FORM 10-Q
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the quarterly period ended June 28, 1996
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the transition period from_______________to___________________
Commission File Number 0-18655
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THE FAILURE GROUP, INC.
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(Exact name of registrant as specified in its charter)
DELAWARE 77-0218904
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(State or other jurisdiction of incorporation) (I.R.S. Employer
Identification Number)
149 COMMONWEALTH DRIVE, MENLO PARK, CALIFORNIA 94025
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(Address of principal executive office) (Zip Code)
Registrant's telephone number, including area code (415) 326-9400
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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
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Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date.
Class Outstanding at August 2, 1996
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Common Stock $.001 par value 6,780,006 shares
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
THE FAILURE GROUP, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
JUNE 28, 1996 AND DECEMBER 29, 1995
(IN THOUSANDS, EXCEPT SHARE DATA)
JUNE 28, 1996 DECEMBER 29, 1995
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ASSETS
Current assets:
Cash and cash equivalents......................................... $ 2,700 $ 7,401
Short-term investments............................................ 20,523 17,109
Accounts receivable, net of allowance for doubtful accounts of
$1,200 and $1,500 at June 28, 1996 and December 29, 1995,
respectively..................................................... 21,505 18,919
Prepaid expenses and other assets................................. 3,871 3,601
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Total current assets.......................................... 48,599 47,030
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Property, equipment and leasehold improvements, net................. 28,756 29,083
Other assets........................................................ 2,188 1,595
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$79,543 $77,708
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LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable and accrued liabilities.......................... $ 3,781 $ 3,215
Notes payable and current installments of long-term obligations... 222 222
Accrued payroll and employee benefits............................. 5,499 4,808
Income taxes payable and deferred income taxes.................... 897 608
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Total current liabilities........................................ 10,399 8,853
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Long-term obligations, net of current installments.................. 18,822 18,905
Deferred income taxes.............................................. 1,520 1,520
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Total long-term liabilities...................................... 20,342 20,425
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Stockholders' equity:
Common stock, $.001 per value; 20,000,000 shares authorized;
7,902,496 shares issued and outstanding at June 28, 1996
and December 29, 1995............................................. 8 8
Additional paid-in capital....................................... 32,581 32,538
Net unrealized loss on investments............................... (12) (74)
Retained earnings................................................ 23,229 22,080
Treasury shares, at cost; 1,412,232 and 1,265,105 shares at
June 28, 1996 and December 29, 1995, respectively................ (7,004) (6,122)
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Total stockholders' equity..................................... 48,802 48,430
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$79,543 $77,708
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The accompanying notes are an integral part of these condensed consolidated
financial statements.
2
THE FAILURE GROUP, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
FOR THE QUARTERS AND SIX MONTHS ENDED JUNE 28, 1996 AND JUNE 30, 1995
(IN THOUSANDS, EXCEPT PER SHARE DATA)
Quarters Ended Six Months Ended
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June 28, June 30, June 28, June 30,
1996 1995 1996 1995
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Revenues
Professional fees................................ $ 14,261 $ 14,299 $ 27,689 $27,756
Equipment fees and billed expenses............... 1,521 1,526 2,969 3,051
Other revenue.................................... 122 163 257 333
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15,904 15,988 30,915 31,140
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Operating expenses
Professional compensation and related expenses... 8,566 8,401 16,818 16,779
Other operating expenses......................... 3,439 3,816 6,744 7,341
General and administrative expenses.............. 2,354 2,648 4,759 5,092
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14,359 14,865 28,321 29,212
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Operating income.............................. 1,545 1,123 2,594 1,928
Other income and expense
Other income, net................................ 45 30 81 49
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Income before income taxes....................... 1,590 1,153 2,675 1,977
Provision for income taxes......................... 644 467 1,083 801
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Income before extraordinary item.............. $ 946 $ 686 $ 1,592 $ 1,176
Extraordinary item (net of taxes of $301).......... (443) -- (443) --
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Net income.................................... $ 503 $ 686 $ 1,149 $ 1,176
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Income per share before extraordinary item......... $ .14 $.10 $ .24 $.18
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Extraordinary item per share....................... $ (.07) $ -- $ (.07) $ --
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Net income per share............................... $ .08 $.10 $ .17 $.18
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Weighted average number of common shares........... 6,618 6,584 6,665 6,593
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The accompanying notes are an integral part of these
condensed consolidated financial statements.
3
THE FAILURE GROUP, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE SIX MONTHS ENDED JUNE 28, 1996 AND JUNE 30, 1995
(IN THOUSANDS)
SIX MONTHS ENDED
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JUNE 28, 1996 JUNE 30, 1995
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Cash flows from operating activities
Net income, (before extraordinary
item for 1996).................................... $ 1,592 $ 1,176
Adjustments to reconcile net income to net
cash provided by operating activities
Depreciation and amortization.................... 1,750 1,710
Provision for doubtful accounts.................. 939 1,682
Issuance of stock to directors................... -- 45
Changes in operating assets and liabilities
Accounts receivable............................. (3,525) (428)
Prepaid expenses................................ (270) (2,005)
Accounts payable and accrued liabilities....... 566 139
Income tax receivable........................... -- (2)
Accrued payroll and employee benefits........... 691 1,182
Income taxes payable and current deferred
income tax................................... 289 (17)
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Net cash provided by operating activities..... 2,032 3,482
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Cash flows from investing activities
Capital expenditures................................ (1,405) (796)
Acquisition of PLG, Inc............................. (501) --
Net change in short-term investments................ (3,352) (530)
Other assets........................................ (110) (292)
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Net cash used by investing activities................ (5,368) (1,618)
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Cash flows from financing activities
Extraordinary item, retirement of debt
(net of taxes)..................................... (443) --
Proceeds from borrowings and issuance of long-term
obligations........................................ 8 27
Repayments of borrowings and
long-term obligations.............................. (91) (275)
Net purchases of common stock........................ (1,024) (241)
Net issuance and retirements of common stock....... 185 --
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Net cash used by financing activities.................. (1,365) (489)
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Net (decrease) increase in cash and cash
equivalents.......................................... (4,701) 1,375
Cash and cash equivalents at beginning of
period............................................... 7,401 2,976
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Cash and cash equivalents at end of period............. $ 2,700 $ 4,351
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The accompanying notes are an integral part of these condensed consolidated
financial statements
4
THE FAILURE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
FOR THE FISCAL QUARTERS AND SIX MONTHS ENDED JUNE 28, 1996 AND JUNE 30, 1995
NOTE 1: BASIS OF PRESENTATION
The Failure Group, Inc. ("FGI" and, together with its subsidiaries, the
"Company") is a multidisciplinary organization providing engineering consulting,
scientific, investigation and information support services. The Company operates
on a 52-53 week fiscal calendar year ending on the Friday closest to the last
day of December.
The accompanying condensed, consolidated financial statements are
prepared in accordance with generally accepted accounting principles and include
the accounts of FGI and its subsidiaries. All significant intercompany
transactions and balances have been eliminated in consolidation. In the opinion
of management, all adjustments which are necessary for the fair presentation of
the condensed consolidated financial statements have been included and all such
adjustments are of a normal and recurring nature. The operating results for the
quarter and six month period ended June 28, 1996, are not necessarily
representative of the results of future quarterly or annual periods.
NOTE 2: SUPPLEMENTAL CASH FLOW INFORMATION
The following is supplemental disclosure of cash flow information, in
thousands.
Six Months Ended
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June 28, 1996 June 30, 1995
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Cash paid during the period:
Interest $1,196 $1,043
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Income taxes $ 490 $ 875
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NOTE 3: ACQUISITION OF ENVIRONMENTAL HEALTH STRATEGIES, INC.
On August 1, 1996, the Company acquired all of the outstanding capital
stock of Environmental Health Strategies, Inc. ("EHS") for a combination of cash
and stock totaling approximately $2,050,000. The terms of the purchase also
consider future payments based upon the performance of EHS. The amount of these
payments cannot be determined until such performance occurs. EHS is a privately-
held provider of epidemiological advice and services to industrial and legal
clients on a wide variety of topics, including occupational and environmental
health, pharmaceutical and medical device issues and health-related consumer
product safety. In 1995 they earned over $2 million in revenues. The impact of
the financial combination of EHS and the Company is immaterial. Thus, disclosure
of the combined results is not presented.
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ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion should be read in conjunction with the attached
unaudited, condensed, consolidated financial statements and notes thereto and
with the Company's audited consolidated financial statements and notes thereto
for the fiscal year ended December 29, 1995, which is contained in the Company's
1995 Annual Report.
GENERAL
The Company derives most of its revenues from professional service activities.
Revenues from professional services are mostly derived under "time and expenses"
and "fixed-fee" billing arrangements, and are recorded as work is performed.
Professional fees are a function of the total number of hours billed to clients
and the associated hourly billing rates or fixed-fee arrangement with the
client. The Company also derives revenue from equipment fees and net billed
expenses which consist primarily of fees charged to clients for use of the
Company's equipment and facilities in connection with services provided. Other
revenue is generated primarily from photographic services. The Company's
principal expenses are professional compensation and related expenses.
RESULTS OF OPERATIONS
1996 fiscal quarter and six month period ended June 28, 1996 compared to 1995
fiscal quarter ended June 30, 1995
Revenues for the second quarter and first six months of 1996 decreased by 1%.
Revenues for the second quarter were $15.9 million compared to $16.0 million in
the same fiscal quarter of 1995. Additionally, revenues for the first six months
in 1996 were $31.0 million as compared to $31.1 million for the comparable
period of the prior year. This decline was a result of a 4% decrease in billable
hours partially offset by a 2% increase in the average hourly billable rate.
Professional fees for the second quarter and first six months of 1996 remained
essentially the same at $14.3 million for the comparable quarters and $27.7
million for the comparable six month periods. Equipment fees and net billed
expenses were 3% lower than the comparable six month period in the prior year,
as a result of a decline in the usage of the Company's software and database
equipment.
The principal focus of the Company is to increase its revenues and contain its
level of spending. To accomplish this goal, the Company will remain focused on
expanding and diversifying its practice areas by emphasizing business
development and continuing to explore potential acquisitions. Additionally, the
Company will remain vigilant with regards to its focus on cost management.
However, there can be no assurance that the Company will be able to achieve
these goals.
Professional compensation and related expenses, which relate to employees
involved directly in the Company's consulting/professional practice, increased
by 2% to $8.6 million in the second quarter of 1996 compared to $8.4 million in
the same period in 1995. This change was attributable to a Company -wide salary
increase to the consulting staff, which was implemented in April 1996.
Professional compensation, as a percentage of total revenues, was 54% for the
second quarter of 1996 as compared to 53% for the second quarter of 1995. For
the six-month periods ending June 28, 1996 and June 30, 1995, professional
compensation and related expenses remained constant at $16.8 million and
represented 54% of total revenues.
Other operating expenses in the first quarter of 1996 decreased 10% to $3.4
million from $3.8 million in the comparable quarter of 1995. This quarter-to-
quarter decline was due to of a 79% decrease in bad debt
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allowance resulting from the collection of older receivables and a 6% decrease
in occupancy expenses. Other operating expenses were 22% of total revenues for
the second quarter of 1996 as compared to 24% for the comparable quarter of
1995. Operating expenses decreased 8% to $6.7 million for the first six months
of 1996 compared to $7.3 million as in the same period in 1995. This decrease
was attributable to a 57% decrease in bad debt allowance and a 12% decrease in
computer expense. Other operating expenses as a percentage of total revenues was
22% and 24% for the first six month period of 1996 and 1995, respectively.
Driven by a 63% decrease in outside consulting expenses, a 16% decrease in
administrative labor and a 15% decrease in liability insurance expense, general
and administrative expenses in the second fiscal quarter of 1996 decreased 11%
to $2.4 million as compared to $2.6 million in the same period of the prior
year. General and administrative expenses represented 15% of total revenues for
the second quarter of 1996 and 17% for the second quarter of 1995. For the first
six months of 1996, general and administrative expenses decreased 7% to $4.8
million as compared to $5.1 million for the corresponding period in 1995. This
decrease was primarily attributable to a 55% decline in outside consulting
expenses and a 10% decrease in administrative labor. General and administrative
expenses represented 15% of total revenues for the first six month period in
1996 as compared to 16% for the comparable period of 1995.
Other income (expense) consists primarily of interest expense on the Company's
mortgage obligation, net of investment income earned on available cash and
short-term investment and rental income from leasing excess space in the
Company-owned operating facilities located in Menlo Park, California. The
primary change in other income (expense) for the second quarters and the first
six-month periods of 1996 and 1995 were derived from higher rental income.
In June 1996, the Company committed to refinance its building mortgage which
held a 10.75 percent fixed rate note, amortized on a 30-year basis with the
balance due in 1999, to the new note in the amount of $18.7 million, having a
15-year term with a floating rate tied to LIBOR. This rate is subject to
adjustment every six months. This new loan became effective August 1, 1996.
LIQUIDITY AND CAPITAL RESOURCES
1996 fiscal quarter and six month period ended June 28, 1996 compared to 1995
fiscal quarter and six month ended June 30, 1995
Net cash provided by operating activities was $2.0 million in the first six
months of 1996 compared to $3.5 million for the comparable period of fiscal
1995. This decrease in cash provided by operating activities can be attributable
to higher outstanding Accounts Receivable compared to the prior year, due to a
timing of the cash receipts. Accounts receivable represented 125 days of revenue
at June 28, 1996 compared with 123 days at June 30, 1995.
Net cash used by investing activities was $5.4 million and $ 1.6 million for the
second quarters of 1996 and 1995, respectively. This increase was partially a
result of an increase in short-term investments, plus an increase in the
purchase of capital assets.
Net cash used by financing activities was $1.4 million in the first six months
of fiscal 1996 compared to $489,000 in the comparable period of fiscal 1995.
Decreases in cash provided by financing activities over the comparable period
resulted primarily from a prepayment charge of $443 for the refinance of the
Company's fixed-rate mortgage. This extinguishment of debt was classified as
extraordinary item in the Statement of Income. Additionally, during the first
six months of 1996, the Company purchased 177,000 shares of common stock as
compared to 70,000 shares in the comparable period in 1995.
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At June 28, 1996, the Company had $2.7 million in cash balances, $20.5 million
in short-term investments and a $10 million line of credit agreement. The
Company's long-term obligations on June 28, 1996, consisted primarily of a
mortgage obligation for the Company's office facility in the San Francisco area
in the amount of $18.6 million which was refinanced as of August 1, 1996.
(Please refer to the results of operations discussion for the details of the
refinancing). Management believes that its existing cash and short-term
investment balances, together with existing bank credit facilities and funds
generated from operations, will provide adequate cash to fund the Company's
anticipated cash needs through at least the next twelve-month period.
PART II - OTHER INFORMATION
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
At the Company's 1996 Annual Meeting of Stockholders held on June 5, 1996 (the
"Annual Meeting"), the following members were elected to the Board of Directors:
BROKER
FOR WITHHELD NON-VOTE
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Roger L. McCarthy 5,892,539 406,013 N/A
Samuel H. Armacost 5,865,019 433,533 N/A
Alexander D. Cross 5,865,219 433,333 N/A
Elmer W. Johnson 5,865,219 433,333 N/A
Edward J. Keith 5,865,219 433,333 N/A
Michael R. Gaulke 5,892,939 405,613 N/A
Subbaiah V. Malladi 5,762,119 536,433 N/A
George T. VanGilder 5,892,939 405,613 N/A
The following proposal was approved by the stockholders at the Company's Annual
Meeting:
AFFIRMATIVE NEGATIVE VOTES BROKER
VOTES VOTES WITHHELD NON-VOTE
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1. Appointment of KPMG Peat 6,265,427 2,550 30,575 0
Marwick LLP as independent
auditors for the period ending
January 3, 1997
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibit 11.1, "Statement Regarding Computation of Net Income Per Share"
Exhibit 27.1 "Financial Data Schedule"
(b) No reports on Form 8-K were filed during the quarter for which this report
is filed
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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.
THE FAILURE GROUP, INC.
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Registrant
Date: August 9, 1996 /s/ Michael R. Gaulke
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Michael R. Gaulke, President and CEO
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Index to Exhibits
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Exhibit
Number Description of Document Page
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11.1 Statement Regarding Computation of Net Income Per Share 11
27.1 Financial Data Schedule 12