10-Q 1 form10q_111505.txt FORM 10-Q UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-Q (x) Quarterly report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 For the quarterly period ended October 1, 2005 or [ ] Transition report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 COMMISSION FILE NUMBER: 0-27617 THE MANAGEMENT NETWORK GROUP, INC. (Exact name of registrant as specified in its charter) DELAWARE 48-1129619 ------------------------------- ------------------ (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 7300 COLLEGE BLVD., SUITE 302, OVERLAND PARK, KS 66210 (Address of principal executive offices) (Zip Code) 913-345-9315 Registrant's telephone number, including area code Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [X] No [ ] Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes [ ] No [X] Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes [ ] No [X] Indicate the number of shares outstanding of each of the issuer's classes of common stock as of the latest practicable date. As of November 11, 2005 TMNG had outstanding 35,547,521 shares of common stock. THE MANAGEMENT NETWORK GROUP, INC. INDEX PAGE PART I. FINANCIAL INFORMATION: ITEM 1. Consolidated Condensed Financial Statements (unaudited) Consolidated Condensed Balance Sheets - October 1, 2005 and January 1, 2005 ....................................... 3 Consolidated Condensed Statements of Operations and Comprehensive Income (Loss) - Thirteen weeks and Thirty-nine weeks ended October 1, 2005 and October 2, 2004 ........................................... 4 Consolidated Condensed Statements of Cash Flows Thirty-nine weeks ended October 1, 2005 and October 2, 2004............................................ 5 Notes to Consolidated Condensed Financial Statements ................................................ 6 ITEM 2. Management's Discussion and Analysis of Financial Condition and Results of Operations .........................11 ITEM 3. Quantitative and Qualitative Disclosures about Market Risk .................................................16 ITEM 4. Controls and Procedures .....................................16 PART II. OTHER INFORMATION ITEM 1. Legal Proceedings ...........................................16 ITEM 2. Unregistered Sales of Equity Securities and Use of Proceeds..16 ITEM 3. Defaults Upon Senior Securities..............................16 ITEM 4. Submission of Matters to a Vote of Securities Holders........16 ITEM 5. Other Information............................................16 ITEM 6. Exhibits.....................................................17 Signatures ..........................................................17 Certifications ......................................................18 PART I. FINANCIAL INFORMATION ITEM 1. CONSOLIDATED CONDENSED FINANCIAL STATEMENTS THE MANAGEMENT NETWORK GROUP, INC. CONSOLIDATED CONDENSED BALANCE SHEETS (In thousands, except share data) (unaudited)
October 1, January 1, 2005 2005 ---------- ---------- CURRENT ASSETS: Cash and cash equivalents ................................ $ 11,974 $ 10,882 Short-term investments ................................... 40,300 41,300 Receivables: Accounts receivable .................................... 4,833 4,663 Accounts receivable - unbilled ......................... 2,309 1,911 ---------- ---------- 7,142 6,574 Less: Allowance for doubtful accounts .................. (363) (396) ---------- ---------- 6,779 6,178 Prepaid and other assets ................................. 1,079 1,945 ---------- ---------- Total current assets ........................... 60,132 60,305 ---------- ---------- Property and equipment, net .............................. 974 896 Goodwill ................................................. 13,365 13,365 Identifiable intangible assets, net ...................... 242 487 Loan to officer .......................................... 300 300 ---------- ---------- Total Assets ............................................... $ 75,013 $ 75,353 ========== ========== CURRENT LIABILITIES: Trade accounts payable ................................... $ 457 $ 845 Accrued payroll, bonuses and related expenses ............ 1,826 1,040 Other accrued liabilities ................................ 2,059 2,574 Unfavorable and capital lease obligations ................ 605 725 ---------- ---------- Total current liabilities ...................... 4,947 5,184 Unfavorable and capital lease obligations .................. 2,970 3,422 STOCKHOLDERS' EQUITY: Common Stock: ............................................ 35 35 Voting - $.001 par value, 100,000,000 shares authorized; 35,256,785 and 34,750,562 shares issued and outstanding on October 1, 2005 and January 1, 2005, respectively Preferred stock - $.001 par value, 10,000,000 shares Authorized, no shares issued or outstanding Additional paid-in capital ............................... 158,670 157,857 Accumulated deficit ...................................... (91,439) (90,885) Accumulated other comprehensive income - Foreign currency translation adjustment ................. 186 352 Unearned compensation .................................... (356) (612) ---------- ---------- Total stockholders' equity ...................... 67,096 66,747 ---------- ---------- Total Liabilities and Stockholders' Equity ................. $ 75,013 $ 75,353 ========== ==========
See notes to consolidated condensed financial statements. THE MANAGEMENT NETWORK GROUP, INC. CONSOLIDATED CONDENSED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME (LOSS) (In thousands, except per share data) (unaudited)
For the thirteen For the thirty-nine weeks ended weeks ended ------------------------------ ------------------------------- October 1, October 2, October 1, October 2, 2005 2004 2005 2004 ------------- ------------- ------------- ------------- Revenues $ 8,057 $ 6,546 $ 24,141 $ 17,509 Cost of Services: Direct cost of services .................... 3,846 3,441 11,759 9,093 Equity related charges ..................... 12 51 81 157 -------- -------- -------- -------- Total cost of services ................... 3,858 3,492 11,840 9,250 -------- -------- -------- -------- Gross Profit 4,199 3,054 12,301 8,259 Operating Expenses: Selling, general and administrative ........ 4,484 3,860 13,293 12,318 Real estate restructuring .................. 75 Intangible asset amortization .............. 42 218 245 774 Equity related charges ..................... 60 261 448 776 -------- -------- -------- -------- Total operating expenses ................. 4,586 4,339 14,061 13,868 -------- -------- -------- -------- Loss from operations ......................... (387) (1,285) (1,760) (5,609) Other Income: Interest income ............................ 424 189 1,127 470 Other, net................................. (10) 110 (25) -------- -------- -------- -------- Total other income ....................... 424 179 1,237 445 -------- -------- -------- -------- Income (loss) from continuing operations before income tax provision ................ 37 (1,106) (523) (5,164) Income tax provision ......................... (13) (13) (31) (47) -------- -------- -------- -------- Income (loss) from continuing operations ..... 24 (1,119) (554) (5,211) Discontinued operations: Net loss from discontinued operations (includes a charge for impairment of goodwill of $2,163 for thirty-nine weeks ended October 2, 2004) .................... (2,276) -------- -------- -------- -------- Net income (loss) ............................ 24 (1,119) (554) (7,487) Other comprehensive item - Foreign currency translation adjustment .... 26 (1) (165) (6) -------- -------- -------- -------- Comprehensive income (loss) .................. $ 50 $ (1,120) $ (719) $ (7,493) ======== ======== ======== ======== Income (loss) from continuing operations per common share Basic and diluted .......................... $ 0.00 $ (0.03) $ (0.02) $ (0.15) ======== ======== ======== ======== Net loss from discontinued operations per common share Basic and diluted........................... $ (0.07) ======== ======== ======== ======== Net income (loss) per common share Basic and diluted .......................... $ 0.00 $ (0.03) $ (0.02) $ (0.22) ======== ======== ======== ======== Shares used in calculation of income (loss) from continuing operations, net loss from discontinued operations, and net income (loss) per common share Basic ...................................... 35,156 34,631 35,079 34,586 ======== ======== ======== ======== Diluted .................................... 35,525 34,631 35,079 34,586 ======== ======== ======== ========
See notes to consolidated condensed financial statements. THE MANAGEMENT NETWORK GROUP, INC. CONSOLIDATED CONDENSED STATEMENTS OF CASH FLOWS (In thousands) (unaudited)
For the thirty-nine weeks ended ------------------------------- October 1, October 2, 2005 2004 ---------- ---------- CASH FLOWS FROM OPERATING ACTIVITIES: Net loss .............................................. $ (554) $ (7,487) Adjust for loss from discontinued operations (includes non-cash goodwill impairment charge of $2,163 in the thirty-nine weeks ended October 2, 2004).............................. 2,276 ---------- ---------- Loss from continuing operations (554) (5,211) Adjustments to reconcile net loss to net cash provided by operating activities: Depreciation and amortization ...................... 622 1,294 Equity related charges ............................. 529 933 Loss on retirement of assets ....................... 40 Other changes in operating assets and liabilities: Accounts receivable ........................... (202) (85) Accounts receivable - unbilled ................ (398) (762) Prepaid and other assets ...................... 865 (158) Trade accounts payable ........................ (388) (52) Accrued liabilities ........................... 107 373 ---------- ---------- Net cash provided by (used in) operating activities from continuing operations..... 581 (3,628) Net cash used in discontinued operations ... (113) ---------- ---------- Net cash provided by (used in) operating activities ............................... 581 (3,741) ---------- ---------- CASH FLOWS FROM INVESTING ACTIVITIES: Purchases of short-term investments ................... (7,350) (400) Proceeds from maturities and sales of short-term investments .......................................... 8,350 4,600 Acquisition of property and equipment, net ............ (288) (107) ---------- ---------- Net cash provided by investing activities .. 712 4,093 ---------- ---------- CASH FLOWS FROM FINANCING ACTIVITIES: Payments made on long-term obligations ................ (576) (538) Proceeds from exercise of options ..................... 452 564 Issuance of common stock through employee stock purchase plan.................................. 88 49 ---------- ---------- Net cash provided by (used in) financing activities ..................... (36) 75 ---------- ---------- Effect of exchange rate on cash and cash equivalents .... (165) (6) ---------- ---------- Net increase in cash and cash equivalents ............... 1,092 421 Cash and cash equivalents, beginning of period .......... 10,882 8,825 ---------- ---------- Cash and cash equivalents, end of period ................ $ 11,974 9,246 ========== ========== Supplemental disclosure of cash flow information: Cash paid during period for interest .................... $ 3 $ 26 ========== ========== Cash paid during period for taxes ....................... $ 31 $ 47 ========== ==========
See notes to consolidated condensed financial statements. THE MANAGEMENT NETWORK GROUP, INC. NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS (UNAUDITED) 1. BASIS OF REPORTING The accompanying consolidated condensed financial statements of The Management Network Group, Inc. ("TMNG" or the "Company") as of October 1, 2005, and for the thirteen and thirty-nine weeks ended October 1, 2005 and October 2, 2004, are unaudited and reflect all normal recurring adjustments which are, in the opinion of management, necessary for the fair presentation of the Company's consolidated condensed financial position, results of operations, and cash flows as of these dates and for the periods presented. The consolidated condensed financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America for interim financial information. Consequently, these statements do not include all the disclosures normally required by accounting principles generally accepted in the United States of America for annual financial statements nor those normally made in the Company's annual report on Form 10-K. Accordingly, reference should be made to the Company's annual report on Form 10-K for additional disclosures, including a summary of the Company's accounting policies. Changes in Presentation Auction rate securities, which prior to the fourth quarter of 2004 were recorded in cash and cash equivalents due to their liquidity and pricing reset feature, have been included as short-term investments in the accompanying balance sheets and sales and maturities of these securities have been reflected as investing activities in the statements of cash flows. Stock Based Compensation During the thirteen weeks ended October 1, 2005, the Company granted 25,000 shares of restricted stock to key management personnel. These grants had a fair value on the date of grant of $55,000. During the thirteen weeks ended October 1, 2005, and October 2, 2004 the Company recognized compensation expense of $72,000 and $312,000, respectively, related to the restricted stock grants made to key management personnel. The compensation cost associated with such grants is being amortized through charges to operations on a graded vesting schedule over periods ranging from two to four years. During the thirteen weeks ended October 1, 2005, the Company granted options to purchase 112,000 and 100,000 shares of the Company's common stock to employees and members of the Company's Board of Directors, respectively, at a weighted average exercise price of $2.28. During the thirteen weeks ended October 2, 2004, the Company granted options to purchase 66,000 shares of the Company's common stock to employees at a weighted average exercise price of $2.12. At the date of the grants, the exercise price of the option awards equaled the market price of the Company's common stock. During the thirty-nine weeks ended October 1, 2005, the Company granted 200,000 shares of restricted stock to key management personnel. These grants had a fair value on the date of grant of $447,000. During the thirty-nine weeks ended October 1, 2005 and October 2, 2004, the Company recognized compensation expense of $529,000 and $933,000, respectively, related to the issuance of restricted stock grants made to key management personnel. During the thirty-nine weeks ended October 1, 2005, the Company granted options to purchase 397,500 and 300,000 shares of the Company's common stock to employees and members of the Company's Board of Directors, respectively, at a weighted average exercise price of $2.26. During the thirty-nine weeks ended October 2, 2004, the Company granted 239,000 options to purchase the Company's common stock to employees at a weighted average exercise price of $2.98. At the dates of grants, the exercise price of the option awards equaled the market price of the Company's common stock. The Company utilizes an intrinsic value methodology in accounting for stock based compensation for employees and certain non-employee directors in accordance with the provisions of Accounting Principles Board Opinion ("APB") No. 25, "Accounting for Stock Issued to Employees" and related Interpretations, and accounts for stock-based compensation for non-employees utilizing a fair value methodology in accordance with Statement of Financial Accounting Standards ("SFAS") No. 123, "Accounting for Stock-Based Compensation" as amended by SFAS No. 148 "Accounting for Stock Based Compensation - Transition and Disclosure." If compensation cost for the Company's APB 25 grants and the employee stock purchase plan had been determined under SFAS No. 123, based upon the fair value at the grant date, consistent with the Black-Scholes option pricing methodology, the Company's net income for the thirteen weeks ended October 1, 2005 would have decreased by approximately $0.5 million, the net loss for the thirteen weeks ended October 2, 2004 would have increased by $0.5 million, and the Company's net loss for the thirty-nine weeks ended October 1, 2005 and October 2, 2004, would have increased by approximately $1.2 million and $2.2 million, respectively. For purposes of pro forma disclosures required under the provisions of SFAS No. 123, as amended by SFAS No. 148, the estimated fair value of options is amortized to pro forma expense over the options' vesting period. The following table contains pro forma information for the thirteen and thirty-nine weeks ended October 1, 2005, and October 2, 2004 (in thousands, except per share amounts):
FOR THE THIRTEEN WEEKS ENDED FOR THE THIRTY-NINE WEEKS ENDED ----------------------------- ------------------------------- October 1, October 2, October 1, October 2, 2005 2004 2005 2004 ------------ ------------ ----------- ----------- Net income (loss), as reported: $ 24 $ (1,119) $ (554) $ (7,487) Add: Stock-based employee compensation expense included in reported net income (loss), net of related tax effects 72 312 529 933 Deduct: Total stock-based compensation expense determined under fair value based method for all awards, net of related tax effects (539) (785) (1,759) (3,170) ------------ ------------ ----------- ----------- Pro forma net loss $ (443) $ (1,592) $ (1,784) $ (9,724) ============ ============ =========== =========== Net income (loss) per share Basic and diluted, as reported $ 0.00 $ (0.03) $ (0.02) $ (0.22) ============ ============ =========== =========== Basic and diluted, pro forma $ (0.01) $ (0.05) $ (0.05) $ (0.28) ============ ============ =========== ===========
Recent Accounting Pronouncements In December 2004, the FASB issued SFAS 123(R), "Share-Based Payment". SFAS No. 123(R) revises SFAS 123, Accounting for Stock-Based Compensation, and supersedes APB Opinion No. 25, Accounting for Stock Issued to Employees, and its related implementation guidance. SFAS 123(R) will require compensation costs related to share-based payment transactions to be recognized in the financial statements (with limited exceptions). The amount of compensation cost will be measured based on the grant-date fair value of the equity or liability instruments issued. Compensation cost will be recognized over the period that an employee provides service in exchange for the award. The Company will adopt SFAS No. 123(R) effective January 1, 2006 and is currently evaluating the financial statement impact of the adoption of SFAS No. 123(R), although this is expected to result in increased compensation expense in future periods. 2. EARNINGS (LOSS) PER SHARE The Company calculates and presents earnings (loss) per share using a dual presentation of basic and diluted earnings (loss) per share. Basic earnings (loss) per share is computed by dividing net income (loss) by the weighted average number of common shares outstanding for the period. Diluted earnings (loss) per share is computed in the same manner except the weighted average number of shares is increased for dilutive securities. The following table sets forth the computation of diluted shares outstanding (amounts in thousands):
FOR THE THIRTEEN WEEKS ENDED FOR THE THIRTY-NINE WEEKS ENDED ----------------------------- ------------------------------- October 1, October 2, October 1, October 2, 2005 2004 2005 2004 ------------ ----------- ----------- ----------- Weighted average shares outstanding - basic 35,156 34,631 35,079 34,586 Effect of dilutive securities: Stock options 369 ------------ ------------ ----------- ----------- Weighted average shares outstanding - diluted 35,525 34,631 35,079 34,586 ============ ============ =========== ===========
In accordance with the provisions of SFAS No. 128 "Earnings Per Share", the Company has not included the effect of stock options in the calculation of diluted loss per share for the thirteen weeks ended October 2, 2004 and thirty-nine weeks ended October 1, 2005 and October 2, 2004, as the Company reported a loss from continuing operations for these periods and the effect would have been anti-dilutive. Had the Company reported net income for the thirteen weeks ended October 2, 2004, the treasury method of calculating common stock equivalents would have resulted in approximately 230,000 additional diluted shares. Had the Company reported net income for the thirty-nine weeks ended October 1, 2005, and October 2, 2004, the treasury method of calculating common stock equivalents would have resulted in approximately 394,000 and 754,000 additional diluted shares, respectively. 3. DISCONTINUED OPERATIONS During the thirteen weeks ended April 3, 2004, management and the Board of Directors elected to discontinue the hardware segment of the Company. The Company concluded that this segment of the business did not align well with the strategic focus of the Company. Charges related to the discontinuation of the hardware business were $2.3 million and relate primarily to goodwill impairment and severance charges. These charges are reported as a component of discontinued operations. The hardware segment's results of operations have been classified as discontinued operations. Net sales and loss from discontinued operations are as follows (amounts in thousands): FOR THIRTY-NINE WEEKS ENDED ------------------------------------------------------ October 2, 2004 ---------- Revenue $ 13 Goodwill impairment and severance charge $ (2,213) Operating loss (63) ---------- Loss from discontinued operations $ (2,276) ========== 4. BUSINESS SEGMENTS The Company identifies its segments based on the way management organizes the Company to assess performance and make operating decisions regarding the allocation of resources. In accordance with the criteria in SFAS No. 131 "Disclosure about Segments of an Enterprise and Related Information," the Company has concluded it has four operating segments: Operations, Strategy, Marketing and International; which are aggregated in one reportable segment, the Management Consulting Services segment. Management Consulting Services includes business strategy and planning, marketing and customer relationship management, billing system support, operating system support, revenue assurance, corporate investment services, and business model transformation. In accordance with the provisions of SFAS No 131, revenues earned in the United States and internationally based on the location where the services are performed are shown in the following table (amounts in thousands):
----------------------------------------------------------------------------- FOR THE THIRTEEN WEEKS ENDED FOR THE THIRTY-NINE WEEKS ENDED ----------------------------------------------------------------------------- October 1, 2005 OCTOBER 2, 2004 October 1, 2005 OCTOBER 2, 2004 ------------------ ---------------- ------------------ ---------------- United States $ 7,705 $ 5,352 $22,726 $13,930 International: United Kingdom 248 825 1,019 1,374 Australia 104 65 351 65 Portugal 1,124 The Netherlands 304 39 705 Canada 113 Belize 173 Other 6 25 ------- ------- ------- ------- Total $ 8,057 $ 6,546 $24,141 $17,509 ======= ======= ======= =======
5. GOODWILL During the thirty-nine weeks ended October 2, 2004, the Company recorded a $2.2 million goodwill impairment loss related to the discontinuation of the hardware segment and has reflected this amount in the Statement of Operations and Comprehensive Loss as a component of discontinued operations. The changes in the carrying amount of goodwill as of October 1, 2005 are as follows (amounts in thousands):
Management Consulting Discontinued Segment Operations Total --------------------- ------------ ------- Balance as of January 3, 2004 $ 13,365 $ 2,163 $15,528 Impairment loss in year ended January 1, 2005 (2,163) (2,163) -------- --------- -------- Balance as of January 1, 2005 and October 1, 2005 $ 13,365 $ 0 $13,365 ======== ========= ========
6. OTHER IDENTIFIABLE INTANGIBLE ASSETS Included in the Company's consolidated balance sheet as of October 1, 2005, and January 1, 2005, are the following identifiable assets (amounts in thousands):
October 1, 2005 January 1, 2005 ------------------------ ------------------------ Accumulated Accumulated Cost Amortization Cost Amortization ------- ------------ ------- ------------ Customer relationships $ 1,908 $(1,666) $ 1,908 $(1,538) Employment agreements 3,200 (3,200) 3,200 (3,083) ------- ------- ------- ------- Total $ 5,108 $(4,866) $ 5,108 $(4,621) ======= ======= ======= =======
Intangible amortization expense for the thirteen weeks ended October 1, 2005 and October 2, 2004 was $42,000 and $218,000, respectively. Intangible amortization expense for the thirty-nine weeks ended October 1, 2005 and October 2, 2004 was $245,000 and $774,000, respectively. Intangible amortization expense is estimated to be approximately $43,000 for the remainder of fiscal year 2005, $171,000 in fiscal year 2006 and $28,000 in fiscal year 2007. 7. INCOME TAXES In the thirteen weeks ended October 1, 2005, the Company generated income from continuing operations of $37,000, which would result in a statutory tax expense of $15,000, however, the Company utilized its net operating loss carry-forwards to offset a portion of this income tax expense, with the remaining expense related to state income taxes in jurisdictions where net operating loss carry-forwards were not available. In the thirty-nine weeks ended October 1, 2005 and the thirteen weeks and thirty-nine weeks ended October 2, 2004, the Company generated income tax benefits of $210,000, $437,000 and $2.1 million, respectively. The Company recorded full valuation allowances against these income tax benefits in accordance with the provisions of SFAS No. 109, "Accounting for Income Taxes," which requires an estimation of the recoverability of the recorded income tax asset balances. In addition, the Company reported income tax provisions of $13,000 for the thirteen weeks ended October 1, 2005 and October 2, 2004, and income tax provisions of $31,000 and $47,000 for the thirty-nine weeks ended October 1, 2005 and October 2, 2004, respectively, related to state tax expense. As of October 1, 2005, the Company recorded $26.8 million of valuation allowance in connection with its deferred tax assets. As of October 1, 2005, the Company had an income tax receivable balance of $162,000, net of reserves, related to pending foreign tax returns. Subsequent to the end of the third quarter of fiscal year 2005, the Company was notified that the refunds related to these returns were being challenged. Management intends to fight this matter vigorously and believes it has established adequate reserves against these receivables. The Company establishes reserves for potential tax liabilities when, despite the belief that tax return positions are fully supported, certain positions are likely to be challenged and not fully sustained. Such tax reserves are analyzed on a quarterly basis and adjusted based upon changes in facts and circumstances, such as the progress of federal and state audits, case law and emerging legislation. The Company establishes the reserves based upon its assessment of exposure associated with possible future assessments that may result from the examination of Federal, state, or international tax returns. These tax reserves did not change materially during the thirteen weeks ended October 1, 2005 and October 2, 2004. Management believes that it has established adequate reserves in the event of loss or settlement of any potential tax liabilities. 8. REAL ESTATE RESTRUCTURING In the fourth quarter of fiscal year 2004, the Company made the decision to consolidate office space. In connection with this decision, a sublease agreement for unutilized space was entered into with a third party for the remainder of the original lease term. In accordance with SFAS No. 146 "Accounting for Costs Associated with Exit or Disposal Activities," the decision to consolidate office space resulted in charges of $75,000 related to the buyout of an office equipment lease in the thirty-nine weeks ended October 1, 2005. The restructuring charge of $75,000 has been reflected as a component of Loss from Operations in the Statement of Operations and Comprehensive Loss. 9. LOAN TO OFFICER As of October 1, 2005, there is one remaining line of credit between the Company and its Chief Executive Officer, Richard P. Nespola, which originated in fiscal year 2001. Aggregate borrowings available and outstanding against the line of credit at October 1, 2005 and January 1, 2005 totaled $300,000. The balance is due in 2011. In accordance with the loan provisions, the interest rate charged on the loans is equal to the Applicable Federal Rate (AFR), as announced by the Internal Revenue Service, for short-term obligations (with annual compounding) in effect for the month in which the advance is made, until fully paid. All interest payments have been made in a timely fashion. Pursuant to the Sarbanes-Oxley Act, no further loan agreements or draws against the line may be made by the Company to, or arranged by the Company for its executive officers. 10. CONTINGENCIES In June 1998, the bankruptcy trustee of a former client, Communications Network Corporation, sued TMNG for a total of $320,000 in the U.S. Bankruptcy Court in New York seeking recovery of $160,000 alleging an improper payment of consulting fees paid by the former client during the period from July 1, 1996, when an involuntary bankruptcy proceeding was initiated against the former client, through August 6, 1996, when the former client agreed to an order for relief in the bankruptcy proceeding, and $160,000 in consulting fees paid by the former client after August 6, 1996. Although the Company denies these claims and plans to vigorously defend itself, management has established reserves of $160,000 as of October 1, 2005 and January 1, 2005, which it believes are adequate. The bankruptcy trustee has also sued TMNG for at least $1.85 million for breach of contract, breach of fiduciary duties and negligence. Although assurance cannot be given as to the ultimate outcome of this proceeding, TMNG believes the Company has meritorious defenses to the claims made by the bankruptcy trustee, including particularly the claims for breach of contract, breach of fiduciary duty and negligence, and that the ultimate resolution of this matter will not materially harm the Company's business. As of October 1, 2005 the Company has outstanding demands aggregating approximately $1.0 million by the bankruptcy trustees of several former clients in connection with collected balances near the customers' respective bankruptcy filing dates. Although the Company does not believe it received any preference payments from these former clients and plans to vigorously defend its position, the Company has established reserves of $727,000 as of October 1, 2005 and January 1, 2005, which it believes are adequate. The Company may become involved in various legal and administrative actions arising in the normal course of business. These could include actions brought by taxing authorities challenging the employment status of consultants utilized by the Company. In addition, future customer bankruptcies could result in additional claims on collected balances for professional services near the bankruptcy filing date. While the resolution of any of such actions, claims, or the matters described above may have an impact on the financial results for the period in which they occur, the Company believes that the ultimate disposition of these matters will not have a material adverse effect upon its consolidated results of operations, cash flows or financial position. ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS In addition to historical information, this quarterly report contains forward-looking statements. Certain risks and uncertainties could cause actual results to differ materially from those reflected in such forward-looking statements. Factors that might cause a difference include, but are not limited to, those discussed in the sections entitled "Management's Discussion and Analysis of Financial Condition and Results of Operations" and "Business - Risk Factors" in our annual report on Form 10-K for the fiscal year ended January 1, 2005. Readers are cautioned not to place undue reliance on these forward-looking statements, which reflect management's opinions only as of the date of this report. We undertake no obligation to revise, or publicly release the results of any revision to, these forward-looking statements. Readers should carefully review the risk factors described in our annual report and in other documents that we file from time to time with the Securities and Exchange Commission. EXECUTIVE FINANCIAL OVERVIEW As discussed in our 2004 annual report on Form 10-K for the fiscal year ended January 1, 2005 the communications industry experienced a significant economic recession from 2001 through 2004. We are a consultancy to the industry, and as a result experienced a significant reduction in consulting business during that period primarily due to the recession. We experienced significant revenue declines and/or net losses from 2001 to 2004. During this period we maintained relatively consistent gross margins through innovative pricing and high consultant utilization levels. Beginning in late 2004 and continuing through the third quarter of 2005, we see significant change in the industry resulting from consolidation, technology transformation and the convergence of telecommunications, media and entertainment sectors. During the thirteen and thirty-nine weeks ended October 1, 2005, our revenues increased 23% and 38%, respectively, compared with the same periods in 2004. Additionally, gross margins improved to 51% during the thirty-nine weeks ended October 1, 2005 compared with 47% during the same period of 2004. We believe these improved operating results and margins are reflective of our efforts to identify, adapt to and capitalize on these change elements, combined with growth of wireless and Internet protocol (IP) initiatives within the communications sector. Selling, general and administrative costs in the thirteen and thirty-nine weeks ended October 1, 2005 were up approximately 15% and 8%, respectively, as compared to the same period of 2004. The increase reflects management's efforts to invest in intellectual property, including proprietary toolsets and methodologies to support new wireless and IP consultative and managed services offerings as well as increases in variable selling expenses to support the significant increase in revenues. Although these investments have impacted our short-term profitability, we believe they will better enable us to capitalize on the industry migration toward wireless and IP platforms. We are also focusing our marketing efforts on growth markets surrounding large and sustainable clients to maintain a portfolio of business that is high credit quality, thus reducing bad debt risks. Our comprehensive cost containment efforts have provided offset to our investment initiatives, and have assisted us in generating positive cash from operations for the thirty-nine weeks ended October 1, 2005, and allowed us to maintain strong levels of cash and short-term investments. Our short-term investments primarily consist of money market funds and investment-grade auction rate securities. Returns on our short-term investments have increased over recent periods as a result of increasing interest rates. OPERATIONAL OVERVIEW Revenues typically consist of consulting fees for professional services and related expense reimbursements. Our consulting services are typically contracted on a time and materials basis, a time and materials basis not to exceed contract price, a fixed fee basis, or contingent fee basis. Contract revenues on contracts with a not to exceed contract price or a fixed price are recorded under the percentage of completion method, utilizing estimates of project completion under both of these types of contracts. Larger fixed price contracts have recently begun to represent a more significant component of our revenue mix. Contract revenues on contingent fee contracts are deferred until the revenue is realizable and earned. Generally a client relationship begins with a short-term engagement utilizing a few consultants. Our sales strategy focuses on building long-term relationships with both new and existing clients to gain additional engagements within existing accounts and referrals for new clients. Strategic alliances with other companies are also used to sell services. We anticipate that we will continue to pursue these marketing strategies in the future. Because we are a consulting company, we experience fluctuations in revenues derived from clients during the course of a project lifecycle. As a result, the volume of work performed for specific clients varies from period to period and a major client from one period may not use our services or the same volume of services in another period. In addition, clients generally may end their engagements with little or no penalty or notice. If a client engagement ends earlier than expected, we must re-deploy professional service personnel as any resulting unbillable time could harm our margins. Cost of services consists primarily of compensation for consultants who are employees and amortization of equity related non-cash charges incurred in connection with restricted stock awards primarily to consultants, as well as fees paid to independent contractor organizations and related expense reimbursements. Employee compensation includes certain unbillable time, training, vacation time, benefits and payroll taxes. Gross margins are primarily impacted by the type of consulting services provided; the size of service contracts and negotiated volume discounts; changes in our pricing policies and those of competitors; utilization rates of consultants and independent subject matter experts; and employee and independent contractor organization costs, which tend to be higher in a competitive labor market. Operating expenses include selling, general and administrative, equity related charges, intangible asset amortization, and real estate restructuring charges. Sales and marketing expenses consist primarily of personnel salaries, bonuses, and related costs for direct client sales efforts and marketing staff. We primarily use a relationship sales model in which partners, principals and senior consultants generate revenues. In addition, sales and marketing expenses include costs associated with marketing collateral, product development, trade shows and advertising. General and administrative expenses consist mainly of costs for accounting, recruiting and staffing, information technology, personnel, insurance, rent, and outside professional services incurred in the normal course of business. The equity related charges consist of non-cash amortization charges incurred in connection with restricted stock awards, primarily to principals and certain senior executives. CRITICAL ACCOUNTING POLICIES While the selection and application of any accounting policy may involve some level of subjective judgments and estimates, we believe the following accounting policies are the most critical to our consolidated financial statements, potentially involve the most subjective judgments in their selection and application, and are the most susceptible to uncertainties and changing conditions: Allowance for Doubtful Accounts; Impairment of Goodwill and Long-lived Intangible Assets; Revenue Recognition; and Deferred Income Tax Assets. Allowances for Doubtful Accounts--Substantially all of our receivables are owed by companies in the communications industry. We typically bill customers for services after all or a portion of the services have been performed and require customers to pay within 30 days. We attempt to control credit risk by being diligent in credit approvals, limiting the amount of credit extended to customers and monitoring customers' payment records and credit status as work is being performed for them. We recorded no bad debt expense for the thirteen and thirty-nine week periods ended October 1, 2005 and recorded bad debt expense of $134,000 and $348,000 for the thirteen and thirty-nine week periods ended October 2, 2004. During the thirteen weeks and thirty nine weeks ended October 1, 2005, no provision was necessary in our allowance for doubtful accounts to maintain a level appropriate with the anticipated default rate of the underlying accounts receivable balances. Our allowance for doubtful accounts totaled $363,000 and $396,000 as of October 1, 2005 and January 1, 2005, respectively. The calculation of these amounts is based on judgment about the anticipated default rate on receivables owed to us as of the end of the reporting period. That judgment was based on uncollected account experience in prior years and our ongoing evaluation of the credit status of our customers and the communications industry in general. We have attempted to mitigate credit risk by concentrating our marketing efforts on the largest and most stable companies in the communications industry and by tightly controlling the amount of credit provided to customers. If we are unsuccessful in these efforts, or if our customers file for bankruptcy or experience financial difficulties, it is possible that the allowance for doubtful accounts will be insufficient and we will have a greater bad debt loss than the amount reserved, which would adversely affect our cash flow and financial performance. Impairment of Goodwill and Long-lived Intangible Assets--Goodwill and other long-lived intangible assets arising from our acquisitions are subjected to periodic review for impairment. SFAS No. 142 requires an annual evaluation at the reporting unit level of the fair value of goodwill and compares the calculated fair value of the reporting unit to its book value to determine whether impairment has been deemed to occur. Any impairment charge would be based on the most recent estimates of the recoverability of the recorded goodwill and intangibles balances. If the remaining book value assigned to goodwill and other intangible assets acquired in an acquisition is higher than the estimated fair value of the reporting unit, there is a requirement to write down these assets. The determination of fair value requires management to make assumptions about future cash flows and discounted rates. These assumptions require significant judgment and estimations about future events and are thus subject to significant uncertainty. If actual cash flows turn out to be less than projected, we may be required to take further write-downs, which could increase the variability and volatility of our future results. Effective March 4, 2004, management and the Board of Directors elected to discontinue our hardware business. We concluded this segment of the business did not align well with our strategic focus. We incurred goodwill impairment charges of $2.2 million in the first quarter of fiscal year 2004, related to the discontinuation of the hardware business, in accordance with the provisions of SFAS No. 142. Revenue Recognition--We recognize revenue from time and materials based contracts in the period in which our services are performed. In addition to time and materials contracts, our other types of contracts include time and materials contracts not to exceed contract price, fixed fee contracts, and contingent fee contracts. We recognize revenues on time and materials contracts not to exceed contract price and fixed fee contracts using the percentage of completion method. Percentage of completion accounting involves calculating the percentage of services provided during the reporting period compared with the total estimated services to be provided over the duration of the contract. For all contracts, estimates of total contract revenues and costs are continuously monitored during the term of the contract, and recorded revenues and costs are subject to revisions as the contract progresses. Such revisions may result in material increases or decreases in revenues and income and are reflected in the financial statements in the periods in which they are first identified. Due to the nature of contingent fee contracts, we recognize costs as they are incurred on the project and defer revenue recognition until the revenue is realizable and earned as agreed to by our clients. Although these contracts can be very rewarding, the profitability of these contracts is dependent on our ability to deliver results for our clients. As we continue to adapt to changes in the communications consulting industry, we periodically enter into more fixed fee contracts in which revenue is based upon delivery of services or solutions, and contingent fee contracts, in which revenue is subject to achievement of savings or other agreed upon results, rather than time spent. Both of these types of contracts are typically more results-oriented and are subject to greater risk associated with revenue recognition and overall project profitability than traditional time and materials contracts. Deferred Income Tax Assets--We have generated substantial deferred income tax assets primarily from the accelerated financial statement write-off of goodwill, the charge to compensation expense taken for stock options and net operating loss carry forwards. For us to realize the income tax benefit of these assets, we must generate sufficient taxable income in future periods when such deductions are allowed for income tax purposes. In some cases where deferred taxes were the result of compensation expense recognized on stock options, our ability to realize the income tax benefit of these assets is also dependent on our share price increasing to a point where these options will be exercised. In assessing whether a valuation allowance is needed in connection with our deferred income tax assets, we have evaluated our ability to carry back tax losses to prior years that reported taxable income, and our ability to generate sufficient taxable income in future periods to utilize the benefit of the deferred income tax assets. Such projections of future taxable income require significant subjective judgments and estimates by us. As of October 1, 2005, cumulative valuation allowances in the amount of $26.8 million were recorded in connection with the deferred income tax assets. We continue to evaluate the recoverability of the recorded deferred income tax asset balances. If we continue to report net operating losses for financial reporting for the entirety of 2005 or in future years, no additional income tax benefit may be recognized for those losses, since we would be required to increase our valuation allowance to offset such amounts. RESULTS OF OPERATIONS THIRTEEN WEEKS ENDED OCTOBER 1, 2005 COMPARED TO THIRTEEN WEEKS ENDED OCTOBER 2, 2004 REVENUES Revenues increased 23.1% to $8.1 million for the thirteen weeks ended October 1, 2005 from $6.5 million for the thirteen weeks ended October 2, 2004. The increase in revenue is primarily attributable to increased penetration of consulting services to our top 5 client relationships, with emphasis in growth areas of wireless and IP. During the thirteen weeks ended October 1, 2005 and October 2, 2004, we provided services on a comparable number of customer projects, however, revenue per project was $86,000 in the thirteen weeks ended October 1, 2005, compared to $67,000 in the thirteen weeks ended October 2, 2004. The increase in average revenue per project was primarily attributable to a small number of large engagements in the mix in the thirteen weeks ended October 2, 2005. Our international revenue base decreased to 4.4% of our revenues in the thirteen weeks ended October 1, 2005, from 18.2% in the thirteen weeks ended October 2, 2004, due primarily to the completion of multiple large projects in Western Europe at the end of fiscal year 2004, combined with an increase in our domestic project and revenue base. Revenues recognized in connection with fixed price and contingent fee engagements totaled $1.5 million and $2.4 million for the thirteen weeks ended October 1, 2005 and October 2, 2004, respectively, representing 18.3% and 37.2% of total revenue, respectively. The mix of contract engagement types will vary by quarter, depending on the type of engagement. COSTS OF SERVICES Direct costs of services increased to $3.8 million for the thirteen weeks ended October 1, 2005, compared to $3.4 million for the thirteen weeks ended October 2, 2004. As a percentage of revenues, our gross margin based on direct cost of service was 52.3% for the thirteen weeks ended October 1, 2005, compared to 47.4% for the thirteen weeks ended October 2, 2004. The increase in gross margin was primarily attributable to a shift in the mix of services to more strategy and management consulting engagements which typically yield higher margins than staffing engagements, coupled with higher revenue leading to better utilization levels. Non-cash stock based compensation charges were $12,000 for the thirteen weeks ended October 1, 2005, compared to $51,000 for the thirteen weeks ended October 2, 2004. Non-cash stock based compensation charges primarily relate to the Company's granting of restricted stock to select executives and key consultants during the fourth quarter of fiscal year 2003, which are being amortized on a graded vesting schedule over a period of two years from the date of grant. OPERATING EXPENSES In total, operating expenses increased to $4.6 million for the thirteen weeks ended October 1, 2005, or 5.7% from $4.3 million for the thirteen weeks ended October 2, 2004. Operating expenses include selling, general and administrative costs, equity related charges, and intangible asset amortization. Selling, general and administrative expense for the thirteen weeks ended October 1, 2005 was $4.5 million compared to $3.9 million for the thirteen weeks ended October 2, 2004. The increase is primarily related to increased investment in our initiative to develop our Mobile Virtual Network Enablement (MVNE) offerings and toolsets for IP transformation. Intangible asset amortization was $42,000 and $218,000 for the thirteen weeks ended October 1, 2005 and October 2, 2004, respectively. The $176,000 decrease in amortization expense was due to certain intangible assets becoming fully amortized during fiscal year 2004 and first quarter 2005. Non-cash stock based compensation charges were $60,000 in the thirteen weeks ended October 1, 2005 compared to $261,000 for the thirteen weeks ended October 2, 2004. The charges relate to the award of restricted stock to select executives and key employees, which are being amortized on a graded vesting schedule over a period of two years from the date of grant for the fiscal year 2003 grants and four years from the date of grant for the fiscal year 2005 grants. The decrease in equity-related charges is the result of reversals of previously recognized compensation expense related to forfeitures of restricted stock. OTHER INCOME Interest income was $424,000 and $189,000 for the thirteen weeks ended October 1, 2005 and October 2, 2004, respectively, and represented interest earned on invested balances. Interest income increased for the thirteen weeks ended October 1, 2005 as compared to the thirteen weeks ended October 2, 2004 due primarily to increases in interest rates from 2004 to 2005. We primarily invest in money market funds and investment-grade auction rate securities as part of our overall investment policy. INCOME TAXES In the thirteen weeks ended October 1, 2005 and October 2, 2004, we recorded provision for state income taxes of $13,000. For the thirteen weeks ended October 1, 2005, the effective tax rate differed from the federal statutory rate primarily due to our use of net operating loss carry-forwards to offset income tax expense. For the thirteen weeks ended October 2, 2004, the effective tax rate differed from the federal statutory rate primarily due to valuation allowances recorded on tax benefits as a result of uncertainties about their recoverability. THIRTY-NINE WEEKS ENDED OCTOBER 1, 2005 COMPARED TO THIRTY-NINE WEEKS ENDED OCTOBER 2, 2005 REVENUES Revenues increased 37.9% to $24.1 million for the thirty-nine weeks ended October 1, 2005, from $17.5 million for the thirty-nine weeks ended October 2, 2004. The increase in revenue is primarily attributable to increased penetration of consulting services to our top 5 client relationships, with emphasis in growth areas of wireless and IP. During the thirty-nine weeks ended October 1, 2005, we provided services on 197 customer projects, compared to 153 projects performed in the thirty-nine weeks ended October 2, 2004. Average revenue per project was $123,000 in the thirty-nine weeks ended October 1, 2005 compared to $114,000 in the thirty-nine weeks ended October 23, 2004. International revenue base decreased to 5.9% of revenues for the thirty-nine weeks ended October 1, 2005, from 20.4% for the thirty-nine weeks ended October 2, 2004, due primarily to the completion of multiple large projects in Western Europe at the end of fiscal year 2004, combined with an increase in our domestic project and revenue base. Revenues recognized by the Company in connection with fixed price and contingent fee engagements totaled $6.5 million and $4.5 million for the thirty-nine weeks ended October 1, 2005 and October 2, 2004, respectively, representing 26.9% and 25.6% of total revenue, respectively. COST OF SERVICES Direct costs of services increased to $11.8 million for the thirty-nine weeks ended October 1, 2005 compared to $9.1 million for the thirty-nine weeks ended October 2, 2004. As a percentage of revenues, our gross margin based on direct cost of services was 51.3% for the thirty-nine weeks ended October 1, 2005, compared to 48.1% for the thirty-nine weeks ended October 2, 2004. The increase in gross margin was primarily attributable to a shift in the mix of services to more strategy and management consulting engagements which typically yield higher margins than staffing engagements. Non-cash stock based compensation charges were $81,000 for the thirty-nine weeks ended October 1, 2005, compared to $157,000 for the thirty-nine weeks ended October 2, 2004. Non-cash stock based compensation charges primarily relate to our granting of restricted stock to select executives and key consultants during the fourth quarter of fiscal year 2003, which are being amortized on a graded vesting schedule over a period of two years from the date of grant. The decrease in equity-related charges is the result of reversals of previously recognized compensation expense related to forfeitures of restricted stock. OPERATING EXPENSES In total, operating expenses increased to $14.1 million for the thirty-nine weeks ended October 1, 2005, or 1.4% from $13.9 million for the thirty-nine weeks ended October 2, 2004. Operating expenses include selling, general and administrative costs, real estate restructuring, equity related charges, and intangible asset amortization. Selling, general and administrative expenses for the thirty-nine weeks ended October 1, 2005 were $13.3 million compared to $12.3 million for the thirty-nine weeks ended October 2, 2004. The increase is primarily related to increased investment in our initiative to develop our MVNE offerings and toolsets for IP transformation, as well as increases in selling expenses due to significant increase in revenues. Intangible asset amortization was $245,000 and $774,000 for the thirty-nine weeks ended October 1, 2005 and October 2, 2004, respectively. The decrease in amortization expense was due to certain intangible assets becoming fully amortized during fiscal year 2004 and first quarter 2005. Non-cash stock based compensation charges were $448,000 in the thirty-nine weeks ended October 1, 2005 compared to $776,000 for the thirty-nine weeks ended October 2, 2004. The charges relate to the award of restricted stock to select executives and key employees, which are being amortized on a graded vesting schedule over a period of two years from the date of grant for the fiscal year 2003 grants and four years from the date of grant for the fiscal year 2005 grants. The decrease in equity-related charges is the result of reversals of previously recognized compensation expense related to forfeitures of restricted stock. OTHER INCOME Interest income was $1,127,000 and $470,000 for the thirty-nine weeks ended October 1, 2005 and October 2, 2004, respectively, and represented interest earned on invested balances. Interest income increased for the thirty-nine weeks ended October 1, 2005 due primarily to increases in interest rates from 2004 to 2005. We primarily invest in money market funds and investment-grade auction rate securities as part of our overall investment policy. Other income increased due to investment gains recognized in the thirty-nine weeks ended October 1, 2005. INCOME TAXES In the thirty-nine weeks ended October 1, 2005 and October 2, 2004, we recorded provision for state income taxes of $31,000 and $47,000, respectively. The effective tax rate for these periods differed from the federal statutory rate primarily due to valuation allowances recorded on tax benefits as a result of uncertainties about their recoverability. DISCONTINUED OPERATIONS In the thirty-nine weeks ended October 2, 2004, charges related to the discontinuation of the hardware business were $2.2 million for goodwill impairment and severance charges. In addition, operating losses of the discontinued operations were $63,000 for the thirty-nine weeks ended October 2, 2004. These amounts are reported within discontinued operations in the Statement of Operations and Comprehensive Loss. LIQUIDITY AND CAPITAL RESOURCES In fiscal year 2004, through additional clarifying guidance, we determined that our investments in auction rate securities are more appropriately classified as available-for-sale short-term investments rather than cash equivalents and we have reflected such change retroactively in our financial statements and in our liquidity discussions. Auction rate securities generally have long-term stated maturities; however, for the investor, these securities have certain economic characteristics of short-term investments because of their rate setting mechanism. The return on these securities is designed to track short-term interest rates due to a "Dutch" auction process which resets the coupon rate (or dividend rate). Auction rate securities are designed to be highly liquid. Unless an auction fails, an investor can, by electing not to bid, recoup the principal amount of its investment at each auction date. To date we have experienced no failed auctions. Net cash provided by operating activities was $0.6 million for the thirty-nine weeks ended October 1, 2005, compared to net cash used in operating activities of $3.7 million for the thirty-nine weeks ended October 2, 2004. We generated positive cash flow from our operating activities for the thirty-nine weeks ended October 1, 2005 after offsetting net losses by non-cash operating expenses consisting of depreciation, amortization, and equity related charges. Negative cash flow from operating activities for the thirty-nine weeks ended October 2, 2004 was primarily due to operating losses. Net cash provided by investing activities was $0.7 million and $4.1 million for the thirty-nine weeks ended October 1, 2005 and October 2, 2004, respectively. This includes net proceeds from sales and reinvestments of auction rate securities of $1.0 million and $4.2 million in the thirty-nine weeks ended October 1, 2005 and October 2, 2004, respectively. Cash provided by investing activities also includes the acquisition of office equipment, software and computer equipment of $288,000 and $107,000 for the thirty-nine weeks ended October 1, 2005 and October 2, 2004, respectively. Net cash used in financing activities was $36,000 in the thirty-nine weeks ended October 1, 2005 and related to payments made on unfavorable and capital lease obligations, partially offset by proceeds received from exercise of stock options and purchases under our employee stock purchase plan. Net cash provided by financing activities was $75,000 in the thirty-nine weeks ended October 2, 2004 and proceeds from the exercise of stock options and purchases under our employee stock purchase plan were slightly in excess of payments made on unfavorable and capital lease obligations. At October 1, 2005, we had approximately $52.3 million in cash and cash equivalents and short-term investments. We believe we have sufficient cash to meet anticipated cash requirements, including anticipated capital expenditures, consideration for possible acquisitions, and any future operating losses that may be incurred, for at least the next 12 months. We have established a flexible model that provides a lower fixed cost structure than most consulting firms, enabling us to scale operating cost structures more quickly based on market conditions. Our strong cash position has enabled us to weather adverse conditions in the telecommunications industry and to make investments in intellectual property we believe are enabling us to capitalize on the current recovery and transformation of the industry; however, if the industry and demand for consulting services do not continue to rebound and we continue to experience negative cash flow, we could experience liquidity challenges at some future point. ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK We do not invest excess funds in derivative financial instruments or other market rate sensitive instruments for the purpose of managing our foreign currency exchange or interest rate risk. We invest excess funds in short-term investments, including auction rate securities, the yield of which is exposed to interest rate market risk. Auction rate securities are classified as available-for-sale and reported on the balance sheet at cost, which approximates market value, as the rate on such securities resets generally every 28 to 35 days. Consequently, interest rate movements do not materially affect the balance sheet valuation of fixed income investments. Changes in the overall level of interest rates do affect our interest income generated from investments. We do not have material exposure to market related risks. Foreign currency exchange rate risk may become material given U.S. dollar to foreign currency exchange rate changes in international engagements denominated in the local currency of our clients. ITEM 4. CONTROLS AND PROCEDURES A review and evaluation was performed by our management, including our Chief Executive Officer (the "CEO") and Chief Financial Officer (the "CFO"), of the effectiveness of the design and operation of our disclosure controls and procedures as of the end of the period covered by this quarterly report. Based on that review and evaluation, the CEO and CFO have concluded that our current disclosure controls and procedures, as designed and implemented, were effective. There have been no significant changes in our internal control over financial reporting or in other factors that could significantly affect our internal control over financial reporting subsequent to the date of their evaluation. There were no significant material weaknesses identified in the course of such review and evaluation and, therefore, we took no corrective measures. PART II. OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS We have not been subject to any material new litigation or claims since the time of our 10-K filing, on April 1, 2005. For a summary of litigation in which we are currently involved, refer to our annual report on Form 10-K, as filed with the Securities and Exchange Commission on April 1, 2005 and Note 10 to the Condensed Consolidated financial statements included elsewhere in this report. ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS None ITEM 3. DEFAULTS UPON SENIOR SECURITIES None ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS None ITEM 5. OTHER INFORMATION None ITEM 6. EXHIBITS (a) Exhibits Exhibit 31. Certifications pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. Exhibit 32. Certifications furnished pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
SIGNATURE TITLE DATE --------- ----- ---- /s/ Richard P. Nespola CHAIRMAN, PRESIDENT AND CHIEF NOVEMBER 15, 2005 ------------------------------ EXECUTIVE OFFICER RICHARD P. NESPOLA /s/ Donald E. Klumb CHIEF FINANCIAL OFFICER AND NOVEMBER 15, 2005 ----------------------------- TREASURER DONALD E. KLUMB (PRINCIPAL FINANCIAL OFFICER AND PRINCIPAL ACCOUNTING OFFICER)