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 2, 2005
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
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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 13, 2005, TMNG had outstanding 35,135,828 shares of common stock.
THE MANAGEMENT NETWORK GROUP, INC.
INDEX
PAGE
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PART I. FINANCIAL INFORMATION
ITEM 1. Consolidated Condensed Financial Statements (unaudited):
Consolidated Condensed Balance Sheets - April 2, 2005
and January 1, 2005 ...................................... 3
Consolidated Condensed Statements of Operations and
Comprehensive Loss - Thirteen weeks ended April 2, 2005
and April 3, 2004 .......................................... 4
Consolidated Condensed Statements of Cash Flows
- Thirteen weeks ended April 2, 2005 and April 3, 2004 ..... 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 ................................................ 14
ITEM 4. Controls and Procedures ...................................... 14
PART II. OTHER INFORMATION
ITEM 1. Legal Proceedings ............................................ 15
ITEM 2. Unregistered Sales of Equity Securities and Use of Proceeds .. 15
ITEM 3. Defaults Upon Senior Securities .............................. 15
ITEM 4. Submission of Matters to a Vote of Security Holders .......... 15
ITEM 5. Other Information ............................................ 15
ITEM 6. Exhibits ..................................................... 15
Signatures............................................................ 15
Exhibits.............................................................. 15
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)
April 2, January 1,
2005 2005
---------- ----------
CURRENT ASSETS:
Cash and cash equivalents ................................ $ 12,741 $ 10,882
Short-term investments ................................... 38,550 41,300
Receivables:
Accounts receivable .................................... 3,559 4,663
Accounts receivable - unbilled ......................... 3,929 1,911
---------- ----------
7,488 6,574
Less: Allowance for doubtful accounts .................. (358) (396)
---------- ----------
7,130 6,178
Prepaid and other assets .................................. 1,288 1,945
---------- ----------
Total current assets ........................... 59,709 60,305
---------- ----------
Property and equipment, net ............................. 1,027 896
Goodwill ................................................. 13,365 13,365
Identifiable intangible assets, net ...................... 327 487
Loan to officer .......................................... 300 300
---------- ----------
Total Assets ............................................... $ 74,728 $ 75,353
========== ==========
CURRENT LIABILITIES:
Trade accounts payable ................................... $ 555 $ 845
Accrued payroll, bonuses and related expenses ............ 1,524 1,040
Other accrued liabilities ................................ 2,322 2,574
Unfavorable and capital lease obligations 611 725
---------- ----------
Total current liabilities ...................... 5,012 5,184
Unfavorable and capital lease obligations .................. 3,266 3,422
STOCKHOLDERS' EQUITY
Common Stock: ............................................ 35 35
Voting - $.001 par value, 100,000,000 shares
authorized; 35,037,289 and 34,750,562 issued and
outstanding on April 2, 2005 and January 1, 2005,
respectively
Preferred stock - $.001 par value, 10,000,000 shares
authorized, no shares issued or outstanding
Additional paid-in capital ............................... 158,407 157,857
Accumulated deficit ...................................... (91,493) (90,885)
Accumulated other comprehensive income -
Foreign currency translation adjustment ................. 282 352
Unearned compensation .................................... (781) (612)
---------- ----------
Total stockholders' equity ...................... 66,450 66,747
---------- ----------
Total Liabilities and Stockholders' Equity ................. $ 74,728 $ 75,353
========== ==========
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
------------------------------
April 2, April 3,
2005 2004
--------- ----------
Revenues .................................. $ 7,067 $ 5,779
Cost of Services:
Direct cost of services ................. 3,394 2,913
Equity related charges .................. 35 54
--------- ---------
Total cost of services ................ 3,429 2,967
--------- ---------
Gross Profit .............................. 3,638 2,812
Operating Expenses:
Selling, general and administrative ..... 4,147 4,278
Real estate restructuring ............... 75
Intangible asset amortization............ 160 339
Equity related charges .................. 188 283
--------- ---------
Total operating expenses .............. 4,570 4,900
--------- ---------
Loss from operations ...................... (932) (2,088)
Other Income:
Interest income ......................... 324 136
Other, net .............................. 15 (9)
--------- ---------
Total other income .................... 339 127
--------- ---------
Loss from continuing operations before
income tax provision ..................... (593) (1,961)
Income tax provision ...................... (15) (14)
--------- ---------
Loss from continuing operations............ (608) (1,975)
--------- ---------
Discontinued operations:
Net loss from discontinued operations
(includes a charge for impairment of
Goodwill of $2,163 for the thirteen
weeks ended April 3, 2004) ............ (2,276)
--------- ---------
Net loss (608) (4,251)
Other comprehensive item -
Foreign currency translation
adjustment ............................ (70) (15)
--------- ---------
Comprehensive loss ........................ $ (678) $ (4,266)
========= =========
Loss from continuing operations
per common share
Basic and Diluted ...................... $ (0.02) $ (0.06)
Loss from discontinued operations
per common share
Basic and Diluted ...................... $ (0.06)
--------- ---------
Loss per common share
Basic and Diluted ....................... $ (0.02) $ (0.12)
========= =========
Shares used in calculation of loss
from continuing operations, loss from
discontinued operations, and net loss
per common share
Basic and Diluted ....................... 34,977 34,503
========= =========
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
-------------------------------
April 2, April 3,
2005 2004
---------- ----------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss .............................................. $ (608) $ (4,251)
Adjust for loss from discontinued operations
(includes non-cash goodwill impairment
charge of $2,163 in the thirteen weeks
ended April 3, 2004)................................ 2,276
---------- ----------
Loss from continuing operations (608) (1,975)
Adjustments to reconcile net loss to net
cash used in operating activities:
Depreciation and amortization ...................... 282 521
Equity related charges ............................. 223 337
Other changes in operating assets and liabilities:
Accounts receivable ........................... 1,066 649
Accounts receivable - unbilled ................ (2,018) (1,329)
Prepaid and other assets ...................... 657 (390)
Trade accounts payable ........................ (291) (158)
Accrued liabilities ........................... 59 465
---------- ----------
Net cash used in operating activities
from continuing operations .............. (630) (1,880)
Net cash used in discontinued operations ... (113)
---------- ----------
Net cash used in operating activities ...... (630) (1,993)
---------- ----------
CASH FLOWS FROM INVESTING ACTIVITIES:
Proceeds from maturities and sales of short-term
investments .......................................... 2,750 1,299
Acquisition of property and equipment ................. (86) (35)
---------- ----------
Net cash provided by investing activities .. 2,664 1,264
---------- ----------
CASH FLOWS FROM FINANCING ACTIVITIES:
Payments made on long-term obligations ................ (263) (100)
Proceeds from exercise of options ..................... 158 453
---------- ----------
Net cash provided by (used in) financing
activities ............................... (105) 353
---------- ----------
Effect of exchange rate on cash and cash
equivalents ............................................ (70) (15)
---------- ----------
Net increase (decrease) in cash and cash equivalents .... 1,859 (391)
Cash and cash equivalents, beginning of period .......... 10,882 8,825
---------- ----------
Cash and cash equivalents, end of period ................ $ 12,741 $ 8,434
========== ==========
Supplemental disclosure of cash flow information:
Cash paid during period for interest ................. $ 1 $ 9
========== ==========
Cash paid during period for taxes .................... $ 15 $ 14
========== ==========
Non-cash acquisitions of property and equipment
included in accrued liabilities ................... $ 169
==========
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. ("TMNG or the "Company") as of April 2, 2005 and January 1,
2005, and for the thirteen weeks ended April 2, 2005 and April 3, 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.
Changes in Presentation
Auction rate securities which prior to the fourth quarter of 2004 were recorded
in cash and cash equivalents due to their liquidity and pricing reset feature,
have been included as short-term investments in the accompanying balance sheet
and sales and maturities of these securities have been reflected as investing
activities in the statements of cash flows.
Stock Based Compensation
During the thirteen weeks ended April 3, 2004, the Company granted 175,000
shares of restricted stock to key executives. These grants had a fair value on
the date of grant of $392,000. During the thirteen weeks ended April 2, 2005 and
April 3, 2004, the Company recognized compensation expense of $223,000 and
$337,000, respectively, related to the restricted stock grants made during first
quarter 2005 as well as 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 through charges to operations on a graded vesting
schedule over periods ranging from two to four years.
During the thirteen weeks ended April 2, 2005, the Company granted options to
purchase 205,000 shares of the Company's common stock at a weighted average
exercise price of $2.36. 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 April 3, 2004, the Company granted approximately 75,000
stock options to employees 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.
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 ("APB") Opinion
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 No. 25 option grants, restricted
stock 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 April 2, 2005 and April 3, 2004 would have
increased/decreased by approximately $0.4 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
April 2, 2005 and April 3, 2004 (in thousands, except per share amounts):
THIRTEEN WEEKS ENDED
--------------------------------
APRIL 2, 2005 APRIL 3, 2004
------------- -------------
Net loss, as reported: $ (608) $ (4,251)
Add: Stock based employee compensation
expense included in reported net
income (loss) 223 337
Deduct: Total stock-based compensation
expense determined under fair value based
method for all awards (606) (1,250)
----------- -----------
Pro forma net loss $ (991) $ (5,164)
=========== ===========
Loss per share
Basic and diluted, as reported $ (0.02) $ (0.12)
=========== ===========
Basic and diluted, pro forma $ (0.03) $ (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 April 2, 2005
and April 3, 2004 as the Company reported a loss from continuing operations for
both periods and the effect would have been anti-dilutive. The weighted average
shares of common stock outstanding for basic and diluted loss per share for the
thirteen weeks ended April 2, 2005 and April 3, 2004 were 34,977,000 and
34,503,000, respectively. Had the Company reported net income for the thirteen
weeks ended April 2, 2005 and April 3, 2004, the treasury stock method of
calculating common stock equivalents would have resulted in approximately
475,000 and 1,719,000 additional dilutive shares, respectively.
NEW ACCOUNTING STANDARDS--In December 2004, the Financial Accounting Standards
Board ("FASB") issued SFAS No. 123(R), "Share-Based Payment," replacing SFAS No.
123 and superseding APB Opinion No. 25. SFAS No. 123(R), as recently amended,
requires public companies to recognize compensation expense for the cost of
awards of equity compensation effective for fiscal years beginning after June
15, 2005. This compensation cost will be measured as the fair value of the award
estimated using an option-pricing model on the grant date. The Company is
currently evaluating the various transition provisions under SFAS No. 123(R) and
will adopt SFAS No. 123(R) effective January 1, 2006, which is expected to
result in increased compensation expense in future periods.
3. DISCONTINUED OPERATIONS
During the thirteen weeks ended April 3, 2004, management and the Board of
Directors elected to discontinue 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 discontinuation of the
hardware business were $2.3 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.
Net sales and loss from discontinued operations are as follows (amounts in
thousands):
FOR THE
THIRTEEN
WEEKS ENDED
April 3, 2004
-------------
Net sales $ 11
========
Goodwill impairment
and severance charge $(2,213)
Operating loss (63)
--------
Loss from discontinued
operations $(2,276)
========
4. BUSINESS SEGMENTS
The Company identifies its segments based on the way management organizes the
Company to assess performance and make operating decisions regarding the
allocation of resources. In accordance with the criteria in SFAS No. 131
"Disclosure about Segments of an Enterprise and Related Information," the
Company has concluded it has four operating segments: Operations, Strategy,
Marketing and International; which are aggregated in one reportable segment, the
Management Consulting Services segment. 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.
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
--------------------------------------------------------------------
APRIL 2, 2005 APRIL 3, 2004
------------- -------------
United States $ 6,608 $ 4,414
International:
Portugal 860
The Netherlands 39 218
Great Britain 203
United Kingdom 345
Other 75 84
------- -------
Total $7,067 $ 5,779
======= =======
5. GOODWILL
During the thirteen weeks ended April 3, 2004, the Company recorded a $2.2
million goodwill impairment loss related to the discontinuation 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 2, 2005 are as follows (amounts in
thousands):
Management Consulting Discontinued
Segment Operations Total
--------------------- ------------ -------
Balance as of January 3, 2004 $ 13,365 $ 2,163 $ 15,528
Impairment loss (2,163) (2,163)
-------- --------- --------
Balance as of January 1, 2005 13,365 $ 0 13,365
=========
Impairment loss
--------- --------
Balance as of April 2, 2005 $ 13,365 $13,365
========= ========
6. OTHER IDENTIFIABLE INTANGIBLE ASSETS
Included in the Company's consolidated balance sheets as of April 2, 2005 and
January 1, 2005, are the following identifiable intangible assets (amounts in
thousands):
April 2, 2005 January 1, 2005
------------------------ ------------------------
Accumulated Accumulated
Cost Amortization Cost Amortization
------- ------------ ------- ------------
Customer relationships $ 1,908 $(1,581) $ 1,908 $(1,538)
Employment agreements 3,200 (3,200) 3,200 (3,083)
------- -------- ------- --------
Total $ 5,108 $(4,781) $ 5,108 $(4,621)
======= ======== ======= ========
Intangible amortization expense for the thirteen weeks ended April 2, 2005 and
April 3, 2004 was $160,000 and $339,000, respectively. Intangible amortization
expense is estimated to be approximately $128,000 for the remainder of fiscal
year 2005, $171,000 in fiscal year 2006 and $28,000 in fiscal year 2007.
7. INCOME TAXES
In the thirteen weeks ended April 2, 2005 and April 3, 2004, the Company
generated income tax benefits of $233,000 and $817,000, respectively. The
Company recorded full valuation allowances against these income tax benefits in
accordance with 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 income tax provision of $15,000 and
$14,000 for the thirteen weeks ended April 2, 2005 and April 3, 2004,
respectively, related to state tax expense. As of April 2, 2005, the Company
recorded $26.9 million of valuation allowance in connection with its deferred
tax assets.
The Company establishes reserves for potential tax liabilities when, despite the
belief that tax return positions are fully supported, certain positions are
likely to be challenged and not be fully sustained. Such tax reserves are
analyzed on a quarterly basis and adjusted based upon
changes in facts and circumstances, such as the progress of federal and state
audits, case law and emerging legislation. The Company establishes the reserves
based upon its assessment of exposure associated with possible future
assessments that may result from the examination of federal, state, or
international tax returns. These tax reserves did not change materially during
the thirteen week periods ended April 2, 2005 and April 3, 2004. Management
believes that it has established adequate reserves in the event of loss or
settlement of any potential tax liabilities.
8. REAL ESTATE RESTRUCTURING
In the fourth quarter of fiscal year 2004, the Company made the decision to
consolidate office space. In connection with this decision, a sublease agreement
for unutilized space was entered into with a third party for the remainder of
the original lease term. In accordance with SFAS No. 146, "Accounting for Costs
Associated with Exit or Disposal Activities," the decision to consolidate office
space resulted in charges of $75,000 related to the buyout of an office
equipment lease in the thirteen weeks ended April 2, 2005. The restructuring
charge of $75,000 has been reflected as a component of Loss from Operations in
the Statement of Operations and Comprehensive Loss.
9. LOANS TO OFFICERS
As of April 2, 2005, there is one remaining line of credit between the Company
and its Chief Executive Officer, Richard P. Nespola, which originated in fiscal
year 2001. Aggregate borrowings available and outstanding against the line of
credit at April 2, 2005 and January 1, 2005 totaled $300,000 and are 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.
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 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. Although the Company denies these claims and plans
to vigorously defend itself, management has established reserves of $160,000 as
of April 2, 2005 and January 1, 2005.
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's business.
As of April 2, 2005 the Company had outstanding demands aggregating
approximately $1.0 million by the bankruptcy trustees of several former clients
in connection with collected balances near the customers' respective bankruptcy
filing dates. 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 $727,000 as of April 2, 2005 and January
1, 2005.
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, future customer bankruptcies could result in
additional claims on collected balances for professional services near the
bankruptcy filing date. While the resolution of any such actions, claims, or the
matters described above may have an impact on the financial results for the
period in which they occur, 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 our annual report on Form 10-K for the fiscal year ended January 1,
2005. 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 our
annual report on Form 10-K for the fiscal year ended January 1, 2005.
EXECUTIVE FINANCIAL OVERVIEW
As discussed in our 2004 annual report on Form 10-K for the fiscal year ended
January 1, 2005, the communications industry experienced a significant economic
recession from 2001 through 2004. We are a consultancy to the industry, and as a
result experienced a significant reduction in consulting business primarily due
to the recession. We experienced significant revenue declines and/or net losses
from 2001 to 2004. During this period we maintained relatively consistent gross
margins through innovative pricing and high consultant utilization levels.
Beginning in late 2004 and continuing through the first quarter of 2005, we saw
what we believe is the beginning of a recovery in the telecommunication sector.
During the thirteen weeks ended April 2, 2005, revenues increased 22% compared
with the same period of 2004. Additionally, gross margins improved to over 51%
compared with 49% during the same period of 2004. We believe these improved
operating results are reflective of our efforts to capitalize on the growth of
wireless and Internet protocol (IP) initiatives within the communications
sector.
We have also implemented many programs to size the business consistent with our
lower revenue base. Such steps included 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. Selling,
general and administrative costs in the first quarter of 2005 are comparable to
the first quarter of 2004. It is management's intention to increase investment
in building new solutions and offerings for wireless and IP initiatives. We are
focusing our marketing efforts on large and sustainable clients to maintain a
portfolio of business that is high credit quality, thus reducing bad debt risks.
Our comprehensive cost reduction efforts have assisted us in minimizing cash
used in operations and allowed us to maintain strong levels of cash and
short-term investments. Our short term investments primarily consist of money
market funds and investment-grade auction rate securities. Returns on our
short-term investments have increased over recent periods as a result of
increasing interest rates.
OPERATIONAL OVERVIEW
Revenues typically consist of consulting fees for professional services and
related expense reimbursements. Our 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 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 our 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. Our 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. We anticipate that we will continue to
do so in the future. Because we are a consulting company, we experience
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 our
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, we must re-deploy professional service personnel as any
resulting unbillable time could harm our margins.
Cost of services consists primarily of compensation for consultants who are
employees and amortization of equity related non-cash charges incurred in
connection with 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. Gross margins are primarily
impacted by the type of consulting services provided; the size of service
contracts and negotiated volume discounts; changes in our 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, intangible asset amortization, and real estate restructuring charges.
Sales and marketing expenses consist primarily of personnel salaries, bonuses,
and related costs for direct client sales efforts and marketing staff. We
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 costs for accounting, recruiting
and staffing, information technology, personnel, 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 awards, primarily to principals and certain senior
executives.
CRITICAL ACCOUNTING POLICIES
While the selection and application of any accounting policy may involve some
level of subjective judgments and estimates, we believe the following accounting
policies are the most critical to our consolidated financial statements,
potentially involve the most subjective judgments in their selection and
application, and are the most susceptible to uncertainties and changing
conditions:
o Allowance for Doubtful Accounts;
o Impairment of Goodwill and Long-lived Intangible Assets;
o Revenue Recognition; and
o Deferred Income Tax Assets.
ALLOWANCES FOR DOUBTFUL ACCOUNTS--Substantially all of our receivables are owed
by companies in the communications industry. We typically bill customers for
services after all or a portion of the services have been performed and require
customers to pay within 30 days. We attempt to control credit risk by being
diligent in credit approvals, limiting the amount of credit extended to
customers and monitoring customers' payment records and credit status as work is
being performed for them.
We recorded no bad debt expense for the thirteen weeks ended April 2, 2005 and
recorded bad debt expense of $108,000 for the thirteen weeks ended April 3,
2004. During the thirteen weeks ended April 2, 2005, no provision was necessary
for our allowance for doubtful accounts to maintain a level appropriate with the
anticipated default rate of the underlying accounts receivable balances. Our
allowance for doubtful accounts totaled $358,000 and $396,000 as of April 2,
2005 and January 1, 2005, respectively. The calculation of these amounts is
based on judgment about the anticipated default rate on receivables owed to us
as of the end of the reporting period. That judgment was based on uncollected
account experience in prior years and our ongoing evaluation of the credit
status of our customers and the communications industry in general.
We have attempted to mitigate credit risk by concentrating our 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 we are
unsuccessful in these efforts, or if our customers file for bankruptcy or
experience financial difficulties, it is possible that the allowance for
doubtful accounts will be insufficient and we will have a greater bad debt loss
than the amount reserved, which would adversely affect our cash flow and
financial performance.
IMPAIRMENT OF GOODWILL AND LONG-LIVED INTANGIBLE ASSETS--Goodwill and other
long-lived intangible assets arising from our acquisitions are subjected to
periodic review for impairment. SFAS No. 142 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 estimated fair value of the reporting unit, there is a requirement to write
down these assets. The determination of fair value requires management to make
assumptions about future cash flows and discount rates. Management's assumptions
require significant judgment and estimation which could result in variable and
volatile fair values.
Effective March 4, 2004, management and the Board of Directors elected to
discontinue our hardware business. We concluded this segment of the business did
not align well with our strategic focus. We incurred goodwill impairment charges
of $2.2 million in the thirteen weeks ended April 3, 2004, related to the
discontinuation of the hardware business, in accordance with the provisions of
SFAS No. 142.
REVENUE RECOGNITION--Historically, most of our consulting practice contracts
have been on a time and materials basis, in which customers are billed for time
and materials expended in performing their engagements. We recognize revenue
from those types of customer contracts in the period in which our services are
performed. In addition to time and materials contracts, our other types of
contracts include time and materials contracts 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
terms than consulting contracts (e.g., longer than one year).
We recognize revenues on time and materials contracts not to exceed contract
price and fixed fee contracts using the percentage of completion method.
Percentage of completion accounting involves calculating the percentage of
services 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 in revenues and income and are reflected in the financial statements
in the periods in which they are first identified.
Due to the nature of contingent fee contracts, we recognize costs as they are
incurred on the project and defer revenue recognition until the revenue is
realizable and earned as agreed to by our clients. Although these contracts can
be very rewarding, the profitability of these contracts is dependent on our
ability to deliver results for our clients.
As we continue to adapt to changes in the communications consulting industry, we
entered 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.
DEFERRED INCOME TAX ASSETS--We have generated substantial deferred income tax
assets primarily from the accelerated financial statement write-off of goodwill,
the charge to compensation expense taken for stock options and net operating
loss carry forwards. For us to realize the income tax benefit of these assets,
we 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 our deferred income tax assets, we have
evaluated our ability to carry back tax losses to prior years that reported
taxable income, and our ability 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 us. As of April 2, 2005, cumulative valuation allowances in the
amount of $26.9 million were recorded in connection with the deferred income tax
assets. We continue to evaluate the recoverability of the recorded deferred
income tax asset balances. If we continue to report net operating losses for
financial reporting, no additional tax benefit would be recognized for those
losses, since we would be required to increase our valuation allowance to offset
such amounts.
RESULTS OF OPERATIONS
THIRTEEN WEEKS ENDED APRIL 2, 2005 COMPARED TO THIRTEEN WEEKS ENDED APRIL 3,
2004
Effective March 4, 2004, management and the Board of Directors elected to
discontinue all hardware business (previously reported as the separate business
segment "All Other"). Operating results of the hardware segment for the thirteen
weeks ended April 3, 2004, have been included as a component of discontinued
operations in the Consolidated Condensed Statements of Operations and
Comprehensive Loss contained herein.
REVENUES
Revenues increased 22.3% to $7.1 million for the thirteen weeks ended April 2,
2005 from $5.8 million for the thirteen weeks ended April 3, 2004. The increase
in revenue is attributable to an increase in the number of consulting projects
due partially to our market penetration consulting to wireless and IP clients,
coupled with improving economics within the telecommunications industry. During
the thirteen weeks ended April 2, 2005, the Company provided services on 123
customer projects, compared to 75 projects performed in the thirteen weeks ended
April 3, 2004. Average revenue per project was $57,000 in the thirteen weeks
ended April 2, 2005 compared to $77,000 in the thirteen weeks ended April 3,
2004. The decrease in average revenue per project was primarily attributable to
one large project that was undertaken in the thirteen weeks ended April 3, 2004.
Our international revenue base decreased to 6.5% of revenues for the thirteen
weeks ended April 2, 2005, from 23.6% for the thirteen weeks ended April 3,
2004, due primarily to the end of multiple large projects in Western Europe at
the end of fiscal year 2004, combined with an increase in our domestic project
and revenue base.
Revenues recognized in connection with fixed price and contingent fee
engagements totaled $3.2 million and $1.1 million for the thirteen weeks ended
April 2, 2005 and April 3, 2004, respectively, representing 45.2% and 18.6% of
total revenue during the thirteen weeks ended April 2, 2005 and April 3, 2004,
respectively. This is due to the mix of our business shifting to more strategy
and management consulting opportunities which are more likely to be structured
as fixed price or contingent fee engagements.
COSTS OF SERVICES
Direct costs of services increased to $3.4 million for the thirteen weeks ended
April 2, 2005, compared to $2.9 million for the thirteen weeks ended April 3,
2004. As a percentage of revenue, our gross margin based on direct cost of
service was 52.0% for the thirteen weeks ended April 2, 2005, compared to 49.6%
for the thirteen weeks ended April 3, 2004. The increase in gross margin was
primarily attributable to a shift in the mix of services to more strategy and
management consulting engagements in relation to staffing opportunities.
Non-cash stock based compensation charges were $35,000 for the thirteen weeks
ended April 2, 2005, compared to $54,000 for the thirteen weeks ended April 3,
2004. Non-cash stock based compensation charges primarily relate to the
Company's granting of restricted stock to select executives and key consultants
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.
OPERATING EXPENSES
In total, operating expenses decreased to $4.6 million for the thirteen weeks
ended April 2, 2005, or 6.7% from $4.9 million for the thirteen weeks ended
April 3, 2004. Operating expenses include selling, general and administrative
costs, real estate restructuring, equity related charges, and intangible asset
amortization. Selling, general and administrative expenses for the thirteen
weeks ended April 2, 2005 were $4.1 million, compared to $4.3 million for the
thirteen weeks ended April 3, 2004. The largest component of the decrease was a
decline in rent expense of $141,000 related to the consolidation of office
space. We continue to examine cost-reduction measures to enhance our
profitability and manage operating expenses to better align them with the size
of the business. We expect operating expenses to increase slightly in future
periods as we continue to invest in new offerings and solutions.
Intangible asset amortization was $160,000 and $339,000 for the thirteen weeks
ended April 2, 2005 and April 3, 2004, respectively. The decrease in
amortization expense was due to certain intangible assets becoming fully
amortized during fiscal year 2004 and first quarter 2005.
In the fourth quarter of fiscal year 2004, we made the decision to consolidate
office space. In connection with this decision, a sublease agreement for
unutilized space was entered into with a third party for the remainder of the
original lease term. In accordance with SFAS No. 146 "Accounting for Costs
Associated with Exit or Disposal Activities," the decision to consolidate office
space resulted in charges of $75,000 related to the buyout of an office
equipment lease in the thirteen weeks ended April 2, 2005.
Non-cash stock based compensation charges were $188,000 in the thirteen weeks
ended April 2, 2005 compared to $283,000 for the thirteen weeks ended April 3,
2004. The charges relate to the award of restricted stock to select executives
and key employees during the fourth quarter of fiscal year 2003 and first
quarter of fiscal year 2005, which are being amortized on a graded vesting
schedule over a period of two years from the date of grant for the fiscal year
2003 grants and four years from the date of grant for the fiscal year 2005
grants.
OTHER INCOME AND EXPENSES
Interest income was $324,000 and $136,000 for the thirteen weeks ended April 2,
2005 and April 3, 2004, respectively, and represented interest earned on
invested balances. Interest income increased for the thirteen weeks ended April
2, 2005 as compared to the thirteen weeks ended April 3, 2004 due to increases
in interest rates from 2004 to 2005. We primarily invest in money market funds
and investment-grade auction rate securities as part of our overall investment
policy.
INCOME TAXES
In the thirteen weeks ended April 2, 2005 and April 3, 2004 we recorded no
income tax benefit related to our 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. We
continue to evaluate the recoverability of our recorded deferred income tax
asset balances. If we continue to report net operating losses for financial
reporting, no additional tax benefit would be recognized for those losses, since
we would be required to increase our valuation allowance to offset such amounts.
We also reported an income tax provision of $15,000 and $14,000 for the thirteen
weeks ended April 2, 2005 and April 3, 2004, respectively, related to state tax
expense.
DISCONTINUED OPERATIONS
For the thirteen weeks ended April 3, 2004, charges related to the
discontinuation of the hardware business were $2.3 million and relate primarily
to goodwill impairment and severance charges of $2.2 million. In addition,
operating losses of the discontinued operations were $63,000 for the thirteen
weeks ended April 3, 2004. These charges are reported within discontinued
operations in the Statement of Operations and Comprehensive Loss.
LIQUIDITY AND CAPITAL RESOURCES
In fiscal year 2004, through additional clarifying guidance, we determined that
our investments in auction rate securities are more appropriately classified as
available-for-sale short-term investments rather than cash equivalents and we
have reflected such change retroactively in our financial statements and in our
liquidity discussions. Auction rate securities generally have long-term stated
maturities; however, for the investor, these securities have certain economic
characteristics of short-term investments because of their rate setting
mechanism. The return on these securities is designed to track short-term
interest rates due to a "Dutch" auction process which resets the coupon rate (or
dividend rate). Auction rate securities are designed to be highly liquid. Unless
an auction fails, an investor can, by electing not to bid, recoup the principal
amount of its investment at each auction date. To date we have experienced no
failed auctions.
Net cash used in operating activities was $0.6 million and $2.0 million for the
thirteen weeks ended April 2, 2005 and April 3, 2004, respectively. We incurred
negative cash flow from operating activities for the thirteen weeks ended April
2, 2005 due to changes in working capital. Negative cash flow from operating
activities for the thirteen weeks ended April 3, 2004 is primarily due to
operating losses.
Net cash provided by investing activities was $2.7 million and $1.3 million for
the thirteen weeks ended April 2, 2005 and April 3, 2004, respectively. Net cash
provided by investing activities includes maturities and sales of auction rate
securities of $2.8 million and $1.3 million in the thirteen weeks ended April 2,
2005 and April 3, 2004, respectively. Cash used in investing activities was
$86,000 and $35,000 for the thirteen weeks ended April 2, 2005 and April 3,
2004, respectively, related to the acquisition of office equipment, software and
computer equipment.
Net cash used in financing activities was $105,000 in the thirteen weeks ended
April 2, 2005, and related to payments made by the Company on the current
portion of its capital lease obligations, partially offset by proceeds received
from the exercise of employee stock options. Net cash provided by financing
activities was $353,000 in the thirteen weeks ended April 3, 2004, and related
to proceeds received from the exercise of employee stock options, and partially
offset by payments made on the current portion of its capital lease obligations.
At April 2, 2005, we had approximately $51.3 million in cash, cash equivalents
and short-term investments. At April 2, 2005, we had capital lease obligations
of $61,000. We believe we have 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. We have established
a flexible model that provides a lower fixed cost structure than most consulting
firms, enabling us to scale operating cost structures more quickly based on
market conditions. Although we are well positioned because of our 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
continue to rebound and we continue to experience negative cash flow, we could
experience liquidity challenges at some future point.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We do not invest excess funds in derivative financial instruments or other
market rate sensitive instruments for the purpose of managing our foreign
currency exchange rate risk. We invest excess funds in short-term investments,
including auction rate securities, the yield of which is exposed to interest
rate market risk. Auction rate securities are classified as available-for-sale
and reported on the balance sheet at fair value, which equals market value, as
the rate on such securities resets generally every 28 to 35 days. Consequently,
interest rate movements do not materially affect the balance sheet valuation of
fixed income investments. Changes in the overall level of interest rates do
affect our interest income generated from investments.
We do 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 our clients.
ITEM 4. CONTROLS AND PROCEDURES
A review and evaluation was performed by our management, including our Chief
Executive Officer (the "CEO") and Chief Financial Officer (the "CFO"), of the
effectiveness of the design and operation of our 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 our current
disclosure controls and procedures, as designed and implemented, were effective.
There have been no significant changes in our internal controls or in other
factors that could significantly affect our 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, we took
no corrective measures.
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
We have not been subject to any material new litigation or claims since the time
of our 10-K filing, on April 1, 2005. For a summary of litigation in which we
are currently involved, refer to our annual report on Form 10-K, as filed with
the Securities and Exchange Commission on April 1, 2005 and Notes 10 of the
Condensed Consolidated Financial Statements included elsewhere in this report.
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
None
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None
ITEM 5. OTHER INFORMATION
None
ITEM 6. EXHIBITS
(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.
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 16, 2005
------------------------------- Executive Officer
Richard P. Nespola (Principal executive officer)
/s/ DONALD E. KLUMB Chief Financial Officer and May 16, 2005
------------------------------- Treasurer
Donald E. Klumb (Principal financial officer
and principal accounting
officer)