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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
Quarterly Report Pursuant to Section 13 or 15(d) of the
Securities Exchange Act of 1934
For the quarterly period ended September 30, 2006
Commission File Number: 0-16284
TECHTEAM GLOBAL, INC.
(Exact name of registrant as specified in its charter)
DELAWARE 38-2774613
(State or other jurisdiction (I.R.S. Employer
of incorporation) Identification No.)
27335 WEST 11 MILE ROAD, SOUTHFIELD, MI 48033
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (248) 357-2866
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes [X] No [ ]
Indicate by check mark whether the registrant is a large accelerated filer, an
accelerated filer, or a non-accelerated filer. See definition of "accelerated
filer and large accelerated filer" in Rule 12b-2 of the Exchange Act. (Check
one):
Large accelerated filer [ ] Accelerated filer [X] Non- accelerated filer [ ]
Indicate by check mark whether the registrant is a shell company (as defined in
Rule 12b-2 of the Exchange Act). Yes [ ] No [X]
The number of shares of the registrant's common stock outstanding at November 1,
2006 was 10,322,993.
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1
TECHTEAM GLOBAL, INC.
FORM 10-Q
TABLE OF CONTENTS
PAGE
NUMBER
------
PART I - FINANCIAL INFORMATION
Item 1 Financial Statements
Condensed Consolidated Statements of Operations --
Three and Nine Months Ended September 30, 2006 and 2005 3
Condensed Consolidated Balance Sheets --
As of September 30, 2006 and December 31, 2005 4
Condensed Consolidated Statements of Cash Flows --
Nine Months Ended September 30, 2006 and 2005 6
Notes to Condensed Consolidated Financial Statements 7
Item 2 Management's Discussion and Analysis of Financial
Condition and Results of Operations 18
Item 3 Quantitative and Qualitative Disclosures About Market Risk 31
Item 4 Controls and Procedures 31
PART II - OTHER INFORMATION
Item 1 Legal Proceedings 32
Item 1A Risk Factors 32
Item 2 Unregistered Sales of Equity Securities and Use of Proceeds 32
Item 6 Exhibits 33
SIGNATURES 34
2
PART 1 -- FINANCIAL INFORMATION
ITEM 1 -- FINANCIAL STATEMENTS
TECHTEAM GLOBAL, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)
(In thousands, except per share data)
THREE MONTHS
ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
----------------- -------------------
2006 2005 2006 2005
------- ------- -------- --------
REVENUE
IT outsourcing services ....................... $21,293 $17,892 $ 60,803 $ 55,631
Government technology services ................ 12,285 14,482 35,771 43,662
IT consulting and systems integration ......... 6,189 6,758 19,662 19,690
Technical staffing ............................ 2,021 1,967 6,401 6,099
Learning services ............................. 239 215 857 555
------- ------- -------- --------
TOTAL REVENUE .................................... 42,027 41,314 123,494 125,637
------- ------- -------- --------
COST OF REVENUE
Cost of revenue ............................... 31,664 30,971 92,780 93,585
Asset impairment loss ......................... -- -- 580 --
------- ------- -------- --------
TOTAL COST OF REVENUE ............................ 31,664 30,971 93,360 93,585
------- ------- -------- --------
GROSS PROFIT ..................................... 10,363 10,343 30,134 32,052
Selling, general, and administrative expense .. 9,946 8,606 29,547 25,767
------- ------- -------- --------
OPERATING INCOME ................................. 417 1,737 587 6,285
Interest income, net .......................... 205 151 525 314
Foreign currency transaction loss ............. (5) (99) (104) (3)
------- ------- -------- --------
INCOME BEFORE INCOME TAXES ....................... 617 1,789 1,008 6,596
Income tax provision .......................... 236 563 365 2,098
------- ------- -------- --------
INCOME FROM CONTINUING OPERATIONS ................ 381 1,226 643 4,498
Income (loss) from discontinued operations,
net of tax ................................. (11) 3 (11) 59
------- ------- -------- --------
NET INCOME ....................................... $ 370 $ 1,229 $ 632 $ 4,557
======= ======= ======== ========
BASIC EARNINGS PER COMMON SHARE
Income from continuing operations ............. $ 0.04 $ 0.12 $ 0.06 $ 0.46
Income from discontinued operations ........... -- -- -- 0.01
------- ------- -------- --------
Total basic earnings per common share ......... $ 0.04 $ 0.12 $ 0.06 $ 0.47
======= ======= ======== ========
BASIC EARNINGS PER PREFERRED SHARE
Income from continuing operations ............. $ N/A $ N/A $ N/A $ 0.46
Income from discontinued operations ........... N/A N/A N/A 0.01
------- ------- -------- --------
Total basic earnings per preferred share ...... $ N/A $ N/A $ N/A $ 0.47
======= ======= ======== ========
DILUTED EARNINGS PER COMMON SHARE
Income from continuing operations ............. $ 0.04 $ 0.12 $ 0.06 $ 0.45
Income from discontinued operations ........... -- -- -- 0.01
------- ------- -------- --------
Total diluted earnings per common share ....... $ 0.04 $ 0.12 $ 0.06 $ 0.45
======= ======= ======== ========
WEIGHTED AVERAGE NUMBER OF COMMON SHARES AND
COMMON SHARE EQUIVALENTS OUTSTANDING
Basic -- common ............................... 10,193 9,892 10,041 9,365
Basic -- preferred ............................ -- -- -- 327
Diluted -- common ............................. 10,242 10,209 10,217 9,718
See accompanying notes.
3
TECHTEAM GLOBAL, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands)
SEPTEMBER 30, DECEMBER 31,
ASSETS 2006 2005
------ ------------- ------------
(Unaudited)
CURRENT ASSETS
Cash and cash equivalents ............................. $ 26,398 $ 34,756
Accounts receivable (less allowance of $669 at
September 30, 2006 and $757 at December 31, 2005) .. 40,945 43,770
Prepaid expenses and other ............................ 5,820 2,464
Deferred income taxes ................................. 146 200
-------- --------
TOTAL CURRENT ASSETS .................................. 73,309 81,190
-------- --------
PROPERTY, EQUIPMENT, AND PURCHASED SOFTWARE
Computer equipment and office furniture ............... 25,517 23,577
Purchased software .................................... 13,552 12,885
Leasehold improvements ................................ 5,422 5,047
Transportation equipment .............................. 446 425
-------- --------
44,937 41,934
Less -- accumulated depreciation and amortization ..... (36,197) (33,871)
-------- --------
NET PROPERTY, EQUIPMENT, AND PURCHASED SOFTWARE ....... 8,740 8,063
-------- --------
OTHER ASSETS
Goodwill .............................................. 22,151 22,104
Intangible assets, net ................................ 9,728 11,213
Other ................................................. 474 440
-------- --------
TOTAL OTHER ASSETS .................................... 32,353 33,757
-------- --------
TOTAL ASSETS ............................................. $114,402 $123,010
======== ========
See accompanying notes.
4
TECHTEAM GLOBAL, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS (continued)
(In thousands, except share and per share amounts)
SEPTEMBER 30, DECEMBER 31,
LIABILITIES AND SHAREHOLDERS' EQUITY 2006 2005
------------------------------------ ------------- ------------
(Unaudited)
CURRENT LIABILITIES
Accounts payable ..................................... $ 6,755 $ 12,753
Accrued payroll, related taxes, and withholdings ..... 8,279 10,020
Accrued expenses ..................................... 7,500 7,579
Deferred revenue ..................................... 1,205 303
-------- --------
TOTAL CURRENT LIABILITIES ............................ 23,739 30,655
-------- --------
LONG-TERM LIABILITIES
Long-term debt ....................................... 5,118 10,937
Deferred income taxes ................................ 1,851 2,614
Other long-term liabilities .......................... 529 564
-------- --------
TOTAL LONG-TERM LIABILITIES .......................... 7,498 14,115
-------- --------
SHAREHOLDERS' EQUITY
Preferred stock, $0.01 par value, 5,000,000 shares
authorized, none issued and outstanding at
September 30, 2006 and December 31, 2005 .......... -- --
Common stock, $0.01 par value, 45,000,000 shares
authorized, 10,320,993 and 9,943,262 shares
issued and outstanding at September 30, 2006 and
December 31, 2005, respectively ................... 103 99
Additional paid-in capital ........................... 70,933 69,148
Unamortized deferred compensation .................... -- (866)
Retained earnings .................................... 10,893 10,261
Accumulated other comprehensive income (loss) ........ 1,236 (402)
-------- --------
TOTAL SHAREHOLDERS' EQUITY ........................... 83,165 78,240
-------- --------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY .............. $114,402 $123,010
======== ========
See accompanying notes.
5
TECHTEAM GLOBAL, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
(In thousands)
NINE MONTHS ENDED
SEPTEMBER 30,
------------------
2006 2005
------- --------
CASH FLOWS FROM OPERATING ACTIVITIES
Net income ................................................... $ 632 $ 4,557
Adjustments to reconcile net income to net cash provided by
(used in) operating activities:
Depreciation and amortization .......................... 3,773 4,105
Asset impairment loss .................................. 580 --
Non-cash expense related to stock-based compensation ... 385 431
Other .................................................. 160 (166)
Changes in current assets and liabilities .............. (6,689) 829
Changes in long-term assets and liabilities ............ (838) (1,306)
(Income) loss from discontinued operations ............. 11 (59)
Net operating cash flow from discontinued operations ... 55 55
------- --------
Net cash provided by (used in) operating activities ....... (1,931) 8,446
------- --------
CASH FLOWS FROM INVESTING ACTIVITIES
Purchase of property, equipment, and software ................ (3,155) (2,344)
Cash paid for acquisitions, net of cash acquired ............. (494) (21,687)
------- --------
Net cash used in investing activities ..................... (3,649) (24,031)
------- --------
CASH FLOWS FROM FINANCING ACTIVITIES
Proceeds from issuance of common stock ....................... 2,186 2,972
Tax benefit from stock options ............................... 166 --
Payments on long-term debt ................................... (5,819) (5,184)
Proceeds from issuance of long-term debt ..................... -- 15,000
Net financing cash flow from discontinued operations ......... -- (11)
------- --------
Net cash provided by (used in) financing activities ....... (3,467) 12,777
------- --------
EFFECT OF EXCHANGE RATE CHANGES ON CASH AND CASH EQUIVALENTS .... 689 (1,113)
------- --------
DECREASE IN CASH AND CASH EQUIVALENTS ........................... (8,358) (3,921)
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD ................ 34,756 40,436
------- --------
CASH AND CASH EQUIVALENTS AT END OF PERIOD ...................... $26,398 $ 36,515
======= ========
See accompanying notes.
6
TECHTEAM GLOBAL, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1 -- BASIS OF PRESENTATION
The accompanying unaudited condensed consolidated financial statements have been
prepared by TechTeam Global, Inc. ("TechTeam," the "Company" or "we") in
accordance with United States generally accepted accounting principles for
interim financial information and the instructions to Form 10-Q and Article 10
of Regulation S-X. Accordingly, they do not include all of the information and
footnotes required by United States generally accepted accounting principles for
complete financial statements. In the opinion of management, all adjustments
considered necessary for a fair presentation have been included, and such
adjustments are of a normal recurring nature. Operating results for the three
and nine months ended September 30, 2006 are not necessarily indicative of the
results that may be expected for the year ending December 31, 2006. For further
information, refer to the consolidated financial statements and footnotes
thereto included in the Company's Annual Report on Form 10-K for the year ended
December 31, 2005.
NOTE 2 -- COMPREHENSIVE INCOME
Comprehensive income is defined as net income and all non-ownership changes in
shareholders' equity. For the Company, comprehensive income consists of net
income and the foreign currency translation adjustment for the period. A summary
of comprehensive income for the periods presented is as follows:
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------ -----------------
2006 2005 2006 2005
---- ------ ------ -------
(In thousands)
COMPREHENSIVE INCOME
Net income .................................. $370 $1,229 $ 632 $ 4,557
Other comprehensive income (loss) --
Foreign currency translation adjustment .. 407 227 1,638 (2,376)
---- ------ ------ -------
Comprehensive income ........................ $777 $1,456 $2,270 $ 2,181
==== ====== ====== =======
NOTE 3 -- EARNINGS PER SHARE
For periods ending prior to July 1, 2005, earnings per share is computed using
the two-class method as required by Statement of Financial Accounting Standards
("SFAS") No. 128, "Earnings Per Share." The two-class method is an earnings
allocation formula that determines earnings per share separately for common
stock and participating securities according to dividends declared (or
accumulated) and participation rights in undistributed earnings. The Company's
redeemable convertible preferred stock, outstanding between April 2003 and May
2005, was a participating security under SFAS 128. The redeemable convertible
preferred stock had rights to undistributed earnings, but was not required to
participate in net losses of the Company. In May 2005 through a series of
transactions, the holder of the Company's preferred stock converted all 689,656
shares of preferred stock into an equal number of shares of unregistered Company
common stock and sold those shares in the open market pursuant to rules and
regulations of the United States Securities and Exchange Commission.
Earnings per share for common stock is computed using the weighted average
number of common shares and common share equivalents outstanding. Common share
equivalents consist of stock options, unvested restricted stock issued to
employees, and shares held in escrow in connection with the Company's
acquisition of TechTeam Akela SRL. Earnings per share for preferred stock is
computed using the weighted average number of preferred shares outstanding.
Earnings are allocated to each class of stock pro rata based on the weighted
average number of shares and share equivalents outstanding for each class of
stock.
7
TECHTEAM GLOBAL, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(continued)
NOTE 3 -- EARNINGS PER SHARE (continued)
During the three months ended September 30, 2006 and 2005, 832,300 and 95,000
stock options, respectively, were excluded from the computation of diluted
earnings per share because the exercise prices of the options were higher than
the average market price of the Company's common stock for the respective
period. During the nine months ended September 30, 2006 and 2005, 576,900 and
95,000 stock options, respectively, were excluded from the computation of
diluted earnings per share because the exercise prices of the options were
higher than the average market price of the Company's common stock for the
respective period.
The following table reconciles the numerators and denominators of the basic and
diluted earnings per share computations for income from continuing operations:
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------ -----------------
2006 2005 2006 2005
------- ------- ------- ------
(In thousands, except per share data)
Income from continuing operations ................... $ 381 $ 1,226 $ 643 $4,498
Less - Income from continuing operations allocated
to preferred shareholders ........................ -- -- -- 152
------- ------- ------- ------
Income from continuing operations available
to common shareholders ........................... $ 381 $ 1,226 $ 643 $4,346
======= ======= ======= ======
Basic weighted average common shares ................ 10,193 9,892 10,041 9,365
Common stock equivalents ............................ 49 317 176 353
------- ------- ------- ------
Diluted weighted average common shares .............. 10,242 10,209 10,217 9,718
======= ======= ======= ======
Weighted average preferred shares ................... -- -- -- 327
======= ======= ======= ======
Earnings per share from continuing operations:
Basic earnings per common share .................. $ 0.04 $ 0.12 $ 0.06 $ 0.46
Basic earnings per preferred share ............... $ N/A $ N/A $ N/A $ 0.46
Diluted earnings per common share ................ $ 0.04 $ 0.12 $ 0.06 $ 0.45
NOTE 4 -- PROPERTY, EQUIPMENT, AND PURCHASED SOFTWARE
We continually evaluate whether events and circumstances have occurred that
indicate the remaining estimated useful lives of long-lived assets may warrant
revision or that the remaining balances may not be recoverable. When factors
indicate that such costs should be evaluated for possible impairment, we
estimate the undiscounted cash flows of the long-lived assets over their
remaining lives to evaluate whether the costs are recoverable. In the first
quarter of 2006, we determined that certain software would no longer be used.
Since we expect no future cash flows related to the software asset, we recorded
an impairment loss of $580,000 to cost of revenue in the first quarter of 2006
in our IT Outsourcing Services segment, which represented the net book value of
the asset. We did not record an impairment loss in any other period presented.
8
TECHTEAM GLOBAL, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(continued)
NOTE 5 -- GOODWILL AND OTHER INTANGIBLE ASSETS
Changes in the carrying amount of goodwill since December 31, 2005 consist of
the following:
IT GOVERNMENT IT CONSULTING
OUTSOURCING TECHNOLOGY AND SYSTEMS
SERVICES SERVICES INTEGRATION TOTAL
----------- ---------- ------------- -------
(In thousands)
Balance as of January 1, 2006 ....... $371 $19,670 $2,063 $22,104
Goodwill acquired ................ -- -- 12 12
Effect of exchange rate changes .. -- -- 35 35
---- ------- ------ -------
Balance as of September 30, 2006 .... $371 $19,670 $2,110 $22,151
==== ======= ====== =======
Goodwill is not amortized, but instead is subject to an annual impairment test
on October 1 or whenever significant events or changes occur that might indicate
impairment of recorded costs. In performing the Company's goodwill impairment
evaluation, the Company identifies its reporting units and determines the
carrying value of each reporting unit by assigning the assets and liabilities,
including the existing goodwill and intangible assets, to these reporting units.
The Company determines the estimated fair value of each reporting unit and
compares it to the carrying amount of the reporting unit. We did not record an
impairment loss in any period presented.
In the future, to the extent the carrying amount of a reporting unit exceeds the
fair value of a reporting unit, an indication would exist that a reporting
unit's goodwill may be impaired, and the Company would be required to perform
the second step of the impairment test. In the second step, the Company must
compare the implied fair value of the reporting unit goodwill with the carrying
amount of the reporting unit's goodwill. The implied fair value of goodwill is
determined by allocating the fair value of the reporting unit to all of the
assets (recognized and unrecognized) and liabilities of the reporting unit in a
manner similar to a purchase price allocation in an acquisition. The residual
fair value after this allocation is the implied fair value of the reporting
unit's goodwill.
Other intangible assets consist of the following at September 30, 2006:
WEIGHTED
AVERAGE
ACCUMULATED AMORTIZATION
COST AMORTIZATION PERIOD
------- ------------ ------------
(In thousands)
Customer-related assets..... $12,682 $3,714 7.8 years
Noncompete agreement........ 885 346 4.3 years
Trademark and name.......... 384 163 3.9 years
------- ------
$13,951 $4,223
======= ======
Intangible assets acquired in a business combination are recognized only if such
assets arise from a contractual or other legal right and are separable, that is,
capable of being sold, transferred, licensed, rented, or exchanged. Intangible
assets acquired in a business combination that do not meet these criteria are
considered a component of goodwill. The useful life of amortizable intangible
assets is determined based on the period from which we expect to realize cash
flows from these assets and considers, among other items, ability and cost to
renew contracts with similar terms and conditions and historical customer
retention rates.
9
TECHTEAM GLOBAL, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(continued)
NOTE 5 -- GOODWILL AND OTHER INTANGIBLE ASSETS (continued)
We re-evaluate amortizable intangible assets based on undiscounted operating
cash flows whenever significant events or changes occur that might indicate
impairment of recorded costs. If undiscounted cash flows are insufficient to
recover recorded costs, we write down the carrying value of the assets to fair
value based on discounted cash flows or market values. We did not record an
impairment loss for amortizable intangible assets in any period presented.
Our expected future amortization expense for intangible assets held at September
30, 2006 is as follows: $504,000 for the remainder of 2006, $1,914,000 in 2007,
$1,908,000 in 2008, $1,630,000 in 2009, and $1,483,000 in 2010.
NOTE 6 -- STOCK-BASED COMPENSATION
ADOPTION OF SFAS 123R
Effective January 1, 2006, the Company adopted the provisions of SFAS 123R,
"Share-Based Payment," which requires companies to measure and recognize
compensation expense for all share-based payment awards to employees and
directors based on estimated fair values of all awards. Compensation expense is
recognized over the period during which an employee or director is required to
provide service in exchange for the award. SFAS 123R supersedes the Company's
previous accounting methodology using the intrinsic value method under
Accounting Principles Board Opinion No. 25 ("APB 25"), "Accounting for Stock
Issued to Employees," and related interpretations. Under the intrinsic value
method, no share-based compensation expense had been recognized in the Company's
consolidated statements of operations for stock option awards with an exercise
price equal to or greater than the fair value of the underlying stock on the
date of grant.
The Company adopted SFAS 123R using the modified prospective transition method.
Under this transition method, stock-based compensation expense recognized after
the effective date includes: (1) compensation expense for all share-based awards
granted prior to, but not yet vested, as of December 31, 2005, based on the
grant-date fair value estimated in accordance with the original provisions of
SFAS 123, and (2) compensation cost for all share-based awards granted
subsequent to January 1, 2006, based on the grant-date fair value estimated in
accordance with the provisions of SFAS 123R. In accordance with the modified
prospective transition method, the Company's consolidated financial statements
from prior periods have not been restated and do not include the impact of SFAS
123R.
As a result of adopting SFAS 123R, the company recorded pre-tax and after-tax
amounts of $40,000 and $26,000, respectively, for share-based compensation
expense during the three months ended September 30, 2006, and recorded pre-tax
and after-tax amounts of $243,000 and $160,000, respectively, for share-based
compensation expense during the nine months ended September 30, 2006.
Stock-based compensation expense recognized in each period is based on the value
of the portion of the share-based award that is ultimately expected to vest.
SFAS 123R requires that forfeitures be estimated at the time of the grant and
revised, if necessary, in subsequent periods if actual forfeitures differ from
those estimates. In our pro forma disclosures required under SFAS 123 for
periods prior to 2006, we accounted for forfeitures as they occurred.
On November 10, 2005 the Financial Accounting Standards Board ("FASB") issued
FASB Staff Position No. 123R-3, "Transition Election Related to Accounting for
Tax Effect of Share-Based Payment Awards." The Company has elected to adopt the
alternative transition method provided in the FASB Staff Position for
calculating the tax effect of share-based compensation pursuant to SFAS 123R.
The alternative transition method includes simplified methods to establish the
beginning balance of the additional paid-in capital pool ("APIC Pool") related
to the tax effect of employee share-based compensation, and to determine the
subsequent impact on the APIC Pool and consolidated statements of cash flows of
the tax effects of employee and director share-based awards that are outstanding
as of the adoption of SFAS 123R.
10
TECHTEAM GLOBAL, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(continued)
NOTE 6 -- STOCK-BASED COMPENSATION (continued)
STOCK OPTIONS
As of September 30, 2006, we have stock options outstanding under two plans --
the 2004 Incentive Stock and Awards Plan ("2004 Plan") and the 1990 Nonqualified
Stock Option Plan ("1990 Plan"). As a result of the adoption of the 2004 Plan,
options may no longer be granted under the 1990 Plan.
The Company also had the 1996 Non-Employee Directors Stock Plan ("1996 Plan"),
which expired on December 31, 2005. All remaining outstanding options under the
1996 Plan were either exercised or terminated in 2006. The Company expects to
seek approval from its shareholders for a new non-employee directors stock plan
in 2007. In the event a new plan is not approved by the Company's shareholders,
non-employee directors in the aggregate will receive a cash payment equal to the
estimated fair value of 110,000 stock options, as determined using the
Black-Scholes valuation model. The Company recorded approximately $90,000 of
compensation expense for the potential stock option award or cash payment for
the three and nine months ended September 30, 2006.
Under the 2004 Plan, the Compensation Committee of the Board of Directors may
issue stock options, performance shares, and restricted stock to employees and
consultants representing up to 1,200,000 shares of our common stock. Stock
options may be granted with terms up to ten years and must have an exercise
price that is equal to or greater than the fair market value of our common stock
on the date of grant. Options outstanding under the 1990 Plan have expiration
terms ranging from four to six years and become exercisable ratably over periods
ranging from three to five years.
The company recorded $40,000 and $243,000 of compensation expense relating to
outstanding options during the three and nine months ended September 30, 2006,
respectively. No compensation expense related to outstanding options was
recorded during the three and nine months ended September 30, 2005. As of
September 30, 2006, total unrecognized compensation cost related to stock
options was $222,000, which we expect to recognize over a weighted-average
period of approximately 1 year.
The Company records compensation expense for employee stock options based on the
estimated fair value of the options on the date of grant using the Black-Scholes
valuation model. The Company uses historical data among other factors to
estimate the expected price volatility, the expected option term, and the
expected forfeiture rate. The risk-free rate is based on the U.S. Treasury yield
curve in effect at the date of grant for the expected term of the option. The
following assumptions were used to estimate the fair value of options granted
during the nine months ended September 30, 2006 and 2005:
NINE MONTHS ENDED SEPTEMBER 30,
-------------------------------
2006 2005
---------- ----------
Expected dividend yield............ 0.0% 0.0%
Weighted average volatility........ 42% 42%
Risk free interest rate............ 4.4% - 4.7% 3.3% - 4.0%
Expected term (in years)........... 3.0 3.1
11
TECHTEAM GLOBAL, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(continued)
NOTE 6 -- STOCK-BASED COMPENSATION (continued)
The following table summarizes the Company's activities with respect to its
stock option plans as of and for the nine months ended September 30, 2006:
WEIGHTED WEIGHTED
AVERAGE AVERAGE
EXERCISE REMAINING AGGREGATE
NUMBER OF PRICE PER CONTRACTUAL INTRINSIC
SHARES SHARE TERM VALUE
--------- --------- ----------- ---------
Outstanding at January 1, 2006 ........ 1,402,970 $ 9.41
Granted ............................ 135,000 $ 9.69
Exercised .......................... (344,336) $ 6.35
Canceled ........................... (271,667) $12.46
--------- ------
Outstanding at September 30, 2006 ..... 921,967 $ 9.59 7.8 Years $133,867
========= ====== ========= ========
Vested and expected to vest in the
future at September 30, 2006 ....... 921,967 $ 9.59 7.8 Years $133,867
========= ====== ========= ========
Exercisable at September 30, 2006 ..... 811,967 $ 9.67 7.9 Years $ 97,027
========= ====== ========= ========
No options were issued during the three months ended September 30, 2006. The
weighted average grant-date fair value of options issued during the three months
ended September 30, 2005 was $4.09. The weighted average grant-date fair value
of options issued during the nine months ended September 30, 2006 and 2005, was
$3.21 and $3.66, respectively. The total intrinsic value of options exercised
during the three months ended September 30, 2006 and 2005, was $53,000 and
$71,000, respectively, and the total intrinsic value of options exercised during
the nine months ended September 30, 2006 and 2005, was $1,185,000 and
$2,112,000, respectively. The intrinsic values were determined as of the date of
exercise.
Cash received from option exercises under all plans for the three months ended
September 30, 2006 and 2005, was $259,000 and $177,000, respectively. Cash
received from option exercises under all plans for the nine months ended
September 30, 2006 and 2005, was $2,186,000 and $2,972,000, respectively. The
actual tax benefit realized related to tax deductions from option exercises
under all plans totaled approximately $12,000 and $17,000 for the three months
ended September 30, 2006 and 2005, respectively, and totaled approximately
$83,000 and $306,000 for the nine months ended September 30, 2006 and 2005,
respectively.
RESTRICTED COMMON STOCK
All restricted stock is authorized and issued under the 2004 Plan. Under the
2004 Plan, the Compensation Committee of the Board of Directors may issue stock
options, performance shares, and restricted stock to employees and consultants
representing up to 1,200,000 shares of our common stock. Performance shares and
restricted stock awards may be granted subject to such terms and conditions as
the Compensation Committee deems appropriate, including a condition that one or
more performance goals be achieved for the participant to realize all or a
portion of the award. The Company issued 4,000 shares of restricted stock under
the 2004 Plan during the three months ended September 30, 2006. The Company
issued 30,000 shares of restricted stock under the 2004 Plan during the nine
months ended September 30, 2006, the majority of which vest ratably over a
period of four years. No shares of restricted stock were granted under the 2004
Plan during the three and nine months ended September 30, 2005. No performance
shares were granted during any period presented.
12
TECHTEAM GLOBAL, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(continued)
NOTE 6 -- STOCK-BASED COMPENSATION (continued)
Effective January 1, 2004, our Board of Directors approved the Executive
Long-Term Incentive Plan ("Long-Term Incentive Plan"), in which awards may be
issued under: (1) a restricted stock program that focuses on retaining high
performing executives over a longer period of time, (2) a performance stock
program that focuses on rewarding extraordinary performing executives, and (3) a
non-qualified stock option program that focuses on the long-term retention of
key executives. Awards under these programs are administered in conjunction with
the 2004 Plan whereby shares available for issuance are funded by the shares
available for issuance under the 2004 Plan.
Under the restricted stock program, certain members of management are entitled
to an award of restricted stock equal to a percentage of the participant's
salary if certain operating targets are met on a rolling three-year basis,
except that the first year of the plan was based on the operating target for
only the first year, and the second year of the plan was based on the cumulative
operating target for the first and second years. Restricted stock awards do not
vest ratably but instead become 100% vested at the end of five years from the
date of grant. During the three months ended September 30, 2006 and 2005, no
shares of restricted stock were granted under the Long-Term Incentive Plan.
During the nine months ended September 30, 2006 and 2005, the Company granted
42,306 and 46,460 shares of restricted stock, respectively, to certain employees
under the Long-Term Incentive Plan.
The Company recorded approximately $42,000 and $23,000 of compensation expense
related to outstanding shares of restricted stock under all plans during the
three months ended September 30, 2006 and 2005, respectively, and recorded
approximately $123,000 and $70,000 of compensation expense related to
outstanding shares of restricted stock under all plans during the nine months
ended September 30, 2006 and 2005, respectively. The weighted average grant-date
fair value of restricted stock granted under all plans during the nine months
ended September 30, 2006 and 2005, was $10.11 and $11.35 per share,
respectively. Under the Long-Term Incentive Plan, the fair value of restricted
stock awards is determined based on the average closing trading price of the
Company's common stock for thirty (30) trading days prior to the date of grant.
The fair value of restricted stock awards granted under the 2004 Plan was
determined based on the closing trading price of the Company's common stock on
the grant date.
At September 30, 2006 and 2005, there was approximately $625,000 and $463,000,
respectively, of total unrecognized compensation expense related to nonvested
shares of restricted stock granted to employees. Unrecognized compensation
expense at September 30, 2006 is expected to be recognized over a weighted
average period of 3.7 years. Unrecognized compensation expense related to
nonvested shares of restricted stock awards was recorded as unamortized deferred
compensation within shareholders' equity at December 31, 2005. As part of the
modified prospective transition method of adoption of SFAS 123R, approximately
$866,000 of unamortized deferred compensation at December 31, 2005 has been
reclassified as a component of additional paid-in-capital.
The following table summarizes the Company's activities with respect to its
nonvested stock activity for the nine months ended September 30, 2006:
WEIGHTED
AVERAGE
EXERCISE
NUMBER OF PRICE PER
SHARES SHARE
--------- ---------
Nonvested at January 1, 2006 ...... 46,460 $11.35
Granted ........................... 72,306 $10.11
Vested ............................ -- $ --
Forfeited ......................... (38,546) $10.94
------- ------
Nonvested at September 30, 2006 ... 80,220 $10.63
======= ======
13
TECHTEAM GLOBAL, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(continued)
NOTE 6 -- STOCK-BASED COMPENSATION (continued)
PRO FORMA EMPLOYEE SHARE-BASED COMPENSATION EXPENSE
Prior to December 31, 2005, the Company accounted for its share-based
compensation arrangements in accordance with the provisions and related
interpretations of APB 25. The following pro forma table illustrates the effect
on net income and earnings per share had the share-based awards been determined
consistent with SFAS 123R:
THREE MONTHS NINE MONTHS
ENDED ENDED
SEPTEMBER 30, SEPTEMBER 30,
2005 2005
------------- -------------
(In thousands, except
per share data)
Reported net income ................................... $1,229 $4,557
Add -- total stock-based compensation expense
included in reported net income, net of tax ........ 25 82
Deduct -- total stock-based compensation expense
determined under the fair value method for all
awards, net of tax ................................. (126) (806)
------ ------
Pro forma net income .................................. $1,128 $3,833
====== ======
Basic earnings per common and preferred share:
As reported ........................................ $ 0.12 $ 0.47
Pro forma .......................................... $ 0.11 $ 0.40
Diluted earnings per common share:
As reported ........................................ $ 0.12 $ 0.45
Pro forma .......................................... $ 0.11 $ 0.38
NOTE 7 -- INCOME TAXES
For the three months ended September 30, 2006, the consolidated effective tax
rate of 38.2% differs from the statutory tax rate in the United States of 34%
primarily due to state income taxes, nondeductible expenses, and an unfavorable
change in the expected utilization of foreign tax loss carryforwards that
resulted in an adjustment to the expected tax rate for the year. For the nine
months ended September 30, 2006, the consolidated effective tax rate of 36.2%
differs from the statutory tax rate of 34% primarily due to state income taxes
and nondeductible expenses.
For the three and nine months ended September 30, 2005, the consolidated
effective tax rate of 31.5% and 31.8%, respectively, differs from the statutory
tax rate of 34% primarily due to the tax benefit of tax rates in certain foreign
countries that are lower than 34% and the tax benefit of certain permanent
deductions.
No provision has been made with respect to approximately $9,469,000 million of
undistributed earnings of foreign subsidiaries at September 30, 2006, since we
consider these earnings to be permanently reinvested.
In July 2006, the FASB issued FASB Interpretation No. 48, "Accounting for
Uncertainty in Income Taxes" ("FIN 48"). FIN 48 prescribes a recognition
threshold and measurement attribute for the financial statement recognition and
measurement of a tax position taken in a tax return. FIN 48 also provides
guidance regarding subsequent reversal of a tax position, balance sheet
classification, accounting in interim periods, disclosure, and transition. FIN
48 is effective for fiscal years beginning after December 15, 2006. The Company
has not completed its analysis of the potential impact of FIN 48 on the
Company's financial position or results of operations.
14
TECHTEAM GLOBAL, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(continued)
NOTE 8 -- SEGMENT REPORTING
Operating segments are defined as components of an enterprise about which
separate financial information is available that is evaluated regularly by the
chief operating decision maker, or decision-making group, in deciding how to
allocate resources and in assessing performance. Our chief operating
decision-making group is the Executive Leadership Team, which is comprised of
the President and the lead executives of the Company and its subsidiaries.
The accounting policies of the operating segments are the same as those
described in Note 1 to the Company's consolidated financial statements contained
in the Company's Annual Report on Form 10-K for the year ended December 31,
2005. We evaluate segment performance based on segment gross profit. We do not
allocate assets to operating segments, but we allocate certain amounts of
depreciation and amortization expense to operating segments.
Financial information for our operating segments is as follows:
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------ -------------------
2006 2005 2006 2005
------- ------- -------- --------
(In thousands)
REVENUE
IT outsourcing ......................... $21,293 $17,892 $ 60,803 $ 55,631
Government technology services ......... 12,285 14,482 35,771 43,662
IT consulting and systems integration .. 6,189 6,758 19,662 19,690
Technical staffing ..................... 2,021 1,967 6,401 6,099
Learning services ...................... 239 215 857 555
------- ------- -------- --------
Total revenue ............................. $42,027 $41,314 $123,494 $125,637
======= ======= ======== ========
GROSS PROFIT
IT outsourcing ......................... $ 5,468 $ 4,550 $ 15,089 $ 13,991
Less -- asset impairment loss .......... -- -- 580 --
------- ------- -------- --------
Total IT outsourcing services ....... 5,468 4,550 14,509 13,991
Government technology services ......... 3,389 4,010 10,111 12,601
IT consulting and systems integration .. 1,169 1,337 4,194 3,964
Technical staffing ..................... 276 406 1,058 1,349
Learning services ...................... 61 40 262 147
------- ------- -------- --------
Total gross profit ........................ 10,363 10,343 30,134 32,052
Selling, general, and administrative
expense .............................. 9,946 8,606 29,547 25,767
Interest income, net ................... 205 151 525 314
Foreign currency transaction loss ...... (5) (99) (104) (3)
------- ------- -------- --------
Income before income taxes ................ $ 617 $ 1,789 $ 1,008 $ 6,596
======= ======= ======== ========
15
TECHTEAM GLOBAL, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(continued)
NOTE 8 -- SEGMENT REPORTING (continued)
We attribute revenue to different geographic areas on the basis of the location
providing the services to the customer. Revenue by geographic area is presented
below:
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------ -------------------
2006 2005 2006 2005
------- ------- -------- --------
(In thousands)
REVENUE
United States ... $27,916 $29,747 $ 82,814 $ 88,693
Europe:
Belgium ...... 9,347 8,413 27,214 26,679
Other ........ 4,764 3,154 13,466 10,265
------- ------- -------- --------
Total Europe .... 14,111 11,567 40,680 36,944
------- ------- -------- --------
Total revenue ...... $42,027 $41,314 $123,494 $125,637
======= ======= ======== ========
Revenue from customers, or groups of customers under common control, that
comprise 10% or greater of our total revenue in any period presented are as
follows:
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------ -----------------
2006 2005 2006 2005
---- ---- ---- ----
Ford Motor Company and Subsidiaries ..... 26.0% 26.4% 26.7% 27.4%
United States Government ................ 25.9% 29.5% 25.5% 29.7%
---- ---- ---- ----
Total ................................... 51.9% 55.9% 52.2% 57.1%
==== ==== ==== ====
We conduct business under multiple contracts with various entities within the
Ford Motor Company organization and with various agencies and departments of the
United States Government. For the three and nine months ended September 30, 2006
and 2005, no single agency or department of the United States Government
comprised 10% or greater of the Company's total revenue.
NOTE 9 -- CONTINGENCIES
On November 1, 2006, the Company agreed, in principle, to resolve claims
previously reported by the Company that were brought against it by William F.
Coyro, Jr., its former President and Chief Executive Officer, and David W.
Morgan, its former Vice President of Finance and Business Development, Chief
Financial Officer and Treasurer. The Company expects to have these settlements,
with full release of any existing liability of the Company, finalized in
November 2006. The settlement agreement with Mr. Morgan is dependent upon the
dismissal with prejudice of the complaint Mr. Morgan filed with the U.S.
Department of Labor Occupational Safety and Health Agency asserting that he
resigned from employment with the Company due to actions taken against him as a
result of certain activities protected under Section 806 of the Corporate and
Criminal Fraud Accountability Act of 2002, Title VIII of the Sarbanes-Oxley Act
of 2002, 18 U.S.C. Section 1514A. During the three months ended September 30,
2006, the Company recorded pre-tax expense of $650,000 necessary for the Company
to conclude these settlements.
16
TECHTEAM GLOBAL, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(continued)
NOTE 9 -- CONTINGENCIES (continued)
In addition to the above matter, from time to time the Company is involved in
various litigation matters arising in the ordinary course of its business. None
of these matters, individually or in the aggregate, currently is material to the
Company.
NOTE 10 -- DISCONTINUED OPERATIONS
TechTeam Capital Group, LLC ("Capital Group"), a subsidiary of the Company,
previously wrote leases for computer, telecommunications, and other types of
capital equipment. Capital Group ceased writing new leases in March 2000 and has
no remaining active leases. The primary activity that remains in closing down
the leasing operation is the collection of accounts receivable. As a result,
Capital Group has been presented as a discontinued operation in accordance with
SFAS No. 144, "Accounting for the Disposal or Impairment of Long-Lived Assets."
Under SFAS 144, the operating results of Capital Group are presented separately
from continuing operations in the accompanying financial statements for all
periods presented. Capital Group previously was reported as a separate operating
segment. Summarized information for Capital Group is as follows:
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------ -----------------
2006 2005 2006 2005
---- ---- ---- ----
(In thousands)
Revenue ...................... $ -- $6 $ -- $74
Income before income taxes ... $(11) $3 $(11) $87
17
FORWARD-LOOKING STATEMENTS
This Quarterly Report on Form 10-Q, including "Management's Discussion and
Analysis of Financial Condition and Results of Operations" in Item 2, contains
forward-looking statements that involve risks and uncertainties, as well as
assumptions that, if they never materialize or prove incorrect, could cause the
results of TechTeam Global, Inc. and its consolidated subsidiaries ("TechTeam")
to differ materially from those expressed or implied by such forward-looking
statements. All statements other than statements of historical fact are
statements that could be deemed forward-looking statements, including any
projections of revenue, gross margin, expenses, earnings or losses from
operations, synergies, or other financial items; any statements of the plans,
strategies, and objectives of management for future operations; any statement
concerning developments or performance relating to our services; any statements
regarding future economic conditions or performance; any statements of
expectation or belief; and any statements of assumptions underlying any of the
foregoing. The risks, uncertainties and assumptions referred to above include
the performance of contracts by suppliers, customers, and partners; employee
management issues; the difficulty of aligning expense levels with revenue
changes; complexities of global political and economic developments; and other
risks that are described herein, including but not limited to the items
discussed in "Factors that Could Affect Future Results" set forth in
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" in Item 2 of this report, and that are otherwise described from time
to time in TechTeam's Securities and Exchange Commission reports filed after
this report. TechTeam assumes no obligation and does not intend to update these
forward-looking statements.
ITEM 2 -- MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
OVERVIEW
TechTeam is a global provider of information technology ("IT") and business
process outsourcing services to Fortune 1000 companies, multinational companies,
product providers, small and mid-size companies, and government entities.
Our third quarter 2006 operating results reflect the first quarter of improved
operating results after five consecutive quarters of declining results caused
primarily by the conclusion and wind-down of certain contracts in both our
Government Technology Services and IT Consulting and Systems Integration
segments, the latter of which provided significant growth in 2005. These
declines have been fully offset by 19% organic revenue growth over the third
quarter of 2005 in our IT Outsourcing Services segment primarily from new
customer accounts. Our operating results for the third quarter of 2006 also
include a charge of $650,000 related to the settlement of claims previously
reported by the Company that were brought against it by certain former Company
officers.
Our operating results for the nine months ended September 30, 2006, include the
negative impact of an asset impairment loss of $580,000, recorded to cost of
revenue during the first quarter; legal and professional fees incurred during
the first and second quarters totaling $1.4 million associated with a complaint
filed by a shareholder, Costa Brava Partnership III, L.P. ("Costa Brava"),
seeking to inspect certain books and records of the Company, the related proxy
contest initiated by Costa Brava related to the election of the Company's Board
of Directors, and the Settlement Agreement resolving these matters; and the
aforementioned charge related to the settlement of claims.
We are diligently working to replace the revenue in our Government Technology
Services and IT Consulting and Systems Integration segments. In this respect, we
were recently successful in winning several significant government contracts,
including those with the National Institutes of Health, Office of Information
Technology; the Department of Health and Human Services, Program Support Center,
Division of Payments Management; and the U.S. Army, Army Research Laboratory.
While the decline in revenue from certain project-based work in IT Consulting
and Systems Integration was expected, we were not able to replace the work prior
to the decline in revenue. Yet, we expect to execute a new contract with a
current, major hospitality customer that, depending on the customer's plans,
might represent a substantial new multi-year program.
18
Although we have experienced significant growth in IT Outsourcing Services, our
profitability in this segment has suffered due to expenses incurred in the
ramp-up of two new customer accounts, the largest of which was launched in three
phases over an eight-month period. As we are committed to delivering world-class
service, we were careful to staff these new customer accounts with additional
resources during their initial ramp-up. While this delayed the profitability of
these accounts, we believe it has proven our determination to deliver quality
customer results, on which long-term client relationships are built. These
accounts have improved their performance each quarter in 2006 and are now
profitable. We are also focused on improving the performance of other contracts
where profitability lags behind Company averages. In the aggregate, the initial
five customer accounts on which we have focused yielded a total profit
improvement of approximately $577,000 from the second quarter to the third
quarter.
We will continue to meet certain challenges as we look to improve our operating
performance in future periods. We expect certain reductions to selling, general
and administrative ("SG&A") expense in future periods as we continually attempt
to reduce inefficient and non-value-added costs, we benefit from certain leases
that have expired and have not been renewed, and we maintain our balance between
investing in revenue growth and containing costs. However, we anticipate certain
increases to SG&A expense as we continue to make careful and considerate
investments in areas such as our global sales and marketing capabilities,
additional executive talent, and our technology infrastructure. We are
maintaining a proactive focus on spending and cost avoidance and will continue
to pursue SG&A spending levels that are 20% of revenue or less. This is a
challenge that will likely take the next several quarters to achieve as we make
investments to position the Company for long-term growth.
Moreover, while the integration of our help desk facility in Romania has
improved the profitability and flexibility of our existing business and
multi-lingual help desk, the effects of increasing competition for resources can
be seen in Romania. Over the past year, a number of companies, including
outsourcing competitors, have opened call centers in Bucharest. As a result of
the increased competition for multi-lingual resources, over the long-term, we
expect our labor costs to continue to increase at a rate greater than the
Company experiences in other regions in which we operate. In an effort to
address this risk, we are evaluating other regions within Romania and in the
Asia-Pacific region to establish new operations.
Finally, Ford Motor Company ("Ford") is under significant financial pressures
and recently announced it was accelerating its turnaround plan ("Way Forward
Plan"). Ford continues to be a significant customer of the Company, and we
estimate that our total revenue from Ford under all programs will decline
approximately 4-7% in 2006 from 2005. Please refer to our discussion of Ford in
the "Impact of Business with Major Clients" section of MD&A.
Business Growth and Direction
As previously reported, TechTeam has been undergoing a period of transition in
leadership, which has led Mr. William C. Brown as President and Chief Executive
Officer to realign our management structure and teams into three macro business
units and maintain a focus on building a strong business development pipeline
and process. This realignment of TechTeam's organization along business units --
the Americas; Europe, Middle East and Africa ("EMEA"); and TechTeam Government
Solutions -- is designed to support growth and address the continued
globalization of the Company's business. In support of this realignment, Mr.
Brown recently appointed Mr. Christoph Neut to the position of Senior Vice
President of EMEA. Mr. Neut previously served as TechTeam's Vice President of
Sales and Marketing, EMEA. Simultaneously, Mr. Brown appointed Mr. Robert W.
Gumber as Vice President of Service Delivery, US and EMEA, who previously served
as TechTeam's Vice President of Operations, EMEA. Finally in October 2006, the
Company hired Mr. Mark P. Francischetti as Vice President of Sales and
Marketing, Americas.
The investments we have made in our sales and marketing resources and
capabilities to support our business development efforts, most notably in EMEA,
are demonstrating results as evidenced by the Company achieving its strongest
quarter of 2006 in terms of contract wins. These wins include, but are not
limited to, the government contracts noted previously and contracts with
Boehringer Ingelheim UK, a new client in the automotive industry, and a new
Fortune 100 company in Europe. Our efforts to develop channel partners to sell
our services have also shown success, as we have been notified by one potential
channel partner that we have been awarded new business with them.
19
We are also working to expand our geographic support in response to the
requirements of our customers. We have multiple proposals outstanding with
existing customers to provide services for their operations in the Asia-Pacific
region. We anticipate that we will establish a TechTeam presence in the
Asia-Pacific region during the first half of 2007.
RESULTS OF OPERATIONS
THREE MONTHS ENDED SEPTEMBER 30, 2006 COMPARED TO SEPTEMBER 30, 2005
REVENUE
THREE MONTHS ENDED
SEPTEMBER 30,
------------------ INCREASE %
2006 2005 (DECREASE) CHANGE
------- ------- ---------- ------
(In thousands, except percentages)
REVENUE
IT outsourcing services ................ $21,293 $17,892 $ 3,401 19.0%
Government technology services ......... 12,285 14,482 (2,197) (15.2)%
IT consulting and systems integration .. 6,189 6,758 (569) (8.4)%
Technical staffing ..................... 2,021 1,967 54 2.7%
Learning services ...................... 239 215 24 11.2%
------- ------- -------
TOTAL REVENUE ............................. $42,027 $41,314 $ 713 1.7%
======= ======= =======
As shown in the above table, the moderate overall revenue increase of 1.7% to
$42.0 million for the quarter ended September 30, 2006, is attributable to
significant growth in IT Outsourcing Services from new customer contracts that
was offset by revenue declines from the conclusion of certain contracts in our
Government Technology Services segment and the wind-down of certain systems
implementation and training projects in our IT Consulting and Systems
Integration segment. Excluding revenue from our acquisition of TechTeam Akela
SRL ("Akela") on October 3, 2005, revenue decreased slightly to $40.8 million
for the quarter ended September 30, 2006, from the comparable quarter in 2005.
Revenue was also positively affected by the weakening of the U.S. dollar
relative to the European euro and other international currencies in which the
Company conducts business, which increased revenue by approximately $484,000
over the comparable period in 2005.
IT Outsourcing Services
Revenue from our IT Outsourcing Services segment increased 19.0% to $21.3
million for the quarter ended September 30, 2006, from $17.9 million for the
comparable quarter in 2005, as a result of a 24.9% increase in revenue in the
United States and a 13.4% increase in revenue in Europe. The revenue growth in
the U.S. is primarily due to new customer contracts. The revenue growth in
Europe is primarily from our shared services offering for our pharmaceutical
clients, which grew by 95.0% from the third quarter of 2005, revenue growth from
Ford Motor Company ("Ford"), and the weakening of the U.S. dollar relative to
the European euro and other international currencies in which the Company
conducts business. The weakening of the U.S dollar increased revenue by
approximately $329,000 over the comparable period in 2005.
Globally, IT Outsourcing Services revenue generated from Ford declined slightly
to $9.0 million for the quarter ended September 30, 2006, from $9.1 million for
the comparable quarter in 2005. Revenue from Ford declined in each country
except the United Kingdom, where we began providing SPOC services to the Jaguar
and Land Rover group on March 17, 2006. Revenue from Ford in other regions
decreased primarily due to a reduction in the number of seats supported as Ford
continues to restructure its operations and reduce its worldwide workforce and
from lower prices charged under the Global SPOC Program contract renewal on
December 1, 2005. Please refer to our discussion of Ford in the "Impact of
Business with Major Clients" section of MD&A.
20
Government Technology Services
Revenue from our Government Technology Services segment decreased 15.2% to $12.3
million for the quarter ended September 30, 2006, from $14.5 million for the
comparable quarter in 2005, primarily due to the conclusion of certain contracts
that provided $1.9 million in revenue in the third quarter of 2005, and the
completion of projects at other customers. We are diligently working to replace
this revenue through our pursuit of new contract vehicles, while maintaining a
keen focus on existing contracts that are scheduled to expire where the Company
will have to recompete for the work. In this respect, as noted in the Overview
to MD&A, we were recently successful in winning several significant contracts.
IT Consulting and Systems Integration
Revenue from our IT Consulting and Systems Integration segment decreased 8.4% to
$6.2 million for the quarter ended September 30, 2006, from $6.8 million for the
comparable quarter in 2005, due to the wind-down of certain systems
implementation and training projects in the hospitality industry that drove
significant growth in this segment in 2005. The decline in revenue was partially
offset by our acquisition of Akela on October 3, 2005. Excluding revenue from
our acquisition of Akela, revenue from IT Consulting and Systems Integration
decreased 21.9% to $5.3 million for the quarter ended September 30, 2006, from
the comparable quarter in 2005. While the decline in revenue from certain
project-based work was expected, we were not able to replace the work prior to
the decline in revenue. Yet, we expect to execute a new contract with a current,
major hospitality customer that, depending on the customer's plans, might
represent a substantial new multi-year program.
Geographic Discussion
Total revenue generated in the United States decreased 6.2% to $27.9 million for
the quarter ended September 30, 2006, from $29.7 million for the comparable
quarter in 2005, primarily due to the aforementioned decline in revenue from our
Government Technology Services and IT Consulting and Systems Integration
segments. These declines were partially offset by revenue from new customer
contracts in our IT Outsourcing Services segment. Excluding revenue from our
government-based subsidiaries, revenue generated in the United States increased
4.7% to $15.8 million for the quarter ended September 30, 2006, from $15.1
million for the comparable quarter in 2005, which consists of the revenue growth
from IT Outsourcing Services partially offset by the decline in revenue from IT
Consulting and Systems Integration.
Revenue generated in Europe increased 22.0% to $14.1 million for the quarter
ended September 30, 2006, from $11.6 million for the comparable quarter in 2005,
primarily due to our acquisition of Akela and revenue growth in IT Outsourcing
Services from our shared services offering for our pharmaceutical clients and
revenue growth from Ford. Excluding revenue from Akela, revenue generated in
Europe increased 11.8% to $12.9 million for the quarter ended September 30,
2006, from the comparable period in 2005. Revenue was also positively affected
by the weakening of the U.S. dollar relative to the European euro and other
international currencies in which the Company conducts business. If revenue in
Europe for the quarter ended September 30, 2006 were translated into U.S.
dollars at the average exchange rate for the comparable period in 2005, reported
revenue would have been decreased by approximately $484,000. Since most of the
Company's international operating expenses are also incurred in the same foreign
currencies in which the associated revenue is denominated, the net impact of
exchange rate fluctuations on net income is considerably less than the estimated
impact on revenue and is not significant.
21
GROSS PROFIT
THREE MONTHS ENDED SEPTEMBER 30,
------------------------------------
2006 2005
----------------- -----------------
GROSS GROSS INCREASE %
AMOUNT MARGIN % AMOUNT MARGIN % (DECREASE) CHANGE
------- -------- ------- -------- ---------- ------
(In thousands, except percentages)
GROSS PROFIT
IT outsourcing services .. $ 5,468 25.7% $ 4,550 25.4% $ 918 20.2%
Government technology
services .............. 3,389 27.6% 4,010 27.7% (621) (15.5)%
IT consulting and systems
integration ........... 1,169 18.9% 1,337 19.8% (168) (12.6)%
Technical staffing ....... 276 13.7% 406 20.6% (130) (32.0)%
Learning services ........ 61 25.5% 40 18.6% 21 52.5%
------- ------- -----
TOTAL GROSS PROFIT .......... $10,363 24.7% $10,343 25.0% $ 20 0.2%
======= ======= =====
Consistent with revenue, we experienced significant growth in gross profit from
IT Outsourcing Services from new customer contracts that was offset by a
reduction in gross profit from the conclusion of certain contracts in our
Government Technology Services segment and the wind-down of certain systems
implementation and training projects in our IT Consulting and Systems
Integration segment.
IT Outsourcing Services
Gross profit from our IT Outsourcing Services segment increased 20.2% to $5.5
million for the quarter ended September 30, 2006, from $4.6 million for the
comparable quarter in 2005. Gross margin (defined as gross profit divided by
revenue) increased to 25.7% for the quarter ended September 30, 2006, from 25.4%
for the comparable period in 2005. This segment experienced an increase in gross
profit and gross margin related to our shared services offering for our
pharmaceutical clients where we experienced 95.0% revenue growth and were
successful in transitioning the majority of the service delivery for these
customers to our Romanian facility. However, these and other improvements in
gross margin have been largely offset by substandard profitability on two new
customer accounts, the largest of which was launched in three phases over an
eight-month period. We have been diligently pursuing improvement programs for
the two new customer accounts and other accounts that have been performing below
expectations. All of these accounts experienced an improvement in gross profit
and gross margin in the third quarter of 2006 from the second quarter of 2006
that we believe is sustainable and can be further improved.
Government Technology Services
Gross profit from our Government Technology Services segment decreased 15.5% to
$3.4 million for the quarter ended September 30, 2006, from $4.0 million for the
comparable quarter in 2005. Gross margin remains consistent at 27.6% for the
quarter ended September 30, 2006, from 27.7% for the comparable period in 2005.
The decrease in gross profit and gross margin is primarily due to the conclusion
of certain contracts that provided $1.9 million in revenue in the third quarter
of 2005, and the completion of projects at other customers. The inclusion of
resale items for both periods had the effect of reducing gross margin by
approximately 100-150 basis points in the third quarter of 2006 and 2005.
22
IT Consulting and Systems Integration
Gross profit from our IT Consulting and Systems Integration segment decreased
12.6% to $1.2 million for the quarter ended September 30, 2006, from $1.3
million for the comparable quarter in 2005. Gross margin decreased to 18.9% for
the quarter ended September 30, 2006, from 19.8% for the comparable quarter in
2005. The decrease in gross profit and gross margin was primarily due to the
wind-down of certain systems implementation and training projects in the
hospitality industry that drove significant growth in this segment in 2005, and
we are experiencing a temporary decline in gross profit and gross margin from
our on-going project installing personal computers at Ford subcontracted through
Dell Inc. These declines were partially offset by our acquisition of Akela on
October 3, 2005. While some of the decline in gross profit and gross margin from
the wind-down of certain project-based work was expected, we were not able to
replace the work prior to these declines.
OPERATING EXPENSES AND OTHER
THREE MONTHS ENDED
SEPTEMBER 30,
------------------ INCREASE %
2006 2005 (DECREASE) CHANGE
------ ------ --------- ------
(In thousands, except percentages)
OPERATING EXPENSES AND OTHER
Selling, general, and administrative expense .. $9,946 $8,606 $1,340 15.6%
Net interest income ........................... $ 205 $ 151 $ 54 35.8%
Foreign currency transaction loss ............. $ (5) $ (99) $ 94 (94.9)%
Income tax provision .......................... $ 236 $ 563 $ (327) (58.1)%
Selling, general, and administrative ("SG&A") expense increased 15.6% to $9.9
million, or 23.7% of total revenue, for the quarter ended September 30, 2006,
from $8.6 million, or 20.8% of total revenue, for the comparable period in 2005.
The increase in SG&A expense can be primarily attributed to: (1) costs related
to the settlement of claims previously reported by the Company that were brought
against it by certain former Company officers ($650,000), (2) the acquisition of
Akela ($281,000), (3) increased technology infrastructure costs ($287,000), (4)
the reversal of a receivable related to a refund of Michigan Single Business Tax
for a prior year refund in which collection is no longer probable ($125,000) and
(5) costs associated with potential acquisitions that the Company is no longer
pursuing ($80,000). These increases were partially offset by cost savings from
the expiration of certain leases and the consolidation of the business into
smaller facilities and other existing facilities ($157,000).
Net interest income increased to $205,000 for the quarter ended September 30,
2006, from $151,000 for the comparable period in 2005, as a result of earning
higher average rates of return on invested cash equivalents and having less
average outstanding long-term debt on which the Company is paying interest
expense.
The consolidated effective tax rate of 38.2% for the quarter ended September 30,
2006 differs from the statutory tax rate in the United States of 34% primarily
due to state income taxes, nondeductible expenses, and an unfavorable change in
the expected utilization of foreign tax loss carryforwards that resulted in an
adjustment to the expected tax rate for the year. The consolidated effective tax
rate of 31.5% for the quarter ended September 30, 2005 differs from the
statutory tax rate of 34% primarily due to the tax benefit from tax rates in
certain foreign countries that are lower than 34% and the tax benefit of certain
permanent deductions.
23
RESULTS OF OPERATIONS
NINE MONTHS ENDED SEPTEMBER 30, 2006 COMPARED TO SEPTEMBER 30, 2005
REVENUE
NINE MONTHS ENDED
SEPTEMBER 30,
------------------- INCREASE %
2006 2005 (DECREASE) CHANGE
-------- -------- ---------- ------
(In thousands, except percentages)
REVENUE
IT outsourcing services ................ $ 60,803 $ 55,631 $ 5,172 9.3%
Government technology services ......... 35,771 43,662 (7,891) (18.1)%
IT consulting and systems integration .. 19,662 19,690 (28) (0.1)%
Technical staffing ..................... 6,401 6,099 302 5.0%
Learning services ...................... 857 555 302 54.4%
-------- -------- -------
TOTAL REVENUE ............................. $123,494 $125,637 $(2,143) (1.7)%
======== ======== =======
As shown in the above table, the overall revenue decline of 1.7% to $123.5
million for the nine months ended September 30, 2006 is attributable to the
conclusion of certain contracts in our Government Technology Services segment
and the wind-down of certain systems implementation and training projects in our
IT Consulting and Systems Integration segment. These decreases were partially
offset by our acquisition of Akela on October 3, 2005, and growth in IT
Outsourcing Services from new customer accounts. Excluding revenue from Akela,
revenue decreased 4.1% to $120.5 million for the nine months ended September 30,
2006, from the comparable period in 2005. Revenue was also negatively affected
by the strengthening of the U.S. dollar relative to the European euro and other
international currencies in which the Company conducts business, which decreased
revenue by approximately $870,000 over the comparable period in 2005.
IT Outsourcing Services
Revenue from our IT Outsourcing Services segment increased 9.3% to $60.8 million
for the nine months ended September 30, 2006, from $55.6 million for the
comparable period in 2005, as a result of a 16.1% increase in revenue in the
United States and a 3.0% increase in revenue in Europe. The revenue growth in
the U.S. is primarily due to new customer contracts. Europe experienced revenue
growth primarily from our shared services offering for our pharmaceutical
clients, which grew by 44.7% from the nine months ended September 30, 2005.
Revenue growth in Europe was offset by a decline in revenue from Ford and the
strengthening of the U.S. dollar relative to the European euro and other
international currencies in which the Company conducts business. The
strengthening of the U.S dollar reduced revenue by approximately $675,000 over
the comparable period in 2005.
Globally, IT Outsourcing Services revenue generated from Ford declined 5.4% to
$26.9 million for the nine months ended September 30, 2006, from $28.4 million
for the comparable period in 2005. Revenue from Ford declined in each country
except the United Kingdom, where we began providing SPOC services to the Jaguar
and Land Rover group on March 17, 2006. Revenue from Ford in other regions
decreased primarily due to a reduction in the number of seats supported as Ford
continues to restructure its operations and reduce its worldwide workforce and
from lower prices charged under the Global SPOC Program contract renewal on
December 1, 2005. Excluding the effect of changes in foreign exchange rates,
revenue from Ford declined approximately 4.5% in 2006 from the nine months ended
September 30, 2005. Please refer to our discussion of Ford in the "Impact of
Business with Major Clients" section of MD&A.
24
Government Technology Services
Revenue from our Government Technology Services segment decreased 18.1% to $35.8
million for the nine months ended September 30, 2006, from $43.7 million for the
comparable period in 2005, primarily due to the conclusion of certain contracts
that provided additional revenue of $6.0 million for the nine months ended
September 30, 2005, as compared to the same period in 2006, and the completion
of other projects at other customers. As noted earlier, we are diligently
working to replace this revenue through our pursuit of new contract vehicles,
while maintaining a keen focus on existing contracts that are scheduled to
expire where the Company will have to recompete for the work. In this respect,
as noted in the Overview to MD&A, we were recently successful in winning several
significant contracts.
IT Consulting and Systems Integration
Revenue from our IT Consulting and Systems Integration segment decreased
slightly to $19.7 million for the nine months ended September 30, 2006, from
$19.7 million for the comparable period in 2005. Excluding revenue from our
acquisition of Akela, revenue from IT Consulting and Systems Integration
decreased 11.4% to $17.5 million for the nine months ended September 30, 2006,
from the comparable period in 2005, due to the previously-mentioned wind-down of
certain systems implementation and training projects in the hospitality industry
that drove significant growth in this segment in 2005. While the decline in
revenue from this project-based work was expected, we were not able to replace
the work prior to the decline in revenue. Yet, we expect to execute a new
contract with a current, major hospitality customer that, depending on the
customer's plans, might represent a substantial new multi-year program.
Geographic Discussion
Total revenue generated in the United States decreased 6.6% to $82.8 million for
the nine months ended September 30, 2006, from $88.7 million for the comparable
period in 2005, primarily due to the aforementioned decline in revenue from our
Government Technology Services and IT Consulting and Systems Integration
segments. These declines were partially offset by revenue from new customer
contracts in our IT Outsourcing Services segment. Excluding revenue from our
government-based subsidiaries, revenue generated in the United States increased
5.3% to $47.1 million for the nine months ended September 30, 2006, from $44.7
million for the comparable quarter in 2005, which consists of the revenue growth
from IT Outsourcing Services partially offset by the decline in revenue from IT
Consulting and Systems Integration.
Revenue generated in Europe increased 10.1% to $40.7 million for the nine months
ended September 30, 2006, from $37.0 million for the comparable period in 2005,
primarily due to our acquisition of Akela and revenue growth in IT Outsourcing
Services from our shared services offering for our pharmaceutical clients.
Excluding revenue from our acquisition of Akela, revenue generated in Europe
increased 1.9% to $37.7 million for the nine months ended September 30, 2006,
from the comparable period in 2005. Revenue was also negatively affected by the
strengthening of the U.S. dollar relative to the European euro and other
international currencies in which the Company conducts business. If revenue in
Europe for the nine months ended September 30, 2006 were translated into U.S.
dollars at the average exchange rate for the comparable period in 2005, reported
revenue would have been increased by approximately $870,000. Since most of the
Company's international operating expenses are also incurred in the same foreign
currencies in which the associated revenue is denominated, the net impact of
exchange rate fluctuations on net income is considerably less than the estimated
impact on revenue and is not significant.
25
GROSS PROFIT
NINE MONTHS ENDED SEPTEMBER 30,
------------------------------------
2006 2005
----------------- -----------------
GROSS GROSS INCREASE %
AMOUNT MARGIN % AMOUNT MARGIN % (DECREASE) CHANGE
------- -------- ------- -------- ---------- ------
(In thousands, except percentages)
GROSS PROFIT
IT outsourcing services .. $15,089 24.8% $13,991 25.1% $ 1,098 7.8%
Asset impairment loss .... 580 -- -- -- 580 --
------- ------- -------
Total IT outsourcing .. 14,509 23.9% 13,991 25.1% 518 3.7%
Government technology
services .............. 10,111 28.3% 12,601 28.9% (2,490) (19.8)%
IT consulting and systems
integration ........... 4,194 21.3% 3,964 20.1% 230 5.8%
Technical staffing ....... 1,058 16.5% 1,349 22.1% (291) (21.6)%
Learning services ........ 262 30.6% 147 26.5% 115 78.2%
------- ------- -------
TOTAL GROSS PROFIT .......... $30,134 24.4% $32,052 25.5% $(1,918) (6.0)%
======= ======= =======
Consistent with revenue, the majority of the overall decline in gross profit is
attributable to the conclusion of certain contracts in our Government Technology
Services segment, the wind-down of certain systems implementation and training
projects in our IT Consulting and Systems Integration segment, and a pre-tax
charge to cost of revenue for the net carrying value of assets of $580,000
related to the Company's decision to discontinue using certain software. These
decreases were partially offset by gross profit growth in IT Outsourcing
Services from new customer accounts and from our acquisition of Akela.
IT Outsourcing Services
Gross profit from our IT Outsourcing Services segment increased 3.7% to $14.5
million for the nine months ended September 30, 2006, from $14.0 million for the
comparable period in 2005. Gross margin decreased to 23.9% for the nine months
ended September 30, 2006, from 25.1% for the comparable period in 2005. For the
nine months ended September 30, 2006, gross profit includes an asset impairment
loss recorded in the first quarter for the net carrying value of assets of
$580,000 related to the Company's decision to discontinue using certain
software. Excluding the asset impairment loss, gross margin decreased to 24.8%
for the nine months ended September 30, 2006, from 25.1% for the comparable
period in 2005. This segment experienced an increase in gross profit and gross
margin related to our shared services offering for our pharmaceutical clients
where we experienced 44.7% revenue growth and were successful in transitioning
the majority of the service delivery for these customers to our Romanian
facility. However, these and other improvements in gross margin have been
largely offset by substandard profitability on two new customer accounts, the
largest of which was launched in three phases over an eight-month period. We
have been diligently pursuing improvement programs for the two new customer
accounts and other accounts that have been performing below expectations. All of
these accounts experienced an improvement in gross profit and gross margin in
the third quarter of 2006 from the second quarter of 2006 that we believe is
sustainable and can be further improved.
Government Technology Services
Gross profit from our Government Technology Services segment decreased 19.8% to
$10.1 million for the nine months ended September 30, 2006, from $12.6 million
for the comparable period in 2005. Gross margin decreased slightly to 28.3% for
the nine months ended September 30, 2006, from 28.9% for the comparable period
in 2005. The decrease in gross profit and gross margin is primarily due to the
conclusion of certain contracts that provided $6.0 million in revenue for the
nine months ended September 30, 2005, and the completion of projects at other
customers. The inclusion of resale items for both periods had the effect of
reducing gross margin by approximately 70-90 basis points for the nine months
ended September 30, 2006 and 2005.
26
IT Consulting and Systems Integration
Gross profit from our IT Consulting and Systems Integration segment increased
5.8% to $4.2 million for the nine months ended September 30, 2006, from $4.0
million for the comparable period in 2005. Gross margin increased to 21.3% for
the nine months ended September 30, 2006, from 20.1% for the comparable period
in 2005. The increase in gross profit and gross margin was primarily due to our
acquisition of Akela. Excluding the gross profit contributed by Akela, gross
profit decreased 16.5% to $3.3 million for the nine months ended September 30,
2006, from the comparable period in 2005, and gross margin decreased to 19.0%
from 20.1%. This increase in gross profit was partially offset by reduced
profitability from the wind-down of certain systems implementation and training
projects in the hospitality industry that drove significant growth in this
segment in 2005, and from a temporary decline in gross profit and gross margin
from our on-going project installing personal computers at Ford subcontracted
through Dell Inc. While some of the decline in gross profit and gross margin
from the wind-down of certain project-based work was expected, we were not able
to replace the work prior to these declines.
OPERATING EXPENSES AND OTHER
NINE MONTHS ENDED
SEPTEMBER 30,
----------------- INCREASE %
2006 2005 (DECREASE) CHANGE
------- ------- ---------- ------
(In thousands, except percentages)
OPERATING EXPENSES AND OTHER
Selling, general, and administrative expense .. $29,547 $25,767 $ 3,780 14.7%
Net interest income ........................... $ 525 $ 314 $ 211 67.2%
Foreign currency transaction loss ............. $ (104) $ (3) $ (101) 3367%
Income tax provision .......................... $ 365 $ 2,098 $(1,733) (82.6)%
Selling, general, and administrative ("SG&A") expense increased 14.7% to $30.0
million, or 23.9% of total revenue, for the nine months ended September 30,
2006, from $25.8 million, or 20.5% of total revenue, for the comparable period
in 2005. The increase in SG&A expense can be primarily attributed to: (1) legal
and professional fees associated with responding to a complaint filed by a
shareholder (Costa Brava) seeking to inspect certain books and records of the
Company, matters relating to the proxy contest initiated by Costa Brava related
to the election of the Company's Board of Directors, and the Settlement
Agreement with respect to these matters ($1.4 million), (2) costs related to the
settlement of claims previously reported by the Company that were brought
against it by certain former Company officers ($650,000), (3) the placement of
the Company's new president and chief executive officer ($110,000), (4) the
acquisition of Akela ($834,000), (5) stock-based compensation expense related to
the Company's adoption of Statement of Financial Accounting Standards ("SFAS")
No. 123R, "Share-Based Payment," primarily attributable to stock options issued
in the first quarter of 2006 ($243,000), (6) an increase in 401(k) expense
related to increased employer matching contributions, more participants in the
plan, and the absence of a benefit from using forfeitures to reduce employer
contributions as we were able to do in 2005 ($328,000), (7) the reversal of a
receivable related to a refund of Michigan Single Business Tax for a prior year
refund in which collection is no longer probable ($125,000) and (8) increased
technology infrastructure costs ($531,000). These increases were partially
offset by a decrease in costs associated with the Company's ongoing compliance
with the Sarbanes-Oxley Act of 2002 ($300,000).
On May 4, 2006, the Company and Costa Brava entered into a settlement agreement
(the "Settlement"). Under the terms of the Settlement, Costa Brava withdrew its
proposal to nominate its own slate of directors for the Company and dismissed
the complaint with prejudice upon the election of directors at the Company's
Annual Shareholders' Meeting on June 14, 2006. Further, under the Settlement,
the Company agreed to reimburse Costa Brava for its documented expenses incurred
in connection with Costa Brava's efforts to replace the Company's current Board
and its efforts to obtain certain books and records of the Company. The Company
recorded a charge of $611,000 for the estimated amount of expense reimbursement
in nine months ended September 30, 2006, which is included in the $1.4 million
of legal and professional fees noted in the preceding paragraph.
27
Net interest income increased to $525,000 for the nine months ended September
30, 2006, from $314,000 for the comparable period in 2005, as a result of
earning higher average rates of return on invested cash equivalents and having
less average outstanding long-term debt on which the Company is paying interest
expense.
The consolidated effective tax rate of 36.2% for the nine months ended September
30, 2006 differs from the statutory tax rate in the United States of 34%
primarily due to state income taxes and nondeductible expenses. The consolidated
effective tax rate of 31.8% for the nine months ended September 30, 2005 differs
from the statutory tax rate of 34% primarily due to the tax benefit of tax rates
in certain foreign countries that are lower than 34% and the tax benefit of
certain permanent deductions.
IMPACT OF BUSINESS WITH MAJOR CLIENTS
We conduct business under multiple contracts with various entities within the
Ford organization and with various agencies and departments of the United States
Government. For the quarter ended September 30, 2006 and 2005, Ford accounted
for 26.0% and 26.4%, respectively, of the Company's total revenue, and the
United States Government accounted for 25.9% and 29.5%, respectively, of the
Company's total revenue. For the nine months ended September 30, 2006 and 2005,
Ford accounted for 26.7% and 27.4%, respectively, of the Company's total
revenue, and the United States Government accounted for 25.5% and 29.7%,
respectively, of the Company's total revenue. No single agency or department of
the United States Government comprised 10% or greater of the Company's total
revenue for any period presented.
Ford Motor Company
Our business with Ford consists of help desk and desk side services, distributed
server support, technical staffing, network management, and a specific project
installing personal computers subcontracted through Dell Inc. Revenue generated
through our business with Ford decreased to $33.0 million for the nine months
ended September 30, 2006, from $34.7 million for the comparable period in 2005.
As a result of financial pressures, Ford has announced that its turnaround plan
(the "Way forward Plan") will result in the reduction of its North American
salaried-related work force by about a third, the equivalent of about 14,000
positions, 4,000 of which occurred earlier in 2006. Our largest contract with
Ford is priced on a per-seat basis. As work force reductions take effect, we
anticipate that we will see a revenue decrease of less than 5% of our annual
revenue from Ford from either the bi-annual dates for seat count adjustment
(December 1 and June 1) or from Ford exercising its contractual right to request
an out-of-cycle seat count adjustment. We expect that the most significant work
force adjustment will take place in the first quarter of 2007. Although it is
increasingly difficult to do so in light of the significant changes already made
to the program, we are working diligently to reduce expenses commensurately with
the reduction in revenue to maintain the profitability on this business. Despite
these trends, we are actively pursuing opportunities within Ford to expand our
SPOC program into new geographic regions over the next twelve months, which we
believe may eventually offset the reduction in revenue caused by the Way Forward
Plan.
Due to Ford's financial condition, Ford continues to seek concessions, whether
in price reductions and/or a change to the service delivery model, in order to
reduce the cost of the services that we perform on their behalf both inside and
outside of the Global SPOC Program. We do not believe that Ford's financial
condition will otherwise affect our business with Ford or the collectibility of
our accounts receivable from Ford. However, any failure to retain a significant
amount of business with Ford, or bankruptcy filing by Ford, would likely have a
material adverse effect on the Company's operating results and liquidity.
United States Government
The U.S. Government's fiscal year ends on September 30 of each year. It is not
uncommon for government agencies to award extra tasks or complete other contract
actions in the weeks before the end of the fiscal year in order to avoid the
loss of unexpended fiscal year funds. Moreover, in years when the U.S.
Government does not complete its budget process before the end of its fiscal
year, government operations typically are funded pursuant to a "continuing
resolution" that authorizes agencies of the government to continue to operate,
but traditionally does not authorize new spending initiatives. When the
government operates pursuant to a continuing resolution, delays can occur in
procurement of products and services, and such delays can affect the Company's
revenue,
28
profit, and cash flow during the period of delay.
The Company's recent contract award from the National Institutes of Health
("NIH"), Office of Information Technology, contains an expansion of services and
positions beyond current levels. At present, the U.S. Congress has not
appropriated the budget for NIH and, therefore, we are not able to commence work
on the expanded services and positions until such budget is appropriated by
Congress and signed by the President. As a result, we anticipate a delay before
the Company is able to generate revenue under the expanded portion of this
contract but will be able to perform at government fiscal year 2006 funding
levels under the congressionally approved continuing resolution.
LIQUIDITY AND CAPITAL RESOURCES
Cash and cash equivalents were $26.4 million at September 30, 2006, as compared
to $34.8 million at December 31, 2005. During the nine months ended September
30, 2006, cash and cash equivalents decreased $8.4 million primarily due to $1.9
million in net cash used in operating activities, $3.2 million in cash used for
capital expenditures, $5.8 million in long-term debt repayments, and $494,000 in
cash paid for past acquisitions. The uses of cash were partially offset by $2.2
million in cash proceeds from the exercise of stock options. The negative cash
flow from operating activities of $1.9 million for the nine months ended
September 30, 2006 was primarily due to a significant decrease in current
liabilities of $6.9 million, which was partially offset by income prior to
non-cash charges for depreciation and amortization and stock-based compensation.
Although year-to-date cash flow from operating activities is negative, cash flow
from operations was positive in the second and third quarters of 2006. We expect
our cash flow from operations to improve in the fourth quarter and subsequent
quarters as collection challenges with certain customers are resolved and our
profitability improves.
Under various task order contracts with the United States Department of Homeland
Security ("DHS"), we serve as the prime contractor and Electronic Data Systems
Corporation ("EDS") serves as the subcontractor. EDS performs in excess of 95%
of the work under the contract and creates the invoices, which the Company
forwards to the DHS. Under the subcontract agreement with EDS, we do not pay
EDS' invoices until Sytel, a subsidiary within our Government Technology
Services business segment, receives payment from the DHS. Furthermore, we record
revenue under this contract on a net basis whereby we only record revenue for
the portion of the work that Sytel performs under the contract along with an
administrative fee related to revenue earned by EDS. As a result, our accounts
receivable include the gross amount billed to DHS by Sytel, including EDS'
invoice, and our accounts payable include the amounts billed by EDS, but our
recorded revenue does not include the amounts billed to Sytel by EDS. This has
negatively affected our calculation of days sales outstanding.
Long-term cash requirements, other than for normal operating expenses, are
anticipated for continued expansion in Europe, enhancements of existing
technologies, additional consideration that is payable to the selling
shareholders Akela and TechTeam A.N.E. NV/SA if specific performance conditions
and operating targets are met, possible global expansion activities, the
possible payment of Company dividends, possible repurchases of our common stock,
and the possible acquisition of businesses complementary to the Company's
existing businesses. We believe that positive cash flows from operations,
together with existing cash balances, will continue to be sufficient to meet our
ongoing requirements for the next twelve months and foreseeable future. We have
historically not paid dividends.
NEW ACCOUNTING PRONOUNCEMENTS
Effective January 1, 2006, the Company adopted the provisions of SFAS 123R,
"Share-Based Payment," which requires companies to measure and recognize
compensation expense for all share-based payment awards to employees and
directors based on estimated fair values of all awards. SFAS 123R supersedes the
Company's previous accounting methodology using the intrinsic value method under
Accounting Principles Board Opinion No. 25 ("APB 25"), "Accounting for Stock
Issued to Employees," and related interpretations. Under the intrinsic value
method, no share-based compensation expense had been recognized in the Company's
consolidated statements of operations for stock option awards with an exercise
price equal to the fair value of the underlying stock on the date of grant.
29
The Company adopted SFAS 123R using the modified prospective transition method.
Under this transition method, stock-based compensation expense recognized after
the effective date includes: (1) compensation expense for all share-based awards
granted prior to, but not yet vested, as of December 31, 2005, based on the
grant-date fair value estimated in accordance with the original provisions of
SFAS 123, and (2) compensation cost for all share-based awards granted
subsequent to January 1, 2006, based on the grant-date fair value estimated in
accordance with the provisions of SFAS 123R. In accordance with the modified
prospective transition method, the Company's consolidated financial statements
from prior periods have not been restated and do not include the impact of SFAS
123R.
The company recorded pre-tax and after-tax amounts of $40,000 and $26,000,
respectively, for share-based compensation expense during the three months ended
September 30, 2006, as a result of adopting SFAS 123R. The Company recorded
pre-tax and after-tax amounts of $243,000 and $160,000, respectively, for
share-based compensation expense during the nine months ended September 30,
2006, as a result of adopting SFAS 123R.
In July 2006, the FASB issued FASB Interpretation No. 48, "Accounting for
Uncertainty in Income Taxes" ("FIN 48"). FIN 48 prescribes a recognition
threshold and measurement attribute for the financial statement recognition and
measurement of a tax position taken in a tax return. FIN 48 also provides
guidance regarding subsequent reversal of a tax position, balance sheet
classification, accounting in interim periods, disclosure, and transition. FIN
48 is effective for fiscal years beginning after December 15, 2006. The Company
has not completed its analysis of the potential impact of FIN 48 on the
Company's financial position or results of operations.
MATERIAL COMMITMENTS
There have been no significant changes in our material commitments disclosed in
"Item 7 -- Management's Discussion and Analysis of Financial Condition and
Results of Operations" of our Annual Report on Form 10-K for the year ended
December 31, 2005.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
There have been no changes in the selection and application of critical
accounting policies and estimates disclosed in "Item 7 -- Management's
Discussion and Analysis of Financial Condition and Results of Operations" of our
Annual Report on Form 10-K for the year ended December 31, 2005, except for the
addition of the following item:
STOCK-BASED COMPENSATION:
The Company records compensation expense for employee stock options based on the
estimated fair value of the options on the date of grant using the Black-Scholes
option-pricing model. The Company uses historical data among other factors to
estimate the expected price volatility, the expected option term, and the
expected forfeiture rate. The risk-free rate is based on the U.S. Treasury yield
curve in effect at the date of grant for the expected term of the option.
The following assumptions were used to estimate the fair value of options
granted during the nine months ended September 30, 2006 and 2005:
NINE MONTHS ENDED SEPTEMBER 30,
-------------------------------
2006 2005
---------- ----------
Expected dividend yield ............ 0.0% 0.0%
Weighted average volatility ........ 42% 42%
Risk free interest rate ............ 4.4% - 4.7% 3.3% - 4.0%
Expected term (in years) ........... 3.0 3.1
30
The Black-Scholes option valuation model was developed for use in estimating the
fair value of traded options, which have no vesting restrictions and are fully
transferable. In addition, option valuation models require the input of highly
subjective assumptions, including the expected stock price volatility. Because
our employee stock options have characteristics significantly different from
those of traded options, and because changes in the assumptions can materially
affect the fair value estimate, in management's opinion, the existing models do
not necessarily provide a reliable single measure of the fair value of the
Company's employee stock-based compensation.
ITEM 3 -- QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
There have been no material changes in reported market risks disclosed in "Item
7A -- Quantitative and Qualitative Disclosures About Market Risk" of our Annual
Report on Form 10-K for the year ended December 31, 2005.
ITEM 4 -- CONTROLS AND PROCEDURES
EVALUATION OF DISCLOSURE CONTROLS AND PROCEDURES
As of September 30, 2006, our management, with the participation of our chief
executive officer and chief financial officer, evaluated the effectiveness of
the design and operation of our disclosure controls and procedures (as defined
in Rules 13a-15(e) and 15d-15(e) under the Exchange Act). Based on this
evaluation, our chief executive officer and chief financial officer concluded
that, as of September 30, 2006, our disclosure controls and procedures were (1)
designed to ensure that material information relating to us, including our
consolidated subsidiaries, is made known to our chief executive officer and
chief financial officer by others within those entities, particularly during the
period in which this report was being prepared and (2) effective, in that they
provide reasonable assurance that information required to be disclosed by us in
the reports that we file or submit under the Exchange Act is recorded,
processed, summarized and reported within the time periods specified in the U.S.
Securities and Exchange Commission's rules and forms.
It should be noted that any system of controls, however well designed and
operated, can provide only reasonable, and not absolute, assurance that the
objectives of the system will be met. In addition, the design of any control
system is based in part upon certain assumptions about the likelihood of certain
events. Because of these and other inherent limitations of control systems,
there is only reasonable assurance that our controls will succeed in achieving
their goals under all potential future conditions.
CHANGES IN INTERNAL CONTROL OVER FINANCIAL REPORTING
No changes in our internal control over financial reporting (as defined in Rules
13a-15(f) and 15d-15(f) under the Exchange Act) occurred during the quarter
ended September 30, 2006, that has materially affected, or is reasonably likely
to materially affect, our internal control over financial reporting.
31
PART II -- OTHER INFORMATION
ITEM 1 -- LEGAL PROCEEDINGS
On November 1, 2006, the Company agreed, in principle, to resolve claims
previously reported by the Company that were brought against it by William F.
Coyro, Jr., its former President and Chief Executive Officer, and David W.
Morgan, its former Vice President of Finance and Business Development, Chief
Financial Officer and Treasurer. The Company expects to have these settlements,
with full release of any existing liability of the Company, finalized in
November 2006. The settlement agreement with Mr. Morgan is dependent upon the
dismissal with prejudice of the complaint Mr. Morgan filed with the U.S.
Department of Labor Occupational Safety and Health Agency asserting that he
resigned from employment with the Company due to actions taken against him as a
result of certain activities protected under Section 806 of the Corporate and
Criminal Fraud Accountability Act of 2002, Title VIII of the Sarbanes-Oxley Act
of 2002, 18 U.S.C. Section 1514A. During the three months ended September 30,
2006, the Company recorded pre-tax expense of $650,000 necessary for the Company
to conclude these settlements.
In addition to the above matters, from time to time the Company is involved in
various litigation matters arising in the ordinary course of its business. None
of these matters, individually or in the aggregate, currently is material to the
Company.
ITEM 1A -- RISK FACTORS
There have been no changes in the risk factors disclosed in "Item 1A -- Risk
Factors" of our Annual Report on Form 10-K for the year ended December 31, 2005,
except that the following risk factor described as "We may become engaged in a
proxy contest relating to the election of our Board of Directors, which contest
could adversely affect our business," as disclosed in our Annual Report on Form
10-K, is no longer applicable as a result of the Company executing a settlement
agreement with a shareholder.
ITEM 2 -- UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
There were no sales of unregistered equity securities of the Company during the
three months ended September 30, 2006.
The following table sets forth the information with respect to purchases made by
the Company of shares of its common stock during the third quarter of 2006:
TOTAL NUMBER OF MAXIMUM NUMBER OF
TOTAL NUMBER AVERAGE SHARES PURCHASED AS SHARES THAT MAY YET
OF SHARES PRICE PAID PART OF PUBLICLY BE PURCHASED UNDER
PERIOD PURCHASED PER SHARE ANNOUNCED PROGRAMS THE PROGRAMS
------ ------------ ---------- -------------------- -------------------
July 1, 2006 to July 31, 2006 7,120 (a) $8.73 -- --
August 1, 2006 to August 31, 2006 7,757 (a) $7.99 -- --
September 1, 2006 to September 30, 2006 12,102 (a) $7.92 -- --
(a) All purchases of shares were made for the purpose of contributing the
purchased shares to the TechTeam Global Retirement Savings Plan (one of the
Company's 401(k) plans) for employer matching contributions. The purchases
were not made pursuant to publicly announced plans and were made in the
open market.
32
ITEM 6 -- EXHIBITS
The following exhibits are filed as part of this report on Form 10-Q:
10.29 Seventh Amendment to Lease Agreement, dated August 24, 2006, for office
space in Southfield, Michigan between Eleven Inkster, L.L.C. and the
Company.
31.1 Certification Pursuant to Rule 13a-14(a) of the Securities Exchange Act of
1934, as Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of
2002.
31.2 Certification Pursuant to Rule 13a-14(a) of the Securities Exchange Act of
1934, as Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of
2002.
32.1 Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002.
32.2 Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002.
33
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.
TechTeam Global, Inc.
(Registrant)
Date: November 9, 2006 By: /s/ William C. Brown
------------------------------------
William C. Brown
President and Chief Executive Officer
(Principal Executive Officer)
By: /s/ Marc J. Lichtman
------------------------------------
Marc J. Lichtman
Vice President, Chief Financial
Officer, and Treasurer (Principal
Financial Officer)
34
Exhibit Index
Exhibit No. Description
----------- -----------
10.29 Seventh Amendment to Lease Agreement, dated August 24, 2006, for
office space in Southfield, Michigan between Eleven Inkster,
L.L.C. and the Company.
31.1 Certification Pursuant to Rule 13a-14(a) of the Securities
Exchange Act of 1934, as Adopted Pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002.
31.2 Certification Pursuant to Rule 13a-14(a) of the Securities
Exchange Act of 1934, as Adopted Pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002.
32.1 Certification Pursuant to 18 U.S.C. Section 1350, as Adopted
Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
32.2 Certification Pursuant to 18 U.S.C. Section 1350, as Adopted
Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.