UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(x) Quarterly report pursuant to
Section 13 or 15(d) of the Securities Exchange Act of 1934
For the quarterly period ended April 03, 2004
or
[ ] Transition report pursuant to Section 13 or 15(d) of the
Securities Exchange Act of 1934
COMMISSION FILE NUMBER: 0-27617
THE MANAGEMENT NETWORK GROUP, INC.
(Exact name of registrant as specified in its charter)
DELAWARE 48-1129619
------------------------------- ------------------
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
7300 COLLEGE BLVD., SUITE 302, OVERLAND PARK, KS 66210
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(Address of principal executive offices) (Zip Code)
913-345-9315
--------------------------------------------------
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 is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act). Yes [ ] No [X]
Indicate the number of shares outstanding of each of the issuer's classes of
common stock as of the latest practicable date.
As of May 14, 2004 TMNG had outstanding 34,661,541 shares of common stock.
THE MANAGEMENT NETWORK GROUP, INC.
INDEX
PAGE
----
PART I. FINANCIAL INFORMATION:
ITEM 1. Consolidated Condensed Financial Statements:
Consolidated Condensed Balance Sheets (unaudited)- April 03, 2004
and January 03, 2004 .................................... 3
Consolidated Condensed Statements of Operations and
Comprehensive Loss (unaudited) - Thirteen weeks
ended April 03, 2004 and March 29, 2003 .................... 4
Consolidated Condensed Statements of Cash Flows
(unaudited) - Thirteen weeks ended April 03, 2004
and March 29, 2003 ......................................... 6
Notes to Consolidated Condensed Financial Statements
(unaudited) ................................................ 8
ITEM 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations .............. 11
ITEM 3. Quantitative and Qualitative Disclosures About
Market Risk ................................................ 16
ITEM 4. Controls and Procedures ..................................... 16
PART II. OTHER INFORMATION
ITEM 1. Legal Proceedings ........................................... 16
ITEM 6. Exhibits and Reports on Form 8-K ............................ 16
Signatures............................................................ 16
Certifications........................................................ 17
Exhibits.............................................................. 17
PART I. FINANCIAL INFORMATION
ITEM 1. CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
THE MANAGEMENT NETWORK GROUP, INC.
CONSOLIDATED CONDENSED BALANCE SHEETS
(In thousands, except share data)
(unaudited)
January 03, April 03,
2004 2004
------------ -----------
CURRENT ASSETS:
Cash and cash equivalents ................................ $ 52,875 $ 51,184
Receivables:
Accounts receivable .................................... 5,376 4,842
Accounts receivable - unbilled ......................... 2,140 3,469
--------- ---------
7,516 8,311
Less: Allowance for doubtful accounts .................. (652) (767)
--------- ---------
6,864 7,544
Refundable income taxes ................................. 1,557 1,506
Prepaid and other assets ................................. 710 1,086
--------- ---------
Total current assets ........................... 62,006 61,320
--------- ---------
Property and Equipment (net of accumulated depreciation of
$2,722 and $2,904 for fiscal year ended January 3, 2004
and thirteen weeks ended April 3, 2004) ................. 1,558 1,411
Goodwill ................................................... 15,528 13,365
Customer relationships, net 541 498
Identifiable intangible assets, net ........................ 937 642
Other assets ............................................... 402 416
--------- ---------
Total Assets ............................................... $ 80,972 $ 77,652
========= =========
CURRENT LIABILITIES:
Trade accounts payable ................................... $ 635 $ 477
Accrued payroll, bonuses and related expenses ............ 1,251 1,694
Other accrued liabilities ................................ 1,816 1,754
Deferred revenue ......................................... 288 471
Unfavorable and capital lease obligations 785 696
--------- ---------
Total current liabilities ...................... 4,775 5,092
Unfavorable and capital lease obligations .................. 2,828 2,667
STOCKHOLDERS' EQUITY
Common Stock: ............................................ 34 34
Voting - $.001 par value, 100,000,000 shares
authorized; 34,371,068 and 34,551,533 issued and
outstanding on January 03, 2004 and April 03, 2004,
respectively
Additional paid-in capital ............................... 157,292 157,677
Accumulated deficit ...................................... (82,190) (86,441)
Accumulated other comprehensive income -
Foreign currency translation adjustment ................. 176 161
Unearned compensation .................................... (1,943) (1,538)
--------- ---------
Total stockholders' equity ...................... 73,369 69,893
--------- ---------
Total Liabilities and Stockholders' Equity ................. $ 80,972 $ 77,652
========= =========
See notes to consolidated condensed financial statements.
THE MANAGEMENT NETWORK GROUP, INC.
CONSOLIDATED CONDENSED STATEMENTS OF OPERATIONS AND
COMPREHENSIVE LOSS
(In thousands, except per share data)
(unaudited)
For the Thirteen Weeks Ended
------------------------------
March 29, April 03,
2003 2004
--------- ---------
Revenues .................................. $ 7,240 $ 5,779
Cost of Services:
Direct cost of services ................. 3,673 2,913
Equity related charges (benefit) ........ (20) 54
-------- --------
Total cost of services ................ 3,653 2,967
-------- --------
Gross Profit .............................. 3,587 2,812
Operating Expenses:
Selling, general and administrative ..... 5,071 4,278
Equity related charges .................. 11 283
Intangible asset amortization............ 715 339
-------- --------
Total operating expenses .............. 5,797 4,900
-------- --------
Loss from operations ...................... (2,210) (2,088)
Other Income:
Interest income ......................... 177 136
Other, net .............................. (17) (9)
-------- --------
Total other income .................... 160 127
-------- --------
Loss from continuing operations before
income tax (provision) benefit ........... (2,050) (1,961)
Income tax (provision) benefit ............ 748 (14)
-------- --------
Loss from continuing operations............ (1,302) (1,975)
-------- -------
Discontinued operations:
Net income (loss) from discontinued operations
(net of income tax provision of $47 for the
thirteen weeks ended March 29, 2003 and including
charge for impairment of goodwill of $2,163 for
the thirteen weeks ended April 3, 2004) 71 (2,276)
-------- --------
Net loss (1,231) (4,251)
Other comprehensive item -
Foreign currency translation
adjustment ............................ (14) (15)
-------- --------
Comprehensive loss ........................ $ (1,245) $ (4,236)
======== ========
Loss from continuing operations
per common share
Basic and Diluted $ (0.04) $ (0.06)
======== ========
Loss from discontinued operations
per common share
Basic and Diluted $ (0.06)
======== ========
Loss per common share
Basic and Diluted $ (0.04) $ (0.12)
======== ========
Shares used in calculation of loss
from continuing operations, loss from
discontinued operations, and net loss
per common share
Basic and Diluted ..................... 33,347 34,503
======== ========
On March 4, 2004, management and the Board of Directors elected to shut down the
hardware segment of the Company. The quarter ended March 29, 2003 has been
restated to report the income from discontinued operations, net of tax. For a
further discussion see Item 1, "Notes to Consolidated Condensed Financial
Statements, Note 3 "Discontinued Operations."
See notes to consolidated condensed financial statements.
THE MANAGEMENT NETWORK GROUP, INC.
CONSOLIDATED CONDENSED STATEMENTS OF CASH FLOWS
(In thousands)
(unaudited)
For the Thirteen Weeks Ended
------------------------------
March 29, April 03,
2003 2004
---------- ---------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss ..................................... $ (1,231) $ (4,251)
Deduct:
Income(loss)from discontinued operations 71 (2,276)
-------- --------
Loss from continuing operations (1,302) (1,975)
Adjustments to reconcile net loss to net
cash provided by operating activities:
Depreciation and amortization ...................... 945 521
Equity related charges (benefit) ................... (9) 337
Income tax charge recognized upon exercise
of stock options ................................ (13)
Deferred income taxes .............................. 56
Other changes in operating assets and
liabilities:
Accounts receivable ........................... 1,475 649
Accounts receivable - unbilled ................ 309 (1,329)
Refundable income taxes ....................... (841) 51
Prepaid and other assets ...................... 367 (390)
Trade accounts payable ........................ (350) (158)
Deferred revenue .............................. 170 183
Accrued liabilities ........................... (145) 231
-------- --------
Net cash provided by (used in) continuing
operations ................................ 662 (1,880)
Net cash provided by (used in) discontinued
operations ................................. 71 (113)
-------- --------
Net cash provided by (used in) operating
Activities ................................. 733 (1,993)
-------- --------
CASH FLOWS FROM INVESTING ACTIVITIES:
Acquisition of property and equipment ................. (10) (35)
-------- --------
Net cash used in investing
activities ................................. (10) (35)
-------- --------
CASH FLOWS FROM FINANCING ACTIVITIES:
Payments made on long-term obligations ................ (122) (100)
Proceeds from exercise of options ..................... 12 453
-------- --------
Net cash provided by (used in) financing
activities ................................. (110) 353
-------- --------
Effect of exchange rate on cash and cash
equivalents ............................................ (14) (15)
-------- --------
Net increase (decrease) in cash and cash equivalents .... 599 (1,691)
Cash and cash equivalents, beginning of period .......... 53,786 52,875
-------- --------
Cash and cash equivalents, end of period ................ $ 54,385 $ 51,184
======== ========
Supplemental disclosure of cash flow information:
Cash paid during period for interest .................... $ 17 $ 9
======== ========
Cash paid during period for taxes ....................... $ 98 $ 14
======== ========
See notes to consolidated condensed financial statements.
THE MANAGEMENT NETWORK GROUP, INC.
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
(UNAUDITED)
1. Basis of Reporting
The accompanying consolidated condensed financial statements of The Management
Network Group, Inc. (the "Company") as of April 03, 2004, and for the thirteen
weeks ended April 03, 2004 and March 29, 2003, are unaudited and reflect all
normal recurring adjustments which are, in the opinion of management, necessary
for the fair presentation of the Company's consolidated condensed financial
position, results of operations, and cash flows as of these dates and for the
periods presented. The consolidated condensed financial statements have been
prepared in accordance with accounting principles generally accepted in the
United States of America for interim financial information. Consequently, these
statements do not include all the disclosures normally required by accounting
principles generally accepted in the United States of America for annual
financial statements nor those normally made in the Company's annual report on
Form 10-K. Accordingly, reference should be made to the Company's annual report
on Form 10-K for additional disclosures, including a summary of the Company's
accounting policies.
Stock Based Compensation
During the thirteen weeks ended April 3, 2004, the Company recognized
approximately $337,000 in compensation expense related primarily to the issuance
of restricted stock grants made to key management personnel. The grants were
made in the fourth quarter of fiscal 2003 and the compensation cost associated
with such grants is being amortized by charges to operations on a graded vesting
schedule over a period of two years from the date of grant. During the first
quarter of fiscal 2004, the Company granted options to purchase 75,000 shares of
the Company's common stock at a weighted average exercise price of $3.90. At the
date of grant, the exercise price of the option awards equaled the market price
of the Company's common stock. During the thirteen weeks ended March 29, 2003,
the Company granted approximately 510,000 stock options to employees at a
weighted average exercise price of $1.42. At the date of grant, the exercise
price of the option awards equaled the market price of the Company's common
stock.
The Company utilizes an intrinsic value methodology in accounting for stock
based compensation for employees and certain non-employee directors in
accordance with the provisions of Accounting Principles Board Opinion ("APB")
No. 25, "Accounting for Stock Issued to Employees" and related Interpretations,
and accounts for stock-based compensation for non-employees utilizing a fair
value methodology in accordance with SFAS No. 123, "Accounting for Stock-Based
Compensation" as amended by SFAS No. 148 "Accounting for Stock Based
Compensation - Transition and Disclosure." If compensation cost for the
Company's APB 25 grants and the employee stock purchase plan had been determined
under SFAS No. 123, based upon the fair value at the grant date, consistent with
the Black-Scholes option pricing methodology, the Company's net loss for the
thirteen weeks ended March 29, 2003 and April 03, 2004 would have increased by
approximately $0.7 million and $0.9 million, respectively. For purposes of pro
forma disclosures required under the provisions of SFAS No. 123, as amended by
SFAS No. 148, the estimated fair value of options is amortized to pro forma
expense over the options' vesting period. The following table contains pro forma
information for the thirteen weeks ended March 29, 2003 and April 03, 2004 (in
thousands, except per share amounts):
THIRTEEN WEEKS ENDED
----------------------------------
MARCH 29, 2003 APRIL 03, 2004
--------------- --------------
Net loss, as reported: $(1,231) $(4,251)
Add: Stock based employee compensation
expense (benefit) included in reported net
income (loss), net of related tax effects (5) 337
Deduct: Total stock-based compensation
(expense) benefit determined under fair
value based method for all awards, net of
related tax effects (731) (1,250)
------------ ------------
Pro forma net loss $(1,967) $(5,164)
============ ============
Loss per share
Basic and diluted, as reported $ (0.04) $ (0.12)
============ ============
Basic and diluted, pro forma $ (0.06) $ (0.15)
============ ============
2. Loss Per Share
The Company calculates and presents loss per share using a dual presentation of
basic and diluted loss per share. Basic loss per share is computed by dividing
net loss by the weighted average number of common shares outstanding for the
period. In accordance with the provisions of SFAS No. 128 "Earnings Per Share",
the Company has not included the effect of common stock options in the
calculation of diluted loss per share for the thirteen weeks ended March 29,
2003 and April 03, 2004 as the Company reported a loss from continuing
operations for both periods and the effect would have been antidilutive. The
weighted average shares of common stock outstanding for basic and diluted loss
per share for the thirteen weeks ended March 29, 2003 and April 03, 2004 were
33,347,000 and 34,503,000, respectively. Had the Company reported net income for
the thirteen weeks ended March 29, 2003 and April 03, 2004, the treasury method
of calculating common stock equivalents would have resulted in approximately
110,000 and 1,719,000 additional diluted shares, respectively.
3.Discontinued Operations
During the first quarter of fiscal year 2004, management and the Board of
Directors elected to shut down the hardware segment of the Company. The Company
concluded that this segment of the business did not align well with the
strategic focus of the Company. Charges related to the shutdown of the hardware
business were $2.2 million and relate primarily to goodwill impairment and
severance charges. These charges are reported as a component of discontinued
operations. The hardware segment's results of operations have been classified as
discontinued operations and prior periods have been restated. For business
segment reporting purposes, the hardware segment was previously recorded as the
"All Other" segment.
Net sales and income (loss) from discontinued operations are as follows (amounts
in thousands):
FOR THE THIRTEEN WEEKS ENDED
----------------------------------------------------------------------
MARCH 29, 2003 APRIL 03, 2004
-------------- --------------
Net sales $ 166 $ 11
Goodwill impairment
and severance charge $ (2,213)
Operating income (loss) $ 118 (63)
Income tax provision 47
------- --------
Income (loss) from
discontinued operations $ 71 $ (2,276)
======= ========
4. Business Segments
In accordance with the criteria in SFAS No. 131 "Disclosure about Segments of an
Enterprise and Related Information," the Company historically concluded it had
five operating segments, of which four were aggregated in one reportable
segment, the Management Consulting Services segment, and the remaining segment
in All Other. Management Consulting Services includes business strategy and
planning, marketing and customer relationship management, operating system
support, revenue assurance, corporate investment services, networks, and
business model transformation. All Other consisted of computer hardware
commissions and rebates received in connection with the procurement of hardware
for third parties. Effective with the shut down of the All Other segment in
March 2004, the Company has only one reportable segment, and therefore
summarized financial information concerning the Management Consulting segment is
not included. For summarized financial information regarding the All Other
segment, see Note 3 "Discontinued Operations."
In accordance with the provisions of SFAS No 131, revenues earned in the United
States and internationally based on the location where the services are
performed are shown in the following table (amounts in thousands):
FOR THE THIRTEEN WEEKS ENDED
------------------------------------
MARCH 29, 2003 APRIL 03, 2004
-------------- --------------
United States $ 6,956 $ 4,414
International:
Ireland 32
Great Britain 203
The Netherlands 229 218
Canada
Belize 23 84
Portugal 860
------- -------
Total $ 7,240 $ 5,779
======= =======
5. Goodwill
Effective at the start of fiscal year 2002, the Company adopted the provisions
of SFAS No. 142 "Accounting for Goodwill and Intangible Assets". In accordance
with provisions of the Statement, goodwill has not been amortized in fiscal
years 2004 and 2003. The Statement requires an annual evaluation at the
reporting unit level of the fair value of goodwill and compares the calculated
fair value of the reporting unit to its book value to determine whether
impairment has been deemed to occur. Any impairment charge would be based on the
most recent estimates of the recoverability of the recorded goodwill and
intangibles balances. If the remaining book value assigned to goodwill and other
intangible assets acquired in an acquisition is higher than the amounts the
Company currently would expect to realize based on updated financial and cash
flow projections from the reporting unit, there is a requirement to write down
these assets. During the first quarter of fiscal year 2004, the Company recorded
a $2.2 million goodwill impairment loss related to the shutdown of the hardware
segment and has reflected this amount in the Statement of Operations and
Comprehensive Loss as a component of discontinued operations. The changes in the
carrying amount of goodwill as of April 03, 2004 are as follows (amounts in
thousands):
Management Consulting All Other
Segment Segment Total
--------------------- --------- -------
Balance as of December 28, 2002 $ 29,145 $ 2,163 $ 31,308
Impairment loss (15,780) (15,780)
-------- -------- -------
Balance as of January 03, 2004 13,365 2,163 15,528
Impairment loss (2,163) (2,163)
--------- -------- -------
Balance as of April 03, 2004 $ 13,365 $ 0 $13,365
======== ======== =======
6. Customer Relationships and Other Identifiable Intangible Assets
Included in the Company's consolidated balance sheet as of the end of the latest
fiscal year, January 03, 2004, and the end of the first quarter, April 03, 2004,
are the following identifiable intangible assets (amounts in thousands):
January 03, 2004 April 03, 2004
------------------------ ------------------------
Accumulated Accumulated
Cost Amortization Cost Amortization
------- ------------ ------- ------------
Customer relationships $ 3,086 $(2,545) $ 3,086 $(2,588)
Employment agreements 3,200 (2,292) 3,200 (2,558)
Tradename 350 (321) 350 (350)
Covenant not to compete 203 (203) 203 (203)
------- ------- ------- -------
Total $ 6,839 $(5,361) $ 6,839 $(5,699)
======= ======= ======= =======
Intangible amortization expense for the thirteen weeks ended March 29, 2003 and
April 03, 2004 was $715,000 and $339,000, respectively. Intangible amortization
expense is estimated to be approximately $1.0 million in fiscal year 2004, $0.3
million in fiscal year 2005, and $0.2 million in fiscal year 2006.
7. Income Taxes
In the first quarter of fiscal year 2004, the Company generated an income tax
benefit of $817,000. The Company recorded a valuation allowance against this
income tax benefit in accordance with the provisions of SFAS No. 109 "Accounting
for Income Taxes" which requires an estimation of the recoverability of the
recorded income tax asset balances. In addition, the Company reported an income
tax provision of $14,000 for the first quarter of fiscal year 2004 related to
state income tax expense. For the comparable period in the first quarter of
fiscal 2003, the Company record a net income tax benefit of $701,000, of which
an income tax benefit of $748,000 was allocated to loss from continuing
operations, and an income tax provision of $47,000 was allocated to income from
discontinued operations. As of April 3, 2004 the Company had recorded $24.8
million of valuation allowances in connection with its deferred tax assets.
8. Loans to Officers
As of April 03, 2004, there was one outstanding line of credit between the
Company and an officer. The maximum aggregate amount available for borrowing
under that loan agreement is $300,000. An aggregate borrowing against the line
of credit at March 29, 2003 and April 03, 2004 totaled $300,000 for each period
and is due in 2011. These amounts are included in other assets in the
non-current assets section of the balance sheet. In accordance with the loan
provisions, the interest rate charged on the loans is equal to the Applicable
Federal Rate (AFR), as announced by the Internal Revenue Service, for short-term
obligations (with annual compounding) in effect for the month in which the
advance is made, until fully paid. Pursuant to the Sarbanes-Oxley Act, no
further loan agreements or draws against the line may be made by the Company to,
or arranged by the Company for its executive officers.
9. Significant Customer Contracts
On December 10, 1999, the Company entered into a consulting services agreement
with a significant customer under which the customer committed to $22 million of
consulting fees over a three-year period commencing January 1, 2000. During
fiscal year 2002 the agreement was extended for two additional years beyond the
original term of the agreement, in exchange for an expanded preferred contractor
relationship and immediate commitment to a significant consulting arrangement.
The agreement provides for minimum annual usage requirements in connection with
consulting services performed under the agreement, and as of January 3, 2004 a
shortfall in minimum annual usage requirements of consulting services under the
agreement was deemed to have occurred. The shortfall was not remedied by the
customer during the first quarter of 2004, resulting in the customer's default
on the contract.
On March 4, 2004, TMNG filed suit against the customer for breach of the
consulting agreement, seeking damages of approximately $5.7 million against the
customer. The customer responded to the suit on March 26, 2004 with its answer
and two counterclaims, neither of which seeks money damages at this time. The
customer has requested a declaration that TMNG first breached the agreement and
that the customer is therefore not liable for any damages. Additionally, during
the first quarter of fiscal 2004 the customer informed the Company of its
decision to cancel the consulting agreement. The Company does not believe the
counterclaims asserted by the customer to be meritorious, and plans to
vigorously pursue enforcement of the contract and to obtain payment of the
consideration under the contract.
10. Contingencies
In June 1998, the bankruptcy trustee of a former client, Communications Network
Corporation, sued TMNG for a total of $320,000 in the U.S. Bankruptcy Court in
New York seeking recovery of $160,000 alleging an improper payment of consulting
fees paid by the former client during the period from July 1, 1996, when an
involuntary bankruptcy proceeding was initiated against the former client,
through August 6, 1996, when the former client agreed to an order for relief in
the bankruptcy proceeding, and $160,000 in consulting fees paid by the former
client after August 6, 1996.
The bankruptcy trustee has also sued TMNG for at least $1.85 million for breach
of contract, breach of fiduciary duties and negligence. Although assurance
cannot be given as to the ultimate outcome of this proceeding, TMNG believes the
Company has meritorious defenses to the claims made by the bankruptcy trustee,
including particularly the claims for breach of contract, breach of fiduciary
duty and negligence, and that the ultimate resolution of this matter will not
materially harm the Company business.
The Company has received demands aggregating approximately $1.2 million by the
bankruptcy trustees of several former clients in connection with collected
balances near the customers' respective bankruptcy filing dates. As of April 03,
2004 the remaining demands for such collected balances aggregated $1.1 million.
Although the Company does not believe it received any preference payments from
these former clients and plans to vigorously defend its position, the Company
has established reserves of $854,000, which it believes are adequate in the
event of loss or settlement on such claims.
The Company may become involved in various legal and administrative actions
arising in the normal course of business. These could include actions brought by
taxing authorities challenging the employment status of consultants utilized by
the Company. In addition, customer bankruptcies could result in additional
claims on collected balances for professional services near the bankruptcy
filing date. While the resolution of any of such actions, claims, or the matters
described above may have an impact on the financial results for the period in
which it is resolved, the Company believes that the ultimate disposition of
these matters will not have a material adverse effect upon its consolidated
results of operations, cash flows or financial position.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
In addition to historical information, this quarterly report contains
forward-looking statements. Certain risks and uncertainties could cause actual
results to differ materially from those reflected in such forward-looking
statements. Factors that might cause a difference include, but are not limited
to, those discussed in the sections entitled "Management's Discussion and
Analysis of Financial Condition and Results of Operations" and "Business - Risk
Factors" in the Company's annual report on Form 10-K for the fiscal year ended
January 03, 2004. Readers are cautioned not to place undue reliance on these
forward-looking statements, which reflect management's opinions only as of the
date of this report. We undertake no obligation to revise, or publicly release
the results of any revision to, these forward-looking statements. Readers should
carefully review the risk factors described in our annual report and in other
documents that we file from time to time with the Securities and Exchange
Commission.
The following should be read in connection with Management's Discussion and
Analysis of Financial Condition and Results of Operations as presented in the
Company's annual report on Form 10-K for the fiscal year ended January 03, 2004.
EXECUTIVE FINANCIAL OVERVIEW
As previously discussed in the Company's 2003 annual report on Form 10-K as
filed with the Securities and Exchange Commission on March 31, 2004, the
communications industry is experiencing a significant economic downturn that
began in fiscal year 2001. TMNG is a consultancy to the industry, and as a
result has experienced a significant reduction in consulting business since that
year. The Company has experienced significant revenue declines and net losses
from 2001 to 2004.
During fiscal year 2003, as a result of a combination of operating losses, the
resignation of certain key personnel and revised and reduced financial
projections, the Company recorded goodwill and intangible impairment losses
$19.5 million for select reporting units and recorded valuation reserves of
$24.0 million against deferred income tax assets. During the first quarter of
2004, management and the Board of Directors elected to shutdown the hardware
segment of the Company, resulting in a goodwill impairment charge of $2.2
million. The Company also recorded additional valuation reserves of $0.8 million
against deferred income tax assets, which offset income tax benefits, generated
on operating losses for the quarter.
The Company has implemented many programs to size the business with its lower
revenue base. Such steps include staff reductions and other selling, general and
administrative cost cutting measures to maintain appropriate pricing and
utilization metrics, which are critical to a management consultancy. Although
revenues decreased approximately 20.2% for the thirteen weeks ended April 3,
2004 as compared to the thirteen weeks ended March 29, 2003, management
responded through effective cost management initiatives by reducing direct cost
of service by a comparable 20.7% and selling, general and administrative
expenses by 15.6% for the comparable period, reflecting such cost reduction
measures. Such cost reductions also enabled the Company to minimize cash used in
operations, although in the first quarter of fiscal year 2004 cash used in
continuing operations was $1.9 million compared with cash provided from
operations of $0.7 million in first quarter of fiscal year 2003. The Company
also is focusing its marketing efforts on large and sustainable clients to
maintain a portfolio of business that is high credit quality and thus reduce bad
debt risks.
OPERATIONAL OVERVIEW
Revenues typically consist of consulting fees for professional services and
related expense reimbursements. A significant percentage of the Company's
consulting services are contracted on a time and materials basis, a time and
materials basis not to exceed contract price, or a fixed cost basis. Contract
revenues on contracts with a not to exceed contract price or a fixed cost price
are recorded under the percentage of completion method, utilizing estimates of
project completion under both of these types of contracts. Larger fixed price
contracts have recently begun to represent a more significant component of the
Company's revenue mix.
Generally a client relationship begins with a short-term engagement utilizing a
few consultants. TMNG's sales strategy focuses on building long-term
relationships with both new and existing clients to gain additional engagements
within existing accounts and referrals for new clients. Strategic alliances with
other companies are also used to sell services. TMNG anticipates that the
Company will continue to do so in the future. Because TMNG is a consulting
company, the Company experiences fluctuations in revenues derived from clients
during the course of a project lifecycle. As a result, the volume of work
performed for specific clients varies from period to period and a major client
from one period may not use TMNG services in another period. In addition,
clients generally may end their engagements with little or no penalty or notice.
If a client engagement ends earlier than expected, the Company must re-deploy
professional service personnel as any resulting unbillable time could harm
margins.
Cost of services consists primarily of client-related compensation for
consultants who are employees and amortization of equity related non-cash
charges incurred in connection with restricted stock granted to key management
personnel and restricted stock awards primarily to consultants, as well as fees
paid to independent contractor organizations and related expense reimbursements.
Employee compensation includes certain unbillable time, training, vacation time,
benefits and payroll taxes. Margins are primarily impacted by the type of
consulting services provided, the size of service contracts and negotiated
volume discounts, changes in TMNG pricing policies and those of competitors,
utilization rates of consultants and independent subject matter experts; and
employee and independent contractor organization costs associated with a
competitive labor market.
Operating expenses include selling, general and administrative, equity related
charges, and intangible asset amortization. Sales and marketing expenses consist
primarily of personnel salaries, bonuses, and related costs for direct client
sales efforts and marketing staff. The Company primarily uses a relationship
sales model in which partners, principals and senior consultants generate
revenues. In addition, sales and marketing expenses include costs associated
with marketing collateral, product development, trade shows and advertising.
General and administrative expenses consist mainly of accounting and recruiting
personnel costs, insurance, rent, and outside professional services incurred in
the normal course of business. The equity related charges consist of non-cash
amortization charges incurred in connection with restricted stock granted to key
management personnel. Intangible asset amortization relates to amortization of
identifiable intangible assets
CRITICAL ACCOUNTING POLICIES
While the selection and application of any accounting policy may involve some
level of subjective judgments and estimates, the Company believes the following
accounting policies are the most critical to the Company's consolidated
financial statements, potentially involve the most subjective judgments in their
selection and application, and are the most susceptible to uncertainties and
changing conditions:
- Allowance for Doubtful Accounts;
- Fair Value Accounting of Acquired Businesses;
- Impairment of Goodwill and Long-Lived Intangible Assets;
- Revenue Recognition; and
- Deferred Income Tax Assets.
Allowances for Doubtful Accounts - Substantially all of the Company's
receivables are owed by companies in the communications industry. The Company
typically bills customers for services after all or portions of the services
have been performed and requires customers to pay within 30 days. The Company
attempts to control credit risk by being diligent in credit approvals, limiting
the amount of credit extended to customers and monitoring customers' payment
record and credit status as work is being performed for them.
The Company recorded bad debt expense in the amount of $108,000 and $200,000 for
the first quarter of fiscal years 2004 and 2003, respectively, and the Company's
allowance for doubtful accounts totaled $767,000 and $652,000 at April 3, 2004
and January 3, 2004, respectively. The calculation of these amounts is based on
judgment about the anticipated default rate on receivables owed as of the end of
the reporting period. That judgment was based on uncollected account experience
in prior years and the ongoing evaluation of the credit status of the Company's
customers and the communications industry in general.
The Company has endeavored to mitigate credit risk by concentrating its
marketing efforts on the largest and most stable companies in the communications
industry and by tightly controlling the amount of credit provided to customers.
If the Company is unsuccessful in these efforts, or if more of the Company's
customers file for bankruptcy or experience financial difficulties, it is
possible that the allowance for doubtful accounts will be insufficient and the
Company will have a greater bad debt loss than the amount reserved, which would
adversely affect cash flow and financial performance.
Fair Value of Acquired Businesses - TMNG has acquired three professional service
organizations over the last four years. A significant component of the value of
these acquired businesses has been allocated to intangible assets. The Financial
Accounting Standards Board ("FASB") issued SFAS No. 141 "Accounting for Business
Combinations", which requires acquired businesses to be recorded at fair value
by the acquiring entity. SFAS No. 141 also requires that intangible assets that
meet the legal or separable criterion be separately recognized on the financial
statements at their fair value, and provides guidance on the types of intangible
assets subject to recognition. Determining the fair value for these specifically
identified intangible assets involves significant professional judgment,
estimates and projections related to the valuation to be applied to intangible
assets like customer lists, employment agreements and trade names. Specifically,
the FASB issued EITF No. 02-17 "Recognition of Customer Relationship Intangible
Assets Acquired in a Business Combination" in 2002 which provided an expanded
definition of how to value customer relationships and includes not only the
current backlog of an acquired entity, but also the expectations of future
revenues resulting from current customer relationships. In accordance with the
provisions of EITF No. 02-17, management has made estimates and assumptions
regarding projected future revenues resulting from the customer relationships
acquired in TMNG's acquisitions. The subjective nature of management's
assumptions adds an increased risk associated with estimates surrounding the
projected performance of the acquired entity. Additionally, as the Company
amortizes the intangible assets over time, the purchase accounting allocation
directly impacts the amortization expense we record on our financial statements.
Impairment of Goodwill and Long-lived Intangible Assets - Goodwill and other
long-lived intangible assets arising from the Company's acquisitions, as
discussed above, are subjected to periodic review for impairment. SFAS No. 142
"Accounting for Goodwill and Intangible Assets" requires an annual evaluation at
the reporting unit level of the fair value of goodwill and compares the
calculated fair value of the reporting unit to its book value to determine
whether an impairment has been deemed to occur. Any impairment charge would be
based on the most recent estimates of the recoverability of the recorded
goodwill and intangibles balances. If the remaining book value assigned to
goodwill and other intangible assets acquired in an acquisition is higher than
the amounts the Company currently would expect to realize based on updated
financial and cash flow projections from the reporting unit, there is a
requirement to write down these assets. Effective March 4, 2004, management and
the Board of Directors elected to shut down the Company's hardware business. The
Company concluded that this segment of the business did not align well with the
strategic focus of the Company. The Company incurred goodwill impairment charges
of $2.2 million related to the shutdown of the hardware business in accordance
with the provisions of SFAS No. 142.
Revenue Recognition - Historically, most of TMNG's consulting practice contracts
have been on a time and material basis, in which customers are billed for time
and materials expended in performing their contracts. The Company has recognized
revenue from those types of customer contracts in the period in which our
services are performed. TMNG has many types of contracts, including time and
materials contracts, time and materials with cap, fixed fee contracts, and
managed services or outsourcing contracts. Managed services or outsourcing
contracts typically have longer contract terms than consulting contracts. The
typical length of the Company's outsourcing contracts is two to five years.
The Company recognizes revenues on time and material with cap and fixed fee
contracts using the percentage of completion method. Percentage of completion
accounting involves calculating the percentage of service provided during the
reporting period compared with the total estimated services to be provided over
the duration of the contract. For all contracts, estimates of total contract
revenues and costs are continuously monitored during the term of the contract,
and recorded revenues and costs are subject to revision as the contract
progresses. Such revisions may result in increase or decrease to revenues and
income and are reflected in the financial statements in the periods in which
they are first identified.
As TMNG continues to adapt to changes in the communications consulting industry,
the Company has elected to enter into more fixed fee contracts in which revenue
is based upon delivery of services or solutions, and contingent fee contracts,
in which revenue is subject to achievement of savings or other agreed upon
results, rather than time spent. Both of these types of contracts are typically
more results-oriented and are subject to greater risk associated with revenue
recognition and overall project profitability than traditional time and
materials contracts. Due to the nature of fixed fee and contingent fee
contracts, the amount and timing of revenue recognized may be subject to
adjustment or deferral, and additional costs and effort as compared to what was
originally planned may need to be expended to fulfill delivery requirements on
such contracts, which could adversely affect our consolidated financial
position, results of operations and liquidity.
Deferred Income Tax Assets - The Company has generated substantial deferred
income tax assets primarily from the accelerated financial statement write-off
of goodwill, the charge to compensation expense taken related to stock options
and net operating loss carry forwards. For the Company to realize the income tax
benefit of these assets, it must generate sufficient taxable income in future
periods when such deductions are allowed for income tax purposes. In assessing
whether a valuation allowance is needed in connection with the Company's
deferred income tax assets, management has evaluated the ability of the Company
to carry back tax losses to prior years that reported taxable income, and the
ability of the Company to generate sufficient taxable income in future periods
to utilize the benefit of the deferred income tax assets. Such projections of
future taxable income require significant subjective judgments and estimates by
the Company. As of April 03, 2004, valuation allowances in the amount of $24.8
million were recorded in connection with the deferred income tax assets.
Management continues to evaluate the recoverability of the recorded deferred
income tax asset balances. In the event the Company continues to report net
operating losses for financial reporting, no tax benefit would be recognized for
those losses.
RESULTS OF OPERATIONS
THIRTEEN WEEKS ENDED APRIL 03, 2004 COMPARED TO THIRTEEN WEEKS ENDED MARCH 29,
2003
REVENUES
Revenues decreased 20.2% to $5.8 million for the first quarter of fiscal year
2004 from $7.2 million for the first quarter of fiscal year 2003. The decrease
in revenues was primarily associated with the decline in utilization of
management consulting services by communication service providers and continuing
adverse conditions in the communication and technology industry, which
correlates with significant layoffs of management personnel by such clients. As
discussed above in the "Operational Overview", client relationships and the
development of such relationships is key to the Company's revenue producing
opportunities. These client relationships are developed with specific sponsors
in customer organizations, and the departure of these personnel therefore can
negatively impact revenue opportunities, potentially resulting in downsized,
deferred, or in some cases the cancellation of customer engagements. In
addition, there has been continued deferral of key management consulting
pipeline opportunities and an increase in managed services outsourcing by
clients, which partially displaces what were historically management consulting
opportunities for TMNG. During the first quarter of fiscal year 2004, the
Company provided services on 75 customer projects, compared to 84 projects
performed in the first quarter of fiscal year 2003. Average revenue per project
was $77,000 in the first quarter of fiscal year 2004 compared to $86,000 in the
first quarter of fiscal year 2003. International revenue base increased to 23.6%
of the Company's revenues for the first quarter of fiscal year 2004, from 3.9%
for the first quarter of fiscal year 2003, due primarily to a significant
increase in project activity with large global carriers primarily in Western
Europe in the wireline and wireless practice combined with a decrease in the
Company's domestic revenue base. Revenues recognized by the Company in
connection with fixed price engagements totaled $1.1 million and $1.8 million
for the first quarters of fiscal years 2004 and 2003, respectively, representing
18.7% of total revenue during the first quarter of fiscal year 2004, and 25.0%
of first quarter fiscal year 2003 total revenue. Effective March 4, 2004,
management and the Board of Directors elected to shut down all hardware business
(previously reported as the separate business segment "All Other"). Operating
results of the hardware segment for the first quarter of fiscal years 2004 and
2003 have been included as a component of discontinued operations in the
Consolidated Condensed Statements of Operations and Comprehensive Loss contained
herein.
COSTS OF SERVICES
Direct costs of services decreased 20.7% to $2.9 million for the first quarter
of fiscal year 2004 compared to $3.7 million for the first quarter of fiscal
2003. The decrease was attributable primarily to fewer consulting engagements.
As a percentage of revenues, the Company's gross margin based on direct cost of
services was 49.6% for the first quarter of fiscal year 2004 compared to 49.3%
for the first quarter of fiscal year 2003.
OPERATING EXPENSES
In total, operating expenses decreased by 15.5% to $4.9 million for the first
quarter of fiscal year 2004, from $5.8 million for the first quarter of fiscal
year 2003. Operating expenses include selling, general and administrative costs,
equity related charges, and intangible asset amortization. Selling, general and
administrative expenses for the first quarter of fiscal 2004 were $4.3 million,
compared to $5.1 million for the first quarter of 2003. A reduction of selling
and administrative personnel to properly size the business to the lower revenue
volumes represented $0.4 million of the above decrease, and was part of
management's cost-reduction efforts. The remaining decrease in selling, general
and administrative expenses as compared to the first quarter of fiscal 2003
related to a decrease in rent and other operating costs. Management continues to
examine cost-reduction measures to enhance the Company's profitability and
manage operating expenses to better align them with the size of the Company.
Intangible asset amortization was $0.3 million and $0.7 million for the thirteen
weeks ended April 3, 2004 and March 29, 2003, respectively. The decrease in
amortization expense was due to intangible asset impairments recorded in fiscal
year 2003 that had the effect of lowering the recorded intangible asset balance
subject to amortization in fiscal year 2004. Such impairments totaled $3.7
million in fiscal year 2003.
Non-cash stock based compensation charges were $283,000 in the first quarter of
fiscal year 2004 compared to $11,000 for the first quarter of fiscal year 2003.
The $283,000 non-cash stock based compensation charges for the first quarter of
fiscal year 2004 relate to the Company's granting of restricted stock to select
executives and key employees during the fourth quarter of fiscal year 2003. The
non-cash stock based compensation charges for the first quarter of fiscal year
2003 related to pre-initial offering grants of stock options, which were fully
amortized during fiscal year 2003.
OTHER INCOME AND EXPENSES
Interest income was $136,000 and $177,000 for the first quarter of fiscal years
2004 and 2003, respectively, and represented interest earned on invested
balances. Interest income decreased during the first quarter of fiscal year 2004
due to lower interest rate returns from fiscal year 2003 to fiscal year 2004.
The Company invests in short-term, high-grade investment instruments as part of
our overall investment policy.
INCOME TAXES
In the first quarter of fiscal year 2004, the Company fully reserved its income
tax benefit generated by its pre-tax losses in accordance with the provisions of
SFAS No. 109 "Accounting for Income Taxes" which requires an estimation of the
recoverability of the recorded income tax asset balances. The Company also
reported an income tax provision of $14,000 for the first quarter of fiscal year
2004 related to state tax income tax expense. In the first quarter of fiscal
year 2003, the Company recognized a net income tax benefit of $701,000, of which
an income tax benefit of $748,000 was allocated to loss from continuing
operations, and an income tax provision of $47,000 was allocated to income from
discontinued operations. The Company generally records an income tax benefit at
a blended rate of 40.2% for Federal and state income tax purposes. The primary
reason for the variance between the effective and statutory income tax rates in
2003 relates to a portion of the reported intangible asset amortization not
deductible for Federal income tax purposes.
DISCONTINUED OPERATIONS
On March 4, 2004, management and the Board of Directors elected to shut down the
Company's hardware business. The Company concluded that this segment of the
business does not align well with the strategic focus of the Company. Charges
related to the shutdown of the hardware business were $2.2 million and relate
primarily to goodwill impairment and severance charges. In addition losses
generated in the first quarter of 2004 from operations by the discontinued
segment were $63,000. These charges are reported within discontinued operations.
The prior period has been restated to separately report the income generated by
the discontinued segment, on a net of tax basis, resulting in income of $71,000
for the first quarter of fiscal year 2003. For business segment reporting
purposes, the hardware segment was previously recorded as the "All Other"
segment.
LIQUIDITY AND CAPITAL RESOURCES
Net cash used in operating activities was $2.0 million for the first quarter of
fiscal year 2004, compared to net cash provided by operating activities of $0.7
million for the first quarter of fiscal year 2003. The Company incurred negative
cash flow from its operating activities for the first quarter of fiscal year
2004 primarily due to operating losses. The Company generated positive cash flow
from its operating activities in the first quarter of fiscal year 2003 primarily
due to the reduction in accounts receivable balances reflecting more focused
billing and collection activities, partially offset by an operating loss.
Net cash used in investing activities was $35,000 and $10,000 for the first
quarter of fiscal year 2004 and fiscal year 2003, respectively. Cash used in
investing activities in the first quarter of fiscal year 2004 related to
capitalization of office equipment, software and computer equipment by the
Company. Cash used in investing activities in the first quarter of fiscal year
2003 related to capitalization of software and computer equipment by the
Company.
Net cash provided by financing activities was $353,000 in the first quarter of
fiscal year 2004, and related to proceeds received from the exercise of employee
stock options, partially offset by payments made by the Company on the current
portion of its capital lease obligations and outstanding debt. Net cash used in
financing activities was $110,000 in the first quarter of fiscal year 2003, and
related to payments made by the Company on the current portion of its capital
lease obligations and outstanding debt, partially offset by proceeds received
from the exercise of employee stock options.
As of April 03, 2004, the Company has the following contractual obligations and
commercial commitments by year (amounts in millions):
Later
Years
Through
2004 2005 2006 2007 2008 2011 Total
---- ---- ---- ---- ---- ------- -----
Capital leases $0.2 $0.2 $ 0.4
Operating leases $1.4 $1.6 $1.5 $1.6 $1.6 $3.8 $11.5
---- ---- ---- ---- ---- ---- -----
Total $1.6 $1.8 $1.5 $1.6 $1.6 $3.8 $11.9
==== ==== ==== ==== ==== ==== =====
At April 03, 2004, TMNG had approximately $51.2 million in cash and cash
equivalents. TMNG believes it has sufficient cash to meet anticipated cash
requirements, including anticipated capital expenditures, consideration for
possible acquisitions, and any continuing operating losses, for at least the
next 12 months. The Company has established a flexible model that provides a
lower fixed cost structure than most consulting firms, enabling TMNG to scale
operating cost structures more quickly based on market conditions. Although the
Company is well positioned because of its cash reserves to weather continuing
adverse conditions in the communications industry for a period of time, if the
industry and demand for consulting services do not rebound in the foreseeable
future and we continue to experience negative cash flow, we could experience
liquidity challenges.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company does not invest excess funds in derivative financial instruments or
other market rate sensitive instruments for the purpose of managing its foreign
currency exchange rate risk. The Company invests excess funds in short-term
investments, the yield of which is exposed to interest rate market risk.
Although the Company does not presently have material exposure to market related
risk, if the Company transacts increased levels of business with international
customers, foreign currency exchange risk may become material given U.S. dollar
to foreign curency rate changes for projects denominated in the local currency
of foreign clients.
ITEM 4. CONTROLS AND PROCEDURES
A review and evaluation was performed by the Company's management, including the
Company's Chief Executive Officer (the "CEO") and Chief Financial Officer (the
"CFO"), of the effectiveness of the design and operation of the Company's
disclosure controls and procedures as of the end of the period covered by this
quarterly report. Based on that review and evaluation, the CEO and CFO have
concluded that the Company's current disclosure controls and procedures, as
designed and implemented, were effective. There have been no significant changes
in the Company's internal controls or in other factors that could significantly
affect the Company's internal controls subsequent to the date of their
evaluation. There were no significant material weaknesses identified in the
course of such review and evaluation and, therefore, the Company took no
corrective measures.
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
TMNG has not been subject to any material new litigation or claims against the
Company since the time of TMNG's 10-K filing, on March 31, 2004. For a summary
of litigation in which TMNG is currently involved, refer to TMNG's 10-K, as
filed with the Securities and Exchange Commission on March 31, 2004 and Notes 9
and 10 of the Condensed Consolidated financial statements included elsewhere in
this report.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
Exhibit 31. Certifications Pursuant to Section 302 of the Sarbanes-Oxley
Act of 2002.
Exhibit 32. Certifications Furnished Pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002
(b) Reports on Form 8-K
The Company filed a Form 8-K on May 7, 2004 with the Securities and
Exchange Commission in connection with its earnings release dated May 6,
2004.
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.
SIGNATURE TITLE DATE
--------- ----- ----
/s/ RICHARD P. NESPOLA Chairman, President and Chief May 18, 2004
----------------------------- Executive Officer
Richard P. Nespola (Principal executive officer)
/s/ DONALD E. KLUMB Chief Financial Officer and May 18, 2004
----------------------------- Treasurer
Donald E. Klumb (Principal financial officer
and principal accounting
officer)