| MANAGEMENT NETWORK GROUP INC Item 1A Risk Factors |
| 8 ITEM 1A RISK FACTORS Our business, operating results, financial condition and stock price are subject to numerous risks, uncertainties, and contingencies, many of which are beyond our control |
| The following important factors, among others, could cause actual results to differ materially from those contemplated in forward-looking statements made in this annual report on Form 10-K or presented elsewhere by management from time to time |
| Investors are urged to consider these risk factors when evaluating an investment in TMNG RISK THAT MAY IMPACT OUR FINANCIAL PERFORMANCE Factors outside of our control could cause companies to delay new product and new business initiatives and to seek to control expenses by reducing the use of outside consultants |
| The communications industry is in a period of consolidation, which could reduce our client base, eliminate future opportunities or create conflicts of interest among clients |
| As a result, current industry conditions may continue to harm our business, financial condition, results of operations, liquidity and ability to make acquisitions and raise investment capital |
| Future client financial difficulties and/or bankruptcies could require us to write-off receivables that are in excess bad debt reserves, which would harm our results of operations in future fiscal periods |
| OUR BUSINESS IS COMPLETELY DEPENDENT ON CONDITIONS IN THE CONVERGING COMMUNICATIONS, MEDIA AND ENTERTAINMENT INDUSTRY We focus almost exclusively on customers in the converging communications, media and entertainment industry and investment banking and private equity firms investing in that industry |
| We experienced significant growth in demand for our services throughout the 1990s |
| Between 2000 and 2004, the communications industry experienced a number of adverse conditions, including bankruptcies, layoffs, consolidation and contraction, declining market values, and in some cases financial scandals |
| These macro economic conditions substantially reduced the demand for our services and caused our revenues to decline, resulting in operating losses, negative cash flow and a decline in our stock price |
| If we are not able to capitalize on the opportunity created by the converging communications industry, we may continue to incur operating losses and negative cash flow, which may eventually adversely affect our liquidity |
| WE ARE DEPENDENT ON A LIMITED NUMBER OF LARGE CUSTOMERS FOR A MAJOR PORTION OF OUR REVENUES, AND THE LOSS OF A MAJOR CUSTOMER COULD SUBSTANTIALLY REDUCE REVENUES AND HARM OUR BUSINESS AND LIQUIDITY We derive a substantial portion of our revenues from a relatively limited number of clients (see Item 1, "e Business-Major Customers "e ) |
| This results in part from a conscious strategy to market our services to the largest and most stable companies in the industry, but our concentration of revenues with a small number of clients does expose us to risk |
| Our revenues and financial condition could be impaired if a major client stopped using our services |
| The services required by any one client may be affected by industry consolidation or adverse industry conditions, technological developments, economic slowdown or the clientapstas internal strategy or budget constraints |
| As a result, the volume of work performed for specific clients varies from period to period, and a major client in one period may not use our services in a subsequent period |
| In future quarters, our operating results may be below the expectations of public market analysts or investors, and the price of our common stock may decline |
| Factors that could cause quarterly fluctuations include: - - the beginning and ending of significant contracts during a quarter; - - the size and scope of assignments; - - the potential loss of key clients; - - the form of customer contracts changing primarily from time and materials to fixed price or contingent fee, based on project results; - - consultant turnover, utilization rates and billing rates; - - the loss of key consultants, which could cause clients to end their relationships with us; - - the ability of clients to terminate engagements without penalty; - - fluctuations in demand for our services resulting from budget cuts, project delays, industry consolidations or downturns or similar events; - - clients &apos decisions to divert resources to other projects, which may limit clients &apos resources that would otherwise be allocated to services we could provide; - - reductions in the prices of services offered by our competitors; - - developments in the communications market and economic conditions; - - seasonality during the summer, vacation and holiday periods; - - fluctuations in the value of foreign currencies versus the US dollar; and - - global economic and political conditions and related risks, including acts of terrorism |
| Because a significant portion of our non-consultant expenses are relatively fixed, a variation in the number of client assignments or the timing of the initiation or the completion of client assignments may cause significant variations in operating results from quarter-to-quarter and could result in continuing losses |
| To the extent the addition of consultant employees is not followed by corresponding increases in revenues, additional expenses would be incurred that would not be matched by corresponding revenues |
| Therefore, profitability would decline and we could potentially experience further losses and our stock price would likely decline |
| THERE CAN BE NO ASSURANCE OUR INVESTMENT IN NEW OFFERINGS WILL YIELD THE INTENDED RESULTS As discussed in Item 1 - "e Business-General "e and Item 7 - "e Managementapstas Discussion and Analysis of Financial Condition and Results of Operations - Executive Financial Overview "e and "e Operating Expenses, "e we have invested in proprietary toolsets designed to enable us to capitalize on industry convergence and the migration to wireless and IP platforms |
| We believe these investments had a positive impact on our 2005 revenues and will positively affect our revenues and profitability in 2006, but they did adversely impact our short-term profitability in 2005 |
| There can be no assurance these investments, or others like them, will continue to produce increased revenues or enable us to become profitable and cash flow positive in 2006 or future years |
| A SIGNIFICANT PORTION OF OUR BUSINESS IS REPRESENTED BY FIXED FEE CONTRACTS, WHICH EXPOSE US TO ADDITIONAL RISKS Fixed fee contracts entail subjective judgments and estimates about revenue recognition and are subject to uncertainties and contingencies |
| For a more complete discussion of our accounting for revenue recognition, see "e Critical Accounting Policies "e included in Item 7, "e Managementapstas Discussion and Analysis of Financial Condition and Results of Operations "e |
| Fixed fee contracts expose us to the risk that our cost of performing the contract may be higher than expected, reducing or eliminating our profit margin from the contract |
| WE HAVE MADE SEVERAL ACQUISITIONS AND MAY CONTINUE TO MAKE ACQUISITIONS, WHICH ENTAIL RISKS THAT COULD HARM OUR FINANCIAL PERFORMANCE OR STOCK PRICE As part of our business strategy, we have made and may continue to make acquisitions |
| Any future acquisition would be accompanied by the risks commonly encountered in acquisitions |
| These risks include: 9 - - the difficulty associated with assimilating the personnel and operations of acquired companies; - - the potential disruption of our existing business; - - further reductions in our cash reserves; - - adverse effects on our financial statements, including write-offs and assumption of liabilities of acquired businesses; and - - paying too much for an acquired company |
| If we make acquisitions and any of these problems materialize, these acquisitions could negatively affect our operations, profitability and financial condition |
| ANY FUTURE DECREASE IN REVENUES OF ACQUIRED BUSINESSES MAY RESULT IN ADDITIONAL ASSET IMPAIRMENTS AND ADVERSELY AFFECT OUR PROFITABLITY We have made and may continue to make acquisitions |
| As a result, goodwill and intangible assets constitute a significant balance of the assets reported on our balance sheet |
| We have, in the past, been required to write down goodwill and intangible assets on our financial statements as a result of declining revenues and earnings of the businesses we acquire |
| We may continue to be required to take asset impairment charges in the future |
| Our earnings and profitability would be adversely affected by any further asset impairments |
| WE HAVE REDUCED CONSULTANT HEADCOUNT WHICH COULD ADVERSELY AFFECT OUR ABILITY TO OBTAIN AND PERFORM CONSULTING ENGAGEMENTS Following the economic downturn of the first part of this decade, we undertook a series of cost-cutting measures to better align our operating costs with the reduced demand for communications consulting services |
| As part of these cost-cutting measures, we have reduced our employee consultant headcount |
| More recently we have begun to expand the skill sets of our consultant base by replacing existing consultants with professionals better suited to support our next generation offerings |
| Because the talents and skills of our consulting resources are limited in comparison to much larger firms, we may lose opportunities to obtain future consulting engagements or have difficulty performing engagements we do obtain, any of which could harm our business |
| THE MARKET IN WHICH WE OPERATE IS INTENSELY COMPETITIVE, AND ACTIONS BY COMPETITORS COULD RENDER OUR SERVICES LESS COMPETITIVE, CAUSING REVENUES AND INCOME TO DECLINE The market for consulting services to communications companies is intensely competitive, highly fragmented and subject to rapid change |
| Competitors include strategy and management consulting firms and major global outsourcing firms like IBM, Electronic Data Systems Corporation (EDS) and Computer Sciences Corporation, which have become more significant competitors recently due to the outsourcing of business support systems and operating support systems by communications companies |
| We are also subject to competition from large technical firms from the Asian markets, like Infosys Technologies, Ltd |
| that can provide significant cost advantages |
| Some of these competitors have also formed strategic alliances with communications and technology companies serving the industry |
| We also compete with internal resources of our clients |
| Although non-exhaustive, a partial list of our competitors includes: - - Accenture; - - Booz-Allen & Hamilton; - - Cap Gemini; - - DiamondCluster International, Inc |
| Many information technology-consulting firms also maintain significant practice groups devoted to the communications industry |
| Many of these companies have a national and international presence and may have greater personnel, financial, technical and marketing resources than we do |
| We may not be able to compete successfully with our existing competitors or with any new competitors |
| 10 We also believe our ability to compete depends on a number of factors outside of our control, including: - - the prices at which others offer competitive services, including aggressive price competition and discounting on individual engagements which may become increasingly prevalent in the current industry environment; - - the ability and willingness of our competitors to finance customers &apos projects on favorable terms; - - the ability of our competitors to undertake more extensive marketing campaigns than we can; - - the extent, if any, to which our competitors develop proprietary tools that improve their ability to compete with us; - - the ability of our customers to perform the services themselves; and - - the extent of our competitors &apos responsiveness to customer needs |
| We may not be able to compete effectively on these or other factors |
| If we are unable to compete effectively, our market position, and therefore our revenues and profitability, would decline |
| WE MUST CONTINUALLY ENHANCE OUR SERVICES TO MEET THE CHANGING NEEDS OF THE CONVERENCE OF COMMUNICATIONS CUSTOMERS WITH MEDIA AND ENTERTAINMENT, OR WE MAY LOSE FUTURE BUSINESS TO OUR COMPETITORS Our future success will depend upon our ability to enhance existing services and to introduce new services to meet the requirements of customers in a rapidly developing and evolving market, particularly in the areas of wireless communications and next-generation technologies supporting the convergence of communications, media and content |
| Present or future services may not satisfy the needs of the communications market |
| If we are unable to anticipate or respond adequately to customer needs, we may lose business and our financial performance will suffer |
| IF WE ARE NOT ABLE TO EFFECTIVELY RECRUIT AND RETAIN MANAGEMENT AND CONSULTING PERSONNEL THAT PROVIDE US WITH NEW TALENT SETS ENABLING THE IMPLEMENTATION OF NEW STRATEGIC OFFERINGS IN A RAPIDLY CHANGING MARKET, OUR FINANCIAL PERFORMANCE MAY BE NEGATIVELY IMPACTED Our ability to adapt to changing market conditions will depend on our ability to recruit and retain talented personnel, which cannot be assured |
| We may face two critical challenges in the recruitment of new management personnel |
| The first is the ability to recruit talented management personnel with the skill sets necessary to capitalize on an industry undergoing revolutionary change, and the second is the ability to execute such recruitment with an appropriate compensation arrangement |
| If we are unable to recruit and retain the people we need to perform our consulting engagements in a rapidly changing environment, our business may suffer |
| We must attract new consultants to implement our strategic plans |
| The number of potential consultants that meet our hiring criteria is relatively small, and there is significant competition for these consultants from direct competitors and others in the communications industry |
| Competition for these consultants may result in significant increases in our costs to attract and retain the consultants, which could reduce margins and profitability |
| In addition, we will need to attract consultants in international locations, principally Europe, to support our international strategic plans |
| We have limited experience in recruiting internationally, and may not be able to do so |
| Any inability to recruit new consultants or retain existing consultants could impair our ability to service existing engagements or undertake new engagements |
| If we are unable to attract and retain quality consultants, our revenues and profitability would decline |
| OUR ENGAGEMENTS WITH CLIENTS MAY NOT BE PROFITABLE OR MAY BE TERMINATED BY OUR CLIENTS ON SHORT NOTICE Unexpected costs, delays or failure to achieve anticipated cost reductions could make our contracts unprofitable |
| We have many types of contracts, including time and materials contracts, fixed-price contracts and contingent fee contracts |
| When making proposals for engagements, we estimate the costs and timing for completing the projects |
| These estimates reflect our best judgment regarding our costs, as well as the efficiencies of our methodologies and professionals as we plan to deploy them on our projects |
| Any increased or unexpected costs, delays or failures to achieve anticipated cost reductions in connection with the performance of these engagements, including delays caused by factors outside our control, could make these contracts less profitable or unprofitable, which would have an adverse effect on our profit margin |
| Under many of our contracts, the payment of some or all of our fees is conditioned upon our performance |
| We are increasingly moving away from contracts that are priced solely on a time and materials basis and toward contracts that also include incentives related to factors such as benefits produced |
| During fiscal year 2005, we estimate that approximately 28dtta1prca of our contracts had some fixed-price, incentive-based or other pricing terms that conditioned some or all of our fees on our ability to deliver these defined goals |
| The trend to include greater incentives in our contracts may increase the variability in revenues and margins earned on such contracts, and may expose us to greater risk of loss on the contracts if we do not perform successfully |
| Additionally, the estimates required for revenue recognition on these contracts expose us to risk of misstatement of financial results if our estimates prove to be inaccurate |
| 11 A majority of our contracts can be terminated by our clients with short notice and without significant penalty |
| Our clients typically retain us on a non-exclusive, engagement-by-engagement basis, rather than under exclusive long-term contracts |
| A majority of our consulting engagements are less than 12 months in duration |
| The advance notice of termination required for contracts of shorter duration and lower revenues is typically 30 days |
| Longer-term, larger and more complex contracts generally require a longer notice period for termination and may include an early termination charge to be paid to us |
| Additionally, large client projects involve multiple engagements or stages, and there is a risk that a client may choose not to retain us for additional stages of a project or that a client will cancel or delay additional planned engagements |
| These terminations, cancellations or delays could result from factors unrelated to our work product or the project, such as business or financial conditions of the client, changes in client strategies or the economy in general |
| Consequently, our profit margins in subsequent periods may be lower than expected |
| OUR PROFITABLITY WILL SUFFER IF WE ARE NOT ABLE TO MAINTAIN OUR PRICING AND UTILIZATION RATES AND CONTROL COSTS Our profitability is largely a function of the rates we are able to obtain for our services and the utilization rate, or chargeability, of our professionals |
| If we do not maintain pricing for our services and an appropriate utilization rate for our professionals without corresponding cost reductions, our profitability will suffer |
| We are under increasing price competition from competitors, which could adversely affect our profitability |
| IF INTERNATIONAL BUSINESS VOLUMES INCREASE, WE MAY BE EXPOSED TO A NUMBER OF BUSINESS AND ECONOMIC RISKS, WHICH COULD RESULT IN INCREASED EXPENSES AND DECLINING PROFITABILITY If our international business volumes increase, we will face a number of business and economic risks, including: - - unfavorable foreign currency exchange rates or fluctuations; - - difficulties in staffing and managing foreign operations; - - seasonal reductions in business activity; - - competition from local and foreign-based consulting companies; - - ability to protect our intellectual property; - - unexpected changes in trading policies and regulatory requirements; - - legal uncertainties inherent in transnational operations such as export and import regulations, tariffs and other trade barriers; - - the impact of foreign laws, regulations and trade customs; - - US and foreign taxation issues; - - operational issues such as longer customer payment cycles and greater difficulties in collecting accounts receivable; - - language and cultural differences; - - changes in foreign communications markets; - - increased cost of marketing and servicing international clients; - - potential limits on our ability to repatriate foreign profits; - - general political and economic trends, including the potential impact of terrorist attack or international hostilities; and - - expropriations of assets, including bank accounts, intellectual property and physical assets by foreign governments |
| In addition, we may not be able to successfully execute our business plan in foreign markets |
| If we are unable to achieve anticipated levels of revenues from international operations, our overall revenues and profitability may decline |
| WE ARE DEPENDENT ON A LIMITED NUMBER OF KEY PERSONNEL, AND THE LOSS OF THESE INDIVIDUALS COULD HARM OUR COMPETITIVE POSITION AND FINANCIAL PERFORMANCE Our business consists primarily of the delivery of professional services and, accordingly, our success depends upon the efforts, abilities, business generation capabilities and project execution of our executive officers and key consultants |
| Our success is also dependent upon the 12 managerial, operational, marketing, and administrative skills of our executive officers, particularly Richard Nespola, TMNGapstas Chairman, President and Chief Executive Officer |
| The loss of any executive officer or key consultant or group of consultants, or the failure of these individuals to generate business or otherwise perform at or above historical levels, could result in a loss of customers or revenues, which could harm our financial performance |
| IF WE FAIL TO PERFORM EFFECTIVELY ON PROJECT ENGAGEMENTS, OUR REPUTATION, AND THEREFORE OUR COMPETITIVE POSITION AND FINANCIAL PERFORMANCE, COULD BE HARMED Many of our engagements come from existing clients or from referrals by existing clients |
| Therefore, our growth is dependent on our reputation and on client satisfaction |
| The failure to perform services that meet a clientapstas expectations may damage our reputation and harm our ability to attract new business |
| IF WE FAIL TO DEVELOP AND MAINTAIN LONG-TERM RELATIONSHIPS WITH OUR CUSTOMERS, OUR SUCCESS WOULD BE JEOPARDIZED A substantial majority of our business is derived from repeat customers |
| Future success depends to a significant extent on our ability to develop long-term relationships with successful communications providers who will give us new and repeat business |
| Inability to build long-term customer relations would result in declines in our revenues and profitability |
| This may increasingly be the case with any further consolidation or contraction in the industry |
| WE CLASSIFY A LARGE NUMBER OF SUBCONTRACTORS AS INDEPENDENT CONTRACTORS FOR TAX AND EMPLOYMENT LAW PURPOSES IF THESE FIRMS OR PERSONNEL WERE TO BE RECLASSIFIED AS EMPLOYEES, WE COULD BE SUBJECT TO BACK TAXES, INTEREST, PENALTIES AND OTHER LEGAL CLAIMS We provide a significant percentage of consulting services through independent contractors and, therefore, do not pay Federal or state employment taxes or withhold income taxes for such persons |
| We generally do not include these independent contractors in our benefit plans |
| In the future, the IRS or state authorities may challenge the status of consultants as independent contractors |
| Independent contractors may also initiate proceedings to seek reclassification as employees under state law |
| In either case, if persons engaged by us as independent contractors are determined to be employees by the IRS or any state taxation department, we would be required to pay applicable federal and state employment taxes and withhold income taxes with respect to such contractors, and could become liable for amounts required to be paid or withheld in prior periods along with interest and penalties |
| In addition, we could be required to include such contractors in benefit plans retroactively and going forward |
| WE COULD BE SUBJECT TO CLAIMS FOR PROFESSIONAL LIABILITY, WHICH COULD HARM OUR FINANCIAL PERFORMANCE As a provider of professional services, we face the risk of liability claims |
| A liability claim brought against us could harm our business |
| We may also be subject to claims by clients for the actions of our consultants and employees arising from damages to clients &apos business or otherwise, or clients may demand a reduction in fees because of dissatisfaction with our services |
| OUR INABILITY TO PROTECT OUR INTELLECTUAL PROPERTY COULD HARM OUR COMPETITIVE POSITION AND FINANCIAL PERFORMANCE Despite our efforts to protect proprietary rights from unauthorized use or disclosure, parties, including former employees or consultants, may attempt to disclose, obtain or use our solutions or technologies |
| The steps we have taken may not prevent misappropriation of our intellectual property, particularly in foreign countries where laws or law enforcement practices may not protect proprietary rights as fully as in the United States |
| Unauthorized disclosure of our proprietary information could make our solutions and methodologies available to others and harm our competitive position |
| RISK THAT COULD AFFECT OUR STOCK PRICE THE MARKET PRICE OF OUR COMMON STOCK IS VOLATILE, AND INVESTORS MAY EXPERIENCE INVESTMENT LOSSES The market price of our common stock is volatile and has declined significantly from its initial public offering price |
| Our stock price could continue to decline or fluctuate in response to a variety of factors, including: - - variations in quarterly operating results; - - announcements of technological innovations that render talent outdated; - - future trends in the communications industry; - - acquisitions or strategic alliances by us or others in the industry; 13 - - failure to achieve financial analysts &apos or other estimates of results of operations for any fiscal period; - - the relatively small public float and relatively low volume at which our stock trades; - - changes in estimates of performance or recommendations by financial analysts; - - any further reduction in our revenues or continued losses during 2006 and future years; and - - continuing adverse market conditions in the communications industry and the economy as a whole |
| In addition, the stock market itself experiences significant price and volume fluctuations |
| These fluctuations particularly affect the market prices of the securities of many technology and communications companies |
| These broad market fluctuations could continue to harm the market price of our common stock |
| If the market price of our common stock falls below dlra1dtta00 per share for a period of 180 consecutive calendar days, we may risk being delisted from the NASDAQ Stock Market on which our stock trades |
| The recent decline in our overall market capitalization may also discourage analysts and investors from following us |
| Additionally, due to the limited public float of our common stock, investors may find their investment illiquid, and suffer losses |
| PRINCIPAL STOCKHOLDERS, EXECUTIVE OFFICERS AND DIRECTORS HAVE SUBSTANTIAL CONTROL OVER OUR VOTING STOCK Executive officers, directors and stockholders owning more than five percent of our outstanding common stock (and their affiliates) own a majority of our outstanding common stock |
| If all such persons acted together, they would have the ability to control all matters submitted to the stockholders for approval (including the election and removal of directors and any merger, consolidation or sale of all or substantially all of our assets) and to control our management and affairs |
| Concentration of ownership of our common stock may have the effect of delaying, deferring or preventing a change in control, impeding a merger, consolidation, takeover or other business combination involving us or discouraging a potential acquirer from making a tender offer or otherwise attempting to obtain control of us, any of which could be beneficial to our shareholders |
| WE MAY SEEK TO RAISE ADDITIONAL FUNDS, WHICH MAY BE DILUTIVE TO STOCKHOLDERS OR IMPOSE OPERATIONAL RESTRICTIONS Although we have not been required to obtain new debt or equity financing to support our operations or complete acquisitions, we may decide or be required to raise new capital for these or other purposes in the future |
| There can be no assurances any such capital would be available to us on acceptable terms |
| Any additional equity financing, if available, may be dilutive to our stockholders and debt financing, if available, may involve restrictive covenants, which may limit our operating flexibility with respect to certain business matters |
| If additional funds are raised through the issuance of equity securities, our stockholders may experience dilution in the voting power or net book value per share of our stock, and any additional equity securities may have rights, preferences and privileges senior to those of the holders of our common stock |
| ANTI-TAKEOVER PROVISIONS AND OUR RIGHT TO ISSUE PREFERRED STOCK COULD MAKE A THIRD PARTY ACQUISITION DIFFICULT Our certificate of incorporation, bylaws, and anti-takeover provisions of Delaware law could make it more difficult for a third party to acquire control of our Company |
| In addition, our bylaws provide for a classified board, with board members serving staggered three-year terms |
| The Delaware anti-takeover provisions and the existence of a classified board, in addition to our relatively small public float, could make it more difficult for a third party to acquire us, even if such transaction were in the best interest of our shareholders |