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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 JANUARY 1, 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 whether the Registrant (1) has filed all reports 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. []
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Act). YES [ ] NO [X]
The aggregate market value of the voting stock held by non-affiliates of the
Registrant, as of July 3, 2004 was approximately $42.8 million. As of April 1,
2005 the Registrant had 34,862,289 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 2005 proxy statement which will be filed with the Securities and
Exchange Commission within 120 days of the end of our fiscal year.
THE MANAGEMENT NETWORK GROUP, INC.
FORM 10-K
TABLE OF CONTENTS
PAGE
----
PART I
Item 1. Business.................................................... 3
Item 2. Property.................................................... 15
Item 3. Legal Proceedings........................................... 15
Item 4. Submission of Matters to a Vote of Security Holders......... 16
PART II
Item 5. Market for Registrant's Common Equity and Related
Stockholder Matters......................................... 16
Item 6. Selected Consolidated Financial Data........................ 18
Item 7. Management's Discussion and Analysis of Financial Condition
and Results of Operations................................... 20
Item 7A. Quantitative and Qualitative Disclosures About Market
Risk........................................................ 27
Item 8. Consolidated Financial Statements........................... 28
Item 9. Changes in and Disagreements With Accountants on Accounting
and Financial Disclosure.................................... 54
Item 9A. Controls and Procedures .................................... 54
Item 9B. Other Information .......................................... 54
PART III
Item 10. Directors and Executive Officers of the Registrant.......... 54
Item 11. Executive Compensation...................................... 54
Item 12. Security Ownership of Certain Beneficial Owners and
Management.................................................. 54
Item 13. Certain Relationships and Related Transactions.............. 54
Item 14. Principal Accountant Fees and Services ..................... 54
PART IV
Item 15. Exhibits and Financial Statement Schedules ................. 54
SIGNATURES............................................................ 55
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 1, "Business - 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 primarily to communications service providers, technology
companies and financial services firms located principally in North America and
Western Europe. Historically, in addition to North America and Western Europe,
we have provided consulting services to clients in almost all other major
international markets. 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).
From our inception to mid-fiscal year 2000, we have been a provider of a
comprehensive range of services to the global communications industry with
significant focus and emphasis on management and operational consulting
services. During fiscal year 2000 we identified early leading indicators of the
market downturn in the communications industry (See "Market Overview" in Item 1
for an additional discussion of market conditions). We broadened our focus and
emphasis to include not only management and operational consulting but also
strategy and marketing to enable us to deliver more comprehensive solutions to
our communications service provider clients. To accomplish this transformation,
we looked to increase the breadth of our employee work base, hiring consultants
of increasingly diverse backgrounds with various technical competencies, and
began an acquisition strategy to acquire consulting companies whose offerings
complemented or expanded the offerings we historically provided. Key
acquisitions completed by us during the last five years included Cambridge
Strategic Management Group, Inc. (now "TMNG Strategy"), The Weathersby Group,
Inc. (now "TMNG Marketing") and Tri-Com Computer Services, Inc. ("TMNG
Technologies"). These acquired businesses focused primarily on strategy, new
product launch initiatives, customer acquisition and retention, and technology
consulting to the global communications industry. We believe these acquisitions
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. We have integrated these practices and are now bringing a fully
integrated suite of offerings to the communications marketplace.
As we primarily focus on communications service providers, during the course of
numerous engagements we have learned what the service providers' key business
objectives consist of, both near and long term. In addition, we have built
product offerings targeting software and technology companies, investment
banking and private equity firms, which invest in and serve the communications
industry. Our services to software and technology firms have included strategy
definition, product positioning, application development, assistance in
responding to requests for proposals, and implementing solutions within the
service provider environment. Services to the investment banking and private
equity community have included prospect validation, due diligence, and
operational management outsourcing.
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.
Our key strategic initiatives focus on supporting wireless and Internet Protocol
("IP") initiatives in the market place. We have been evolving our service
offerings to support the growth and transformation of communications over the
next generation of technologies, including IP voice, data and content offerings
over both wireline and wireless networks. We have been providing communications
consulting expertise to new and growing organizations. In 2003, we took a
leadership position in the wireless industry by providing a suite of offerings
to assist wireless carriers with the impact of wireless number portability
(WNP). In 2004, we have continued to expand our presence in wireless and in
conjunction with Bear, Stearns & Co., completed an in-depth review of new
broadband wireless technologies from a business and economic perspective. We are
investing in intellectual capital to assist major communications service
providers in dealing with the voice over internet protocol ("VoIP") and IP
managed offerings which we believe are transforming the industry. We have also
established a Mobile Virtual Network Enablement ("MVNE") practice to offer
end-to-end consulting services to the fast growing Mobile Virtual Network
Operator ("MVNO") market. Finally, we have recruited executives with expertise
and relationships serving the rural local exchange carrier (RLEC) market and are
building presence and market share in that industry segment of communications
service providers.
We intend to continue capitalizing on our industry expertise by refreshing
existing proprietary toolsets and building new toolsets to 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 maintain 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 the most sound and practical
recommendations to our clients.
MARKET OVERVIEW
The demand for consulting services increased throughout the 1990's. This trend
was especially prevalent for consulting services of communications and
e-commerce consulting firms. The key contributor to this was the significant
projected growth of the internet and e-commerce which stimulated capital
investment into new and existing wireline communications providers, enabling
their investment in new network technology and the creation of new broadband
market offerings. Investment was further accelerated through global deregulation
of the communications industry throughout the 1990's. The deregulation of the
communications industry resulted in increased competition by new market
entrants; a massive influx of debt and equity capital to the sector to fund new
and existing carrier entrants; rapid internet growth, spurring broadband
internet access services, digital subscriber line (DSL) internet access and
unbundled local loops that forged the way for wholesale DSL business models; and
technological innovations, allowing new service offerings in the areas of voice,
data, video and content.
In parallel to the wireline sector, significant investment was made in wireless
communications. There was tremendous growth occurring as voice communications
were migrating to wireless networks and devices. In addition, the personal
communications services (PCS) auctions in the United States and universal mobile
telecommunications system (UMTS) broadband spectrum auctions in Europe resulted
in new providers, additional services, and improved technology. Increased
customer penetration of wireless services occurred in both consumer and business
customers, and services were expanded to include wireless data offerings
primarily in Europe and Asia.
By mid-2000, following the first announcements of disappointing financial
performance by wireline and wireless communication service providers and their
vendors, it became apparent that the rate of investment and adoption was far
exceeding the expected rate of consumption in e-commerce and broadband
offerings. The massive inflow of capital in communications during the 1990's
resulted in an inflated market scenario, where once solid business models were
now ill equipped to function and adjust to the adverse macroeconomic
environment. The cycle was further perpetuated by the over saturation of new
market entrants where supply far exceeded levels sustainable by the market,
creating pressure for consolidation and funding contraction. As a result, the
industry experienced a significant number of bankruptcies and layoffs in excess
of one-half million individuals in the United States alone. Because
communications companies often purchased services from one another, the
bankruptcies led to a vicious cycle of industry-wide destabilization with each
successive bankruptcy jeopardizing another company's liquidity position.
The industry experienced further instability during 2002 due to government
investigations into the accounting practices of several large communications
providers that revealed the perpetuation of accounting improprieties, including
the material overstatement of revenues and the understatement of expenses. Such
inquiries have resulted in ongoing restatements of previously reported financial
statements, resulting in additional destabilization within the industry, and
eroding investors' confidence.
These macroeconomic forces destabilized the communications industry and
depressed the market for outside consulting services, including ours.
Communications companies continued to reduce demand for external consultants,
seeking instead to utilize more internal resources, or in some cases delayed
capital and operating expenditures related to the launch of new products and
services, particularly in networks and technology. This resulted in a continued
substantial decline in our revenue and profits during fiscal years 2001, 2002
and 2003, although the trend appeared to level off during fiscal year 2004 (see
Item 1, "Business - Risk Factors" and Item 7, "Management's Discussion and
Analysis").
Today, the global communications industry is in the midst of what we believe is
to be revolutionary change. After approximately four years of
retrenching and restructuring, the complements of regulatory decisions and new
technologies 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
and resulting in the 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.
As we enter fiscal year 2005, we believe the large global communications
companies will be strategically focused on the following key initiatives, with
priority depending upon present position and state of the company: bundling of
services (i.e., wireline, wireless, high-speed data and video) to compete with
cable companies; continued 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 VoIP. It is also expected that
further market consolidation will occur over the next few years.
It is our belief that the regulatory environment will also continue to play a
key factor in the strategy and operations of communications providers as these
decisions impact intercarrier costs and pricing. In 2004, the Federal
Communications Commission ("FCC") and State Public Utility Commissions ("PUC's")
continued to consider the regulatory treatment of IP-enabled services, like
VoIP. While it is difficult to predict future outcomes, it seems apparent from
the various VoIP orders released by the FCC that they are moving towards a
national regulatory regime with limited regulation, rather than state-by-state
regulation. These recent regulatory decisions surrounding intercarrier pricing
of certain network elements played a role in the consolidations of
inter-exchange carrier ("IXC") players like AT&T and MCI as their long-term
ability to compete was impaired. In addition to these developments, several key
legislators wish to "re-open" the Telecommunications Act of 1996 during the 2005
legislative session. The FCC's continued promotion of flexibility in use of
licensed spectrum and easing of spectrum caps has led to consolidation of
wireless carriers and the development of advanced wireless technologies which
now make wireless a viable "substitute" for wireline rather than just a
complement to the bundle.
The convergence of content providers and wireless distribution channels (i.e.,
carriers) has 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. As
MVNOs, companies traditionally known for content, 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 regulatory, competitive and technological developments will
increase demand for consulting services, with increased focus on 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 significantly 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 their core
competencies, they must ultimately either recruit and employ experts or retain
outside specialists. 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 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
continue to position ourselves to respond to that anticipated need.
BUSINESS STRATEGY
Our objective is to establish ourselves as the consulting company of choice to
the communications industry, which includes the service providers and technology
companies that serve the industry, 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. Organic expansion involves
assisting clients in further defining competitive position, launching new
products and services and generating revenues through integrated offerings
jointly developed by us and our acquired companies. Organic expansion will also
focus on offerings geared towards increasing clients' efficiencies. We have
expanded our offerings through the acquisition of TMNG Marketing in late 2000.
TMNG Marketing provides a full spectrum of marketing consulting services,
including product development, churn management and market research that takes
clients from the point of product definition to customer acquisition and
retention. Additionally, in March 2002, we acquired TMNG Strategy. TMNG Strategy
provides a wide range of business strategy services including analyses of
industry and competitive environments; product and distribution strategies;
finance, including business case development, modeling, cost analysis and
benchmarking; and due diligence and risk assessment.
- - 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. Special focus will be placed on brand and eminence
building in the wireless consulting and VoIP arenas. Direct marketing efforts
and other marketing initiatives are underway to continue building awareness of
TMNG and communicating our key strengths, including our unique high level of
experienced consultants, our singular focus on the global telecommunications
industry, our integrated end-to-end solution and our 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 resulting from revolutionary change occurring
within the communications sector. One key element of our business model is the
attraction and retention of high quality, experienced consultants. 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.
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.
- - Maintaining a global presence
We plan to maintain our presence globally to deliver services and solution
capabilities to client companies located around the world. 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, especially in Western Europe.
- - Building intellectual capital and a comprehensive suite of wireless and VoIP
consultative offerings
We have completed engagements with wireless clients in the U.S., Europe, Latin
America, Asia and the Middle East. Our services have included business and
strategic planning, product development, customer acquisition and retention,
business and operations process design and reengineering, revenue and cost
management and network planning. In 2003 we continued to build a suite of
offerings to support WNP for the wireless industry. During 2004, we co-authored
a study with Bear, Stearns & Co. analyzing the impact of new broadband wireless
technologies on public and private companies in the telecommunications sector.
In 2005, our top two strategic focuses will be continued development of service
offerings supporting wireless communication service providers and the
transformation to IP technologies.
- - 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, 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 billing
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, accounts receivable management and
cash collections to profits in the bank.
- - 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.
- - 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 these 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 us. With the communications industry experiencing
significant economic challenge, contraction and consolidation, we believe our
principal competitive factor is our continual focus on the communications
industry and the ability to develop and deliver solutions that enhance client
revenue and asset utilization and provide return on investment. We also believe
the complementary experience and expertise of our professionals represents a
competitive advantage. In a down economic environment our biggest competitor is
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 2004, we utilized approximately 259 consultants, representing
a combination of employee consultants and independent contracting firms. Of
these, 70 were employee consultants and approximately 189 were working on
engagements for us primarily through independent subcontracting firms. In
addition to the consultants, we have an administrative staff of approximately 27
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 historically concluded we had five operating segments,
of which four were aggregated in one reportable segment, the Management
Consulting Services segment, and the remaining segment in All Other. Services
provided by the Management Consulting Services segment include business strategy
and planning, marketing and customer relationship management, billing system
support, operating system support, revenue assurance, corporate investment
services, and network management. All Other consisted of computer hardware
commissions and rebates received in connection with the procurement of hardware
for third parties. Effective with the discontinuation of the hardware business
in March 2004, we now have one reportable segment, and therefore summarized
financial information concerning the Management Consulting Services segment is
not included in this report. For summarized financial information regarding the
All Other segment, see Note 4 "Discontinued Operations." There are no
inter-segment sales.
MAJOR CUSTOMERS
We have provided services to approximately 1,000 domestic and international
customers, primarily communication service providers and large technology and
applications firms serving the communications industry and investment banking
and private equity firms that invest in the sector. We depend on a small number
of key customers for a significant portion of revenues. Revenues from two global
carriers each accounted for more than 10% of our revenues, and in the aggregate
accounted for 26.2% of revenues in fiscal year 2004 and 25.3% of revenues in
fiscal year 2003. Also during fiscal year 2004, our top ten customers accounted
for approximately 67.0% 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 and seek to offer
broad and diversified services to these customers. We anticipate 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. As we expand internationally,
third quarter revenue may fluctuate as a result of significant vacation periods
taken in the summer months.
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
OUR BUSINESS IS COMPLETELY DEPENDENT ON CONDITIONS IN THE COMMUNICATIONS
INDUSTRY
We focus almost exclusively on customers in the communications industry and
investment banking and private equity firms investing in that industry. We
experienced significant growth in demand for our services throughout the 1990's.
Since 2000, the communications industry has experienced a number of adverse
conditions, including bankruptcies, layoffs, consolidation and contradiction,
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 the communications industry does not recover and
demand for our services does not increase in the foreseeable future, we may
continue to incur operating losses and negative cash flow, which may eventually
adversely affect our liquidity.
ADVERSE CONDITIONS IN THE COMMUNICATIONS INDUSTRY MAY HURT OUR BUSINESS
Future client financial difficulties and/or bankruptcies could require us to
write-off receivables that are in excess of bad debt reserves, which would harm
our results of operations in future fiscal periods. Client bankruptcies could
also create an at-risk situation on funds collected for professional services
within 90 days of the bankruptcy filing date. In addition, any continuing
deterioration of conditions in the communications sector 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.
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. The services required by any one client may be affected by industry
consolidation or adverse industry conditions, technological developments,
economic slowdown or internal 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.
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. This is especially true under present economic
conditions impacting the communications industry, a typical result being fewer
opportunities and discounted pricing. Factors that could cause quarterly
fluctuations include:
- - the beginning and ending of significant contracts during a quarter;
- - the size and scope of assignments;
- - 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 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;
- - fluctuations 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.
AN INCREASING PERCENTAGE OF OUR BUSINESS IS REPRESENTED BY CONTINGENT FEE OR
FIXED FEE CONTRACTS, WHICH EXPOSE US TO ADDITIONAL RISKS
Fixed and contingent 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. In
contingent fee contracts, some or all of our compensation may be dependent on
the achievement of certain benefits or results. If those benefits or results are
not achieved, we could lose money on 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:
- - 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 if the
business does not perform as expected 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 CONTINUING DECREASE IN CURRENT AND PROJECTED REVENUES MAY RESULT IN
ADDITIONAL ASSET IMPAIRMENTS THAT WOULD CONTINUE TO ADVERSELY AFFECT OUR
PROFITABLITY
We have made and may continue to make acquisitions. As a result, goodwill and
intangible assets constitute a significant portion 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 assets impairment charges in the future. Our earnings and profitability
would be adversely affected by any further asset impairments.
The Financial Accounting Standards Board ("FASB") has issued SFAS No. 142
"Accounting for Goodwill and Intangible Assets." SFAS No. 142 requires an annual
evaluation of goodwill to determine if an impairment of goodwill has occurred.
The evaluation involves calculating enterprise fair value, which may be based on
a number of analyses, including a discounted cash flow projection of future
financial results. Estimated fair values are then compared to the total recorded
book value to determine if an impairment of goodwill is deemed to have occurred.
If an impairment of goodwill is deemed to have occurred, this would negatively
affect our consolidated results of operations. We recorded impairment charges of
$27.1 million, $15.8 million, and $2.2 million related to the impairment of
goodwill in 2002, 2003, and 2004, respectively. If we are not able to achieve
projected future operating performance and related cash flows, goodwill may
become further impaired, and the resulting asset impairment would be charged to
operating income.
In connection with SFAS No. 144 "Accounting for the Impairment or Disposal of
Long-Lived Assets" we are using our best estimates based on 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 such events,
including significant decreases in revenue from customers whose relationships
were valued in purchase accounting. We performed impairment tests, and
determined that the carrying value of customer relationships exceeded their fair
market value and recorded an impairment loss of approximately $3.7 million in
2003. If we are not able to achieve projected future operating performance and
related cash flows, intangible assets may become further impaired, and the
resulting asset impairment would be charged to operating income.
WE HAVE REDUCED CONSULTANT HEADCOUNT WHICH COULD ADVERSELY AFFECT OUR ABILITY TO
PERFORM CONSULTING ENGAGEMENTS AND OBTAIN NEW BUSINESS
We have undergone a series of cost-cutting measures since 2001 to better align
our operating costs with the reduced demand for communications consulting
services. As part of these cost-costing measures, we have reduced our employee
consultant headcount. Because the talents and skills of those consultants are no
longer available to us, 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 COMPETE IS INTENSELY COMPETITIVE - 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;
- - Infosys Technologies, Ltd.; and
- - McKinsey & Company
- - Computer Sciences Corporation
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. We may not be able to compete successfully
with our existing competitors or with any new competitors.
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 CUSTOMERS
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.
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 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 2004, we estimate that approximately 40.5% 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.
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 fluctuations in foreign currency exchange rates;
- - 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;
- - 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, 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 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 relationships could
result in declining 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.
In particular, we are currently a defendant in litigation brought by the
bankruptcy trustee of a former client. This litigation seeks to recover at least
$1.85 million for breach of contract, breach of fiduciary duties and negligence,
plus $320,000 in consulting fees paid by the former client. See Item 3, "Legal
Proceedings."
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;
- - 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 2005 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. Our stock price
tends to track the stock price of communications companies, which have declined
substantially and may continue to do so. These broad market fluctuations could
continue to harm the market price of our common stock. If the market price of
our common stock continues to decline, 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. Debt
financing, if available, may involve restrictive covenants, which may limit our
operating flexibility with respect to certain business matters. Debt financing
would require payments of principal and interest, which could adversely affect
our cash flow and profitability. Any debt financing may be secured by our
tangible and intangible assets, which could expose us to the loss of those
assets if we are unable to meet debt service requirements. 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 us. 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 transactions were in the best interest of our
shareholders.
FINANCIAL INFORMATION ABOUT FOREIGN AND DOMESTIC OPERATIONS
For information about foreign and domestic operations, see Item 8, "Consolidated
Financial Statements," Note 5 "Business Segments, Major Customers and
Significant Group Concentrations of Credit Risk."
ITEM 2. PROPERTY
Our principal executive offices are located in 4,305 square feet of space in
Overland Park, Kansas. This facility houses the executive, corporate and
administrative offices and is under a lease, which expires in August 2005. In
addition to the executive offices, we also lease 7,575 square feet of space in
McLean, Virginia for our TMNG Marketing subsidiary, under a lease which expires
in June 2009, and 10,344 square feet of space in Boston, Massachusetts, under a
lease which expires in 2011. The Boston and McLean locations are primarily
utilized by management and consulting personnel.
In the fourth quarter of fiscal year 2004, we made the decision to consolidate
office space. In connection with this decision, a sublease agreement for 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. For
additional discussion of this sublease, see Item 8, "Consolidated Financial
Statements," Note 8 "Real Estate Restructuring."
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.
In June 1998, the bankruptcy trustee of a former client, Communications Network
Corporation, sued us 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. Although we deny these claims and plan to
vigorously defend ourselves, we have reserves at January 1, 2005 of $160,000,
which we believe are adequate in the event of loss or settlement on those
claims.
The bankruptcy trustee has also sued us for at least $1.85 million for breach of
contract, breach of fiduciary duties and negligence. Although assurance cannot
be given as to the ultimate outcome of this proceeding, we believe we have
meritorious defenses to the claims made by the bankruptcy trustee, including
particularly the claims for breach of contract, breach of fiduciary duty and
negligence, and we believe that the ultimate resolution of this matter will not
materially harm our business.
In 2002 and 2003, we received demands aggregating approximately $1.2 million by
the bankruptcy trustees of several former clients in connection with collected
balances near the customers' respective bankruptcy filing dates. Although we do
not believe we received any preferential payments from these former clients and
plan to vigorously defend those claims, we have reserves at January 1, 2005 of
$727,000, which we believe are adequate in the event of loss or settlement on
those claims.
On August 25, 2004, we entered into a mediated settlement agreement to settle
pending litigation with a 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 cash settlement payment to us, in
the amount of $2 million to settle all claims and disputes arising under the
consulting services agreement. We have no obligation to render further services
to the customer. At October 11, 2004, we received the $2 million settlement from
the customer and the parties dismissed one another from liability.
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 2004.
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
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
ending January 1, 2005 and January 3, 2004 by quarter were as follows:
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
High Low
First quarter, fiscal year 2003 $ 1.90 $ 1.25
Second quarter, fiscal year 2003 $ 2.02 $ 1.21
Third quarter, fiscal year 2003 $ 2.82 $ 1.74
Fourth quarter, fiscal year 2003 $ 3.53 $ 2.31
The above information reflects inter-dealer prices, without retail mark-up,
markdown or commissions and may not necessarily represent actual transactions.
As of March 31, 2005 the closing price of our Common Stock was $2.37 per share.
At such date, there were approximately 93 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))
PLANS APPROVED BY SECURITY HOLDERS
- - 1998 Equity Incentive Plan - Stock Options 4,455,385 $ 5.16 2,279,419
- - 1998 Equity Incentive Plan - Restricted Stock 658,000 n/a 542,000
PLANS NOT APPROVED BY SECURITY HOLDERS
- - 2000 Supplemental Stock Plan 1,053,564 $ 4.71 2,744,478
For an additional discussion of our equity compensation plans, see Item 8,
"Consolidated Financial Statements," Note 10 "Stock Option Plan and Stock Based
Compensation."
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 30, December 29, December 28, January 3, January 1,
2000 2001 2002 2004 2005
(IN THOUSANDS, EXCEPT PER SHARE DATA)
CONSOLIDATED STATEMENTS OF OPERATIONS DATA:
Revenues ............................................ $ 77,727 $ 54,236 $ 33,057 $ 23,245 $ 23,704
Cost of services:
Direct cost of services ........................... 40,396 27,338 16,111 11,927 12,319
Equity related charges (benefits).................. 5,519 2,322 721 (57) 205
-------- -------- -------- -------- --------
Total cost of services .................... 45,915 29,660 16,832 11,870 12,524
-------- -------- -------- -------- --------
Gross profit ........................................ 31,812 24,576 16,225 11,375 11,180
Operating expenses:
Selling, general and administrative................. 16,024 16,727 23,811 19,359 16,037
Legal settlement .................................. (1,294)
Real estate restructuring ......................... 1,545
Goodwill and intangible asset impairment .......... 25,165 19,484
Goodwill and intangibles amortization ............. 621 1,996 2,887 2,343 992
Equity related charges ............................ 1,564 843 353 142 958
-------- -------- -------- -------- --------
Total operating expenses .................. 18,209 19,566 52,216 41,328 18,238
-------- -------- -------- -------- --------
Income (loss) from operations ....................... 13,603 5,010 (35,991) (29,953) (7,058)
Other income (expense):
Interest income ................................... 3,327 2,433 996 624 718
Interest expense .................................. (14) (63) (51) (30)
Other, net ........................................ (152) (8) 26
-------- -------- -------- -------- --------
Total other income (expense) .............. 3,175 2,411 959 573 688
Income (loss) from continuing operations before income
tax (provision) benefit and cumulative effect of a
change in accounting principle .................... 16,778 7,421 (35,032) (29,380) (6,370)
Income tax (provision) benefit ...................... (6,711) (2,141) 12,389 (12,978) (49)
-------- -------- -------- -------- --------
Income (loss) from continuing operations before
cumulative effect of a change in accounting principle 10,067 5,280 (22,643) (42,358) (6,419)
Cumulative effect of a change in accounting principle,
net of taxes (1,140)
-------- -------- -------- -------- --------
Income (loss)from continuing operations.............. 10,067 5,280 (23,783) (42,358) (6,419)
Discontinued operations:
net income (loss) from discontinued operations..... 328 380 34 (2,276)
-------- -------- -------- -------- --------
Net income (loss) ................................... $ 10,067 $ 5,608 $(23,403) $(42,324) (8,695)
======== ======== ======== ======== ========
Income (loss) from continuing operations before
cumulative effect of a change in accounting principle
per common share
Basic ............................................. $ 0.36 $ 0.18 $( 0.69) $( 1.26) $ (0.18)
======== ======== ======== ======== ========
Diluted ........................................... $ 0.34 $ 0.17 $( 0.69) $( 1.26) $ (0.18)
======== ======== ======== ======== ========
Net income (loss) from discontinued operations per
common share
Basic and Diluted ................................. $ 0.01 $ 0.01 $ (0.07)
======== ======== ======== ======== ========
Net income (loss) per common share
Basic ............................................. $ 0.36 $ 0.19 $( 0.71) $( 1.26) $ (0.25)
======== ======== ======== ======== ========
Diluted ........................................... $ 0.34 $ 0.18 $( 0.71) $( 1.26) $ (0.25)
======== ======== ======== ======== ========
Weighted average common shares outstanding
Basic ............................................. 28,110 29,736 32,734 33,545 34,619
======== ======== ======== ======== ========
Diluted ........................................... 29,208 30,774 32,734 33,545 34,619
======== ======== ======== ======== ========
FISCAL YEAR ENDED
---------------------------------------------------------------
December 30, December 29, December 28, January 3, January 1,
2000 2001 2002 2004 2005
---------- ---------- ----------- ----------- -----------
CONSOLIDATED BALANCE SHEET DATA:
Net working capital ..................... $ 89,148 $ 94,569 $ 63,478 $57,231 $55,121
Total assets ............................ $119,429 $129,042 $125,459 $81,582 $75,353
Total debt (including current debt) ..... $ 338 $ 885 $ 493 $ 200
Total stockholders' equity ............. $111,472 $123,992 $115,726 $73,369 $66,747
On August 2, 2000, the SEC declared our Registration Statement on Form S-1 (File
No. 333-40864) effective. On August 2, 2000, we closed our offering of an
aggregate of 3,000,000 shares of our Common Stock at an aggregate offering price
of $68.6 million. Net proceeds to us, after deducting proceeds to shareholders
of $45.9 million, underwriting discounts and commissions of $1.1 million and
offering expenses of $728,000 were $20.9 million. Proceeds were used for working
capital, general corporate purposes and as possible consideration for
acquisitions.
On September 5, 2000, we completed our acquisition of The Weathersby Group, a
Maryland corporation. The acquisition resulted in a total purchase price of
approximately $19.2 million consisting of $11.2 million cash and $8.0 million in
common stock. Additionally, we incurred direct costs of $1.5 million related to
the acquisition.
On September 5, 2001, we completed our acquisition of Tri-Com, 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.
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 1, "Business - Risk Factors."
EXECUTIVE FINANCIAL OVERVIEW
Included in Item 1, "Business", is a 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, with an analysis of the financial impact
on us.
As previously noted, the communications industry has experienced a significant
economic recession from 2001 through 2004. We are a consultancy to the industry,
and as a result experienced a significant reduction in consulting business
primarily due to the recession. We have experienced significant revenue declines
and/or net loss from 2001 to 2004 (see Item 6, "Selected Consolidated Financial
Data"). While our revenues have declined significantly in recent years, we have
maintained relatively consistent gross margins through innovative pricing and
high consultant utilization levels. Additionally, our ability to manage costs
and leverage our flexible staffing model further allowed us to maintain our
gross margins.
As a result of a combination of significantly lower operating results of
reporting units during fiscal years 2002 and 2003, the resignation of certain
key personnel and revised and reduced financial projections, our operating
expenses include goodwill and intangible impairment losses of $27.1 million and
$19.5 million in fiscal years 2002 and 2003, respectively. 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 2003 and 2004, we also
recorded valuation reserves of $24.0 million and $2.6 million, respectively, in
connection with deferred income tax assets, which were generated primarily by
goodwill impairment and current operating losses.
We have implemented many programs to size the business consistent with our lower
revenue base. Such steps included staff reductions and other selling, general
and administrative cost cutting measures to maintain appropriate pricing and
utilization metrics which are critical to a management consultancy. Such cost
reductions also assisted us in reducing cash used in operations. Selling,
general and administrative costs were $23.8 million, $19.4 million and $16.0
million in fiscal years 2002, 2003 and 2004, respectively, reflective of these
cost cutting initiatives. We have also focused our marketing efforts on large
and sustainable clients to maintain a portfolio of business that is high credit
quality and thus reduce bad debt risks.
OPERATIONAL OVERVIEW
We report our financial data on a 52/53-week fiscal year for reporting purposes.
Fiscal year 2003 was a 53 week fiscal year. Fiscal years 2002 and 2004 had 52
weeks. 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. Contract revenues on
contracts with a not to exceed contract price or a fixed price are recorded
under the percentage of completion method, utilizing estimates of project
completion under both of these types of contracts. Larger fixed price contracts
have recently begun to represent a more significant component of our revenue
mix. Contract revenues on contingent fee contracts are deferred until the
revenue is realizable and earned.
Generally a client relationship begins with a short-term engagement utilizing a
few consultants. Our sales strategy focuses on building long-term relationships
with both new and existing clients to gain additional engagements within
existing accounts and referrals for new clients. Strategic alliances with other
companies are also used to sell services. We anticipate that we will continue to
do so in the future. Because we are a consulting company, we experience
fluctuations in revenues derived from clients during the course of a project
lifecycle. As a result, the volume of work performed for specific clients varies
from period to period and a major client from one period may not use our
services in another period. In addition, clients generally may end their
engagements with little or no penalty or notice. If a client engagement ends
earlier than expected, we must re-deploy professional service personnel as any
resulting unbillable time could harm margins.
Cost of services consists primarily of client-related compensation for
consultants who are employees and amortization of equity related non-cash
charges incurred in connection with 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 40.9% to
49.40% during the period from 1999 to 2004. 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 SME's;
and employee and independent contractor organization costs associated with a
competitive labor market.
Operating expenses include selling, general and administrative, equity related
charges, intangible asset amortization, and goodwill and intangible asset
impairments. Operating expenses for fiscal year 2004 also include a litigation
settlement and real estate restructuring charge. 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 $1,207,000, $575,000 and $399,000
for fiscal years 2002, 2003 and 2004, respectively, and our allowance for
doubtful accounts totaled $471,000, $652,000 and $396,000 at the end of fiscal
years 2002, 2003 and 2004, 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 more of our customers file for bankruptcy
or experience financial difficulties, it is possible that the allowance for
doubtful accounts will be insufficient and we will have a greater bad debt loss
than the amount reserved, which would adversely affect our cash flow and
financial performance.
Impairment of Goodwill and Long-lived Intangible Assets - Goodwill and other
long-lived intangible assets arising from our acquisitions are subjected to
periodic review for impairment. SFAS No. 142 requires an annual evaluation at
the reporting unit level of the fair value of goodwill and compares the
calculated fair value of the reporting unit to its book value to determine
whether an impairment has been deemed to occur. Any impairment charge would be
based on the most recent estimates of the recoverability of the recorded
goodwill and intangibles balances. If the remaining book value assigned to
goodwill and other intangible assets acquired in an acquisition is higher than
the amounts we would currently expect to realize based on updated financial and
cash flow projections from the reporting unit, there is a requirement to write
down these assets.
Effective March 4, 2004, management and the Board of Directors elected to
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 years 2002 and 2003, the resignation of key personnel, and revised
and reduced financial projections, we recorded goodwill impairment losses of
$27.1 million and $15.8 million in 2002
and 2003, respectively, in accordance with the provisions of SFAS No. 142. For
an additional discussion see Item 8, "Consolidated Financial Statements," Note 3
"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 Income (Loss).
Revenue Recognition - Historically, most of our consulting practice contracts
have been on a time and materials basis, in which customers are billed for time
and materials expended in performing their engagements. We recognize revenue
from those types of customer contracts in the period in which our services are
performed. In addition to time and materials contracts, our other types of
contracts include time and materials contracts not to exceed contract price,
fixed fee contracts, managed services or outsourcing contracts, and contingent
fee contracts. Managed services or outsourcing contracts typically have longer
terms than consulting contracts (e.g., longer than one year).
We recognize revenues on time and materials contracts not to exceed contract
price and fixed fee contracts using the percentage of completion method.
Percentage of completion accounting involves calculating the percentage of
services provided during the reporting period compared with the total estimated
services to be provided over the duration of the contract. For all contracts,
estimates of total contract revenues and costs are continuously monitored during
the term of the contract, and recorded revenues and costs are subject to
revisions as the contract progresses. Such revisions may result in an increase
or decrease to revenues and income and are reflected in the financial statements
in the periods in which they are first identified.
As we continue to adapt to changes in the communications consulting industry, we
have elected to enter into more fixed fee contracts in which revenue is based
upon delivery of services or solutions, and contingent fee contracts, in which
revenue is subject to achievement of savings or other agreed upon results,
rather than time spent. Both of these types of contracts are typically more
results-oriented and are subject to greater risk associated with revenue
recognition and overall project profitability than traditional time and
materials contracts. Due to the nature of these contingent fee contracts, 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. Additional costs and effort as compared to what was originally planned
may need to be expended to fulfill delivery requirements on such contracts,
which could adversely affect our consolidated financial position, results of
operations and liquidity.
Deferred Income Tax Assets - We have generated substantial deferred income tax
assets primarily from the accelerated financial statement write-off of goodwill,
the charge to compensation expense taken for stock options and net operating
loss carry forwards. For us to realize the income tax benefit of these assets,
we must generate sufficient taxable income in future periods when such
deductions are allowed for income tax purposes. In assessing whether a valuation
allowance is needed in connection with our deferred income tax assets, we have
evaluated our ability to carry back tax losses to prior years that reported
taxable income, and our ability to generate sufficient taxable income in future
periods to utilize the benefit of the deferred income tax assets. Such
projections of future taxable income require significant subjective judgments
and estimates by us. As of January 1, 2005, cumulative valuation allowances in
the amount of $26.2 million were recorded in connection with the deferred income
tax assets. We continue to evaluate the recoverability of the recorded deferred
income tax asset balances. If we continue to report net operating losses for
financial reporting, no additional tax benefit would be recognized for those
losses, since we may be required to increase our valuation allowance to offset
such amounts.
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 Income (Loss) have been adjusted for fiscal years 2004, 2003, and
2002 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 4, "Discontinued Operations."
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 Income (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.
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.
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.
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 cash
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.
Non-cash stock based compensation 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.
FISCAL 2003 COMPARED TO FISCAL 2002
REVENUES
Revenues decreased 29.7% to $23.2 million for fiscal year 2003 from $33.1
million for fiscal year 2002. 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 decrease in revenues was primarily associated with the
decline in utilization of management consulting services by communication
service providers, which correlated with significant layoffs of management
personnel by such clients, and continuing adverse conditions in the
communication and technology industry. In addition, there was continued deferral
of key management consult