THOMAS GROUP INC - 10-Q Quarterly Report

Delaware
(State or other jurisdiction
of incorporation or organization)

72-0843540
(I.R.S. Employer Identification No.)

5221 North O'Connor Boulevard
Suite 500
Irving, TX 75039-3714
(Address of principal executive offices, including zip code)

NONE
(Former name, former address and former fiscal year, if changed since last report)

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 / /

As of August 12, 2002 there were 4,192,137 shares of the registrant's common stock outstanding.

			Page No.
Item 1	—	Financial Statements (unaudited)
		Consolidated Balance Sheets, June 30, 2002 and December 31, 2001	3
		Consolidated Statements of Operations for the Three and Six Month Periods Ended June 30, 2002 and 2001	4
		Consolidated Statements of Cash Flows for the Six Month Periods Ended June 30, 2002 and 2001	5
		Notes to Consolidated Financial Statements	6
Item 2	—	Management's Discussion and Analysis of Financial Condition and Results of Operations	12
Item 3	—	Quantitative and Qualitative Disclosures About Market Risk	16
PART II—OTHER INFORMATION
Item 2	—	Changes in Securities and Use of Proceeds	18
Item 6	—	Exhibits and Reports on Form 8-K	18

THOMAS GROUP, INC.
CONSOLIDATED BALANCE SHEETS
(In thousands, except share data)
(Unaudited)

THOMAS GROUP, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except share data)
(Unaudited)

THOMAS GROUP, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
(Unaudited)

1. The unaudited consolidated financial statements of Thomas Group, Inc. (the "Company") include all adjustments, which include only normal recurring adjustments, which are, in the opinion of management, necessary to present fairly the results of operations of the Company for the interim periods presented. The unaudited financial statements should be read in conjunction with the consolidated financial statements and notes thereto in the Company's Form 10-K for the 2001 fiscal year filed with the Securities and Exchange Commission. The results of operations for the three and six month periods ended June 30, 2002 are not necessarily indicative of the results of operations for the entire year ending December 31, 2002. Certain amounts from prior periods have been reclassified to conform with the 2002 presentation.

2. Financing Agreement and Liquidity Plan—The Company currently maintains a $7.5 million credit facility consisting of a $5.0 million term note and a $2.5 million revolving note. At June 30, 2002, the balance on the revolving note was $1.4 million. At August 12, 2002 the balance on the revolving note was $1.7 million. All United States assets of the Company and certain percentages of the outstanding capital voting stock of each foreign subsidiary secure the $7.5 million credit facility. The $2.5 million revolving portion of this facility is a borrowing base loan related to a percentage of the Company's United States trade accounts receivable. This revolving credit portion bears interest at prime plus 2%. The $5.0 million term loan portion is due in monthly installments of $200,000 plus accrued interest beginning July 15, 2002, with the remaining balance due on December 3, 2003. As of August 12, 2002, the Company had not made the first principal payment due by July 15, 2002. Required principal payments on the term loan total $1.2 million in 2002 and $3.8 million in 2003. This term loan bears interest at prime plus 4%. In addition, the Company is required to pay the lender a $150,000 amendment fee payable in two equal installments due September 15, 2002 and December 15, 2002. Both the term and revolving portions of the facility are callable on demand by the lender on April 30, 2003 if the lender provides written notice of its intent to call 90 days prior to April 30, 2003.

Amounts outstanding at June 30, 2002 under the revolving line of credit and the term loan have been classified on the balance sheet as current liabilities due to the ability of the lender to call the loans due within twelve months of the balance sheet date.

The terms of the facility contain several financial covenants which, if breached, could result in acceleration of amounts owed. The covenants require the Company to maintain certain levels of tangible net worth, current ratio, cash flow coverage ratio, avoid two consecutive fiscal quarters that generate operating losses and restrict annual capital expenditures in excess of $300,000. In addition, the covenants required the Company to secure $1.0 million in new equity or subordinated debt by each of May 15 and June 30 of 2002, for a total of $2.0 million. As of August 12, 2002, the Company had not obtained the required equity or subordinated debt. The facility also contains a covenant requiring monthly principal payments against the $5.0 million term loan in the amount of $200,000 each beginning July 15, 2002. On June 30, 2002, the Company was not in compliance with any of the financial covenants of its $7.5 million credit facility, all of which were waived by the lender. See discussion of the Company's liquidity plan below for the current status of the Company's efforts to raise new equity or subordinated debt.

Recent operating results and the terms of the Company's current indebtedness give rise to concerns about the Company's ability to generate cash flow from operations sufficient to make scheduled debt payments as they become due. As of June 30, 2002, the Company has obtained the following subordinated

debt from members of the Company's board of directors, satisfying a portion of the subordinated debt or equity infusion required by the covenants of the revolving credit facility:

Issue Date	Date Funded	Principal & Interest Maturity Date	Semi-Annual Interest Accrual Dates	Interest Rate	Principal Amount
3/29/02	4/4/02	4/1/04	Oct 1/Apr 1	Prime + 6%	$	1,000,000
3/29/02	3/29/02	4/1/04	Oct 1/Apr 1	Prime + 6%	$	92,000
5/31/02	5/28/02	6/1/04	Dec 1/Jun 1	Prime + 6%	$	400,000

The $0.4 million in subordinated debt obtained on May 28, 2002, the Company's income tax refund of $0.8 million and tightened cost controls allowed the Company to delay any decisions on commitments for external equity or subordinated debt, including the proposed letter of intent mentioned in the Company's Form 10-Q filed with the Securities and Exchange Commission for the quarter ended March 31, 2002. At this time, the Company is no longer in negotiations with the issuer of such letter of intent. The Company was unable to obtain the remaining debt or equity financing required by its lender as of June 30, 2002, or to make certain required principal payments and the lender has waived such events of default. The Company is currently seeking to raise the additional debt or equity necessary to regain compliance with the covenants of the $7.5 million credit facility and to provide additional liquidity for operations. Although management is confident that the debt or equity can be raised, the Company can give no assurances that any debt or equity raised will be sufficient to prevent the Company from being in default on its current credit facility or be sufficient to meet operating cash requirements.

In addition to the Company's need to raise additional equity or debt financing, the Company's ability to generate cash flow from operations sufficient to make scheduled payments on its debts as they become due will depend on its future performance and its ability to successfully implement business and growth strategies. Since the first quarter of 2001, the Company has implemented cost saving measures including staff reductions, downsizing and subleasing of facilities and greater control over alliances with strategic business partners. The Company will take additional cost savings measures such as those taken recently, if necessary, to enhance its liquidity position. The Company's performance will also be affected by prevailing economic conditions. Many of these factors are beyond the Company's control. If future cash flows and capital resources are insufficient to meet the Company's debt obligations and commitments, it may be forced to reduce or delay activities and capital expenditures, obtain additional equity capital beyond what is required under its current credit facility or restructure or refinance its debt. In the event that the Company is unable to do so, it may be left without sufficient liquidity and it may not be able to meet its debt service requirements. In such a case, an event of default would occur under the credit facility and could result in all of the Company's indebtedness becoming immediately due and payable. As a result, the Company's lender would be able to foreclose on the Company's assets.

3. Restructuring—On June 3, 2002, the Company filed a petition with the German government for insolvency of its German subsidiary. An administrator was appointed by the German government and is expected to make a formal determination on the request for insolvency by September 3, 2002. This action was taken in response to declining revenue and cash flows from operations in Germany during 2001, and continuing through 2002. All existing German contracts were completed in the second quarter of 2002, and the Company has no significant future revenue prospects in Germany. Due to the expectation of little to no future revenue, the Company expects the administrator to approve the petition for insolvency. The Company continues serving the European market through its profitable operations in Switzerland.

The expected loss from liquidation of the German subsidiary is presented on the statements of operations and statements of cash flows under the caption "Restructuring". The carrying amounts of the

following assets and liabilities of the German subsidiary are included as part of the restructuring charge: (amounts in thousands)

Cash and cash equivalents	$	84
Trade accounts receivable		404
Other assets		152
Property and equipment, net		68
Accounts payable and accrued liabilities		(329	)

Loss from restructuring activities	$	379

The Company believes the probability that the German courts would enforce an alternative to insolvency is remote. Such alternatives could include continuing operations in a diminished capacity or the sale of the German subsidiary to an unrelated third party, the effects of which could change the restructuring charge recorded. Upon approval of insolvency and liquidation of the German subsidiary, the Company will record a non-cash restructuring charge of $0.6 million related to unrealized foreign currency losses accumulated prior to 2001. This amount is currently carried on the balance sheet as a reduction of equity under the caption "Accumulated other comprehensive loss". The Company also retained $0.3 million of office equipment and furniture on the balance sheet pending the final determination of the German court. The Company expects to receive these assets in satisfaction of the intercompany debt the German subsidiary owes the parent company in the United States. Should the Company be unable to collect this debt from the German government, an additional restructuring charge of $0.3 million would be recorded. Due to the probability of insolvency approval, the Company has recorded no estimates for future expenses related to this insolvency petition and believes that any such expenses incurred would not have a material adverse effect on the consolidated results of operations, financial condition or cash flows of the Company.

Results of operations of the German subsidiary for the three and six month periods ended June 30, 2002 and 2001 were: (amounts in thousands)

	Three Months Ended June 30,					Six Months Ended June 30,
	2002			2001		2002			2001
Net revenue	$	439		$	3,072	$	1,201		$	4,276
Net cost of sales		405			1,204		872			1,833

Gross profit		34			1,868		329			2,443
Selling, general and administrative		407			818		1,066			1,331

Operating income (loss)	$	(373	)	$	1,050	$	(737	)	$	1,112

Cash flows of the German subsidiary for the three and six month periods ended June 30, 2002 and 2001 were: (amounts in thousands)

	Three Months Ended June 30						Six Months Ended June 30,
	2002			2001			2002			2001
Cash provided by (used for) operating activities	$	(624	)	$	589		$	(51	)	$	554
Cash provided by (used for) investing activities		18			11			11			(38	)
Cash provided by (used for) financing activities		—			(307	)		—			(307	)
Effect of exchange rate changes on cash		(82	)		—			(81	)		6

Cash provided by (used for) continuing operations	$	(688	)	$	293		$	(121	)	$	215

4. Earnings Per Share—Basic earnings per share is based on the number of weighted average shares outstanding. Diluted earnings per share includes the effect of dilutive securities such as stock options and warrants. The following table reconciles basic earnings per share to diluted earnings per share under the provisions of Statement of Financial Accounting Standards No. 128, "Earnings Per Share."

		Three Months Ended June 30,					Six Months Ended June 30,
		2002			2001		2002			2001
		In thousands, except per share data
Numerator:
	Net income (loss)	$	(2,319	)	$	1,051	$	(6,145	)	$	1,461

Denominator:
Weighted Average Shares Outstanding:
	Basic		4,192			4,158		4,181			4,171
	Effect of Dilutive Securities:
	Common Stock Options		—			12		—			12

	Diluted		4,192			4,170		4,181			4,183

Earnings (Loss) per share:
	Basic	$	(.55	)	$	.25	$	(1.47	)	$	.35
	Diluted	$	(.55	)	$	.25	$	(1.47	)	$	.35

Stock options outstanding in 2002 and 2001 that are not included in the diluted earnings per share computation due to the antidilutive effects are 1,391,243 and 938,407, respectively. Such options are excluded due to the Company incurring a net loss for the period or due to exercise prices exceeding the average market value of the Company's common stock for the applicable period.

5. Significant Clients—The Company recorded revenue from Robert Bosch of $3.9 million and $7.6 million or 49% and 47% of revenue for the three and six month periods ended June 30, 2002. Revenue for the same client totaled $7.6 million and $13.6 million or 48% and 42% of revenue for the three and six month periods ended June 30, 2001.

Revenue from Acton Burnell totaled $2.2 million and $4.4 million or 26% and 27% of revenue for the three and six month periods ended June 30, 2002.

Revenue from Opel totaled $2.3 million or 14% of revenue for the three month period ended June 30, 2001.

There were no other clients from whom revenue exceeded 10% of total revenue in the three and six months ended June 30, 2002 and 2001, respectively.

6. Comprehensive Income or Loss—Comprehensive income includes all changes in equity except those resulting from investments by stockholders and distributions to stockholders. For the three and six months ended June 30, 2002 and 2001, net income or loss is the only component of comprehensive income.

7. Legal Proceedings—The Company is subject to various claims and other legal matters, such as collection matters initiated by the Company, in the course of conducting its business. Due to the current liquidity condition of the Company, such claims and other legal matters or the cost of prosecuting and/or defending such claims and other legal matters could have a material adverse effect on the Company's consolidated results of operations, financial condition or cash flows.

	Six Months Ended June 30,
	2002		2001
	In thousands of dollars
Interest paid	$	166	$	114
Taxes paid	$	1,003	$	1,306

9. Recent Accounting Standards—During the first quarter of 2002, the Company adopted the Financial Accounting Standards Board ("FASB") Staff Announcement Topic No. D-103 that requires certain reimbursable expenses incurred be classified in the statement of operations as revenue. Those expenses often include, but are not limited to, expenses related to airfare, mileage, hotel stays, out-of-town meals, photocopies and telecommunications and facsimile charges. This FASB Staff Announcement is required to be applied in financial reporting periods beginning after December 15, 2001. In adopting these new rules, the Company reclassified, to revenue, approximately $0.4 million and $0.9 million of reimbursable expenses received for out-of-pocket expenses for the three and six month periods ended June 30, 2002, respectively, and approximately $2.5 million and $4.6 million for the three and six month periods ended June 30, 2001, respectively.

10. Segment Data—The Company operates in one industry segment, but conducts its business primarily in three geographic areas: the United States, Europe and Asia. Information regarding these areas follows:

		Three Months Ended June 30,					Six Months Ended June 30,
		2002			2001		2002			2001
		In thousands of dollars
Revenue before reimbursements:
North America		$	2,738		$	1,472	$	5,483		$	6,802
Europe			4,377			10,964		8,840			18,722
Asia/Pacific			892			3,376		1,972			6,648

	Total revenue before reimbursements	$	8,007		$	15,812	$	16,295		$	32,172

Gross profit (loss):
North America		$	3,090		$	1,285	$	3,445		$	2,977
Europe			1,354			6,339		2,708			9,921
Asia/Pacific			(1,549	)		156		(1,798	)		1,593

	Total gross profit	$	2,895		$	7,780	$	4,355		$	14,491

11. Income Taxes—At December 31, 2001, the Company determined, based primarily on its recent history of operating losses in the United States, that it could no longer consider the recovery of its net deferred tax assets as more likely than not. Accordingly, the Company's net deferred tax assets were reduced by a valuation allowance adjustment. Consistent with the Company's position at December 31, 2001, the Company recorded no tax benefits for operating losses generated in the six month period ended June 30, 2002. However, recently Congress passed a law to allow companies the opportunity to carryback net operating losses five years versus the previous three year carryback provision. This change allowed the Company to file for tax refunds for the years 1996 and 1997 for which the related benefit and receivable of approximately $798,000 and $125,000 was recorded in the first and second quarters of 2002, respectively. The Company also recorded income tax expense on the profits of its foreign operations of $259,000 and $264,000 in the first and second quarters of 2002, respectively. Utilization of net operating loss

			June 30, 2002			December 31, 2001
ASSETS
Current Assets
	Cash and cash equivalents		$	1,290		$	3,821
	Trade accounts receivable, net of allowances of $234 and $640 in 2002 and 2001, respectively			4,842			8,583
	Unbilled receivables			38			57
	Other assets			1,094			2,411

		Total Current Assets		7,264			14,872

Property and equipment, net				3,093			3,502
Other assets				209			3,381

			$	10,566		$	21,755

LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities
	Accounts payable and accrued liabilities		$	2,836		$	5,088
	Revolving line of credit			1,353			2,145
	Current term debt			5,000			1,200
	Income taxes payable			563			1,042
	Current maturities of other long-term obligations			6			5

		Total Current Liabilities		9,758			9,480
Long-term debt				-			3,800
Indebtedness to related parties				1,492			-
Other long-term obligations				30			3,084

		Total Liabilities		11,280			16,364

Stockholders' Equity
	Common stock, $.01 par value; 25,000,000 shares authorized; 6,745,536 and 6,705,333 shares issued and 4,192,137 and 4,151,934 shares outstanding in 2002 and 2001, respectively			67			67
	Additional paid-in capital			24,473			24,433
	Retained earnings (accumulated deficit)			(1,433	)		4,712
	Accumulated other comprehensive loss			(1,362	)		(1,362	)
	Treasury stock, 2,553,399 shares in 2002 and 2001, at cost, respectively			(22,459	)		(22,459	)

		Total Stockholders' Equity (Deficit)		(714	)		5,391

			$	10,566		$	21,755

	Three Months Ended June 30,					Six Months Ended June 30,
	2002			2001		2002			2001
Consulting revenue before reimbursements	$	8,007		$	15,812	$	16,295		$	32,172
Reimbursements		445			2,517		923			4,607

Total revenue		8,452			18,329		17,218			36,779

Cost of sales before reimbursable expenses		5,112			8,032		11,940			17,681
Reimbursable expenses		445			2,517		923			4,607

Total cost of sales		5,557			10,549		12,863			22,288

Gross profit		2,895			7,780		4,355			14,491
Selling, general and administrative		4,526			6,116		10,288			12,119

Operating income (loss) before restructuring		(1,631	)		1,664		(5,933	)		2,372
Restructuring		379			-		379			-

Operating income (loss)		(2,010	)		1,664		(6,312	)		2,372
Other income (expense), net		(170	)		88		(233	)		63

Income (loss) before income taxes		(2,180	)		1,752		(6,545	)		2,435
Income taxes (benefit)		139			701		(400	)		974

Net income (loss)	$	(2,319	)	$	1,051	$	(6,145	)	$	1,461

Earnings (loss) per common share:
Basic	$	(.55	)	$	.25	$	(1.47	)	$	.35
Diluted	$	(.55	)	$	.25	$	(1.47	)	$	.35
Weighted average shares:
Basic		4,192,118			4,158,384		4,180,810			4,171,357
Diluted		4,192,118			4,170,255		4,180,810			4,183,205

		Six Months Ended June 30,
		2002			2001
Cash Flows From Operating Activities:
Net income (loss)		$	(6,145	)	$	1,461
Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities:
	Depreciation		632			656
	Amortization		9			9
	Bad debt		-			138
	Loss on sale of assets		7			113
	Loss from restructuring activities		379			—
	Amortization of stock option grants		(35	)		21
	Foreign currency loss		93			-
	Other		10			-
Change in operating assets and liabilities:
	Decrease in trade accounts receivable		3,210			2,254
	Decrease in unbilled receivables		18			84
	(Increase) decrease in other assets		1,342			(695	)
	Decrease in accounts payable and accrued liabilities		(1,953	)		(1,293	)
	Decrease in income taxes payable		(482	)		(390	)

Net Cash Provided By (Used In) Operating Activities			(2,915	)		2,358
Cash Flows from Investing Activities:
Proceeds from sale of assets			29			3
Capital expenditures			(351	)		(351	)

Net Cash Used In Investing Activities			(322	)		(348	)
Cash Flows From Financing Activities:
Purchase of treasury stock			—			(455	)
Proceeds from exercise of stock options			—			87
Advances of related party indebtedness			1,492			—
Net advances (repayments) — line of credit			(794	)		(1,005	)

Net Cash Provided By (Used In) Financing Activities			698			(1,373	)
Effect of Exchange Rate Changes on Cash			8			650

Net Change In Cash			(2,531	)		1,287
Cash and Cash Equivalents:
Beginning of period			3,821			6,631

End of period		$	1,290		$	7,918