FORM 10-Q
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED JUNE 27, 1997
Commission file number 0-28352
TECHNOLOGY SERVICE GROUP, INC.
(Exact name of Registrant as specified in its charter)
Delaware 59-1637426
(State or other jurisdiction of (I.R.S. Employer
Incorporation or Organization) Identification Number)
20 Mansell Court East - Suite 200
Roswell, Georgia 30076
(Address of principal executive offices) (Zip Code)
(770) 587-0208
(Registrant's Telephone Number,
including area code)
Indicate by check mark whether 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 ___
At July 31, 1997, there were 4,708,476 shares of common stock, $.01 par value,
outstanding.
<PAGE>
INDEX
Page
Number
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Consolidated Balance Sheets at June 27, 1997
(unaudited) and March 28, 1997 3
Consolidated Statements of Operations for the
three months ended June 27, 1997 (unaudited) and
June 28, 1996 (unaudited) 4
Consolidated Statements of Cash Flows for the
three months ended June 27, 1997 (unaudited) and
June 28, 1996 (unaudited) 5
Consolidated Statement of Changes in Stockholders'
Equity for the three months ended June 27, 1997
(unaudited) 6
Notes to Consolidated Financial Statements 7
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations 10
PART II. OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K 18
2
<PAGE>
PART I - FINANCIAL INFORMATION
Item 1. Financial Statements
TECHNOLOGY SERVICE GROUP, INC.
CONSOLIDATED BALANCE SHEETS
June 27, March 28,
1997 1997
--------------- ------------
(Unaudited)
ASSETS
Current assets:
Cash $ 99,924 $ 67,880
Accounts receivable, less
allowance for doubtful
accounts of $147,000 3,162,195 3,234,777
Inventories 9,781,012 10,879,180
Refundable income taxes 301,146 --
Deferred tax asset 350,174 542,654
Prepaid expenses and other
current assets 112,549 140,981
------------ ------------
Total current assets 13,807,000 14,865,472
Property and equipment, net 723,758 847,443
Other assets 4,037,175 4,059,467
------------ ------------
$ 18,567,933 $ 19,772,382
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Bank overdraft $ 324,194 $ 242,652
Borrowings under revolving
credit agreement 2,399,705 3,810,961
Accounts payable 1,938,012 1,047,206
Income taxes payable -- 126,007
Deferred revenue -- 375,000
Accrued liabilities 742,455 1,015,032
Accrued restructuring charges -- 27,794
--------------- -------------
Total current liabilities 5,404,366 6,644,652
Long-term liabilities -- --
--------------- -------------
Total liabilities 5,404,366 6,644,652
--------------- -------------
Commitments and contingencies -- --
Stockholders' equity:
Preferred stock, $100 par value,
100,000 authorized,
none issued or outstanding -- --
Common stock, $.01 par value,
10,000,000 shares authorized,
4,701,760 shares issued and
outstanding 47,018 47,018
Capital in excess of par value 11,962,856 11,962,856
Retained earnings 1,159,579 1,122,449
Cumulative translation adjustment (5,886) (4,593)
-------------- --------------
Total stockholders' equity 13,163,567 13,127,730
-------------- --------------
$ 18,567,933 $ 19,772,382
============== ==============
The accompanying notes are an integral part of these
consolidated financial statements.
3
<PAGE>
TECHNOLOGY SERVICE GROUP, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
Three Months Ended
----------------------------------
June 27, June 28,
1997 1996
--------------- -----------------
Net sales $ 6,216,558 $ 12,078,496
--------------- -----------------
Costs and expenses:
Cost of goods sold 5,122,640 9,840,449
General and administrative
expenses 554,065 644,985
Marketing and selling
expenses 164,555 361,478
Engineering, research and
development expenses 292,028 409,095
Litigation settlement -- (105,146)
Interest expense 72,150 141,540
Other income (14,089) (16,187)
--------------- -----------------
6,191,349 11,276,214
--------------- -----------------
Income before income tax (expense)
benefit 25,209 802,282
Income tax (expense) benefit 11,921 (217,202)
--------------- -----------------
Net income $ 37,130 $ 585,080
=============== =================
Income per common and common
equivalent share:
Primary $ 0.02 $ 0.13
=============== =================
Assuming full dilution $ 0.02 $ 0.13
=============== =================
Weighted average number of
common and common equivalent
shares outstanding:
Primary 5,025,208 4,501,732
=============== =================
Assuming full dilution 5,025,208 4,501,732
=============== =================
The accompanying notes are an integral part of these
consolidated financial statements.
4
<PAGE>
TECHNOLOGY SERVICE GROUP, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
<TABLE>
<CAPTION>
Three Months Ended
-----------------------------------
June 27, June 28,
1997 1996
--------------- ----------------
<S> <C> <C>
Cash flows from operating activities
Net income $ 37,130 $ 585,080
Adjustments to reconcile net income to net cash
provided by (used for) operating activities
Depreciation and amortization 227,146 287,973
Gain on disposition of assets (633) --
Provisions for inventory losses and
warranty expense 61,170 172,942
Provision for uncollectible accounts receivable -- 30,882
Deferred tax expense (benefit) 274,832 ( 45,390)
Changes in operating assets and
liabilities
(Increase) decrease in accounts 72,582 (2,795,058)
receivable
(Increase) decrease in inventories 1,070,364 (1,203,069)
(Increase) in refundable income taxes (301,146) --
Decrease in prepaid expenses and
other current assets 28,432 75,517
(Increase) in other assets (127,410) (12)
Increase in accounts payable 890,806 515,291
Increase (decrease) in income taxes payable (126,007) 113,549
(Decrease) in accrued liabilities (305,943) (340,655)
(Decrease) in accrued restructuring charges (27,794) --
(Decrease) in deferred revenue (375,000) (485,512)
Other 88 (633)
------------ -------------
Net cash provided by (used for)
operating activities 1,398,617 (3,089,095)
------------ -------------
Cash flows from investing activities
Proceeds from disposition of assets 696 --
Capital expenditures (37,555) (58,981)
------------ -------------
Net cash used for investing activities (36,859) (58,981)
------------ -------------
Cash flows from financing activities
Net payments under revolving credit
agreement (1,411,256) (901,025)
Proceeds from initial public offering, net
of issuance expenses -- 8,648,215
Proceeds from exercise of common stock
options and warrants -- 160,000
Repayment of notes payable to stockholders -- (2,800,000)
Principal payments on long-term debt and
capital lease obligations -- (2,578,410)
Increase in bank overdraft 81,542 760,228
------------ -------------
Net cash provided by (used for)
financing activities (1,329,714) 3,289,008
------------ -------------
Increase in cash 32,044 140,932
Cash, beginning of period 67,880 19,787
============ =============
Cash, end of period $ 99,924 $ 160,719
============ =============
</TABLE>
The accompanying notes are an integral part of these
consolidated financial statements.
5
<PAGE>
TECHNOLOGY SERVICE GROUP, INC.
STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY
FOR THE THREE MONTHS ENDED JUNE 27, 1997
(Unaudited)
<TABLE>
<CAPTION>
Capital in Cummulative
Common Excess of Retained Translation
Stock Par Value Earnings Adjustment Total
------- ------------- ------------- ----------- -------------
<S> <C> <C> <C> <C> <C>
Balance at March 29, 1996 $47,018 $ 11,962,856 $ 1,122,449 $ (4,593) $ 13,127,730
Net income for the period -- -- 37,130 -- 37,130
Foreign currency translation
adjustment -- -- -- (1,293) (1,293)
------- ------------- ------------- -------- -------------
Balance at June 27, 1997 $47,018 $ 11,962,856 $ 1,159,579 $ (5,886) $ 13,163,567
======= ============= ============= ======== =============
</TABLE>
The accompanying notes are an integral part of these
consolidated financial statements.
6
<PAGE>
TECHNOLOGY SERVICE GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. GENERAL
The accompanying unaudited consolidated balance sheet as of June 27,
1997, unaudited consolidated statements of operations for the three months ended
June 27, 1997 and June 28, 1996, unaudited consolidated statements of cash flows
for the three months ended June 27, 1997 and June 28, 1996, and unaudited
consolidated statement of changes in stockholders' equity for the three months
ended June 27, 1997 have been prepared in accordance with instructions to Form
10-Q. Accordingly, the financial information does not include all of the
information and footnotes required by generally accepted accounting principles
for complete financial statements. In the opinion of management, all
adjustments, consisting only of normal recurring accruals and adjustments,
necessary for a fair presentation of the financial position of the Company at
June 27, 1997 and its operations and its cash flows for the three months ended
June 27, 1997 and June 28, 1996 have been made. For further information, refer
to the audited financial statements and footnotes included in the Company's
annual report on Form 10-K for the fiscal year ended March 28, 1997.
The results of operations for the three months ended June 27, 1997 are
not necessarily indicative of the results for the entire fiscal year ending
April 3, 1998.
2. INVENTORIES
Inventories at June 27, 1997 and March 28, 1997 consisted of the
following:
June 27, March 28,
1997 1997
-------------- -------------
Raw materials $ 6,229,106 $ 6,153,808
Work-in-process 1,826,929 2,117,668
Finished goods 2,840,375 4,036,191
-------------- -------------
10,896,410 12,307,667
Reserve for potential losses (1,115,398) (1,428,487)
-------------- -------------
$ 9,781,012 $ 10,879,180
============== =============
3. BORROWINGS UNDER REVOLVING CREDIT AGREEMENT
At June 27, 1997 and March 28, 1997, the Company is able to borrow up
to a maximum of $9 million under a revolving credit agreement pursuant to the
terms of a Loan and Security Agreement (the "Loan Agreement") between the
Company and its bank. At June 27, 1997 and March 28, 1997, the Company had
outstanding debt of $2,399,705 and $3,810,961, respectively, under the revolving
credit agreement. Indebtedness outstanding under the Loan Agreement is secured
by substantially all assets of the Company including accounts receivable,
inventories and property and equipment. The borrowing limit under the revolving
credit agreement is based upon specified percentages applied to the value of
collateral, consisting of eligible accounts receivable and inventories. Interest
is payable monthly at a variable rate per annum equal to 1.5% above a base rate
quoted by Citibank, N.A. (8.5% at June 27, 1997 and March 28, 1997).
7
<PAGE>
4. INCOME PER COMMON AND COMMON EQUIVALENT SHARE
Income per common and common equivalent share for the three months
ended June 27, 1997 and June 28, 1996 is computed on the basis of the weighted
average number of common shares outstanding and dilutive common equivalent
shares outstanding during the period, except as required by Accounting
Principles Board Opinion No. 15, Earnings per Share, all outstanding options and
warrants have been included in the calculation in accordance with the modified
treasury stock method and except as required by Securities and Exchange
Commission Staff Accounting Bulletin ("SECSAB") Topic 4:D, shares of common
stock underlying warrants issued and options granted during the 12 months prior
to the Company's May 10, 1996 initial public offering at prices below the public
offering price have been included in the calculation of weighted average of
common and common equivalent shares outstanding as if they were outstanding as
of the beginning of the periods.
5. INCOME TAXES
Income taxes charged (credited) to operations for the three months
ended June 27, 1997 and June 28, 1996 consisted of the following:
Three Months Ended
------------------------------
June 27, June 28,
1997 1996
------------ -----------
Current tax expense (benefit)
Federal $ (257,308) $ 218,953
State (29,445) 43,640
------------ -----------
(286,753) 262,593
------------ -----------
Deferred tax expense (benefit)
Federal 248,486 (34,742)
State 26,346 (10,649)
------------ -----------
274,832 (45,391)
------------ -----------
$ (11,921) $ 217,202
============ ===========
A reconciliation of income tax expense (benefit) for the three months
ended June 27, 1997 and June 28, 1996 to income tax expense (benefit) determined
by applying the applicable U.S. statutory federal income tax rate to income
before income taxes is as follows:
Three Months Ended
-------------------------------
June 27, June 28,
1997 1996
------------- --------------
Statutory U.S. tax rates $ 8,361 $ 272,776
State taxes, net of federal
benefit (19,433) 26,276
Non-deductible expenses 13,564 14,932
Utilization of loss carryforwards (71,995) (71,995)
Other 57,582 (24,787)
------------ -----------
Effective tax rates $ (11,921) $ 217,202
============ ===========
8
<PAGE>
6. SUPPLEMENTAL CASH FLOW INFORMATION
Supplemental cash flow information for the three months ended June 27,
1997 and June 28, 1996 consists of the following:
Three Months Ended
---------------------------
June 27, June 28,
1997 1996
--------- -----------
Interest paid $81,632 $ 284,035
Income taxes paid 140,400 149,044
Deferred offering expenses charged
against proceeds of initial
public offering -- 338,372
Tax benefits applied to goodwill 82,352 159,663
8. COMMITMENTS AND CONTINGENT LIABILITIES
In June 1997, the Company entered into an agreement with Southwestern
Bell Telephone Company ("SWBT") that supersedes and terminates a December 1994
agreement. Under the new agreement, the Company agreed to reduce SWBT's
remaining purchase commitment to approximately $3 million from approximately $8
million under the former agreement. In addition, the Company provided an
upgraded electronic key product and, among other things, agreed to provide
equipment and software to upgrade SWBT's payphone management system. SWBT made a
$250,000 cash payment to the Company, terminated the Company's obligation to pay
royalties on sales of a certain product to other customers, terminated a
contingent obligation of the Company to repay revenue of $375,000 from the sale
of product software under the former agreement, and agreed to make additional
cash payments to the Company of $250,000 on July 2, 1997, $100,000 on September
1, 1997, $150,000 on December 31, 1997 and $250,000 on March 31, 1998 subject to
the Company's compliance with its obligations, including conditions with respect
to performance, service and repair. SWBT has the right to cancel the agreement
upon default by the Company. Therefore, there is no assurance that the Company
will receive the additional payments or that it will ship the products set forth
in the agreement.
At June 27, 1997, the Company is committed to purchase approximately
$5.5 million of product assemblies under the terms of a manufacturing agreement
entered into in October 1994. Upon a termination of the agreement by the
Company, the Company is obligated to purchase inventories held by the
manufacturer and pay vendor cancellation and restocking charges, and a
reasonable profit thereon. In addition, the Company is obligated to pay a
cancellation penalty of up to $500,000 if it cancels its purchase obligation or
a substantial portion thereof. The amount of the cancellation penalty, if any,
will vary depending upon quantities purchased by the Company.
9
<PAGE>
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations
Forward Looking Statements
This report contains certain forward looking statements concerning the
Company's operations, economic performance and financial condition. Such
statements are subject to various risks and uncertainties. Actual results could
differ materially from those currently anticipated due to a number of factors,
including those identified herein.
Results of Operations
The following table shows certain line items in the Company's
consolidated statements of operations for the three months ended June 27, 1997
and June 28, 1996 that are discussed below together with amounts expressed as a
percentage of sales and with the change expressed as a percentage.
<TABLE>
<CAPTION>
Three Months Three Months
Ended Percent Ended Percent Percentage
June 27, of June 28, of Increase
1997 Sales 1996 Sales (Decrease)
---------------- --------- ----------------- --------- ------------
<S> <C> <C> <C> <C> <C>
Sales $ 6,216,558 100% $ 12,078,496 100% (49%)
Cost of goods sold 5,122,640 82% 9,840,449 81% (48%)
General and administrative expenses 554,065 9% 644,985 5% (14%)
Marketing and selling expenses 164,555 3% 361,478 3% (54%)
Engineering, research and development
expenses 292,028 5% 409,095 3% (29%)
Litigation settlement -- -- (105,146) (1%) (100%)
Interest expense 72,150 1% 141,540 1% (49%)
Income tax expense (benefit) (11,921) 0% 217,202 2% (105%)
</TABLE>
Sales. The decrease in sales for the three months ended June 27, 1997
as compared to the three months ended June 28, 1996 is primarily attributable to
(i) a decrease in sales volume of smart payphone systems and processors and (ii)
a 25% reduction in the sales price of GeminiTM processors under the terms of a
sales agreement between the Company and Telesector Resources Group, Inc. and its
affiliates ("NYNEX") entered into during the year ended March 28, 1997, offset
by (i) an increase in exported wireless payphone systems of approximately
$600,000 and (ii) sales revenue of $625,000 under the terms of a new sales
agreement between the Company and Southwestern Bell Telephone Company ("SWBT")
entered into in June 1997. Sales of smart payphone products decreased by
approximately $6.7 million and accounted for approximately 25% of sales during
the three months ended June 27, 1997 as compared to 69% of sales during the
three months ended June 28, 1996. Refurbishment and repair services and related
product sales for the three months ended June 27, 1997 decreased by
approximately 10% as compared to the same period last year, and accounted for
55% of sales as compared to 31% last year. No export sales were made during the
three months ended June 28, 1996.
The Company believes that the uncertainty in the marketplace caused by
the implementation of the Telecommunications Reform Act of 1996 (the
"Telecommunications Act") and the merger activity within the industry is
adversely affecting its sales. In addition, following a high level of demand at
the start of the program last year, NYNEX has stabilized its deployment of the
Company's smart payphone systems and processors under the five-year agreement
entered into last year.
In June 1997, the Company entered into an agreement with SWBT that
supersedes and terminates a December 1994 agreement. Under the new agreement,
the Company agreed to reduce SWBT's remaining
10
<PAGE>
purchase commitment of GemStarTM processor kits to approximately $3 million from
approximately $8 million under the former agreement. In addition, the Company
provided an upgraded electronic key product and, among other things, agreed to
provide equipment and software to upgrade SWBT's payphone management system.
SWBT made a $250,000 cash payment to the Company, terminated the Company's
obligation to pay royalties on sales of GemStar processors to other customers,
terminated a contingent obligation of the Company to repay revenue of $375,000
from the sale of product software under the former agreement, and agreed to make
additional cash payments to the Company of $250,000 on July 2, 1997, $100,000 on
September 1, 1997, $150,000 on December 31, 1997 and $250,000 on March 31, 1998
subject to the Company's compliance with its obligations, including conditions
with respect to performance, service and repair.
Cost of Goods Sold. Cost of goods sold as a percentage of sales
increased to 82% for the three months ended June 27, 1997 as compared to 81% for
the three months ended June 28, 1996. This increase resulted principally from
the decrease in sales volume and sales prices referred to above and an increase
in manufacturing costs of printed circuit board assemblies shifted to contract
manufacturers, offset by the impact of the initial sales revenues recognized
under the terms of the new agreement between the Company and SWBT.
General and Administrative Expenses. The decline in general and
administrative expenses is primarily attributable to the closure of one of the
Company's manufacturing facilities during the year ended March 28, 1997, a
decrease in accrued performance based compensation and a reduction in the
provision for doubtful accounts receivable.
Marketing and Selling Expenses. The decrease in marketing and selling
expenses during the three months ended June 27, 1997 as compared to the same
period last year is primarily attributable to the expiration of a royalty
agreement and the resulting decrease in royalty expense associated with sales of
smart payphone products.
Engineering, Research and Development Expenses. The Company began to
expand its engineering resources during the three months ended June 28, 1996 in
order to facilitate the development of a new smart payphone processor and the
implementation of lower-cost manufacturing methodologies. During the three
months ended June 27, 1997, the requirement for contract engineering services
diminished and the related expense decreased accordingly. Also, the Company
capitalized approximately $130,000 of software development costs in connection
with the development of its new smart payphone processor during the three months
ended June 27, 1997. Software development costs during the three months ended
June 28, 1996 were not significant.
Litigation Settlement. Pursuant to the terms of a settlement agreement
and mutual release dated July 3, 1996, a suit filed against the Company by a
former supplier to collect approximately $400,000 of unpaid obligations was
dismissed with prejudice. As a result of the settlement agreement, the Company
realized a gain of $105,146 representing the difference between unpaid
obligations recorded in the Company's accounts and aggregate settlement payments
set forth in the settlement agreement.
Interest Expense. The decrease in interest expense during the three
months ended June 27, 1997 as compared to the same period last year is primarily
due to the repayment of outstanding bank and stockholder debt obligations during
May 1996 from proceeds of the Company's initial public offering. See "Liquidity
and Capital Resources - Cash Flows From Financing Activities," below.
Income Taxes. During the three months ended June 27, 1997, the Company
recorded an income tax benefit of $11,921 on pre-tax income of $25,209 as
compared to an income tax provision of $217,202 on pre-tax income of $802,282
for the three months ended June 28, 1996. Current tax benefits for the three
months ended June 27, 1997 amounted to $286,753 as compared to current tax
expense of $262,593 for the three months ended
11
<PAGE>
June 28, 1996. Deferred tax expense for the three months ended June 27, 1997
amounted to $274,832 as compared to deferred tax benefits of $45,391 for the
three months ended June 28, 1996.
Liquidity and Capital Resources
The Loan Agreement
At June 27, 1997 and March 28, 1997, the Company is able to borrow up
to a maximum of $9 million under a revolving credit agreement under the terms of
a Loan and Security Agreement (the "Loan Agreement") between the Company and its
bank. At June 27, 1997 and March 28, 1997, the Company had outstanding debt of
$2,399,705 and $3,810,961, respectively, under the revolving credit agreement.
Indebtedness outstanding under the Loan Agreement is secured by substantially
all assets of the Company including accounts receivable, inventories and
property and equipment. The borrowing limit under the revolving credit agreement
is based upon specified percentages applied to the value of collateral,
consisting of eligible accounts receivable and inventories. Interest is payable
monthly at a variable rate per annum equal to 1.5% above a base rate quoted by
Citibank, N.A. (8.5% at June 27, 1997 and March 28, 1997). The Loan Agreement
expires on November 30, 1997, and is renewable annually for one-year periods
unless terminated by the bank upon an occurrence of an event of default or by
the Company upon at least 90 days notice.
The Loan Agreement contains conditions and covenants that prevent or
restrict the Company from engaging in certain transactions without the consent
of the bank, including merging or consolidating, payment of subordinated
stockholder debt obligations, declaration or payment of dividends, and
disposition of assets, among others. Additionally, the Loan Agreement requires
the Company to comply with specific financial covenants, including covenants
with respect to cash flow, working capital and net worth. Noncompliance with any
of these conditions and covenants or the occurrence of an event of default, if
not waived or corrected, could accelerate the maturity of indebtedness
outstanding under the Loan Agreement. Although the Company was in compliance
with the covenants set forth in the Loan Agreement at June 27, 1997, there is no
assurance that the Company will be able to remain in compliance with such
covenants in the future.
The Company uses the financing available under the Loan Agreement to
finance its working capital requirements. If an event of default under the
existing revolving credit facility were to occur, however, the Company's ability
in this regard could be curtailed. In such event, the Company would seek
alternative financing sources, but there is no assurance that alternative
financing sources would be available on commercially reasonable terms, or at
all. Further, the Loan Agreement expires on November 30, 1997 unless it is
renewed in accordance with its terms. The Company is presently discussing
renewal options with its bank. Although the Company believes that it will
negotiate an acceptable renewal agreement, there is no assurance that its
efforts will be successful. The Company's liquidity would be materially and
adversely affected if it is unable to renew or refinance is present credit
facility.
The Company borrows funds to finance increases in accounts receivable
and inventories and decreases in bank overdrafts, accounts payable and accrued
liability obligations to the extent that such requirements exceed cash provided
by operations, if any. The Company also uses the financing available under the
revolving credit agreement to fund operations, investing activities and payments
on long-term debt when necessary. The Company repays borrowed funds with cash,
if any, provided by operating activities. The Company measures its liquidity
based upon the amount of funds that the Company is able to borrow under the Loan
Agreement, which varies based upon operating performance and the value of
current assets and liabilities. At June 27, 1997, the Company was able to borrow
approximately $5.4 million under its revolving credit facility.
Cash Flows From Financing Activities
During May 1996, the Company completed an initial public offering of
1,150,000 Units, each Unit consisting of one share of common stock and a
redeemable warrant, at a price of $9.00 per Unit for gross
12
<PAGE>
proceeds of $10,350,000. In connection with the offering, the Company issued
warrants to the underwriter to purchase 100,000 shares of common stock (the
"Underwriter Warrants") for gross proceeds of $10. Net proceeds received by the
Company as of June 28, 1996, after underwriting discounts and expenses of
$1,231,897 and other expenses of $808,269, aggregated $8,309,444. At March 29,
1996, the Company had incurred and deferred offering expenses of $338,372.
Accordingly, net proceeds from the Company's initial public offering during the
three months ended June 28, 1996 aggregated $8,648,215.
The proceeds of the offering, net of underwriting discounts and
expenses, were initially used to repay 10% interest bearing subordinated notes
payable to stockholders of $2.8 million and outstanding indebtedness under the
Loan Agreement of $6,318,113. Indebtedness outstanding under the Loan Agreement
repaid with the net proceeds consisted of a $2.2 million term note due November
30, 1997, $309,524 outstanding under a $650,000 term note due November 30, 1997
and indebtedness under the revolving credit line of $3,808,589. Total principal
payments on long-term debt and capital lease obligations during the three months
ended June 28, 1996 aggregated $2,578,410.
Net payments under the Company's revolving credit line during the three
months ended June 27, 1997 amounted to $1,411,256 as compared to $901,025 during
the three months ended June 28, 1996. Exclusive of payments made with the
proceeds of the offering, the net proceeds under the revolving credit agreement
during the three months ended June 28, 1996 aggregated $2,907,564.
The Company has also established a cash management program with its
bank pursuant to which the Company funds drafts as they clear the bank.
Accordingly, the Company maintains bank overdrafts representing outstanding
drafts and utilizes the cash management account as a source of funding. Bank
overdrafts vary according to many factors, including the volume of business, and
the timing of purchases and disbursements. During the three months ended June
27, 1997, the Company's bank overdrafts increased by $81,542 as compared to an
increase of $760,228 during the three months ended June 28, 1996.
In June 1996, the Company issued 40,000 shares of common stock for
aggregate proceeds of $160,000 upon the exercise of outstanding common stock
purchase warrants issued in May 1995.
Cash Flows From Operating Activities
Three Months Ended June 27, 1997. Cash provided by operating activities
during the three months ended June 27, 1997 amounted to $1,398,617. During the
three months ended June 27, 1997, the Company's operations generated $599,645 in
cash, after adjustments related to non-cash charges and credits of $562,515.
Changes in operating assets and liabilities provided $798,972 of cash during the
three months ended June 27, 1997. Inventories decreased by $1,070,364 primarily
as a result of shipments of smart payphone products manufactured during the year
ended March 28, 1997. Accounts payable increased by $890,806 primarily as a
result of fluctuations in inventory purchases. The decrease in accrued
liabilities of $305,943 and deferred revenue of $375,000 is primarily
attributable to satisfaction of obligations under the new sales agreement
between the Company and SWBT, and the payment of performance based compensation
accrued at March 28, 1997. The increase in other assets is attributable to the
capitalization of software development costs of approximately $130,000. The
increase in refundable income taxes of $301,146 is primarily attributable to
current tax benefits recognized the three months ended June 27, 1997. Income
taxes payable declined by $126,007 due to payments made during the three months
ended June 27, 1997.
Three Months Ended June 28, 1996. Cash used to fund operating
activities during the three months ended June 28, 1996 amounted to $3,089,095.
During the three months ended June 28, 1996, the Company's operations generated
$1,031,487 in cash, after adjustments related to non-cash charges and credits of
$446,407. Changes in operating assets and liabilities used $4,120,582 of cash
during the three months ended June 28, 1996. Accounts receivable increased by
$2,795,058 as a result of an increase in the volume of business during
13
<PAGE>
the period. The increase in inventory of $1,203,069 and accounts payable of
$515,291, although partially related to the increase in the volume of business,
was primarily attributable to an excess of inventory purchases under purchase
commitments over sales requirements as a result of a change in the delivery
requirements of one of the Company's customers. During the three months ended
June 28, 1996, the Company satisfied the majority of its delivery requirements
with respect to prepayments from customers and deferred revenue decreased by
$485,512. The decrease in accrued liabilities of $340,655 was primarily
attributable to the payment of interest accrued under the terms of the
subordinated notes payable to stockholders that were retired during the period,
and the payment of performance based compensation accrued at the beginning of
the period. Current tax expense for the period exceeded estimated tax payments
and income taxes payable increased by $113,549.
Cash Flows From Investing Activities
Cash used to fund investing activities during the three months ended
June 27, 1997 amounted to $36,859 as compared to $58,981 during three months
ended June 28, 1996. The Company's capital expenditures during these periods
consisted primarily of investments in manufacturing tooling and equipment and
automated test equipment. The Company expects that its capital expenditures over
the next several quarters will increase as the Company continues to invest in
manufacturing and test equipment required to improve its in-house prototype and
manufacturing capabilities and moves forward to select and begin the
implementation of new management information systems (see "Capital Commitments
and Liquidity," below).
Capital Commitments and Liquidity
The Company has not entered into any significant commitments for the
purchase of capital assets. However, the Company intends to purchase and install
information systems and capital equipment, including printed circuit board
assembly equipment and other manufacturing equipment, to advance its prototype
manufacturing and product testing capabilities during the next year. In
addition, the Company intends to expand its manufacturing capabilities through
the purchase of capital equipment in the future as required to meet the needs of
its business. However, there can be no assurance that capital expenditures will
be made as planned or that additional capital expenditures will not be required.
The Company believes, based on its current plans and assumptions relating to its
operations, that its sources of capital, including capital available under the
revolving credit line and cash flow from operations will be adequate to satisfy
its anticipated cash needs, including anticipated capital expenditures, for at
least the next year. However, in the event that the Company's plans or the basis
for its assumptions change or prove to be inaccurate, or cash flow and sources
of capital prove to be insufficient to provide for the Company's cash
requirements (due to unanticipated expenses, loss of sales revenues, a
significant increase in inventories, operating difficulties or otherwise), the
Company would be required to seek additional financing. In such an event, there
can be no assurance that additional financing would be available to the Company
on commercially reasonable terms, or at all.
Extension of credit to customers and inventory purchases represent the
principal working capital requirements of the Company, and significant increases
in accounts receivable and inventory balances could have an adverse effect on
the Company's liquidity. The Company's accounts receivable, less allowances for
doubtful accounts, at June 27, 1997 and March 28, 1997 amounted to $3,162,195
and $3,234,777, respectively. Accounts receivable at June 27, 1997 and March 28,
1997 consists primarily of amounts due from the Regional Bell Operating
Companies. The Company's inventories, less allowances for potential losses due
to obsolescence and excess quantities, amounted to $9,781,012 and $10,879,180 at
June 27, 1997 and March 28, 1997, respectively. The level of inventory
maintained by the Company is dependent on a number of factors, including
delivery requirements of customers, availability and lead-time of components and
the ability of the Company to estimate and plan the volume of its business. The
Company markets a wide range of services and products and the requirements of
its customers vary significantly from period to period. Accordingly, inventory
balances may vary significantly.
14
<PAGE>
At June 27, 1997, the Company is committed to purchase approximately
$5.5 million of smart payphone assemblies under the terms of a manufacturing
agreement entered into in October 1994. Upon a termination of the agreement by
the Company, the Company is obligated to purchase inventories held by the
manufacturer and pay vendor cancellation and restocking charges, and a
reasonable profit thereon. In addition, the Company is obligated to pay a
cancellation penalty of up to $500,000 if it cancels its purchase obligation or
a substantial portion thereof. The amount of the cancellation penalty, if any,
will vary depending upon quantities purchased by the Company.
Operating Trends and Uncertainties
Dependence on Customers and Contractual Relationships. During the past
three years, four of the RBOCs have accounted for the majority of the Company's
sales. The Company anticipates that it will continue to derive most of its
revenues from such customers, and other regional telephone companies, for the
foreseeable future. Significant reductions and/or fluctuations in sales volume
from these customers can have material adverse effects on the Company's
business. In addition, the loss of a significant customer could have a material
adverse effect on the Company's business.
The Company's prospects for continued profitability are largely
dependent upon the RBOCs upgrading the technological capabilities of their
installed base of payphones, and utilizing the Company's products and services
for such upgrade conversion programs. Also, the Company's prospects and the
ability of the Company to maintain a profitable level of operations are
dependent upon its ability to continue to secure contract awards from the RBOCs.
In addition, the Company's prospects for growth are dependent upon the market
acceptance and success of its smart payphone products, as well as development of
smart products containing additional advanced features. If the Company is unable
to attract the interest of the RBOCs to deploy the Company's smart payphone
products, the Company's sales revenues, business and prospects for growth would
be adversely affected. Further, the Company's ability to maintain and/or
increase its sales is dependent upon its ability to compete for and maintain
satisfactory relationships with the RBOCs, particularly those RBOCs that are
presently significant customers of the Company.
Sales Prices. The Company's agreements with its contract manufacturers
generally provide that the Company will bear certain cost increases incurred by
the manufacturer. Accordingly, the Company's manufacturing costs may fluctuate
based on costs incurred by its contract manufacturers and such fluctuations
could have a material and adverse impact on earnings. The Company's sales
agreements with customers generally have fixed product prices with limited price
escalation provisions. Consequently, there is a risk that the Company may not be
able to increase sales prices when product costs increase. In the event the
Company's costs increase without a corresponding price increase or orders are
lost due to price increases, the Company's profitability would be adversely
affected. The Company encounters substantial competition with respect to smart
payphone contract awards from the RBOCs. Pending the release of the Company's
new smart payphone processor later this year, market pressures have eroded
margins on the product version currently being shipped. Until the Company
releases its new smart payphone processor, the Company will realize little to no
gross profit with respect to smart product sales to NYNEX. Any other price
reductions in response to competition will result in reduced gross profit
margins unless the Company is able to achieve reductions in product costs.
Seasonality. The Company's sales are generally stronger during periods
when weather does not interfere with the maintenance and installation of
payphone equipment by the Company's customers, and may be adversely impacted
near the end of the calendar year by the budget short falls of customers.
However, the Company may also receive large year-end orders from its customers
for shipment in December depending upon their budget positions. In the event the
Company does not receive any significant end of year orders for its smart
payphone products, its third quarter sales may decline significantly in relation
to other quarters.
15
<PAGE>
Sources of Supply and Dependence on Contract Manufacturers. The Company
generally assembles its smart payphone products from assemblies produced by
certain manufacturers under contractual arrangements. To the extent that such
manufacturers encounter difficulties in their production processes that delay
shipment to the Company or that affect the quality of items supplied to the
Company, the Company's ability to perform its sales agreements or otherwise to
meet supply schedules with its customers can be adversely affected. In the event
that contract manufacturers delay shipments or supply defective materials to the
Company, and such delays or defects are material, the Company's customer
relations could deteriorate and its sales and operating results could be
materially and adversely affected.
As a percentage of revenues, the majority of the Company's products
contain components or assemblies that are purchased from single sources. The
Company believes that there are alternative sources of supply for most of the
components and assemblies currently purchased from those sources. Most of the
components and assemblies used by the Company for which there are not
immediately available alternative sources of supply are provided to the Company
under standard purchase arrangements. In addition, suppliers of certain
electronic parts and components to the Company and its contract manufacturers
occasionally place their customers on allocation for those parts. If a shortage
or termination of the supply of any one or more of such components or assemblies
were to occur, the Company's business could be materially and adversely
affected. In such event, the Company would have to incur the costs associated
with redesigning its products to include available components or assemblies or
otherwise obtain adequate substitutes, and those costs could be material. Also,
any delays in redesigning products or obtaining substitute components could
adversely affect the Company's business.
Telecommunication Act. On February 8, 1996, the President signed into
law the Telecommunications Reform Act of 1996 (the "Telecommunications Act"),
the most comprehensive reform of communications law since the enactment of the
Communications Act of 1934. As a result of the Telecommunications Act, the RBOCs
will be permitted to manufacture and provide telecommunications equipment and to
manufacture customer premises equipment when certain competitive conditions have
been met. It is possible that one or more RBOCs will decide to manufacture
payphone products, which would increase the competition faced by the Company and
could decrease demand for the Company's products by such RBOCs. Notwithstanding,
the Company believes that deregulation generally will benefit the Company.
However, there can be no assurance that the Company will benefit from
deregulation or that it will not be adversely affected by deregulation.
Net Operating Loss Carryforwards. As of June 27, 1997, the Company had
net operating loss carryforwards for income tax purposes of approximately $11
million to offset future taxable income. Under Section 382 of the Internal
Revenue Code of 1986, as amended, the utilization of net operating loss
carryforwards is limited after an ownership change, as defined in such Section
382, to an annual amount equal to the value of the loss corporation's
outstanding stock immediately before the date of the ownership change multiplied
by the federal long-term tax-exempt rate in effect during the month the
ownership change occurred. Such an ownership change occurred on October 31, 1994
and could occur in the future. As a result, the Company will be subject to an
annual limitation on the use of its net operating losses of approximately
$210,000. This limitation only affects net operating losses incurred up to the
ownership change and does not reduce the total amount of net operating losses
which may be taken, but limits the amount which may be used in a particular
year. Therefore, in the event the Company maintains profitable operations, such
limitation would have the effect of increasing the Company's tax liability and
reducing net income and available cash resources if the taxable income during a
year exceeded the allowable loss carried forward to that year. In addition,
because of such limitations, the Company will be unable to use a significant
portion of its net operating loss carryforwards.
New Accounting Pronouncements
In February 1997, the Financial Accounting Standards Board issued
Statement of Financial Accounting Standards No. 128, Earnings Per Share ("SFAS
128"). SFAS 128 requires disclosure of basic earnings per
16
<PAGE>
share based on income available to common stockholders and the weighted average
number of common shares outstanding during the period, and diluted earnings per
share based on income available to common stockholders and the weighted average
number of common and dilutive potential common shares outstanding during the
period. The adoption of SFAS 128 is required for fiscal years ending after
December 15, 1997, and earlier adoption is not permitted. The adoption of SFAS
128 is not expected to have a material effect on the Company's results of
operations or financial position.
Also, in February 1997, the Financial Accounting Standards Board issued
Statement of Financial Accounting Standards No. 129, Disclosure of Information
about Capital Structure ("SFAS 129"). SFAS 129 requires a Company to explain the
privileges and rights of its various outstanding securities, the number of
shares issued upon conversion, exercise or satisfaction of required conditions
during the most recent annual fiscal period, liquidation preferences of
preferred stock and other matters with respect to preferred stock. Although the
statement is effective for periods ending after December 15, 1997, the Company's
financial statement disclosures are in compliance with SFAS 129.
In June 1997, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standards No. 130, Reporting Comprehensive Income ("SFAS
130"). SFAS 130 establishes standards for reporting and display of comprehensive
income and its components in a full set of general-purpose financial statements.
Comprehensive income is defined as the change in equity of a business during a
period from transactions and events and circumstances from non-owner sources,
and includes all changes in equity during a period except those resulting from
investments by owners and distributions to owners. SFAS 130 is effective for
fiscal years beginning after December 15, 1997. The adoption of SFAS 130 is not
expected to have a material effect on the Company's results of operations or
financial position.
Also, in June 1997, the Financial Accounting Standards Board issued
Statement of Financial Accounting Standards No. 131, Disclosures about Segments
of an Enterprise and Related Information ("SFAS 131"). SFAS 131 requires public
entities to report certain information about operating segments, their products
and services, the geographic areas in which they operate, and their major
customers, in complete financial statements and in condensed interim financial
statements issued to stockholders. SFAS 131 is effective for fiscal years
beginning after December 15, 1997. The adoption of SFAS 131 is not expected to
have a material effect on the Company's results of operations or financial
position.
17
<PAGE>
PART II - OTHER INFORMATION
Item 6 - Exhibits and Reports on Form 8-K
(a) Exhibits
The following exhibits are filed herewith as a part of this Report.
Exhibit
No. Description of Exhibit
--- ----------------------
11. Statement re computation of per share earnings
27. Financial Data Schedule (EDGAR Filing only)
(b) Reports on Form 8-K
No reports on Form 8-K were filed during the quarter for which this
report is filed.
18
<PAGE>
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.
TECHNOLOGY SERVICE GROUP, INC.
(Registrant)
Date: August 6, 1997 By: /s/ Vincent C. Bisceglia
-----------------------------------
Vincent C. Bisceglia
President & Chief Executive Officer
By: /s/ William H. Thompson
----------------------------------
William H. Thompson
Vice President of Finance
& Chief Financial Officer
19
<PAGE>
EXHIBIT INDEX
Exhibit
No. Description of Exhibit At Page
--- ---------------------- -------
11. Statement re computation of per share earnings 21
27. Financial Data Schedule (EDGAR filing only) 22
EXHIBIT 11
STATEMENT RE COMPUTATION OF EARNINGS PER SHARE
<TABLE>
<CAPTION>
Three Months Ended
----------------------------
June 27, June 28,
1997 (1) 1996 (1)
---------- ----------
<S> <C> <C>
Weighted average number of common and common equivalent
shares outstanding:
Weighted average number of shares of common
stock outstanding during the period 4,701,760 4,107,473
Incremental shares assumed to be outstanding
related to common stock options granted and
outstanding 588,800 449,529
Incremental shares assumed to be outstanding
related to common stock warrants issued and
outstanding 675,000 390,769
Shares of common stock assumed to be purchased
upon exercise of outstanding options and
warrants based on average market price (940,352) (446,039)
---------- -----------
Weighted average number of common and common
equivalent shares outstanding - Primary earnings
per share 5,025,208 4,501,732
Adjustment of number of shares assumed to
be purchased upon exercise of options and
warrants based on the closing market price -- --
---------- -----------
Weighted average number of common and common
equivalent shares outstanding - Earnings per
share assuming full dilution 5,025,208 4,501,732
========== ===========
Net income (loss) $ 37,130 $ 585,080
Adjustment of interest expense (income), net
of tax effect, due to 20% limitation on purchase
of shares upon exercise of outstanding options
and warrants based on average market price 60,321 --
---------- -----------
Net income - Primary earnings per share 97,451 585,080
Additional adjustment of interest expense (income),
net of tax effect, due to 20% limitation on purchase
of shares upon exercise of outstanding options
and warrants based on closing market price (16,200) --
---------- -----------
Net income - Earnings per share assuming
full dilution $ 81,251 $ 585,080
========== ===========
Net income (loss) per share:
Primary $ 0.02 $ 0.13
========== ===========
Assuming full dilution $ 0.02 $ 0.13
========== ===========
</TABLE>
(1) Computations do not reflect exercise of outstanding options and warrants if
the effect thereof is anti-dilutive except as required by Accounting
Principles Board Opinion No. 15 (APB #15) under the modified treasury stock
method, and except as required by Securities and Exchange Commission
Accounting Bulletin Topic 4D, stock options granted during the twelve
months prior to the Company's initial public offering at prices below the
public offering price have been included in the calculation of weighted
average shares of common stock as if they were outstanding as of the
beginning of the periods presented.
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>I
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
COMPANY'S FINANCIAL STATEMENTS FOR THE THREE MONTHS ENDED JUNE 27, 1997 AND IS
QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> MAR-28-1997
<PERIOD-END> JUN-27-1997
<CASH> 99,924
<SECURITIES> 0
<RECEIVABLES> 3,308,746
<ALLOWANCES> (146,551)
<INVENTORY> 9,781,012
<CURRENT-ASSETS> 13,807,000
<PP&E> 2,599,381
<DEPRECIATION> (1,875,623)
<TOTAL-ASSETS> 18,567,933
<CURRENT-LIABILITIES> 5,404,366
<BONDS> 0
0
0
<COMMON> 47,018
<OTHER-SE> 13,116,549
<TOTAL-LIABILITY-AND-EQUITY> 18,567,933
<SALES> 6,216,558
<TOTAL-REVENUES> 6,216,558
<CGS> 5,122,640
<TOTAL-COSTS> 5,122,640
<OTHER-EXPENSES> 292,028
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 72,150
<INCOME-PRETAX> 25,209
<INCOME-TAX> (11,921)
<INCOME-CONTINUING> 37,130
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 37,130
<EPS-PRIMARY> .02
<EPS-DILUTED> .02
</TABLE>
