1 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 SEPTEMBER 30, 1999 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 COMMISSION FILE NUMBER 0-22010 ----------- THOMAS GROUP, INC. (Exact name of registrant as specified in its charter) DELAWARE 72-0843540 (State or other jurisdiction of incorporation or organization) (I.R.S. Employer Identification No.) 5221 NORTH O'CONNOR BOULEVARD SUITE 500 IRVING, TX 75039-3714 (Address of principal executive offices, including zip code) (972) 869-3400 (Registrant's telephone number, including area code) ----------- NONE (Former name, former address and former fiscal year, if changed since last report) ----------- Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [X] No [ ] As of October 30, 1999 the following number of shares of the registrant's stock were outstanding: Common Stock 4,833,020 Class B Common Stock 3,970 --------- Total 4,836,990 ========= 1 2 THOMAS GROUP, INC. PART I - FINANCIAL INFORMATION PAGE NO. Item 1 - Financial Statements (unaudited) Consolidated Balance Sheets, September 30, 1999 and December 31, 1998......................................... 3 Consolidated Statements of Operations for the Three Months and Nine Months Ended September 30, 1999 and 1998.................. 4 Consolidated Statements of Cash Flows for the Nine Months Ended September 30, 1999 and 1998............................... 5 Notes to Consolidated Financial Statements.................... 6 Item 2 - Management's Discussion and Analysis of Financial Condition and Results of Operations..................................... 9 PART II - OTHER INFORMATION Item 6 - Exhibits and Reports on Form 8-K............................ 15 2 3 ITEM I - FINANCIAL STATEMENTS THOMAS GROUP, INC. CONSOLIDATED BALANCE SHEETS (IN THOUSANDS, EXCEPT SHARE DATA) (UNAUDITED) SEPTEMBER 30, DECEMBER 31, ASSETS 1999 1998 ------------ ------------ Current Assets Cash and cash equivalents ............................................ $ 10,141 $ 6,376 Trade accounts receivable, net of allowances of $396 ................. 11,125 11,239 Unbilled receivables ................................................. 72 740 Income tax receivable ................................................ 539 -- Deferred tax asset ................................................... 4,389 2,331 Other assets ......................................................... 1,146 405 -------- -------- Total Current Assets .............................................. 27,412 21,091 -------- -------- Property and Equipment, net ............................................. 2,750 3,627 Deferred Tax Asset ...................................................... 836 2,519 Other Assets ............................................................ 3,116 4,394 -------- -------- $ 34,114 $ 31,631 ======== ======== LIABILITIES AND STOCKHOLDERS' EQUITY Current Liabilities Accounts payable and accrued liabilities ............................. $ 7,311 $ 6,028 Income taxes payable ................................................. 919 602 Advance payments ..................................................... -- 532 Current maturities of long-term obligations .......................... 326 329 -------- -------- Total Current Liabilities ......................................... 8,556 7,491 Long-Term Obligations ................................................... 4,020 2,928 -------- -------- Total Liabilities ................................................. 12,576 10,419 -------- -------- Commitments and Contingencies Stockholders' Equity Common Stock, $.01 par value; 25,000,000 shares authorized; 6,594,931 and 6,536,416 shares issued ............................. 66 65 Additional paid-in capital ........................................... 23,521 22,699 Retained earnings .................................................... 15,232 13,654 Accumulated other comprehensive income - foreign currency translation .............................................. (789) (482) Treasury stock, 1,762,399 and 1,558,849 shares of Common, at cost .... (16,492) (14,724) -------- -------- Total Stockholders' Equity ........................................ 21,538 21,212 -------- -------- $ 34,114 $ 31,631 ======== ======== See accompanying notes to consolidated financial statements. 3 4 THOMAS GROUP, INC. CONSOLIDATED STATEMENTS OF OPERATIONS (IN THOUSANDS, EXCEPT SHARE DATA) (UNAUDITED) NINE MONTHS THREE MONTHS ENDED ENDED SEPTEMBER 30, SEPTEMBER 30, ---------------------------- -------------------------- 1999 1998 1999 1998 ------------- ----------- ----------- ----------- Revenue ........................................... $ 14,774 $ 17,439 $ 45,236 $ 49,650 Cost of Sales ............................... 7,971 9,621 25,705 29,422 ----------- ----------- ----------- ----------- Gross Margin ...................................... 6,803 7,818 19,531 20,228 Selling, General and Administrative ......... 4,600 4,668 13,817 23,979 ----------- ----------- ----------- ----------- Operating Income (Loss) ........................... 2,203 3,150 5,714 (3,751) Interest Income (Expense), Net .................... 73 (70) 139 (131) ----------- ----------- ----------- ----------- Income (Loss)from Continuing Operations Before .... 2,276 3,080 5,853 (3,882) Income Tax Income Tax (Benefit) .............................. 831 1,124 2,260 (1,511) ----------- ----------- ----------- ----------- Income (Loss) from Continuing Operations .......... 1,445 1,956 3,593 (2,371) ----------- ----------- ----------- ----------- Discontinued Operations: Loss from Operations, net of income tax ........... -- -- -- (1,092) Estimated loss on disposal, including provision for operating losses through disposal date, net of income tax ..................................... (2,015) (435) (2,015) (3,341) ----------- ----------- ----------- ----------- Net Income (Loss) ................................. $ (570) $ 1,521 $ 1,578 $ (6,804) =========== =========== =========== =========== Earnings (Loss) per common share: Basic: Income (Loss) from Continuing Operations .......... $ 0.30 $ 0.40 $ 0.73 $ (0.44) Discontinued Operations: Loss from Operations ............................ -- -- -- (0.20) Estimated Loss on Disposal ...................... (0.42) (0.09) (0.41) (0.62) ----------- ----------- ----------- ----------- Net Income (Loss) per share ....................... $ (0.12) $ 0.31 $ 0.32 $ (1.26) =========== =========== =========== =========== Diluted: Income from Continuing Operations ................. $ 0.29 $ 0.39 $ 0.73 $ (0.44) Discontinued Operations: Loss from Operations ............................ -- -- -- (0.20) Estimated Loss on Disposal ...................... (0.41) (0.09) (0.41) (0.62) ----------- ----------- ----------- ----------- Net Income (Loss) per share ....................... $ (0.12) $ 0.30 $ 0.32 $ (1.26) =========== =========== =========== =========== Weighted average shares: Basic ............................................. 4,829,770 4,946,380 4,892,438 5,403,607 Diluted ........................................... 4,899,419 5,055,283 4,952,982 5,403,607 See accompanying notes to consolidated financial statements. 4 5 THOMAS GROUP, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS (IN THOUSANDS) (UNAUDITED) NINE MONTHS ENDED SEPTEMBER 30, ---------------------- 1999 1998 ---------- --------- Cash Flows From Operating Activities: Net income (loss) from continuing operations .......................................... $ 3,593 $ (2,371) Adjustments to reconcile net income (loss) from continuing operations to net cash from operating activities Depreciation and amortization ............................................... 1,187 1,143 Allowance for doubtful accounts ............................................. -- 101 Provision for write-down of assets .......................................... -- 3,602 Deferred taxes .............................................................. 860 (2,491) Gain (loss) on disposal of property ......................................... (3) 37 Other ....................................................................... 218 219 Change in operating assets and liabilities (Increase) decrease in trade accounts receivable ....................... (85) 1,305 (Increase) decrease in income tax receivable ........................... (539) -- (Increase) decrease in unbilled receivables ............................ 668 (1,516) (Increase) decrease in other assets .................................... 816 1,468 Increase (decrease) in accounts payable and accrued liabilities ........ (1,009) 1,422 Increase (decrease) in advance payments ................................ (532) 175 Increase (decrease) in income taxes payable ............................ 609 (366) -------- -------- Net Cash Provided By (Used In) Operating Activities ............... 5,783 2,728 Cash Flows From Investing Activities: Capital expenditures .................................................................. (362) (781) -------- -------- Net Cash Used In Investing Activities ............................. (362) (781) Cash Flows From Financing Activities: Purchase of treasury stock ............................................................ (1,768) (10,605) Proceeds from exercise of stock options ............................................... 315 547 Other long-term obligations ........................................................... (58) (228) Advances - line of credit ............................................................. -- 32,508 Repayment - line of credit ............................................................ -- (32,508) Net repayments from (advances to) affiliates .......................................... -- 2,274 -------- -------- Net Cash Used In Financing Activities ............................. (1,511) (8,012) Effect of Exchange Rate Changes on Cash ................................................... (145) (41) -------- -------- Net cash provided by (used in) continuing operations ...................................... 3,765 (6,106) Discontinued Operations: Net cash used in operating activities ........................................... -- (2,507) -------- -------- Net increase (decrease) in cash and cash equivalents ...................................... 3,765 (8,613) Cash and Cash Equivalents: Beginning of period ................................................................... 6,376 11,254 -------- -------- End of period ......................................................................... $ 10,141 $ 2,641 ======== ======== See accompanying notes to consolidated financial statements. 5 6 THOMAS GROUP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) 1. The unaudited consolidated financial statements of Thomas Group, Inc. (the "Company") include all adjustments, which include only normal recurring adjustments, which are, in the opinion of management, necessary to present fairly the results of operations of the Company for the interim periods presented. The unaudited financial statements should be read in conjunction with the consolidated financial statements and notes thereto in the Company's 1998 Annual Report to Stockholders. The results of operations for the three and nine-month periods ended September 30, 1999 are not necessarily indicative of the results of operations for the entire year ending December 31, 1999. Certain consolidated financial statement amounts have been reclassified from the previously reported financial statements in order to conform with the current presentation. 2. Earnings Per Share - Basic earnings per share is based on the number of weighted average shares outstanding. The following table reconciles basic earnings per share to diluted earnings per share under the provisions of Statement of Financial Accounting Standards No. 128, "Earnings Per Share." The following illustrates the reconciliation of the numerators and denominators of the basic and diluted earnings per share computations: THREE MONTHS ENDED NINE MONTHS ENDED SEPTEMBER 30, SEPTEMBER 30, ------------------- ------------------- In thousands, except per share data 1999 1998 1999 1998 -------- -------- --------- ------- NUMERATOR: Net Income (Loss) ................. $ (570) $ 1,521 $ 1,578 ($6,804) ======= ======= ======= ======= DENOMINATOR: Weighted Average Shares Outstanding: Basic .......................... 4,830 4,946 4,892 5,403 Effect of Dilutive Securities: Common Stock Options ... -- 109 61 -- ------- ------- ------- ------- Diluted ........................ 4,830 5,055 4,953 5,403 ======= ======= ======= ======= EARNINGS (LOSS) PER SHARE: Basic ............................. $ (0.12) $ 0.31 $ 0.32 $ (1.26) Diluted ........................... $ (0.12) $ 0.30 $ 0.32 $ (1.26) 6 7 THOMAS GROUP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (UNAUDITED) 3. Deferred Taxes - As a result of the restructuring charges and losses from discontinued operations recognized in the second quarter of 1998 and the third quarter of 1999, the Company maintains deferred tax assets of $5.3 million at September 30, 1999. Utilization of the deferred tax asset is dependent on future taxable income in excess of existing taxable temporary differences. The asset has been recognized because management believes it is more likely than not that the deferred tax asset will be utilized in future years. This conclusion is based on the belief that current and future levels of taxable income will be sufficient to realize the benefits of the deferred tax asset on domestic operations. 4. Significant Clients - The Company recorded revenue from one client of $4.7 million, or 31.9% of total revenue, and $14.4 million, or 31.9% of total revenue, during the three and nine months ended September 30, 1999, respectively. Revenue from the same client totaled $5.9 million, or 33.9% of total revenue, and $13.2 million, or 26.7% of total revenue for the three and nine months ended September 30, 1998, respectively. The Company recorded revenue from a second client of $1.6 million, or 10.6% of total revenue during the three months ended September 30, 1999. There was no other client from which revenue exceeded 10% of total revenue in the three or nine-month periods ended September 30, 1999 or September 30, 1998. 5. Comprehensive Income - In the first quarter of 1998, the Company adopted Statement of Financial Accounting Standards No. 130, "Reporting Comprehensive Income", which establishes standards for reporting and display of comprehensive income. Comprehensive income includes all changes in equity (foreign currency translation) except those resulting from investments by owners and distributions to owners. THREE MONTHS ENDED NINE MONTHS ENDED SEPTEMBER 30, SEPTEMBER 30, ------------------- ------------------- In thousands of dollars 1999 1998 1999 1998 --------- -------- --------- -------- Net income (loss) ............................... $ (570) $ 1,521 $ 1,578 $(6,804) Increase (Decrease) in other comprehensive income 184 248 (307) 129 ------- ------- ------- ------- Comprehensive income (loss) .................... $ (386) $ 1,769 $ 1,271 $(6,675) ======= ======= ======= ======= 6. Revolving Credit Agreement - The Company previously maintained a $20 million revolving credit agreement with Comerica Bank. Terms of the agreement provided for a $1 million per quarter reduction in available credit beginning in 1999. In April 1999 the Company amended the agreement to reduce the maximum available borrowings to $15 million with no quarterly reduction. The agreement is in place to provide funding for potential future operating cash requirements or business expansion purposes. Loans under this agreement bear interest at the prime rate or other similar interest options. There has been no utilization of the credit facility during the first nine months of 1999. 7. Litigation - The Company is subject to various claims and other legal matters, described below, in the course of conducting its business. The Company believes that neither such claims and other legal matters will have a material adverse effect on the Company's consolidated results of operations, financial condition or cash flows. On April 28, 1999 a judgment was entered in all matters in favor of the Company in the legal action Creative Dimensions in Management, Inc. v. Thomas Group, Inc. This matter arose out of disputes under two agreements between the Company and Creative Dimensions in Management, Inc., a small private company with whom the Company had an alliance. 7 8 THOMAS GROUP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (UNAUDITED) The case Thomas Group, Inc. v. Blevins, et al., and the case Blevins, et al. V. Thomas Group, Inc. were settled on October 25, 1999. The cases arose out of the purchase agreements and consulting agreement in connection with the Company's purchase of Interlink Technologies. The Company is party to a legal action styled Philip R. Thomas and Wayne Heirtzler Thomas v. Thomas Group, Inc., before the U.S. District Court, Middle District of Louisiana, consolidated with another action styled Thomas Group of Louisiana, Inc. v. Philip R. Thomas and Wayne Heirtzler Thomas. Mr. and Mrs. Thomas sought to "enforce leases" and seized, under a writ of sequestration, movable assets at the Company's CEO Center in Louisiana. No damages were alleged by Mr. and Mrs. Thomas. The second suit was filed against Mr. and Mrs. Thomas by a subsidiary of the Company, seeking to dissolve the writ of sequestration and asserting a claim for damages. A hearing was held on February 2, 1999 on the motions of the Company and its subsidiary to dissolve the writ of sequestration, and the court has lifted the sequestration order. The Company has amended its complaint in this action, to seek a declaratory judgment from the federal court that the Company is not in default under any of the leases relating to the Louisiana property. The Company is party to an arbitration proceeding with the former Chairman and CEO of the Company, styled Thomas Group, Inc. v. Philip Thomas. The Company timely paid Mr. Thomas all benefits due him under his written employment agreement, including a $1.8 million severance payment, yet Mr. Thomas has demanded additional compensation and retirement benefits. On December 18, 1998, the Company initiated this proceeding before the American Arbitration Association in Dallas, Texas pursuant to an arbitration clause in Mr. Thomas' employment agreement. On December 31, 1998, Mr. Thomas filed suit in Dallas County District Court in an action styled Philip R. Thomas v. Thomas Group, Inc. The Company moved to stay the litigation based on the parties' written agreement to arbitrate, and the litigation has been stayed. The Company believes Mr. Thomas' claims have no merit, vigorously contests Mr. Thomas' claims, and is seeking a determination that Mr. Thomas is owed nothing further as a result of his employment relationship with the Company. 8. Supplemental Disclosure of Cash Flow Information NINE MONTHS ENDED SEPTEMBER 30, ------------------------------- 1999 1998 --------------- --------------- Interest paid................................... $ 120 $ 169 Income taxes paid............................... $ 803 $ 1,965 8 9 ITEM 2 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED) OVERVIEW The Company derives the majority of its revenue from monthly fixed and incentive fees for the implementation of Total Cycle Time and other business improvement programs. Incentive fees are tied to improvements in a variety of client performance measures typically involving response time, asset utilization, productivity and profitability. Due to the Company's use of incentive fee contracts, variations in revenue levels may cause fluctuations in quarterly results. Factors such as a client's commitment to a Total Cycle Time program, general economic and industry conditions, and other issues could affect a client's business performance, thereby affecting the Company's incentive fee revenue and quarterly earnings. Quarterly revenue and earnings of the Company may also be impacted by the size and timing of starts and completions of individual contracts. UNLESS OTHERWISE STATED, THE DISCUSSION THAT FOLLOWS PERTAINS TO CONTINUING OPERATIONS ONLY. The following table sets forth the percentages which items in the statement of operations bear to revenue: THREE MONTHS ENDED NINE MONTHS ENDED SEPTEMBER 30, SEPTEMBER 30, ------------------ ----------------- 1999 1998 1999 1998 -------- -------- -------- ------- Revenue ......................................................... 100.0% 100.0% 100.0% 100.0% Cost of Sales ............................................. 54.0 55.2 56.8 59.3 ----- ----- ----- ----- Gross Margin .................................................... 46.0 44.8 43.2 40.7 Selling, General and ...................................... 31.1 ` 26.7 30.5 27.3 Administrative Restructuring costs ...................................... -- -- -- 21.0 ----- ----- ----- ----- Operating Income (Loss) ......................................... 14.9 18.1 12.7 (7.6) Interest Income (Expense), Net .................................. 0.5 (0.4) 0.3 (0.2) ----- ----- ----- ----- Income (Loss) from Continuing Operations Before ................. 15.4 17.7 Income Taxes .................................................... 13.0 (7.8) Income Taxes (Benefit) .......................................... 5.6 6.5 5.0 (3.0) ===== ===== ===== ===== Income (Loss) from Continuing Operations ........................ 9.8% 11.2% 8.0% (4.8)% ===== ===== ===== ===== The following table sets forth the Company's revenue by geographic distribution: THREE MONTHS ENDED NINE MONTHS ENDED SEPTEMBER 30, SEPTEMBER 30, ----------------- ------------------ 1999 1998 1999 1998 ------- ------- ------- ------- United States .... $ 9,411 $12,568 $28,677 $34,265 Europe ........... 3,877 3,972 12,030 12,697 Asia/Pacific ..... 1,486 899 4,529 2,688 ------- ------- ------- ------- Total Revenue $14,774 $17,439 $45,236 $49,650 ======= ======= ======= ======= 9 10 ITEM 2 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED) THREE MONTHS ENDED SEPTEMBER 30, 1999 COMPARED TO THREE MONTHS ENDED SEPTEMBER 30, 1998 REVENUE - Revenue decreased 15.3% in the third quarter of 1999 from the third quarter of 1998. This revenue decrease resulted from a $0.2 million increase in fixed fee revenue offset by a $2.8 million decline in incentive revenue. Fixed fee and incentive revenue represent 95.8% and 4.2% of revenue, respectively, for the third quarter of 1999 and 80.3% and 19.7% of revenue, respectively, for the third quarter of 1998. The United States component of revenue decreased 25.1% due to contract completions exceeding new contract start-ups. European revenue decreased 2.4% and is expected to increase in the near future due to new significant contracts in this region. Asia/Pacific revenue increased 65.3% due to new contracts started in 1999. GROSS PROFIT - Gross profit was 46% of revenue in the third quarter of 1999 compared to 44.8% of revenue in the third quarter of 1998. This increase in percentage was due, in part to the use of part-time ResultantsSM in 1999 who are compensated only when they are working on client assignments. Average full-time ResultantsSM headcount decreased from 130 in the third quarter of 1998 to 124 in the third quarter of 1999. The use of part-time professionals is intended to reduce the volatility of the Company's profit margin in the event of a reduction in the number of active contracts. SELLING, GENERAL AND ADMINISTRATIVE EXPENSES - Selling, general and administrative expenses consist of all operating expenses not directly associated with the generation of revenue. A significant portion of selling, general and administrative expenses are for corporate personnel (including corporate officers), non-program-related travel and entertainment, corporate facilities costs, and professional and legal costs. Selling, general and administrative expenses, as a percentage of total revenue, increased to 31.1% in the third quarter of 1999 from 26.7% in the third quarter of 1998. The increase in percentage is primarily due to the decrease in revenue in these comparable periods. DISCONTINUED OPERATIONS - In the second quarter of 1998, the Company announced its plan to dispose of its Information Technologies business segment. The Company recorded an after tax charge of approximately $2.9 million as the estimated loss on disposal of the segment, including estimated operating losses during the phase-out period. Terms of the sale required a revision to the estimated loss on disposal and an additional $0.4 million after tax charge was recorded in the third quarter of 1998. Settlement of a lawsuit related to this discontinued segment required another revision to the estimated loss on disposal and an additional $2.0 million after tax charge was recorded in the third quarter of 1999. OTHER - The Company's effective tax rate was 37% in the third quarter of 1999, as compared to the 36% rate in the third quarter of 1998. The slight increase is attributable to certain 1998 adjustments made to accommodate the restructuring charge and discontinued operations and a change in the mix of domestic and foreign revenue sources. RESULTS OF OPERATIONS - Income from continuing operations in the third quarter of 1999 was $1.4 million, or $0.29 per diluted share, a decrease of $0.6 million compared to income from continuing operations of $2.0 million, or $0.39 per diluted share, in the third quarter of 1998. NINE MONTHS ENDED SEPTEMBER 30, 1999 COMPARED TO NINE MONTHS ENDED SEPTEMBER 30, 1998 REVENUE - Revenue decreased 8.9% in the first nine months of 1999 compared to the first nine months of 1998. The decrease consisted of a $0.6 million increase in fixed fee revenue and a $5.0 million decrease in incentive revenue. Fixed fee and incentive revenue represent 88.1% and 11.9%, respectively, of revenue in the first nine months of 1999 and 79.0% and 21.0% of revenue, respectively, in the first nine months of 1998. 10 11 ITEM 2 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED) The United States component of revenue decreased 16.3%, primarily as a result of contract completions in the second half of 1998. Asia/Pacific revenue increased 68.5% for the comparable period due to the increased referenceability of the Company in the region which has been converted to four new contracts since the end of 1998. GROSS PROFIT - Gross profit was 43.2% of revenue in the first nine months of 1999 compared to 40.7% of revenue in the first nine months of 1998. This increase was primarily the result of the use of part-time ResultantsSM in 1999 who are compensated only when they are working on client assignments. The use of part-time professionals is intended to reduce the volatility of the Company's profit margin in the event of a reduction in the number of active contracts. SELLING, GENERAL AND ADMINISTRATIVE EXPENSES - In the nine months ended September 30, 1998 selling, general and admininstrative expenses include restructuring costs and other nonrecurring personnel costs totaling $10.4 million. Selling, general and administrative expense, excluding the restructuring charge, as a percentage of total revenue increased to 30.5% in the first nine months of 1999 from 27.3% in the first nine months of 1998. On an absolute basis, selling, general and administrative expense increased $0.2 million. The overall increase in selling, general and administrative expense in 1999 versus 1998 is primarily the increased costs of supporting certain litigation in 1999. The cases are, however, being resolved and legal expenses are expected to be lower in the future. (See Litigation later in this discussion.) DISCONTINUED OPERATIONS - In the second quarter of 1998, the Company announced its plan to dispose of its Information Technologies business segment. The Company recorded an after tax charge of approximately $2.9 million as the estimated loss on disposal of the segment, including estimated operating losses during the phase-out period. Terms of the sale required a revision to the estimated loss on disposal and an additional $0.4 million after tax charge was recorded in the third quarter of 1998 resulting in a total charge of $3.3 million as the estimate loss on disposal of the segment for 1998. Settlement of a lawsuit related to this discontinued segment required another revision to the estimated loss on disposal and an additional $2.0 million after tax charge was recorded in the third quarter of 1999. The Company realized a loss of $1.1 million net of tax in the first quarter of 1998 as a result of the operations of the discontinued segment. OTHER - The Company's effective tax rate was 39% in the first nine months of 1999, equal to the 39% rate in the first nine months of 1998. As a result of the restructuring charges and losses from discontinued operations recognized in the second quarter of 1998, the Company maintains deferred tax assets of $5.3 million and an income tax receivable of $0.5 million at September 30, 1999. The income tax receivable is to be applied to current year tax liability. The deferred tax asset will be applied to future tax liabilities. Utilization of the deferred tax asset and receivable is dependent on future taxable profits in excess of existing taxable temporary differences. At a tax rate of 40% the Company needs to realize pre-tax income of $13 million in the next five years to fully realize the total tax benefit of $5.3 million. Assuming margins remain equivalent to historical levels, business under commitment (backlog) at September 30, 1999 should produce income before taxes of approximately $11 million in the next two years. Management believes that closing sufficient additional revenue to generate $2 million of additional income before taxes in the next two years is highly likely. The Company will continue in future periods to evaluate the realizability of the tax assets and make necessary adjustments through charges to expense should projected future taxable income be insufficient to realize the benefit of the tax assets. RESULTS OF OPERATIONS - Income from continuing operations in the first nine months of 1999 was $3.6 million, or $0.73 per diluted share, an increase of $6.0 million from a loss from continuing operations of $2.4 million, or $0.44 per share, in the first nine months of 1998. 11 12 ITEM 2 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED) LIQUIDITY AND CAPITAL RESOURCES Cash and cash equivalents increased by $3.8 million in the first nine months of 1999 compared to a $8.9 million decrease in the first nine months of 1998. The major components of these changes are discussed below: CASH FLOWS FROM OPERATING ACTIVITIES - Operating activities provided cash of $7.8 million in the nine months ended September 30, 1999 compared to a use of cash of $2.3 million in the first nine months of 1998. Accounts receivable balances more than 30 days past due were $1.7 million at September 30, 1999, compared to $2.0 million at December 31, 1998 and $3.7 million at September 30, 1998. Days sales outstanding in accounts receivable was 62 days at September 30, 1999 and 53 days at December 31, 1998. CASH FLOWS FROM INVESTING ACTIVITIES - Cash flows used in investing activities totaled $0.4 million in the first nine months of 1999 and were attributable to office facilities and miscellaneous equipment. Capital expenditures for the comparable period of the prior year were primarily for the purchase of computers and network computing equipment. CASH FLOWS FROM FINANCING ACTIVITIES - In February 1999, the Board of Directors of the Company approved a stock repurchase plan for up to 250,000 shares of Common Stock of the Company. Shares are purchased in the open market. During the first nine months of 1999, the Company purchased 203,550 shares of stock its stock at an average price of approximately $8.67 per share. Cash flows used in financing activities in the first half of 1998 were primarily for the purchase of outstanding stock. In February 1998, the Company entered into a stock purchase agreement with its then Chairman and Chief Executive Officer to repurchase shares of common stock for $8.2 million in cash and satisfaction of a $2.3 million debt to the Company. Terms of the agreement called for independent determination of the value (and consequently, the number) of shares to be acquired. In April 1998 the number of shares was determined to be approximately 1.3 million, representing a discount to the market value during the settlement period. The Company previously maintained a $20 million revolving credit agreement with Comerica Bank. Terms of the agreement provided for a $1 million per quarter reduction in available credit beginning in the first quarter of 1999. In April 1999 the Company amended the agreement to reduce maximum allowable borrowings to $15 million with no quarterly reduction. The agreement is in place to provide funding for potential future operating cash requirements or business expansion purposes. Loans under this agreement bear interest at the prime rate or other similar interest options. There has been no utilization of the credit facility during the first nine months of 1999. FINANCIAL CONDITION The Company believes that its financial condition remains strong and that it has the financial resources necessary to meet its needs. Cash provided by operating activities and the Company's credit facility should be sufficient to meet short and long-term operational needs. LITIGATION The Company is subject to various claims and other legal matters, described below, in the course of conducting its business. The Company believes that neither such claims and other legal matters will have a material adverse effect on the Company's consolidated results of operations, financial condition or cash flows. 12 13 ITEM 2 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED) The case of Thomas Group, Inc. v. Blevins, et al., and the case Blevins, et al. v. Thomas Group, Inc., were settled on October 25, 1999. The cases arose out of the purchase agreement and consulting agreement in connection with the Company's purchase of Interlink Technologies. The Company is party to a legal action styled Philip R. Thomas and Wayne Heirtzler Thomas v. Thomas Group, Inc., before the U.S. District Court, Middle District of Louisiana, consolidated with another action styled Thomas Group of Louisiana, Inc. v. Philip R. Thomas and Wayne Heirtzler Thomas. Mr. and Mrs. Thomas sought to "enforce leases" and seized, under a writ of sequestration, movable assets at the Company's CEO Center in Louisiana. No damages were alleged by Mr. and Mrs. Thomas. The second suit was filed against Mr. and Mrs. Thomas by a subsidiary of the Company, seeking to dissolve the writ of sequestration and asserting a claim for damages. A hearing was held on February 2, 1999 on the motions of the Company and its subsidiary to dissolve the writ of sequestration, and the court has lifted the sequestration order. The Company has amended its complaint in this action, to seek a declaratory judgment from the federal court that the Company is not in default under any of the leases relating to the Louisiana property. The Company is party to an arbitration proceeding with the former Chairman and CEO of the Company, styled Thomas Group, Inc. v. Philip Thomas. The Company timely paid Mr. Thomas all benefits due him under his written employment agreement, including a $1.8 million severance payment, yet Mr. Thomas has demanded additional compensation and retirement benefits. On December 18, 1998, the Company initiated this proceeding before the American Arbitration Association in Dallas, Texas pursuant to an arbitration clause in Mr. Thomas' employment agreement. On December 31, 1998, Mr. Thomas filed suit in Dallas County District Court in an action styled Philip R. Thomas v. Thomas Group, Inc. The Company moved to stay the litigation based on the parties' written agreement to arbitrate, and the litigation has been stayed. The Company believes Mr. Thomas' claims have no merit, vigorously contests Mr. Thomas' claims, and is seeking a determination that Mr. Thomas is owed nothing further as a result of his employment relationship with the Company. YEAR 2000 ISSUES The Company's internal business information systems are primarily comprised of commercial application software products offered for license by Microsoft Corporation and other recognized providers. Because these providers' products are widely distributed commercially developed applications, the Company anticipates these applications have been or will be brought into compliance by the manufacturers. The Company has implemented new accounting and financial reporting software that is Year 2000 compliant. To be Year 2000 compliant, many of the various software programs utilized by the Company required upgrading. Generally these upgrades were included as part of the licensing for use of the program, and were available at no additional cost. Hardware purchases in the last year have been made in contemplation of the Year 2000, but not specifically for that purpose. As such, the Company estimates the total cost incurred to date specifically for Year 2000 compliance to be less than $0.1 million. The Company does not anticipate any Year 2000 compliance issues to arise related to its primary internal business information systems. Thomas Group is not aware of any further material operational issues or costs associated with preparing internal systems for the Year 2000. However, the Company utilizes other third party network equipment, telecommunication products, and other third party software products that may or may not be Year 2000 compliant. Although the Company is currently taking steps to address the impact, if any, of the Year 2000 issue surrounding such third party products, failure of any critical technology to operate properly in the Year 2000 may have an adverse impact on business operations or require the Company to incur unanticipated expenses to remedy any problems. 13 14 ITEM 2 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED) The Company is unaware of any client who may be impacted by the Year 2000 issue. A failure of a client to appropriately handle issues related to the Year 2000 might have an adverse impact on the financial results of the Company. "SAFE HARBOR" STATEMENT UNDER THE PRIVATE SECURITIES LITIGATION REFORM ACT: With the exception of historical information, the matters discussed in this report are "forward looking statements" as that term is defined in Section 21E of the Securities Exchange Act of 1934. While the Company believes that its strategic plan is on target and its business outlook remains strong, several important factors have been identified, which could cause actual results to differ materially from those predicted, included by way of example: o The competitive nature of the management consulting industry, in light of new entrants into the industry and the difficulty of differentiating the services offered to potential clients. o The time required by prospective clients to fully understand the value and complexity of a typical Total Cycle Time (TCT) program may result in an extended lead time to close new business. o Performance-oriented fees are earned upon the achievement of improvements in a client's business. The client's commitment to a TCT program and general economic/industry conditions could impact a client's business performance and consequently the Company's ability to forecast the timing and ultimate realization of performance-oriented fees. o The ability of the Company to productively re-deploy personnel during program transition periods. o The ability of the Company to create alliances and make acquisitions that are accretive to earnings. 14 15 ITEM 2 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED) THOMAS GROUP, INC. PART II - OTHER INFORMATION Item 6 - Exhibits and Reports on Form 8-K (a) Exhibits: 27 Financial Data Schedule (b) Reports on Form 8-K for the Quarter Ending September 30, 1999: none 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. THOMAS GROUP, INC. Registrant November 15, 1999 /s/ J. Thomas Williams ----------------- ---------------------- Date J. Thomas Williams Chief Executive Officer November 15, 1999 /s/ Leland L. Grubb, Jr. ----------------- ----------------------- Date Leland L. Grubb, Jr. Vice President, Chief Financial Officer and Treasurer (Principal Financial and Accounting Officer) 15 16 EXHIBIT INDEX EXHIBIT NUMBER DESCRIPTION - ------- ----------- 27 Financial Data Schedule