax returns filed for fiscal years 2005 and prior.





Reconciliation
of Liabilities for Unrecognized Tax Benefits for the six months ended February
28, 2010 and 2009 (in thousands) are as follows:





Balance
      at September 1, 2009 and 2008
                  
                  $
                  202
                  
                  
                  $
                  693Unrecognized
      tax positions of prior periods:Increase
                  
                  
                  -
                  
                  
                  
                  -Decrease
                  
                  
                  -
                  
                  
                  
                  -Unrecognized
      tax positions of current year:Increase
                  
                  
                  2
                  
                  
                  
                  6Decrease
                  
                  
                  -
                  
                  
                  
                  -Decrease
      in Unrecognized tax benefits due to settlements
                  
                  
                  -
                  
                  
                  
                  (547
                  )Decrease
      in Unrecognized tax benefits due to lapse ofstatute
      of limitations
                  
                  
                  -
                  
                  
                  
                  -Balance
      at February 28, 2010 and 2009
                  
                  $
                  204
                  
                  
                  $
                  152





For the Six Months Ended,February 28, 2010
                  
                  
                  February 28, 2009Total
      amount of unrecognized tax benefits that, if recognized, would affect the
      effective tax rate
                  
                  $
                  91
                  
                  
                  $
                  53Accrued
      interest and penalties for unrecognized tax benefits
                  
                  $
                  89
                  
                  
                  $
                  67Interest
      and penalties classified as income tax expense (benefit)
                  
                  $
                  11
                  
                  
                  $
                  (35
                  )




Subsequent
Events





ASC 855
“Subsequent Events” establishes general standards of accounting for and
disclosure of events that occur after the balance sheet date but before
financial statements are issued.  The pronouncement provides: (a) the
period after the balance sheet date during which management of a reporting
entity should evaluate events or transactions that may occur for potential
recognition or disclosure in the financial statements; (b) the circumstances
under which an entity should recognize events or transactions occurring after
the balance sheet date in its financial statements; and (c) the disclosures that
an entity should make about events or transactions that occurred after the
balance sheet date. From February to April 2010, management assessed the
likelihood that procurement services revenue from  commercial clients
would grow and examined the profitability and investment required to grow these
revenues.  In April 2010, management implemented a restructuring of
its commercial procurement services business. Management believes the effect of
this restructuring will be to reduce costs of up to $2.0 million annually. The
cost estimates for the restructuring have not been finalized but are estimated
to be up to $150,000.  However, management is now focusing its efforts
on attracting talent to our higher gross margin consulting practices in the
commercial sector, which may off-set cost these containment savings in future
periods.  Management has evaluated subsequent events and has
determined that no other recognized and non-recognized subsequent events
warranted inclusion or disclosure in the interim financial statements as of
February 28, 2010.


12





3.
Acquisitions





Enterprise
Management Solutions, Inc.





On May
12, 2009, KOAN-IT (US) acquired certain assets of EMS, a company under Chapter
11 bankruptcy protection in the Middle District of Florida.  The
purchase price consisted of $150,000 cash at closing. Additionally, the Company
capitalized professional fees of $108,000 that were associated with the
acquisition of the assets of EMS.  The acquisition was funded through
borrowings under the Credit Facility with the Lender (as these terms are defined
in Note 6 below).





KOAN-IT
Corp.





On
February 12, 2009, EIS Canada, EIS-US, KOAN-IT and the shareholders of KOAN-IT
(the “Shareholders”) entered into a Share Purchase Agreement pursuant to which
(i) EIS-Canada acquired all of the outstanding stock of KOAN-IT from the
Shareholders and (ii) EIS- US acquired all of the outstanding stock of KOAN-IT
(US), from KOAN-IT for an aggregate consideration of up to approximately $3.3
million.  The purchase price consisted of (i) cash at closing in an
aggregate amount equal to $1.2 million (consisting of $1.2 million for the
outstanding stock of KOAN-IT and $20,000 for the outstanding stock of KOAN-IT
(US)), (ii) unsecured subordinated 6% promissory notes issued to each of the
Shareholders in an aggregate principal amount of $408,000 payable in full on the
12 month anniversary of the closing and (iii) the potential right to receive
additional cash consideration each year for the next three years on the
anniversary of the closing, in the aggregate totaling $1.6 million if certain
performance goals are met. The payment on the promissory notes was paid in full
on the 12-month anniversary of the closing. As per the Share Purchase Agreement,
the Company is obligated to deliver its calculation of contingent payments for
the first year anniversary of closing to the former shareholders of KOAN-IT by
May 15, 2010. The Company is currently in the process of calculating contingent
payments for the first year anniversary closing.





eBusiness
Applications Solutions, Inc. and Aveeva, Inc.





On August
13, 2008, EGS, a wholly-owned subsidiary of Emtec, eBAS, Aveeva and Ms. Jessica
Chopra (“Ms. Chopra”) entered into a Purchase Agreement, pursuant to which EGS
agreed to acquire all of the outstanding stock of eBAS and Aveeva from Ms.
Chopra. The purchase price consists of (i) cash at closing in an aggregate
amount equal to $7.3 million and (ii) the potential obligation to pay contingent
consideration of $1.0 million each year for three years on the anniversary of
the closing if certain performance goals are met. There were no contingent
payments of additional cash consideration owed for the first year anniversary of
closing.





Luceo,
Inc.





On March
20, 2008, EGS, Luceo and Mr. Sivapatham Natarajan (“Mr. Natarajan”) entered into
a Stock Purchase Agreement pursuant to which EGS acquired all of the outstanding
stock of Luceo from Mr. Natarajan for a purchase price that consisted of (i)
cash at closing in an aggregate amount equal to $1.8 million; (ii) a
subordinated promissory note in a principal amount of $820,000 which was payable
in two equal installments of $410,000 each on the 12 month and 18 month
anniversaries of the closing and (iii) contingent payments of additional cash
consideration each year for three years on the anniversary of the closing if
certain performance goals are met. During the year ended August 31, 2008, the
purchase price was reduced by $68,000 in connection with the working capital
adjustment. The payments on the promissory note were paid in full on its due
dates. There were no contingent payments of additional cash consideration owed
for the first year anniversary. The Company is currently in the process of
calculating the contingent payment of additional cash for the second year’s
anniversary that ended on March 31, 2010.


13





To the
extent performance targets are achieved for the above referenced acquisitions of
Luceo, eBAS/Aveeva and KOAN-IT on future anniversary dates, the Company will
treat contingent payments as additional purchase price and increase goodwill.
This treatment is supported by the factors discussed in FASB Codification
805-10-55, formerly SFAS 141 and EITF 95-8.





4.  Stock-Based
Compensation




Stock
Options




An
amendment to the Company’s 2006 Stock-Based Incentive Compensation Plan (the
“2006 Plan”) was approved by the Company’s stockholders on February 2, 2009. The
2006 Plan authorizes the granting of stock options to directors and eligible
employees. The amendment increased the aggregate number of shares of Common
Stock available under the 2006 Plan from 1,400,000 shares to 2,543,207 shares
eligible for issuance at prices not less than 100% of the fair value of the
Company’s common stock on the date of grant (110% in the case of stockholders
owning more than 10% of the Company’s common stock). Options under the 2006 Plan
have terms from 7 to 10 years and certain options vest immediately and others
through a term up to 4 years.




The
Company measures the fair value of options on the grant date using the
Black-Scholes option valuation model.  The Company estimated the
expected volatility using the Company’s historical stock price data over the
expected term of the stock options.  The Company also used historical
exercise patterns and forfeiture behaviors to estimate the options, expected
term and our forfeiture rate.  The risk-free interest rate is based on
the U.S. Treasury zero-coupon yield curve in effect on the grant
date.  Both expected volatility and the risk-free interest rate are
based on a period that approximates the expected term.




A summary
of stock options for the six months ended February 28, 2010 is as
follows:




For the Six Months Ended February 28, 2010
                                    
                                    Shares
                                    
                                    
                                    Weighted Average
                                      Exercise Price
                                    
                                    Weighted Average
                                      Remaining Term
                                    
                                    Aggregate Intrinsic
                                      Value *Options
      Outstanding -September 1, 2009
                                    
                                    
                                    359,500
                                    
                                    
                                    $
                                    1.15Options
      Granted
                                    
                                    
                                    13,333
                                    
                                    
                                    $
                                    0.97Options
      Exercised
                                    
                                    
                                    -
                                    
                                    
                                    
                                    -Options
      Forfeited or Expired
                                    
                                    
                                    (1,000
                                    )
                                    
                                    $
                                    1.31Options
      Outstanding - February 28, 2010
                                    
                                    
                                    371,833
                                    
                                    
                                    $
                                    1.14
                                    
                                    5.41
      years
                                    
                                    $
                                    33,025Options
      Exercisable - February 28, 2010
                                    
                                    
                                    327,418
                                    
                                    
                                    $
                                    1.12
                                    
                                    5.62
      years
                                    
                                    $
                                    33,025




*
Represents the total pre-tax intrinsic value based on the Company’s average
closing stock prices for the six months ended February 28, 2010.




There
were no stock options issued during the three months ended November 30, 2009 and
13,333 stock options issued during the three months ended February 28, 2010. The
following assumptions were used to value stock options issued during the three
months ended February 28, 2010:


14





2010Weighted-Average
      Fair Value
                      
                      $
                      0.67AssumptionsExpected
      Volatility
                      
                      
                      87.86
                      %Expected
      Term
                      
                      5
      yearsExpected
      Forfeiture Rate
                      
                      
                      0
                      %Dividend
      Yield
                      
                      
                      0
                      %Risk-Free
      Interest Rate
                      
                      
                      2.01
                      %




Nonvested Stock (Restricted
Stock)




The
following table summarizes the Company’s restricted stock activity during the
six months ended February 28, 2010:




For the Six Months Ended February 28, 2010
                      
                      Shares
                      
                      
                      Weighted Average Grant
                        Date Fair Value
                      
                      
                      Fair ValueNonvested
      - September 1, 2009
                      
                      
                      565,859
                      
                      
                      $
                      0.72Granted
                      
                      
                      547,341
                      
                      
                      $
                      0.98Vested
                      
                      
                      (397,909
                      )
                      
                      $
                      0.72
                      
                      
                      $
                      393,514
                      (a)Forfeited
                      
                      
                      -
                      
                      
                      
                      -Nonvested
      - November 30, 2009
                      
                      
                      715,291
                      
                      
                      $
                      0.92
                      
                      
                      $
                      965,643
                      (b)




(a)
            The
      fair value of vested restricted stock shares represents the total pre-tax
      fair value, based on the closing stock price on the day of vesting, which
      would have been received by holders of restricted stock shares had all
      such holders sold their underlying shares on that
  date.




(b)
            The
      aggregate fair value of the nonvested restricted stock shares expected to
      vest represents the total pre-tax fair value, based on the Company’s
      closing stock price as of February 28,  2010 which would have
      been received by holders of restricted stock shares had all such holders
      sold their underlying shares on that
date.




The fair
value of these shares was determined based upon the quoted closing price of the
Company’s stock on the Over-the-Counter Bulletin Board on the grant
date.  The Company recognizes compensation expense associated with the
issuance of such shares using the closing price of the Company’s common stock on
the date of grant over the vesting period on a straight-line basis.




Stock Options and Nonvested
Stock




Stock-based
compensation costs related to the 2006 Plan totaled $188,512 and $41,597, for
the three months ended February 28, 2010 and 2009, respectively, and $274,415
and $83,772 for the six months ended February 28, 2010 and 2009,
respectively.  As of February 28, 2010, the Company had recognized a
total of $1.15 million in compensation costs and had $461,000 of unrecognized
compensation cost related to the 2006 Plan.  The cost is expected to
be recognized over a remaining period of 3 years.


15





5.  Warrants




On August
5, 2005, the Company issued certain stockholders stock warrants that evidence
the obligation of the Company to issue a variable number of shares, in the
aggregate, equal to 10% of then total issued and outstanding shares of the
Company’s common stock, measured on a post-exercise basis, at any date during
the 5-year term of the warrants, which ends August 5, 2010.  The aggregate
exercise price of these warrants is fixed at $3.7 million. The exercise price
per warrant will vary based upon the number of shares issuable under the
warrants. The number of shares issuable under the warrants totaled 1,749,151 and
1,676,069 shares, with an exercise price of $2.11 and $2.21 per share, as of
February 28, 2010 and February 28, 2009, respectively. The outstanding
warrants were anti-dilutive for the six months ended February 28, 2010 and
February 29, 2009 because the exercise price was greater than the average market
price of the Company’s common shares.




Effective
as of September 1, 2009, the Company adopted FASB Accounting Standards
Codification, which includes the applicable authoritative literature relating to
the recording and disclosure of warrants, formerly included in EITF 07-05,
“Determining Whether an Instrument (or Embedded Feature) Is Indexed to an
Entity’s Own Stock”. The adoption of these standards related to the above
mentioned warrants was not recorded in the financial statements because the
Company determined that the impact was not material.





6.  Line
of Credit




The
Company, Emtec NJ, Emtec LLC, Emtec Federal, Emtec Global, Luceo, eBAS, and
Aveeva (collectively, the “Borrower”), have a Loan and Security Agreement with
De Lage Landen Financial Services, Inc. (the “Lender”) pursuant to which the
Lender provides the Borrower with a revolving credit loan and floor plan loan
(the “Credit Facility”). The Credit Facility provides for aggregate borrowings
of the lesser of $32.0 million or 85% of Borrower’s eligible accounts
receivable, plus 100% of unsold inventory financed by the Lender. The floor plan
loan portion of the Credit Facility is for the purchase of inventory from
approved vendors and for other business purposes. The Credit Facility subjects
the Borrower to mandatory repayments upon the occurrence of certain events as
set forth in the Credit Facility.




On
December 5, 2008, the Borrower entered into a First Amendment and Joinder to
Loan and Security Agreement and Schedule to Loan and Security Agreement (the
“First Amendment”) with the Lender, pursuant to which the Lender extended the
term of the loans issued to the Borrower under the Loan and Security Agreement
from December 7, 2008 until December 7, 2010 and made certain other amendments
to the Loan and Security Agreement, including the following:





§
            The
      First Amendment changed the base rate of interest to the three month (90
      day) LIBOR rate from the previous base rate of the “Prime
      Rate.”





§
            The
      First Amendment changed the interest rate for revolving credit loans to
      the base rate plus 3.25% from the previous interest rate for revolving
      credit loans which was the base rate minus 0.5%, and changed the interest
      rate for floorplan loans, if applicable, to 6.25% in excess of the base
      rate from the previous interest rate for floorplan loans of 2.5% in excess
      of the base rate.




16


§
            The
      First Amendment amended the Schedule to provide that the Borrower must pay
      the Lender a floorplan annual volume commitment fee if the aggregate
      amount of all floorplan loans does not equal or exceed $60.0 million in a
      12 month period from December 1st through November 30th.  The
      floorplan commitment fee is equal to the amount that the floorplan usage
      during such 12 month period is less than $60.0 million multiplied by
      1%.  If the Borrower terminates the Credit Facility during a 12
      month period, the Borrower shall be required to pay the Lender a prorated
      portion of the annual volume commitment fee.  For the period
      from December 1, 2008 through November 30, 2009, the Company’s floorplan
      volume was approximately $30.0 million. The Company has total accrual of
      $300,000 in commitment fees as interest payable on the consolidated
      financial statements of which, approximately $280,000 was expensed during
      the year ended August 31, 2009 and approximately $20,000 was expensed in
      three months ended November 30,
2009.




The
Company had balances of $10.6 million and $9.0 million outstanding under the
revolving portion of the Credit Facility, and balances of $929,000 and $5.4
million (included in the Company’s accounts payable) outstanding plus $578,000
and $321,000 in open approvals under the floor plan portion of the Credit
Facility at February 28, 2010 and August 31, 2009, respectively. Net
availability was $4.3 million and $11.9 million under the revolving portion of
the Credit Facility, and additionally $15.6 million and $5.4 million was
available under the floor plan portion of the Credit Facility as of February 28,
2010 and August 31, 2009, respectively.




As of
February 28, 2010, the Company determined that it was in compliance with its
financial covenants under the Credit Facility.




7.  Concentration
of Credit Risk




Financial
instruments that potentially subject the Company to a concentration of credit
risk consist principally of accounts receivable.




The
Company’s revenues, by client type, consist of the following (in
thousands):





For the Three Months EndedFebruary 28, 2010
                    
                    
                    February 28 2009Departments
      of the U.S. Government
                    
                    $
                    15,514
                    
                    
                    
                    43.0
                    %
                    
                    $
                    11,244
                    
                    
                    
                    26.9
                    %Canada
      Government Agencies
                    
                    
                    372
                    
                    
                    
                    1.0
                    %
                    
                    
                    -
                    
                    
                    
                    0.0
                    %State
      and Local Governments
                    
                    
                    1,079
                    
                    
                    
                    3.0
                    %
                    
                    
                    1,949
                    
                    
                    
                    4.6
                    %Commercial
      Companies
                    
                    
                    11,886
                    
                    
                    
                    32.9
                    %
                    
                    
                    17,980
                    
                    
                    
                    42.8
                    %Education
      and other
                    
                    
                    7,252
                    
                    
                    
                    20.1
                    %
                    
                    
                    10,788
                    
                    
                    
                    25.7
                    %Total
      Revenues
                    
                    $
                    36,103
                    
                    
                    
                    100.0
                    %
                    
                    $
                    41,961
                    
                    
                    
                    100.0
                    %





For the Six Months EndedFebruary 28, 2010
                    
                    
                    February 28 2009Departments
      of the U.S. Government
                    
                    $
                    56,914
                    
                    
                    
                    51.9
                    %
                    
                    $
                    51,440
                    
                    
                    
                    46.0
                    %Canada
      Government Agencies
                    
                    
                    721
                    
                    
                    
                    0.7
                    %
                    
                    
                    -
                    
                    
                    
                    0.0
                    %State
      and Local Governments
                    
                    
                    2,136
                    
                    
                    
                    1.9
                    %
                    
                    
                    4,945
                    
                    
                    
                    4.4
                    %Commercial
      Companies
                    
                    
                    25,485
                    
                    
                    
                    23.2
                    %
                    
                    
                    34,739
                    
                    
                    
                    31.0
                    %Education
      and other
                    
                    
                    24,424
                    
                    
                    
                    22.3
                    %
                    
                    
                    20,857
                    
                    
                    
                    18.6
                    %Total
      Revenues
                    
                    $
                    109,680
                    
                    
                    
                    100.0
                    %
                    
                    $
                    111,981
                    
                    
                    
                    100.0
                    %





The
Company reviews a client's credit history before extending
credit.  The Company does not require collateral or other security to
support credit sales. The Company provides an allowance for doubtful accounts
based on the credit risk of specific clients, historical experience and other
identified risks. Trade receivables are carried at original invoice less an
estimate made for doubtful receivables, based on review by management of all
outstanding amounts on a periodic basis.  Trade receivables are
considered delinquent when payment is not received within standard terms of
sale, and are charged-off against the allowance for doubtful accounts when
management determines that recovery is unlikely and ceases its collection
efforts.


17





The trade
account receivables consist of the following (in thousands):





February 28,
                    
                    
                    August 31,2010
                    
                    
                    2009Trade
      receivables
                    
                    $
                    20,938
                    
                    
                    $
                    29,767Allowance
      for doubtful accounts
                    
                    
                    (438
                    )
                    
                    
                    (304
                    )Trade
      receivables, net
                    
                    $
                    20,500
                    
                    
                    $
                    29,463





Trade
receivables include $1.2 million and $1.5 million of unbilled revenue as of
February 28, 2010 and August 31, 2009, respectively.





Major
Customers





Sales to
one school district accounted for approximately $4.6 million or 15.5% of the
Company’s total revenues for three months ended February 28, 2010. The same
customer accounted for approximately $4.2 million or 10.0% of the Company’s
total revenues for the three months ended February 29, 2009.





Sales to
one  school district and to a department of the United States
Government accounted for approximately $15.5 million or 14.3% and $11.3 million
or 10.4% of the Company’s total revenues for the six months ended February 28,
2010, respectively.  The same customers accounted for approximately
$13.2 million or 11.7% and $744,000 or 0.7% of the Company’s total revenues for
the six months ended February 28, 2009, respectively.





Trade
receivables due from one school district and a department of the U.S. Government
accounted for approximately 9.6% and 6.8%, respectively, of the Company’s trade
receivables as of February 28, 2010. The same clients accounted for
approximately 14.4% and 21.4%, respectively of the Company’s trade receivable as
of August 31, 2009.




8.  Accrued
Liabilities




At
February 28, 2010 and August 31, 2009, accrued liabilities consisted of the
following (in thousands):




February 28, 2010
                      
                      
                      August 31, 2009Accrued
      payroll
                      
                      $
                      2,158
                      
                      
                      $
                      2,559Accrued
      commissions
                      
                      
                      352
                      
                      
                      
                      586Accrued
      state sales taxes
                      
                      
                      44
                      
                      
                      
                      74Accrued
      third-party service fees
                      
                      
                      72
                      
                      
                      
                      72Other
      accrued expenses
                      
                      
                      3,040
                      
                      
                      
                      3,432$
                      5,666
                      
                      
                      $
                      6,723




18




9.
            Long-Term
      Debt




At
February 28, 2010 and August 31, 2009, the Company’s long-term debt consisted of
the following (in thousands):




February 28,
                        
                        
                        August 31,2010
                        
                        
                        20095%
      subordinated note payable to DARR Global Holdings, Inc.
                        
                        $
                        170
                        
                        
                        $
                        3458%
      subordinated note payable to Mr. Siva Natarajan
                        
                        
                        -
                        
                        
                        
                        4106%
      subordinated note payable to Former Shareholders of
KOAN-IT
                        
                        
                        -
                        
                        
                        
                        458Total
      debt
                        
                        
                        170
                        
                        
                        
                        1,213Less
      current portion
                        
                        
                        (170
                        )
                        
                        
                        (1,213
                        )Long-term
      debt, net of current portion
                        
                        $
                        -
                        
                        
                        $
                        -




10.
            Related
      Party Transactions





One of
the Company’s facilities is leased under a non-cancelable operating lease
agreement with an entity that is owned by a former director and current
officer of the Company and their related family members. During the three months
ended February 28, 2010 and 2009, the Company recorded expense under this lease
totaling $52,000 and $45,000, respectively. During the six months ended February
28, 2010 and 2009, the Company recorded expense under this lease totaling
$103,000 and $90,000, respectively The facilities consist of office and
warehouse space totaling 42,480 square feet located in Springfield, New
Jersey.




The
Company is occupying approximately 36,000 square feet of office and warehouse
space in a 70,000 square-foot building in Suwannee, GA. This space is leased
from GS&T Properties, LLC, in which an officer of the Company is a passive
investor with an approximately 10% equity interest. The current lease term is
through November 2014 with monthly rent of $21,000. During the three months
ended February 28, 2010 and 2009, the Company recorded expense under this lease
totaling $50,000 and $47,000, respectively. During the six months ended February
28, 2010 and 2009, the Company recorded expense under this lease totaling
$100,000 and $94,000, respectively.





In
conjunction with the acquisition of eBAS/Aveeva, the Company entered into a
lease for approximately 20,000 square feet of office space in Fremont,
California.  This space is leased from the spouse of an officer of
eBAS/Aveeva.  The lease term is through August 31, 2011 with a monthly
rent of $20,000. In March 2009, the Company subleased a portion of the building
for a monthly rent of $3,000 on a month-to-month basis, which was terminated
effective February 1, 2010. During the three months ended February 28, 2010
and 2009, the Company recorded expense under this lease totaling $55,000 and
$60,000, respectively. During the six months ended February 28, 2010 and 2009,
the Company recorded expense under this lease totaling $108,000 and $121,000,
respectively.





Management
believes the lease payments referenced above are at or below market lease rates
for similar facilities.


19


11.
            Legal
      Proceedings





During
December 2007, the Company received a subpoena issued by the GSA Office of
Inspector General (“OIG”), apparently as part of an ongoing, industry-wide
investigation.  The Company produced documents and data in response to the
subpoena to the OIG during 2008.  In September 2009, the Company became
aware that it had been named along with several other prominent IT companies in
a qui tam lawsuit entitled Christopher Crennen, et al., v. Dell
Marketing, et al., filed in the United States District Court for the
District of Massachusetts alleging violations of the False Claims Act relating
to the Company's obligations under the Buy American Act and the Trade Agreements
Act.





Qui tam
lawsuits typically remain under seal (hence, usually unknown to the defendant)
for some time while the government decides whether or not to intervene on behalf
of a private qui tam plaintiff (known as a relator) and take the lead in the
litigation.  These lawsuits can involve significant monetary damages and
penalties and award bounties to private plaintiffs who successfully bring the
suits.  The lawsuit, which was previously under seal, appears to have been
the cause of the OIG subpoena.





To date,
the government has declined to intervene in the lawsuit, however the Company can
provide no assurance that the government will not intervene in this case or in
any other qui tam suit against the Company in the future.   The
Company does not know whether the relator(s) will pursue the qui tam lawsuit
independently.  The Company has filed a motion to dismiss the
lawsuit.  At this time, the Company is unable to predict the timing
and outcome of this matter.





12.
            Segment
      Information





The
Company provides segment financial information in accordance with ASC 280,
“Segment Reporting.”  The Company’s business activities are divided into
two business segments, EIS and EGS. EIS consists of the Systems Division,
which includes Emtec NJ, Emtec LLC, Emtec Federal and the business service
management solutions offered by the ITSM practice. EGS is the Company’s
enterprise applications services solutions and training business including its
ERP and Application Development practice and its Business Analysis and Quality
Assurance Practice.  The accounting policies of our segments are the
same as those described in Note 2 and there are no material intersegment
transactions. Summarized financial information relating to the Company’s
operating segments is as follows (in thousands):




(Unaudited)February
      28 ,
                                
                                
                                August
      31,2010
                                
                                
                                2009Identifiable
      Assets:EIS
                                
                                $
                                43,801
                                
                                
                                $
                                51,586EGS
                                
                                
                                12,823
                                
                                
                                
                                13,687Total
      Assets
                                
                                $
                                56,624
                                
                                
                                $
                                65,273


20




For
      the Three Months Ended
                                                                            
                                                                            
                                                                            For
      the Six Months EndedFebruary
      28,
                                                                            
                                                                            
                                                                            February
      28,(Unaudited)
                                                                            
                                                                            
                                                                            (Unaudited)2010
                                                                            
                                                                            
                                                                            2009
                                                                            
                                                                            
                                                                            2010
                                                                            
                                                                            
                                                                            2009RevenuesEIS
                                                                            
                                                                            $
                                                                            29,179
                                                                            
                                                                            
                                                                            $
                                                                            33,297
                                                                            
                                                                            
                                                                            $
                                                                            95,009
                                                                            
                                                                            
                                                                            $
                                                                            92,603EGS
                                                                            
                                                                            
                                                                            6,924
                                                                            
                                                                            
                                                                            
                                                                            8,664
                                                                            
                                                                            
                                                                            
                                                                            14,671
                                                                            
                                                                            
                                                                            
                                                                            19,378Total
      Revenue
                                                                            
                                                                            $
                                                                            36,103
                                                                            
                                                                            
                                                                            $
                                                                            41,961
                                                                            
                                                                            
                                                                            $
                                                                            109,680
                                                                            
                                                                            
                                                                            $
                                                                            111,981Gross
      ProfitEIS
                                                                            
                                                                            $
                                                                            4,708
                                                                            
                                                                            
                                                                            $
                                                                            4,512
                                                                            
                                                                            
                                                                            $
                                                                            13,882
                                                                            
                                                                            
                                                                            $
                                                                            11,199EGS
                                                                            
                                                                            
                                                                            1,194
                                                                            
                                                                            
                                                                            
                                                                            1,614
                                                                            
                                                                            
                                                                            
                                                                            2,564
                                                                            
                                                                            
                                                                            
                                                                            3,722Gross
      Profit
                                                                            
                                                                            $
                                                                            5,902
                                                                            
                                                                            
                                                                            $
                                                                            6,126
                                                                            
                                                                            
                                                                            $
                                                                            16,446
                                                                            
                                                                            
                                                                            $
                                                                            14,921Depreciation
      and amortizationEIS
                                                                            
                                                                            $
                                                                            342
                                                                            
                                                                            
                                                                            $
                                                                            350
                                                                            
                                                                            
                                                                            $
                                                                            711
                                                                            
                                                                            
                                                                            $
                                                                            675EGS
                                                                            
                                                                            
                                                                            229
                                                                            
                                                                            
                                                                            
                                                                            218
                                                                            
                                                                            
                                                                            
                                                                            456
                                                                            
                                                                            
                                                                            
                                                                            427Depreciation
      and amortization
                                                                            
                                                                            $
                                                                            571
                                                                            
                                                                            
                                                                            $
                                                                            568
                                                                            
                                                                            
                                                                            $
                                                                            1,167
                                                                            
                                                                            
                                                                            $
                                                                            1,102Operating
      Income (loss)EIS
                                                                            
                                                                            $
                                                                            (1,173
                                                                            )
                                                                            
                                                                            $
                                                                            (632
                                                                            )
                                                                            
                                                                            $
                                                                            1,237
                                                                            
                                                                            
                                                                            $
                                                                            568EGS
                                                                            
                                                                            
                                                                            (94
                                                                            )
                                                                            
                                                                            
                                                                            280
                                                                            
                                                                            
                                                                            
                                                                            12
                                                                            
                                                                            
                                                                            
                                                                            1,010Operating
      Income (loss)
                                                                            
                                                                            $
                                                                            (1,267
                                                                            )
                                                                            
                                                                            $
                                                                            (352
                                                                            )
                                                                            
                                                                            $
                                                                            1,249
                                                                            
                                                                            
                                                                            $
                                                                            1,578Interest
      and Other Expense (Income)EIS
                                                                            
                                                                            $
                                                                            99
                                                                            
                                                                            
                                                                            $
                                                                            156
                                                                            
                                                                            
                                                                            $
                                                                            170
                                                                            
                                                                            
                                                                            $
                                                                            290EGS
                                                                            
                                                                            
                                                                            53
                                                                            
                                                                            
                                                                            
                                                                            108
                                                                            
                                                                            
                                                                            
                                                                            108
                                                                            
                                                                            
                                                                            
                                                                            227Interest
      and Other Expense (Income)
                                                                            
                                                                            $
                                                                            152
                                                                            
                                                                            
                                                                            $
                                                                            264
                                                                            
                                                                            
                                                                            $
                                                                            278
                                                                            
                                                                            
                                                                            $
                                                                            517Provision
      for Income TaxesEIS
                                                                            
                                                                            $
                                                                            (523
                                                                            )
                                                                            
                                                                            $
                                                                            (309
                                                                            )
                                                                            
                                                                            $
                                                                            435
                                                                            
                                                                            
                                                                            $
                                                                            107EGS
                                                                            
                                                                            
                                                                            (46
                                                                            )
                                                                            
                                                                            
                                                                            78
                                                                            
                                                                            
                                                                            
                                                                            (22
                                                                            )
                                                                            
                                                                            
                                                                            333Provision
      for Income Taxes
                                                                            
                                                                            $
                                                                            (569
                                                                            )
                                                                            
                                                                            $
                                                                            (231
                                                                            )
                                                                            
                                                                            $
                                                                            413
                                                                            
                                                                            
                                                                            $
                                                                            440Net
      Income (loss)EIS
                                                                            
                                                                            $
                                                                            (749
                                                                            )
                                                                            
                                                                            $
                                                                            (479
                                                                            )
                                                                            
                                                                            $
                                                                            632
                                                                            
                                                                            
                                                                            $
                                                                            171EGS
                                                                            
                                                                            
                                                                            (101
                                                                            )
                                                                            
                                                                            
                                                                            94
                                                                            
                                                                            
                                                                            
                                                                            (74
                                                                            )
                                                                            
                                                                            
                                                                            450Net
      Income (loss)
                                                                            
                                                                            $
                                                                            (850
                                                                            )
                                                                            
                                                                            $
                                                                            (385
                                                                            )
                                                                            
                                                                            $
                                                                            558
                                                                            
                                                                            
                                                                            $
                                                                            621Capital
      expendituresEIS
                                                                            
                                                                            $
                                                                            117
                                                                            
                                                                            
                                                                            $
                                                                            205
                                                                            
                                                                            
                                                                            $
                                                                            206
                                                                            
                                                                            
                                                                            $
                                                                            279EGS
                                                                            
                                                                            
                                                                            5
                                                                            
                                                                            
                                                                            
                                                                            32
                                                                            
                                                                            
                                                                            
                                                                            45
                                                                            
                                                                            
                                                                            
                                                                            36Capital
      expenditures
                                                                            
                                                                            $
                                                                            122
                                                                            
                                                                            
                                                                            $
                                                                            237
                                                                            
                                                                            
                                                                            $
                                                                            251
                                                                            
                                                                            
                                                                            $
                                                                            315


21




Item
2. Management’s Discussion and Analysis of Financial Condition and Results of
Operations




The
following discussion and analysis should be read in conjunction with, and is
qualified in its entirety by, the unaudited financial statements, including the
notes thereto, appearing elsewhere in this Quarterly Report on Form
10-Q.




Cautionary
Statement Regarding Forward-Looking Statements




You
should carefully review the information contained in this Quarterly Report on
Form 10-Q and in other reports or documents that we file from time to time with
the Securities and Exchange Commission (the “SEC”).  In addition to
historical information, this Quarterly Report on Form 10-Q contains our beliefs
regarding future events and our future financial performance.  In some
cases, you can identify those so-called “forward-looking statements” by words
such as “may,” “will,” “should,” expects,” “plans,” “anticipates,” “believes,”
“estimates,” “predicts,” “potential,” or “continue” or the negative of those
words and other comparable words.  You should be aware that those
statements are only our predictions.  Actual events or results may
differ materially.  We undertake no obligation to publicly release any
revisions to forward-looking statements after the date of this report. In
evaluating those statements, you should specifically consider various factors,
including the risk factors discussed in our Annual Report on Form 10-K for the
year ended August 31, 2009 and other reports or documents that we file from time
to time with the SEC.  All forward-looking statements attributable to
us or a person acting on our behalf are expressly qualified in their entirety by
this cautionary statement.




Assumptions
relating to budgeting, marketing, and other management decisions are subjective
in many respects and thus susceptible to interpretations and periodic revisions
based on actual experience and business developments, the impact of which may
cause us to alter our marketing, capital expenditure or other budgets, which may
in turn affect our business, financial position, results of operations and cash
flows.




Overview
of Emtec




We are a
systems integrator providing IT services and products to the federal, state,
local, education and commercial markets. We help our clients identify and
prioritize areas for improvement and then implement process, technology and
business application improvements that reduce cost, improve service and align
the delivery of IT with the needs of their organization. Our value based
management methods, coupled with IT technology, consulting and development
services, allow us to address a wide range of specific client needs, as well as
support broader IT transformation initiatives.  Our client base is
comprised of departments of federal, state and local governments in the United
States and Canada, schools and commercial businesses throughout the United
States and Canada.





Our
business has been seasonal in past years. While we have taken steps to alleviate
this seasonality, our Federal and Education clients typically purchase less of
our procurement services in the second quarter of our fiscal year.  In
the past, the diversification of our customer base in our commercial, state and
local practices has alleviated some of this seasonality.





Our gross
profit can be impacted by various factors including changes in mix of products
and services sold, changes in technical employee utilization rates, changes in
the billing rates, the mix of client type and the decision to aggressively price
certain products and services.


22


Factors
that may in the future have a negative impact on our selling, general and
administrative expenses for both divisions 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.





In our
EIS division during 2009, we embarked upon cost cutting initiatives to stabilize
the profitability of our business and to focus more on selling services. The Companyhasnotto daterealizedsignificant benefits from these cost
containment measures in fiscal 2010 because of our investments in future
growth related to strengthening the executive management team, marketing
initiatives and other professional fees related to merger and acquisition
opportunities.  In April 2010, management analyzed the profitability
of commercial clients related to its procurement services business, and
initiated cost containment measures to align SG&A expenses consistent with
the Company’s focus on our consulting services in the commercial sector.
Management estimates that up to $2 million in annualized costs will be reduced
as a result of this restructuring and that the costs associated with the
restructuring are estimated to be up to $150,000, primarily related to severance
costs. However, management is now focusing its efforts on attracting talent to
our higher gross margin consulting practices in the commercial sector, which may
off-set these cost containment savings in future periods.





We have
divided our operating activity into two operating segments for reporting
purposes: EIS and EGS. EIS consists of the Company’s historical business, which
we refer to as the Systems Division, and the business service management
solutions offered by the ITSM practice. EGS is the Company’s enterprise
applications services solutions and training business including its ERP and
Application Development practice and its Business Analysis and Quality Assurance
Practice.


23


Consolidated
Statements of Operations for the Three Months Ended February 28, 2010 compared
with the Three Months Ended February 28, 2009.





EMTEC,
INC.


CONSOLIDATED
STATEMENTS OF INCOME


(In
thousands)




Three Months Ended February 28,2010
                                  
                                  
                                  2009
                                  
                                  
                                  Change
                                  
                                  
                                  %RevenuesProcurement
      services
                                  
                                  $
                                  23,275
                                  
                                  
                                  $
                                  29,414
                                  
                                  
                                  $
                                  (6,139
                                  )
                                  
                                  
                                  (20.9
                                  )%Service
      and consulting
                                  
                                  
                                  12,828
                                  
                                  
                                  
                                  12,547
                                  
                                  
                                  
                                  281
                                  
                                  
                                  
                                  2.2
                                  %Total Revenues
                                  
                                  
                                  36,103
                                  
                                  
                                  
                                  41,961
                                  
                                  
                                  
                                  (5,858
                                  )
                                  
                                  
                                  (14.0
                                  )%Cost of SalesCost
      of procurement services
                                  
                                  
                                  21,036
                                  
                                  
                                  
                                  26,371
                                  
                                  
                                  
                                  (5,335
                                  )
                                  
                                  
                                  (20.2
                                  )%Service
      and consulting
                                  
                                  
                                  9,165
                                  
                                  
                                  
                                  9,464
                                  
                                  
                                  
                                  (299
                                  )
                                  
                                  
                                  (3.2
                                  )%Total Cost of Sales
                                  
                                  
                                  30,201
                                  
                                  
                                  
                                  35,835
                                  
                                  
                                  
                                  (5,634
                                  )
                                  
                                  
                                  (15.7
                                  )%Gross ProfitProcurement
      services
                                  
                                  
                                  2,239
                                  
                                  
                                  
                                  3,043
                                  
                                  
                                  
                                  (804
                                  )
                                  
                                  
                                  (26.4
                                  )%Procurement
      services %
                                  
                                  
                                  9.6
                                  %
                                  
                                  
                                  10.3
                                  %Service
      and consulting
                                  
                                  
                                  3,663
                                  
                                  
                                  
                                  3,083
                                  
                                  
                                  
                                  580
                                  
                                  
                                  
                                  18.8
                                  %Service
      and consulting %
                                  
                                  
                                  28.6
                                  %
                                  
                                  
                                  24.6
                                  %Total Gross Profit
                                  
                                  
                                  5,902
                                  
                                  
                                  
                                  6,126
                                  
                                  
                                  
                                  (224
                                  )
                                  
                                  
                                  (3.7
                                  )%Total Gross Profit %
                                  
                                  
                                  16.3
                                  %
                                  
                                  
                                  14.6
                                  %Operating
      expenses:Selling,
      general, and administrative expenses
                                  
                                  
                                  6,441
                                  
                                  
                                  
                                  5,758
                                  
                                  
                                  
                                  683
                                  
                                  
                                  
                                  11.9
                                  %Rent
      expense – related party
                                  
                                  
                                  157
                                  
                                  
                                  
                                  152
                                  
                                  
                                  
                                  5
                                  
                                  
                                  
                                  3.3
                                  %Depreciation
      and amortization
                                  
                                  
                                  571
                                  
                                  
                                  
                                  568
                                  
                                  
                                  
                                  3
                                  
                                  
                                  
                                  0.5
                                  %Total
      operating expenses
                                  
                                  
                                  7,169
                                  
                                  
                                  
                                  6,478
                                  
                                  
                                  
                                  691
                                  
                                  
                                  
                                  10.7
                                  %Percent
      of revenues
                                  
                                  
                                  19.9
                                  %
                                  
                                  
                                  15.4
                                  %Operating
      income (loss)
                                  
                                  
                                  (1,267
                                  )
                                  
                                  
                                  (352
                                  )
                                  
                                  
                                  (915
                                  )
                                  
                                  
                                  259.9
                                  %Percent
      of revenues
                                  
                                  
                                  -3.5
                                  %
                                  
                                  
                                  -0.8
                                  %Other
      expense (income):Interest
      income – other
                                  
                                  
                                  (5
                                  )
                                  
                                  
                                  (6
                                  )
                                  
                                  
                                  1
                                  
                                  
                                  
                                  (16.7
                                  )%Interest
      expense
                                  
                                  
                                  159
                                  
                                  
                                  
                                  270
                                  
                                  
                                  
                                  (111
                                  )
                                  
                                  
                                  (41.1
                                  )%Other
                                  
                                  
                                  (2
                                  )
                                  
                                  
                                  -
                                  
                                  
                                  
                                  (2
                                  )
                                  
                                  N/AIncome
      (loss) before income taxes
                                  
                                  
                                  (1,419
                                  )
                                  
                                  
                                  (616
                                  )
                                  
                                  
                                  (803
                                  )
                                  
                                  
                                  130.4
                                  %Provision
      (benefit) for income taxes
                                  
                                  
                                  (569
                                  )
                                  
                                  
                                  (231
                                  )
                                  
                                  
                                  (338
                                  )
                                  
                                  
                                  146.3
                                  %Net
      income (loss)
                                  
                                  $
                                  (850
                                  )
                                  
                                  $
                                  (385
                                  )
                                  
                                  $
                                  (465
                                  )
                                  
                                  
                                  120.8
                                  %Percent
      of revenues
                                  
                                  
                                  -2.4
                                  %
                                  
                                  
                                  -0.9
                                  %





We
currently categorize our revenues and costs of sales into “Procurement Services”
and “Services and Consulting.”  We have made the categorizations in
order to analyze our growth in consulting and other services as a percentage of
our overall revenues.  We have divided our business into two
segments.  EIS provides a broad range of IT infrastructure services
for our clients.  These services are focused on improving the value IT
assets provide to an organization, and to reduce the costs of these
assets.  EGS was formed to provide IT application consulting and other
services.  These services typically include business process
improvement through the use of technology.  Our consultants are
skilled in a wide array of technologies in this segment.





We
discuss the results of each segment below.


24




Results
of Operations -EIS




EIS
serves Departments of the U.S. Government, Canadian Government Agencies, State
and Local Governments, Education markets and Commercial companies.





Our
business has been seasonal in past years. While we have taken steps to alleviate
this seasonality, our Federal and Education clients typically purchase less of
our procurement services in this quarter.  In the past, the
diversification of our customer base in our commercial, state and local
practices has alleviated some of this seasonality.




In 2009,
we embarked upon cost cutting initiatives to stabilize the profitability of our
business and to focus more on selling services.  While our sales into
Federal clients recovered and have continued to improve as well as our Education
practice has been able to grow, our commercial, state and local business has
declined due to a slow economic recovery which has prevented us from attracting
new profitable customers, who purchase procurement services. Management’s
analysis concluded that we were profitable in the commercial, state and local
business only when customers were of sufficient scale in purchasing procurement
services. Management also analyzed the impact of investing in this business and
concluded that investment in growth should be focused on our consulting services
in the commercial sector.  Since our analysis showed that the current
level of gross profit from this sector is insufficient to cover the costs of the
SG&A for the sector thus management decided reduce expenses in April of
2010. Management estimates that up to $2 million in annualized costs will be
reduced as a result of this restructuring and that the costs associated with the
restructuring are estimated to be up to $150,000, primarily related to severance
costs. Management is now focusing its efforts on attracting talent to our higher
gross margin consulting practices in the commercial sector.




Since
this portion of our business did not recover in our second quarter, which is
slowest for our education and federal customers, our overall results show a
decline in revenue and profitability.  However, in our federal
business revenues increased during the quarter versus the same period in prior
year and in our education business, our consulting services revenue continued to
grow over the same period in the prior year.




The
following discussion and analysis provides information that management believes
is relevant to an assessment and understanding of our EIS Results of Operations
for the three months ended February 28, 2010 and 2009.


25


EIS


STATEMENTS
OF INCOME


(In
thousands)




Three Months Ended February 28,2010
                                
                                
                                2009
                                
                                
                                Change
                                
                                
                                %RevenuesProcurement
      services
                                
                                $
                                23,275
                                
                                
                                $
                                29,414
                                
                                
                                $
                                (6,139
                                )
                                
                                
                                -20.9
                                %Service
      and consulting
                                
                                
                                5,904
                                
                                
                                
                                3,883
                                
                                
                                
                                2,021
                                
                                
                                
                                52.0
                                %Total Revenues
                                
                                
                                29,179
                                
                                
                                
                                33,297
                                
                                
                                
                                (4,118
                                )
                                
                                
                                -12.4
                                %Cost of SalesCost
      of procurement services
                                
                                
                                21,036
                                
                                
                                
                                26,371
                                
                                
                                
                                (5,335
                                )
                                
                                
                                -20.2
                                %Service
      and consulting
                                
                                
                                3,435
                                
                                
                                
                                2,414
                                
                                
                                
                                1,021
                                
                                
                                
                                42.3
                                %Total Cost of Sales
                                
                                
                                24,471
                                
                                
                                
                                28,785
                                
                                
                                
                                (4,314
                                )
                                
                                
                                -15.0
                                %Gross ProfitProcurement
      services
                                
                                
                                2,239
                                
                                
                                
                                3,043
                                
                                
                                
                                (804
                                )
                                
                                
                                -26.4
                                %Procurement
      services %
                                
                                
                                9.6
                                %
                                
                                
                                10.3
                                %Service
      and consulting
                                
                                
                                2,469
                                
                                
                                
                                1,469
                                
                                
                                
                                1,000
                                
                                
                                
                                68.1
                                %Service
      and consulting %
                                
                                
                                41.8
                                %
                                
                                
                                37.8
                                %Total Gross Profit
                                
                                
                                4,708
                                
                                
                                
                                4,512
                                
                                
                                
                                196
                                
                                
                                
                                4.3
                                %Total Gross Profit %
                                
                                
                                16.1
                                %
                                
                                
                                13.6
                                %Operating
      expenses:Selling,
      general, and administrative expenses
                                
                                
                                5,437
                                
                                
                                
                                4,702
                                
                                
                                
                                735
                                
                                
                                
                                15.6
                                %Rent
      expense – related party
                                
                                
                                102
                                
                                
                                
                                92
                                
                                
                                
                                10
                                
                                
                                
                                10.9
                                %Depreciation
      and amortization
                                
                                
                                342
                                
                                
                                
                                350
                                
                                
                                
                                (8
                                )
                                
                                
                                -2.3
                                %Total
      operating expenses
                                
                                
                                5,881
                                
                                
                                
                                5,144
                                
                                
                                
                                737
                                
                                
                                
                                14.3
                                %Percent
      of revenues
                                
                                
                                20.2
                                %
                                
                                
                                15.4
                                %Operating
      loss
                                
                                
                                (1,173
                                )
                                
                                
                                (632
                                )
                                
                                
                                (541
                                )
                                
                                
                                85.6
                                %Percent
      of revenues
                                
                                
                                -4.0
                                %
                                
                                
                                -1.9
                                %Other
      expense (income):Interest
      income – other
                                
                                
                                (5
                                )
                                
                                
                                (6
                                )
                                
                                
                                1
                                
                                
                                
                                -16.7
                                %Interest
      expense
                                
                                
                                104
                                
                                
                                
                                162
                                
                                
                                
                                (58
                                )
                                
                                
                                -35.8
                                %Other
                                
                                
                                -
                                
                                
                                
                                -
                                
                                
                                
                                -
                                
                                
                                
                                N/ALoss
      before income taxes
                                
                                
                                (1,272
                                )
                                
                                
                                (788
                                )
                                
                                
                                (484
                                )
                                
                                
                                61.4
                                %Provision
      (benefit) for income taxes
                                
                                
                                (523
                                )
                                
                                
                                (309
                                )
                                
                                
                                (214
                                )
                                
                                
                                69.2
                                %Net
      loss
                                
                                $
                                (749
                                )
                                
                                $
                                (479
                                )
                                
                                $
                                (270
                                )
                                
                                
                                56.4
                                %Percent
      of revenues
                                
                                
                                -2.6
                                %
                                
                                
                                -1.4
                                %




Comparison
of the Three Months Ended February 28, 2010 and 2009 - EIS




Revenues -
EIS




EIS
division’s total revenues decreased $4.1 million, or 12.4%, to $29.2 million for
the three months ended February 28, 2010, compared to $33.3 million for the
three months ended February 28, 2009.  EIS division’s total revenue
includes revenues from the Company’s historical business, which we refer to as
the Systems Division, and KOAN-IT, which was acquired on February 12, 2009, and
includes the assets of EMS, which were acquired on May 12, 2009. The increase
associated with the acquisition of KOAN-IT was $1.4 million for the three months
ended February 28, 2010. This increase is primarily due to comparing a full
quarter of operations in the three months ended February 28, 2010 to a shorter
stub period in the three months ended February 28, 2009.  Without
these acquisitions Systems Division’s revenue decreased $5.5 million, or 16.8%,
to $27.6 million for the three months ended February 28, 2010, compared to $33.1
million for the three months ended February 28, 2009.


26


Procurement
services revenue decreased $6.1 million, or 20.9%, to $23.3 million for the
three months ended February 28, 2010, compared to $29.4 million for the three
months ended February 28, 2009.  EIS division’s total procurement
services revenue includes revenues from the Company’s historical business, which
we refer to as the Systems Division, and KOAN-IT, which was acquired on February
12, 2009, and includes the assets of EMS, which were acquired on May 12,
2009.  The increase associated with the acquisition of KOAN-IT was
$268,000 for the three months ended February 28, 2010 as compared to a shorter
stub period in the three months ended February 28, 2009.  Without
these acquisitions Systems Division’s procurement service revenue decreased $6.4
million, or 21.8%, to $23 million for the three months ended February 28, 2010,
compared to $29.4 million for the three months ended February 28,
2009.  As mentioned previously, this decrease is mainly due to a
continued decrease in business from our commercial, state and local clients and
the deferral of some projects in future quarters from our education business. We
believe that this decrease in commercial business can be attributed to the
current general economic downturn and our focus on growing our consulting and
services revenues.




Services
and consulting revenue increased $2.0 million, or 52.0%, to $5.9 million for the
three months ended February 28, 2010, compared to $3.9 million for the three
months ended February 28, 2009. The increase associated with the acquisition of
KOAN-IT was $1.2 million for the three months ended February 28, 2010 to a
shorter stub period in the three months ended February 28,
2009.  Without these acquisitions, Systems Division’s services and
consulting revenue increased $854,000, or 22.9%, to $4.6 million for the three
months ended February 28, 2010, compared to $3.7 million for the three months
ended February 28, 2009.  This increase is mainly attributable to
various IT projects for a school district and various departments of the U.S.
government during the three months ended February 28, 2010.




Our EIS
division’s revenues, by client type, are comprised of the following (in
thousands):





For the Three Months EndedFebruary 28, 2010
                  
                  
                  February 28 2009Departments
      of the U.S. Government
                  
                  $
                  15,514
                  
                  
                  
                  53.1
                  %
                  
                  $
                  11,245
                  
                  
                  
                  33.8
                  %Canada
      Government Agencies
                  
                  
                  372
                  
                  
                  
                  1.3
                  %
                  
                  
                  -
                  
                  
                  
                  0.0
                  %State
      and Local Governments
                  
                  
                  1,079
                  
                  
                  
                  3.7
                  %
                  
                  
                  1,949
                  
                  
                  
                  5.9
                  %Commercial
      Companies
                  
                  
                  4,962
                  
                  
                  
                  17.0
                  %
                  
                  
                  9,315
                  
                  
                  
                  28.0
                  %Education
      and other
                  
                  
                  7,252
                  
                  
                  
                  24.9
                  %
                  
                  
                  10,788
                  
                  
                  
                  32.4
                  %Total
      Revenues
                  
                  $
                  29,179
                  
                  
                  
                  100.0
                  %
                  
                  $
                  33,297
                  
                  
                  
                  100.0
                  %





During
the three months ended February 28, 2010 and 2009, U.S. governmental
department and agency related revenues represented approximately 53.1% and 33.8%
of total EIS division’s revenues, respectively. Revenues from various civilian
and military U.S. governmental departments and agencies increased by
approximately $4.3 million during the three months ended February 28, 2010
compared with the three months ended February 28, 2009. This increase is
primarily attributable to various IT projects for various departments of the
U.S. government during the three months ended February 28,
2010.


27


Our state
and local government business remains uncertain due to the tight budgetary
pressures within governmental agencies in the State of New Jersey.




Revenues
from commercial clients decreased by approximately $4.4 million during the three
months ended February 28, 2010 compared with the three months ended February 28,
2009. This decrease is mainly due to the general economic downturn that caused
reductions in technology and discretionary spending by our commercial clients.
As discussed previously, we have taken steps after this quarter to reduce our
focus on unprofitable commercial clients for the EIS segment.




During
the three months ended February 28, 2010, revenues from our education business
decreased by approximately $3.5 million compared with the three months ended
February 28, 2009.  This decrease is mainly due to deferral of IT
procurement services projects with school districts during the three months
ended February 28, 2010.  During our fiscal years 2008 and 2009, we
took steps to increase our business with our existing customers by outsourcing
more of their infrastructure managed services needs and to increase our
penetration with additional clients in this market. We believe these steps will
increase the amount of long-term recurring revenue we have with these
clients.





Gross Profit -
EIS




Aggregate
gross profit for our EIS division increased $196,000, or 4.3%, to $4.7 million
for the three months ended February 28, 2010 as compared to $4.5 million for the
three months ended February 28, 2009. EIS division’s gross profit includes gross
profit from the Company’s historical business, which we refer to as the Systems
Division, and KOAN-IT, which was acquired on February 12, 2009 and includes the
assets of EMS which were acquired on May 12, 2009.  The increase
associated with the acquisition of KOAN-IT was $542,000 for the three months
ended February 28, 2010 to a shorter stub period in the three months ended
February 28, 2009.  Without these acquisitions Systems Division’s
gross profit decreased $347,000, or 7.7%, to $4.1 million for the three months
ended February 28, 2010, compared to $4.5 million for the three months ended
February 28, 2009.   This decrease was mainly due to a decrease
in revenue as discussed in the total revenue section.




Measured
as a percentage of revenues, our gross profit margin for our EIS division
increased to 16.1% of our EIS division’s revenues for the three months ended
February 28, 2010 from 13.6% for the three months ended February 28, 2009. This
increase is primarily due to an increasing portion of our EIS division’s revenue
coming from higher margin consulting services revenues, especially an increase
in our services and consulting revenue associated with IT projects for a school
district, ITSM practice, and various departments of the U.S. government during
the three months ended February 28, 2010.





Selling, General and
Administrative Expenses -EIS




Selling,
general and administrative expenses for our EIS division increased by $735,000,
or 15.6% to $5.4 million for the three months ended February 28, 2010, compared
to $4.7 million for the three months ended February 28, 2009.


28


EIS
division’s selling, general and administrative expenses includes selling,
general and administrative expenses from Systems Division and KOAN-IT which was
acquired on February 12, 2009 and the assets of EMS, which were acquired on May
12, 2009. The increase associated with the acquisition of KOAN-IT was $307,000
for the three months ended February 28, 2010 to a shorter stub period in the
three months ended February 28, 2009.  Without these acquisitions
Systems Division’s selling, general, and administrative expenses increased
$428,000, or 9.2%, to $5.0 million for the three months ended February 28, 2010,
compared to $4.6 million for the three months ended February 28,
2009.   This increase is mainly due to increase in expense
categories such as compensation expense associated with our investment in new
hires partially offset by changes in commission structure, training expense,
travel, professional and legal fees. As mentioned previously in April 2010,
management implemented a cost reduction restructuring in our commercial, state
and local business, which is designed to cut approximately $2.0 million in
annualized costs out of our commercial state and local practices.  In
addition, there were expenses associated with new growth initiatives totaling
$400,000, which included the hiring of our new Chief Strategy and Delivery
Officer, recruiting fees, merger and acquisition expenses related to a recent
acquisition, which was completed in March 2010 and stock expense associated with
the departure of Keith Grabel.




Rent Expense-Related Party -
EIS





We occupy
approximately 42,000 square feet of office and warehouse space in Springfield,
New Jersey. This space is leased from a limited liability company owned by a
certain former director and current officer of the Company and his related
family members. The original lease term was through April 2009 with monthly base
rent of $15,000. We exercised the option to extend the lease for an additional
five-year term through April 2014, with monthly base rent of $18,000. During the
three months ended February 28, 2010 and 2009, we recorded $52,000 and $45,000
in expense under this lease, respectively.





We occupy
approximately 36,000 square feet of office and warehouse space in a 70,000
square foot building in Suwannee, GA.  This space is leased from a
limited liability company in which a certain officer of our company is a passive
investor with an approximately 10% equity interest. The current lease term is
through November 2014 with monthly rent of $21,000.  During the three
months ended February 28, 2010 and 2009, we recorded expense under this lease
totaling $50,000 and $47,000, respectively.





Management
believes the facilities noted above are being leased at rates consistent with
the market rates.





Depreciation and
Amortization - EIS





Depreciation
and amortization expense for our EIS division decreased by 2.3%, or $8,000, to
$342,000 for the three months ended February 28, 2010, compared to $350,000 for
the three months ended February 28, 2009.  EIS division’s depreciation
and amortization expense includes depreciation and amortization expense from
Systems Division and KOAN-IT, which was acquired on February 12, 2009, and the
assets of EMS, which were acquired on May 12, 2009.   The
increase associated with the acquisition of KOAN-IT was $58,000 for the three
months ended February 28, 2010 as compared to a shorter stub period in the three
months ended February 28, 2009.  Without these acquisitions Systems
Division’s depreciation and amortization decreased $66,000, or 19.5%, to
$272,000 for the three months ended February 28, 2010, compared to $338,000 for
the three months ended February 28, 2009.


29


As of
February 28, 2010, intangible assets of the EIS division consisted of: the
estimated value ascribed to customer relationships of $9.9 million less
accumulated amortization of $2.9 million; the estimated value ascribed to
non-competes of $29,000 less accumulated amortization of $6,000; and the
estimated value ascribed to trademarks of $175,000 less accumulated amortization
of $37,000.  As of August 31, 2009 intangible assets of the EIS division
consisted of: the estimated value ascribed to customer relationships of $9.9
million less accumulated amortization of $2.5 million; the estimated value
ascribed to non-competes of $28,000 less accumulated amortization of $3,000; and
the estimated value ascribed to trademarks of $169,000 less accumulated
amortization of $19,000. The assets ascribed to customer relationships are being
amortized on a straight-line basis over 6 to 15 years and non-compete covenants
and trademarks are being amortized on a straight-line basis over 5 years. 
Amortization expense for the EIS division was $209,000, and $154,000 for the
three months ended February 28, 2010 and 2009, respectively.





Operating Income (loss) -
EIS





Operating
loss for our EIS division for the three months ended February 28,
2010 increased by 85.6%, or $541,000, to $1.2 million, compared to
operating loss of $632,000 for the three months ended February 28,
2009. This increase in operating loss is mainly due to decreased total
revenues from our Systems Division and increased selling, general and
administrative expenses as discussed in the Total Revenue and Selling, General
and Administrative Expenses sections above.





Interest expense -
EIS





Interest
expense for the EIS division decreased by 35.8%, or $58,000, to $104,000 for the
three months ended February 28, 2010, compared to $162,000 for the three months
ended February 28, 2009. This is primarily attributable to lower balances on
various notes payable and a lower average interest rate charged on the line of
credit, which was attributable to a decrease in the prime rate during this
period. The average interest rate charged on the line of credit by the Lender
was approximately 3.5% and 4.1% for three months ended February 28, 2010 and
2009, respectively.





Provision (benefit) for
income taxes -EIS





We
recorded income tax benefit of $523,000 for the three months ended February 28,
2010 as compared to $309,000 for the three months ended February 28, 2009. The
effective tax benefit rate was 41.0% for the three months ended February 28,
2010 as compared to 39.3% for the three months ended February 28, 2009. The
increase in tax benefit rate was primarily the result of a current fiscal 2010
tax deduction for vested stock awards.




Results
of Operations –EGS




Most of
the clients EGS serves are commercial clients.  While our consultants
are typically working on long- term projects, we believe that the general
economic slowdown has impacted our ability to sell services the way these
businesses had typically operated before we acquired them.  In
addition, it has been our intention to convert these businesses to a new sales
model and cross-sell their services across our organization.  During
2009, we took steps to add additional sales resources in the U.S., to change our
training methodologies of our consultants and to shift recruiting resources to
an onshore/offshore model.  We have also defined four practices within
EGS that we are starting to sell as full service practice offerings using
projects as opposed to typical staff augmentation.


30


The
following discussion and analysis provides information that management believes
is relevant to an assessment and understanding of our Results of Operations for
EGS for the three months ended February 28, 2010 and 2009.




EGS


STATEMENTS
OF INCOME


(In
thousands)




Three
      Months Ended February 28,2010
                                
                                
                                2009
                                
                                
                                Change
                                
                                
                                %RevenuesService
      and consulting
                                
                                $
                                6,924
                                
                                
                                $
                                8,664
                                
                                
                                $
                                (1,740
                                )
                                
                                
                                -20.1
                                %Total Revenues
                                
                                
                                6,924
                                
                                
                                
                                8,664
                                
                                
                                
                                (1,740
                                )
                                
                                
                                -20.1
                                %Cost of SalesService
      and consulting
                                
                                
                                5,730
                                
                                
                                
                                7,050
                                
                                
                                
                                (1,320
                                )
                                
                                
                                -18.7
                                %Total Cost of Sales
                                
                                
                                5,730
                                
                                
                                
                                7,050
                                
                                
                                
                                (1,320
                                )
                                
                                
                                -18.7
                                %Gross ProfitService
      and consulting
                                
                                
                                1,194
                                
                                
                                
                                1,614
                                
                                
                                
                                (420
                                )
                                
                                
                                -26.0
                                %Service
      and consulting %
                                
                                
                                17.2
                                %
                                
                                
                                18.6
                                %Total Gross Profit
                                
                                
                                1,194
                                
                                
                                
                                1,614
                                
                                
                                
                                (420
                                )
                                
                                
                                -26.0
                                %Total Gross Profit %
                                
                                
                                17.2
                                %
                                
                                
                                18.6
                                %Operating
      expenses:Selling,
      general, and administrative expenses
                                
                                
                                1,004
                                
                                
                                
                                1,056
                                
                                
                                
                                (52
                                )
                                
                                
                                -4.9
                                %Rent
      expense – related party
                                
                                
                                55
                                
                                
                                
                                60
                                
                                
                                
                                (5
                                )
                                
                                
                                -8.3
                                %Depreciation
      and amortization
                                
                                
                                229
                                
                                
                                
                                218
                                
                                
                                
                                11
                                
                                
                                
                                5.0
                                %Total
      operating expenses
                                
                                
                                1,288
                                
                                
                                
                                1,334
                                
                                
                                
                                (46
                                )
                                
                                
                                -3.4
                                %Percent
      of revenues
                                
                                
                                18.6
                                %
                                
                                
                                15.4
                                %Operating
      income (loss)
                                
                                
                                (94
                                )
                                
                                
                                280
                                
                                
                                
                                (374
                                )
                                
                                
                                -133.6
                                %Percent
      of revenues
                                
                                
                                -1.4
                                %
                                
                                
                                3.2
                                %Other
      expense (income):Interest
      income – other
                                
                                
                                -
                                
                                
                                
                                -
                                
                                
                                
                                -
                                
                                
                                N/AInterest
      expense
                                
                                
                                55
                                
                                
                                
                                108
                                
                                
                                
                                (53
                                )
                                
                                
                                -49.1
                                %Other
                                
                                
                                (2
                                )
                                
                                
                                -
                                
                                
                                
                                (2
                                )
                                
                                N/AIncome
      (loss)  before income taxes
                                
                                
                                (147
                                )
                                
                                
                                172
                                
                                
                                
                                (319
                                )
                                
                                
                                -185.5
                                %Provision
      (benefit) for income taxes
                                
                                
                                (46
                                )
                                
                                
                                78
                                
                                
                                
                                (124
                                )
                                
                                
                                -159.0
                                %Net
      income (loss)
                                
                                $
                                (101
                                )
                                
                                $
                                94
                                
                                
                                $
                                (195
                                )
                                
                                
                                -207.4
                                %Percent
      of revenues
                                
                                
                                -1.5
                                %
                                
                                
                                1.1
                                %




Comparison
of the Three Months Ended February 28, 2010 and 2009 - EGS




Revenues -
EGS




EGS
revenue consists of its ERP and Application Development practice and its
Business Analysis and Quality Assurance practice.  EGS division’s
total revenues decreased $1.7 million, or 20.1%, to $6.9 million for the three
months ended February 28, 2010, compared to $8.7 million for the three months
ended February 28, 2009. This decline was caused by a 13.2% decrease in hours
billed and a 8.0% decrease in the average hourly billing rate during the three
months ended February 28, 2010 compared with the corresponding period in 2009.
The decrease in billable hours is mainly due to decreases in our Business
Analysis and Quality Assurance practices and the decrease in billing rates is
due to decrease in both of our practices. Most of the clients EGS serves are
commercial clients and we believe that this decrease in commercial business is
primarily attributed to the current general economic downturn and resultant
pricing pressures. In February 2010, we began to see an increase in hours billed
and an increase in billable rates per hour.  While the overall revenue
for the quarter has declined, we believe the market is showing signs of
rebounding.


31


Gross Profit -
EGS




EGS
division’s gross profit decreased $420,000, or 26.0%, to $1.2 million for the
three months ended February 28, 2010, compared to $1.6 million for the three
months ended February 28, 2009. We believe this decrease is mainly due to the
economic downturn as discussed in the Revenue section above.





Measured
as percentages of revenue, our gross profit margin for the EGS division
decreased to 17.2% of our EGS division’s revenues for the three months ended
February 28, 2010 from 18.6% for the three months ended February 28, 2009. We
believe this decrease is mainly due to the decreased billing rate per hour that
was the, result of pricing pressure from our commercial clients.





Selling, General and
Administrative Expenses - EGS





EGS
division’s selling, general and administrative expenses decreased $52,000, or
4.9%, to $1.0 million for the three months ended February 28, 2010, compared to
$1.05 million for the three months ended February 28, 2009. This decrease of
approximately $52,000 in selling, general and administrative expenses is
primarily attributable to the reduction of various expense categories including
compensation due to lower gross profits, recruiting, business insurance, rent
for guesthouses, professional and consulting fees, training, and other various
expense categories, which was offset by approximately $98,000 in bad-debt
expense.





Rent Expense-Related Party -
EGS




We occupy
approximately 20,000 square feet of office space in Fremont, CA.  This
space is leased from the spouse of the President of eBAS/Aveeva.  The
lease term is for 3 years with monthly base rent of $20,000. In March 2009, we
subleased portion of the building for a monthly rent of $3,000 on a
month-to-month basis, which was terminated effective February 1,
2010. During the three months ended February 28, 2010 and 2009, we recorded
expense under this lease totaling $55,000 and $60,000 $60,000 in expense under
this lease.





Management
believes the lease noted above is being leased at a rate consistent with the
market rate.





Depreciation and
Amortization - EGS





EGS
division’s depreciation and amortization expense increased $11,000, or 5.0%, to
$229,000 for the three months ended February 28, 2010, compared to $218,000 for
the three months ended February 28, 2009. The increase is mainly due to
depreciation expense associated with computer equipment we purchased for our
training facility during three months ended August 31, 2009.





As of
February 28, 2010, intangible assets of the EGS division consisted of the
estimated value ascribed to customer relationships of $4.2 million less
accumulated amortization of $1.2 million, and the estimated value ascribed to
non-competes of $370,000 less accumulated amortization of $123,000. As of
August 31, 2009, intangible assets of the EGS division consisted of the
estimated value ascribed to customer relationships of $4.2 million less
accumulated amortization of $820,000, and the estimated value ascribed to
non-competes of $370,000 less accumulated amortization of $86,000. The assets
ascribed to customer relationships are being amortized on a straight-line basis
over 5 to 9 years and noncompete covenants and trademarks are being amortized on
a straight-line basis over 5 years. Amortization expense for the EGS division
was $200,000, and $200,000 for the three months ended February 28, 2010 and
2009, respectively.


32


Operating income (loss)
-EGS





Operating
loss for our EGS division for the three months ended February 28, 2010 was
$94,000, compared to operating income of $280,000 for the three months ended
February 28, 2009. This decrease in operating income is mainly due to a decrease
in services and consulting revenue as discussed in the Revenue and Gross Profit
sections above.




Interest expense
-EGS





Interest
expense for our EGS division for the three months ended February 28, 2010
decreased by 49.1%, or $53,000, to $55,000, compared to interest expense of
$108,000 for the three months ended February 28, 2009. This is primarily
attributable to the absence during the quarter of interest costs related to an
8% subordinated note payable, which was paid in full in September 2009 and a
lower average interest rate charged on the line of credit attributable to a
decrease in the prime rate during this period. The average interest rate charged
on the line of credit by the Lender was approximately 3.5% and 4.1% for three
months ended February 28, 2010 and 2009, respectively.





Provision (benefit) for
income taxes -EGS




We
recorded an income tax benefit of $46,000 for the three months ended February
28, 2010 as compared to income tax expense of $78,000 for the three months ended
February 28, 2009. The effective tax benefit rate was 32.0% for the three months
ended February 28, 2010 as compared to tax rate of 45.7% for the three months
ended February 28, 2009. The higher effective tax rate in the three
months ended February 28, 2010 was primarily the result of the effect of
permanently non-deductible expenses on a smaller pre-tax income
base.


33


Consolidated
Statements of Income for the Six Months Ended February 28, 2010 compared with
the Six Months Ended February 28, 2009.





EMTEC,
INC.


CONSOLIDATED
STATEMENTS OF INCOME


(In
thousands)




Six
      Months Ended February 28,2010
                                              
                                              
                                              2009
                                              
                                              
                                              Change
                                              
                                              
                                              %RevenuesProcurement
      services
                                              
                                              $
                                              82,657
                                              
                                              
                                              $
                                              85,773
                                              
                                              
                                              $
                                              (3,116
                                              )
                                              
                                              
                                              (3.6
                                              )%Service
      and consulting
                                              
                                              
                                              27,023
                                              
                                              
                                              
                                              26,208
                                              
                                              
                                              
                                              815
                                              
                                              
                                              
                                              3.1
                                              %Total Revenues
                                              
                                              
                                              109,680
                                              
                                              
                                              
                                              111,981
                                              
                                              
                                              
                                              (2,301
                                              )
                                              
                                              
                                              (2.1
                                              )%Cost of SalesCost
      of procurement services
                                              
                                              
                                              74,209
                                              
                                              
                                              
                                              76,763
                                              
                                              
                                              
                                              (2,554
                                              )
                                              
                                              
                                              (3.3
                                              )%Service
      and consulting
                                              
                                              
                                              19,025
                                              
                                              
                                              
                                              20,297
                                              
                                              
                                              
                                              (1,272
                                              )
                                              
                                              
                                              (6.3
                                              )%Total Cost of Sales
                                              
                                              
                                              93,234
                                              
                                              
                                              
                                              97,060
                                              
                                              
                                              
                                              (3,826
                                              )
                                              
                                              
                                              (3.9
                                              )%Gross ProfitProcurement
      services
                                              
                                              
                                              8,448
                                              
                                              
                                              
                                              9,010
                                              
                                              
                                              
                                              (562
                                              )
                                              
                                              
                                              (6.2
                                              )%Procurement
      services %
                                              
                                              
                                              10.2
                                              %
                                              
                                              
                                              10.5
                                              %Service
      and consulting
                                              
                                              
                                              7,998
                                              
                                              
                                              
                                              5,911
                                              
                                              
                                              
                                              2,087
                                              
                                              
                                              
                                              35.3
                                              %Service
      and consulting %
                                              
                                              
                                              29.6
                                              %
                                              
                                              
                                              22.6
                                              %Total Gross Profit
                                              
                                              
                                              16,446
                                              
                                              
                                              
                                              14,921
                                              
                                              
                                              
                                              1,525
                                              
                                              
                                              
                                              10.2
                                              %Total Gross Profit %
                                              
                                              
                                              15.0
                                              %
                                              
                                              
                                              13.3
                                              %Operating
      expenses:Selling,
      general, and administrative expenses
                                              
                                              
                                              13,719
                                              
                                              
                                              
                                              11,936
                                              
                                              
                                              
                                              1,783
                                              
                                              
                                              
                                              14.9
                                              %Rent
      expense – related party
                                              
                                              
                                              311
                                              
                                              
                                              
                                              305
                                              
                                              
                                              
                                              6
                                              
                                              
                                              
                                              2.0
                                              %Depreciation
      and amortization
                                              
                                              
                                              1,167
                                              
                                              
                                              
                                              1,102
                                              
                                              
                                              
                                              65
                                              
                                              
                                              
                                              5.9
                                              %Total
      operating expenses
                                              
                                              
                                              15,197
                                              
                                              
                                              
                                              13,343
                                              
                                              
                                              
                                              1,854
                                              
                                              
                                              
                                              13.9
                                              %Percent
      of revenues
                                              
                                              
                                              13.9
                                              %
                                              
                                              
                                              11.9
                                              %Operating
      income
                                              
                                              
                                              1,249
                                              
                                              
                                              
                                              1,578
                                              
                                              
                                              
                                              (329
                                              )
                                              
                                              
                                              (20.8
                                              )%Percent
      of revenues
                                              
                                              
                                              1.1
                                              %
                                              
                                              
                                              1.4
                                              %Other
      expense (income):Interest
      income – other
                                              
                                              
                                              (16
                                              )
                                              
                                              
                                              (11
                                              )
                                              
                                              
                                              (5
                                              )
                                              
                                              
                                              45.5
                                              %Interest
      expense
                                              
                                              
                                              303
                                              
                                              
                                              
                                              524
                                              
                                              
                                              
                                              (221
                                              )
                                              
                                              
                                              (42.2
                                              )%Other
                                              
                                              
                                              (9
                                              )
                                              
                                              
                                              4
                                              
                                              
                                              
                                              (13
                                              )
                                              
                                              
                                              (325.0
                                              )%Income
      before income taxes
                                              
                                              
                                              971
                                              
                                              
                                              
                                              1,061
                                              
                                              
                                              
                                              (90
                                              )
                                              
                                              
                                              (8.5
                                              )%Provision
      for income taxes
                                              
                                              
                                              413
                                              
                                              
                                              
                                              440
                                              
                                              
                                              
                                              (27
                                              )
                                              
                                              
                                              (6.1
                                              )%Net
      income
                                              
                                              $
                                              558
                                              
                                              
                                              $
                                              621
                                              
                                              
                                              $
                                              (63
                                              )
                                              
                                              
                                              (10.1
                                              )%Percent
      of revenues
                                              
                                              
                                              0.5
                                              %
                                              
                                              
                                              0.6
                                              %




Results
of Operations -EIS




The
following discussion and analysis provides information that management believes
is relevant to an assessment and understanding of our EIS Results of Operations
for the six months ended February 28, 2010 and 2009.


34




EIS


STATEMENTS
OF INCOME


(In
thousands)




Six
      Months Ended February 28,2010
                                  
                                  
                                  2009
                                  
                                  
                                  Change
                                  
                                  
                                  %RevenuesProcurement
      services
                                  
                                  $
                                  82,657
                                  
                                  
                                  $
                                  85,773
                                  
                                  
                                  $
                                  (3,116
                                  )
                                  
                                  
                                  -3.6
                                  %Service
      and consulting
                                  
                                  
                                  12,352
                                  
                                  
                                  
                                  6,830
                                  
                                  
                                  
                                  5,522
                                  
                                  
                                  
                                  80.8
                                  %Total Revenues
                                  
                                  
                                  95,009
                                  
                                  
                                  
                                  92,603
                                  
                                  
                                  
                                  2,406
                                  
                                  
                                  
                                  2.6
                                  %Cost of SalesCost
      of procurement services
                                  
                                  
                                  74,209
                                  
                                  
                                  
                                  76,763
                                  
                                  
                                  
                                  (2,554
                                  )
                                  
                                  
                                  -3.3
                                  %Service
      and consulting
                                  
                                  
                                  6,918
                                  
                                  
                                  
                                  4,641
                                  
                                  
                                  
                                  2,277
                                  
                                  
                                  
                                  49.1
                                  %Total Cost of Sales
                                  
                                  
                                  81,127
                                  
                                  
                                  
                                  81,404
                                  
                                  
                                  
                                  (277
                                  )
                                  
                                  
                                  -0.3
                                  %Gross ProfitProcurement
      services
                                  
                                  
                                  8,448
                                  
                                  
                                  
                                  9,010
                                  
                                  
                                  
                                  (562
                                  )
                                  
                                  
                                  -6.2
                                  %Procurement
      services %
                                  
                                  
                                  10.2
                                  %
                                  
                                  
                                  10.5
                                  %Service
      and consulting
                                  
                                  
                                  5,434
                                  
                                  
                                  
                                  2,189
                                  
                                  
                                  
                                  3,245
                                  
                                  
                                  
                                  148.2
                                  %Service
      and consulting %
                                  
                                  
                                  44.0
                                  %
                                  
                                  
                                  32.0
                                  %Total Gross Profit
                                  
                                  
                                  13,882
                                  
                                  
                                  
                                  11,199
                                  
                                  
                                  
                                  2,683
                                  
                                  
                                  
                                  24.0
                                  %Total Gross Profit %
                                  
                                  
                                  14.6
                                  %
                                  
                                  
                                  12.1
                                  %Operating
      expenses:Selling,
      general, and administrative expenses
                                  
                                  
                                  11,731
                                  
                                  
                                  
                                  9,772
                                  
                                  
                                  
                                  1,959
                                  
                                  
                                  
                                  20.0
                                  %Rent
      expense – related party
                                  
                                  
                                  203
                                  
                                  
                                  
                                  184
                                  
                                  
                                  
                                  19
                                  
                                  
                                  
                                  10.3
                                  %Depreciation
      and amortization
                                  
                                  
                                  711
                                  
                                  
                                  
                                  675
                                  
                                  
                                  
                                  36
                                  
                                  
                                  
                                  5.3
                                  %Total
      operating expenses
                                  
                                  
                                  12,645
                                  
                                  
                                  
                                  10,631
                                  
                                  
                                  
                                  2,014
                                  
                                  
                                  
                                  18.9
                                  %Percent
      of revenues
                                  
                                  
                                  13.3
                                  %
                                  
                                  
                                  11.5
                                  %Operating
      income
                                  
                                  
                                  1,237
                                  
                                  
                                  
                                  568
                                  
                                  
                                  
                                  669
                                  
                                  
                                  
                                  117.8
                                  %Percent
      of revenues
                                  
                                  
                                  1.3
                                  %
                                  
                                  
                                  0.6
                                  %Other
      expense (income):Interest
      income – other
                                  
                                  
                                  (16
                                  )
                                  
                                  
                                  (10
                                  )
                                  
                                  
                                  (6
                                  )
                                  
                                  
                                  60.0
                                  %Interest
      expense
                                  
                                  
                                  191
                                  
                                  
                                  
                                  300
                                  
                                  
                                  
                                  (109
                                  )
                                  
                                  
                                  -36.3
                                  %Other
                                  
                                  
                                  (5
                                  )
                                  
                                  
                                  -
                                  
                                  
                                  
                                  (5
                                  )
                                  
                                  
                                  N/AIncome
      before income taxes
                                  
                                  
                                  1,067
                                  
                                  
                                  
                                  278
                                  
                                  
                                  
                                  789
                                  
                                  
                                  
                                  283.8
                                  %Provision
      (benefit) for income taxes
                                  
                                  
                                  435
                                  
                                  
                                  
                                  107
                                  
                                  
                                  
                                  328
                                  
                                  
                                  
                                  306.5
                                  %Net
      income
                                  
                                  $
                                  632
                                  
                                  
                                  $
                                  171
                                  
                                  
                                  $
                                  461
                                  
                                  
                                  
                                  269.6
                                  %Percent
      of revenues
                                  
                                  
                                  0.7
                                  %
                                  
                                  
                                  0.2
                                  %




Comparison
of the Six Months Ended February 28, 2010 and 2009 - EIS




Revenues -
EIS




EIS
division’s total revenues increased $2.4 million, or 2.6%, to $95.0 million for
the six months ended February 28, 2010, compared to $92.6 million for the six
months ended February 28, 2009.  EIS division’s total revenue includes
revenues from the Company’s historical business, which we refer to as the
Systems Division, and KOAN-IT, which was acquired on February 12, 2009, and
includes the assets of EMS, which were acquired on May 12, 2009.  The
increase associated with the acquisition of KOAN-IT was $3.2 million for the six
months ended February 28, 2010. This increase is primarily due to comparing six
months of operations ended February 28, 2010 to a shorter stub period in the six
months ended February 28, 2009.  Without these acquisitions Systems
Division’s revenue decreased $755,000, or 0.8%, to $91.7 million for the six
months ended February 28, 2010, compared to $92.4 million for the six months
ended February 28, 2009.


35


Procurement
services revenue decreased $3.1 million, or 3.6%, to $82.6 million for the six
months ended February 28, 2010, compared to $85.7 million for the six months
ended February 28, 2009. This decrease is mainly due to our clients’ decreased
IT spending, particularly in commercial business and various governmental
agencies in the State of New Jersey.  We believe that this decrease in
commercial business can be attributed to the general economic
downturn.




Services
and consulting revenue increased $5.5 million, or 80.8%, to $12.3 million for
the six months ended February 28, 2010, compared to $6.8 million for the six
months ended February 28, 2009. EIS division’s services and consulting revenue
includes revenues from the Company’s historical business, which we refer to as
the Systems Division, and KOAN-IT, which was acquired on February 12, 2009, and
includes the assets of EMS, which were acquired on May 12, 2009.  The
increase associated with the acquisition of KOAN-IT was $2.7 million for the six
months ended February 28, 2010. This increase is primarily due to comparing six
months of operations ended February 28, 2010 to a shorter stub period in the six
months ended February 28, 2009.  Without these acquisitions Systems
Division’s services and consulting revenue increased $2.8 million, or 41.5%, to
$9.4 million for the six months ended February 28, 2010, compared to $6.7
million for the six months ended February 28, 2009.




Our EIS
division’s revenues, by client type, are comprised of the following (in
thousands):





For the Six Months EndedFebruary 28, 2010
                    
                    
                    February 28, 2009Departments
      of the U.S. Government
                    
                    $
                    56,915
                    
                    
                    
                    59.9
                    %
                    
                    $
                    51,440
                    
                    
                    
                    55.6
                    %Canada
      Government Agencies
                    
                    
                    721
                    
                    
                    
                    0.8
                    %
                    
                    
                    -
                    
                    
                    
                    0.0
                    %State
      and Local Governments
                    
                    
                    2,136
                    
                    
                    
                    2.2
                    %
                    
                    
                    4,945
                    
                    
                    
                    5.3
                    %Commercial
      Companies
                    
                    
                    10,813
                    
                    
                    
                    11.4
                    %
                    
                    
                    15,361
                    
                    
                    
                    16.6
                    %Education
      and other
                    
                    
                    24,424
                    
                    
                    
                    25.7
                    %
                    
                    
                    20,857
                    
                    
                    
                    22.5
                    %Total
      Revenues
                    
                    $
                    95,009
                    
                    
                    
                    100.0
                    %
                    
                    $
                    92,603
                    
                    
                    
                    100.0
                    %





During
the six months ended February 28, 2010 and 2009, U.S. governmental
department and agency related revenues represented approximately 59.9% and 55.6%
of total EIS division’s revenues, respectively. These clients include the
Department of Defense, Department of Justice, Department of Homeland Security,
Department of Health and Human Services, Department of Agriculture and
Department of Commerce. Revenues from various civilian and military U.S.
governmental departments and agencies increased by approximately $5.5 million
during the six months ended February 28, 2010 compared with the six months ended
February 28, 2009. This increase is primarily attributable to retooling of our
federal sales force during fiscal 2009 to focus more on services.




The state
and local government business remains uncertain due to the tight budgetary
pressures within governmental agencies in the State of New Jersey.




Revenues
from commercial clients decreased by approximately $4.5 million during the six
months ended February 28, 2010 compared with the six months ended February 28,
2009. This decrease is mainly due to the current economic downturn that caused
reductions in technology and discretionary spending by our commercial clients.
As mentioned previously, we have taken steps to reduce expenses in our
commercial sector.


36


During
the six months ended February 28, 2010, revenues from our education business
increased by approximately $3.6 million compared with the six months ended
February 28, 2009.  This increase is attributable to the increase in
various IT projects for school districts during the six months ended February
28, 2010.  During our fiscal years 2008 and 2009, we took steps to
increase our business with our existing customers by outsourcing more of their
infrastructure managed services needs and to increase our penetration with
additional clients in this market.  We believe these steps will
increase the amount of long-term recurring revenue we have with these
clients.
 
 Gross Profit -
EIS
  Aggregate
gross profit for our EIS division increased $2.7 million, or 24.0%, to $13.9
million for the six months ended February 28, 2010 as compared to $11.2 million
for the six months ended February 28, 2009. EIS division’s services and
consulting revenue includes revenues from the Company’s historical business,
which we refer to as the Systems Division, and KOAN-IT, which was acquired on
February 12, 2009, and includes the assets of EMS, which were acquired on May
12, 2009.  The increase associated with the acquisition of KOAN-IT was
$1.1 million for the six months ended February 28, 2010. This increase is
primarily due to comparing six months of operations ended February 28, 2010 to a
shorter stub period in the six months ended February 28,
2009.  Without these acquisitions Systems Division’s aggregated gross
profit increased $1.6 million, or 14.4%, to $12.8 million for the six months
ended February 28, 2010, compared to $11.2 million for the six months ended
February 28, 2009.  This increase is mainly attributable to various IT
projects for school districts and various departments of the U.S. government
during the six months ended February 28, 2010.
  Measured
as a percentage of revenues, our gross profit margin for our EIS division
increased to 14.6% of our EIS division’s revenues for the six months ended
February 28, 2010 from 12.1% for the six months ended February 28, 2009. This
increase is primarily a result of an increase in our service and consulting
gross profit margin attributable to higher utilization of our engineering
resources and increase in our services and consulting revenue associated with IT
projects for school districts in and various departments of the U.S. government
during the six months ended February 28, 2010.
 
 Selling, General and
Administrative Expenses -EIS
  Selling,
general and administrative expenses for our EIS division increased by $1.9
million, or 20.0% to $11.7 million for the six months ended February 28, 2010,
compared to $9.8 million for the six months ended February 28,
2009.
 
 EIS
division’s selling, general and administrative expenses includes selling,
general and administrative expenses from Systems Division and KOAN-IT which was
acquired on February 12, 2009 and the assets of EMS, which were acquired on May
12, 2009.  The increase associated with the acquisition of KOAN-IT was
$730,000 for the six months ended February 28, 2010. This increase is primarily
due to comparing six months of operations ended February 28, 2010 to a shorter
stub period in the six months ended February 28, 2009.  Without these
acquisitions Systems Division’s selling, general and administrative expenses
increased $1.2 million, or 12.7%, to $10.9 million for the six months ended
February 28, 2010, compared to $9.7 million for the six months ended February
28, 2009. This increase is mainly due to our investments in future growth as
follows: 1) approximately $575,000 in compensation of new hires and executives;
2) approximately $100,000 in recruiting fees; 3) approximately $80,000 in
marketing initiatives; 4) approximately $140,000 professional, legal and merger
related expenses; 4) the remaining approximately $200,000 in various expense
categories such as travel, lodging, training and entertainment and lodging
related expenses. Additionally, during the six months ended February 28, 2009,
the Company recovered $270,000 of previously expensed professional fees
associated with defending the Company’s tax positions during the IRS’ 2003 and
2004 tax audits and appeals process, based on an indemnification right
associated with the April 2004 Westwood merger.
  37
  Rent Expense-Related Party -
EIS
 
 We occupy
approximately 42,000 square feet of office and warehouse space in Springfield,
New Jersey. This space is leased from a limited liability company owned by a
certain former director and current officer of the Company and his related
family members. The original lease term was through April 2009 with monthly base
rent of $15,000. We exercised the option to extend the lease for an additional
five year term through April 2014, with monthly base rent of $18,000. During the
six months ended February 28, 2010 and 2009, we recorded $103,000 and $90,000 in
expense under this lease, respectively.
 
 We occupy
approximately 36,000 square feet of office and warehouse space in a 70,000
square foot building in Suwannee, GA.  This space is leased from a
limited liability company in which a certain officer of our company is a passive
investor with an approximately 10% equity interest. The current lease term is
through November 2014 with monthly rent of $21,000.  During the six
months ended February 28, 2010 and 2009, we recorded expense under this lease
totaling $100,000 and $94,000, respectively.
 
 Management
believes the facilities noted above are being leased at rates consistent with
the market rates.
 
 Depreciation and
Amortization - EIS
 
 Depreciation
and amortization expense for our EIS division increased by 5.3%, or $36,000, to
$711,000 for the six months ended February 28, 2010, compared to $675,000 for
the six months ended February 28, 2009.  EIS division’s depreciation
and amortization expense includes depreciation and amortization expense from
Systems Division and KOAN-IT, which was acquired on February 12, 2009, and the
assets of EMS, which were acquired on May 12, 2009. The increase associated with
the acquisition of KOAN-IT was $127,000 for the six months ended February 28,
2010. This increase is primarily due to comparing six months of operations ended
February 28, 2010 to a shorter stub period in the six months ended February 28,
2009.  Without these acquisitions Systems Division’s depreciation and
amortization expenses decreased $90,000, or 13.6%, to $572,000 for the six
months ended February 28, 2010, compared to $662,000 for the six months ended
February 28, 2009. This is primarily attributable to a lower depreciable capital
asset base than prior periods.
 
 As of
February 28, 2010, intangible assets of the EIS division consisted of: the
estimated value ascribed to customer relationships of $9.9 million less
accumulated amortization of $2.9 million; the estimated value ascribed to
non-competes of $29,000 less accumulated amortization of $6,000; and the
estimated value ascribed to trademarks of $175,000 less accumulated amortization
of $37,000.  As of August 31, 2009 intangible assets of the EIS division
consisted of: the estimated value ascribed to customer relationships of $9.9
million less accumulated amortization of $2.5 million; the estimated value
ascribed to non-competes of $28,000 less accumulated amortization of $3,000; and
the estimated value ascribed to trademarks of $169,000 less accumulated
amortization of $19,000. The assets ascribed to customer relationships are being
amortized on a straight-line basis over 6 to 15 years and non-compete covenants
and trademarks are being amortized on a straight-line basis over 5 years. 
Amortization expense for the EIS division was $418,000, and $299,000 for the six
months ended February 28, 2010 and 2009, respectively.
  38
  Operating Income -
EIS
 
 Operating
income for our EIS division for the six months ended February 28,
2010 increased by 117.8%, or $669,000, to $1.2 million, compared to
operating income of $568,000 for the six months ended February 28, 2009.
This increase in operating income is mainly attributable to increased services
and consulting revenue as discussed in the Total Revenue and Gross Profit
sections above.
 
 Interest expense -
EIS
 
 Interest
expense for the EIS division decreased by 36.3%, or $109,000, to $191,000 for
the six months ended February 28, 2010, compared to $300,000 for the six months
ended February 28, 2009.  We recorded approximately $20,000 in unused
floor plan fees as interest expense during the six months ended February 28,
2010. Without this unused floor plan fee accrual under the credit facility with
the Lender, our interest expense would have been decreased by
$129,000.  This is primarily attributable to lower balances on various
notes payable and a lower average interest rate charged on the line of credit,
which was attributable to a decrease in the prime rate during this period. The
average interest rate charged on the line of credit by the Lender was
approximately 3.5% and 4.1% for six months ended February 28, 2010 and 2009,
respectively.
 
 Provision for income taxes
-EIS
 
 We
recorded income tax expense of $435,000 for the six months ended February 28,
2010 as compared to $107,000 for the six months ended February 28, 2009. The
effective tax rate was 40.9% for the six months ended February 28, 2010 as
compared to 38.4% for the three months ended February 28, 2009. The lower
effective tax rate in the six months ended February 28, 2009 was primarily
the result of over accruals of interest expense in prior periods that
resulted in recognition of offsets to income tax expense for the six months
ended February 28, 2009 due to net tax settlements during the
period.
  39
  Results
of Operations –EGS
  The
following discussion and analysis provides information that management believes
is relevant to an assessment and understanding of our EGS Results of Operations
for the six months ended February 28, 2010 and 2009.
  EGS
 STATEMENTS
OF INCOME
 (In
thousands)
 Six Months Ended February 28,2010
                                    
                                    
                                    2009
                                    
                                    
                                    Change
                                    
                                    
                                    %RevenuesService
      and consulting
                                    
                                    $
                                    14,671
                                    
                                    
                                    $
                                    19,378
                                    
                                    
                                    $
                                    (4,707
                                    )
                                    
                                    
                                    -24.3
                                    %Total Revenues
                                    
                                    
                                    14,671
                                    
                                    
                                    
                                    19,378
                                    
                                    
                                    
                                    (4,707
                                    )
                                    
                                    
                                    -24.3
                                    %Cost of SalesService
      and consulting
                                    
                                    
                                    12,107
                                    
                                    
                                    
                                    15,656
                                    
                                    
                                    
                                    (3,549
                                    )
                                    
                                    
                                    -22.7
                                    %Total Cost of Sales
                                    
                                    
                                    12,107
                                    
                                    
                                    
                                    15,656
                                    
                                    
                                    
                                    (3,549
                                    )
                                    
                                    
                                    -22.7
                                    %Gross ProfitService
      and consulting
                                    
                                    
                                    2,564
                                    
                                    
                                    
                                    3,722
                                    
                                    
                                    
                                    (1,158
                                    )
                                    
                                    
                                    -31.1
                                    %Service
      and consulting %
                                    
                                    
                                    17.5
                                    %
                                    
                                    
                                    19.2
                                    %Total Gross Profit
                                    
                                    
                                    2,564
                                    
                                    
                                    
                                    3,722
                                    
                                    
                                    
                                    (1,158
                                    )
                                    
                                    
                                    -31.1
                                    %Total Gross Profit %
                                    
                                    
                                    17.5
                                    %
                                    
                                    
                                    19.2
                                    %Operating
      expenses:Selling,
      general, and administrative expenses
                                    
                                    
                                    1,988
                                    
                                    
                                    
                                    2,164
                                    
                                    
                                    
                                    (176
                                    )
                                    
                                    
                                    -8.1
                                    %Rent
      expense – related party
                                    
                                    
                                    108
                                    
                                    
                                    
                                    121
                                    
                                    
                                    
                                    (13
                                    )
                                    
                                    
                                    -10.7
                                    %Depreciation
      and amortization
                                    
                                    
                                    456
                                    
                                    
                                    
                                    427
                                    
                                    
                                    
                                    29
                                    
                                    
                                    
                                    6.8
                                    %Total
      operating expenses
                                    
                                    
                                    2,552
                                    
                                    
                                    
                                    2,712
                                    
                                    
                                    
                                    (160
                                    )
                                    
                                    
                                    -5.9
                                    %Percent
      of revenues
                                    
                                    
                                    17.4
                                    %
                                    
                                    
                                    14.0
                                    %Operating
      income
                                    
                                    
                                    12
                                    
                                    
                                    
                                    1,010
                                    
                                    
                                    
                                    (998
                                    )
                                    
                                    
                                    -98.8
                                    %Percent
      of revenues
                                    
                                    
                                    0.1
                                    %
                                    
                                    
                                    5.2
                                    %Other
      expense (income):Interest
      income – other
                                    
                                    
                                    -
                                    
                                    
                                    
                                    (1
                                    )
                                    
                                    
                                    1
                                    
                                    
                                    
                                    -100.0
                                    %Interest
      expense
                                    
                                    
                                    112
                                    
                                    
                                    
                                    224
                                    
                                    
                                    
                                    (112
                                    )
                                    
                                    
                                    -50.0
                                    %Other
                                    
                                    
                                    (4
                                    )
                                    
                                    
                                    4
                                    
                                    
                                    
                                    (8
                                    )
                                    
                                    
                                    -200.0
                                    %Income
      (loss) before income taxes
                                    
                                    
                                    (96
                                    )
                                    
                                    
                                    783
                                    
                                    
                                    
                                    (879
                                    )
                                    
                                    
                                    -112.3
                                    %Provision
      (benefit) for income taxes
                                    
                                    
                                    (22
                                    )
                                    
                                    
                                    333
                                    
                                    
                                    
                                    (355
                                    )
                                    
                                    
                                    -106.6
                                    %Net
      income (loss)
                                    
                                    $
                                    (74
                                    )
                                    
                                    $
                                    450
                                    
                                    
                                    $
                                    (524
                                    )
                                    
                                    
                                    -116.4
                                    %Percent
      of revenues
                                    
                                    
                                    -0.5
                                    %
                                    
                                    
                                    2.3
                                    %
  Comparison
of the Six Months Ended February 28, 2010 and 2009 - EGS
  Revenues -
EGS
  EGS
revenue consists of its ERP and Application Development practice and its
Business Analysis and Quality Assurance practice.  EGS division’s
total revenues decreased $4.7 million, or 24.3%, to $14.7 million for the six
months ended February 28, 2010, compared to $19.4 million for the six months
ended February 28, 2009. This decline was caused by a 18.0% decrease in hours
billed and a 7.6% decrease in the average hourly billing rate during the six
months ended February 28, 2010 compared with the corresponding period in 2009.
The decrease in billable hours and rate is mainly due to decreases in our
Business Analysis and Quality Assurance practices. Most of the clients EGS
serves are commercial clients and we believe that this decrease in commercial
business is primarily attributed to the current general economic
downturn.
  40
  Gross
Profit - EGS
  EGS
division’s gross profit decreased $1.1 million, or 31.1%, to $2.6 million for
the six months ended February 28, 2010, compared to $3.7 million for the six
months ended February 28, 2009. We believe this decrease is mainly due to the
general economic downturn as discussed in the Revenue section
above.
 
 Measured
as percentages of revenues, our gross profit margin for the EGS division
decreased to 17.5% of our EGS division’s revenues for the six months ended
February 28, 2010 from 19.2% for the six months ended February 28, 2009. We
believe this decrease is mainly due to the decreased billing rate per hour that
resulted from, pricing pressure from our commercial clients.
 
 Selling, General and
Administrative Expenses - EGS
 
 EGS
division’s selling, general and administrative expenses decreased $176,000, or
8.1%, to $2.0 million, for the six months ended February 28, 2010, compared to
$2.2 million for the six months ended February 28, 2009. This decrease in
selling, general and administrative expenses is primarily attributable to the
reduction of various expense categories including commissions due to lower gross
profits, travel, lodging, recruiting, business insurance, rent for guesthouses,
professional and consulting fees and training and others. Selling, general and
administrative expenses for the six months ended February 28, 2010 includes
$90,000 in retention bonuses paid to business development
personnel.
 
 Rent Expense-Related Party -
EGS
  We occupy
approximately 20,000 square feet of office space in Fremont, CA.  This
space is leased from the spouse of the President of eBAS/Aveeva.  The
lease term is for 3 years with monthly base rent of $20,000. In March 2009, we
subleased portion of the building for a monthly rent of $3,000 on a
month-to-month basis, which was terminated effective February 1,
2010. During the six months ended February 28, 2010 and 2009, we recorded
expense under this lease totaling $108,000 and $121,000 in expense under this
lease.
 
 Management
believes the lease noted above is being leased at a rate consistent with the
market rate.
 
 Depreciation and
Amortization - EGS
 
 EGS
division’s depreciation and amortization expense increased $29,000, or 6.8%, to
$456,000 for the six months ended February 28, 2010, compared to $427,000 for
the six months ended February 28, 2009. The increase is due to depreciation
expense associated with computer equipment we purchased for our training
facility during six months ended August 31, 2009.
  41
  As of
February 28, 2010, intangible assets of the EGS division consisted of the
estimated value ascribed to customer relationships of $4.2 million less
accumulated amortization of $1.2 million, and the estimated value ascribed to
non-competes of $370,000 less accumulated amortization of $123,000. As of
August 31, 2009, intangible assets of the EGS division consisted of the
estimated value ascribed to customer relationships of $4.2 million less
accumulated amortization of $820,000, and the estimated value ascribed to
non-competes of $370,000 less accumulated amortization of $86,000. The assets
ascribed to customer relationships are being amortized on a straight-line basis
over 5 to 9 years and noncompete covenants and trademarks are being amortized on
a straight-line basis over 5 years. Amortization expense for the EGS division
was $399,000, and $400,000 for the six months ended February 28, 2010 and 2009,
respectively.
  Operating income
-EGS
 
 Operating
income for our EGS division for the six months ended February 28, 2010 decreased
by 98.8%, or $998,000, to $12,000, compared to operating income of $1.0 million
for the six months ended February 28, 2009. This decrease in operating income is
mainly due to a decrease in services and consulting revenue as discussed in the
Revenue and Gross Profit sections above. Additionally, during the six months
ended February 28, 2010, we paid $90,000 in retention bonuses to business
development personnel, which decreased our operating income.
  Interest expense
-EGS
 
 Interest
expense for our EGS division for the six months ended February 28, 2010
decreased by 50.0%, or $112,000, to $112,000, compared to interest expense of
$224,000 for the six months ended February 28, 2009. This is primarily
attributable to lower total interest on an 8% subordinated note payable, which
was paid in full in September 2009 and a lower average interest rate charged on
the line of credit attributable to a decrease in the prime rate during this
period. The average interest rate charged on the line of credit by the Lender
was approximately 3.5% and 4.1% for six months ended February 28, 2010 and 2009,
respectively.
 
 Provision for income taxes
-EGS
  
 We
recorded an income tax benefit of $22,000 for the six months ended February 28,
2010 as compared to income tax expense of $333,000 for the six months ended
February 28, 2009. The effective tax benefit rate was 22.9% for the six months
ended February 28, 2010 as compared to tax rate of 42.5% for the six months
ended February 28, 2009. The higher effective tax rate in the six
months ended February 28, 2010 was primarily the result of the effect of
permanently non-deductible expenses on a smaller pre-tax income
base.
  42
  Recently
Issued Accounting Standards
  Noncontrolling
Interests in Consolidated Financial Statements
 
 We
adopted the new accounting and presentation standards for noncontrolling
interests in accordance with ASC 810 “Consolidation” effective September 1,
2009.  This statement establishes accounting and reporting standards
for the noncontrolling interests (minority interests) in a subsidiary and for
the deconsolidation of a subsidiary. Effective September 1, 2009, noncontrolling
interests will be classified as equity in the Company’s financial statements and
income and comprehensive income attributed to the noncontrolling interests will
be included in the Company’s income and comprehensive income. The provisions of
this standard must be applied retrospectively upon adoption. The adoption of the
new accounting and presentation standards did not have any effect on our
financial statements since all of our existing subsidiaries are
wholly-owned.
 
 Stock
Warrants
  We
adopted the FASB Accounting Standards Codification of which certain literature
was originally documented in EITF 07-05  “Determining Whether an
Instrument (or Embedded Feature) is Indexed to an Entity’s Own Stock Abstract,”
to determine if liability treatment would be necessary for the outstanding stock
warrants effective September 1, 2009.  The provisions of this standard
must be applied retrospectively upon adoption. The adoption of these standards
related to the outstanding warrants for the Company was not recorded in the
financial statements because the Company determined that the impact was not
material.
 
 Business
Combinations
 
 We
adopted the new accounting standard for business combinations in accordance with
ASC 805 “Business Combinations.”  The new standard establishes
principles and requirements for how an acquirer in a business combination
recognizes and measures the assets acquired, liabilities assumed and any
noncontrolling interest in the acquiree. The new provisions of ASC 805 are
effective for our business combinations occurring on or after September 1,
2009.  There was no financial statement impact upon adoption of the
provision of ASC 805, but it may materially affect our accounting for future
acquisitions.
 
 Subsequent
Events
 
 In
February 2010, the Financial Accounting Standards Board (“FASB”) issued amended
guidance on subsequent events. Under this amended guidance, SEC filers are no
longer required to disclose the date through which subsequent events have been
evaluated in originally issued and revised financial statements. This guidance
was effective immediately and we adopted these new requirements for the period
ended February 28, 2010.
  Recurring
and Nonrecurring Fair Value Measurements
 
 In
January 2010, the FASB issued guidance to amend the disclosure requirements
related to recurring and nonrecurring fair value measurements. The guidance
requires disclosure of transfers of assets and liabilities between Level 1 and
Level 2 of the fair value measurement hierarchy, including the reasons and the
timing of the transfers and information on purchases, sales, issuance, and
settlements on a gross basis in the reconciliation of the assets and liabilities
measured under Level 3 of the fair value measurement hierarchy. This guidance is
effective for us beginning March 1, 2010. We do not expect the adoption
will have an impact on its consolidated financial position or results of
operations.
 
 43
  Liquidity
and Capital Resources
  Cash at
February 28, 2010 of $2.8 million represented an increase of $1.1 million from
cash of $1.7 million at August 31, 2009. We are a net borrower; consequently, we
believe our cash balance must be viewed along with the available balance on our
line of credit.  Borrowings under our line of credit at February 28,
2010 increased to $10.6 million from $9.0 million at August 31, 2009. As of
February 28, 2010, our net working capital (defined as the excess of our current
assets over our current liabilities) was $1.6 million higher than it was at
August 31 2009.
 
 The
Company, Emtec NJ, Emtec LLC, Emtec Federal, Emtec Global, Luceo, eBAS and
Aveeva (collectively, the “Borrower”), are parties to a Loan and Security
Agreement with De Lage Landen Financial Services, Inc. (the “Lender”) pursuant
to which the Lender provides the Borrower with a revolving credit loan and floor
plan loan (the “Credit Facility”) until December 7, 2010. The Credit Facility
provides for aggregate borrowings of the lesser of $32.0 million or 85% of
Borrower’s eligible accounts receivable, plus 100% of unsold inventory financed
by the Lender. The floor plan loan portion of the Credit Facility is for the
purchase of inventory from approved vendors and for other business purposes. The
Credit Facility subjects the Borrower to mandatory repayments upon the
occurrence of certain events as set forth in the Credit Facility. For detailed
information on terms of the Credit Facility, refer to footnote#6 – Line of
Credit of the Condensed Consolidated Financial Statements in this Quarterly
Report on the Form 10-Q for the six months ended February 28, 2010, or the
annual financial statements and notes thereto included in the Company's Annual
Report on Form 10-K for the fiscal year ended August 31, 2009.
  The
Company had balances of $10.6 million and $9.0 million outstanding under the
revolving portion of the Credit Facility, and balances of
$929,000  and $5.4 million (included in the Company’s accounts
payable) outstanding plus $578,000 and $321,000 in open approvals under the
floor plan portion of the Credit Facility at  February 28, 2010 and
August 31, 2009, respectively. Net availability was $4.3 million and $11.9
million under the revolving portion of the Credit Facility, and additionally
$15.6 million and $5.4 million was available under the floor plan portion of the
Credit Facility as of February 28, 2010 and August 31, 2009,
respectively.
 
 As of
February 28, 2010, the Company determined that it was in compliance with its
financial covenants under the Credit Facility.
 
 As of
February 28, 2010, we had open term credit facilities with our primary trade
vendors, including aggregators and manufacturers, of approximately $41.5 million
with outstanding principal of approximately $10.5 million. Under these lines, we
are typically obligated to pay each invoice within 30-45 days from the date of
such invoice. These credit lines could be reduced or eliminated without notice
and this action could have a material adverse affect on our business, result of
operations and financial condition.
  Capital
expenditures of approximately $251,000 during the six months ended February 28,
2010 related primarily to the purchase of computer equipment for internal use,
purchase of automobile for our service technicians and software costs to upgrade
various modules of our accounting systems.
  44
 
 We
anticipate that our primary sources of liquidity in fiscal year 2010 will be
cash generated from operations, trade vendor credit and cash available to us
under our 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 affect on our
revenues. Our future financial performance could be negatively affected by
unforeseen factors and unplanned expenses.
 
 We
believe that funds generated from operations, trade vendor credit and bank
borrowings should be sufficient to meet our current operating cash requirements
through the next twelve months. However, there can be no assurance that all of
the aforementioned sources of cash can be realized.
 
 Critical
Accounting Policies
  Our
financial statements are prepared in accordance with accounting principles that
are generally accepted in the United States. 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, 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.
  Revenue
Recognition
  We are an
IT systems integrator, providing consulting, staffing, application services and
infrastructure solutions to commercial, federal, education, 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.
  In
accordance with paragraph 40 FASB Topic ASC paragraph 280-10-50, it is
impracticable for us to report the revenues from external customers for each of
our products and services or each group of similar products and services
offered. Our revenue recognition policy is as follows:
  We
recognize revenue from the sales of products when risk of loss and title passes,
which is upon client acceptance.
  Product
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 Staff Accounting
Bulletin 104 (“SAB 104”) 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:
  45
  §
              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 & hold”
      basis.  We follow the SAB 104 criteria and recognize revenue
      from these sales prior to date of physical delivery only when all the
      criteria of SAB 104 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. As of February
      28, 2010 and 2009, we did not have any bill & hold
      transactions.
  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
product 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.
  Revenue
from the sale of warranties and support service contracts is recognized on a
straight-line basis over the term of the contract.
  We
recognize revenue from sale arrangements that contain both procurement revenue
and services and consulting revenue 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.
  Service
and consulting 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.
  46
  Trade
Receivables
 
 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.
 
 Inventories
 
 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.
 
 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 Others”, 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.
 Intangible
assets at November 30, 2009 and August 31, 2009 consisted of the value ascribed
to customer relationships and noncompete covenants.  The assets
ascribed to customer relationships are being amortized on a straight-line basis
over 5 to 15 years and five years for noncompete
covenants.  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 350 “Intangibles-Goodwill and
Others.”  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.
 
 Rebates
 
 Rebates
are recorded in the accompanying consolidated statements of income as a
reduction of the cost of revenues.
  47
  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.
 
 48
  Item
3.     Quantitative and Qualitative Information About
Market Risk
  We do not
engage in trading market risk sensitive instruments and do not purchase hedging
instruments or “other than trading” instruments that are likely to expose us to
market risk, whether interest rate, foreign currency exchange, commodity price
or equity price risk.  We have entered into no forward or future
contracts, purchased no options and entered into no swaps.  Our
primary market risk exposures are those of interest rate
fluctuations.  A change in interest rates would affect the rate at
which we could borrow funds under our revolving credit facility.  Our
balance on the line of credit at February 28, 2010 was approximately $10.6
million. Assuming no material increase or decrease in such balance, a one
percent change in the interest rate would change our interest expense by
approximately $106,000 annually.
  49
  Item
4T.   Controls and Procedures
  (a) Our
management carried out an evaluation, with the participation of our Chief
Executive Officer and Chief Financial Officer, of the effectiveness of our
disclosure controls and procedures (as defined in Rule 13a-15(e) under the
Securities Exchange Act of 1934, as amended (the “Exchange Act”)) as of February
28, 2010.  Based upon that evaluation, our Chief Executive Officer and
Chief Financial Officer concluded that our disclosure controls and procedures
including the accumulation and communication of disclosures to the Company’s
Chief Executive Officer and Chief Financial Officer as appropriate to allow
timely decision regarding required disclosure, were effective to provide
reasonable assurance that information required to be disclosed by us in reports
that we file or submit under the Exchange Act are recorded, processed,
summarized and reported, within the time periods specified in the rules and
forms of the SEC. It should be noted that the design of any system of controls
is based in part upon certain assumptions about the likelihood of future events,
and there can be no assurance that any design will succeed in achieving the
stated goals under all potential future conditions, regardless of how
remote.
  (b) There
has not been any change in our internal control over financial reporting in
connection with the evaluation required by Rule 13a-15(d) under the Exchange Act
that occurred during the quarter ended February 28, 2010 that has materially
affected, or is reasonably likely to materially affect, our internal control
over financial reporting.
  50
  PART
II – OTHER INFORMATION
  Item
1.     Legal Proceedings
  During
December 2007, we received a subpoena issued by the GSA Office of Inspector
General,  apparently as part of an ongoing, industry-wide
investigation.  We produced documents and data in response to the subpoena
to the OIG during 2008.  In September 2009, we became aware that the
Company had been named along with several other prominent IT companies in a qui
tam lawsuit entitled Christopher Crennen, et al., v. Dell
Marketing, et al., filed in the United States District Court for the
District of Massachusetts alleging violations of the False Claims Act related to
the Company's obligations under the Buy American Act and the Trade Agreements
Act.  Qui tam lawsuits typically remain under seal (hence, usually unknown
to the defendant) for some time while the government decides whether or not to
intervene on behalf of a private qui tam plaintiff (known as a relator) and take
the lead in the litigation.  These lawsuits can involve significant
monetary damages and penalties and award bounties to private plaintiffs who
successfully bring the suits.  The lawsuit, which was previously under
seal, appears to have been the cause of the OIG subpoena.  Despite its
investigation, to date the government has declined to intervene in the lawsuit,
however we can provide no assurance that the government will not intervene in
this case or in any other qui tam suit against the Company in the
future.   The Company does not know whether the relators will pursue
the qui tam lawsuit independently.  We have filed a motion to dismiss the
lawsuit.  At this time, we are unable to predict the timing and
outcome of this matter.
  The
Company is occasionally involved in various lawsuits, claims, and administrative
proceedings arising in the normal course of business.  Except as set
forth above, the Company believes that any liability or loss associated with
such matters, individually or in the aggregate, will not have a material adverse
effect on the Company’s financial condition or results of
operations.
  51
  Item
4.      Submission of Matters to a vote by
Securities Holders
  The
Annual Meeting of Shareholders of the Company (the “Meeting”) was held on
February 4, 2010. There were present at the Meeting in person or by proxy
shareholders holding an aggregate of 14,743,023 shares of Common Stock out of a
total number of 15,742,431 shares of Common Stock outstanding and entitled to
vote at the Meeting.
 
 1.
              Election
      of  Directors.
 
 The
following directors were elected as Class A directors.
 
 NOMINEE
                                        
                                        FOR
                                        
                                        
                                        AGAINST
                                        
                                        
                                        ABSTENSIONSRobert
      J. Mannarino
                                        
                                        13,809,800
                                        
                                        
                                        500
                                        
                                        
                                        932,723Gregory
      L. Cowan
                                        
                                        13,809,800
                                        
                                        
                                        500
                                        
                                        
                                        932,723
 
 2.
              The
      stockholders ratified the appointment of McGladrey & Pullen, LLP as
      the Company’s independent registered public accounting firm for the fiscal
      year ending August 31, 2010 by the vote set forth
  below:
  FOR
              
              AGAINST
              
              
              ABSTENSIONS14,084,261
              
              50,894
              
              
              607,180
  The terms
of office of Dinesh R. Desai, Brian McAdams and Gregory Chandler as Class A
directors continue until the 2012 annual meeting of stockholders.
  52
  Item
6.     Exhibits
  Exhibit 10.1 –
Employment Agreement between the Company and Brian Mandel dated March 1,
2010.
  Exhibit 10.2 – Second
Lease Amendment dated December 1, 2009, between the Company and GS&T
Properties, LLC for office space in Suwanee, Georgia.
  Exhibit 10.3 – Lease
Agreement dated March 9, 2010, between the Company and Brandywine Radnor Center,
LLC for office space in Radnor, Pennsylvania.
  Exhibit 10.4 –
Employment Agreement between the Company and Samir Bhatt dated December 1,
2009.(1)
  Exhibit 31.1 - Rule
13a-14(a)/15d-14(a) Certification of Dinesh R. Desai, Principal Executive
Officer, of Emtec, Inc. datedApril 14, 2010.
  Exhibit 31.2 - Rule
13a-14(a)/15d-14(a) Certification of Gregory P. Chandler, Principal Financial
Officer, of Emtec, Inc. dated April 14, 2010.
  Exhibit 32.1 -
Section 1350 Certificate of Dinesh R. Desai, Principal Executive Officer, of
Emtec, Inc. dated April 14, 2010.
  Exhibit 32.2 -
Section 1350 Certificate of Gregory P. Chandler, Principal Financial Officer, of
Emtec, Inc. dated April 14, 2010.
 (1)Previously filed as an
exhibit to Registrant’s Form 10-Q dated November 30, 2009, filed on January 14,
2010 and incorporated herein by reference.
  53
 
 SIGNATURES
 
 Pursuant
to the requirements of the Securities Exchange Act of 1934, the Registrant has
duly caused this Report to be signed on its behalf by the undersigned thereunto
duly authorized.
 
 EMTEC,
      INC.By:
                  /s/  DINESH R.
    DESAIDinesh
      R. DesaiChairman and ChiefExecutive
      Officer(Principal Executive Officer)By:
                  /s/  GREGORY P.
      CHANDLERGregory P. ChandlerChief Financial Officer(Principal Financial
Officer)
 
 Date:
April 14, 2010
  54