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 October 2, 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
------------------------------------------------------
(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 October 28, 2004 TMNG had outstanding 34,645,708 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)-
October 2, 2004 and January 3, 2004 ......................... 3
Consolidated Condensed Statements of Operations and
Comprehensive Loss (unaudited) - Thirteen Weeks
ended October 2, 2004 and September 27, 2003 and
Thirty-nine Weeks ended October 2, 2004 and
September 27, 2003......................................... 4
Consolidated Condensed Statements of Cash Flows
(unaudited) - Thirty-nine Weeks ended October 2,
2004 and September 27, 2003................................ 5
Notes to Consolidated Condensed Financial
Statements .................................................. 6
ITEM 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations .........................10
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 2. Unregistered Sales of Equity Securities and Use of Proceeds .16
ITEM 6. Exhibits ....................................................16
Signatures ..........................................................16
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 3, October 2,
2004 2004
------------ ------------
CURRENT ASSETS:
Cash and cash equivalents ................................ $ 52,875 $ 49,096
Receivables:
Accounts receivable .................................... 5,376 5,057
Accounts receivable - unbilled ......................... 2,140 2,902
------------ ------------
7,516 7,959
Less: Allowance for doubtful accounts .................. (652) (248)
------------ ------------
6,864 7,711
Refundable income taxes .................................. 1,557 1,336
Prepaid and other assets ................................. 710 825
------------ ------------
Total current assets ........................... 62,006 58,968
------------ ------------
Property and equipment (net of accumulated depreciation of
$2,722 and $3,159 at January 3, 2004 and October 2, 2004,
respectively) ........................................... 1,558 1,104
Goodwill ................................................... 15,528 13,365
Other intangible assets, net ............................... 1,478 704
Other assets ............................................... 402 445
------------ ------------
Total Assets ............................................... $ 80,972 $ 74,586
============ ============
CURRENT LIABILITIES:
Trade accounts payable ................................... $ 635 $ 583
Accrued payroll, bonuses and related expenses ............ 1,251 1,846
Other accrued liabilities ................................ 2,104 1,724
Unfavorable and capital lease obligations ................ 785 628
------------ ------------
Total current liabilities ...................... 4,775 4,781
Unfavorable and capital lease obligations .................. 2,828 2,383
STOCKHOLDERS' EQUITY
Common Stock: ............................................ 34 35
Voting - $.001 par value, 100,000,000 shares authorized;
34,371,068 and 34,645,708 issued and outstanding on
January 3, 2004 and October 2, 2004, respectively
Additional paid-in capital ............................... 157,292 157,726
Accumulated deficit ...................................... (82,190) (89,677)
Accumulated other comprehensive income -
Foreign currency translation adjustment ................. 176 170
Unearned compensation .................................... (1,943) (832)
------------ ------------
Total stockholders' equity ...................... 73,369 67,422
------------ ------------
Total Liabilities and Stockholders' Equity ................. $ 80,972 $ 74,586
============ ============
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 For the thirty-nine
weeks ended weeks ended
------------------------------ -------------------------------
September 27, October 2, September 27, October 2,
2003 2004 2003 2004
------------- ------------- ------------- -------------
Revenues $ 4,691 $ 6,546 $ 16,894 $ 17,509
Cost of Services:
Direct cost of services .................... 2,506 3,441 8,903 9,093
Equity related charges (benefit) ........... (10) 51 (114) 157
-------- -------- -------- --------
Total cost of services ................... 2,496 3,492 8,789 9,250
-------- -------- -------- --------
Gross Profit 2,195 3,054 8,105 8,259
Operating Expenses:
Selling, general and administrative ........ 4,432 3,860 14,759 12,318
Goodwill and intangible asset impairment.... 18,942
Intangible asset amortization .............. 504 218 1,863 774
Equity related charges ..................... 7 261 10 776
-------- -------- -------- --------
Total operating expenses ................. 4,943 4,339 35,574 13,868
-------- -------- -------- --------
Loss from operations ......................... (2,748) (1,285) (27,469) (5,609)
Other Income:
Interest income ............................ 136 189 474 470
Other, net................................. (9) (10) (41) (25)
-------- -------- -------- --------
Total other income ....................... 127 179 433 445
-------- -------- -------- --------
Loss from continuing operations before
income tax (provision) benefit ............. (2,621) (1,106) (27,036) (5,164)
Income tax (provision) benefit ............... (13) 4,367 (47)
-------- -------- -------- --------
Loss from continuing operations .............. (2,621) (1,119) (22,669) (5,211)
Discontinued operations:
Net income (loss) from discontinued operations
(net of income tax provision of $53 for the
thirty-nine weeks ended September 27, 2003
and including charge for impairment of
goodwill of $2,163 for thirty-nine weeks
ended October 2, 2004) .................... (30) 49 (2,276)
-------- -------- -------- --------
Net loss ..................................... (2,651) (1,119) (22,620) (7,487)
Other comprehensive item -
Foreign currency translation adjustment .... 12 (1) 21 (6)
-------- -------- -------- --------
Comprehensive loss ........................... $ (2,639) $ (1,120) $(22,599) $ (7,493)
======== ======== ======== ========
Loss from continuing operations
per common share
Basic and diluted .......................... $ (0.08) $ (0.03) $ (0.68) $ (0.15)
======== ======== ======== ========
Loss from discontinued operations
per common share
Basic and diluted........................... $ (0.07)
======== ======== ======== ========
Loss per common share
Basic and diluted .......................... $ (0.08) $ (0.03) $ (0.68) $ (0.22)
======== ======== ======== ========
Basic and diluted weighted average shares
outstanding .............................. 33,458 34,631 33,392 34,586
======== ======== ======== ========
On March 4, 2004, management and the Board of Directors elected to shut down the
hardware segment of the Company. The thirteen weeks and thirty-nine weeks ended
September 27, 2003 have 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 thirty-nine weeks ended
-------------------------------
September 27, October 2,
2003 2004
---------- ----------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss .............................................. $(22,620) $ (7,487)
Adjust for
(Income) loss from discontinued operations (49) 2,276
---------- ----------
Loss from continuing operations (22,669) (5,211)
Adjustments to reconcile net loss to net cash
provided by operating activities:
Goodwill and intangible asset impairment ........... 18,942
Depreciation and amortization ...................... 2,526 1,294
Equity related charges (benefit) ................... (104) 933
Deferred income taxes .............................. (2,063)
Loss on retirement of assets ....................... 40
Other changes in operating assets and
liabilities, net of business acquisitions:
Accounts receivable ........................... 2,426 (85)
Accounts receivable - unbilled ................ 218 (762)
Refundable income taxes ....................... (2,759) 221
Prepaid and other assets ...................... 969 (158)
Trade accounts payable ........................ (580) (52)
Accrued liabilities ........................... (1,220) 152
---------- ----------
Net cash used in continuing operations...... (4,314) (3,628)
---------- ----------
Net cash provided by (used in) discontinued
operations ................................. 49 (113)
---------- ----------
Net cash used in operating activities ...... (4,265) (3,741)
---------- ----------
CASH FLOWS FROM INVESTING ACTIVITIES:
Acquisition of property and equipment, net ............ (98) (107)
---------- ----------
Net cash used in investing activities ...... (98) (107)
---------- ----------
CASH FLOWS FROM FINANCING ACTIVITIES:
Payments made on long-term obligations ................ (314) (538)
Proceeds from exercise of stock options ............... 243 564
Issuance of common stock, net of expenses ............. 38 49
---------- ----------
Net cash provided by (used in) financing
activities ............................... (33) 75
---------- ----------
Effect of exchange rate on cash and cash
equivalents ............................................ 21 (6)
---------- ----------
Net decrease in cash and cash equivalents ............... (4,375) (3,779)
Cash and cash equivalents, beginning of period .......... 53,786 52,875
---------- ----------
Cash and cash equivalents, end of period ................ $ 49,411 49,096
========== ==========
Supplemental disclosure of cash flow information:
Cash paid during period for interest .................... $ 41 $ 26
========== ==========
Cash paid during period for taxes ....................... $ 493 $ 47
========== ==========
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 October 2, 2004, and for the thirteen
and thirty-nine weeks ended September 27, 2003 and October 2, 2004, 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.
Certain prior-year amounts have been reclassified to conform to the current-year
presentation
STOCK BASED COMPENSATION
During the thirteen weeks ended October 2, 2004, the Company recognized $312,000
in compensation expense related primarily to the issuance of restricted stock
grants made to key management personnel in the fourth quarter of fiscal year
2003. 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 thirteen weeks ended October 2, 2004, the
Company granted options to purchase 66,000 shares of the Company's common stock
at a weighted average exercise price of $2.12. 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 September 27, 2003, the Company
granted approximately 25,000 stock options to employees at a weighted average
exercise price of $1.75. During the thirteen weeks ended September 27, 2003 the
Company recorded a net credit to compensation expense related to all stock
options of $3,000, attributable primarily to the forfeiture of unvested stock
options by employees, offset by the recognition of compensation expense on
pre-initial public offering grants of stock options.
During the thirty-nine weeks ended October 2, 2004, the Company granted 239,000
stock options to employees at a weighted average exercise price of $2.98. During
the same period, the Company recognized $933,000 in compensation expense related
primarily to the issuance of restricted stock to key management personnel in the
fourth quarter of fiscal year 2003. During the thirty-nine weeks ended September
27, 2003, the Company granted 540,500 stock options to employees and 75,000
stock options to independent members of the Company's Board of Directors at a
weighted average exercise price of $1.44 and $1.49, respectively, and recorded a
net credit to compensation expense related to all stock options of $104,000,
attributable primarily to the forfeiture of unvested stock options by employees,
partially offset by the recognition of compensation expense on pre-initial
public offering grants of stock options. The grants of stock options to
independent board members were made in connection with the appointment by the
Board of Directors of Frank M. Siskowski and Robert J. Currey to fill vacancies
on the board during 2003.
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 Statement of Financial Accounting Standards
("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 September 27, 2003 and
October 2, 2004, would have increased by approximately $686,000 and $473,000,
respectively, the Company's net loss for the thirty-nine weeks ended September
27, 2003, would have decreased by approximately $132,000 and the Company's net
loss for the thirty-nine weeks ended October 2, 2004 would have increased by
approximately $2.2 million.
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 and thirty-nine weeks
ended September 27, 2003, and October 2, 2004 (in thousands, except per share
amounts):
FOR THE THIRTEEN WEEKS ENDED FOR THE THIRTY-NINE WEEKS ENDED
---------------------------- ------------------------------
September 27, October 2, September 27, October 2,
2003 2004 2003 2004
----------- ----------- ---------- ----------
Net loss, as reported: $(2,651) $(1,119) $(22,620) $ (7,487)
Add: Stock-based employee
compensation expense (benefit) included in
reported net loss, net of related tax effects (3) 312 (100) 933
Deduct: Total stock-based compensation
(expense) benefit determined under fair value
based method for all awards, net of related (689) (785) 232 (3,170)
tax effects
------------ ------------ ---------- ----------
Pro forma net loss $(3,343) $(1,592) $(22,488) $ (9,724)
============ ============ ========== ==========
Loss per share
Basic and diluted, as reported $ (0.08) $(0.03) $(0.68) $ (0.22)
============ ============ ========== ==========
Basic and diluted, pro forma $ (0.10) $(0.05) $(0.67) $ (0.28)
============ ============ ========== ==========
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 and thirty-nine weeks
ended September 27, 2003 and October 2, 2004, as the Company reported a loss
from continuing operations for all 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 September 27, 2003 and
October 2, 2004, were 33,458,000 and 34,631,000, respectively. The weighted
average shares of common stock outstanding for basic and diluted loss per share
for the thirty-nine weeks ended September 27, 2003, and October 2, 2004, were
33,392,000 and 34,586,000, respectively. Had the Company reported net income for
the thirteen weeks ended September 27, 2003 and October 2, 2004, the treasury
stock method of calculating common stock equivalents would have resulted in
approximately 307,000 and 230,000 additional diluted shares, respectively. Had
the Company reported net income for the thirty-nine weeks ended September 27,
2003, and October 2, 2004, the treasury stock method of calculating common stock
equivalents would have resulted in approximately 208,000 and 754,000 additional
diluted shares, respectively.
3. DISCONTINUED OPERATIONS
During the thirteen weeks ended April 3, 2004, management and the Board of
Directors elected to shutdown 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 in the first quarter of fiscal year 2004 were $2.2 million and related
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.
Revenue and income (loss) from discontinued operations are as follows (amounts
in thousands):
FOR THE THIRTEEN WEEKS ENDED FOR THIRTY-NINE WEEKS ENDED
----------------------------- ----------------------------
September 27, October 2, September 27, October 2,
2003 2004 2003 2004
--------- -------- -------- --------
Revenue $ 223 $ 13
Goodwill impairment
and severance charge $ (2,213)
Operating income (loss) $ (30) $ 102 (63)
Income tax provision 53
------- -------- -------- --------
Income (loss) from
discontinued operations $ (30) $ 49 $ (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, billing system
support, operating system support, revenue assurance, corporate investment
services, and network management. 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 FOR THE THIRTY-NINE WEEKS ENDED
------------------------------------- -------------------------------------
SEPTEMBER 27, 2003 OCTOBER 2, 2004 SEPTEMBER 27, 2003 OCTOBER 2, 2004
------------------ ---------------- ------------------ ----------------
United States $ 4,010 $ 5,352 $15,328 $ 13,930
International:
Great Britain 825 1,374
Portugal 210 216 1,124
The Netherlands 237 304 769 705
Belize 234 375 173
Canada 95 113
Other 65 111 90
------- ------- ------- -------
Total $ 4,691 $ 6,546 $16,894 $17,509
======= ======= ======= =======
5. GOODWILL
In accordance with provisions of SFAS 142 "Accounting for Goodwill and
Intangible Assets," goodwill is not being amortized. 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 have occurred. Any impairment
charge would be based on the most recent estimates of the recoverability of the
recorded goodwill balances. If the remaining book value assigned to goodwill
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 thirteen weeks ended April 3, 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. During the thirteen weeks ended
June 28, 2003, the Company performed an interim test to determine whether an
impairment of goodwill had occurred at the reporting unit level. The Company
performed the interim test due to the significantly lower operating results of
one of the Company's reporting units, compared to the projected financial
results that were utilized in determining the reporting unit's fair value in the
previous annual goodwill impairment test. Additionally, during the thirteen
weeks ended June 28, 2003 two executives of companies acquired by TMNG tendered
their resignations to the Company, which also had the effect of lowering the
financial projections of one of the entities. Based on an analysis of projected
future cash flows and utilizing the assistance of an outside valuation firm, the
Company determined that the carrying value of goodwill acquired in the CSMG
acquisition exceeded its fair value and recorded an impairment loss related to
the Management Consulting Segment of approximately $15.8 million in the second
quarter of fiscal year 2003. The goodwill impairment loss has been reflected as
a component of Loss from Operations in the Statement of Operations and
Comprehensive Loss. The changes in the carrying amount of goodwill 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 3, 2004 13,365 2,163 15,528
Impairment loss on discontinued operations (2,163) (2,163)
--------- -------- -------
Balance as of October 2, 2004 $ 13,365 $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 3, 2004, and the end of the thirty-nine weeks ended October
2, 2004, are the following identifiable intangible assets (amounts in
thousands):
January 3, 2004 October 2, 2004
------------------------ ------------------------
Accumulated Accumulated
Cost Amortization Cost Amortization
------- ------------ ------- ------------
Customer relationships $ 3,086 $(2,545) $ 3,086 $(2,674)
Employment agreements 3,200 (2,292) 3,200 (2,908)
Tradename 350 (321)
Covenant not to compete 203 (203)
------- ------- ------- -------
Total $ 6,839 $(5,361) $ 6,286 $(5,582)
======= ======= ======= =======
In connection with SFAS No. 144 "Accounting for the Impairment or Disposal of
Long-Lived Assets" the Company, using its best estimates based on reasonable and
supportable assumptions and projections, reviews for impairment long-lived
assets and certain identifiable intangibles to be held and used whenever events
or changes in circumstances indicate that the carrying amount of its assets
might not be recoverable. During the thirty-nine weeks ended September 27, 2003,
management identified certain events, including the significant decrease in
revenue from customers whose relationships were valued in purchase accounting
for the CSMG acquisition. The Company performed an impairment test, and
determined that the carrying value of customer relationships exceeded its fair
market value and recorded an impairment loss related to the Management
Consulting Segment of approximately $3.1 million. Fair value was based on an
analysis of projected future cash flows. The impairment loss has been reflected
as a component of Loss from Operations in the Statement of Operations and
Comprehensive Loss.
Intangible amortization expense for the thirteen weeks ended September 27, 2003
and October 2, 2004 was $504,000 and $218,000, respectively. Intangible
amortization expense for the thirty-nine weeks ended September 27, 2003 and
October 2, 2004 was $1,863,000 and $774,000, respectively. Intangible
amortization expense is estimated to be approximately $1.0 million for fiscal
year 2004, $0.3 million in fiscal year 2005, and $0.2 million in fiscal year
2006.
7. INCOME TAXES
In the thirteen and thirty-nine weeks ended October 2, 2004, the Company
generated an income tax benefit of $437,000 and $2.1 million respectively. The
Company recorded a valuation allowance against these income tax benefits 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
$13,000 and $47,000 for the thirteen and thirty-nine weeks ended October 2, 2004
related to state income tax expense. For the comparable period in the thirteen
and thirty-nine weeks ended September 27, 2003, the Company generated income tax
benefits of $1.0 million and $10.5 million respectively, and recorded valuation
allowances against these income tax benefits of $1.0 million and $6.2 million,
respectively. The majority of the valuation allowance relates to impairment
losses of goodwill and other intangible assets that were initially recorded in
connection with the Company's acquisitions and net operating losses. As of
October 2, 2004 the Company has fully reserved its deferred income tax assets
with a cumulative valuation allowance of $26.1 million.
8. LOANS TO OFFICER
As of October 2, 2004, there was one outstanding line of credit between the
Company and its Chief Executive Officer. The maximum aggregate amount available
for borrowing under that loan agreement is $300,000. The aggregate borrowing
against the line of credit was $300,000 at September 27, 2003 and October 2,
2004 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 provided 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 fiscal year 2004, resulting in the
customer's default on the contract.
On March 4, 2004, the Company 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 sought money damages. The customer
requested a declaration that the Company first breached the agreement and that
the customer was therefore not liable for any damages. Additionally, during the
first quarter of fiscal year 2004 the customer informed the Company of its
decision to cancel the consulting agreement.
On August 25, 2004, the Company entered into a mediated settlement agreement to
settle the pending litigation with the customer. Pursuant to the terms of the
settlement agreement, each party was dismissed from any liability for the claims
made against it and the customer agreed to make a settlement payment to the
Company, in the amount of $2 million to settle all claims and disputes arising
under the consulting services agreement. The Company has no obligation to render
further services to the customer. At October 11, 2004, the Company had received
the $2 million settlement from the customer and the parties had dismissed one
another from all liability. This payment, excluding approximately $700,000 in
previously recorded receivables, will be recognized as income in the fourth
quarter of fiscal year 2004.
10. CONTINGENCIES
In June 1998, the bankruptcy trustee of a former client, Communications Network
Corporation, sued the Company for a total of $320,000 in the U.S. Bankruptcy
Court in New York. The suit seeks recovery of an alleged preferential payment of
$160,000 for 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. The suit also seeks recovery of
$160,000 in consulting fees paid by the former client after August 6, 1996.
The bankruptcy trustee also sued the Company 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, The
Company believes it 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's business.
As of October 2, 2004 the Company has outstanding demands aggregating
approximately $1.0 million by the bankruptcy trustees of several former clients
in connection with balances collected near the customers' respective bankruptcy
filing dates. Although the Company does not believe it received any preferential
payments from these former clients and plans to vigorously defend its position,
the Company has established reserves of $753,000, 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 3, 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 3, 2004.
EXECUTIVE FINANCIAL OVERVIEW
As previously discussed in the Company's annual report on Form 10-K for the
fiscal year ended January 3, 2004, the communications industry has experienced a
significant economic downturn that began in fiscal year 2001 and continues to go
through significant changes resulting from a combination of competitive,
regulatory and technology factors, with growth occurring primarily in wireless
and internet protocol (IP) services. TMNG is a consultancy to the industry, and
as a result has experienced a significant reduction in consulting business since
2001. However, the Company is migrating the focus of its service offerings to
position itself in this new economic environment.
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 asset impairment
losses of $19.5 million for select reporting units and recorded valuation
reserves of $24.0 million against deferred income tax assets. During the
thirteen weeks ended April 3, 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. During the thirty-nine weeks ended October 2,
2004, the Company also recorded additional valuation reserves of $2.2 million
against deferred income tax assets, which offset income tax benefits generated
on operating losses for the thirty-nine week period.
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 gross margin,
pricing and utilization metrics, which are critical to a management consultancy.
The Company reduced selling, general and administrative expense during the
thirteen weeks ended October 2, 2004 by 13% from the comparable thirteen week
period ended September 27, 2003. Such cost reductions also enabled the Company
to minimize cash used in operations. Cash used in continuing operations was $3.9
million for the thirty-nine weeks ended October 2, 2004, compared with cash used
in continuing operations of $4.3 million for the thirty-nine weeks ended
September 27, 2003. The Company is also focusing its marketing efforts on large
and sustainable clients to maintain a portfolio of business that is high credit
quality, thus reducing bad debt risks.
OPERATIONAL OVERVIEW
Revenues typically consist of consulting fees for professional services and
related expense reimbursements. The Company's consulting services are typically
contracted on a time and materials basis, a time and materials basis not to
exceed contract price, a fixed fee basis, or contingent fee 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. Contract revenues on contingent fee contracts are
deferred until the revenue is realizable and earned.
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 primarily granted 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 use 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 for 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 a portion 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 $95,000 and $134,000 for
the thirteen weeks ended September 27, 2003 and October 2, 2004, respectively,
and $448,000 and $348,000 for the thirty-nine weeks ended September 27, 2003 and
October 2, 2004, respectively. The Company's allowance for doubtful accounts
totaled $652,000 and $248,000 at January 3, 2004 and October 2, 2004,
respectively. The decrease in the allowance for doubtful accounts was primarily
attributable to bad debt write-offs in the second quarter of fiscal year 2004.
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 attempted 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 Accounting for 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. 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 have occured. 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 in the thirteen
weeks ended April 3, 2004, related to the shutdown of the hardware business in
accordance with the provisions of SFAS No. 142.
In the thirteen weeks ended June 28, 2003, the operating results of one of the
Company's reporting units were significantly lower than projections and two
executives of acquired companies tendered their resignations. These events
resulted in the recognition of a goodwill impairment loss and intangible asset
impairment loss in the amounts of $15.8 million and $3.1 million, respectively.
The impairment losses have been reflected as a component of Loss from Operations
in the Statement of Operations and Comprehensive Loss.
Revenue Recognition - Historically, most of the Company'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. Other types of contracts include time and materials
basis not to exceed contract price, fixed fee contracts, managed services or
outsourcing contracts, and contingent fee 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 basis not to exceed
contract price 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 revisions as the contract progresses. Such revisions may result in an
increase or decrease to revenues and income and are reflected in the financial
statements in the periods in which they are first identified.
As the Company 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 these contingent fee contracts,
the Company recognizes costs as they are incurred on the project and defers
revenue recognition until the revenue is realizable and earned. Additional costs
and effort in excess of 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 October 2, 2004, cumulative valuation allowances in the
amounts of $26.1 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 OCTOBER 2, 2004 COMPARED TO THIRTEEN WEEKS ENDED SEPTEMBER
27, 2003
REVENUES
Revenues increased 39.5% to $6.5 million for the thirteen weeks ended October 2,
2004 from $4.7 million for the thirteen weeks ended September 27, 2003. The
increase in revenue is attributable to improving telecom spend, primarily toward
wireless and IP, along with an increase in the number and average size of
projects. During the thirteen weeks ended October 2, 2004, the Company provided
services on 97 customer projects, compared to 75 projects performed in the
thirteen weeks ended September 27, 2003. Average revenue per project was $67,000
in the thirteen weeks ended October 2, 2004, compared to $63,000 in the thirteen
weeks ended September 27, 2003. Our international revenue base increased to
18.3% of our revenues in the thirteen weeks ended October 2, 2004, from 14.5% in
the thirteen weeks ended September 27, 2003, due primarily to a significant
increase in project activity with large wireline and wireless global carriers
located in Western Europe and Australia.
Revenues recognized in connection with fixed price engagements totaled $2.4
million and $0.6 million for the thirteen weeks ended October 2, 2004 and
September 27, 2003, respectively, representing 37.2% and 12.2% of total revenue
during the thirteen weeks ended October 2, 2004, and September 27, 2003,
respectively.
Effective March 4, 2004, management and the Board of Directors elected to
shutdown all hardware business (previously reported as the separate business
segment "All Other"). Operating results of the hardware segment for the thirteen
weeks ended September 27, 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 increased to $3.4 million for the thirteen weeks ended
October 2, 2004, as compared to $2.5 million for the thirteen weeks ended
September 27, 2003. As a percentage of revenues, our gross margin based on
direct cost of service was 47.4% for the thirteen weeks ended October 2, 2004,
compared to 46.6% for the thirteen weeks ended September 27, 2003. The increase
in gross margin was primarily attributable to the mix of services and pricing of
projects.
Non-cash equity related charges were $51,000 for the thirteen weeks ended
October 2, 2004, compared to benefits of $10,000 for the thirteen weeks ended
September 27, 2003. Non-cash equity related charges in the thirteen weeks ended
October 2, 2004, primarily relate to the award of restricted stock to select
executives and key employees during the fourth quarter of fiscal year 2003,
which are being amortized on a graded vesting schedule over a period of two
years from the date of grant. The non-cash equity related benefit for the
thirteen weeks ended September 27, 2003, was primarily attributable to the
cancellation and forfeiture of unvested stock options by employees.
OPERATING EXPENSES
In total, operating expenses decreased to $4.3 million for the thirteen weeks
ended October 2, 2004, or 12.2% from $4.9 million for the thirteen weeks ended
September 27, 2003. Operating expenses include selling, general and
administrative costs, equity related charges, goodwill and intangible asset
impairment, and intangible asset amortization. Selling, general and
administrative expense for the thirteen weeks ended October 2, 2004 was $3.9
million compared to $4.4 million for the thirteen weeks ended September 27,
2003. The major component of the 12.9% decrease was a decline in payroll related
expenses of $400,000 related to a reduction in headcount as part of the
Company's on-going effort to re-size the business. 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 $218,000 and $504,000 for the thirteen weeks
ended October 2, 2004 and September 27, 2003, respectively. The decrease in
amortization expense was due to intangible asset impairments recorded in fiscal
year 2003 and certain intangibles becoming fully amortized, which had the
combined 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 equity related charges were $261,000 in the thirteen weeks ended
October 2, 2004. The charges relate to the award of restricted stock to select
executives and key employees during the fourth quarter of fiscal year 2003,
which are being amortized on a graded vesting schedule over a period of two
years from the date of grant. The non-cash equity related charges for the
thirteen weeks ended September 27, 2003 of $7,000, were primarily attributable
to recognition of compensation expense on pre-initial public offering grants of
stock options, offset by forfeitures of unvested stock options by employees.
OTHER INCOME
Interest income was $189,000 and $136,000 for the thirteen weeks ended October
2, 2004 and September 27, 2003, respectively, and represented interest earned on
invested balances. Interest income increased for the thirteen weeks ended
October 2, 2004 as compared to the thirteen weeks ended September 27, 2003, due
to investing cash reserves at higher interest rate returns in 2004 compared to
2003. The Company invests in short-term, high-grade investment instruments as
part of our overall investment policy.
INCOME TAXES
In the thirteen weeks ended October 2, 2004, the Company fully reserved its
income tax benefit generated by its pre-tax losses from continuing operations of
$1.1 million 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
$13,000 for the thirteen weeks ended October 2, 2004 related to state tax income
tax expense. In the thirteen weeks ended September 27, 2003, the Company
recorded a valuation allowance of $1.0 million to reserve the entire income tax
benefit generated in the third quarter.
THIRTY-NINE WEEKS ENDED OCTOBER 2, 2004 COMPARED TO THIRTY-NINE WEEKS ENDED
SEPTEMBER 27, 2003
REVENUES
Revenues increased 3.6% to $17.5 million for the thirty-nine weeks ended October
2, 2004, from $16.9 million for the thirty-nine weeks ended September 27, 2003.
The increase in revenue is attributable to improving telecom industry spend,
primarily toward wireless and IP, along with a slight increase in our average
project size. During the thirty-nine weeks ended October 2, 2004, the Company
provided services on 153 customer projects, compared to 154 projects performed
in the thirty-nine weeks ended September 27, 2003. Average revenue per project
was $114,000 during the thirty-nine weeks ended October 2, 2004 compared to
$110,000 in the thirty nine weeks ended September 27, 2003. International
revenue base increased to 20.5% of the Company's revenues for the thirty-nine
weeks ended October 2, 2004, from 9.3% for the thirty-nine weeks ended September
27, 2003, due primarily to a significant increase in project activity with large
global wireline and wireless carriers located in Western Europe and Australia.
Revenues recognized in connection with fixed price engagements totaled $4.5
million and $4.1 million for the thirty-nine weeks ended October 2, 2004 and
September 27, 2003, respectively, representing 25.6% and 24.5% of total revenue
during the thirty-nine weeks ended October 2, 2004, and September 27, 2003,
respectively.
Effective March 4, 2004, management and the Board of Directors elected to
shutdown all hardware business (previously reported as the separate business
segment "All Other"). Operating results of the hardware segment for the
thirty-nine weeks ended October 2, 2004 and September 27, 2003 have been
included as a component of discontinued operations in the Consolidated Condensed
Statements of Operations and Comprehensive Loss contained herein.
COST OF SERVICES
Direct costs of services increased 2.1% to $9.1 million for the thirty-nine
weeks ended October 2, 2004 compared to $8.9 million for the thirty-nine weeks
ended September 27, 2003, consistent with higher revenue generation on project
activity. As a percentage of revenues, our gross margin was 48.1% based upon
direct cost of services for the thirty-nine weeks ended October 2, 2004,
compared to 47.3% for the thirty-nine weeks ended September 27, 2003. The
increase in gross margin was primarily attributable to the mix of services and
pricing of projects.
Non-cash equity related charges were $157,000 for the thirty-nine weeks ended
October 2, 2004, compared to benefits of $114,000 for the thirty-nine weeks
ended September 27, 2003. Non-cash equity related charges for the thirty-nine
weeks ended October 2, 2004 relate to the award of restricted stock to select
executives and key employees during the fourth quarter of fiscal year 2003,
which are being amortized on a graded vesting schedule over a period of two
years from the date of grant. The non-cash stock equity related benefit for the
thirty-nine weeks ended September 27, 2003, was primarily attributable to the
cancellation and forfeiture of unvested stock options by employees.
OPERATING EXPENSES
In total, operating expenses decreased to $13.9 million for the thirty-nine
weeks ended October 2, 2004, or 61.0% from $35.6 million for the thirty-nine
weeks ended September 27, 2003. Operating expenses include selling, general and
administrative costs, equity related charges, goodwill and intangible asset
impairment, and intangible asset amortization. The major component of the $21.7
million decrease in operating expenses was an $18.9 million charge in the
thirty-nine weeks ended September 27, 2003 for goodwill and intangible asset
impairment related to one of our acquired entities. Selling, general and
administrative expenses for the thirty-nine weeks ended September 27, 2004 were
$12.3 million compared to $14.8 million for the thirty-nine weeks ended
September 27, 2003. The major component of the 16.5% decrease was a decline in
payroll related expenses of $1.1 million related to a reduction in headcount as
part of the Company's on-going effort to re-size the business. 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 $774,000 and $1.9 million for the thirty-nine
weeks ended October 2, 2004 and September 27, 2003, respectively. The decrease
in amortization expense was due to intangible asset impairments recorded in
fiscal year 2003 and certain intangibles becoming fully amortized, which had the
combined 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 equity related charges were $776,000 in the thirty-nine weeks ended
October 2, 2004. The charges relate to the award of restricted stock to select
executives and key employees during the fourth quarter of fiscal year 2003,
which are being amortized on a graded vesting schedule over a period of two
years from the date of grant. The non-cash equity related charges for the
thirty-nine weeks ended September 27, 2003 of $261,000, were primarily
attributable to recognition of compensation expense on pre-initial public
offering grants of stock options, offset by forfeitures of unvested stock
options by employees.
OTHER INCOME
Interest income was $470,000 and $474,000 for the thirty-nine weeks ended
October 2, 2004 and September 27, 2003, respectively, and represented interest
earned on invested balances. Interest income remained consistent for the
thirty-nine weeks ended October 2, 2004 compared to thirty-nine weeks ended
September 27, 2003, as lower invested balances in 2004 were offset by higher
interest rate returns in 2004 compared to 2003. The Company invests in
short-term, high-grade investment instruments as part of our overall investment
policy.
INCOME TAXES
For the thirty-nine weeks ended October 2, 2004 the Company fully reserved its
deferred income tax asset and benefits generated by its pre-tax losses of $5.2
million from continuing operations 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 $47,000 for the thirty-nine weeks ended
October 2, 2004 related to state income tax expense. In the thirty-nine weeks
ended September 27, 2003, the Company generated an income tax benefit of $10.5
million offset by a valuation allowance of $6.2 million.
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 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. In addition losses
generated in the thirty-nine weeks ended October 2, 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 loss generated by the discontinued segment, on a net of tax basis, of
$30,000 and income of $49,000 for the thirteen and thirty-nine weeks ended
September 27, 2003. For business segment reporting purposes, the hardware
segment was previously recorded as the "All Other" segment.
LIQUIDITY AND CAPITAL RESOURCES
Our primary cash requirements are employee and consultant compensation and other
selling, general and administrative expenses typical for a consulting company in
our industry. We have historically met cash requirements primarily through cash
generated by operations. During the recent periods in which we have experienced
negative cash flow due to operating losses, we have used our cash reserves to
meet operating cash requirements.
Net cash used in continuing operating activities was $3.6 million for the thirty
nine weeks ended October 2, 2004, compared to net cash used in continuing
operating activities of $4.3 million for the thirty-nine weeks ended September
27, 2003. The Company incurred negative cash flow from its operating activities
for the thirty-nine weeks ended October 2, 2004 and September 27, 2003 primarily
due to operating losses.
Net cash used in investing activities was $107,000 and $98,000 for the
thirty-nine weeks ended October 2, 2004 and September 27, 2003, respectively.
Cash used in investing activities in 2004 and 2003 related to capitalization of
office equipment, software and computer equipment by the Company.
Net cash provided by financing activities was $75,000 in the thirty-nine weeks
ended October 2, 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 $33,000 in the thirty-nine weeks ended
September 27, 2003, and related to payments made on the current portion of its
capital lease obligations and outstanding debt, partially offset by proceeds
received from the exercise of employee stock options and purchase of stock under
the Company's employee stock purchase plan.
At October 2, 2004, TMNG had approximately $49.1 million in cash and cash
equivalents and virtually no long term debt. The Company 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. The Company is well positioned because of
its cash reserves and minimal debt position to weather continuing adverse
conditions in the communications industry for a period of time; however, if the
industry and demand for consulting services do not continue to 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.
The Company does not have material exposure to market related risks. Foreign
currency exchange rate risk may become material given U.S. dollar to foreign
currency exchange rate changes and significant increases in international
engagements denominated in the local currency of the Company's 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 upon that review and evaluation, the CEO and CFO have
concluded that the Company's 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 material weaknesses identified in the course of such review and
evaluation and accordingly, the Company implemented 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, 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
to the Condensed Consolidated Financial Statements included elsewhere in this
report.
ITEM 2. UNREGISTERED SALES OF EQUITY SECURTIES AND USE OF PROCEEDS
None
ITEM 6. EXHIBITS
(a) Exhibits
Exhibit 31. Certifications Pursuant to Section 302 of the Sarbanes-Oxley Act of
2002.
Exhibit 32. Certifications Pursuant to Section 906 of the Sarbanes-Oxley Act of
2002.
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 NOVEMBER 16, 2004
------------------------------ EXECUTIVE OFFICER
RICHARD P. NESPOLA
/S/ DONALD E. KLUMB CHIEF FINANCIAL OFFICER AND NOVEMBER 16, 2004
----------------------------- TREASURER
DONALD E. KLUMB (PRINCIPAL FINANCIAL OFFICER
AND PRINCIPAL ACCOUNTING
OFFICER)