UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
(MARK ONE)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 2005
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE
SECURITIES EXCHANGE ACT OF 1934
COMMISSION FILE NUMBER: 000-27617
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 NUMBER)
7300 COLLEGE BOULEVARD,
SUITE 302, OVERLAND PARK, KANSAS 66210
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (ZIP CODE)
REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (913) 345-9315
SECURITIES REGISTERED PURSUANT TO SECTION 12(B) OF THE ACT:
TITLE OF EACH CLASS NAME OF EACH EXCHANGE ON WHICH REGISTERED
------------------- -----------------------------------------
COMMON STOCK (.001 PAR VALUE) NASDAQ NATIONAL MARKET
SECURITIES REGISTERED PURSUANT TO SECTION 12(G) OF THE ACT: NONE.
Indicate by check mark if the registrant is a well-known seasoned issuer, as
defined in Rule 405 of the Securities Act. YES [ ] NO [X]
Indicate by check mark if the registrant is not required to file reports
pursuant to Section 13 or Section 15(d) of the Act. YES [ ] NO [X]
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 if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of Registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [X]
Indicate by check mark whether the registrant is a large accelerated filer, an
accelerated filer, or a non-accelerated filer. See definition of "accelerated
filer and large accelerated filer" in Rule 12b-2 of the Exchange Act. Large
Accelerated Filer [ ] Accelerated Filer [ ] Non-accelerated Filer [X]
Indicate by check mark whether the registrant is a shell company (as defined in
Rule 12b-2 of the Exchange Act). YES [ ] NO [X]
The aggregate market value of the voting stock held by non-affiliates of the
Registrant, as of July 2, 2005 was approximately $37.2 million. As of March 28,
2005 the Registrant had 35,790,286 shares of common stock, par value $0.001 per
share (the Common Stock), issued and outstanding.
DOCUMENTS INCORPORATED BY REFERENCE
The information required to be provided in Part III (Items 10, 11, 12, 13 and
14) of this Annual Report on Form 10-K is hereby incorporated by reference from
our definitive 2006 proxy statement which will be filed with the Securities and
Exchange Commission within 120 days of the end of our fiscal year ended December
31, 2005.
THE MANAGEMENT NETWORK GROUP, INC.
FORM 10-K
TABLE OF CONTENTS
PAGE
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PART I
Item 1. Business.................................................... 3
Item 1A. Risk Factors................................................ 8
Item 2. Property.................................................... 14
Item 3. Legal Proceedings........................................... 14
Item 4. Submission of Matters to a Vote of Security Holders......... 15
PART II
Item 5. Market for Registrant's Common Equity, Related
Stockholder Matters and Issuer Purchases of Equity
Securities ................................................. 15
Item 6. Selected Consolidated Financial Data........................ 16
Item 7. Management's Discussion and Analysis of Financial Condition
and Results of Operations................................... 18
Item 7A. Quantitative and Qualitative Disclosures About Market
Risk........................................................ 24
Item 8. Consolidated Financial Statements........................... 25
Item 9. Changes in and Disagreements With Accountants on Accounting
and Financial Disclosure.................................... 46
Item 9A. Controls and Procedures .................................... 46
Item 9B. Other Information .......................................... 46
PART III
Item 10. Directors and Executive Officers of the Registrant.......... 46
Item 11. Executive Compensation...................................... 46
Item 12. Security Ownership of Certain Beneficial Owners and
Management and Related Stockholder Matters ................. 46
Item 13. Certain Relationships and Related Transactions.............. 46
Item 14. Principal Accountant Fees and Services ..................... 46
PART IV
Item 15. Exhibits and Financial Statement Schedules ................. 46
2
PART I
DISCLOSURE REGARDING FORWARD-LOOKING STATEMENTS
CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING INFORMATION
With the exception of historical information, this report on Form 10-K contains
forward-looking statements as defined in the Private Securities Litigation
Reform Act of 1995 and identified by such words as "will be," "intend,"
"continue," "believe," "may," "expect," "hope," "anticipate," "goal," "forecast"
or other comparable terms. Our actual financial condition, results of operations
or business may vary materially from those contemplated by such forward-looking
statements and involve various risks and uncertainties, including but not
limited to those discussed in Item 1A, "Risk Factors." Investors are cautioned
not to place undue reliance on any forward-looking statements.
WEBSITE ACCESS TO EXCHANGE ACTS REPORTS
Our internet website address is www.tmng.com. We make available free of charge
through our website all of our filings with the Securities and Exchange
Commission (SEC), including our annual reports on Form 10-K, quarterly reports
on Form 10-Q, current reports on Form 8-K, and amendments to those reports filed
or furnished pursuant to Section 13(a) or 15(d) of the Exchange Act as soon as
reasonably practicable after we electronically file such material with, or
furnish it to the SEC. The charters of our audit, nominating and compensation
committees and our Code of Business Conduct are also available on our website
and in print to any shareholder who requests them.
ITEM 1. BUSINESS
When used in this report, the terms "TMNG," "we," "us," "our" or the "Company"
refer to The Management Network Group, Inc. and its subsidiaries.
GENERAL
TMNG, a Delaware corporation, founded in 1990, is a leader in consulting to the
communications industry. We have built a fully integrated suite of consulting
offerings including strategy, management, marketing, operational, and technology
consulting services (see "Services" in Item 1). Our clientele includes a variety
of businesses whose products, services and interests are focused on the
evolution of the communications industry, including wireless and traditional
wireline communications service providers, as well as technology companies,
media and entertainment companies, and financial services firms that invest in
the communications industry. Our clients are located principally in the United
States, however, the Company also provides services to customers in Europe and
other foreign countries. We believe we are unique in our ability to provide a
comprehensive business solution to the communications industry, including
strategy consulting and business planning, product/service definition and
launch, customer acquisition and retention, business model transformation,
technical support and process modeling for business support systems (BSS) and
operations support systems (OSS). We have consulting experience with almost all
major aspects of managing a global communications company. In addition, we
provide marketing consulting services to clients outside of the communications
industry, primarily in the Eastern region of the United States (Mid-Atlantic).
We capitalize on our industry expertise by developing and enhancing new and
existing proprietary toolsets that enable us to provide strategic, management,
marketing, operational, and technology support to our clients. Our toolsets are
consulting guidelines, processes and benchmarks created and updated by our
consultants based on their experience over many consulting engagements. These
toolsets assist clients to improve productivity, gain competitive advantage,
reduce time to market and market entry risk, and increase revenues and profits.
Our services are provided by teams comprised of senior professionals recruited
from prestigious university campuses complemented by teams of consultants from
the communications industry averaging 15 years of experience.
We have provided a unique technology agnostic and vendor neutral position to
make unbiased evaluations and recommendations that are based on a thorough
knowledge of each solution and each client's situation. Therefore, we are able
to capitalize on extensive experience across complex multi-technology
communications systems environments to provide what we believe are the most
sound and practical recommendations to our clients.
Over the last six years, the Company has transformed from a provider of
primarily management and operational consulting services to a provider of a
fully integrated suite of offerings to the communications marketplace. This
transformation has been accomplished through increasing the breadth of our
employee work base, by hiring consultants of increasingly diverse backgrounds
with various technical competencies, and implementing an acquisition strategy to
acquire consulting companies whose offerings complemented, and expanded the
offerings we historically provided. We believe these actions have expanded key
client relationships, have uniquely positioned us in the market to effectively
serve today's needs of large global communication service providers, and
provided an expansion of our key direct distribution channel elements.
Recently, with the market dynamics changing (see "Market Overview" in Item 1) we
have been focusing on the opportunity to expand our offerings through indirect
channel partners. We believe partnering will better enable us to serve large
clients in what has become a shrinking and consolidating marketplace. We provide
our partners with contacts, strategic business analysis, business process
outsourcing (BPO) solutions, and depth of knowledge and experience in serving
the industry. The partnerships bring us technology solutions and systems
integration capabilities which enable our partners and us to provide more
comprehensive client offerings and solutions to effectively compete with other
global consultancies.
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During fiscal year 2005, we made strategic investments designed to position us
in three key ways--growing our core management consulting offerings with
emphasis in Internet Protocol (IP) and wireless solutions; maintaining a solid
base of carrier relations and expanding into the cable, media, and content
arenas; and launching managed services with partners that facilitate Mobile
Virtual Network Operators (MVNO), IP transformation or convergence of offerings.
During fiscal year 2005, we launched our own non-commercial MVNO, TMNG Mobile,
the first such service launch by a professional services company. This has
positioned us to demonstrate to potential market entrants, that we can, with our
partners, deliver an end-to-end solution. Through our strategy business group we
are expanding engagements with high profile clients, and providing market
assessments and business case development services. For those MVNOs electing to
move forward, we have developed differentiated consulting capabilities to help
the MVNO build its back-office facilities or to leverage, via TMNG Global and
partners, a Mobile Virtual Network Enablement (MVNE) solution.
Another key achievement during fiscal year 2005 was the development of our
managed services capability to support IP transformation. This capability is
designed to support enterprises across multiple industries as they migrate their
legacy communication network architectures to IP platforms. TMNG believes it has
unique expertise, in particular, in helping enterprises understand, protect and
migrate valuable customer data and processes to new technology platforms. To
further the visibility of our services, we signed in 2005 a five-year exclusive
economic relationship with S3 Matching Technologies Inc. (S3), through which we
have jointly designed solutions for IP network migration for both communication
service providers and global outsourcing firms. These solutions marry industry
know-how with proven technology and are capable of doing so under an outsourced
framework. We have already developed and validated our proprietary data
management optimization (DMO) solution. DMO addresses one of the critical first
steps in the migration from legacy to IP environments, as it provides the
intelligence surrounding databases of network elements and enables accurate and
efficient migration to IP.
Finally, in 2005 we began to design a management and operational consulting
offering in support of media and communications convergence. We are working in
partnership with network service platform provider, Personeta Inc., to develop a
compelling offering for small-to-mid-sized carriers. These are carriers who need
to support convergence of offerings to enterprise clients, utilizing existing
legacy and IP, both wire line and wireless networks, in a cost-effective manner
as an alternative to massive capital-intensive network investment. This is an
initiative that we and our partner began implementing in late 2005 and will
continue to be a key area of focus during fiscal year 2006.
As these and other industry trends develop, TMNG expects to utilize its long
history of engagement experience with clients to continue modifying its
toolsets, develop new methodologies, and expand selectively its base of employee
consultants to support and extend its thought leadership and capabilities in the
communications industry.
MARKET OVERVIEW
TMNG serves a global communications marketplace that is just now emerging from
an approximately four-year period of retrenchment and restructuring. The
macroeconomic forces that drove this environment destabilized the industry and
depressed the market for outside consulting services, including ours. These
circumstances resulted in a continued substantial decline in our revenue and
profits during fiscal years 2001, 2002 and 2003. That trend leveled off during
fiscal year 2004 and improved during fiscal year 2005 (see Item 1A, "Risk
Factors" and Item 7, "Management's Discussion and Analysis").
Today, the global communications industry is in the midst of what we believe to
be revolutionary change. The complements of regulatory decisions, new
technologies and industry consolidation have begun to stimulate new investment
in the sector. What we believe the future of the global communications industry
will look like is beginning to take shape. A convergence of voice, data and
video or content based communications is occurring. This is bringing both new
competitors to the market, such as Yahoo! and Google, and consolidation of
existing industry competitors. In addition, cable communications companies that
historically offered video services are now positioning themselves as providers
of voice and other data and content services.
Wireline, wireless and cable companies alike have their eye on
convergence--where any type of content or application can be delivered
seamlessly across fixed or mobile networks. For traditional telecom companies,
convergence will ultimately come in the form of IP Multimedia Subsystems (IMS).
IMS is expected to have profound influence on the communications industry
through the emergence of new business models. IMS will allow network owners to
derive value from their networks while simultaneously opening their networks to
third parties to develop and offer their own customized and enhanced services
and applications. IMS and convergence are costly and complicated; while the
evolution is underway it will not occur without challenges.
The convergence of content providers and wireless distribution channels (i.e.,
carriers) has also opened new segments of the market through the MVNO model.
MVNOs are mobile operators that do not own their own wireless spectrum or
network infrastructure. Instead, MVNOs contract with existing wireless carriers
to purchase wholesale access to wireless networks. We believe the MVNO model
will move the market for wireless services from a voice-focused market to one
focused on value-added non-voice services extending into media and
entertainment. Players like ESPN and Disney aim to transform the way consumers
view their wireless services. We expect this transformation of the wireless
market to occur rapidly and present numerous challenges to the traditional
carriers and MVNOs, alike.
We expect these profound changes to increase demand for consulting services,
with increased focus on convergence and wireless and IP based offerings,
outsourced BPO service opportunities, and the need for existing management
consultancies to provide solutions to these new communications industry
challenges. As discussed in Item 1, "Business - General," we have invested to
enable us to provide such services.
It has been our experience that because the expertise needed by communications
companies to address the market's needs is typically outside
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their core competencies, they must ultimately either recruit and employ experts
or retain outside specialists. Additionally, the convergence of the
communications, media and technology industries has brought forth many
non-communications companies who we believe do not possess the experience or
skill sets needed to execute new business plans. We believe due to the range of
expertise required and the time associated with hiring and training new
personnel, bringing expertise in-house is often not a viable option. Although
demand for consulting services has been down in recent years, we believe
customers will need to contract with consultative firms or outsource some of the
expertise required to adapt to new environments and capitalize on new
technologies now emerging. When retaining outside specialists, we believe
communications companies need experts that fully understand the communications
industry and can provide timely and unbiased advice and recommendations. We
intend to continue responding to that anticipated need.
BUSINESS STRATEGY
Our objective is to establish ourselves as the consulting company of choice to
the converging communications, media and entertainment industry, which includes
the service providers and technology companies that serve the industry, media
and entertainment companies, and the financial services and investment banking
firms that invest in the sector. The following are key strategies we have
adopted to pursue this objective.
- Develop and evolve existing offerings/solutions and thought leadership
We plan to continue expanding our end-to-end solutions offerings, both by
organic expansion and/or through acquisitions. Expanding our consulting
solutions involves bundling or buying the capabilities that support change
elements in the adoption of IP and wireless technology and support of
convergence of communications with media and content, with emphasis on wireless.
We plan to continue extending our product offerings to the communications
industry. We believe wireline and wireless providers will be strategically
focused on the following key initiatives, with priority depending upon present
position and state of the company: bundling or convergence of services (i.e.,
wireline, wireless, high-speed data and video); continued consolidation and
aggressive reduction of costs; reassessment of core competencies in order to
leverage strengths and exit weak areas; and migration to new technologies--next
generation wireless and IP. Our solutions will assist clients in redefining
competitive position, launching new products and services and generating
revenues through integrated offerings. Such offerings will also be focused on
increasing clients' efficiencies in these transformations. We will also evaluate
expanding our offerings to include managed services, with partners surrounding
these initiatives.
- Continue to build the TMNG brand
We plan to continue building and communicating the TMNG brand, further
positioning ourselves as the consultancy of choice for the global communications
industry. In late 2005, TMNG was rebranded to TMNG Global, with our strategy
group rebranded to Cambridge Strategic Management Group (CSMG). These changes
were made to better represent the end-to-end capabilities we offer through our
strategic consulting, management consulting and managed services practices. When
acquired, the CSMG name was a powerful brand. We made the decision to
reintroduce this brand to capitalize on that value and provide the separation
between our strategy and management consulting practices, providing a level of
independence and neutrality desired by clients. Direct marketing efforts and
other marketing initiatives are underway to continue building awareness of TMNG
and communicating our key strengths, including our uniquely high level of
experienced consultants, focus on the global telecommunications industry,
integrated end-to-end solution and commitment to bringing clients a positive
return on their investment.
- Focused and effective retention and recruitment
We plan to further enhance our business model to accommodate the anticipated
types of consulting services as a result of revolutionary change occurring
within the communications sector. One key element of the business model we
believe will be required is the attraction and retention of high quality,
experienced consultants. In what we believe is a rebounding economic
environment, our two primary challenges in the recruitment of new consulting
personnel are the ability to recruit talented personnel with the skill sets
necessary to capitalize on an industry undergoing revolutionary change and the
ability to execute such recruitment with an appropriate compensation
arrangement. The market for skilled consultants has become more competitive in
the current industry environment.
We reinvigorate existing skill sets of our consultants with proprietary toolsets
that provide methodologies they use to augment their experience and help analyze
and solve clients' problems. We utilize a network of eRooms to serve as a
knowledge base, enabling consultant collaboration on engagements and providing
support information and updates of TMNG current toolsets and releases of next
generation tools. Finally, we continue to manage our flexible and unique
employee and independent subject matter expert model to maximize skill set
offerings, while minimizing the effect of unbillable consultant time.
- Enhancing our global presence
We plan to further enhance our presence globally to deliver services and
solution capabilities to client companies located around the world. Especially
in Western Europe, we believe the competitive market expertise of our U.S.
consultants can be a key factor for foreign companies facing the business issues
associated with deregulation and competition.
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- Leveraging knowledge and skills through partner channels
We are also focusing on managed service offerings and partnerships with select
global technology, outsourcing and system integration firms as a complement to
our consultancy offerings. We believe this will be a fast growing market segment
which should allow us to leverage our intellectual capital while teaming with
technology partners to bring BPO and managed services offerings to select
clients. We believe we are uniquely positioned to capitalize on these
anticipated market opportunities, particularly because of our vendor neutrality
and proprietary productivity toolsets.
SERVICES
We provide a full range of strategic, marketing, operations and technology
consulting services to the communications industry. Services provided include:
- Strategy and Business Case Development
We provide comprehensive strategic analysis to service providers,
media/entertainment companies, equipment manufacturers and financial investors
in the communications industry. Our approach combines rigorous qualitative and
quantitative analyses with a detailed understanding of industry trends,
technologies, and developments. We provide clients with specific solutions to
their key strategic issues relating to their existing business as well as new
product and service opportunities. Our services include business case
development, data and content strategies, marketing spending optimization,
service and brand diversification, enterprise and small business strategies,
technology commercialization and operational strategies.
- Product Development and Management
We offer global communications service providers the benefit of our hands-on
experience developing and launching new products and services for some of
today's industry leaders. Our product development approach includes market
assessments, product/service definition, business requirements definition,
project management, testing and release. We also help communications clients by
evaluating the profitability of existing product and service offerings to
identify opportunities to consolidate, de-emphasize or decommission offerings to
improve clients' overall profitability.
- Customer Acquisition and Retention
We have developed and implemented acquisition and retention strategies for
clients in the communications industry. We have consultants skilled in the areas
of target market segmentation, campaign management and sales-process management.
Our strategies take into account the needs and preferences of the target market
and include a mix of marketing communications, partner programs, e-marketing,
direct sales, telemarketing, direct response and loyalty and retention programs.
- Revenue and Cost Management
We are dedicated to helping clients uncover and recover missed opportunities at
every stage along the revenue life cycle and reduce the costs associated with
managing business functions. Our approach to revenue and cost management centers
around operational assessment, process improvement, organizational
restructuring, and continuous improvement. Our consultants utilize their
industry expertise and our proprietary TMNG QBC(R) (Quality Business Controls)
toolset to deliver quantifiable benefits to clients.
- Business and Operations Process Redesign and Reengineering
We provide clients with efficient, integrated business and operational
processes, supporting technology systems and web-centric interfaces across all
OSS/BSS applications. We take clients from the point of customer acquisition to
provisioning all the way through to billing, collections and accounts receivable
management to cash and profits in the bank. We have modified our traditional
toolsets, recruited consultants with relevant expertise and initiated marketing
efforts in the burgeoning areas of the wireless enterprise and IP
transformation. We believe that as these two market phenomena evolve we are
well-positioned to bring business and technical solutions to existing clients
and prospective clients alike.
- Corporate Investment Services
We provide a wide range of services to investment banking and private equity
firms in connection with investments and mergers and acquisitions in the
communications industry. Services include evaluation of management teams and
business plans, identification of strengths and weakness of the company, and
analyses of the company's financial models, systems, products and operational
and business processes. Post-investment support is also provided to help
customers in the optimization of their investment through our Operational
Performance Appraisal (OPA(TM)) tool. OPA(TM) features an assessment of
communications companies' revenue assurance, network inventory, network
operations, order management and provisioning, disaster recovery planning and
e-commerce operations and products. The OPA(TM) seeks to help companies optimize
asset utilization, including network assets and inventory. In addition, OPA(TM)
seeks to maximize revenue and minimize associated costs and determine if the
provider's customers are being served effectively.
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- TMNG Resources
TMNG Resources, a business unit of TMNG Marketing, focuses on providing subject
matter experts utilizing a staff augmentation model. As the telecom industry
starts to rebound, we believe service providers may, at least initially, be
hesitant to make permanent hiring decisions and will seek temporary expert
staff. We believe TMNG Resources is uniquely positioned to fill the recruiting
needs of our clients.
COMPETITION
The market for communications consulting services is highly fragmented and
changing rapidly. We face competition from major business and strategy
consulting firms, large systems integration and major global outsourcing firms,
offshore development firms from the Asian markets, equipment and software firms
that have added service offerings, and customers' internal resources. Recently,
there has been a significant increase in demand for firms that can bundle BPO
with systems and technical integration. Many of our competitors are large
organizations that provide a broad range of services to companies in many
industries, including the communications industry. Many of these competitors
have significantly greater financial, technical and marketing resources and
greater name recognition than we do. We believe we have a competitive advantage
due to our single focus on the communications industry, and the comprehensive
offerings we provide to our customers. We also believe the complementary
experience and expertise of our professionals represents a competitive
advantage. With the communications industry experiencing consolidation and
convergence with media and entertainment, we believe our principal competitive
factor is our continual focus on the converging communications industry and the
ability to develop and deliver solutions that enhance client revenue and asset
utilization and provide return on investment. Our biggest competitor is normally
the customer's internal resources. As a result, the most significant competitive
advantage becomes long-lived relationships with key client executives that have
developed over time from consistency in responsiveness to their needs, quality
and reliability of consultants and deliverables, and an appropriate price/value
formula.
We have faced, and expect to continue to face, additional competition from new
entrants into the communications consulting markets. We have also experienced
increased price competition, particularly from large Asian firms providing
technical support and outsourcing and other large firms that have the financial
resources to aggressively price engagements that they have a particular interest
in obtaining. Increased competition could result in further price reductions,
fewer client projects, underutilization of consultants, reduced operating
margins, and loss of market share.
EMPLOYEES
Our ability to recruit and retain experienced, highly qualified and highly
motivated personnel has contributed greatly to our performance and will be
critical in the future. We offer a flexible recruiting model that enhances our
ability to attract consultants and to effectively manage utilization. Our
consultants may work as full time employees or as contingent employees.
Contingent employees receive company-paid medical insurance, vacation and other
employee benefits, but instead of receiving a regular salary, they are only paid
for time spent working on consulting projects for customers or working on
internal projects. Generally, we will offer contingent employment to personnel
who are frequently utilized on consulting projects, and have a skill
set/offering that is in high demand. We also have relationships with many
independent contracting firms to assist in delivery of consulting solutions. Our
current base of independent firms has specialized expertise in discrete areas of
communications, and we typically deploy these firms only when their unique
expertise/offering is required.
During fiscal year 2005, we utilized approximately 289 consultants, representing
a combination of employee consultants and independent contracting firms. Of
these, 74 were employee consultants and approximately 215 were working on
engagements for us primarily through independent subcontracting firms. In
addition to the consultants, we have an administrative staff of approximately 26
employees in the accounting and finance, marketing, recruiting, information
technology, human resources and administrative areas.
BUSINESS SEGMENTS
Based on an analysis of the criteria in Statement of Financial Accounting
Standards (SFAS) No. 131 "Disclosure about Segments of an Enterprise and Related
Information," we have four operating segments, which are aggregated in one
reportable segment, the Management Consulting Services segment. The Management
Consulting Services segment includes business strategy and planning, marketing
and customer relationship management, billing system support, operating system
support, revenue assurance, corporate investment services, and network
management.
MAJOR CUSTOMERS
Since our inception, we have provided services to more than 1,000 domestic and
international customers, primarily communication service providers and large
technology and applications firms serving the communications industry and
private equity firms that invest in the sector. Most recently we have added to
our base of customers with media and entertainment clients looking to leverage
communications infrastructure to deliver offerings to the market. We depend on a
small number of key customers for a significant portion of revenues. For fiscal
year 2005, revenues from two significant customers each accounted for more than
10% of our revenues, and in the aggregate accounted for 41.4% of revenues. Also
during fiscal year 2005, our top ten customers accounted for approximately 70.9%
of total revenue. We generally provide discounted pricing for large projects on
fixed commitments with long-term customers. Because our clients typically engage
services on a project basis, their needs for services vary substantially from
period to period. We continue to concentrate on large wireline and wireless
global communications companies headquartered principally in North America and
Western Europe, emerging MVNOs, large outsourcing firms as partners and most
recently media and entertainment clients. We seek to offer broad and diversified
services to these customers. We anticipate
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that operating results will continue to depend on volume services to a
relatively small number of communication service providers and technology
vendors. We anticipate increased market demand for bundled business process and
technical outsourcing which we and our partners have formalized agreements to
provide.
INTELLECTUAL PROPERTY
Our success is dependent, in part, upon proprietary processes and methodologies.
We rely upon a combination of copyright, trade secret, and trademark law to
protect our intellectual property. Additionally, employees and consultants sign
non-disclosure agreements to assist us in protecting our intellectual property.
We have not applied for patent protection for the proprietary methodologies used
by our consultants. We do not currently anticipate applying for patent
protection for these toolsets and methodologies.
SEASONALITY
In the past, we have experienced seasonal fluctuations in revenue in the fourth
quarter due primarily to the fewer number of business days because of the
holiday periods occurring in that quarter. We may continue to experience
fluctuations in revenue in the fourth quarter and may experience fluctuations in
summer months and other vacation periods.
FINANCIAL INFORMATION ABOUT FOREIGN AND DOMESTIC OPERATIONS
For information about foreign and domestic operations, see Item 8, "Consolidated
Financial Statements," Note 4 "Major Customers and Significant Group
Concentrations of Credit Risk."
ITEM 1A. RISK FACTORS
Our business, operating results, financial condition and stock price are subject
to numerous risks, uncertainties, and contingencies, many of which are beyond
our control. The following important factors, among others, could cause actual
results to differ materially from those contemplated in forward-looking
statements made in this annual report on Form 10-K or presented elsewhere by
management from time to time. Investors are urged to consider these risk factors
when evaluating an investment in TMNG.
RISK THAT MAY IMPACT OUR FINANCIAL PERFORMANCE
Factors outside of our control could cause companies to delay new product and
new business initiatives and to seek to control expenses by reducing the use of
outside consultants. The communications industry is in a period of
consolidation, which could reduce our client base, eliminate future
opportunities or create conflicts of interest among clients. As a result,
current industry conditions may continue to harm our business, financial
condition, results of operations, liquidity and ability to make acquisitions and
raise investment capital. Future client financial difficulties and/or
bankruptcies could require us to write-off receivables that are in excess bad
debt reserves, which would harm our results of operations in future fiscal
periods.
OUR BUSINESS IS COMPLETELY DEPENDENT ON CONDITIONS IN THE CONVERGING
COMMUNICATIONS, MEDIA AND ENTERTAINMENT INDUSTRY
We focus almost exclusively on customers in the converging communications, media
and entertainment industry and investment banking and private equity firms
investing in that industry. We experienced significant growth in demand for our
services throughout the 1990s. Between 2000 and 2004, the communications
industry experienced a number of adverse conditions, including bankruptcies,
layoffs, consolidation and contraction, declining market values, and in some
cases financial scandals. These macro economic conditions substantially reduced
the demand for our services and caused our revenues to decline, resulting in
operating losses, negative cash flow and a decline in our stock price. If we are
not able to capitalize on the opportunity created by the converging
communications industry, we may continue to incur operating losses and negative
cash flow, which may eventually adversely affect our liquidity.
WE ARE DEPENDENT ON A LIMITED NUMBER OF LARGE CUSTOMERS FOR A MAJOR PORTION OF
OUR REVENUES, AND THE LOSS OF A MAJOR CUSTOMER COULD SUBSTANTIALLY REDUCE
REVENUES AND HARM OUR BUSINESS AND LIQUIDITY
We derive a substantial portion of our revenues from a relatively limited number
of clients (see Item 1, "Business-Major Customers"). This results in part from a
conscious strategy to market our services to the largest and most stable
companies in the industry, but our concentration of revenues with a small number
of clients does expose us to risk. Our revenues and financial condition could be
impaired if a major client stopped using our services. The services required by
any one client may be affected by industry consolidation or adverse industry
conditions, technological developments, economic slowdown or the client's
internal strategy or budget constraints. As a result, the volume of work
performed for specific clients varies from period to period, and a major client
in one period may not use our services in a subsequent period.
8
OUR REVENUES AND OPERATING RESULTS MAY FLUCTUATE SIGNIFICANTLY FROM QUARTER-TO-
QUARTER, AND FLUCTUATIONS IN OUR OPERATING RESULTS COULD CAUSE OUR STOCK PRICE
TO DECLINE
Our revenue and operating results may vary significantly from quarter-to-quarter
due to a number of factors. In future quarters, our operating results may be
below the expectations of public market analysts or investors, and the price of
our common stock may decline. Factors that could cause quarterly fluctuations
include:
- the beginning and ending of significant contracts during a quarter;
- the size and scope of assignments;
- the potential loss of key clients;
- the form of customer contracts changing primarily from time and materials to
fixed price or contingent fee, based on project results;
- consultant turnover, utilization rates and billing rates;
- the loss of key consultants, which could cause clients to end their
relationships with us;
- the ability of clients to terminate engagements without penalty;
- fluctuations in demand for our services resulting from budget cuts, project
delays, industry consolidations or downturns or similar events;
- clients' decisions to divert resources to other projects, which may limit
clients' resources that would otherwise be allocated to services we could
provide;
- reductions in the prices of services offered by our competitors;
- developments in the communications market and economic conditions;
- seasonality during the summer, vacation and holiday periods;
- fluctuations in the value of foreign currencies versus the U.S. dollar; and
- global economic and political conditions and related risks, including acts of
terrorism.
Because a significant portion of our non-consultant expenses are relatively
fixed, a variation in the number of client assignments or the timing of the
initiation or the completion of client assignments may cause significant
variations in operating results from quarter-to-quarter and could result in
continuing losses. To the extent the addition of consultant employees is not
followed by corresponding increases in revenues, additional expenses would be
incurred that would not be matched by corresponding revenues. Therefore,
profitability would decline and we could potentially experience further losses
and our stock price would likely decline.
THERE CAN BE NO ASSURANCE OUR INVESTMENT IN NEW OFFERINGS WILL YIELD THE
INTENDED RESULTS
As discussed in Item 1 - "Business-General" and Item 7 - "Management's
Discussion and Analysis of Financial Condition and Results of Operations -
Executive Financial Overview" and "Operating Expenses," we have invested in
proprietary toolsets designed to enable us to capitalize on industry convergence
and the migration to wireless and IP platforms. We believe these investments had
a positive impact on our 2005 revenues and will positively affect our revenues
and profitability in 2006, but they did adversely impact our short-term
profitability in 2005. There can be no assurance these investments, or others
like them, will continue to produce increased revenues or enable us to become
profitable and cash flow positive in 2006 or future years.
A SIGNIFICANT PORTION OF OUR BUSINESS IS REPRESENTED BY FIXED FEE CONTRACTS,
WHICH EXPOSE US TO ADDITIONAL RISKS
Fixed fee contracts entail subjective judgments and estimates about revenue
recognition and are subject to uncertainties and contingencies. For a more
complete discussion of our accounting for revenue recognition, see "Critical
Accounting Policies" included in Item 7, "Management's Discussion and Analysis
of Financial Condition and Results of Operations." Fixed fee contracts expose us
to the risk that our cost of performing the contract may be higher than
expected, reducing or eliminating our profit margin from the contract.
WE HAVE MADE SEVERAL ACQUISITIONS AND MAY CONTINUE TO MAKE ACQUISITIONS, WHICH
ENTAIL RISKS THAT COULD HARM OUR FINANCIAL PERFORMANCE OR STOCK PRICE
As part of our business strategy, we have made and may continue to make
acquisitions. Any future acquisition would be accompanied by the risks commonly
encountered in acquisitions. These risks include:
9
- the difficulty associated with assimilating the personnel and operations of
acquired companies;
- the potential disruption of our existing business;
- further reductions in our cash reserves;
- adverse effects on our financial statements, including write-offs and
assumption of liabilities of acquired businesses; and
- paying too much for an acquired company.
If we make acquisitions and any of these problems materialize, these
acquisitions could negatively affect our operations, profitability and financial
condition.
ANY FUTURE DECREASE IN REVENUES OF ACQUIRED BUSINESSES MAY RESULT IN ADDITIONAL
ASSET IMPAIRMENTS AND ADVERSELY AFFECT OUR PROFITABLITY
We have made and may continue to make acquisitions. As a result, goodwill and
intangible assets constitute a significant balance of the assets reported on our
balance sheet. We have, in the past, been required to write down goodwill and
intangible assets on our financial statements as a result of declining revenues
and earnings of the businesses we acquire. We may continue to be required to
take asset impairment charges in the future. Our earnings and profitability
would be adversely affected by any further asset impairments.
WE HAVE REDUCED CONSULTANT HEADCOUNT WHICH COULD ADVERSELY AFFECT OUR ABILITY TO
OBTAIN AND PERFORM CONSULTING ENGAGEMENTS
Following the economic downturn of the first part of this decade, we undertook a
series of cost-cutting measures to better align our operating costs with the
reduced demand for communications consulting services. As part of these
cost-cutting measures, we have reduced our employee consultant headcount. More
recently we have begun to expand the skill sets of our consultant base by
replacing existing consultants with professionals better suited to support our
next generation offerings. Because the talents and skills of our consulting
resources are limited in comparison to much larger firms, we may lose
opportunities to obtain future consulting engagements or have difficulty
performing engagements we do obtain, any of which could harm our business.
THE MARKET IN WHICH WE OPERATE IS INTENSELY COMPETITIVE, AND ACTIONS BY
COMPETITORS COULD RENDER OUR SERVICES LESS COMPETITIVE, CAUSING REVENUES AND
INCOME TO DECLINE
The market for consulting services to communications companies is intensely
competitive, highly fragmented and subject to rapid change. Competitors include
strategy and management consulting firms and major global outsourcing firms like
IBM, Electronic Data Systems Corporation (EDS) and Computer Sciences
Corporation, which have become more significant competitors recently due to the
outsourcing of business support systems and operating support systems by
communications companies. We are also subject to competition from large
technical firms from the Asian markets, like Infosys Technologies, Ltd. that can
provide significant cost advantages. Some of these competitors have also formed
strategic alliances with communications and technology companies serving the
industry. We also compete with internal resources of our clients. Although
non-exhaustive, a partial list of our competitors includes:
- Accenture;
- Booz-Allen & Hamilton;
- Cap Gemini;
- DiamondCluster International, Inc.;
- IBM;
- EDS;
- Computer Sciences Corporation;
- Infosys Technologies, Ltd.; and
- McKinsey & Company.
Many information technology-consulting firms also maintain significant practice
groups devoted to the communications industry. Many of these companies have a
national and international presence and may have greater personnel, financial,
technical and marketing resources than we do. We may not be able to compete
successfully with our existing competitors or with any new competitors.
10
We also believe our ability to compete depends on a number of factors outside of
our control, including:
- the prices at which others offer competitive services, including aggressive
price competition and discounting on individual engagements which may become
increasingly prevalent in the current industry environment;
- the ability and willingness of our competitors to finance customers' projects
on favorable terms;
- the ability of our competitors to undertake more extensive marketing campaigns
than we can;
- the extent, if any, to which our competitors develop proprietary tools that
improve their ability to compete with us;
- the ability of our customers to perform the services themselves; and
- the extent of our competitors' responsiveness to customer needs.
We may not be able to compete effectively on these or other factors. If we are
unable to compete effectively, our market position, and therefore our revenues
and profitability, would decline.
WE MUST CONTINUALLY ENHANCE OUR SERVICES TO MEET THE CHANGING NEEDS OF THE
CONVERENCE OF COMMUNICATIONS CUSTOMERS WITH MEDIA AND ENTERTAINMENT, OR WE MAY
LOSE FUTURE BUSINESS TO OUR COMPETITORS
Our future success will depend upon our ability to enhance existing services and
to introduce new services to meet the requirements of customers in a rapidly
developing and evolving market, particularly in the areas of wireless
communications and next-generation technologies supporting the convergence of
communications, media and content. Present or future services may not satisfy
the needs of the communications market. If we are unable to anticipate or
respond adequately to customer needs, we may lose business and our financial
performance will suffer.
IF WE ARE NOT ABLE TO EFFECTIVELY RECRUIT AND RETAIN MANAGEMENT AND CONSULTING
PERSONNEL THAT PROVIDE US WITH NEW TALENT SETS ENABLING THE IMPLEMENTATION OF
NEW STRATEGIC OFFERINGS IN A RAPIDLY CHANGING MARKET, OUR FINANCIAL PERFORMANCE
MAY BE NEGATIVELY IMPACTED
Our ability to adapt to changing market conditions will depend on our ability to
recruit and retain talented personnel, which cannot be assured. We may face two
critical challenges in the recruitment of new management personnel. The first is
the ability to recruit talented management personnel with the skill sets
necessary to capitalize on an industry undergoing revolutionary change, and the
second is the ability to execute such recruitment with an appropriate
compensation arrangement. If we are unable to recruit and retain the people we
need to perform our consulting engagements in a rapidly changing environment,
our business may suffer.
We must attract new consultants to implement our strategic plans. The number of
potential consultants that meet our hiring criteria is relatively small, and
there is significant competition for these consultants from direct competitors
and others in the communications industry. Competition for these consultants may
result in significant increases in our costs to attract and retain the
consultants, which could reduce margins and profitability. In addition, we will
need to attract consultants in international locations, principally Europe, to
support our international strategic plans. We have limited experience in
recruiting internationally, and may not be able to do so. Any inability to
recruit new consultants or retain existing consultants could impair our ability
to service existing engagements or undertake new engagements. If we are unable
to attract and retain quality consultants, our revenues and profitability would
decline.
OUR ENGAGEMENTS WITH CLIENTS MAY NOT BE PROFITABLE OR MAY BE TERMINATED BY OUR
CLIENTS ON SHORT NOTICE
Unexpected costs, delays or failure to achieve anticipated cost reductions could
make our contracts unprofitable. We have many types of contracts, including time
and materials contracts, fixed-price contracts and contingent fee contracts.
When making proposals for engagements, we estimate the costs and timing for
completing the projects. These estimates reflect our best judgment regarding our
costs, as well as the efficiencies of our methodologies and professionals as we
plan to deploy them on our projects. Any increased or unexpected costs, delays
or failures to achieve anticipated cost reductions in connection with the
performance of these engagements, including delays caused by factors outside our
control, could make these contracts less profitable or unprofitable, which would
have an adverse effect on our profit margin.
Under many of our contracts, the payment of some or all of our fees is
conditioned upon our performance. We are increasingly moving away from contracts
that are priced solely on a time and materials basis and toward contracts that
also include incentives related to factors such as benefits produced. During
fiscal year 2005, we estimate that approximately 28.1% of our contracts had some
fixed-price, incentive-based or other pricing terms that conditioned some or all
of our fees on our ability to deliver these defined goals. The trend to include
greater incentives in our contracts may increase the variability in revenues and
margins earned on such contracts, and may expose us to greater risk of loss on
the contracts if we do not perform successfully. Additionally, the estimates
required for revenue recognition on these contracts expose us to risk of
misstatement of financial results if our estimates prove to be inaccurate.
11
A majority of our contracts can be terminated by our clients with short notice
and without significant penalty. Our clients typically retain us on a
non-exclusive, engagement-by-engagement basis, rather than under exclusive
long-term contracts. A majority of our consulting engagements are less than 12
months in duration. The advance notice of termination required for contracts of
shorter duration and lower revenues is typically 30 days. Longer-term, larger
and more complex contracts generally require a longer notice period for
termination and may include an early termination charge to be paid to us.
Additionally, large client projects involve multiple engagements or stages, and
there is a risk that a client may choose not to retain us for additional stages
of a project or that a client will cancel or delay additional planned
engagements. These terminations, cancellations or delays could result from
factors unrelated to our work product or the project, such as business or
financial conditions of the client, changes in client strategies or the economy
in general. When contracts are terminated, we lose the associated revenues and
we may not be able to eliminate associated costs in a timely manner.
Consequently, our profit margins in subsequent periods may be lower than
expected.
OUR PROFITABLITY WILL SUFFER IF WE ARE NOT ABLE TO MAINTAIN OUR PRICING AND
UTILIZATION RATES AND CONTROL COSTS
Our profitability is largely a function of the rates we are able to obtain for
our services and the utilization rate, or chargeability, of our professionals.
If we do not maintain pricing for our services and an appropriate utilization
rate for our professionals without corresponding cost reductions, our
profitability will suffer. We are under increasing price competition from
competitors, which could adversely affect our profitability.
IF INTERNATIONAL BUSINESS VOLUMES INCREASE, WE MAY BE EXPOSED TO A NUMBER OF
BUSINESS AND ECONOMIC RISKS, WHICH COULD RESULT IN INCREASED EXPENSES AND
DECLINING PROFITABILITY
If our international business volumes increase, we will face a number of
business and economic risks, including:
- unfavorable foreign currency exchange rates or fluctuations;
- difficulties in staffing and managing foreign operations;
- seasonal reductions in business activity;
- competition from local and foreign-based consulting companies;
- ability to protect our intellectual property;
- unexpected changes in trading policies and regulatory requirements;
- legal uncertainties inherent in transnational operations such as export and
import regulations, tariffs and other trade barriers;
- the impact of foreign laws, regulations and trade customs;
- U.S. and foreign taxation issues;
- operational issues such as longer customer payment cycles and greater
difficulties in collecting accounts receivable;
- language and cultural differences;
- changes in foreign communications markets;
- increased cost of marketing and servicing international clients;
- potential limits on our ability to repatriate foreign profits;
- general political and economic trends, including the potential impact of
terrorist attack or international hostilities; and
- expropriations of assets, including bank accounts, intellectual property and
physical assets by foreign governments.
In addition, we may not be able to successfully execute our business plan in
foreign markets. If we are unable to achieve anticipated levels of revenues from
international operations, our overall revenues and profitability may decline.
WE ARE DEPENDENT ON A LIMITED NUMBER OF KEY PERSONNEL, AND THE LOSS OF THESE
INDIVIDUALS COULD HARM OUR COMPETITIVE POSITION AND FINANCIAL PERFORMANCE
Our business consists primarily of the delivery of professional services and,
accordingly, our success depends upon the efforts, abilities, business
generation capabilities and project execution of our executive officers and key
consultants. Our success is also dependent upon the
12
managerial, operational, marketing, and administrative skills of our executive
officers, particularly Richard Nespola, TMNG's Chairman, President and Chief
Executive Officer. The loss of any executive officer or key consultant or group
of consultants, or the failure of these individuals to generate business or
otherwise perform at or above historical levels, could result in a loss of
customers or revenues, which could harm our financial performance.
IF WE FAIL TO PERFORM EFFECTIVELY ON PROJECT ENGAGEMENTS, OUR REPUTATION, AND
THEREFORE OUR COMPETITIVE POSITION AND FINANCIAL PERFORMANCE, COULD BE HARMED
Many of our engagements come from existing clients or from referrals by existing
clients. Therefore, our growth is dependent on our reputation and on client
satisfaction. The failure to perform services that meet a client's expectations
may damage our reputation and harm our ability to attract new business.
IF WE FAIL TO DEVELOP AND MAINTAIN LONG-TERM RELATIONSHIPS WITH OUR CUSTOMERS,
OUR SUCCESS WOULD BE JEOPARDIZED
A substantial majority of our business is derived from repeat customers. Future
success depends to a significant extent on our ability to develop long-term
relationships with successful communications providers who will give us new and
repeat business. Inability to build long-term customer relations would result in
declines in our revenues and profitability. This may increasingly be the case
with any further consolidation or contraction in the industry.
WE CLASSIFY A LARGE NUMBER OF SUBCONTRACTORS AS INDEPENDENT CONTRACTORS FOR TAX
AND EMPLOYMENT LAW PURPOSES. IF THESE FIRMS OR PERSONNEL WERE TO BE RECLASSIFIED
AS EMPLOYEES, WE COULD BE SUBJECT TO BACK TAXES, INTEREST, PENALTIES AND OTHER
LEGAL CLAIMS
We provide a significant percentage of consulting services through independent
contractors and, therefore, do not pay Federal or state employment taxes or
withhold income taxes for such persons. We generally do not include these
independent contractors in our benefit plans. In the future, the IRS or state
authorities may challenge the status of consultants as independent contractors.
Independent contractors may also initiate proceedings to seek reclassification
as employees under state law. In either case, if persons engaged by us as
independent contractors are determined to be employees by the IRS or any state
taxation department, we would be required to pay applicable federal and state
employment taxes and withhold income taxes with respect to such contractors, and
could become liable for amounts required to be paid or withheld in prior periods
along with interest and penalties. In addition, we could be required to include
such contractors in benefit plans retroactively and going forward.
WE COULD BE SUBJECT TO CLAIMS FOR PROFESSIONAL LIABILITY, WHICH COULD HARM OUR
FINANCIAL PERFORMANCE
As a provider of professional services, we face the risk of liability claims. A
liability claim brought against us could harm our business. We may also be
subject to claims by clients for the actions of our consultants and employees
arising from damages to clients' business or otherwise, or clients may demand a
reduction in fees because of dissatisfaction with our services.
OUR INABILITY TO PROTECT OUR INTELLECTUAL PROPERTY COULD HARM OUR COMPETITIVE
POSITION AND FINANCIAL PERFORMANCE
Despite our efforts to protect proprietary rights from unauthorized use or
disclosure, parties, including former employees or consultants, may attempt to
disclose, obtain or use our solutions or technologies. The steps we have taken
may not prevent misappropriation of our intellectual property, particularly in
foreign countries where laws or law enforcement practices may not protect
proprietary rights as fully as in the United States. Unauthorized disclosure of
our proprietary information could make our solutions and methodologies available
to others and harm our competitive position.
RISK THAT COULD AFFECT OUR STOCK PRICE
THE MARKET PRICE OF OUR COMMON STOCK IS VOLATILE, AND INVESTORS MAY EXPERIENCE
INVESTMENT LOSSES
The market price of our common stock is volatile and has declined significantly
from its initial public offering price. Our stock price could continue to
decline or fluctuate in response to a variety of factors, including:
- variations in quarterly operating results;
- announcements of technological innovations that render talent outdated;
- future trends in the communications industry;
- acquisitions or strategic alliances by us or others in the industry;
13
- failure to achieve financial analysts' or other estimates of results of
operations for any fiscal period;
- the relatively small public float and relatively low volume at which our stock
trades;
- changes in estimates of performance or recommendations by financial analysts;
- any further reduction in our revenues or continued losses during 2006 and
future years; and
- continuing adverse market conditions in the communications industry and the
economy as a whole.
In addition, the stock market itself experiences significant price and volume
fluctuations. These fluctuations particularly affect the market prices of the
securities of many technology and communications companies. These broad market
fluctuations could continue to harm the market price of our common stock. If the
market price of our common stock falls below $1.00 per share for a period of 180
consecutive calendar days, we may risk being delisted from the NASDAQ Stock
Market on which our stock trades. The recent decline in our overall market
capitalization may also discourage analysts and investors from following us.
Additionally, due to the limited public float of our common stock, investors may
find their investment illiquid, and suffer losses.
PRINCIPAL STOCKHOLDERS, EXECUTIVE OFFICERS AND DIRECTORS HAVE SUBSTANTIAL
CONTROL OVER OUR VOTING STOCK
Executive officers, directors and stockholders owning more than five percent of
our outstanding common stock (and their affiliates) own a majority of our
outstanding common stock. If all such persons acted together, they would have
the ability to control all matters submitted to the stockholders for approval
(including the election and removal of directors and any merger, consolidation
or sale of all or substantially all of our assets) and to control our management
and affairs. Concentration of ownership of our common stock may have the effect
of delaying, deferring or preventing a change in control, impeding a merger,
consolidation, takeover or other business combination involving us or
discouraging a potential acquirer from making a tender offer or otherwise
attempting to obtain control of us, any of which could be beneficial to our
shareholders.
WE MAY SEEK TO RAISE ADDITIONAL FUNDS, WHICH MAY BE DILUTIVE TO STOCKHOLDERS OR
IMPOSE OPERATIONAL RESTRICTIONS
Although we have not been required to obtain new debt or equity financing to
support our operations or complete acquisitions, we may decide or be required to
raise new capital for these or other purposes in the future. There can be no
assurances any such capital would be available to us on acceptable terms. Any
additional equity financing, if available, may be dilutive to our stockholders
and debt financing, if available, may involve restrictive covenants, which may
limit our operating flexibility with respect to certain business matters. If
additional funds are raised through the issuance of equity securities, our
stockholders may experience dilution in the voting power or net book value per
share of our stock, and any additional equity securities may have rights,
preferences and privileges senior to those of the holders of our common stock.
ANTI-TAKEOVER PROVISIONS AND OUR RIGHT TO ISSUE PREFERRED STOCK COULD MAKE A
THIRD PARTY ACQUISITION DIFFICULT
Our certificate of incorporation, bylaws, and anti-takeover provisions of
Delaware law could make it more difficult for a third party to acquire control
of our Company. In addition, our bylaws provide for a classified board, with
board members serving staggered three-year terms. The Delaware anti-takeover
provisions and the existence of a classified board, in addition to our
relatively small public float, could make it more difficult for a third party to
acquire us, even if such transaction were in the best interest of our
shareholders.
ITEM 2. PROPERTY
Our principal executive offices are located in a 4,705 square foot facility in
Overland Park, Kansas. This facility houses our executive, corporate and
administrative offices and is under a lease, which expires in August 2010. In
addition to the executive offices, we also lease a 7,575 square foot facility in
McLean, Virginia, which lease expires in June 2009, and a 10,344 square foot
facility in Boston, Massachusetts, which lease expires in 2011. The Boston and
McLean locations are primarily utilized by management and consulting personnel.
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 11,366 square feet of unutilized office space in Boston, Massachusetts was
entered into with a third party through the end of the original lease term in
2011.
ITEM 3. LEGAL PROCEEDINGS
We are involved in legal proceedings and litigation arising in the ordinary
course of business. In addition, customer bankruptcies could result in a claim
on collected balances for professional services near the bankruptcy filing date.
While resolution of legal proceedings, claims and litigation may have an impact
on our financial results for the period in which they are resolved, we believe
that the ultimate disposition of these matters will not have a material adverse
effect upon our consolidated results of operations, cash flows or financial
position.
14
In June 1998, the bankruptcy trustee of a former client, Communications Network
Corporation, sued TMNG for a total of $320,000 in the U.S. Bankruptcy Court in
New York seeking recovery of $160,000 alleging an improper payment of consulting
fees paid by the former client during the period from July 1, 1996, when an
involuntary bankruptcy proceeding was initiated against the former client,
through August 6, 1996, when the former client agreed to an order for relief in
the bankruptcy proceeding, and $160,000 in consulting fees paid by the former
client after August 6, 1996. The bankruptcy trustee also sued us for at least
$1.85 million for breach of contract, breach of fiduciary duties and negligence.
In March 2006, we reached a settlement agreement with the bankruptcy trustee
whereby we agreed to pay the trustee $255,000 in exchange for being released
from all potential liability under the suits discussed above.
Additionally, as of December 31, 2005 the Company has 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 we do not believe we received any
preference payments from these former clients and plan to vigorously defend our
position, we have established reserves of $727,000 as of December 31, 2005,
which we believe are adequate.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of security holders during the fourth
quarter of 2005.
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND
ISSUER PURCHASES OF EQUITY SECURITIES
Our Common Stock is quoted on the NASDAQ Stock Market under the symbol TMNG. The
high and low closing price per share for the Common Stock for the fiscal years
ended December 31, 2005 and January 1, 2005 by quarter were as follows:
High Low
First quarter, fiscal year 2005 $ 2.57 $ 2.20
Second quarter, fiscal year 2005 $ 2.52 $ 1.83
Third quarter, fiscal year 2005 $ 2.59 $ 2.06
Fourth quarter, fiscal year 2005 $ 2.78 $ 2.24
High Low
First quarter, fiscal year 2004 $ 5.50 $ 3.19
Second quarter, fiscal year 2004 $ 3.75 $ 1.77
Third quarter, fiscal year 2004 $ 2.45 $ 1.62
Fourth quarter, fiscal year 2004 $ 2.40 $ 1.92
The above information reflects inter-dealer prices, without retail mark-up,
markdown or commissions and may not necessarily represent actual transactions.
As of March 28, 2006 the closing price of our Common Stock was $2.24 per share.
At such date, there were approximately 84 holders of record of our Common Stock.
Holders of Common Stock are entitled to receive ratably such dividends, if any,
as may be declared by the Board of Directors out of funds legally available. To
date, we have not paid any cash dividends on our Common Stock and do not expect
to declare or pay any cash or other dividends in the foreseeable future.
EQUITY COMPENSATION PLAN INFORMATION
(a) (c)
NUMBER OF NUMBER OF SECURITIES
SECURITIES TO BE ISSUED REMAINING AVAILABLE
UPON EXERCISE OF (b) FOR FUTURE ISSUANCE
OUTSTANDING OPTIONS WEIGHTED AVERAGE UNDER EQUITY COMPENSATION
OR VESTING OF RESTRICTED EXERCISE PRICE OF PLANS (EXCLUDING SECURITIES
STOCK OUTSTANDING OPTIONS REFLECTED IN COLUMN (a))
APPROVED BY SECURITY HOLDERS
- 1998 Equity Incentive Plan - Stock Options 5,052,405 $ 4.51 2,589,985
- 1998 Equity Incentive Plan - Restricted Stock 895,000 n/a 305,000
PLANS NOT APPROVED BY SECURITY HOLDERS
- 2000 Supplemental Stock Plan 957,040 $ 4.63 2,831,087
--------- ---------
TOTAL 6,904,445 5,726,072
========= =========
For an additional discussion of our equity compensation plans, see Item 8,
"Consolidated Financial Statements," Note 9 "Stock Option Plan and Stock-Based
Compensation."
15
ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA
The selected consolidated financial data presented below have been derived from
our consolidated financial statements. The data presented below should be read
in conjunction with Item 7, "Management's Discussion and Analysis of Financial
Condition and Results of Operations," Item 8, "Consolidated Financial
Statements" and Notes thereto and other financial information appearing
elsewhere in this annual report on Form 10-K.
FISCAL YEAR ENDED
-------------------------------------------------------------------------
December 31, January 1, January 3, December 28, December 29,
2005 2005 2004 2002 2001
-------- -------- -------- -------- --------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
CONSOLIDATED STATEMENTS OF OPERATIONS DATA:
Revenues ............................................ $30,378 $23,704 $23,245 $ 33,057 $ 54,236
Cost of services:
Direct cost of services (exclusive of amortization
shown below) 14,834 12,319 11,927 16,111 27,338
Equity related charges (benefits).................. 100 205 (57) 721 2,322
-------- -------- -------- -------- --------
Total cost of services (exclusive of
amortization shown below)................. 14,934 12,524 11,870 16,832 29,660
-------- -------- -------- -------- --------
15,444 11,180 11,375 16,225 24,576
Operating expenses:
Selling, general and administrative................ 18,462 16,037 19,359 23,811 16,727
Legal settlement .................................. 95 (1,294)
Real estate restructuring ......................... 75 1,545
Goodwill and intangible asset impairment .......... 19,484 25,165
Goodwill and intangibles amortization ............. 336 992 2,343 2,887 1,996
Equity related charges ............................ 618 958 142 353 843
-------- -------- -------- -------- --------
Total operating expenses .................. 19,586 18,238 41,328 52,216 19,566
-------- -------- -------- -------- --------
(4,142) (7,058) (29,953) (35,991) 5,010
Other income (expense):
Interest income ................................... 1,632 718 624 996 2,433
Other, net ........................................ 126 (30) (51) (37) (22)
-------- -------- -------- -------- --------
Total other income (expense) .............. 1,758 688 573 959 2,411
Income (loss) from continuing operations before
income tax (provision) benefit and cumulative
effect of a change in accounting principle ......... (2,384) (6,370) (29,380) (35,032) 7,421
Income tax (provision) benefit ...................... (36) (49) (12,978) 12,389 (2,141)
-------- -------- -------- -------- --------
Income (loss) from continuing operations before
cumulative effect of a change in accounting
principle .......................................... (2,420) (6,419) (42,358) (22,643) 5,280
Cumulative effect of a change in accounting
principle, net of taxes ............................ (1,140)
-------- -------- -------- -------- --------
Income (loss) from continuing operations............. (2,420) (6,419) (42,358) (23,783) 5,280
Discontinued operations:
Net income (loss) from discontinued operations..... (2,276) 34 380 328
-------- -------- -------- -------- --------
Net income (loss) ................................... $(2,420) $(8,695) $(42,324) $(23,403) $ 5,608
======== ======== ======== ======== ========
Net income (loss) from continuing operations before
cumulative effect of a change in accounting
principle per common share
Basic ............................................. $ (0.07) $ (0.18) $ (1.26) $ (0.69) $ 0.18
======== ======== ======== ======== ========
Diluted ........................................... $ (0.07) $ (0.18) $ (1.26) $ (0.69) $ 0.17
======== ======== ======== ======== ========
Cumulative effect of a change in accounting
principle per common share
Basic and Diluted ................................. $ (0.03)
======== ======== ======== ======== ========
Net income (loss) from discontinued operations per
common share
Basic and Diluted ................................. $ (0.07) $ 0.01 $ 0.01
======== ======== ======== ======== ========
Net income (loss) per common share
Basic ............................................. $ (0.07) $ (0.25) $ (1.26) $ (0.71) $ 0.19
======== ======== ======== ======== ========
Diluted ........................................... $ (0.07) $ (0.25) $ (1.26) $ (0.71) $ 0.18
======== ======== ======== ======== ========
Weighted average common shares outstanding
Basic ............................................. 35,175 34,619 33,545 32,734 29,736
======== ======== ======== ======== ========
Diluted ........................................... 35,175 34,619 33,545 32,734 30,774
======== ======== ======== ======== ========
16
December 31, January 1, January 3, December 28, December 29,
2005 2005 2004 2002 2001
-------- -------- -------- -------- --------
(IN THOUSANDS)
CONSOLIDATED BALANCE SHEET DATA:
Net working capital ............................... $ 52,497 $ 55,121 $ 57,231 $ 63,478 $ 94,569
Total assets ...................................... $ 73,549 $ 75,353 $ 81,582 $125,459 $129,042
Total capital lease obligations ................... $ 4 $ 200 $ 493 $ 885 $ 338
Total stockholders' equity ....................... $ 66,048 $ 66,747 $ 73,369 $115,726 $123,992
On September 5, 2001, we completed our acquisition of Tri-Com Computer Services
Inc., a Maryland corporation. The acquisition, recorded under the purchase
method of accounting, included the purchase of all outstanding shares of
Tri-Com, which resulted in a total purchase price of approximately $5.2 million
for the equity and assumption of liabilities. Consideration consisted of $1.8
million cash and 490,417 shares of our common stock valued at $3.0 million. We
incurred direct costs of approximately $180,000 related to the acquisition and
recorded this amount as an increase to purchase price. In addition to the
above-mentioned costs, we recorded approximately $216,000 as an increase to
purchase price in connection with the exchange of our stock options for vested
stock appreciation rights held by Tri-Com employees at the time of acquisition.
On March 6, 2002, we completed our acquisition of CSMG, a Delaware corporation.
The acquisition resulted in a total purchase price of approximately $46.5
million consisting of $33.0 million cash and $13.5 million in common stock.
Additionally, we incurred direct costs of $2.3 million related to the
acquisition and recorded this amount as an increase to purchase price.
17
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The following discussion should be read in conjunction with our Consolidated
Financial Statements and Notes thereto included in this Annual Report on Form
10-K. The forward-looking statements included in this discussion and elsewhere
in this Form 10-K involve risks and uncertainties, including anticipated
financial performance, business prospects, industry trends, shareholder returns
and other matters, which reflect management's best judgment based on factors
currently known. Actual results and experience could differ materially from the
anticipated results and other expectations expressed in our forward-looking
statements and should be read in conjunction with the disclosures and
information contained in the sections of this report entitled "Disclosures
Regarding Forward-Looking Statements" and in Item 1A, " Risk Factors."
EXECUTIVE FINANCIAL OVERVIEW
Included in Item 1, "Business" and Item 1A, "Risk Factors", is discussion that
includes a general overview of our Business, Market Overview, Business Strategy,
Competition and Risk Factors. The purpose of this executive overview is to
complement the qualitative discussion of the Business from Item 1.
As previously noted, 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
during that period primarily due to the recession. We experienced significant
revenue declines and/or net losses from 2001 to 2004 (see Item 6, "Selected
Consolidated Financial Data"). During this period we maintained relatively
consistent gross margins through innovative pricing and high consultant
utilization levels.
Beginning in late 2004 and continuing through fiscal year 2005, we have seen
significant changes in the industry resulting from consolidation, technology
transformation and the convergence of telecommunication, media and entertainment
sectors. During 2005, our revenues increased 28% compared with 2004.
Additionally, gross margins improved to nearly 51% in 2005 compared with 47% in
2004. We believe these improved operating results and margins are reflective of
our efforts to identify, adapt to and capitalize on these change elements,
combined with growth of wireless and IP initiatives within the communications
sector.
As a result of a combination of significantly lower operating results of
reporting units during fiscal year 2003, the resignation of certain key
personnel and revised and reduced financial projections, our operating expenses
include goodwill and intangible impairment losses of $19.5 million in fiscal
year 2003. In fiscal year 2004, we recorded a goodwill impairment loss of $2.2
million in connection with the discontinuation of our hardware business. In
fiscal years 2005, 2004, and 2003, we also recorded valuation reserves of $0.9
million, $2.6 million, and $24.0 million, respectively, in connection with
deferred income tax assets, which were generated primarily by goodwill
impairment and current operating losses.
Selling, general and administrative costs were $18.5 million, $16.0 million and
$19.4 million in fiscal years 2005, 2004 and 2003, respectively. The increase
from fiscal year 2004 to fiscal year 2005, primarily reflects non-capitalizable
research & development (R&D) investments in intellectual property, including
proprietary toolsets and methodologies to support new wireless and IP
consultative offerings as well as increases in variable selling expenses to
support the increase in revenues. Although these investments have impacted our
short-term profitability, we believe they will better enable us to capitalize on
the industry convergence and migration toward wireless and IP platforms. We are
also focusing our marketing efforts on growth markets surrounding large and
sustainable clients to maintain a portfolio of business that is high credit
quality, thus reducing bad debt risks.
Our R&D investments have been partially offset by comprehensive cost containment
efforts which have assisted us in maintaining strong levels of cash and
short-term investments. Our short-term investments 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
We report our financial data on a 52/53-week fiscal year. Fiscal years 2005 and
2004 had 52 weeks. Fiscal year 2003 was a 53 week fiscal year. For further
discussion of our fiscal year end see Item 8, "Consolidated Financial
Statements," Note 1 "Organization and Summary of Significant Accounting
Policies," contained herein.
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. Revenues on contracts with a
not to exceed contract price or a fixed cost contract 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
pursue these marketing strategies 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
18
not use our services or the same volume of 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
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 pre-initial public offering grants of equity securities and
restricted stock awards primarily to consultants, as well as fees paid to
independent contractor organizations and related expense reimbursements.
Employee compensation includes certain unbillable time, training, vacation time,
benefits and payroll taxes. Annual gross margins have ranged from 48.9% to 50.8%
during the period from 2003 to 2005. 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, which tend
to be higher in a competitive labor market.
Operating expenses include selling, general and administrative, equity related
charges, intangible asset amortization, and goodwill and intangible asset
impairments, litigation settlements 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 pre-initial public offering grants of equity
securities and restricted stock awards, primarily to principals and certain
senior executives. Impairment relates to the write down of goodwill calculated
in accordance with the provisions of SFAS No. 142, "Accounting for Goodwill and
Intangible Assets" and write down of other intangibles calculated in accordance
with the provisions of SFAS No. 144, "Accounting for the Impairment on Disposal
of Long Lived Assets." Such impairments occur when the carrying amount of a
long-lived asset (asset group) is not recoverable and exceeds its fair value.
That assessment is based on the carrying amount of the asset (asset group) at
the date it is tested for recoverability, whether in use or under development.
CRITICAL ACCOUNTING POLICIES
Our significant accounting policies are summarized in Note 1 to the consolidated
financial statements included in Item 8 "Consolidated Financial Statements" of
this report.
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:
- Allowance for Doubtful Accounts;
- Impairment of Goodwill and Long-lived Intangible Assets;
- Revenue Recognition; and
- 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 record and credit status as work is
being performed for them.
We recorded bad debt expense in the amounts of $399,000 and $575,000 for fiscal
years 2004 and 2003, respectively. We recorded a credit to bad debt expense of
$59,000 in fiscal year 2005 as recoveries offset our estimate of new
uncollectible accounts. Our allowance for doubtful accounts totaled $296,000,
$396,000 and $652,000 at the end of fiscal years 2005, 2004 and 2003,
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 financial performance
and cash flow.
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. If the remaining book value assigned to goodwill 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 discounted rates.
These assumptions require significant judgment and estimations about future
events and are thus subject to significant uncertainty. If actual
19
cash flows turn out to be less than projected, we may be required to take
further write-downs, which could increase the variability and volatility of our
future results.
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 first quarter of fiscal year 2004, related to the
discontinuation of the hardware business, in accordance with the provisions of
SFAS No. 142.
Due to a combination of significantly lower operating results of reporting units
during fiscal year 2003, the resignation of key personnel, and revised and
reduced financial projections, we recorded a goodwill impairment loss of $15.8
million in 2003, in accordance with the provisions of SFAS No. 142. For an
additional discussion see Item 8, "Consolidated Financial Statements," Note 2
"Goodwill and Other Intangible Assets."
In accordance with SFAS No. 144, we use our best estimates based upon reasonable
and supportable assumptions and projections, reviews for impairment of
long-lived assets and certain identifiable intangibles to be held and used
whenever events or changes in circumstances indicate that the carrying amount of
our assets might not be recoverable. During fiscal year 2003 we identified
certain events, including a significant decrease in revenue from customers whose
relationships were valued in purchase accounting. We performed an impairment
test, and determined that the carrying value of customer relationships exceeded
its fair market value and recorded an aggregate impairment loss of $3.7 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.
Revenue Recognition--We recognize revenue from time and material 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, and contingent fee
contracts.
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 a material
increase or decrease in revenues and income and are reflected in the financial
statements in the periods in which they are first identified.
We also enter into 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. 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 and control the cost of providing
these services. 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 carryforwards. 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 some cases where deferred taxes were the
result of compensation expense recognized on stock options, our ability to
realize the income tax benefit of these assets is also dependent on our share
price increasing to a point where these options will be exercised. 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 December 31, 2005, cumulative
valuation allowances in the amount of $27.5 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 in future years, no additional tax
benefit would be recognized for those losses, since we would be required to
increase our valuation allowance to offset such amounts.
RECENT ACCOUNTING PRONOUNCEMENT
In December 2004, the FASB issued SFAS No. 123R which replaces SFAS No. 123 and
supersedes APB No. 25. SFAS No. 123R requires compensation costs related to
share-based payment transactions to be recognized in the financial statements
based on the fair value on the grant date of the equity or liability instruments
issued. Compensation cost will be recognized over the period that an employee
provides service for that award, resulting in a decrease in net earnings. We
will adopt the provisions of this Statement, as amended, using the modified
prospective method beginning in fiscal year 2006. Compensation costs will be
recognized for awards that are issued beginning in 2006 and for awards that have
been granted prior to December 31, 2005 but have yet to reach the end of the
requisite service period. The amount of expense to be recognized over the
remaining service period as of December 31, 2005 is approximately $3.0 million
to $3.5 million. We will begin expensing these costs over the shorter of the
vesting period or the period from the date of grant to the date the employee
becomes eligible for retirement. Based on currently outstanding options, we
expect to record a total expense of approximately $2.0 million to $2.4 million
during fiscal year 2006.
20
RESULTS OF OPERATIONS
On March 4, 2004, management and the Board of Directors elected to discontinue
our hardware business. The Consolidated Statements of Operations and
Comprehensive Loss have been adjusted for fiscal years 2004 and 2003 to report
the income (loss) from discontinued operations, net of tax. For a further
discussion see Item 1, "Notes to Consolidated Condensed Financial Statements,"
Note 3, "Discontinued Operations."
FISCAL 2005 COMPARED TO FISCAL 2004
REVENUES
Revenues increased 28.2% to $30.4 million for fiscal year 2005 from $23.7
million for fiscal year 2004. The increase in revenue in 2005 is attributable to
an increased penetration of consulting services to our top 5 client
relationships, with emphasis in growth areas of wireless and IP. During fiscal
year 2005, we provided services on 231 customer projects, compared to 197
projects performed in fiscal year 2004. Average revenue per project was $132,000
in fiscal year 2005 compared to $120,000 in fiscal year 2004. The increase in
average revenue per project was primarily attributable to a small number of
large engagements in the mix in fiscal year 2005. Our international revenue base
decreased to 3.9% of our revenues for fiscal year 2005, from 22.3% for fiscal
year 2004, due primarily to the completion 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 $8.5 million and $9.6 million in fiscal year 2005 and 2004,
respectively, representing 28.1% and 40.5% of total revenue in fiscal year 2005
and 2004, respectively. The mix of contract engagement types will vary by year,
depending on the type of engagement.
COST OF SERVICES
Direct costs of services increased to $14.8 million for fiscal year 2005
compared to $12.3 million for fiscal year 2004. As a percentage of revenues, our
gross margin based on direct cost of services was 51.2% for fiscal year 2005
compared to 48.0% for fiscal year 2004. The increase in gross margin was
primarily attributable to a shift in the mix of services to more strategy and
management consultancy engagements which typically yield higher margins than
staffing engagements, coupled with better utilization levels.
Non-cash equity related charges were $100,000 and $205,000 for fiscal year 2005
and 2004, respectively. The charges primarily relate to awards of restricted
stock to select executives and key consultants 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 increased by 7.4% to $19.6 million for fiscal year
2005, from $18.2 million for fiscal year 2004. Operating expenses include
selling, general and administrative costs, legal settlement, real estate
restructuring, equity related charges, and intangible asset amortization. The
major components of the increase are discussed by category in the following
paragraphs.
The increase in operating expenses includes $2.4 million related to selling,
general and administrative expense increases in fiscal year 2005 compared to
fiscal year 2004. The increase is primarily related to increased R&D in our
initiative to develop our MVNE offerings and toolsets for IP transformations in
fiscal year 2005 and increases in variable selling expenses to support the
increase in revenues.
In fiscal year 2005 we recorded a charge of $95,000 to settle a preference claim
legal dispute with the bankruptcy trustee of a former client. In fiscal year
2004 we entered into a mediated settlement agreement to settle pending
litigation with a customer regarding a take or pay contract. As part of the
settlement, we received a $2 million payment to settle all claims and disputes
in the litigation. This payment was recorded as a $1.3 million reduction of
operating expenses and $0.7 million reduction of existing receivables. We made
the decision to consolidate office space resulting in a charge to earnings of
$1.5 million in 2004 and an additional expense of $75,000 in fiscal year 2005.
Non-cash equity related charges were $0.6 million in fiscal year 2005 compared
to $1.0 million for fiscal year 2004. The charges primarily relate to the award
of restricted stock issued to select executives and key employees, which are
being amortized on a grading vesting schedule over periods of two to four years
from the date of grant. The decrease in equity related charges is the result of
reversals of previously recognized compensation expense related to forfeitures
of restricted stock.
Intangible asset amortization was $0.3 million in fiscal year 2005, compared to
$1.0 million in fiscal year 2004. The decrease in intangible asset amortization
was due to certain intangible assets becoming fully amortized during fiscal year
2004 and early fiscal year 2005.
OTHER INCOME AND EXPENSES
Interest income was $1.6 million and $0.7 million for fiscal years 2005 and
2004, respectively, and represented interest earned on invested balances.
Interest income increased during fiscal year 2005 due primarily 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.
21
INCOME TAXES
For fiscal years 2005 and 2004 we have fully reserved our deferred income tax
benefits generated by our pre-tax losses from continuing operations of $2.4
million and $6.4 million, respectively. The fiscal years 2005 and 2004 income
tax provisions of $36,000 and $49,000, respectively, relate to state income
taxes. In fiscal years 2005 and 2004, we recorded valuation allowances in the
amount of $0.9 million and $2.6 million, respectively, against deferred income
tax assets. The valuation allowance was calculated utilizing the guidance of
SFAS No. 109 "Accounting for Income Taxes" which requires an estimation of the
recoverability of the recorded deferred income tax asset balances.
FISCAL 2004 COMPARED TO FISCAL 2003
REVENUES
Revenues increased 2.0% to $23.7 million for fiscal year 2004 from $23.2 million
for fiscal year 2003. Included in revenues for fiscal year 2003 was $0.7 million
related to a customer take or pay contract, representing the shortfall in
consulting services utilized by a customer in connection with annual minimum
usage requirements. The increase in revenue in 2004 is attributable to an
increase in engagements in the wireless segment of the telecom industry, along
with a slight increase in the average size of projects. During fiscal year 2004,
we provided services on 197 customer projects, compared to 196 projects
performed in fiscal year 2003. Average revenue per project was $120,000 in
fiscal year 2004 compared to $119,000 in fiscal year 2003. International revenue
base increased to 22.3% of our revenues for fiscal year 2004, from 10.0% for
fiscal year 2003, due primarily to a significant increase in project activity
with select large global wireline and wireless carriers located in Western
Europe and Australia. Revenues recognized in connection with fixed price
engagements totaled $9.6 million and $6.4 million in fiscal year 2004 and 2003,
respectively, representing 40.5% and 27.4% of total revenue in fiscal year 2004
and 2003, respectively.
Effective March 4, 2004, management and the Board of Directors elected to
discontinue our hardware business (previously reported as the separate business
segment "All Other"). Operating results of the hardware business for fiscal
years 2004 and 2003 have been included as a component of discontinued operations
in the Consolidated Statements of Operations and Comprehensive Loss contained
herein.
COST OF SERVICES
Direct costs of services increased to $12.3 million for fiscal year 2004
compared to $11.9 million for fiscal year 2003. As a percentage of revenues, our
gross margin based on direct cost of services was 48.0% for fiscal year 2004
compared to 48.7% for fiscal year 2003. Included in fiscal year 2003 gross
margin is the $0.7 million of revenue from the take or pay contract discussed
above. Gross margin percentage is attributable to the mix of services, pricing
of our projects and efficiency of delivery.
Non-cash equity related charges were $205,000 for fiscal year 2004. The charges
relate to the award of restricted stock issued 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 of $57,000 for fiscal year 2003,
was primarily related to the cancellation and forfeiture of unvested stock
options by employees.
OPERATING EXPENSES
In total, operating expenses decreased by 55.9% to $18.2 million for fiscal year
2004, from $41.3 million for fiscal year 2003. Operating expenses include
selling, general and administrative costs, legal settlement, real estate
restructuring, equity related charges, goodwill and intangible asset impairment,
and intangible asset amortization. The major components of the decrease are
discussed by category in the following paragraphs.
The decrease in operating expenses includes $3.3 million related to selling,
general and administrative expense reductions in fiscal year 2004 compared to
fiscal year 2003. Approximately $1.5 million of the reductions were associated
with reductions in personnel levels and improvement in our utilization rates, as
part of our ongoing effort to properly size the business to a lower revenue
base. In fiscal year 2004 we incurred severance charges of $0.1 million compared
to $0.4 million in fiscal year 2003 related to involuntary employee turnover. We
also reduced outside professional service fees by $0.6 million in fiscal year
2004 from fiscal year 2003. Additionally, throughout fiscal year 2004, we
implemented a number of cost reductions within sales and marketing,
communications, insurance, and other administrative costs. 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 recorded a goodwill and intangible asset impairment charge of $19.5 million
in fiscal year 2003. The goodwill impairment charge is attributable to a
combination of the resignation of key executive personnel during fiscal year
2003 and lower than expected operating results of reporting units during fiscal
year 2003, both of which adversely affected future projections of operating
results utilized in the impairment analysis. The write down of goodwill and
customer relationships was calculated in accordance with the provisions of SFAS
No. 142 and SFAS No. 144, respectively.
In fiscal year 2004 we entered into a mediated settlement agreement to settle
pending litigation with a customer regarding the take or pay contract discussed
in "Revenues" above. As part of the settlement, we received a $2 million payment
to settle all claims and disputes in the litigation. This payment was recorded
as a $1.3 million reduction of operating expenses and $0.7 million reduction of
existing receivables. Also during fiscal year 2004, we made the decision to
consolidate office space resulting in a charge to earnings of $1.5 million.
22
Non-cash equity related charges were $1.0 million in fiscal year 2004 compared
to $0.1 million for fiscal year 2003. The fiscal year 2004 charges relate to the
award of restricted stock issued 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.
OTHER INCOME AND EXPENSES
Interest income was $0.7 million and $0.6 million for fiscal years 2004 and
2003, respectively, and represented interest earned on invested cash and cash
equivalent balances and short-term investments. Interest income increased during
fiscal year 2004 due to investing cash reserves at slightly higher interest rate
returns in 2004 compared to 2003. We primarily invest in money market funds and
investment-grade auction rate securities as part of our overall investment
policy.
INCOME TAXES
For fiscal year 2004 we have fully reserved our deferred income tax benefits
generated by our pre-tax losses of $6.4 million from continuing operations. The
fiscal year 2004 income tax provision of $49,000 relates to state income taxes.
In fiscal year 2003, we recorded a valuation allowance in the amount of $24.0
million against deferred income tax assets, offsetting the income tax benefit
from current year operating losses and resulting in a net income tax provision
of $13.0 million. The valuation allowance was calculated utilizing the guidance
of SFAS No. 109, "Accounting for Income Taxes" which requires an estimation of
the recoverability of the recorded deferred income tax asset balances.
SUMMARY OF QUARTERLY RESULTS OF OPERATIONS -- UNAUDITED
(In thousands, except per share data)
QUARTER ENDED
----------------------------------------------------
APRIL 2, JULY 2, OCTOBER 1, DECEMBER 31,
2005 2005 2005 2005
-------- -------- -------- --------
Revenues ....................................... $ 7,067 $ 9,017 $ 8,057 $ 6,237
======== ======== ======== ========
Gross profit ................................... $ 3,638 $ 4,464 $ 4,199 $ 3,143
======== ======== ======== ========
Net income (loss)............................... $ (608) $ 30 $ 24 $ (1,866)
======== ======== ======== ========
Basic and diluted net
income (loss) per common share ............... $ (0.02) $ 0.00 $ 0.00 $ (0.05)
======== ======== ======== ========
QUARTER ENDED
----------------------------------------------------
APRIL 3, JULY 3, OCTOBER 2, JANUARY 1,
2004 2004 2004 2005
-------- -------- -------- --------
Revenues ....................................... $ 5,779 $ 5,184 $ 6,546 $ 6,195
======== ======== ======== ========
Gross profit ................................... $ 2,812 $ 2,393 $ 3,054 $ 2,921
======== ======== ======== ========
Net loss from discontinued operation............ $ (2,276)
======== ======== ======== ========
Net loss........................................ $ (4,251) $ (2,117) $ (1,119) $ (1,208)
======== ======== ======== ========
Basic and diluted net loss from discontinued
operation per common share .................... $ (0.07)
======== ======== ======== ========
Basic and diluted net loss per common share .... $ (0.13) $ (0.06) $ (0.03) $ (0.03)
======== ======== ======== ========
LIQUIDITY AND CAPITAL RESOURCES
Net cash used in operating activities was $0.8 million, $0.7 million and $0.9
million for fiscal years 2005, 2004, and 2003, respectively. We used cash in
operating activities for fiscal years 2005, 2004 and 2003 primarily due to
operating losses. These losses were substantially offset
23
by effective management of working capital and operating assets and liabilities
and a favorable legal settlement during fiscal year 2004.
Net cash provided by (used in) investing activities was $0.6 million, $2.6
million and ($2.0 million) for fiscal year 2005, 2004, and 2003, respectively.
This includes net proceeds (net purchases) from sales and reinvestments of
auction rate securities of $2.6 million, $2.8 million and ($1.9 million) in
fiscal years 2005, 2004, and 2003, respectively. In fiscal year 2005 net cash
provided by investing activities was reduced by a $1.5 million investment in a
five-year exclusive marketing license with S3 Matching Technologies. Net cash
provided by (used in) investing activities also includes acquisitions of office
equipment, software and computer equipment of $0.5 million, $0.2 million and
$0.1 million in fiscal years 2005, 2004, and 2003, respectively.
Net cash provided by financing activities was $482,000, $22,000, and $94,000 for
fiscal years 2005, 2004, and 2003, respectively, which related to proceeds from
the exercise of employee stock options as well as common stock issued by us as
part of our employee stock purchase program, partially offset by payments made
on long-term obligations.
FINANCIAL COMMITMENTS
As of December 31, 2005, we have the following contractual obligations and
commercial commitments by year (amounts in millions):
2006 2007 2008 2009 2010 2011 Total
---- ---- ---- ---- ---- ------- -----
Operating leases $1.9 $1.9 $1.9 $1.8 $1.6 $0.1 $9.2
---- ---- ---- ---- ---- ---- -----
Total $1.9 $1.9 $1.9 $1.8 $1.6 $0.1 $9.2
==== ==== ==== ==== ==== ==== =====
We have met our cash requirements with a combination of operating revenues and
the use of our cash reserves.
At December 31, 2005, we had approximately $49.7 million in cash, cash
equivalents, and short-term investments. We believe we have sufficient cash and
short-term investments to meet anticipated cash requirements, including
anticipated capital expenditures, consideration for possible acquisitions, and
any future operating losses that may be incurred, for at least the next 12
months. Should our cash and short-term investments prove insufficient we might
need to obtain new debt or equity financing to support our operations or
complete acquisitions. 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. Our strong
cash position and absence of long-term debt have enabled us to weather adverse
conditions in the telecommunications industry and to make investments in
intellectual property we believe are enabling us to capitalize on the current
recovery and transformation of the industry; however, if the industry and demand
for our consulting services do not continue to rebound and we continue to
experience negative cash flow, we could experience liquidity challenges at some
future point.
TRANSACTIONS WITH RELATED PARTIES
During fiscal year 2004, we made payments of $55,000 to a legal firm in which a
member of our Board of Directors owns an equity interest. Such payments were
made in connection with matters arising in the normal course of business. Our
Board of Directors has affirmatively determined that such payments do not
constitute a material relationship between the director and the Company and
concluded the director is independent as defined by the NASDAQ corporate
governance rules.
As of December 31, 2005, there is one remaining line of credit between the
Company and its Chief Financial Officer, Richard P. Nespola, which originated in
fiscal year 2001. Aggregate borrowings outstanding against the line of credit at
December 31, 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. Interest payments on this loan are current as of
December 31, 2005.
ITEM 7A. 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
the fixed income investments. Changes in the overall level of interest rates
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.
24
ITEM 8. CONSOLIDATED FINANCIAL STATEMENTS
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
TO THE BOARD OF DIRECTORS OF
The Management Network Group, Inc.
Overland Park, Kansas
We have audited the accompanying consolidated balance sheets of The Management
Network Group, Inc. and subsidiaries (the "Company") as of December 31, 2005 and
January 1, 2005 and the related consolidated statements of operations and
comprehensive loss, stockholders' equity and cash flows for the fiscal years
ended December 31, 2005, January 1, 2005 and January 3, 2004 (52, 52, and 53
weeks, respectively). These financial statements are the responsibility of the
Company's management. Our responsibility is to express an opinion on these
financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. The Company is not required to
have, nor were we engaged to perform, an audit of its internal control over
financial reporting. Our audits included consideration of internal control over
financial reporting as a basis for designing audit procedures that are
appropriate in the circumstances but not for the purpose of expressing an
opinion on the effectiveness of the Company's internal control over financial
reporting. Accordingly, we express no such opinion. An audit also includes
examining, on a test basis, evidence supporting the amounts and disclosures in
the financial statements, assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, such consolidated financial statements present fairly, in all
material respects, the financial position of the Company as of December 31, 2005
and January 1, 2005, and the results of its operations and its cash flows for
the fiscal years ended December 31, 2005, January 1, 2005 and January 3, 2004 in
conformity with accounting principles generally accepted in the United States of
America.
/S/ DELOITTE & TOUCHE LLP
KANSAS CITY, MISSOURI
March 29, 2006
25
THE MANAGEMENT NETWORK GROUP, INC.
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE DATA)
ASSETS
December 31, January 1,
2005 2005
------------ ------------
CURRENT ASSETS:
Cash and cash equivalents .......................................... $ 10,951 $ 10,882
Short-term investments ............................................. 38,700 41,300
Receivables:
Accounts receivable ............................................. 3,886 4,663
Accounts receivable -- unbilled ................................. 2,559 1,911
--------- ---------
6,445 6,574
Less: Allowance for doubtful accounts ........................... (296) (396)
--------- ---------
6,149 6,178
Refundable income taxes ............................................. 117 769
Prepaid and other assets ............................................ 1,262 1,176
--------- ---------
Total current assets ....................................... 57,179 60,305
--------- ---------
Property and equipment, net ......................................... 900 896
Goodwill............................................................. 13,365 13,365
Intangible assets, net............................................... 1,651 487
Other assets ........................................................ 454 300
-------- --------
Total Assets ........................................................ $ 73,549 $ 75,353
========= =========
CURRENT LIABILITIES:
Trade accounts payable ............................................. $ 1,025 $ 845
Accrued payroll, bonuses and related expenses ...................... 1,136 1,040
Other accrued liabilities .......................................... 1,893 2,574
Unfavorable and capital lease obligations .......................... 628 725
--------- ---------
Total current liabilities .................................. 4,682 5,184
--------- ---------
Unfavorable and capital lease obligations ........................... 2,819 3,422
STOCKHOLDERS' EQUITY:
Common stock:
Voting -- $.001 par value, 100,000,000 shares authorized;
35,705,520 and 34,750,562 shares issued and outstanding on
January 1, 2005, and December 31, 2005, respectively ............ 36 35
Preferred stock -- $.001 par value, 10,000,000 shares
authorized; no shares issued or outstanding
Additional paid-in capital ......................................... 159,586 157,857
Accumulated deficit................................................. (93,305) (90,885)
Accumulated other comprehensive income --
Foreign currency translation adjustment ........................... 147 352
Unearned compensation .............................................. (416) (612)
--------- ---------
Total stockholders' equity ................................. 66,048 66,747
--------- ---------
Total Liabilities and Stockholders' Equity .......................... $ 73,549 $ 75,353
========= =========
See notes to consolidated financial statements.
26
THE MANAGEMENT NETWORK GROUP, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE LOSS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
FISCAL YEAR ENDED
------------------------------------------
December 31 January 1, January 3,
2005 2005 2004
----------- ----------- -----------
Revenues................................................. $ 30,378 $ 23,704 $ 23,245
Cost of services:
Direct cost of services (exclusive of amortization
shown below)........................................... 14,834 12,319 11,927
Equity related charges (benefits)....................... 100 205 (57)
-------- -------- --------
Total cost of services (exclusive of
amortization shown below) ..................... 14,934 12,524 11,870
-------- -------- --------
15,444 11,180 11,375
Operating expenses:
Selling, general and administrative..................... 18,462 16,037 19,359
Legal settlement ....................................... 95 (1,294)
Real estate restructuring .............................. 75 1,545
Goodwill and intangible asset impairment ............... 19,484
Intangible asset amortization .................. 336 992 2,343
Equity related charges ................................. 618 958 142
-------- -------- --------
Total operating expenses ....................... 19,586 18,238 41,328
-------- -------- --------
(4,142) (7,058) (29,953)
Other income (expense):
Interest income ........................................ 1,632 718 624
Other, net ............................................. 126 (30) (51)
-------- -------- --------
Total other income ............................. 1,758 688 573
-------- -------- --------
Loss from continuing operations before income tax
provision ............................................. (2,384) (6,370) (29,380)
Income tax provision .................................... (36) (49) (12,978)
-------- -------- --------
Loss from continuing operations ......................... (2,420) (6,419) (42,358)
Discontinued operations:
Net income (loss) from discontinued operations
(including a charge for impairment of goodwill of
$2,163 in fiscal year 2004 and income tax provision
of $53 for fiscal 2003)................................ (2,276) 34
-------- -------- --------
Net loss ................................................ (2,420) (8,695) (42,324)
Other comprehensive income (loss) -
Foreign currency translation adjustment................. (205) 176 63
-------- -------- --------
Comprehensive loss ...................................... $ (2,625) $ (8,519) $(42,261)
======== ======== ========
Loss from continuing operations per common share
Basic and diluted ...................................... $ (0.07) $ (0.18) $ (1.26)
======== ======== ========
Net income (loss) from discontinued operations per
common share
Basic and diluted ...................................... $ (0.07)
======== ======== ========
Net loss per common share
Basic and diluted....................................... $ (0.07) $ (0.25) $ (1.26)
======== ======== ========
Shares used in calculation of loss from continuing
operations, net income (loss) from discontinued
operations, and net loss per common share
Basic and diluted ...................................... 35,175 34,619 33,545
======== ======== ========
See notes to consolidated financial statements.
27
THE MANAGEMENT NETWORK GROUP, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
FISCAL YEAR ENDED
-----------------------------------------
December 31, January 1, January 3,
2005 2005 2004
------------ ------------ ------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss ................................................. $ (2,420) $ (8,695) $ (42,324)
Adjust for
(Income) loss from discontinued operations (includes
non-cash goodwill impairment charge of $2,163 in
fiscal year 2004) 2,276 (34)
-------- -------- --------
Loss from continuing operations (2,420) (6,419) (42,358)
Adjustments to reconcile net loss to net cash
provided by (used in) operating activities:
Goodwill and intangible asset impairment ............... 19,484
Real estate restructuring charge ....................... 1,545
Depreciation and amortization .......................... 822 1,672 3,197
Equity related charges ................................. 718 1,163 85
Deferred income taxes .................................. 14,066
Bad debt expense ...................................... (59) 399 575
Loss on retirement of assets ........................... 39
Income tax benefit realized upon exercise/
forfeiture of stock options ........................... 45
Other changes in operating assets and liabilities:
Accounts receivable .................................. 736 61 (173)
Accounts receivable -- unbilled ...................... (648) 229 2,092
Refundable income taxes .............................. 652 1,437 2,720
Prepaid and other assets ............................. (239) (364) 1,113
Trade accounts payable ............................... 180 211 (535)
Accrued liabilities .................................. (559) (563) (1,286)
-------- -------- --------
Net cash used in operating activities from
continuing operations ............................. (817) (590) (975)
-------- -------- --------
Net cash used in operating activities (817) (703) (941)
-------- -------- --------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of short-term investments....................... (9,300) (6,850) (9,150)
Proceeds from maturities/sales of short-term investments . 11,900 9,600 7,300
Investment in S3 license ................................. (1,500)
Acquisition of property and equipment, net................ (491) (188) (127)
-------- -------- --------
Net cash provided by (used in) investing activities 609 2,562 (1,977)
-------- -------- --------
CASH FLOWS FROM FINANCING ACTIVITIES:
Issuance of common stock through employee
stock purchase plan .................................... 158 131 70
Payments made on lease obligations ....................... (726) (710) (392)
Exercise of stock options................................. 1,050 601 416
-------- -------- --------
Net cash provided by financing activities 482 22 94
-------- -------- --------
Effect of exchange rate on cash and cash equivalents ....... (205) 176 63
-------- -------- --------
Net increase (decrease) in cash and cash equivalents ....... 69 2,057 (2,761)
Cash and cash equivalents, beginning of period ............. 10,882 8,825 11,586
-------- -------- --------
Cash and cash equivalents, end of period ................... $ 10,951 $ 10,882 $ 8,825
======== ======== ========
Supplemental disclosure of cash flow information:
Cash paid during period for interest ..................... $ 3 $ 30 $ 51
======== ======== ========
Cash paid during period for taxes ........................ $ 36 $ 49 $ 493
======== ======== ========
See notes to consolidated financial statements.
28
THE MANAGEMENT NETWORK GROUP, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(In thousands, except share data)
COMMON STOCK
$.001 PAR
VOTING ADDITIONAL
--------------------- PAID-IN ACCUMULATED
SHARES AMOUNT CAPITAL DEFICIT
------------ ------ ---------- ---------
Balance, December 28, 2002 33,347,228 $33 $155,509 $(39,866)
Option grants 189
Exercise of options 245,304 416
Cancellation of options (294)
Stock surrender (8,702) (12)
Employee stock purchase plan 67,238 70
Stock compensation
Restricted stock grant 720,000 1 2,069
Other comprehensive income -
Foreign currency translation adjustment
Reduction of tax benefit due to exercise/forfeiture
of stock options (655)
Net loss (42,324)
------------ ------ ---------- ---------
Balance, January 3, 2004 34,371,068 34 157,292 (82,190)
Exercise of options 338,165 1 601
Employee stock purchase plan 98,529 131
Stock compensation
Restricted stock grant 15,000 30
Restricted stock cancellation (77,000) (212)
Stock bonus 4,800 15
Other comprehensive income -
Foreign currency translation adjustment
Net loss (8,695)
------------ ------ ---------- ---------
Balance, January 1, 2005 34,750,562 35 157,857 (90,885)
Exercise of options 602,329 1 1,049
Employee stock purchase plan 115,629 158
Stock compensation
Restricted stock grant 300,000 695
Restricted stock cancellation (63,000) (173)
Other comprehensive income -
Foreign currency translation adjustment
Net loss (2,420)
------------ ------ ---------- ---------
Balance, December 31, 2005 35,705,520 $ 36 $ 159,586 $ (93,305)
============ ====== ========== =========
29
ACCUMULATED
OTHER
COMPREHENSIVE UNEARNED
INCOME COMPENSATION TOTAL
------------- -------------- ---------
Balance, December 28, 2002 $113 $(63) $115,726
Option grants (189)
Exercise of options 416
Cancellation of options 294
Stock surrender (12)
Employee stock purchase plan 70
Stock compensation 85 85
Restricted stock grant (2,070)
Other comprehensive income -
Foreign currency translation adjustment 63 63
Reduction of tax benefit due to exercise/forfeiture
of stock options (655)
Net loss (42,324)
------------- -------------- ---------
Balance, January 3, 2004 176 (1,943) 73,369
Exercise of options 602
Employee stock purchase plan 131
Stock compensation 1,149 1,149
Restricted stock grant (30)
Restricted stock cancellation 212
Stock bonus 15
Other comprehensive income -
Foreign currency translation adjustment 176 176
Net loss (8,695)
------------- -------------- ---------
Balance, January 1, 2005 352 (612) 66,747
Exercise of options 1,050
Employee stock purchase plan 158
Stock compensation 718 718
Restricted stock grant (695)
Restricted stock cancellation 173
Other comprehensive income -
Foreign currency translation adjustment (205) (205)
Net loss (2,420)
------------- -------------- ---------
Balance, December 31, 2005 $ 147 $ (416) $ 66,048
============= ============== =========
See notes to consolidated financial statements.
30
THE MANAGEMENT NETWORK GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Nature of Operations - The Management Network Group, Inc. ("TMNG" or the
"Company") was founded in 1990 as a management consulting firm specializing in
providing consulting services to the converging communications industry and the
financial services firms that support it. A majority of the Company's revenues
are from customers in the United States, however, the Company also provides
services to customers in Europe and other foreign countries. TMNG's corporate
offices are located in Overland Park, Kansas.
Principles of Consolidation - The consolidated statements include the accounts
of TMNG and its wholly-owned subsidiaries, The Management Network Group Europe
Ltd. (TMNG-Europe), formed on March 19, 1997, based in the United Kingdom; The
Management Network Group Canada Ltd. (TMNG-Canada), formed on May 14, 1998,
based in Toronto, Canada; TMNG.com, Inc., formed in June 1999; TMNG Marketing,
Inc., acquired on September 5, 2000; TMNG Technologies, Inc., acquired on
September 5, 2001; and TMNG Strategy, Inc., acquired on March 6, 2002. All
significant intercompany accounts and transactions have been eliminated in
consolidation.
Fiscal Year - The Company reports its operating results on a 52/53-week fiscal
year basis. The fiscal year end is determined as the Saturday ending nearest
December 31. The fiscal years ended December 31, 2005 and January 1, 2005
reported 52 weeks of operating results and consisted of four equal 13-week
quarters. The fiscal year ended January 3, 2004 reported 53 weeks of operating
results and consisted of three 13-week quarters and one 14-week quarter. The
fiscal years ended December 31, 2005, January 1, 2005 and January 3, 2004 are
referred to herein as fiscal year 2005, 2004 and 2003, respectively. TMNG Europe
and TMNG Canada maintain year-end dates of December 31.
Revenue Recognition - The Company accounts for revenue and costs in connection
with client service engagements under a time and materials contract in the
period in which the service is performed. The Company generally records revenue
in connection with fixed price contracts under a percentage of completion
method. This method of accounting results in the ratable recognition of revenue
in proportion to the related costs over the client service engagement. Estimates
are prepared to monitor and assess the Company's progress on the engagement from
the initial phase of the project to completion, and these estimates are utilized
in recognizing revenue in the Company's financial statements. If the current
estimates of total contract revenues and contract costs indicate a loss, the
Company records a provision for the entire loss on the contract. The Company has
no such loss contracts as of the end of fiscal years 2005 and 2004. Revenues and
related costs of smaller fixed price contracts are generally recognized upon
contract completion under the completed contract method, and generally involve
immaterial amounts and are of a short duration.
On a more limited basis, the Company also enters into gain sharing contracts,
where the Company's revenue is determined on a success-based revenue model.
Revenues generated on such contracts result from financial success recognized by
the client utilizing agreed upon contract measures and milestones between the
two parties. Due to the contingent nature of these gain-sharing projects, the
Company recognizes costs as they are incurred on the project and defers the
revenue recognition until the revenue is realizable and earned.
Cash and Cash Equivalents - Cash and cash equivalents include cash on hand and
short-term investments with original maturities of three months or less when
purchased.
Short-Term Investments - Short-term investments, which consist of
investment-grade auction rate securities, are classified as "available for sale"
under the provisions of Statement of Financial Accounting Standards (SFAS) No.
115, "Accounting for Certain Investments in Debt and Equity Securities."
Accordingly, the short-term investments are reported at fair value, with any
related unrealized gains and losses included as a separate component of
stockholders' equity, net of applicable taxes, when applicable. Realized gains
and losses and interest and dividends are included in interest income within the
Consolidated Statements of Operations and Comprehensive Loss. Auction rate
securities generally reset every 28 to 35 days; consequently, interest rate
movements do not materially affect the fair value of these investments. At
December 31, 2005 and January 1, 2005 there were no unrealized gains or losses
on short-term investments.
Fair Value of Financial Instruments - The fair value of current financial
instruments approximates the carrying value because of the short maturity of
these instruments.
Property and Equipment - Property and equipment are stated at cost less
accumulated depreciation and amortization. Maintenance and repairs are charged
to expense as incurred. Depreciation is based on the estimated useful lives of
the assets and is computed using the straight-line method, and capital leases
are amortized on a straight-line basis over the life of the lease. Asset lives
range from three to seven years for computers and equipment. Leasehold
improvements are capitalized and amortized over the life of the lease or useful
life of the asset, whichever is shorter.
Research and Development Costs - Expenditures relating to development of new
offerings and services are expensed as incurred. Research and development costs
(exclusive of associated sales and marketing related costs) were $1.0 million in
fiscal year 2005, no research and development costs were incurred in fiscal
years 2004 and 2003.
Goodwill - The Company accounts for goodwill in accordance with the provisions
of SFAS No. 142, "Accounting for Goodwill and Intangible Assets." Goodwill
represents the excess of purchase price over the fair value of net assets
acquired in business combinations accounted for as
31
purchases. The Company evaluates goodwill for impairment on an annual basis on
the last day of the first fiscal month of the fourth quarter and whenever events
or circumstances indicate that these assets may be impaired. The Company
determines impairment by comparing the net assets of each reporting unit to its
respective fair value. In the event a reporting unit's carrying value exceeds
its fair value, an indication exists that the reporting unit goodwill may be
impaired. In this situation, the Company must determine the implied fair value
of goodwill by assigning the reporting unit's fair value to each asset and
liability of the reporting unit. The excess of the fair value of the reporting
unit over the amounts assigned to its assets and liabilities is the implied fair
value of goodwill. An impairment loss is measured by the difference between the
goodwill carrying value and the implied fair value.
Intangible Assets - Intangible assets are stated at cost less accumulated
amortization, and represent customer relationships and employment agreements
acquired in the acquisition of Cambridge Strategic Management Group (CSMG) and
Tri-Com Computer Services, Inc. (Tri-Com), and an investment in an exclusive
marketing license with S3 Matching Technologies. Amortization is based on
estimated useful lives of 3 to 62 months, depending on the nature of the
intangible asset, and is recognized on a straight-line basis.
In connection with SFAS No. 144 "Accounting for the Impairment or Disposal of
Long-lived Assets" the Company uses its best estimate, based on reasonable and
supportable assumptions and projections, to review certain long-lived assets and
identifiable intangibles for impairment whenever events or changes in
circumstances indicate that the carrying amount of these assets might not be
recoverable.
Income Taxes - The Company recognizes a liability or asset for the deferred tax
consequences of temporary differences between the tax basis of assets or
liabilities and their reported amounts in the financial statements. A valuation
allowance is provided when, in the opinion of management, it is more likely than
not that some portion or all of a deferred tax asset will not be realized.
Use of Estimates - The preparation of financial statements in conformity with
accounting principles generally accepted in the United States of America
requires management to make estimates and assumptions that affect the reported
amounts of assets and liabilities and disclosure of contingent assets and
liabilities at the date of the financial statements and the reported amounts of
revenues and expenses during the reporting period. Actual results could differ
from those estimates.
Foreign Currency Transactions and Translation - TMNG-Europe and TMNG-Canada both
conduct business primarily denominated in their respective local currency.
Assets and liabilities have been translated to U.S. dollars at the period-end
exchange rate. Revenue and expenses have been translated at exchange rates which
approximate the average of the rates prevailing during each period. Translation
adjustments are reported as a separate component of other comprehensive income
in the consolidated statements of stockholders' equity. Realized and unrealized
exchange gains and losses included in results of operations were insignificant
for all periods presented.
Stock-Based Compensation - 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 SFAS No. 123, "Accounting for Stock-Based Compensation," as amended by SFAS
No. 148, "Accounting for Stock-Based Compensation - Transition and Disclosure."
For an additional discussion of the Company's stock-based compensation see Note
9 "Stock Option Plan and Stock Based Compensation." If compensation cost for the
Company's APB No. 25 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 pricing methodology, the
Company's net loss for fiscal years 2005, 2004 and 2003 would have increased by
$1.7 million, $2.8 million and $1.1 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 and restricted stock are
amortized to pro forma expense over the vesting period. The following table
contains pro forma information for fiscal years 2005, 2004 and 2003 (in
thousands, except per share amounts):
FISCAL FISCAL FISCAL
YEAR YEAR YEAR
2005 2004 2003
-------- -------- --------
Net loss, as reported: $ (2,420) $ (8,695) $(42,324)
Add: Stock-based employee compensation
expense included in reported net loss,
net of related tax effects 718 1,163 85
Deduct: Total stock-based compensation
expense determined under fair value
based method for all awards, net of related (2,415) (3,988) (1,213)
tax effects
-------- -------- --------
Pro forma net loss $ (4,117) $(11,520) $(43,452)
======== ======== ========
Loss per share
Basic and diluted, as reported $ (0.07) $ (0.25) $ (1.26)
======== ======== ========
Basic and diluted, pro forma $ (0.12) $ (0.33) $ (1.30)
======== ======== ========
32
Earnings (Loss) Per Share - The Company calculates and presents earnings (loss)
per share using a dual presentation of basic and diluted earnings (loss) per
share. Basic earnings (loss) per share is computed by dividing net income (loss)
by the weighted average number of common shares outstanding for the period.
Diluted earnings per share reflects the potential dilution of securities by
adding common stock options and unvested restricted stock in the weighted
average number of common shares outstanding for a period, if dilutive. In
accordance with the provisions of SFAS No. 128, "Earnings Per Share", the
Company has not included the effect of common stock options and unvested
restricted stock for fiscal years 2005, 2004 and 2003 as the Company reported a
loss from continuing operations for those periods. Had the Company reported
income from continuing operations in fiscal years 2005, 2004 and 2003, the
treasury stock method of calculating common stock equivalents would have
resulted in approximately 426,000, 822,000 and 772,000 additional dilutive
shares, respectively.
Recent Accounting Pronouncements - In December 2004, the FASB issued SFAS No.
123R which replaces SFAS No. 123 and supersedes APB No. 25. SFAS No. 123R
requires compensation costs related to share-based payment transactions to be
recognized in the financial statements based on the fair value on the grant date
of the equity or liability instruments issued. Compensation cost will be
recognized over the period that an employee provides service for that award,
resulting in a decrease in net earnings. The Company will adopt the provisions
of this Statement, as amended, using the modified prospective method beginning
in fiscal year 2006. Compensation costs will be recognized for awards that are
issued beginning in 2006 and for awards that have been granted prior to December
31, 2005 but have yet to reach the end of the requisite service period. The
amount of expense to be recognized over the remaining service period as of
December 31, 2005 is approximately $3.0 million to $3.5 million. The Company
will begin expensing these costs over the shorter of the vesting period or the
period from the date of grant to the date the employee becomes eligible for
retirement. Based on currently outstanding options, the Company expects to
record a total expense of approximately $2.0 million to $2.4 million during
fiscal year 2006.
2. GOODWILL AND OTHER INTANGIBLE ASSETS
During the second quarter of fiscal year 2003, the Company performed an interim
goodwill impairment test due to significantly lower than expected operating
results of the CSMG reporting unit and the resignation of a key CSMG executive.
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 the fair market 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
Company subsequently performed its annual impairment test in October 2003, and
each year thereafter, and concluded there was no additional goodwill impairment
as the calculated fair values of its reporting units were higher than their
respective carrying values. The goodwill impairment loss related to fiscal year
2003 has been reflected as a component of Loss from Operations in the Statement
of Operations and Comprehensive Loss for that year.
In the first quarter of fiscal year 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 December 31, 2005 and
January 1, 2005 are as follows (amounts in thousands):
Management Consulting All Other
Segment Segment Total
--------------------- --------- --------
Balance as of January 3, 2004 $ 13,365 $ 2,163 $ 15,528
2004 impairment loss on
discontinued operations (2,163) (2,163)
-------- --------- --------
Balance as of January 1, 2005 and
December 31, 2005 $ 13,365 $ 13,365
======== ========= ========
Included in intangible assets, net are the following (amounts in thousands):
December 31, 2005 January 1, 2005
------------------- ---------------------
Accumulated Accumulated
Cost Amortization Cost Amortization
---- ------------ ---- ------------
Customer relationships $1,908 $(1,709) $1,908 $(1,538)
Employment agreements 3,200 (3,200) 3,200 (3,083)
S3 license agreement 1,500 (48)
------- ------- ------- -------
Total $6,608 $(4,957) $5,108 $(4,621)
======= ======= ======= =======
33
During fiscal year 2003, in accordance with the provisions of SFAS No. 144, the
Company determined that the carrying value of customer relationships exceeded
its fair market value and recorded an impairment loss related to the Management
Consulting Segment and All Other Segment of approximately $3.4 million and $0.3
million, respectively. The impairment losses have been reflected as a component
of Loss from Operations in the Statement of Operations and Comprehensive Loss
for fiscal year 2003.
During fiscal year 2005, the Company entered into a five-year exclusive
marketing license with S3 Matching Technologies Inc. to resell their products
and solutions. The $1.5 million cost of this license has been capitalized as an
intangible asset and is being amortized over the 62 month life of the agreement
on a straight-line basis.
Intangible assets amortization expense for fiscal years 2005, 2004 and 2003 was
$0.3 million, $1.0 million and $2.3 million, respectively. Intangible
amortization expense is estimated to be approximately $0.5 million in fiscal
year 2006 and $0.3 million in fiscal years 2007 through 2010.
3. DISCONTINUED OPERATIONS
On March 4, 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 $2.2 million in
fiscal year 2004 and relate primarily to goodwill impairment and severance
charges. These charges are reported as a component of discontinued operations.
The hardware segment's results of operations have been classified as
discontinued operations and prior periods have been restated.
Revenue and income (loss) from discontinued operations are as follows (amounts
in thousands):
Fiscal Fiscal
Year Year
2004 2003
-------- --------
Revenue $ 13 $ 231
Goodwill impairment
and severance charge $ (2,213)
Operating income (loss) $ (63) $ 87
Income tax provision $ 53
-------- --------
Income (loss) from
discontinued operations $ (2,276) $ 34
======== ========
4. MAJOR CUSTOMERS AND SIGNIFICANT GROUP CONCENTRATIONS OF CREDIT RISK
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,
billing system support, operating system support, revenue assurance, corporate
investment services, and network management. The Company intends to continue to
measure and report its activities using our current segment structure. However,
as the services provided by the Company evolve, management will continue to
evaluate its segment reporting structure.
Major customers in terms of significance to TMNG's revenues (i.e. in excess of
10% of revenues) for fiscal years 2005, 2004 and 2003, and accounts receivable
as of December 31, 2005 and January 1, 2005 were as follows (amounts in
thousands):
REVENUES ACCOUNTS RECEIVABLE
------------------------------------ ---------------------------
FISCAL FISCAL FISCAL
YEAR YEAR YEAR December 31, January 1,
2005 2004 2003 2005 2005
-------- ------ ------ ------------ ------------
Customer A ......... $ 6,098 $ 709
Customer B ......... $2,894 $3,238 $ 438
Customer C ......... $ 6,469 $3,305 $2,692 $1,149 $ 906
Revenues from the Company's ten most significant customers accounted for
approximately 71%, 67% and 67% of revenues for fiscal years 2005, 2004 and 2003,
respectively.
Substantially all of TMNG's receivables are obligations of companies in the
communications, media and entertainment industries. The
34
Company generally does not require collateral or other security on its accounts
receivable. The credit risk on these accounts is controlled through credit
approvals, limits and monitoring procedures. The Company records bad debt
expense based on judgment about the anticipated default rate on receivables owed
to TMNG at the end of the reporting period. That judgment is based on the
Company's uncollected account experience in prior years and the ongoing
evaluation of the credit status of TMNG's customers and the communications
industry in general. The changes in the Company's allowance for doubtful
accounts are as follows (amounts in thousands):
FISCAL FISCAL FISCAL
YEAR YEAR YEAR
2005 2004 2003
------- -------- --------
Beginning balance $ 396 652 471
Bad debt expense (benefit) (59) 399 575
Account write-offs (41) (655) (394)
------- -------- --------
Ending balance $ 296 $ 396 $ 652
======= ======== ========
Revenues earned in the United States and internationally based on the location
where the services are performed are as follows (amounts in thousands):
LOSS FROM CONTINUING OPERATIONS BEFORE
REVENUE INCOME TAX (PROVISIONS) BENEFIT
------------------------------------ --------------------------------------
FY FY FY FY FY FY
2005 2004 2003 2005 2004 2003
-------- -------- -------- -------- -------- --------
United States ........ $ 29,179 $ 18,427 $ 20,915 $ (2,290) $ (4,952) $(26,473)
International:
The Netherlands .... 40 891 964 (3) (239) (1,203)
Canada ............. 245 95 (66) (119)
Belize ............. 173 704 (46) (879)
Portugal .......... 1,124 451 (302) (562)
Great Britain ...... 1,153 2,296 (90) (617)
Australia .......... 386 (104)
Other .............. 6 162 116 (1) (44) (144)
-------- -------- -------- -------- -------- --------
Total ...... $ 30,378 $ 23,704 $ 23,245 $ (2,384) $ (6,370) $(29,380)
======== ======== ======== ======== ======== ========
No significant long-lived assets are deployed outside the United States.
5. PROPERTY AND EQUIPMENT
December 31, January 1,
2005 2005
------------ ------------
(000'S)
Furniture and fixtures............................. $ 660 $ 823
Software and computer equipment.................... 2,140 2,777
Leasehold improvements............................. 774 479
------ ------
3,574 4,079
Less: Accumulated depreciation and amortization.... 2,674 3,183
------ ------
$ 900 $ 896
====== ======
Depreciation and amortization expense on property and equipment was
approximately $486,000, $680,000 and $854,000 for fiscal years 2005, 2004 and
2003, respectively.
35
6. INCOME TAXES
For fiscal years 2005, 2004 and 2003, the income tax provision (benefit),
exclusive of the tax associated with the discontinued operations consists of the
following (amounts in thousands):
FISCAL FISCAL FISCAL
YEAR YEAR YEAR
2005 2004 2003
-------- -------- --------
Federal
Current ............................ $ (992)
Deferred tax benefit ............... $ (714) $(1,992) (8,698)
Change in valuation allowance....... 714 1,992 20,999
-------- -------- --------
0 0 11,309
State
Current ............................ 36 49
Deferred tax benefit ............... (213) (700) (1,244)
Change in valuation allowance ...... 213 700 3,000
-------- -------- --------
36 49 1,756
Foreign
Current ............................ (87)
Deferred tax expense ............... 14 99
Change in valuation allowance ...... (14) (99)
-------- -------- --------
0 0 (87)
-------- -------- --------
Total ................................ $ 36 $ 49 $ 12,978
======== ======== ========
The Company has fully reserved its deferred tax assets with a valuation
allowance as of December 31, 2005 and January 1, 2005, in accordance with the
provisions of SFAS No. 109 "Accounting for Income Taxes." Realization of the
deferred tax asset is dependent on generating sufficient income in future
periods. In evaluating the ability to recover its deferred tax assets, the
Company considers all positive and negative evidence including the Company's
past operating results, the existence of cumulative losses in the most recent
fiscal year and the Company's forecast of future income. In determining future
income, the Company is responsible for assumptions utilized including the amount
of state, federal and international operating income, the reversal of temporary
differences and the implementation of feasible and prudent tax planning
strategies. These assumptions require significant judgment about the forecasts
of future income and are consistent with the plans and estimates the Company is
using to manage the underlying business.
In the fourth quarter of fiscal year 2003, the Company reassessed all
significant estimates and judgments made in connection with its SFAS No. 109
analysis. In performing the updated analysis of the realizability of its
deferred tax assets, the Company considered continuing market uncertainties and
concluded that an increase to the valuation allowance for deferred tax assets
was required. Accordingly, based upon the Company's best estimate, the Company
recorded a non-cash charge in the fourth quarter of fiscal year 2003 of $18.0
million to increase the valuation allowance and fully reserve for all deferred
tax assets.
The following is a reconciliation between the provision for income taxes and the
amounts computed based on loss from continuing operations at the statutory
federal income tax rate (amounts in thousands):
FISCAL YEAR FISCAL YEAR FISCAL YEAR
2005 2004 2003
----------------- ----------------- -----------------
AMOUNT % AMOUNT % AMOUNT %
-------- ---- -------- ---- -------- ----
Computed expected federal income
tax benefit .......................... $ (835) (35.0) $ (2,229) (35.0) $(10,282) (35.0)
State income tax expense, net of
federal benefit ...................... (115) (4.8) (298) (4.7) (1,252) (4.3)
Goodwill impairment.................... 217 0.7
Other ................................. 73 3.0 (17) (0.2) 316 1.1
Valuation allowance ................... 913 38.3 2,593 40.7 23,979 82.0
-------- ---- -------- ---- -------- ----
Total ....................... $ 36 1.5 $ 49 0.8 $ 12,978 44.5
======== ==== ======== ==== ======== ====
36
Items giving rise to the provision for deferred income taxes (benefit) are as
follows (amounts in thousands):
FISCAL FISCAL FISCAL
YEAR YEAR YEAR
2005 2004 2003
-------- -------- --------
Goodwill ....................................... $ 1,349 $ 1,402 $ (4,961)
Bad debt reserve ............................... 22 100 (97)
Stock compensation expense ..................... 497 (196) 45
Intangible assets .............................. 113 (156) (1,831)
Valuation allowance ............................ 913 2,593 23,999
Net operating loss carryforward ................ (2,993) (3,318) (3,212)
Unfavorable lease liability 206 (359) 166
Other .......................................... (107) (66) 2
-------- -------- --------
Total ................................ $ 0 $ 0 $ 14,111
======== ======== ========
The significant components of deferred income tax assets and the related balance
sheet classifications, as of December 31, 2005, January 1, 2005 and January 3,
2004 are as follows (amounts in thousands):
DECEMBER 31, JANUARY 1, JANUARY 3,
2005 2005 2004
------------ ----------- -----------
Current deferred tax assets:
Accounts receivable ....................... $ 118 140 $ 240
Accrued expenses .......................... 118 147 296
Unfavorable lease liability ............... 239 212
Valuation allowance........................ (475) (499) (536)
---------- --------- ---------
Current deferred tax asset ........ $ 0 $ 0 $ 0
========== ========= =========
Non-current deferred tax assets:
Goodwill .................................. $ 10,530 11,879 $ 13,281
Stock compensation expense ................ 1,838 2,335 2,193
Unfavorable lease liability........... .... 1,096 1,329 1,017
Net operating loss carryforward ........... 10,301 7,308 3,944
Intangible assets.......................... 2,584 2,696 2,540
Reserves .................................. 395 365 415
Other ..................................... 271 173 73
Valuation allowance ....................... (27,015) (26,085) (23,463)
---------- --------- ---------
Non-current deferred tax asset .... $ 0 $ 0 $ 0
========== ========= =========
The net operating loss carryforward as of December 31, 2005 is scheduled to
expire as follows (amounts in thousands):
Amount Year
$ 1,831 2016
5,602 2023
10,970 2024
7,206 2025
-------
Total $25,609
=======
37
7. 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. Due to current market conditions, the terms of the
sublease require payments by the sublessee which are less than the payments the
Company must make to the original lessor. In accordance with SFAS No. 146,
"Accounting for Costs Associated with Exit or Disposal Activities," the Company
recognized a charge of $1.3 million for the present value of the total remaining
lease payments less amounts to be received under the sublease. The decision to
consolidate space also resulted in charges of $163,000 relating to impairment of
fixed assets/leasehold improvements and $122,000 for brokerage commissions in
connection with the sublease. The restructuring charge of $1.5 million has been
reflected as a component of Loss from Operations in the Statement of Operations
and Comprehensive Loss in the year ended January 1, 2005. Additional expenses
totaling $75,000 associated with the space consolidation were incurred in the
year ended December 31, 2005.
8. LEASE COMMITMENTS
The Company leases office facilities, computer equipment, office furniture, and
an automobile under various operating leases expiring at various dates through
May 2011.
Following is a summary of future minimum payments under operating leases that
have initial or remaining noncancellable lease terms in excess of one year at
December 31, 2005 (amounts in thousands):
OPERATING
FISCAL YEAR LEASES
--------------------------------------- -----------
2006 $ 1,887
2007 1,886
2008 1,891
2009 1,793
2010 1,640
Thereafter 131
---------
Total minimum lease payments 9,219
Future minimum rentals to be received
under noncancellable subleases (1,444)
---------
Minimum lease payments net of amounts
to be received under subleases $ 7,775
=========
Operating lease minimum payments include the off-market portion of lease
payments recorded through purchase accounting in connection with the Company's
acquisition of CSMG and continuing lease commitments associated with the
consolidation of office space. As of December 31, 2005 and January 1, 2005, the
unamortized balance of these unfavorable lease liabilities was $3.3 million and
$3.9 million, respectively.
At December 31, 2005 and January 1, 2005, future minimum payments under
capitalized leases were $4,000 and $16,000, respectively. All existing capital
leases expire during fiscal year 2006. Assets recorded under capital leases are
included in property and equipment as follows (amounts in thousands):
December 31, January 1,
2005 2005
----------- -----------
Furniture and fixtures $ 156
Software and computer equipment 476 $ 505
----------- -----------
476 661
Less: Accumulated depreciation (472) (534)
----------- -----------
$ 4 $ 127
=========== ===========
Total rental expense was approximately $946,000, $1,852,000 and $1,911,000 for
fiscal years 2005, 2004 and 2003, respectively.
9. STOCK OPTION PLAN AND STOCK BASED COMPENSATION
The Company's 1998 Equity Incentive Plan (the 1998 Plan) is a shareholder
approved plan, which provides for the granting of incentive stock options and
nonqualified stock options to employees, and nonqualified stock options and
restricted shares to employees, directors and
38
consultants. The Company has 7,642,390 shares of the Company's common stock
authorized for issuance as stock options under the 1998 Plan. Incentive stock
options are granted at an exercise price of not less than fair value per share
of the common stock on the date of grant as determined by the Board of
Directors. Vesting and exercise provisions are determined by the Board of
Directors. As of December 31, 2005, all options granted under the 1998 Plan were
non-qualified stock options. Options granted under the 1998 Plan generally
become exercisable over a three to four year period beginning on the date of
grant. Options granted under the 1998 Plan have a maximum term of ten years.
A summary of the status of the Company's 1998 Plan as of December 31, 2005,
January 1, 2005 and January 3, 2004 and changes during the years ending on those
dates is presented below:
EXERCISE PRICE EQUALS FAIR MARKET VALUE AT GRANT DATE:
DECEMBER 31, JANUARY 1, JANUARY 3,
2005 2005 2004
------------------------------- ---------------------------- ------------------------------
WEIGHTED AVERAGE WEIGHTED AVERAGE WEIGHTED AVERAGE
SHARES EXERCISE PRICE SHARES EXERCISE PRICE SHARES EXERCISE PRICE
Outstanding at beginning of year 3,902,196 $ 5.54 4,233,696 $5.57 3,143,459 $ 8.72
Granted 1,761,000 $ 2.45 405,500 $2.38 1,967,500 $ 2.07
Exercised (540,205) $ 1.73 (258,831) $1.57 (116,221) $ 1.43
Forfeited/cancelled (560,711) $ 6.21 (478,169) $5.27 (761,042) $10.17
--------- --------- ---------
Outstanding at end of year 4,562,280 $ 4.72 3,902,196 $5.54 4,233,696 $ 5.57
========= ========= =========
Options exercisable at year-end 2,322,761 $ 6.97 2,331,710 $7.66 1,661,916 $ 9.15
========= ========= =========
Weighted average fair value of
options granted during the year $ 1.58 $1.76 $ 1.60
The following table summarizes information about market value stock options
outstanding as of December 31, 2005:
WEIGHTED AVERAGE
WEIGHTED REMAINING WEIGHTED
RANGE OF NUMBER AVERAGE CONTRACTUAL NUMBER AVERAGE
EXERCISE PRICES OUTSTANDING EXERCISE PRICE LIFE EXERCISABLE EXERCISE PRICE
---------------- ----------------- -------------- ---------------- ----------------- --------------
$ 0.00 to $ 2.00 655,268 $ 1.63 7.12 478,426 $ 1.58
$ 2.01 to $ 3.00 2,618,333 $ 2.40 9.05 568,656 $ 2.30
$ 3.01 to $ 4.00 250,279 $ 3.89 5.59 237,279 $ 3.91
$ 4.01 to $ 5.00 375,000 $ 4.82 5.52 375,000 $ 4.82
$ 5.01 to $10.00 204,000 $ 6.75 5.39 204,000 $ 6.75
$10.01 to $20.00 129,500 $15.12 4.62 129,500 $15.12
$20.01 to $35.00 329,900 $24.41 4.23 329,900 $24.41
--------- ---------
TOTAL 4,562,280 $ 4.72 2,322,761 $ 6.97
========= =========
EXERCISE PRICE LESS THAN FAIR MARKET VALUE AT GRANT DATE:
DECEMBER 31, JANUARY 1, JANUARY 3,
2005 2005 2004
----------------------------- ------------------------------ --------------------------
WEIGHTED AVERAGE WEIGHTED AVERAGE WEIGHTED AVERAGE
SHARES EXERCISE PRICE SHARES EXERCISE PRICE SHARES EXERCISE PRICE
Outstanding at beginning of year 553,189 $ 2.44 629,919 $ 2.51 768,336 $ 2.38
Granted 50,000 $ 2.31
Exercised (52,209) $ 1.88 (34,167) $ 1.94 (84,667) $ 1.90
Forfeited/cancelled (10,855) $ 1.84 (42,563) $ 3.90 (103,750) $ 2.00
--------- --------- -------
Outstanding at end of year 490,125 $ 2.51 553,189 $ 2.44 629,919 $ 2.51
========= ========= =======
Options exercisable at year-end 473,458 $ 2.52 519,855 $ 2.45 579,919 $ 2.52
========= ========= =======
Weighted average fair value of
options granted during the year $ 2.69
The following table summarizes information about below market value stock
options outstanding at December 31, 2005:
WEIGHTED REMAINING WEIGHTED
RANGE OF NUMBER AVERAGE CONTRACTUAL NUMBER AVERAGE
EXERCISE PRICES OUTSTANDING EXERCISE PRICE LIFE EXERCISABLE EXERCISE PRICE
--------------- ---------------- -------------- ---------------- ----------------- --------------
$ 0.00 to $ 2.00 360,125 $1.88 3.42 360,125 $1.88
$ 2.01 to $ 3.00 50,000 $2.31 7.96 33,333 $2.31
$ 3.01 to $ 4.00 50,000 $4.00 3.87 50,000 $4.00
$ 4.01 to $ 5.00
$ 5.01 to $10.00 30,000 $8.00 3.81 30,000 $8.00
$10.01 to $20.00
$20.01 to $35.00
--------- ---------
TOTAL 490,125 $2.51 473,458 $2.52
========= =========
39
The Company has 305,000 shares of the Company's common stock authorized for
issuance as restricted shares under the 1998 Plan for key management personnel.
The shares are subject to restriction based upon a two year vesting schedule
where 30% of the shares vest on the first anniversary of the grant date and the
remaining 70% of the shares vest on the second anniversary.
A summary of the status of the restricted shares granted under the 1998 Plan as
of December 31, 2005, January 1, 2005 and January 3, 2004 and changes during the
years ending on those dates is presented below:
RESTRICTED STOCK:
DECEMBER 31, JANUARY 1, JANUARY 3,
2005 2005 2004
------------------------------- ---------------------------- ------------------------------
SHARES SHARES SHARES
Outstanding at beginning of year 658,000 720,000
Granted 300,000 15,000 720,000
Forfeited/cancelled (63,000) (77,000)
-------- -------- --------
Outstanding at end of year 895,000 658,000 720,000
======== ======== ========
Weighted average fair value of
Shares granted during the year $ 2.32 $ 2.01 $2.87
The Company has 3,788,127 shares of the Company's common stock authorized for
issuance under the 2000 Supplemental Stock Plan (the 2000 Plan). The plan
provides the Company's common stock for the granting of nonqualified stock
options to employees and is not subject to shareholder approval. Vesting and
exercise provisions are determined by the Board of Directors. Options granted
under the plan become exercisable over a period of up to four years beginning on
the date of grant and have a maximum term of ten years.
A summary of the status of the Company's 2000 Plan as of December 31, 2005,
January 1, 2005 and January 3, 2004, and changes during the years ending on
those dates is presented below:
EXERCISE PRICE EQUALS FAIR MARKET VALUE AT GRANT DATE:
DECEMBER 31, JANUARY 1, JANUARY 3,
2005 2005 2004
---------------------------- ---------------------------- -----------------------------
WEIGHTED AVERAGE WEIGHTED AVERAGE WEIGHTED AVERAGE
SHARES EXERCISE PRICE SHARES EXERCISE PRICE SHARES EXERCISE PRICE
Outstanding at beginning of year 1,053,564 $4.71 1,175,160 $4.78 2,212,226 $4.62
Granted 182,500 $2.45 117,500 $2.54 10,000 $1.77
Exercised (9,915) $2.11 (45,167) $3.04 (44,416) $1.85
Forfeited/cancelled (269,109) $3.55 (193,929) $4.23 (1,002,650) $4.53
--------- --------- ----------
Outstanding at end of year 957,040 $4.63 1,053,564 $4.71 1,175,160 $4.78
========= ========= ==========
Options exercisable at year-end 672,225 $5.44 635,630 $5.60 527,545 $5.62
========= ========= ==========
Weighted average fair value of
options granted during the year $1.62 $2.38 $1.37
40
The following table summarizes information about stock options outstanding at
December 31, 2005:
WEIGHTED AVERAGE
WEIGHTED REMAINING WEIGHTED
RANGE OF NUMBER AVERAGE CONTRACTUAL NUMBER AVERAGE
EXERCISE PRICES OUTSTANDING EXERCISE PRICE LIFE EXERCISABLE EXERCISE PRICE
---------------- ----------------- -------------- ---------------- ----------------- --------------
$ 0.00 to $ 2.00 71,000 $ 1.88 7.40 40,166 $ 1.86
$ 2.01 to $ 3.00 204,834 $ 2.45 9.62
$ 3.01 to $ 4.00 456,706 $ 3.72 5.60 415,893 $ 3.78
$ 4.01 to $ 5.00 11,000 $ 4.96 6.73 7,666 $ 4.98
$ 5.01 to $10.00 160,000 $ 5.88 5.81 155,000 $ 5.86
$10.01 to $20.00 3,500 $13.68 4.83 3,500 $13.68
$20.01 to $35.00 50,000 $21.00 4.68 50,000 $21.00
--------- ---------
TOTAL 957,040 $ 4.63 672,225 $ 5.44
========= =========
EXERCISE PRICE LESS THAN FAIR MARKET VALUE AT GRANT DATE:
JANUARY 1, JANUARY 3,
2005 2004
-------------------------- --------------------------
WEIGHTED AVERAGE WEIGHTED AVERAGE
SHARES EXERCISE PRICE SHARES EXERCISE PRICE
Outstanding at beginning of year 8,125 $5.50 23,537 $5.50
Forfeited/cancelled (8,125) $5.50 (15,412) $5.50
------ ------
Outstanding at end of year 0 8,125 $5.50
====== ======
Options exercisable at year-end 0 8,125 $5.50
====== ======
At December 31, 2005, the Company had a total of 6,009,445 outstanding options
to acquire shares with a weighted average exercise price of $4.52 and a weighted
average remaining contractual life of 7.18 years. Of these options 3,468,444
were exercisable at December 31, 2005 with a weighted average exercise price of
$6.08.
The Company follows APB Opinion No. 25 to account for the employee stock
purchase plan and for employee and certain non-employee directors' stock
options. In connection with stock option grants made in fiscal year 2003, the
Company recorded unearned compensation of approximately $58,000, representing
the difference between the exercise price and the fair value of the common stock
on the dates such stock options were granted. Such amounts are being amortized
by charges to operations on a graded vesting method over the corresponding
vesting period of each respective option, generally three to four years. All
option grants in 2005 and 2004 were issued with the exercise price of the option
equal to the market price of the Company's stock as of the grant date.
The Company also follows APB Opinion No. 25 to account for restricted stock
grants made to key management personnel. In connection with restricted stock
granted during fiscal years 2005, 2004 and 2003 the Company recorded unearned
compensation of approximately $695,000, $30,000, and $2,070,000, respectively,
representing the fair value of the common stock on the date such restricted
stock grants were made. The compensation cost associated with restricted stock
is being amortized by charges to operations 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.
The Company recognizes compensation cost over the vesting periods. These options
and restricted shares have resulted in equity related charges to operations of
approximately $0.7 million, $1.2 million, and $0.1 million for fiscal years
2005, 2004 and 2003, respectively. These expenses have been allocated among
various expense categories.
During fiscal year 2000, the Company initiated an employee stock purchase plan
for all eligible employees. Under the plan, shares of the Company's common stock
may be purchased at six-month intervals at 85% of the lower of the fair market
value on the first day of the enrollment period or on the last day of each
six-month period. Employees may purchase shares through a payroll deduction
program having a value not exceeding 15% of their gross compensation during an
offering period. During fiscal years 2005, 2004 and 2003, 116,000, 99,000, and
67,000 shares were purchased under the plan, respectively. At December 31, 2005,
739,000 shares were reserved for future issuance. The employee stock purchase
plan is classified as a non-compensatory plan under APB No. 25.
The Company follows APB Opinion No. 25 to account for its stock plans. In
accordance with SFAS No. 123 the Company also calculates the pro forma impact of
applying the fair value provisions of that standard. Those pro forma disclosures
have been included in Note 1. The fair value of each option grant was estimated
using the following assumptions:
41
FISCAL YEAR 2005 FISCAL YEAR 2004 FISCAL YEAR 2003
---------------- ----------------- ----------------
Expected volatility factor..... 83% 91% 104%
Risk-free interest rate........ 3.58% - 4.55% 3.00% - 4.10% 1.04% - 3.44%
Expected life of options....... 5 years 5 years 5 years
Expected life of stock issued
under employee stock purchase
plan.......................... 0.5 - 2.0 years 0.5 - 2.0 years 0.5 - 2.0 years
Expected dividend rate......... 0% 0% 0%
10. LOANS TO OFFICERS
As of December 31, 2005, there is one outstanding line of credit between the
Company and its Chief Executive Officer, Richard P. Nespola, which originated in
fiscal year 2001. Aggregate borrowings outstanding against the line of credit at
December 31, 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. Interest payments on this loan are current as of
December 31, 2005.
11. LETTER OF CREDIT
In March 2002, the Company entered into a $1.0 million standby letter of credit
(LOC) facility with a financial institution in connection with the CSMG
acquisition. The LOC was required as part of the assignment of the leased office
space from the seller to the Company. The Company originally collateralized the
LOC with a $1.0 million cash deposit with reductions in this amount based on
passage of time. As of December 31, 2005 and for the remainder of the term of
the LOC, the collateral amount is $273,000. The collateral deposited for this
LOC is included in "Cash and Cash Equivalents" on the Company's consolidated
condensed balance sheet as of December 31, 2005 and January 1, 2005. The Company
would be required to perform under the agreement in the event it was to default
on balances due and owing the landlord on the leased office space. An obligation
has not been recorded in connection with the LOC on the Company's consolidated
condensed balance sheet as of December 31, 2005 and January 1, 2005.
12. RELATED PARTY TRANSACTIONS
During fiscal year 2004, the Company made payments of $55,000 to a legal firm in
which a member of the Board of Directors owns an equity interest. Such payments
were made in connection with matters arising in the normal course of business
and were within the limitations set forth by NASDAQ rules.
13. SIGNIFICANT CUSTOMER CONTRACT SETTLEMENT
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 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 received the
$2 million settlement from the customer and the parties dismissed one another
from liability. This payment was recorded in the fourth quarter of fiscal year
2004 as a $1.3 million reduction of operating expenses, in the Consolidated
Statement of Operations and Comprehensive Loss and $0.7 million reduction of
existing receivables.
42
14. CONTINGENCIES
In June 1998, the bankruptcy trustee of a former client, Communications Network
Corporation, sued TMNG for a total of $320,000 in the U.S. Bankruptcy Court in
New York seeking recovery of $160,000 alleging an improper payment of consulting
fees paid by the former client during the period from July 1, 1996, when an
involuntary bankruptcy proceeding was initiated against the former client,
through August 6, 1996, when the former client agreed to an order for relief in
the bankruptcy proceeding, and $160,000 in consulting fees paid by the former
client after August 6, 1996. The bankruptcy trustee also sued TMNG for at least
$1.85 million for breach of contract, breach of fiduciary duties and negligence.
In March 2006, the Company reached a settlement agreement with the bankruptcy
trustee whereby the Company agreed to pay the trustee $255,000 in exchange for
being released from all potential liability under the suits discussed above. The
Company has recognized a charge of $95,000 in fiscal year 2005 to fully accrue
for this liability.
Additionally, as of December 31, 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 December 31, 2005 and January 1, 2005, which it believes are adequate in
the event of loss or settlement on remaining outstanding 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, future 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 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.
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's effective tax rate includes the impact of
such tax reserves and changes to these reserves as considered appropriate by
management. 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
were $649,000 at December 31, 2005 and December 31, 2005. Management believes
that it has established adequate reserves in the event of loss or settlement of
any potential tax liabilities.
43
15. QUARTERLY RESULTS OF OPERATIONS (UNAUDITED)
In management's opinion, the interim financial data below reflect all
adjustments necessary to fairly state the results of the interim periods
presented. Adjustments are of a normal recurring nature necessary for a fair
presentation of the information for the periods presented. Results of any one or
more quarters are not necessarily indicative of annual results or continuing
trends.
(AMOUNTS IN THOUSANDS)
2005 QUARTERS ENDED
--------------------------------------------------------
April 2, July 2, October 1, December 31,
------- -------- ---------- ----------
Revenues ................................... $ 7,067 $ 9,017 $ 8,057 $ 6,237
Cost of Services:
Direct cost of services (exclusive of
amortization shown below)........... .... 3,394 4,519 3,846 3,075
Equity related charges.................... 35 34 12 19
-------- -------- -------- --------
Total cost of services (exclusive
of amortization shown below...... 3,429 4,553 3,858 3,094
-------- -------- -------- --------
3,638 4,464 4,199 3,143
Operating Expenses:
Selling, general and administrative....... 4,147 4,662 4,484 5,169
Legal settlement ......................... 95
Real estate restructuring................. 75
Intangible asset amortization ............ 160 43 42 91
Equity related charges.................... 188 200 60 170
-------- -------- -------- --------
Total operating expenses.......... 4,570 4,905 4,586 5,525
-------- -------- -------- --------
(932) (441) (387) (2,382)
Other Income:
Interest income........................... 324 379 424 505
Other, net................................ 15 95 16
-------- -------- -------- --------
Total other income................ 339 474 424 521
-------- -------- -------- --------
Income (loss) from continuing operations
before income tax provision .............. (593) 33 37 (1,861)
Income tax provision ....................... (15) (3) (13) (5)
-------- -------- -------- --------
Net income (loss) .......................... (608) 30 24 (1,866)
Other comprehensive item -
Foreign currency translation adjustment... (70) (121) 26 (40)
-------- -------- -------- --------
Comprehensive income (loss) ................ $ (678) $ (91) $ 50 $ (1,906)
======== ======== ======== ========
Net income (loss) per common share
Basic and diluted $ (0.02) $ 0.00 $ 0.00 $ (0.05)
======== ======== ======== ========
Shares used in calculation of net income
(loss) per common share
Basic .................................... 34,977 35,104 35,156 35,476
======== ======== ======== ========
Diluted .................................. 34,977 35,461 35,525 35,476
======== ======== ======== ========
44
(AMOUNTS IN THOUSANDS)
2004 QUARTERS ENDED
--------------------------------------------------------
April 3, July 3, October 2, January 1,
------- -------- ---------- ----------
Revenues ................................... $ 5,779 $ 5,184 $ 6,546 $ 6,195
Cost of Services:
Direct cost of services (exclusive of
amortiztion shown below)................. 2,913 2,739 3,441 3,226
Equity related charges.................... 54 52 51 48
-------- -------- -------- --------
Total cost of services (exclusive
of amortization shown below)..... 2,967 2,791 3,492 3,274
-------- -------- -------- --------
2,812 2,393 3,054 2,921
Operating Expenses:
Selling, general and administrative....... 4,278 4,179 3,860 3,720
Legal settlement.......................... (1,294)
Real estate restructuring................. 1,545
Intangible asset amortization ............ 339 218 218 217
Equity related charges.................... 283 232 261 182
-------- -------- -------- --------
Total operating expenses.......... 4,900 4,629 4,339 4,370
-------- -------- -------- --------
(2,088) (2,236) (1,285) (1,449)
Other Income:
Interest income........................... 136 145 189 248
Other, net................................ (9) (6) (10) (5)
-------- -------- -------- --------
Total other income................ 127 139 179 243
-------- -------- -------- --------
Loss from continuing operations before
income tax (provision) benefit ........... (1,961) (2,097) (1,106) (1,206)
Income tax (provision) benefit ............. (14) (20) (13) (2)
-------- -------- -------- --------
Loss from continuing operations ........... (1,975) (2,117) (1,119) (1,208)
Discontinued operations:
Net income (loss) from discontinued operations
(including charge for impairment of goodwill
of $2,163 for the first quarter ended April 3,
2004) (2,276)
-------- -------- -------- --------
Net loss .................................. (4,251) (2,117) (1,119) (1,208)
Other comprehensive item -
Foreign currency translation adjustment... (15) 11 (1) 181
-------- -------- -------- --------
Comprehensive Loss ................ $ (4,266) $ (2,106) $ (1,120) $ (1,027)
======== ======== ======== ========
Loss from continuing operations
per common share
Basic and Diluted ........................ $ (0.06) $ (0.06) $ (0.03) $ (0.03)
======== ======== ======== ========
Loss from discontinued operations
per common share
Basic and Diluted......................... $ (0.07)
======== ======== ======== ========
Loss per common share
Basic and diluted $ (0.13) $ (0.06) $ (0.03) $ (0.03)
======== ======== ======== ========
Basic and diluted weighted average shares
outstanding............................ 34,503 34,625 34,631 34,716
======== ======== ======== ========
See Note 13 "Significant Customer Contract" for discussion of fourth quarter
2004 legal settlement.
See Note 7 "Real Estate Restructuring" for discussion of real estate
restructuring charges.
45
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
ITEM 9A. 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
annual 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 significant material weaknesses identified in the course of such
review and evaluation, and accordingly, the Company implemented no corrective
measures.
ITEM 9B. OTHER INFORMATION
None
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The Company's definitive Proxy Statement for its Annual Meeting of Shareholders
to be held on or about June 22, 2006 (the "Proxy Statement") contains, under the
captions "Election of Directors," "Officers" and "Section 16(a) Beneficial
Ownership Reporting Compliance" the information required by Item 10 of this Form
10-K, which information is incorporated herein by this reference.
ITEM 11. EXECUTIVE COMPENSATION
The Proxy Statement contains under the captions "Election of Directors" and
"Executive Compensation," the information required by Item 11 of this Form 10-K,
which information is incorporated herein by this reference.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND
RELATED STOCKHOLDER MATTERS
The Proxy Statement contains under the caption "Security Ownership of Certain
Beneficial Owners and Management and Related Stockholder Matters" and "Equity
Compensation Plan Information" the information required by Item 12 of this Form
10-K, which information is incorporated herein by this reference.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The Proxy Statement contains under the caption "Certain Relationships and
Transactions with Related Persons" the information required by Item 13 of this
Form 10-K, which information is incorporated herein by this reference.
ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES
The Proxy Statement contains under the caption "Ratification of Appointment of
Independent Registered Public Accounting Firm" the information required by Item
14 of this Form 10-K, which information is incorporated herein by this
reference.
PART IV
ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
(a) The following documents are filed as part of this Annual Report on Form
10-K:
(1) The response to this portion of Item 15 is set forth in Item 8 of Part II
hereof.
(2) Schedules for which provision is made in the applicable accounting
regulations of the Securities and Exchange Commission are not required under the
related instructions or are inapplicable and therefore have been omitted.
(3) Exhibits
See accompanying Index to Exhibits. The Company will furnish to any stockholder,
upon written request, any exhibit listed in the accompanying Index to Exhibits
upon payment by such stockholder of the Company's reasonable expenses in
furnishing any such exhibit.
46
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange
Act of 1934, the Registrant has duly caused this Report on Form 10-K to be
signed on its behalf by the undersigned, thereunto duly authorized, in the City
of Overland Park, State of Kansas, on the 30th day of March 2006.
THE MANAGEMENT NETWORK GROUP, INC.
BY: /S/ RICHARD P. NESPOLA
------------------------------------
RICHARD P. NESPOLA
CHAIRMAN OF THE BOARD,
PRESIDENT AND CHIEF
EXECUTIVE OFFICER
POWER OF ATTORNEY
KNOW ALL PERSONS BY THESE PRESENTS, that each person whose signature appears
below hereby constitutes and appoints Richard P. Nespola as his
attorney-in-fact, with full power of substitution, for him or her in any and all
capacities, to sign any and all amendments to this Report on Form 10-K, and to
file the same, with exhibits thereto and other documents in connection
therewith, with the Securities and Exchange Commission, hereby ratifying and
confirming our signatures as they may be signed by our said attorney to any and
all amendments to said Report.
Pursuant to the requirements of the Securities Exchange Act of 1934, this Report
on Form 10-K has been signed by the following persons in the capacities and on
the dates indicated:
SIGNATURE TITLE DATE
--------- ----- ----
/s/ RICHARD P. NESPOLA Chairman of the Board, March 30, 2006
------------------------------- President and Chief
Richard P. Nespola Executive Officer
(Principal executive
officer)
/s/ DONALD E. KLUMB Chief Financial Officer and March 30, 2006
------------------------------- Treasurer (Principal
Donald E. Klumb financial officer and
principal accounting
officer)
/s/ MICKY K. WOO Director March 30, 2006
-------------------------------
Micky K. Woo
/s/ GRANT G. BEHRMAN Director March 30, 2006
-------------------------------
Grant G. Behrman
/s/ WILLIAM M. MATTHES Director March 30, 2006
-------------------------------
William M. Matthes
/s/ Robert J. Currey Director March 30, 2006
-------------------------------
Robert J. Currey
/s/ ANDREW LIPMAN Director March 30, 2006
-------------------------------
Andrew Lipman
/s/ ROY A. WILKENS Director March 30, 2006
-------------------------------
Roy A. Wilkens
47
/s/ FRANK SISKOWSKI Director March 30, 2006
-------------------------------
Frank Siskowski
INDEX TO EXHIBITS
The following is a list of exhibits filed as part of this report.
EXHIBIT
NUMBER DESCRIPTION OF DOCUMENT
------- -----------------------
3.1* Certificate of Incorporation of the registrant
3.2* By-laws of the Registrant
4.1* Specimen Common Stock Certificate
10.1* Registration Rights Agreement dated January 7, 1998 among
the registrant and certain investors
10.2* Form of Indemnification Agreement between the registrant and
each of its Directors and Officers
10.3* 1998 Equity Incentive Plan and form of agreements thereunder
10.4* 1999 Employee Stock Purchase Plan and form of agreements
thereunder
10.5* Consulting Services Agreement between the registrant and
Williams Communications Group, Inc. dated November 5, 1997
10.6* Credit Agreement, including revolving credit notes and term
notes, dated February 12, 1998 among the registrant and
certain guarantors, lenders and agents
10.7* Lease between Lighton Plaza L.L.C. and the registrant dated
April 23, 1998
10.8* Noncompetition Agreement between the registrant and certain
parties dated February 12, 1998.
10.9* Employment Agreement between the registrant and Richard
Nespola dated February 12, 1998.
10.10* Employment Agreement between the registrant and Micky Woo
dated February 12, 1998.
10.12* Employment Agreement between the registrant and Donald Klumb
dated September 9, 1999
10.13* Amended Lease Agreement between Lighton Plaza L.L.C. and the
registrant dated December 21, 2000
10.16* 2000 Supplemental Stock Plan and form of agreements
thereunder
10.19* Employment Agreement between the registrant and Richard
Nespola dated January 5, 2004
10.20* Employment Agreement between the registrant and Donald Klumb
dated December 19, 2003
48
10.21* Sublease between Best Doctors and the registrant dated
December 30, 2004
21.1 List of subsidiaries of TMNG, Inc.
23.1 Consent of Independent Registered Public Accounting Firm.
24.1 Power of attorney (see signature page)
31.1 Certification of Chief Executive Officer pursuant to Section
302 of the Sarbanes - Oxley Act
31.2 Certification of Chief Financial Officer pursuant to Section
302 of the Sarbanes - Oxley Act
32.1 Certifications furnished pursuant to Section 906 of the
Sarbanes - Oxley Act
* Previously filed
49