ITEM 1. Business.
General
Thomas Group, Inc. (the "Company"), a Delaware corporation, established in 1978, is an international, professional services firm focusing on improving operations, competitiveness and financial performance of major corporate clients through process improvement and strategically aligning operations with technology. Recognized as a leading specialist in operations consulting, the Company creates and implements custom improvement strategies for sustained performance improvement. The Company's clients are typically large companies, many of whom are included in the Fortune or Global 1000.
The Company's products are based on three fundamental principles: a metrics-driven process, attaining and sustaining significant results for clients and program implementation by consultants with senior management experience in industry.
Since 1978, the Company has been developing and improving its Process Value Management ("PVM") methodology for achieving operational excellence. PVM is based on the Company's Total Cycle Time® ("TCT") methods and supplements TCT with numerous process improvement tools the Company has developed over the last 26 years. PVM continues to contribute to the measurable operational improvement of hundreds of companies.
During the Company's first ten years, it originated many of the fast-process methods that transform the processes, procedures and people within clients' organizations to create smooth, efficient and seamless operations. These methods quickly became standard operations for the electronics and semiconductor industries. Soon afterwards, they were being applied to general manufacturing, heavy industry and product inventory. In the late 1980s, in response to numerous client requests, the Company applied the fast-process tools and methods to non-manufacturing processes such as product development, sales, marketing and the strategic alignment of resources. The application of fast-process tools across the entire enterprise led to major process and productivity gains in "white collar" areas that had been ignored for years in the manufacturing plant, again delivering substantial gains for its clients. Today, the Company is involved with new tools, both proprietary and non-proprietary, to drive higher results. The Company is working to help link all of a corporation's strategic processes, not only across its internal functions, but also across entities and geographies.
Statement of Business
The Company's business is helping its clients improve their bottom-line results using the Company's senior executives who work side-by-side with clients to remove barriers, increase productivity, change culture, and focus on quickly satisfying customer needs. This has been the primary focus of the Company since its beginning in 1978.
Process Value Management
The Company's PVM approach is based on its 26 years of experience with process improvement tools and methodologies that drive financial bottom-line results. The Company uses PVM to help an enterprise determine strategic business processes, assess their linkages and efficiencies, and prescribe short and long-term enhancement programs that optimize customer satisfaction and shareholder value. The Company's staff of business professionals who apply PVM methodology are referred to by the Company as "Resultants." An initial client assignment might typically address one or more of these key processes that are dragging down performance. A long-term relationship might involve an implementation team of Resultants working with the client over a number of years to achieve a total transformation to the "Process Managed Enterprise."
Experience has taught us that:
•The Process Managed Enterprise is one in which its management focus and systems are centered on customers and managed around processes;
•All businesses are made up of a series of linked processes, from the initial business concept through all its applied resources to its end customer. All processes, left unmanaged, naturally deteriorate over time;
•People, working in cross-functional teams, focusing on customer needs, are what make processes effective;
•The customer is the final arbiter of the value of the process; and,
•The transformation process itself must deliver short-term operating results as well as long-term systemic business enhancements.
Total Cycle Time
The Company's initial offering, TCT, centers on reducing cycle times and increasing first pass yield (quality), thereby improving overall productivity. Using the Company's methods, business process cycle times-the time from the beginning to the end of any business activity-can normally be reduced by up to 50%, whether the process is engineering, manufacturing, or sales.
For example, in a manufacturing setting, it might take 30 days from the time an order is received until the order is shipped. The Company first determines the baseline time of that process-the time currently expended doing the work. Based on the Company's best practices, a multiplier is used to move from baseline to "entitlement"-how fast the process should run with current resources. The Company's Resultants then work with client management to reduce the current rate to the entitlement by mapping the process, eliminating unnecessary steps, and removing process and cultural barriers.
The key to TCT's success is the Resultants' ability to identify the right metrics to drive the business and the critical processes of the business. Many companies only look at results measures, such as return on net assets. The problem with results measures is that by the time their value is known, it is too late in the process to employ corrective measures. However, when predictive driver measures such as cycle time and first pass yield are used, clients can determine the trajectory of their business and make adjustments as needed.
The Company uses a "cockpit chart" approach to capture the key measurements for a business and to ensure that the focus is on the appropriate processes that will drive results. Cockpit charts contain a balanced combination of results and driver measurements. In addition, these top-level measurements are hierarchical and represent the roll-up of the key processes.
TCT remains a core of the Company's PVM methodology.
Supply Chain Process Value
Supply chain management ("SCM") has matured over the last decade. A milestone in the maturity of SCM, driven by the need for value control in today's competitive global environment, is the leading-edge concept that the demand side management within a supply chain has as much impact on value and cash management as does supply side management.
This is an excellent example of recognizing the interconnectivity of processes and supports the need to shift from a functional to a process view of SCM. Thomas Group's own Supply Chain Process Value ("SCPV") offering within its overarching PVM approach, balances demand side management and supply side management while optimizing responsiveness, quality and value.
The Company has helped hundreds of clients make a successful transition from functional organizations to efficient SCPV cross-functional teams. Using this PVM architecture, the Company analyzes the client's operations and supply chain network, then applies tools such as TCT to drive down inventory levels, reduce delivery time and improve order accuracy. Ideally, this process links back into the client's suppliers and customers and drives additional benefits.
Summary
Over the years, the Company has become a leader in implementing process improvement strategies that make companies faster and improve their competitiveness and financial performance. This ability to link and align a client organization's strategy, technology, people and processes offers a powerful and unique benefit to client companies faced with integrating their operations, internally and externally, throughout the value chain. The Company's strategic plan is to continually add value to its core PVM product offering and to expand its marketing reach through partnerships with industry leaders.
Competitive Strategy
The Company's strategy is to maintain and enhance its position in the development and implementation of its PVM methodology. The Company's strategy includes the following key elements, many of which differentiate it from traditional providers of consulting services.
Emphasize Results. The Company may enter into incentive fee contracts, which make a portion of its revenue from a particular program contingent upon certain measurable results. The Company offers incentive fee contracts in cases where the client prefers that the Company share the risks to achieve entitled results or for clients who prefer to work on a gain-sharing basis. The Company's competitors generally charge fees based on time expended, regardless of results. Thus, the Company's willingness to enter into incentive fee contracts demonstrates the Company's confidence that its programs will positively enhance the businesses of its clients and furthermore provides significant competitive differentiation and advantage.
Target Large Clients and Multiple Program Opportunities. The Company has focused its marketing efforts on companies with annual revenues greater than $400 million, preferably where sequential program opportunities exist. The Company believes larger clients provide greater revenue opportunities because such clients are likely to realize greater economic benefit from the Company's services and will be more likely to engage the Company in follow-on programs.
Focus on Results Implementation and Continuous Improvement. By applying PVM throughout the client's complete business or business unit and by working in close cooperation with the client's management, the Company believes it can more effectively drive operational performance improvements and their associated financial benefits. The Company stresses hands-on implementation of process improvements and focuses on implementation of prioritized changes that improve the client's business culture and processes. In addition to implementing change through its PVM plan, an essential element of a PVM program is "leaving behind" with the client the knowledge and skills needed for the client to continue to sustain continuous improvement. In contrast, traditional consulting firms often provide subject expertise in the form of written assessments or reports that focus on discrete functions or an isolated segment of a business.
Experienced Professional Staff. The Company employs professionals with extensive business management experience, often 20 years or more. Traditional consulting firms often hire recent business school graduates with expertise in a particular subject matter, rather than expertise in business management. The use of seasoned professionals significantly improves the ability of the Company to effectively implement its PVM methodologies and creates a significant competitive difference and advantage for the Company.
Program Focus. The Company focuses primarily on cultural and business process barriers rather than on subject matter barriers and functional units. The Company believes reductions in cultural barriers have a greater impact on improving a client's performance than reducing business process barriers.
Clients
The Company's clients are typically large, diversified enterprises or distinct units of such enterprises, in North America, Europe, and Asia. Many of the Company's clients are Fortune or Global 1000 companies. The Company has worked for over 250 clients, including the following:
Aerospace
Distribution
Mechanical Engineering
Aerostructures
ProSource
ABB
Bombardier
W.W. Grainger
Alstom Power
Delta Air Lines
Dresser Waukesha
Gulfstream
Electronics
Dresser-Rand
ITT Cannon
ABB
GEA
LSG Sky Chefs
Berg
Hilti
Lufthansa Cargo
EDS
Schindler
Lufthansa Technik
Euclid-Hitachi
McDonnell Douglass
Flat Panel Display
Medical Equipment Supplies
TRW
GTE Control Devices
Boston Scientific
Gemplus
Siemens Medical
Automotive
Johnson Electric
GE Medical
Adam Opel
Motorola
Audi
Osram
Specialty Retail
Delco
Philips
Tuesday Morning
Delphi
Texas Instruments
Detroit Diesel
Western Digital
Semiconductor
GM
Yuasa Exide Batteries
Alcatel Mietec
GM DELCO
AMI Microsystems
GM/Warranty
Healthcare
ASM Lithography
Meritor
Centura
AT&T Semiconductor
Osram
Mallinckrodt
Cypress Semiconductor
Pep Boys
Fairchild Semiconductor
Robert Bosch
Government
Ford Microelectronics
Saab
FAA
Hewlett Packard
Siemens
CACI
Hyundai
City of Garland, Texas
IBM
Apparel Manufacturer
United States Army
LG Semiconductor
Brandix
United States Navy
NCR
Esquel Group
National Semiconductor
Lanka Equities
Manufacturing/Industrial
Matra MHS
Tristate Holdings
Breguet
Motorola
Dover
Philips Semiconductor
Banking, Financial Services,
Emerson
Rockwell
Insurance
Kimberly Clark
Signetics
DG Bank
VIAD
ST Microelectronics
Forethought Insurance
Leeds & Northrup
Taiwan Semiconductor
Olivetti
Moore
Trilogy
Sun Life Financial
Pawnee Industries
Pinnacle-lvey
Telecommunications
Chemical
Radium
Allen Telecom
Heraeus
Robert Bosch
Shipley
Siemens
Transportation
Stewart and Stevenson
Alstom
Consumer Products
Teledyne
Amtrak
Givaudan
Thrall
Bombardier
HengAn
Xerox
Burlington Northern Santa Fe
Hillenbrand
Kodak
Utilities
Polaroid
PECO
Rand McNally
Siemens
Robert Bosch
Southern Indiana Gas & Electric
Rubbermaid
There can be no assurance that the Company will perform services for any of its previous clients in the future. In order to maintain and increase its revenues, the Company will need to add new clients or expand existing client relationships to include additional divisions or business units of such clients.
The Company operates in one industry segment, but conducts its business primarily in three geographic areas: North America, Europe and Asia/Pacific. Information regarding these areas follows:
In 2004, two clients accounted for 48% and 33% of the Company's revenue, respectively.
In 2003, two clients accounted for 39% and 32% of the Company's revenue, respectively.
In 2002, two clients accounted for 39% and 28% of the Company's revenue, respectively.
Contractual Arrangements
The Company performs PVM services for clients pursuant to contracts, generally with terms of three months to one year, or targeted process improvement programs that could last from three to six months. Clients compensate the Company for its services in one or more of three forms: fixed fees, task-based or specific deliverable-based, or incentive fees (based on client improvements achieved). The Company's fee structure is based on a client's size, the complexity and geographic deployment of a client's business, the level of improvement opportunity available to a client, the number of barriers to be removed, and certain other factors.
Fixed fees are recognized on a percentage of completion basis using direct labor efforts as the measurement. Time and effort to date on a project are compared to the total estimated time and effort for the entire project; deriving the percentage completion ratio. This ratio is multiplied by the total fixed fee to be earned on the project, resulting in the amount of revenue earned to date on the project.
Task based fees (also known as specific deliverables) are recognized as revenue when the task/deliverable has been completed. Typically, this involves a report, chart, minutes or some other form of proof of completion. This work product is delivered to the client, and the client acknowledges receipt prior to recognition of revenue by the Company.
Incentive (performance-oriented) fees are calculated by our Resultants, using the client's own data and are based on agreed-upon formulas relating to improvements in customer-specific measures. Incentive fee revenue is recognized by the Company in the period in which the related improvements are achieved. In order to mitigate the risk of disputes arising over the achievement of performance
improvements, which drive incentive fees, the Company obtains customer agreement to these achievements prior to recognizing revenue. Factors such as a client's commitment to PVM, general business and economic cycles and a client's product position in the marketplace will affect the performance of the Company's clients, thus affecting the Company's revenue from incentive fee compensation. In 2004, 2003, and 2002, approximately 1%, 1% and 22%, respectively, of the Company's revenue was attributable to incentive fees.
The Company includes in its business under commitment (backlog) signed client contracts and budgeted United States government commitments with terms generally ranging from three months to one year. Budgeted United States government commitments consist of funds that are designated for the Company in the Department of Defense's operating budget as a line item, as opposed to inclusion in a general category. Typically, government agencies agree to sign one-year contracts even though the program may be a budgeted expenditure for several years. The Company considers the budgeted United States government commitments to be equivalent to a signed commercial contract. Therefore, these commitments are included in backlog. Backlog at December 31, 2004, was $22.5 million, of which approximately $18.1 million is expected to be realized within fiscal 2005, and the remaining $4.4 million is expected to be realized in 2006. Backlog was $28.4 million at December 31, 2003.
Competition
Traditional consulting firms provide services similar in some respects to the services provided by the Company. Providers of such services include A.T. Kearney, Inc., Boston Consulting Group, McKinsey & Co., as well as several small firms that primarily focus on time-based management services. Many of the Company's competitors have a larger number of personnel, greater financial, technical and marketing resources than the Company, and there can be no assurance the Company will be able to compete successfully with its existing or new competitors.
The Company believes the competitive factors most important to its business are the unique quality of its PVM methodology, the quality and character of its professional staff, its willingness to be compensated on an incentive basis, its reputation for achieving targeted results and its dedication to implementation of programs that deliver results. The Company believes that no significant competitors offer their clients the opportunity to base fees on the results achieved or emphasize hands-on implementation to the same extent as the Company.
The Company believes its most significant competitor is the propensity for potential clients to "self-medicate" by attempting to implement changes in their businesses themselves in the belief they will achieve results comparable to those resulting from the Company's services without the assistance of outside professionals. The Company believes these attempts to self-medicate result in limited success. However, such attempts may substantially lengthen the Company's sales cycle and may, therefore, limit its business opportunities.
Because the PVM methodology or related shorter term products are not capable of being patented, there can be no assurance the Company will not be subject to competition from others using substantially similar methodologies. However, the Company believes its base of knowledge, experience and clients provides it with a competitive advantage.
Intellectual Property
The Company has secured federal registration for the service marks Total Cycle Time® and TCT®. These registrations expire from May 2005 to August 2012. The Company has filed an application for federal service mark registration for several other marks important to its business. The Company has also made appropriate filings in several European countries to secure protection of its marks in those countries. The Company considers each of these service marks to be significant to its business.
The Company's proprietary methodologies have been developed over 26 years at great expense, have required considerable effort on the part of skilled professionals, are not generally known and are considered trade secrets. In some circumstances, the Company grants clients a limited license to make internal use of certain of the Company's proprietary methodologies following completion of a program. The Company maintains its trade secrets in strict confidence and as part of its standard engagement.
The Company has entered into nondisclosure and noncompete agreements with its current and former employees. There can be no assurance that such agreements will deter any employee of the Company from disclosing confidential information to third parties or from using such information to compete with the Company in the future.
Employees
At March 23, 2005, the Company had a total of 108 employees, consisting of 66 full-time Resultants, 12 part-time Resultants and 10 sales and 20 administrative employees. The Company's employees are not represented by a labor union and are not subject to any collective bargaining agreement. The Company considers its employee relations to be good.
Securities and Exchange Commission
The Company is required to file reports with the Securities and Exchange Commission ("SEC") pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934. The Company routinely files certain reports to the SEC. These forms include:
Form 10-K
Annual Report
Form 10-Q
Quarterly Report
Form 8-K
Current Reports
Schedule 14A
Definitive Proxy Statement
The public may read and copy any materials filed to the SEC by the Company at the SEC's Public Reference Room at 450 Fifth Street, NW, Washington, DC 20549. The public may obtain information on the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330. The Company's filings to the SEC are submitted electronically and can be accessed via the SEC's website at (http://www.sec.gov).
Company Website
Information about the Company can be obtained by accessing the Company's website at (http://www.thomasgroup.com).
ITEM 2.
ITEM 2. Properties.
The Company leases approximately 17,000 square feet of office space at its principal executive office in Irving, Texas, under a lease that expires in July 2006.
The Company also leases approximately 6,000 square feet of office space in Troy, Michigan under a lease that expires in December 2006. Under the same lease, the Company leases another 3,000 square feet in Troy, Michigan that was subleased during 2004. However, the subtenant became delinquent in rent payments to the Company and an event of default occurred. Subsequent to year-end, the subtenant was evicted. The Company has engaged a broker to find a replacement subtenant.
The Company also leases approximately 12,000 square feet of office space in Reston, Virginia under a lease that expires in October 2007. This space was subleased under an agreement expiring October 2007. Subsequent to year-end, the subtenant became delinquent in rent payments and an event of default occurred. The subtenant abandoned the space, and the Company intends to use this facility
as office space due to the amount of time spent in Reston as a result of several US Military projects currently under contract
The Company also leases space for its offices in Zug, Switzerland, and Hong Kong. During 2004, leases for office space in Singapore and Shanghai, China were allowed to expire and were not renewed. The Company believes its facilities are adequate for its current needs.
ITEM 3.
ITEM 3. Legal Proceedings.
In 2002, the Company filed for insolvency of its wholly-owned subsidiary headquartered in Frankfurt, Germany. During 2005, a suit was filed against the company's subsidiary in Switzerland by the German insolvency administrator to recover approximately $0.3 million related to an intercompany receivable between the two entities. The Company and its legal counsel believe that the loss, if any, resulting from the suit will not have a material impact on the company's financial position, results of operations, or cash flows in future years.
During the third quarter of 2003, the Company became aware of past circumstances involving a former employee that management believed would result in future litigation or settlement costs. As such, the Company recorded a $150,000 contingent liability related to the matter. On December 17, 2003, the Company entered into a settlement agreement with its former employee resulting in $121,160 payable to the former employee in two installments, due December 17, 2003 in the amount of $21,160 and January 5, 2004 in the amount of $100,000. The Company made both installment payments. In addition to the settlement payments, as part of the settlement agreement, the Company and the former employee entered into a consulting agreement whereby the Company paid its former employee $84,640, in five equal monthly installments of $16,928 beginning January 2004 and continuing through May 2004. The Company's former employee provided reports related to the financial strength and other conditions of the Asian marketplace as performance under the consulting agreement.
The Company has become subject to various claims and other legal matters, such as collection matters initiated by the Company, in the ordinary course of conducting its business. The Company believes that neither such claims and legal matters nor the cost of prosecuting and/or defending such claims and legal matters will have a material adverse effect on the Company's consolidated results of operations, financial condition or cash flows. No material claims are currently pending; however, no assurances can be given that future claims, if any, may not be material.
ITEM 4.
ITEM 4. Submission of Matters to a Vote of Security Holders.
No matters were submitted to a vote of stockholders, through the solicitation of proxies or otherwise, during the quarter ended December 31, 2004.
PART II
ITEM 5.
ITEM 5. Market for Registrant's Common Equity and Related Stockholder Matters.
Market for Registrant's Common Equity
The Company's common stock is quoted on the OTC Bulletin Board under the symbol TGIS.OB. The stock prices set forth below represent the highest and lowest bid prices per share of the Company's common stock as reported by the OTC Bulletin Board. The prices reported in the following table
reflect inter-dealer prices without retail mark-up, mark-down or commissions, and may not necessarily represent actual transactions.
Holders of Record
As of March 23, 2005 there were approximately 123 holders of record of the Company's common stock.
Dividends
The Company has never paid dividends on its common stock. Payments of future dividends, if any, will be at the discretion of the Company's board of directors after taking into account various factors, including the Company's financial condition, operating results, and current and anticipated cash needs.
Sale of Unregistered Securities
During 2004, the company issued 32,284 shares of unregistered common stock. The shares were issued to John Hamann, former CEO of the Company, under the Company's stock option plans (See the accompanying Note 1(t), Note 11 and Note 15 of the Consolidated Financial Statements, included herein). This transaction did not involve any underwriters, underwriting discount or commissions, or any public offering, and the Company believes that the transaction was exempt from the registration by virtue of Section 4(2) of the Securities Act of 1933, as amended.
ITEM 6.
ITEM 6. Selected Financial Data.
The following table sets forth selected historical financial information of the Company. This historical financial information has been derived from the audited financial statements of the Company. This information should be read in conjunction with, and is qualified by, the consolidated financial statements and notes thereto included in this and previous Annual Reports on Form 10-K.
(a)Includes the reversal of $0.2 million of foreign income taxes payable. (b)Includes $1.3 million of restructuring charges for insolvency proceedings related to the Company's German subsidiary. (c)Includes $0.9 million of federal income tax refunds. (d)Includes $2.9 million of litigation settlement expense, $2.3 million of severance cost related to staff reductions during 2001 and $0.5 million of leasehold improvement write downs related to a loss on a contract for subleased office space. (e)Includes $3.3 million valuation allowance adjustment to the Company's net deferred tax assets. (f)Includes $1.3 million of CEO transition costs and $0.7 million of litigation settlement expense.
ITEM 7.
ITEM 7. Management's Discussion and Analysis of Financial Condition and Results of Operations.
The following discussion should be read in conjunction with the Company's Consolidated Financial Statements and the notes thereto and the other information included in Item 15(a)(1) and (2) of this Annual Report on Form 10-K.
Overview
The Company derives the majority of its revenue from monthly fixed, task-based and incentive fees for the implementation of PVM and other business improvement programs. Task-based fees are based on specific deliverables completed at varying points in time. Incentive fees are tied to improvements in a variety of client performance measures typically involving response time, asset utilization and productivity. Due to the Company's use of task-based and incentive fee contracts, variations in revenue levels may cause fluctuations in quarterly results. Factors such as a client's commitment to a PVM program, general economic and industry conditions and other issues could affect a client's business performance, thereby affecting the Company's incentive fee revenue and quarterly earnings. Quarterly revenue and earnings of the Company may also be impacted by the size of individual contracts relative to the annual revenues of the Company.
In addition to its United States operations, the Company has operations and contracts in the Europe and Asia/Pacific regions. The majority of revenue related transactions in these regions are denominated using the United States dollar. However, some of the Company's revenue related transactions are denominated in the local currency where the client is located. The majority of the Company's operating expenses for its subsidiaries are denominated in the local currency of the subsidiary. Therefore, the Company is exposed to currency fluctuation risks. See Item 7A, "Quantitative and Qualitative Disclosure About Market Risk."
Critical Accounting Policies
The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the amounts reported in the accompanying financial statements and related footnotes. Management bases its estimates and assumptions on historical experience, observance of industry trends and various other sources of information and factors. Actual results could differ from these estimates. Critical accounting policies are defined as those that are reflective of significant judgments and uncertainties, and potentially could result in materially different results under different assumptions and conditions.
Revenue Recognition
Revenue is recognized when realizable and earned generally as services are provided over the life of the contract. Fixed fee revenue is recognized on a percentage completion method, based on direct labor hours expended. Task-based, or deliverable-based, fees are recognized when the task/deliverable is completed and delivered to the client. Incentive fee revenue is recognized in the period in which the related improvements are achieved. In order to mitigate the risk of disputes arising over the achievement of performance improvements, which drive incentive fees, the Company obtains customer agreement to these achievements prior to recognizing revenue.
Deferred Taxes
For United States federal tax purposes, at December 31, 2002, the Company had net operating loss ("NOL") carryovers of approximately $4.2 million. Under the Section 382 limitation, discussed below, $0.7 million was used to offset United States taxable income in 2003. In 2004, $0.2 million expired under Section 382, but an $8.1 million in United States NOL was generated, resulting in a balance of $11.4 million at December 31, 2004. The Company had unused foreign tax credit ("FTC") carryovers
of $0.8 million, on December 31, 2002. These credits were converted to deductions and amended returns were filed for the appropriate years, leaving approximately $3,000 in foreign tax credits at December 31, 2004. In Asia, the Company has approximately $0.7 million of net operating loss carryovers, which currently do not have any statutory expiration date. In Europe, the Company has $2.5 million of net operating loss carryovers. Due to the uncertainty of the Company's ability to utilize its net deferred tax assets, the Company has provided a valuation allowance of $4.7 million. If the Company generates United States and foreign taxable income in future periods, reversal of the valuation allowance could have a significant positive impact on net income in the period that it becomes more likely than not that the foreign tax credit carryover will be realized.
Accumulated Other Comprehensive Loss
At December 31, 2004 the accumulation of prior years' translation adjustments of approximately $682,000 included in accumulated other comprehensive loss relates primarily to the Company's operations in Europe. The Company intends to liquidate its subsidiaries in Europe, and as a result, will reclassify the appropriate amount to the income statement. The Company believes the transaction will be completed by December 31, 2005 and the resulting reclassification will be recorded as a non-cash charge to operations for the year then ended.
Results of Operations
2004 Compared to 2003
Revenue
During the first quarter of 2002, the Company adopted a Financial Accounting Standards Board Staff ("FASB") announcement that requires certain reimbursements received for out-of-pocket expense incurred be classified in the income statement as revenue. The Company has presented revenue in two components: consulting revenue before reimbursements and reimbursements. Reimbursements reclassified to revenue for the years ended December 31, 2004, 2003, and 2002 were $0.1 million, $0.6 million, and $1.6 million, respectively. In addition, cost of sales has been presented in two components: cost of sales before reimbursable expenses and reimbursable expenses.
Revenue decreased $0.4 million, or 1% to $30.0 million in 2004, from $30.4 million in 2003. Fixed fee revenue was $29.6 million, or 99% of revenue in 2004, compared to $29.4 million, or 97% in 2003.
Incentive fee revenue was $0.3 million, or 1% of revenue in 2004, compared to $0.4 million, or 1% of revenue in 2003. Reimbursements were $0.1 million, or 0% of revenue in 2004, compared to $0.6 million, or 2% of revenue in 2003.
The decrease in incentive fee revenue relates to the substantial completion of an incentive based contract during 2004.
North America region revenue increased $1.8 million, or 7%, to $28.9 million in 2004, from $27.1 million in 2003. Revenue from United States government contracts increased $3.4 million, or 15%, to $26.8 million from $23.4 million in 2003. Revenue from commercial clients in the United States and Canada decreased $1.6 million, or 43%, in 2004 to $2.1 million, from $3.7 million in 2003.
Europe region revenue decreased $122,000, or 92% to $10,000 in 2004, from $132,000 in 2003. The decrease is primarily attributable to the significant decline in the European economy, which adversely affected the Company's ability to secure contracts.
Asia/Pacific region revenue decreased $2.1 million, or 66%, to $1.1 million in 2004, from $3.2 million in 2003. The decrease is attributable to the completion of several programs during 2003 that contributed $1.0 million to revenue in 2003, and a $1.1 million reduction in revenue due to substantial completion of another program.
Gross Profit
Gross profit for 2004 increased to $15.0 million and 50% of revenue, from $14.8 million and 49% of revenue in 2003. The improvement in gross profit is primarily attributable to a higher concentration of pure process improvement programs. In 2003, the Company was involved in two contracts with clients requiring software assistance from third-parties, at significant cost to the Company. These programs ended in 2003, and it was decided not to pursue software-related ventures in 2004 due to their lower margins.
Selling, General and Administrative
Selling, general and administrative expense for 2004 decreased $0.4 million, or 3%, to $13.2 million from $13.6 million in 2003. The decrease is comprised of reductions of $0.4 million in expenses such as travel and telecommunications, $0.2 million in outside professional services such as legal and accounting, $0.4 million in leases of office equipment and office space, and $0.4 million in other costs, offset by a $1.0 million increase in selling costs, such as salaries and advertising.
Restructuring
In 2002 the Company incurred restructuring charges of $1.3 million related to the petition for insolvency of its German subsidiary. The Company has yet to be informed as to the determination of the assets related to its former German subsidiary by the insolvency court. Please see the Restructuring discussion under the caption "2003 Compared to 2002" in this section.
Income Taxes
The Company's effective tax rate for 2004 was 3%, compared to an effective tax benefit rate of 23% in 2003. The change in the Company's effective tax rate is primarily related to the reversal of prior year foreign tax estimates in 2003, which did not recur in 2004.
At December 31, 2001, the Company determined, based primarily on its recent history of operating losses in the United States ("US"), that it could no longer consider the recovery of its net deferred tax assets as more likely than not. Accordingly, the Company's net deferred tax assets were reduced by a valuation allowance adjustment. While a valuation allowance is currently required for the Company's
net deferred tax assets, the assets remain available for use in the future, subject to the limitation described below, to offset future income tax liabilities should sufficient amounts of United States and foreign income be generated in the carryforward period.
Consistent with the Company's position at December 31, 2001, the Company recorded no tax benefits for operating losses generated in 2002. However, during 2002, Congress passed a law to allow companies the opportunity to carryback NOLs five years versus the previous two-year carryback provision. This change allowed the Company to carryback NOLs generated prior to 2002 and file for tax refunds for the years 1996 and 1997 for which the related federal tax benefit of approximately $798,000 and $125,000 was realized during 2002. The Company realized an additional $46,000 of state tax refunds during 2002. The Company also recorded income tax expense on the profits of its foreign operations of $531,000 in 2002.
Net Operating Losses and Section 382 Limitation
During 2002, the Company reached agreements with its current Chairman of the Board, General John T. Chain, Jr., and with Edward P. Evans, a stockholder of the Company, to infuse $1.0 million each into the Company, in the form of Subordinated Convertible Notes bearing interest at 6% annually. Upon stockholder approval at the Company's Annual Meeting of Stockholders held November 11, 2002, the principal and unpaid interest of $11,500 on the notes were converted to 5,364,002 shares of common stock of the Company at a conversion price of $0.375 per share. After conversion of the notes and related interest, General Chain and Mr. Evans held approximately 29% and 33% of the Company's outstanding common stock, respectively. The issuance of these shares, when combined with various other changes in certain stockholders' stock ownership during the three year period preceding November 11, 2002, resulted in a change in control as provided in Section 382 of the Internal Revenue Code of 1986, as amended. Under Section 382, such a change in control limits the annual deductible amount of NOL carryforwards that existed on the date of the change in control. The annual limitation is based on a formula involving the value of the Company immediately prior to the change in control, and the result for the Company is an annual limitation of approximately $0.2 million. At December 31, 2002, the Company had approximately $4.2 million of NOL carryforwards available. On the 2003 tax return, the Company deducted $0.5 million of NOL carryforwards to offset income earned after the change in control, and offset income earned prior to the change in control by the $0.2 million limitation amount, resulting in a $3.5 million NOL carryforward at December 31, 2003. In 2004, the Company generated a net operating loss for US tax purposes of $8.1 million due to the intercompany bad debt deduction from the Company's subsidiaries in Asia (See Note 7 of the Consolidated Financial Statements and "Intercompany Bad Debt" below). Under Section 382, $0.2 million of the Company's pre-2003 NOLs expired, resulting in a NOL carryforward balance of $11.4 million at December 31, 2004.
Foreign Tax Credits
At December 31, 2003, the Company had approximately $2.3 million in FTC carryovers, of which $1.5 million expired in 2003 with the remaining $0.8 million expiring in 2005. Due to the lack of foreign source taxable income in 2003, the Company was unable to utilize its FTC carryovers. To avoid losing the FTC carryovers, the Company converted all but $3,000 of the FTC carryovers to tax deductions and carried them back to prior year returns, generating a tax benefit of approximately $34,000, which was recorded during the first quarter of 2004. The remaining FTC carryovers of $3,000 were unable to be utilized and expired on December 31, 2004.
Intercompany Bad Debt
The Company has wholly-owned subsidiaries in Europe and Asia. The subsidiaries in Asia consist of entities in Singapore, China and Hong Kong. The Singapore entity maintained revenue through 2001
and employees through 2003. Similarly, the China entity maintained employees and revenue into 2003. Revenue in these entities was generated by US employees who traveled overseas to perform the work. The Asia subsidiaries were charged, via intercompany accounts, a daily rate for services performed by US employees, plus actual travel costs at no markup. In addition, royalties were accrued to the US parent Company, via intercompany accounts, for use of intellectual property in the performance of such services. Due to a lack of revenue sufficient to support operations in Singapore and China, the intercompany balances owed to the US parent company were $2.3 million from the Singapore entity and $1.2 million from the China entity. During 2003, the Company determined the entities were no longer efficient and substantially liquidated both entities in 2003, resulting in a $3.5 million bad debt deduction on the Company's 2003 US tax return.
The Company's Hong Kong entity substantially completed its only program during 2004 and had no contracts for future revenue; therefore, management decided in 2004 to close the Hong Kong entity. Intercompany accounts had been used to transact business with the US parent Company, as described above, and upon substantial liquidation of the Hong Kong entity at December 31, 2004, the intercompany account balance of $10.1 million was deemed uncollectible. Therefore, in 2004 the US parent company recorded bad debt expense of $10.1 million and conversely, the Hong Kong entity recorded debt forgiveness income in the same amount.
Due to the bad debt deduction described above, the Company recorded no US federal income tax expense in 2004. NOL carryforwards in Hong Kong were available to offset the debt forgiveness income; therefore, no income tax was accrued for Hong Kong. However, the company did provide for $68,000 for US state income taxes due to franchise fees and other minimum taxes and fees levied by certain states in spite of net operating losses for the year.
2003 Compared to 2002
Revenue
During the first quarter of 2002, the Company adopted a FASB announcement that requires certain reimbursements received for out-of-pocket expense incurred be classified in the income statement as revenue. The Company has presented revenue in two components: consulting revenue before reimbursements and reimbursements. Reimbursements reclassified to revenue for the years ended December 31, 2003, 2002 and 2001 were $0.6 million, $1.5 million and $7.7 million, respectively. In addition, cost of sales has also been presented in two components: cost of sales before reimbursable expenses and reimbursable expenses.
Revenue decreased $2.8 million, or 8% to $30.4 million in 2003, from $33.2 million in 2002. Fixed fee revenue was $29.4 million, or 97% of revenue in 2003, compared to $24.3 million, or 73% in 2002. Incentive fee revenue was $0.4 million, or 1% of revenue in 2003, compared to $7.4 million, or 22% of revenue in 2002. Reimbursements were $0.6 million, or 2% of revenue in 2003, compared to $1.5 million, or 5% of revenue in 2002.
The significant decrease in incentive fee revenue relates to the completion of major incentive based contracts in 2002, which were not replaced with similar incentive type contract arrangements in 2003.
North America region revenue increased $12.8 million, or 90%, to $27.1 million in 2003, from $14.3 million in 2002. $11.0 million of the increase, or 86%, was attributable to United States government contracts. The remaining $1.8 million, or 14%, was from commercial clients in the United States and Canada.
Europe region revenue decreased $14.4 million, or 99%, to $0.1 million in 2003, from $14.5 million in 2002. The decrease is primarily attributable to the significant decline in the European economy, which adversely affected the Company's ability to secure contracts. In 2002 the completion of a
significant contract that produced revenue of $13.0 million was not replaced with contracts of a similar magnitude in 2003. In addition, the Company's German subsidiary, which was placed in insolvency during 2002, reflected a $1.3 million decrease in revenue when compared to 2002.
Asia/Pacific region revenue decreased $1.1 million, or 26%, to $3.2 million in 2003, from $4.3 million in 2002. The decrease is attributable to the 2002 completion of a program that contributed $2.4 million to revenue in 2002, offset by $1.3 million in new programs signed in 2003.
Gross Profit
Despite decreased revenues, gross profit for 2003 increased to $14.8 million and 49% of revenue, from $11.4 million and 34% of revenue in 2002. The improvement in gross profit is primarily attributable to direct labor cost reductions achieved as a result of salary reductions and the unpaid furlough of inactive employees not assigned to programs. In addition, travel and telecommunications costs were reduced.
Selling, General and Administrative
Selling, general and administrative expense decreased $3.8 million, or 22%, to $13.6 million from $17.4 million in 2002. The decrease is comprised of $1.4 million reduction in selling and administrative compensation and related expenses such as travel and telecommunications, $1.5 million reduction in outside professional services such as legal, accounting, and business development consulting, $0.6 million reduction in leases of office equipment and office space, and $0.3 million in other cost reductions.
Restructuring
On June 3, 2002, the Company filed a petition with the German government for insolvency of its German subsidiary, giving the insolvency court control of the subsidiary's assets. This action was taken in response to declining revenue and cash flows from the operations of its German subsidiary during 2001 and continuing through 2002. All existing German contracts were completed in the second quarter of 2002, and the German subsidiary had no significant future prospects. On September 1, 2002, the German insolvency court appointed an official receiver for the Company's German subsidiary to take control of the subsidiary and liquidate its assets. The restructuring charge of $1.3 million, of which $1.1 million is non-cash, was recorded in 2002. In February of 2003, the Company filed a proof of claim with the insolvency court, and in September 2003 was notified that further review by the insolvency court was postponed to 2004. The Company has yet to be informed as to the determination of the assets related to its former German subsidiary by the insolvency court.
The loss from liquidation of the German subsidiary is presented in the consolidated statements of operations and consolidated statements of cash flows under the caption "Restructuring charges" and "Loss from restructuring activities," respectively. The restructuring loss of $1.3 million consists of $0.6 million of unrealized foreign currency losses, previously classified under the caption "Accumulated other comprehensive loss" on the Company's consolidated balance sheet. See Note 14 to the Company's consolidated financial statements.
Income Taxes
The Company's effective tax benefit rate for 2003 was 23%, compared to an effective tax benefit rate of 5% in 2002. The change in the Company's effective tax rate is primarily related to the reversal of an accrual related to foreign taxes.
At December 31, 2001, the Company determined, based primarily on its recent history of operating losses in the United States, that it could no longer consider the recovery of its net deferred tax assets as more likely than not. Accordingly, the Company's net deferred tax assets were reduced by a valuation allowance adjustment. While a valuation allowance is currently required for the Company's net deferred tax assets, the assets remain available for use in the future, subject to the limitations described above, to offset future income tax liabilities should sufficient amounts of United States and foreign income be generated in the carryforward period.
Consistent with the Company's position at December 31, 2001, the Company recorded no expense for income offset by NOL carryforwards previously subject to valuation reserve.
Quarterly Results
The following table sets forth certain unaudited operating results for each of the four quarters in the two years ended December 31, 2004. This information has been prepared on the same basis as the audited financial statements and, in the opinion of the Company, includes all adjustments (consisting of normal recurring adjustments) necessary for a fair presentation of the information for the periods presented. The first quarter of 2004 was restated to reflect an adjustment to a tax refund created by the carryback of net operating losses to prior years. Certain quarters prior to December 31, 2003 were restated to reflect the proper depreciation expense related to the Company's prior period adjustment due to a loss recognized on the subleasing of office space in 2001.
(a)The stock prices set forth above represent the highest and lowest sales prices per share of the Company's common stock as reported by the OTC Bulletin Board. The prices reported by the OTC Bulletin Board reflect inter-dealer prices without retail mark-up, mark-down or commissions, and may not necessarily represent actual transactions.
(b)Includes an $184,000 increase in income tax expense related to the adjustment of the carryback of foreign tax credits.
(c)Includes decrease in depreciation expense of $22,000 and $21,000 related to prior period adjustment for the quarters ended March 1, and June 30, 2003, respectively.
(d)Includes increase in depreciation expense of $43,000 related to prior period adjustment for the quarter ended September 30, 2003.
(e)Includes the reversal of $0.2 million of foreign income taxes payable.
Liquidity and Capital Resources
Cash provided by operating activities decreased $3.6 million to $0.6 million in 2004, compared to $4.2 million in 2003. The decrease in 2004 is primarily attributable to an increase in trade accounts receivable as revenue increases in the last two months of 2004 were collected in January 2005.
Net cash used in investing activities decreased $83,000 to $42,000 in 2004, from $125,000 in 2003. The decrease is a result of reduced capital expenditures in 2004. Capital expenditures in 2004 and 2003 consisted of computer hardware and software upgrades.
Net cash used in financing activities decreased $2.2 million to $2.3 million in 2004, from $4.5 million in 2003. The Company paid off its $2.8 million bank term debt during 2004, leaving only $1.4 million in subordinated term debt and an outstanding balance of $0.4 million on its $5.5 million line of credit. In 2003, the Company reduced its bank term debt $2.2 million, and reduced its line of credit $2.3 million.
In January and October of 1999, the Company announced two stock repurchase plans for up to 250,000 and 500,000 shares, respectively, to be purchased on the open market. In August 2000, the Company announced an additional stock repurchase plan of up to 750,000 shares to be purchased on the open market. During 1999, the Company purchased 289,150 shares at an average price of $8.41 per share. During 2000, the Company purchased 596,300 shares at an average price of $7.96 per share. During 2001, the Company purchased 109,100 shares at an average price of $5.11 per share. The Company has not repurchased stock since October 23, 2001 and 505,450 shares remain available to be repurchased under the plans.
Former Credit Facility with Comerica Bank
The Company has traditionally used cash flow from operations, periodically supplemented by borrowings under a bank line of credit, as its primary source of liquidity, when transferring funds among the Company's foreign subsidiaries was not efficient. Beginning in 2001, the Company experienced a significant decline in revenue related to the downturn in the economy. The economic downturn and subsequent revenue decline caused the Company not to be in compliance with certain covenants related to its then existing $15.0 million revolving credit facility, with its then senior lender, Comerica Bank. As a result, Comerica Bank, in January 2002, reduced the maximum allowable borrowings to $10.0 million, secured by the Company's assets. On March 29, 2002, Comerica Bank restructured the Company's credit facility to maximum allowable borrowings of $7.5 million, consisting of a $2.5 million revolving line of credit and a $5.0 million term note. On November 29, 2002, the credit facility was increased to $8.0 million, consisting of a $3.0 million revolving line of credit and a $5.0 million term note. The terms of the November 29, 2002 amended credit facility extended the maturity date on both the term and revolving notes to September 1, 2003. Term note installment payments and a $150,000 amendment fee, related to the March 29, 2002 amendment, were deferred until the September 1, 2003 maturity date. Pursuant to the amended credit facility, Comerica Bank received, as an amendment fee, a warrant to purchase 397,443 shares of the Company's common stock at an exercise price of $0.30 per share. On April 15, 2003, the credit facility was amended to extend the maturity date on both the term and revolving notes and payment of the $150,000 amendment fee to February 2, 2004. In addition, the April 15, 2003 amended credit facility waived all financial covenants through March 31, 2003, certain of which covenants had been breached as of and prior to that date. The Company was required to make a $1.0 million term note payment prior to April 15, 2003. Additional term note payments of $1.2 million were made during the remainder of 2003. At December 31, 2003, the Company was in violation of certain debt covenants under the credit facility, which were waived by the senior lender. On February 2, 2004, the credit facility was revised to extend the maturity date to February 28, 2005. With this revision, a $200,000 term note payment was made on February 28, 2004, and monthly payments of $100,000 were required beginning March 31, 2004.
Five payments of $100,000 each were made through July 2004, bringing the outstanding balance on the term note to $2.1 million. On August 16, 2004, the Company agreed to a credit facility with Bank
of America, N.A, at which point the Company's debt with Comerica Bank was paid in full, the related credit agreement between the Company and Comerica Bank was terminated, and Comerica Bank released all liens related to the credit agreement. The $150,000 amendment fee due to Comerica Bank was forgiven; however, the Company reimbursed Comerica Bank for $128,000 in legal fees incurred preparing amendments since 2001. As of March 23, 2005, the warrant held by Comerica Bank for 397,443 shares of the Company's common stock remains outstanding and expires November 26, 2007.
$5.5 Million Revolving Line of Credit with Bank of America, N.A.
On August 16, 2004, the Company agreed to a $5.5 million revolving line of credit with Bank of America, N.A., replacing Comerica bank as the Company's senior lender. All inventory, chattel paper, accounts, equipment and general intangibles of the Company secure the credit facility. The line of credit is subject to a borrowing base calculated as a percentage of the Company's eligible United States trade accounts receivable less than 90 days old. In addition, the credit facility provides for an "overadvance" amount of $2.2 million on August 16, 2004. The overadvance amount decreases on the 22nd day of each month by $100,000 until it reaches zero. Although the Company has not needed the overadvance amount, the available overadvance amount was $1.7 million at December 31, 2004 and $1.4 million at March 23, 2005. The credit facility matures August 21, 2006, and bears interest at the prime rate, or LIBOR plus 2.5%, if elected, to be paid monthly. The unused portion of the line of credit bears interest at an annual rate of 0.375%, paid quarterly. The Company paid $55,000 as a commitment fee to obtain the financing. The credit agreement contains financial and non-financial covenants, which if breached, could result in acceleration of amounts owed under the credit facility and the senior lender would be able to foreclose on the Company's assets. The financial covenants are tested quarterly and require the Company to:
(1)maintain a debt service coverage ratio of at least 1.25 to 1;
(2)maintain a funded debt to EBITDA ratio of 2.5 to 1 through December 31, 2004 and 1.75 to 1 thereafter; and
(3)restrict annual capital expenditures to $500,000 or less.
At December 31, 2004, the outstanding balance on the line of credit was $0.4 million, classified as a current liability, and the Company was in compliance with all of its debt covenants.
Subordinated Financing
The Company has two outstanding promissory notes, issued to its current Chairman of the Board, General John T. Chain, Jr. The notes are subordinated to the Company's senior lender, and their terms are summarized as follows:
On February 7, 2005, the Company signed an amendment to the credit facility with Bank of America, N.A. allowing, but not requiring, the Company to make regularly scheduled payments of principal of $0.1 million each month against General Chain's subordinated debt so long as the Company is not in default on any agreement with Bank of America, N.A. As of March 23, 2005, the Company has made three payments of $0.1 million each to General Chain against the subordinated note dated May 31, 2002, resulting in a balance of $0.1 million at March 23, 2005. The subordinated note dated March 29, 2002 has an outstanding balance of $1.0 million on March 23, 2005.
The Company's Liquidity Plan
The Company believes that the bank credit facility and subordinated notes provide adequate liquidity based on the Company's current growth strategies and cost control measures. The Company also believes that cash flows provided by operating activities will be sufficient to service debt payments as they become due. In the event that revenue growth exceeds anticipated levels, the Company may be required to seek additional financing.
The Company regularly evaluates its business to enhance its liquidity position. Such evaluation includes appropriate furlough of its unassigned workforce, staff reductions and the downsizing or subleasing of facilities when necessary.
The Company's performance will also be affected by prevailing economic conditions. Many of these factors are beyond the Company's control. Recent conflicts throughout the world involving the United States military could potentially have an adverse affect on the Company's liquidity due to the high concentration of United States government contracts, which could result in delays in program operations. If future cash flows and capital resources are insufficient to meet the Company's debt obligations and commitments, the Company may be forced to reduce or delay activities and capital expenditures, obtain additional equity capital or restructure or refinance its debt.
Off-Balance Sheet Arrangements
At December 31, 2004 or 2003, the Company had no obligations that would qualify to be disclosed as off-balance sheet arrangements.
Contractual Obligations
The Company has contractual obligations with various creditors for the purpose of providing working capital and financing specific assets. The Company also contracts with certain former executives in consulting arrangements designed to facilitate business development. The amounts of the Company's contractual obligations at December 31, 2004, as well as the maturity of these commitments are as follows: (amounts in thousands)
Long-term debt obligations: At December 31, 2004 the Company maintained subordinated debt of $1.4 million in the form of two subordinated notes. One subordinated note, valued at $1.0 million is due April 1, 2006. The second subordinated note is valued at $0.4 million and matures June 1, 2006. Both subordinated notes are in favor of the Company's Chairman of the Board. On February 7, 2005, the Company signed an amendment to the credit facility with Bank of America, N.A. allowing, but not requiring, the Company to make regularly scheduled payments of principal of $0.1 million each month against General Chain's subordinated debt so long as the Company is not in default on any agreement with Bank of America, N.A. As of March 23, 2005, the Company has made three payments of $0.1 million each to General Chain against the subordinated note dated May 31, 2002, resulting in a balance of $0.1 million at March 23, 2005. The subordinated note dated March 29, 2002 has an outstanding balance of $1.0 million on March 23, 2005. Although such payments are not required under the subordinated note agreement or the amendment to the senior credit facility, the Company expects to make such monthly payments from cash flows from operating activities. The Company's senior debt facility with Bank of America, N.A. is a $5.5 million revolving line of credit, classified as a current liability, and had an outstanding balance of $0.4 million at December 31, 2004.
Capital lease obligations: Capital lease obligations relate to office equipment for the Company's sales efforts in Asia.
Operating lease obligations: Operating lease obligations consist of office rental commitments for the Company's offices in Irving, Texas; Troy, Michigan; Reston, Virginia; and Hong Kong. Various equipment leases for copiers, postage meters and laptop computers are maintained under operating leases.
Purchase obligations: Consulting agreements with the Company's former CEO and former President of its Asia/Pacific region are included under this category. The consulting agreements expired in January 2005 and required the above-mentioned former employees to assist the Company with business development activities by performing duties such as maintaining prior business relationships and assisting in the development of new business prospects.
Inflation
Although the operations of the Company are influenced by general economic conditions, the Company does not believe inflation had a material effect on the results of operations during the year ended December 31, 2004. However, there can be no assurance the Company's business will not be affected by inflation in the future.
Risk Factors
The Company's revenue and operating results may fluctuate significantly from quarter to quarter, and fluctuations in operating results could cause its stock price to decline.
The Company's revenue and operating results may vary significantly from quarter-to-quarter due to a number of factors. In future quarters, operating results may be below the expectations of public market analysis or investors, and the price of its common stock may decline. Factors that could cause quarterly fluctuations include:
•the beginning and ending of significant contracts during a quarter;
•the number, size and scope of the engagements;
•incentive fee contracts can create variations in revenue levels and may cause fluctuations in quarterly results;
•the extent to which Resultants can be reassigned efficiently from one engagement to another;
•fluctuations in demand for services resulting from budget cuts, project delays, cyclical downturns or similar events, including the recent economic downturn;
•the possibility and subsequent duration of conflicts involving the United States military could cause delays in program operations related to the Company's government clients;
•clients' decisions to divert resources to other projects, which may limit clients' resources that would otherwise be allocated to services that the Company could provide; and,
•reductions in the prices of services offered by competitors.
The market in which the Company operates is competitive and actions by competitors could render its services less competitive, causing revenue and income to decline.
The ability to compete depends on a number of factors outside of the Company's control, including:
•the prices at which others offer competitive services, including aggressive price competition and discounting on individual engagements;
•the ability of competitors to undertake more extensive marketing campaigns;
•the extent, if any, to which competitors develop proprietary tools that improve their ability to compete;
•the ability of the Company's customers to perform the services themselves; and,
•the extent of competitors' responsiveness to customer needs.
The Company may not be able to compete effectively on these or other factors. If the Company is unable to compete effectively, market position, and therefore revenue and profitability, could decline.
The Company must continually enhance its services to meet the changing needs of its customers or face the possibility of losing future business to competitors.
Future success will depend upon the Company's ability to enhance existing services and to introduce new services to meet the requirements of customers in a rapidly developing and evolving market. Present or future services may not satisfy the needs of the market. If the Company is unable to anticipate or respond adequately to its customers' needs, lost business may result and financial performance could suffer.
International business exposes the Company to various foreign statutory requirements, which could interfere with business or operations and could result in increased expenses and declining profitability.
International operations create special risks, including:
•statutory requirements, which may impair the Company's ability to expatriate foreign profits to help fund domestic operations;
•greater difficulties in managing and staffing foreign operations;
•cultural differences that adversely affect utilization;
•unexpected changes in trading policies, legal and regulatory requirements, tariffs and other foreign taxes;
•greater difficulties in enforcing agreements with clients and collecting accounts receivable;
•the tax system of foreign countries, which may tax the Company's foreign income at higher rates than in the United States and may subject foreign earnings to withholding requirements or tariffs, exchange controls or other restrictions;
•legal requirements and regulations of various foreign countries, which may make compliance by the Company with such laws and regulations difficult and may make enforcement of the Company's intellectual property rights more difficult; and,
•fluctuations in currency exchange rates, which may affect demand for the Company's services and may adversely affect the profitability in United States dollars of services provided by the Company in foreign markets where payment for its services is made in the local currency; and general economic conditions in the foreign countries in which the Company operates, which could have an adverse impact on its earnings from operations in those countries.
The Company is dependent on a limited number of key personnel, and the loss of these individuals could harm its competitive position and financial performance.
The Company's business consists primarily of the delivery of professional services and, accordingly, its success depends upon the efforts, abilities, business generation capabilities and project execution of its executive officers and Resultants. The Company's success is also dependent upon the managerial, operational and administrative skills of its executive officers. The loss of any executive officer or key Resultant or group of Resultants, 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 revenue, and could therefore harm the Company's financial performance.
If the Company fails to perform effectively on project engagements, its reputation, and therefore its competitive position and financial performance, could be harmed.
Many of the Company's engagements come from existing clients or from referrals by existing clients. Therefore, growth is dependent on the Company's reputation and on client satisfaction. The failure to perform services that meet a client's expectations may damage the Company's reputation and harm its ability to attract new business. Damage to the Company's reputation arising from client dissatisfaction could therefore harm financial performance.
Inability to protect intellectual property could harm the Company's competitive position and financial performance.
Despite efforts to protect proprietary rights from unauthorized use or disclosure, parties, including former employees or consultants, may attempt to disclose, obtain or use the Company's solutions or technologies. The steps the Company has taken may not prevent misappropriation of solutions or technologies, 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 proprietary information could make the Company's solutions and methodologies available to others and harm its competitive position.
The terms of the Company's debt contain a number of restrictive covenants, which restrict its flexibility and which, if breached, could result in acceleration of amounts owed.
The credit facility contains covenants that limit the Company's flexibility. These covenants could materially and adversely affect the ability to finance future operations or capital needs or to engage in other business activities that may be in the best interest of the Company. The covenants limit the ability to, among other things:
•encumber assets;
•raise new debt;
•merge, consolidate or dispose of a substantial part of assets;
•engage in acquisitions, make loans, extend guarantees or enter into other investments; and,
•incur indebtedness.
The credit facility also contains covenants concerning the maintenance of minimum levels of debt service coverage, adhere to minimum ratios of funded debt to EBITDA, and restrictions on annual capital expenditures. The Company's ability to comply with these covenants may be affected by events beyond the Company's control, and it cannot be sure that it will be able to comply. A breach of any of these covenants could result in a default under the credit facility and, potentially, an acceleration of the obligation to repay the amounts owed.
"Safe Harbor" Statement Under The Private Securities Litigation Reform Act:
Certain information contained in this report constitutes "forward-looking statements." Forward-looking statements are those that use the words such as "believe," "expect," "anticipate," "intend," "plan," "may," "will," "likely," "should," "estimate," "continue," "future" or the negative thereof, other variations thereon or other comparable expressions. These words indicate future events and trends. Forward-looking statements are the Company's current views with respect to future events and financial performance. These forward-looking statements are subject to many assumptions, risks and uncertainties that could cause actual results to differ significantly from historical results or from those anticipated by the Company. It is advisable not to place undue reliance on the Company's forward-looking statements. The Company undertakes no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events, or otherwise. The most significant risks are detailed from time to time in the Company's filings and reports with the Securities and Exchange Commission including this Annual Report on Form 10-K and the following:
•The competitive nature of the management consulting industry, in light of new entrants into the industry and the difficulty of differentiating the services offered to potential clients;
•The time required by prospective clients to fully understand the value and complexity of a typical PVM program may result in an extended lead time to close new business;
•Performance-oriented fees are earned upon the achievement of improvements in a client's business. The client's commitment to a PVM program and general economic/industry conditions could impact a client's business performance and consequently the Company's ability to forecast the timing and ultimate realization of performance-oriented fees;
•The ability of the Company to productively re-deploy personnel during program transition periods; and,
•The ability of the Company to create alliances and make acquisitions that is accretive to earnings.
ITEM 7A.
ITEM 7A. Quantitative and Qualitative Disclosure About Market Risk.
The Company invests cash balances in excess of operating requirements in short-term securities, generally with maturities of 90 days or less. The Company's credit agreement provides for borrowings, which bear interest at the prime rate, or LIBOR plus 2.5%, if elected. Since January 1, 1994, the prime rate has fluctuated between 9.5% and 4% and the 1-year LIBOR rate has fluctuated between 7.75% and 1.2%. Based on the volatility of the prime rate in recent years, a five-percentage point increase in interest rates would have resulted in $123,000 of additional interest expense in 2004. The Company had borrowings on its revolving line of credit from time to time during 2004, with $0.4 million outstanding at December 31, 2004. Through March 23, 2005, the Company had $2.7 million in borrowings and $3.1 million in repayments on its revolving line of credit. The outstanding balance at March 23, 2005 was $0.
Due to the Company's foreign operations in Europe and Asia, the Company is exposed to transaction adjustments with respect to foreign currency. The Company's functional currency is the United States dollar. Under United States dollar functional currency, the financial statements of foreign subsidiaries are remeasured from the recording currency to the United States dollar. The resulting remeasurement adjustment is recorded as foreign exchange gain or loss in the statement of operations. There is no translation adjustment to the separate component of stockholders' equity or adjustment to comprehensive income. The Company incurred foreign exchange losses of $8,000 and $3,000 for the years ended December 31, 2004 and 2003, respectively. At December 31, 2004, the effect of a 10% increase in foreign exchange rates would have resulted in a $17,000 foreign currency exchange loss on the Company's non-United States denominated assets and a $10,000 foreign exchange gain on the Company's non-United States denominated liabilities. As such, the net effect of a 10% increase in the Company's foreign exchange rates, at December 31, 2004, would have been a $7,000 foreign currency exchange loss. The Company believes that operating under United States dollar functional currency, combined with transacting business in countries with traditionally stable currencies mitigates the effect of any near-term foreign currency transaction adjustments on the Company's financial position, results of operations and cash flows.
The Company has not engaged in foreign currency hedging transactions nor does the Company have any derivative financial instruments. However, going forward, the Company will assess the need to enter into hedging transactions to limit its risk due to fluctuations in exchange rates.
ITEM 8.
ITEM 8. Financial Statements and Supplementary Data.
See Index to Consolidated Financial Statements on page. Supplementary quarterly financial information for the Company is included in Item 7, "Management's Discussion and Analysis of Financial Condition and Results of Operations."
ITEM 9.
ITEM 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure.
Not applicable.
ITEM 9A.
ITEM 9A. Controls and Procedures.
Based on the evaluation of the Company's disclosure controls and procedures as of the end of the period covered by this annual report, James T. Taylor, the Chief Executive Officer, President, Secretary and Chief Financial Officer, has concluded that, in his judgment, the Company's disclosure controls and procedures are effective to ensure that information required to be disclosed by the Company, including the Company's subsidiaries, in the reports it files, or submits under the Securities Exchange Act of
1934, as amended, is recorded, processed, summarized, and reported within the time periods specified in the Securities and Exchange Commission's rules and forms. Management necessarily applied its judgment in assessing the costs and benefits of such controls and procedures, which, by their nature, can provide only reasonable assurance regarding management's control objectives. The design of any system of controls and procedures is based in part upon certain assumptions about the likelihood of future events. There can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions, regardless of how remote.
Extension of Compliance Date for Management's Report on Internal Control Over Financial Reporting
The Company is a non-accelerated filer as defined in Rule 12b-2 of the Act. On March 2, 2005, the Securities and Exchange Commission extended the compliance dates for non-accelerated filers concerning the provisions of Exchange Act Rule 13a-15(d) or 15d-15(d), whichever applies, requiring an evaluation of changes to internal control over financial reporting requirements with respect to the company's first periodic report due after the first annual report that must include management's report on internal control over financial reporting. A company that is a non-accelerated filer must begin to comply with these requirements for its first fiscal year ending on or after July 15, 2006. In addition, the compliance period was extended to the amended portion of the introductory language in paragraph 4 of the certification required by Exchange Act Rules 13a-14(a) and 15d-14(a) that refers to the certifying officers' responsibility for establishing and maintaining internal control over financial reporting for the company, as well as paragraph 4(b). The amended language must be provided in the first annual report required to contain management's internal control report and in all periodic reports filed thereafter. The extended compliance dates also apply to the amendments of Exchange Act Rules 13a-15(a) and 15d-15(a) relating to the maintenance of internal control over financial reporting.
Under the internal control reporting provisions of the Act, Management will be responsible for establishing and maintaining adequate internal control over financial reporting as defined in Rule 13a-15(f) under the Exchange Act. Internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with accounting principles generally accepted in the United States of America.
The Company's internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the Company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the Company are being made only in accordance with authorizations of management and directors of the Company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the Company's assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
Prior to the extended deadline in 2006, management will conduct an evaluation of the effectiveness of internal control over financial reporting based on the framework in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on this evaluation, management will determine whether the Company's internal control over financial reporting is effective. Management's assessment of the effectiveness of the Company's internal control
over financial reporting will be audited by an independent registered public accounting firm and stated in their report which will be included in the Company's Form 10-K filing.
There were no significant changes in the Company's internal controls or in other factors that could significantly affect these controls subsequent to the date of their evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.
ITEM 9B.
ITEM 9B. Other Information.
There was no information required to be disclosed in a report on Form 8-K in the fourth quarter of 2004 which was not reported.
PART III
ITEM 10.
ITEM 10. Directors and Executive Officers of the Registrant.
The information relating to the Company's directors and nominees for election as directors, and the information relating to executive officers of the Company, is incorporated herein by reference from the Company's Proxy Statement for its 2005 Annual Meeting of Stockholders, which will be filed within 120 days of December 31, 2004.
Section 16(a) Beneficial Ownership Reporting Compliance
Section 16(a) of the Securities Exchange Act of 1934 requires certain officers and directors, and any persons who own more than ten-percent of the common stock outstanding to file forms reporting their initial beneficial ownership of shares and subsequent changes in that ownership with the Securities and Exchange. Based solely on a review of the copies of the forms furnished to the Company, or written representations from certain reporting persons that no Forms 5 were required, the Company believes that during the 2004 fiscal year we complied with all section 16(a) filing requirements except that there was one late filing of Form 4 by James T. Taylor for two transactions occurring in 2001 included on Form 4 filed August 2, 2004.
Additional information required by Item 10, including information regarding the Company's audit committee financial expert, is incorporated herein by reference to such information as set forth in the Company's definitive Proxy Statement for our 2005 Annual Meeting of Stockholders to be held on June 29, 2005. The Company has made available free of charge on its Internet Web Site (http://www.thomasgroup.com) the Code of Business Conduct and Ethics applicable to all employees of the Company including the chief executive officer, chief financial officer and principal accounting officer. The Company will make immediate disclosure by a current report on Form 8-K and on its web site of any change to, or waiver from, the Code of Business Conduct and Ethics for principal executive and senior financial officers of the Company. The Company will also provide to any person without charge, upon request, a copy of such code of ethics. Please send your written request to: Thomas Group, Attn: CFO, 5221 N. O'Connor Blvd, Suite 500, Irving, TX 75039.
ITEM 11.
ITEM 11. Executive Compensation.
The discussion under "Executive Compensation" in the Company's Proxy Statement for its 2005 Annual Meeting is incorporated herein by reference.
ITEM 12.
ITEM 12. Security Ownership of Certain Beneficial Owners and Management.
The discussion under "Security Ownership of Certain Beneficial Owners and Management" in the Company's Proxy Statement for its 2005 Annual Meeting is incorporated herein by reference.
The following table provides information related to the number of shares to be issued upon exercise of all outstanding options, warrants and rights and the number of shares available for future issuance under the Company's equity compensation plans at December 31, 2004.
EQUITY COMPENSATION PLAN INFORMATION
(1)These plans include the Thomas Group, Inc. 1988, 1992 and 1997 Stock Option Plans and the Non-Employee Director Plan.
(2)The number of shares is subject to adjustments for changes resulting from stock dividends, stock splits, recapitalizations and similar events.
ITEM 13.
ITEM 13. Certain Relationships and Related Transactions.
The discussion under "Certain Transactions" in the Company's Proxy Statement for its 2005 Annual Meeting is incorporated herein by reference.
ITEM 14.
ITEM 14. Principal Accounting Fees and Services.
The discussion under "Principal Accounting Fees and Services" in the Company's Proxy Statement for its 2005 Annual Meeting is incorporated herein by reference.
PART IV
ITEM 15.
ITEM 15. Exhibits, Financial Statement Schedules, and Reports on Form 8-K.
(a)(1) See "Index to Consolidated Financial Statements" on page of this Annual Report on Form 10-K.
(a)(2) The financial statement schedules required by this item are included in the accompanying notes to the consolidated financial statements beginning on page of this Annual Report on Form 10-K.
(a)(3) Documents filed as part of this Annual Report on Form 10-K are listed sequentially by subsection in the following Exhibit Index.
Exhibit
Number
Description
3.1
Amended and Restated Certificate of Incorporation of the Company filed August 13, 1993, with the State of Delaware Office of the Secretary of State (filed as Exhibit 3.1 to the Company's Annual Report on Form 10-K for the year ended December 31, 1994 and incorporated herein by reference).
3.2
Amended and Restated By-Laws dated May 30, 2001 (filed as Exhibit 3.2 to the Company's Quarterly Report on Form 10-Q for the quarter ended June 30, 2001 and incorporated herein by reference).
4.1
Specimen Certificate evidencing Common Stock (filed as Exhibit 4.1 to the Company's 1993 Form S-1 (file No. 33-64492) and incorporated herein by reference).
4.2
Rights Agreement dated July 9, 1998 (filed as Exhibit 4 to the Company's Report on Form 8-K dated July 16, 1998 and incorporated herein by reference).
4.3
Amendment No. 1 to Rights Agreement dated March 1, 1999 (filed as Exhibit 4.4 to the Company's Annual Report on Form 10-K for the year ended December 31, 1998 and incorporated herein by reference).
4.4
Amendment No. 2 to Rights Agreement dated August 12, 1999 (filed as Exhibit 4.5 to the Company's Quarterly Report on Form 10-Q for the quarter dated June 30, 1999 and incorporated herein by reference).
4.5
Warrant to Purchase Common Stock, dated September 20, 2002, issued to John T. Chain, Jr. (filed as Exhibit 99.3 to the Company's Form 8-K dated October 3, 2002 and incorporated herein by reference).
4.6
Registration Rights Agreement, dated September 20, 2002, by and between the Company and John T. Chain, Jr. (filed as Exhibit 99.4 to the Company's Form 8-K dated October 3, 2002 and incorporated herein by reference).
4.7
First Amendment to Rights Agreement, dated September 13, 2002, between the Company and Computershare Trust Company, as rights agent (filed as Exhibit 99.7 to the Company's Form 8-K dated October 3, 2002 and incorporated herein by reference).
4.8
Warrant to Purchase Common Stock, dated October 17, 2002, issued to Edward P. Evans (filed as Exhibit 99.3 to the Company's Form 8-K/A dated October 22, 2002 and incorporated herein by reference).
4.9
Registration Rights Agreement, dated October 17, 2002, by and between the Company and Edward P. Evans (filed as Exhibit 99.4 to the Company's Form 8-K/A dated October 22, 2002 and incorporated herein by reference).
4.10
Second Amendment to Rights Agreement, dated October 17, 2002, between the Company and Computershare Trust Company, as rights agent (filed as Exhibit 99.7 to the Company's Form 8-K/A dated October 22, 2002 and incorporated herein by reference).
4.11
Amended and Restated Warrant, dated October 17, 2002, issued to John T. Chain, Jr. (filed as Exhibit 99.9 to the Company's Form 8-K/A dated October 22, 2002 and incorporated herein by reference).
10.1
Amended and Restated 1988 Stock Option Plan 9 (filed as Exhibit 10.2 to the Company's Annual Report on Form 10-K for the year ended December 31, 1998 and incorporated herein by reference).
10.2
Amended and Restated 1992 Stock Option Plan (filed as Exhibit 10.3 to the Company's Annual Report on Form 10-K for the year ended December 31, 1998 and incorporated herein by reference).
10.3
Amended and Restated 1997 Stock Option Plan (filed as Exhibit 10.4 to the Company's Annual Report on Form 10-K for the year ended December 31, 1998 and incorporated herein by reference).
10.4
Thomas Group, Inc. 401(k) Savings Plan (filed as Exhibit 10.5 to the Company's Annual Report on Form 10-K for the year ended December 31, 1998 and incorporated herein by reference).
10.5
First Amended and Restated Revolving Credit Loan Agreement dated December 4, 1996 between Comerica Bank-Texas and the Company (filed as Exhibit 10.6 to the Company's Annual Report on Form 10-K for the year ended December 31, 1998 and incorporated herein by reference).
10.6
Non-Employee Director Retainer Fee Plan (filed as Exhibit 10.12 to the Company's Annual Report on Form 10-K for the year ended December 31, 1998 and incorporated herein by reference).
10.7
Amendment No. 1 to Revolving Loan Agreement, dated April 1, 1999 between Comerica Bank-Texas and the Company (filed as Exhibit 10.14 to the Company's Quarterly Report on Form 10-Q for the quarter ended June 30, 1999 and incorporated herein by reference).
10.8
Employment Agreement between the Company and John R. Hamann dated January 12, 2001 (filed as Exhibit 10.1 to the Company's Quarterly Report on Form 10-Q for the quarter ended March 31, 2001 and incorporated herein by reference).
10.9
Third Amendment to First Amended and Restated Revolving Credit loan Agreement, dated March 29, 2002 between Comerica Bank-Texas and the Company (filed as Exhibit 10.8 to the Company's Form 8-K dated April 18, 2002 and incorporated herein by reference).
10.10
Promissory Note between John T. Chain, Jr. and the Company dated March 29, 2002, (filed as Exhibit 10.9 to the Company's Annual Report on Form 10-K for the year ended December 31, 2001 and incorporated herein by reference).
10.11
Promissory Note between John R. Hamann and the Company dated March 29, 2002, (filed as Exhibit 10.11 to the Company's Annual Report on Form 10-K for the year ended December 31, 2001 and incorporated herein by reference).
10.12
Promissory Note between John T. Chain. Jr. and the Company dated May 31, 2002, (filed as Exhibit 10.12 to the Company's Annual Report on Form 10-K for the year ended December 31, 2002 and incorporated herein by reference).
10.13
Note and Warrant Purchase Agreement, dated September 20, 2002, by and between the Company and General Chain (filed as Exhibit 99.1 to the Company's Form 8-K dated October 3, 2002 and incorporated herein by reference).
10.14
6% Subordinated Convertible Promissory Note, dated September 20, 2002, issued to John T. Chain, Jr. in the principal amount of $1,000,000 (filed as Exhibit 99.2 to the Company's Form 8-K dated October 3, 2002 and incorporated herein by reference).
10.15
Subordination Agreement, dated September 20, 2002, by and among the Company, John T. Chain, Jr. and Comerica Bank-Texas (filed as Exhibit 99.5 to the Company's Form 8-K dated October 3, 2002 and incorporated herein by reference).
10.16
Amended and Restated Note and Warrant Purchase Agreement, dated October 17, 2002, by and between the Company, Edward P. Evans and John T. Chain, Jr. (filed as Exhibit 99.1 to the Company's Form 8-K/A dated October 22, 2002 and incorporated herein by reference).
10.17
6% Subordinated Convertible Promissory Note, dated October 17, 2002, issued to Edward P. Evans in the principal amount of $1,000,000 (filed as Exhibit 99.2 to the Company's Form 8-K/A dated October 22, 2002 and incorporated herein by reference).
10.18
Subordination Agreement, dated October 17, 2002, by and among the Company, Edward P. Evans and Comerica Bank-Texas (filed as Exhibit 99.5 to the Company's Form 8-K/A dated October 22, 2002 and incorporated herein by reference).
10.19
Waiver and Consent Agreement, dated October 17, 2002, by and among Edward P. Evans, John T. Chain, Jr. and the Company (filed as Exhibit 99.8 to the Company's Form 8-K/A dated October 22, 2002 and incorporated herein by reference).
10.20
Second Amended and Restated Revolving Credit loan Agreement dated November 26, 2002 between Comerica Bank-Texas and the Company (filed as Exhibit 10.9 to the Company's Form 8-K dated December 27, 2002 and incorporated herein by reference).
10.21
Employment Agreement between the Company and John R. Hamann dated December 21, 2002, (filed as Exhibit 10.21 to the Company's Annual Report on Form 10-K for the year ended December 31, 2002 and incorporated herein by reference).
10.22
Employment Agreement between the Company and James T. Taylor dated December 21, 2002, (filed as Exhibit 10.22 to the Company's Annual Report on Form 10-K for the year ended December 31, 2002 and incorporated herein by reference).
10.23
First Amendment to Second Amended and Restated Revolving Credit Loan Agreement dated April 15, 2003 between Comerica Bank-Texas and the Company, (filed as Exhibit 10.23 to the Company's Annual Report on Form 10-K for the year ended December 31, 2002 and incorporated herein by reference).
10.24
Consulting Agreement between the Company and John R. Hamann dated December 31, 2003 (filed as Exhibit 10.24 to the Company's Annual Report on Form 10-K for the year ended December 31, 2003 and incorporated herein by reference).
10.25
Consulting Agreement by and between the Company, Asian Consulting Resources, Ltd. and G. Toby Marion dated February 19, 2004 (filed as Exhibit 10.25 to the Company's Annual Report on Form 10-K for the year ended December 31, 2003 and incorporated herein by reference).
10.26
Severance Agreement between the Company and G. Toby Marion dated February 19, 2004 (filed as Exhibit 10.26 to the Company's Annual Report on Form 10-K for the year ended December 31, 2003 and incorporated herein by reference).
10.27
Appreciation Rights Agreement between the Company and James T. Taylor dated December 13, 2003 (filed as Exhibit 10.27 to the Company's Annual Report on Form 10-K for the year ended December 31, 2003 and incorporated herein by reference).
10.28
Appreciation Rights Agreement between the Company and John R. Hamann dated December 12, 2003 (filed as Exhibit 10.28 to the Company's Annual Report on Form 10-K for the year ended December 31, 2003 and incorporated herein by reference).
10.29
Consulting Agreement between the Company and John T. Chain, Jr. dated February 5, 2004 (filed as Exhibit 10.29 to the Company's Annual Report on Form 10-K for the year ended December 31, 2003 and incorporated herein by reference).
10.30
Employment Agreement between the Company and Jimmy C. Houlditch dated August 12, 2003 (filed as Exhibit 10.30 to the Company's Annual Report on Form 10-K for the year ended December 31, 2003 and incorporated herein by reference).
10.31
Second Amendment to Second Amended and Restated Revolving Credit Loan Agreement dated February 2, 2004 between Comerica Bank and the Company (filed as Exhibit 10.31 to the Company's Annual Report on Form 10-K for the year ended December 31, 2003 and incorporated herein by reference).
10.32
Loan Agreement dated July 21, 2004 between Bank of America, N.A. and the Company (filed as Exhibit 99.1 to the Company's Form 8-K dated August 20, 2004 and incorporated herein by reference).
*10.33
Amendment No. 1 dated February 7, 2005 between Bank of America, N.A. and the Company.
*10.34
Second Amended Employment Agreement between the Company and James T. Taylor dated February 14, 2005.
*10.35
Amended Employment Agreement between the Company and Jimmy C. Houlditch dated March 28, 2005.
14.1
Code of Ethics (filed as Exhibit 14.1 to the Company's Annual Report on Form 10-K for the year ended December 31, 2003 and incorporated herein by reference).
*21
Subsidiaries of the Company.
*23
Consent of Hein & Associates LLP.
*23.1
Consent of Ernst & Young LLP.
Power of Attorney (set forth on page 33 of this Annual Report on Form 10-K).
*31.1
Certification pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
*32.1
Certification pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
*Filed herewith
(b)Reports on Form 8-K for the quarter ending December 31, 2004:
Date of Filing
Subject
October 19, 2004
Thomas Group, Inc. Third Quarter Earnings Release dated October 18, 2004 (such press release is not incorporated by reference herein or deemed "filed" within the meaning of Section 18 of the Securities Act of 1933, as amended).
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Company has duly caused this Form 10-K to be signed on its behalf by the undersigned, thereunto duly authorized, in the City of Irving, State of Texas, on March 30, 2005.
THOMAS GROUP, INC.
By:
/s/ JAMES T. TAYLOR James T. Taylor
Chief Executive Officer, President,
Secretary, and Chief Financial Officer
POWER OF ATTORNEY
Each individual whose signature appears below constitutes and appoints James T. Taylor such person's true and lawful attorneys-in-fact and agents with full power of substitution and resubstitution, for such person and in such person's name, place, and stead, in any and all capacities, to sign any and all amendments to this Form 10-K and to file the same with all exhibits thereto, and all documents in connection therewith, with the Securities and Exchange Commission, granting unto such attorneys-in-fact and agents, and each of them, full power and authority to do and perform each and every act and thing requisite and necessary to be done in and about the premises, as fully to all intents and purposes as such person might or could do in person, hereby ratifying and confirming all that such attorneys-in-fact and agents or any of them, or their substitute or substitutes, may lawfully do or cause to be done by virtue hereof.
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, this Form 10-K has been signed by the following persons on behalf of the Registrant in the capacities and on the dates indicated.
Signature
Capacity
Date
/s/ JAMES T. TAYLOR James T. Taylor
Chief Executive Officer, President, Secretary and Chief Financial Officer
March 30, 2005
/s/ JIMMY C. HOULDITCH Jimmy C. Houlditch
Vice President, Director, President of North America Operations
March 30, 2005
/s/ JOHN T. CHAIN, JR. John T. Chain, Jr.
Chairman of the Board
March 30, 2005
/s/ EDWARD P. EVANS Edward P. Evans
Director
March 30, 2005
/s/ RICHARD A. FREYTAG Richard A. Freytag
Director
March 30, 2005
/s/ CHARLES M. HARPER Charles M. Harper
Director
March 30, 2005
/s/ DAVID B. MATHIS David B. Mathis
Director
March 30, 2005
ANNUAL REPORT ON FORM 10-K
ITEM 8, and 15(a)(1) and (c)
LIST OF FINANCIAL STATEMENTS
CERTAIN EXHIBITS
FINANCIAL STATEMENTS
YEAR ENDED DECEMBER 31, 2004
THOMAS GROUP, INC.
IRVING, TEXAS
FORM 10-K-ITEM 15(a)(1)
Thomas Group, Inc.
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
The following consolidated financial statements of Thomas Group, Inc. are included in response to Item 8:
Reports of Independent Registered Public Accounting Firms
Consolidated Balance Sheets as of December 31, 2004 and 2003
Consolidated Statements of Operations for the fiscal years ended December 31, 2004, 2003 and 2002
Consolidated Statements of Stockholders' Equity (Deficit) for the fiscal years ended December 31, 2004, 2003 and 2002
Consolidated Statements of Cash Flows for the fiscal years ended December 31, 2004, 2003 and 2002
Notes to Consolidated Financial Statements
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Stockholders
Thomas Group, Inc.
Dallas, TX
We have audited the accompanying consolidated balance sheets of Thomas Group, Inc. as of December 31, 2004 and 2003, and the related consolidated statements of operations, stockholders' equity (deficit) and cash flows for the years then ended. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audit.
We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provided a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Thomas Group, Inc. at December 31, 2004, and 2003 and the consolidated results of operations and cash flows of Thomas Group, Inc. for the years then ended, in conformity with U.S. generally accepted accounting principles.
/s/ HEIN & ASSOCIATES LLP
Dallas, Texas
February 16, 2005
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
Board of Directors and Stockholders
Thomas Group, Inc.
We have audited the consolidated balance sheet of Thomas Group, Inc. (the Company) (not presented herein) and the accompanying related consolidated statements of operations, stockholders' equity and cash flows for the year ended December 31, 2002. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audit.
We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Thomas Group, Inc. at December 31, 2002 and the consolidated results of its operations and its cash flows for the year then ended, in conformity with accounting principles generally accepted in the United States.
As described in Note 1(v), the Company has restated its financial statements for the year ended December 31, 2002 for the correction of an error involving the overstatement of leasehold improvements.
ERNST & YOUNG, LLP
Dallas, Texas
March 7, 2003, except for Note 2 as to which
the date is April 15, 2003
THOMAS GROUP, INC. CONSOLIDATED BALANCE SHEETS
See accompanying notes to consolidated financial statements.
THOMAS GROUP, INC. CONSOLIDATED STATEMENTS OF OPERATIONS
See accompanying notes to consolidated financial statements.
THOMAS GROUP, INC. CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIT)
See accompanying notes to consolidated financial statements.
THOMAS GROUP, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS
See accompanying notes to consolidated financial statements.
THOMAS GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 2004
Note 1 Summary Of Significant Accounting Policies
(a) The Company-Thomas Group, Inc. (the "Company") was incorporated under the laws of the State of Delaware in June 1978 and provides management services designed to improve the competitiveness and profitability of its clients. The Company's specific methodology in its core product is known as PVM and focuses on reducing the time spent on revenue-producing, product development and administrative processes, resulting in operational and financial improvements.
(b) Basis Of Presentation-The accompanying consolidated financial statements include the accounts of the Company and its wholly owned subsidiaries. All significant intercompany transactions and balances have been eliminated. Certain amounts from prior years have been reclassified to conform to the 2004 presentation.
(c) Earnings Per Share-Earnings (loss) per common share is presented in accordance with the provisions of the Statement of Financial Accounting Standards No. 128, "Earnings Per Share" (SFAS 128), which requires the presentation of "basic" and "diluted" earnings per share. Basic earnings (loss) per share is based on the weighted average shares outstanding. Diluted earnings (loss) per share includes the effect of dilutive securities such as stock options and warrants.
The following table reconciles basic earnings per share to diluted earnings per share under the provisions of SFAS 128.
Total stock options and warrants outstanding in 2004, 2003 and 2002 that are not included in the diluted earnings per share computation due to their antidilutive effects are approximately 1,313,000, 1,931,000, and 2,532,000, respectively. Such options and warrants are excluded due to exercise prices exceeding the average market value of the Company's common stock in 2004 and 2003, and due to the Company incurring a net loss in 2002.
(d) Management's Estimates And Assumptions-The presentation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. The Company reviews all significant estimates affecting the financial statements on a recurring basis and records the effect of any necessary adjustments prior to their issuance.
(e) Warrants-During 2002, the Company executed a Warrant Purchase Agreement exercisable for 434,899 shares of common stock to General John T. Chain, Jr., Chairman of its Board of Directors, in consideration for a note in the amount of $1.0 million. The warrants were issued with an exercise price of $0.30 per share and an expiration date of September 20, 2007. These warrants were valued at $0.30 based on the Black Scholes model. On February 16, 2005 General Chain exercised his outstanding warrants in full. The Company received the purchase price from General Chain, and on February 23, 2005, the Company issued 434,899 shares of unregistered common stock to General Chain. A Warrant Purchase Agreement exercisable for 434,899 shares of common stock was also granted during 2002 to Mr. Edward P. Evans, a stockholder, in consideration for a note in the amount of $1.0 million. The warrants were issued with an exercise price of $0.30 per share and an expiration date of October 17, 2007. These warrants were valued at $0.30 based on the Black Scholes model. On February 14, 2005, Mr. Edward P. Evans exercised his outstanding warrants in full. The Company received the purchase price from Mr. Evans, and on February 23, 2005 the Company issued 434,899 shares of unregistered common stock to Mr. Evans.
On November 26, 2002, a Warrant Purchase Agreement exercisable for 397,443 shares of common stock was granted to Comerica Bank, the Company's former senior lender, in consideration for amending its credit facility. The warrants were issued with an exercise price of $0.30 and expire November 26, 2007. These warrants were valued at $0.37 based on the Black Scholes model and remain outstanding at March 23, 2005.
The total fair value of the warrants issued in 2002 was allocated between the warrants and the related debt based on the relative fair value of each. The portion attributable to the warrants was $284,000 and initially recorded as a reduction, or "discount," of the related debt and a corresponding increase in additional paid in capital. The discount was accreted to interest expense over the life of the debt. Interest expense of $99,000 and $185,000 was recorded related to these warrants in 2003 and 2002, respectively. As of December 31, 2003, the discount had been fully accreted.
During 1997, the Company issued 225,000 warrants to purchase common stock to a financial advisor of the Company. During 1998, 175,000 warrants expired. The remaining 50,000 warrants were re-priced at the exercise price of $9.125 per share, the market price on the date of re-pricing. On October 28, 2003, the remaining 50,000 warrants expired.
(f) Advertising-The Company expenses the costs of advertising as incurred. Advertising expense was $0.1 million, $0.2 million, and $0.3 million for the years ended December 31, 2004, 2003, and 2002 respectively.
(g) Property And Equipment-Property and equipment are stated at cost less accumulated depreciation. The Company records impairment losses on long-lived assets used in operations when
events and circumstances indicate that the assets might be impaired and the undiscounted cash flows estimated to be generated by those assets are less than the carrying amounts of those assets.
Depreciation is calculated on an accelerated declining balance or straight-line basis over the estimated useful lives of the various assets as follows:
(h) Capitalized Software Development Costs-The Company capitalized $0.3 million during 2002 and 2001, respectively, of certain software development costs once technological feasibility was achieved. Capitalization of software development costs ceased when the product was available for sale. Software development costs incurred prior to achieving technological feasibility were charged to selling, general and administrative expense. Amortization of previously capitalized software development costs were $0.2 million in 2004, 2003 and 2002, respectively. Unamortized software development costs were $37,000, $0.2 million and $0.4 million at December 31, 2004, 2003 and 2002, respectively. Estimated aggregate amortization expense is $37,000 for the year ending December 31, 2005.
(i) Revenue-Business Improvement Program contracts specify fixed fees, task-based or deliverable-based fees, or incentives based on improvements achieved. Revenue is recognized when realizable and earned generally as services are provided over the life of the contract. Fixed fee revenue is recognized on a percentage completion method, based on direct labor hours expended. Task-based, or deliverable based, fees are recognized when the task/deliverable is completed and delivered to the client. Incentive fee revenue is recognized in the period in which the related improvements are achieved. In order to mitigate the risk of disputes arising over the achievement of performance improvements, which drive incentive fees, the Company obtains customer agreement to these achievements prior to recognizing revenue.
(j) Unbilled Receivables-Although fixed fee revenue recognition generally coincides with billings, as an accommodation to its clients, the Company may structure fee billings to increase in the latter stages of a program. In such instances, revenues recognized for services provided are represented in unbilled receivables.
(k) Advance Payments-The Company occasionally receives advance payments of a portion of its fees. Advance payments are deferred upon receipt and recorded as revenue when earned.
(l) Income Taxes-Deferred income taxes are provided for temporary differences between the financial statement and income tax basis of assets and liabilities. Provisions are made for estimated domestic and foreign income taxes, less available tax credits and deductions, which may be incurred on the remittance of the Company's share of foreign subsidiaries' undistributed earnings.
(m) Cash And Cash Equivalents-Cash equivalents consist of highly liquid investments with original maturities of three months or less.
(n) Accounts Receivable and Allowance for Doubtful Accounts-The Company records trade receivables related to billings to its clients for consulting services. Trade receivables normally have terms of 30 to 60 days. The Company has no interest provision for trade accounts receivable that are
past due. Trade accounts receivable are considered past due when the amount due is still uncollected at the time the terms per the trade receivable have expired. An allowance for doubtful accounts is provided when necessary and is evaluated periodically on a client-by-client basis. For the years ended December 31, 2004 and 2003 there were no receivables written off against the allowance. Receivables written off against the allowance totaled $0.6 million in 2002. The allowance was increased by approximately $69,000 during 2004 as a reserve against a receivable in the Company's Swiss subsidiary. The receivable was subsequently collected in February 2005 and the reserve was reduced to reflect the collection.
(o) Concentration Of Credit Risk-The Company provides its services primarily to a diverse group of large, well-established companies and does not require collateral on receivable balances. For the year ended December 31, 2004, the Company had one client that represented approximately 48% of total revenue, and another client that represented 33% of total revenue.
The Company is currently operating in Europe and Asia where potential economic turmoil may result in significant fluctuations in the value of certain foreign currencies versus the United States dollar. The Company may experience difficulties expanding its operations or may encounter other collection issues if economic conditions should change.
(p) Foreign Currency Translation-The Company's reporting and functional currency is the United States dollar. Under United States dollar functional currency, the financial statements of foreign subsidiaries are remeasured from the recording currency to the United States dollar. Monetary assets such as cash, accounts receivable and most liabilities are remeasured at the period end exchange rate. All other assets, liabilities and stockholders' equity are remeasured based on the historical rates that existed at the time of the transaction. The resulting remeasurement adjustment is recorded as foreign exchange gain or loss in the statement of operations. Revenue and expense transactions are remeasured at the average exchange rate for the period. The resulting remeasurement adjustment is recorded as foreign exchange gain or loss in the statement of operations. Foreign exchange losses were $8,000, $3,000, and $58,000 for the years ending December 31, 2004, 2003, and 2002, respectively. There is no translation adjustment to the separate component of stockholders' equity or adjustment to comprehensive income.
Prior to the change of the Company's reporting and functional currency to the United States dollar, all adjustments resulting from the translation of foreign currency financial statements were recorded and reported as a separate component of stockholders' equity titled "Accumulated other comprehensive loss." Generally accepted accounting principles require that such amounts be reclassified to the income statement and recorded as a non-cash charge to operations upon discontinuance of the operation that generated such currency adjustments. Accordingly, the Company reclassified approximately $104,000, $7,000, and $569,000 to selling, general and administrative expense during the years 2004, 2003, and 2002, respectively, as a result of the substantial liquidation of certain foreign subsidiaries. Due to operating losses in the countries related to translation adjustments, the tax effect is $0 for all years presented in comprehensive income.
At December 31, 2004 the accumulation of prior years' translation adjustments of approximately $682,000 included in accumulated other comprehensive loss relates primarily to the Company's operations in Europe. The Company intends to liquidate its subsidiaries in Switzerland, and as a result, will reclassify the appropriate amount to the income statement. The Company believes the transaction
will be completed by December 31, 2005 and the resulting reclassification will be recorded as a non-cash charge to operations for the year then ended.
(q) Comprehensive Income-Comprehensive income includes all changes in equity except those resulting from investments by stockholders and distributions to stockholders.
(r) Stockholder Rights Plan-On July 9, 1998, the Company announced the adoption of a Stockholder Rights Plan, intended to protect the Company from unfair or coercive takeover attempts. The grant of the rights was made to stockholders of record as of July 20, 1998. Periodically, the Stockholder Rights Plan is amended to exempt certain transactions from triggering the rights. During 2002, the Stockholder Rights Plan was amended, on two separate occasions, regarding the conversion of two $1.0 million subordinated notes to common stock.
(s) Stock Appreciation Rights-Effective April 8, 2003 the Company entered into two Stock Appreciation Right ("SAR") agreements with John R. Hamann, former CEO of the Company, and James T. Taylor current CEO of the Company. Mr. Hamann's agreement granted him 170,317 SARs at a price of $0.42 per SAR. The SARs were exercisable in full or in part immediately upon grant and entitled Mr. Hamann to a cash payment equal to the fair market value, as defined in the agreement, of a share of common stock of the Company over $0.42 per share. In the third quarter of 2004, Mr. Hamann exercised 42,400 SARs, which the Company paid. On December 31, 2004, Mr. Hamann exercised his remaining 127,917 SARs, which the Company paid on January 4, 2005 in accordance with the SARs agreement.
Mr. Taylor's agreement granted him 99,351 SARs at a price of $0.42 per SAR. The SARs are exercisable in full or in part immediately upon grant and entitle Mr. Taylor to a cash payment equal to the fair market value, as defined in the agreement, of a share of common stock of the Company over $0.42 per share. Mr. Taylor's SARs expire the earlier of (a) three months following the date Mr. Taylor ceases to be an employee of the Company other than by reason of death, retirement or disability as each term is defined in the Company's 1997 Stock Option Plan or (b) if Mr. Taylor ceases to be an employee due to death, retirement or disability, the dates set forth in Article 9 of the 1997 Stock Option Plan. The total amount expense related to the aforementioned SAR agreements was $38,000 and $251,000 for the years ended December 31, 2004 and 2003, respectively. Amounts due to SAR holders are classified as a current liability based upon the immediate exercisability of the SAR, and the total amount due was $243,000 and $251,000 at December 31, 2004 and 2003, respectively.
(t) Stock Options And Warrants-On December 16, 2004, the FASB issued SFAS No. 123(R), which addresses the accounting for employee services received in exchange for (a) equity instruments of the enterprise or (b) liabilities that are based on the fair value of the enterprise's equity instruments or that may be settled by the issuance of such equity instruments. Effective July 1, 2005, this statement eliminates the ability to account for employee stock options using the intrinsic value provisions of Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees" and related interpretations, and instead generally requires such options to be valued using a fair-value-based method. The Company currently accounts for its stock-based compensation plans for employees in accordance with Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees" (APB 25) and related interpretations. Adoption of SFAS No. 123(R) will have no impact on the Company's consolidated financial statements as all stock options issued to employees were fully expensed as of December 31, 2002.
The Company already accounts for stock-based compensation for non-employees under the fair value method prescribed by Statement of Financial Accounting Standards No. 123, "Accounting for Stock-Based Compensation." On January 12, 2004, the Company's then CEO, John R. Hamann resigned. As part of the separation agreement between the Company and Mr. Hamann, the expiration date of his 329,683 outstanding options was extended to January 12, 2005. Under generally accepted accounting principles, a modification to terms of an option cancels the existing option, and the option is considered a new issuance; in this case to a non-employee to be accounted for under the fair value method as required under EITF 00-18. The Company recorded approximately $131,000 for the year ending December 31, 2004 related to this transaction. There were no other stock-based compensation grants to non-employees during 2004, 2003 or 2002, respectively.
The Company grants incentive and non-qualified stock options and has reserved 3,550,000 shares of common stock for issuance under its stock option plans. Options to purchase shares of the Company's common stock have been granted to directors, officers and employees. The majority of the options granted become exercisable at the rate of 20% per year, and generally expire ten years after the date of grant.
The Company adopted the disclosure provisions of Statement of Financial Accounting Standards No. 123 (SFAS No. 123), "Accounting for Stock Based Compensation." This statement requires the Company to provide pro forma information regarding net income and net income per share as if compensation cost for the Company's stock options had been determined in accordance with the fair value method. The fair value of these options was estimated at the date of grant using a Black-Scholes option pricing model with the following weighted average assumptions for 2004, 2003, and 2002.
Had compensation cost for the Company's stock option plans been determined based on the fair value at the grant date consistent with the provisions of SFAS No. 123, the Company's net income
(loss) and earnings (loss) per share would have been adjusted to the pro forma amounts indicated below:
(u) Fair Market Value Of Financial Instruments-The Company's financial instruments include notes payable. The carrying value of these notes approximates market value because the borrowing rate is similar to other financial instruments with similar terms.
(v) Prior Period Adjustment-During 2001, the Company recognized a loss on a contract related to the subleasing of its Reston, Virginia office space. This office space included leasehold improvements, the carrying value of which was overlooked in calculating the loss on the sublease transaction. To correct this situation the Company has restated the financial statements related to fiscal years ended 2002 and 2001.
Restatement of 2001 financial statements resulted in an increase to accumulated deficit and a decrease to property and equipment totaling $503,000 as of December 31, 2001. Basic and diluted loss per share increased $0.12 to $3.87 from $3.75 per share.
Restatement of 2002 financial statements resulted in an increase to accumulated deficit and a decrease to property and equipment totaling $419,000 as of December 31, 2002. Selling, general and administrative expense decreased by $84,000 with a corresponding decrease to net loss due to the reversal of depreciation expense related to these leasehold improvements. Basic and diluted loss per share decreased $0.02 to $1.39 from $1.41 per share.
The table below outlines the major line item adjustments related to the restatement of fiscal years ended 2002 and 2001.
(w) Recent Accounting Pronouncements-On December 16, 2004, the FASB issued SFAS No. 123(R), which addresses the accounting for employee services received in exchange for (a) equity instruments of the enterprise or (b) liabilities that are based on the fair value of the enterprise's equity instruments or that may be settled by the issuance of such equity instruments. Effective July 1, 2005, this statement eliminates the ability to account for employee stock options using the intrinsic value provisions of Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees" and related interpretations, and instead generally requires such options to be valued using a fair-value-based method. The Company currently accounts for its stock-based compensation plans for employees in accordance with Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees" (APB 25) and related interpretations. Adoption of SFAS No. 123(R) will have no impact on the Company's consolidated financial statements as all stock options issued to employees were fully expensed as of December 31, 2002.
The Company completed its evaluation of the "American Jobs Creation Act," signed into law on October 22, 2004, which creates a special one-time tax deduction related to the repatriation of certain foreign earnings, under FASB Staff Position 109-2. Based on the Company's evaluation of the "American Jobs Creation Act," the Company believes there is no related income tax effect when applying SFAS No. 109 (See Note 7) for the year ended December 31, 2004.
Note 2 Financing Agreement and Liquidity
On August 16, 2004, the Company agreed to a $5.5 million revolving line of credit with Bank of America, N.A., replacing Comerica bank as the Company's senior lender. A copy of this loan agreement was filed on August 20, 2004 as Exhibit 99.1 to Form 8-K. All inventory, chattel paper, accounts, equipment and general intangibles of the Company secure the credit facility. The line of credit is subject to a borrowing base calculated as a percentage of the Company's eligible United States trade accounts receivable less than 90 days old. In addition, the credit facility provides for an "Overadvance" amount of $2.2 million on August 16, 2004. The overadvance amount decreases on the 22nd day of each month by $100,000 until it reaches zero. Although the Company has not needed the overadvance amount, the available overadvance amount at December 31, 2004 was $1.7 million, and at March 23, 2005 was $1.4 million. The credit facility matures August 21, 2006, and bears interest at the
prime rate, or LIBOR plus 2.5%, if elected, to be paid monthly. The unused portion of the line of credit bears interest at an annual rate of 0.375%, paid quarterly. The Company paid $55,000 as a commitment fee to obtain the financing. The credit agreement contains financial and non-financial covenants, which if breached, could result in acceleration of amounts owed under the credit facility and the senior lender would be able to foreclose on the Company's assets. The financial covenants are tested quarterly and require the Company to:
(1)maintain a debt service coverage ratio of at least 1.25 to 1;
(2)maintain a funded debt to EBITDA ratio of 2.5 to 1 through December 31, 2004 and 1.75 to 1 thereafter
(3)restrict annual capital expenditures to $500,000 or less
The Company utilized the credit line with Bank of America, N.A. to meet working capital requirements during 2004. During 2003 and 2002, the Company utilized a credit facility with its former senior lender, Comerica Bank. Total interest expense under bank credit facilities was $135,000, $384,000, and $491,000 for 2004, 2003, and 2002 respectively. The Company incurred commitment fees on the unused portion of the credit facility in 2004 and 2002, totaling $9,000 and $3,000, respectively, at an interest rate of 0.375%. The credit facility contained no provision for unused commitment fees in 2003.
Total interest expense for 2004 was $289,000, comprised of $143,000 related to bank debt and $145,000 for related party debt, and $1,000 to other parties.
Total interest expense for 2003 was $632,000, comprised of $384,000 related to bank debt, $144,000 for related party debt, $99,000 related to warrants and $5,000 to other parties.
Total interest expense for 2002 was $845,000, comprised of $491,000 related to bank debt, $116,000 for related party debt, $185,000 related to the issuance of warrants and $53,000 to other parties.
At December 31, 2004, the outstanding balance on the line of credit was $0.4 million, classified as a current liability, and the Company was in compliance with all of its debt covenants.
At December 31, 2003, $1.2 million outstanding under the term note was classified as a current liability, due to the repayment required and $1.6 million under the term note was classified as long-term debt due to its maturity date of February 28, 2005. The Company had no outstanding borrowings on its $3.0 million revolving line of credit at December 31, 2003.
Note 3 Other Assets
Note 4 Property And Equipment
Note 5 Other Long-Term Obligations
Note 6 Accounts Payable And Accrued Liabilities
Accrued severance in 2003 relates to a former employee of the Company's operations in Asia.
At December 31, 2004 and 2003 accrued restructuring relates to accrued legal costs associated with the Company's 2002 filing for insolvency of its German subsidiary.
Note 7 Income Taxes
The domestic and foreign source components of income (loss) before taxes are as follows:
In 2004, $13.7 million of intercompany bad debt from foreign subsidiaries of the Company was recorded on the books of the United States parent Company. Conversely, $13.7 million of debt forgiveness income was recorded by the respective subsidiaries in Asia. No taxes are owed as a result of the debt forgiveness income due to net operating loss carryforwards in the Asia subsidiaries which offset the income in 2004.
The reconciliation of income tax from continuing operations computed at the United States federal statutory tax rate to the Company's effective income tax rate is as follows:
Federal, state and foreign income tax expense (benefit) consists of the following:
Significant components of the Company's net deferred tax assets (liabilities) for federal and state income taxes are as follows:
At December 31, 2004, the Company had approximately $9.2 million of state net operating loss carryovers, which expire at various times. The Company also had approximately $3.2 million in foreign net operating loss carryovers at December 31, 2004 of which $0.7 million are in Asian subsidiaries and $2.5 million are in European subsidiaries. Due to liquidation proceedings and operating losses in these subsidiaries, the foreign net operating losses will be forfeited, and therefore no deferred tax asset has been established for the foreign NOLs. At December 31, 2004 the Company had $11.4 million of United States federal net operating loss carryforwards, of which $3.3 million is subject to a $0.2 million Section 382 annual limitation and expires 2022. The remaining $8.1 million was generated in 2004 and is not currently subject to the Section 382 annual limitation and expires in 2024.
While a valuation allowance is currently required for the Company's net deferred tax assets, the United States deferred tax assets remain available for use in the future to offset future income tax liabilities, should sufficient amounts of United States and foreign income be generated in the carryforward periods.
Note 8 Employee Benefit Plans
The Company sponsors a 401(k) retirement plan. The Company, at its discretion, may match a portion of the participants' contribution or make a profit-sharing contribution. Participants are vested in the Company's contributions after five years of full-time service and may join the plan January 1 and July 1 of each year. Matching contributions were $535,000 and $0 for the years ending December 31, 2004 and 2002, respectively. A profit-sharing contribution of $50,000 was made for the year ending December 31, 2003.
In 1994, the Company established a non-qualified deferred compensation plan. In May 2002, the plan was terminated and the participants' entire fund balances were distributed to them, net of required federal taxes. The federal taxes were remitted directly to the Internal Revenue Service on behalf of the employees.
Note 9 Commitments and Contingencies
In 2002, the Company filed for insolvency of its wholly-owned subsidiary, headquartered in Frankfurt, Germany. During 2005, a suit was filed against the company's subsidiary in Switzerland by the German insolvency administrator to recover approximately $0.3 million related to an intercompany receivable between the two entities. The Company and its legal counsel believe that the loss, if any, resulting from the suit will not have a material impact on the company's financial position, results of operations, or cash flows in future years.
The Company has become subject to other various claims and legal matters, such as collection matters initiated by the Company, in the course of conducting its business. The Company believes that neither such claims and other legal matters nor the cost of prosecuting and/or defending such claims and other legal matters will have a material adverse effect on the Company's consolidated results of operations, financial condition or cash flows.
The Company leases office space, vehicles and various types of office equipment under non-cancelable operating leases. Rent expense related to operating leases totaled $1.0 million for 2004, $1.4 million for 2003 and $2.0 million for 2002.
Minimum lease payments required under non-cancelable operating lease arrangements subsequent to December 31, 2004, are as follows:
Note 10 Segment Data And Sales To Major Customers
The Company operates in one industry segment, but conducts its business primarily in three geographic areas: North America, Europe and Asia/Pacific. Information regarding these areas follows:
During 2004, one client accounted for approximately $14.5 million or 48% of revenues and another client accounted for approximately $9.8 million or 33% of revenues.
During 2003, one client accounted for approximately $11.8 million or 39% of revenues and another client accounted for approximately $9.7 million or 32% of revenues.
During 2002, one client accounted for approximately $13.0 million or 39% of revenues and another client accounted for approximately $9.4 million or 28% of revenues.
There were no other clients from whom revenue exceeded 10% of the Company's total revenue in the years ended December 31, 2004, 2003, and 2002, respectively.
Note 11 Related Party Transactions
The Company issued two promissory notes to its current Chairman of the Board, General John T. Chain, Jr. The notes are subordinated to the Company's senior lender and their terms are summarized as follows:
A family member of James T. Taylor, the Company's Chief Executive Officer, President, Secretary, and Chief Financial officer, performed advertising and marketing services during 2004 for the Company. Fees and expenses paid for these services were approximately $4,600.
On February 19, 2004, the Company entered into a consulting agreement with its former Asia region president, Mr. G. Toby Marion. Effective May 1, 2004, the Company agreed to pay $408,750, payable in nine installments of $43,750 per month beginning May 31, 2004 and one installment of $15,000 payable in January 2005. Mr. Marion agreed to consult and advise the Company on doing business in Asia. This agreement expires January 31, 2005. Non-compete and other covenants were re-affirmed and carried into the consulting agreement. Under the terms of the agreement, the Company paid $393,750 during 2004.
On July 1, 2003, the Company entered into a consulting agreement with its Chairman, General John T. Chain, Jr. Under the terms of the contract, General Chain will receive $100,000 annually, in quarterly installments, in return for his services with regards to sales, marketing and financial strategies. The agreement expires June 30, 2005. The Company made payments under this agreement totaling $150,000 during 2004, of which $50,000 was related to services provided in 2003.
On December 17, 2003, the Company entered into settlement and consulting agreements with a former employee to provide services with regards to the Asian marketplace. The Company paid a total of $184,640 and $21,160 during 2004 and 2003, respectively.
Effective April 8, 2003, the Company entered into a SAR agreement with John R. Hamann, former CEO of the Company. Mr. Hamann's agreement granted him 170,317 SARs at a price of $0.42 per SAR. The SARs were exercisable in full or in part immediately upon grant and entitled Mr. Hamann to a cash payment equal to the fair market value, as defined in the agreement, of a share of common stock of the Company over $0.42 per share. The Company received payments of approximately $12,000 for these shares during 2004. In the third quarter of 2004, Mr. Hamann exercised 42,400 SARs, which the Company paid approximately $46,000. On December 31, 2004, Mr. Hamann exercised his remaining 127,917 SARs, which the Company paid approximately $144,000 on January 4, 2005 in accordance with the SARs agreement.
On January 12, 2004, the Company entered into a separation agreement with John R. Hamann, former CEO of the Company. As part of the separation agreement between the Company and Mr. Hamann, the expiration date of his 329,683 outstanding options was extended to January 12, 2005, which created a new stock option issuance under generally accepted accounting principles. Under the new issuance, Mr. Hamann exercised 129,683 options during 2004. The Company issued 32,284 shares of common stock during 2004 related to these exercises. The remaining 97,399 shares were issued on January 4, 2005, based on an exercise date of December 31, 2004. The remaining 200,000 options expired on January 12, 2005 due to their exercise price exceeding market value.
On December 31, 2003, the Company entered into a consulting agreement with its former Chief Executive Officer, John R. Hamann. Effective January 13, 2004, the Company agreed to pay a total of $450,000 to Mr. Hamann in return for his services as an advisor to the Chairman of the Board and seeking out new business for the Company. Monthly payments of $37,500 were made until expiration of this agreement on January 12, 2005. In addition, the Company agreed to pay Mr. Hamann a commission of five percent of the value on any new U.S. commercial business for the Company for clients identified by Mr. Hamann prior to January 13, 2005 and which leads to business under contract prior to July 13, 2005. Non-compete and other covenants were re-affirmed and carried into the consulting agreement. Under the terms of the agreement, the Company paid $436,154 for consulting services and $0 for commissions during 2004.
A family member of John R. Hamann, the Company's former Chief Executive Officer, performed, on a contract basis, marketing services during 2003 and 2002. Fees and expenses related to these services were $30,000 in 2003 and $92,000 in 2002.
On March 29, 2002, the Company issued a promissory note in the original amount of $92,000 to its then Chief Executive Officer, John R. Hamann. Although this note was subordinated to the Company's senior lender, it was repaid to Mr. Hamann in full on April 17, 2003, including unpaid interest, with the permission of the senior lender.
Note 12 Common Stock And Stock Options
A summary of the status of the Company's stock options to employees as of December 31, 2004, 2003, and 2002 and changes in the years then ended is presented below.
The following table summarizes information about stock options outstanding at December 31, 2004.
Note 13 Supplemental Disclosure Of Cash Flow Information
During 2002, a non-cash conversion of $2.0 million of subordinated convertible notes was converted from debt to stockholders' equity.
Note 14 Restructuring
On June 3, 2002, the Company filed a petition with the German government for insolvency of its German subsidiary, giving the insolvency court control of the subsidiary's assets. This action was taken in response to declining revenue and cash flows from the operations of its German subsidiary during 2001 and continuing through 2002. All existing German contracts were completed in the second quarter of 2002, and the German subsidiary had no significant future prospects. On September 1, 2002, the German insolvency court appointed an official receiver for the Company's German subsidiary.
The loss from liquidation for the year ended December 31, 2002 of the German subsidiary is presented in the consolidated statements of operations and consolidated statements of cash flows under the caption "Restructuring charges" and "Loss from restructuring activities," respectively. The carrying amounts of the following assets and liabilities of the German subsidiary are included as part of the 2002 restructuring charge were:
(a)The non-cash restructuring charge for accumulated other comprehensive loss recognized in 2002 represents unrealized foreign currency losses accumulated prior to 2001. This amount had previously been classified as a separate component of stockholders' equity, and upon approval of the insolvency of the German subsidiary, was charged to operations. The Company has recorded no estimates for future expenses related to the insolvency petition and believes that any such expenses incurred would not have a material adverse effect on the consolidated results of operations, financial condition or cash flows of the Company.
Results of operations of the German subsidiary for the year ended December 31, 2002 and 2001 were:
Cash flows of the German subsidiary for the year ended December 31, 2002 and 2001 were as follows:
Note 15 Subsequent Events
On January 4, 2005, the Company issued 97,399 shares of common stock related to the 127,917 SARs Mr. Hamann exercised on December 31, 2004. Under the terms of the Mr. Hamann's SAR agreement, Mr. Hamann is required to exercise a proportional amount of the non-qualified options received on January 12, 2004. As a result of the transaction, the Company paid Mr. Hamann approximately $108,000 for the exercise of his SARs, net of $36,000 owed to the Company as the purchase price of the options and non-qualified options.
At December 31, 2004, the Company's sublease rental liability related to its Troy, Michigan office space was $42,000, which it was amortizing over the term of the original lease. Subsequent to year-end, the Company evicted its Troy sublessee. The Company estimated the remaining sublease losses and recognized an additional liability of approximately $63,000 in the first quarter of 2005.
At December 31, 2004 the Company had capitalized approximately $35,000 in deferred rental expenses related to its office space in Reston, Virginia, which it was amortizing over the term of the original lease. On February 1, 2005, the Company received notice from its sublessee of their intent to vacate the premises effective immediately and that it would not fulfill its remaining commitment under the sublease agreement. Subsequent to the notice by the sublessee, the Company recognized the deferred rental expense in the first quarter of 2005.
At December 31, 2004, the Company had $1.4 million in subordinated debt outstanding to its Chairman, General John T. Chain, Jr. On February 7, 2005 the Company received from its lender,
Bank of America, N.A., as an amendment to its existing credit facility, approval to repay the subordinated debt. Under the terms of the amendment, payments are not to exceed $100,000 per month during 2004.
On February 14, 2005, Mr. Edward P. Evans, a shareholder of the Company, exercised his outstanding warrants in full. The Company received the purchase price of $130,470 and on February 23, 2005 the Company issued 434,899 shares of unregistered common stock to Mr. Evans.
On February 16, 2005, General John T. Chain, Jr., Chairman of the Company, exercised his outstanding warrants in full. The Company received the purchase price of $130,470 and on February 23, 2005, the Company issued 434,899 shares of unregistered common stock to General Chain.
Note 16 Valuation and Qualifying Accounts
The following table summarizes the activity of the allowance for doubtful accounts and the deferred tax asset valuation allowance:
Note 17 Selected Quarterly Financial Data (Unaudited)