ITEM 1 -- BUSINESS
GENERAL
The Metzler Group, Inc. is a leading nationwide provider of consulting services to electric utilities and other energy-related businesses. The Company offers a wide range of consulting services related to information technology, process/operations management, business strategy development, and marketing and sales designed to assist its clients in succeeding in a business environment of changing regulation, increasing competition and evolving technology. The Company has competed successfully in this environment, having achieved revenue growth of 29% from 1994 to 1995 and over 60% in 1996.
The electric utility industry is one of the largest industries in the United States. According to the Edison Electric Institute, in 1995 the total assets of investor-owned utilities (which account for the vast majority of the industry's generating capacity and revenues) exceeded $575 billion and electric utility industry revenues from sales to end users totaled approximately $207 billion.
The demand for consulting services in the U.S. electric utility industry is driven in significant part by the revolutionary change facing the industry as it begins to convert from a regulated monopoly structure to an increasingly competitive environment. Historically, due to the significant fixed costs inherent in generating and transmitting electricity, electric utilities were viewed as natural local monopolies, operating as an integrated entity to generate, transmit and distribute retail electricity within designated geographic service areas without competition from other suppliers.
However, as a result of recent market, regulatory and legislative factors, competition in the electric utility industry is being encouraged at both the state and federal regulatory levels, but the transformation to a competitive market for electricity is proceeding unevenly. Although deregulation of the transportation and telecommunications industries was accomplished relatively rapidly, deregulation of the electric utility industry has been more difficult due to the complex and overlapping web of over 200 federal and state regulatory bodies and the presence of a large number of separate, regulated companies. Accordingly, implementation will likely unfold on a state-by-state basis into the next century and may well face challenges from utilities and state and local governments.
The changing competitive environment in the electric utility industry has forced utility companies to confront an evolving range of strategic options and challenges. In order to deal with these challenges and address these opportunities, electric utilities are formulating and implementing new strategies and tactics, including redesigning business processes, re-engineering work forces, acquiring more effective information technology and adopting or restructuring customer service and marketing programs. Utilities are increasingly turning to experienced outside consulting firms to assist in or lead this process because: (i) the pace of change is eclipsing utilities' internal resources; (ii) many utilities lack the depth and breadth of experience to identify, evaluate and implement the full range of possible options and solutions; (iii) outside specialists often enable electric utilities to develop better solutions in shorter time frames; (iv) purchasing consulting expertise converts fixed labor costs to variable costs and can be more cost-effective; and (v) consultants can often formulate more objective advice, free of internal cultural or political forces.
Metzler believes that several competitive factors distinguish it from other participants in the consulting market including: (i) established electric utility expertise developed over more than thirteen years of providing consulting services to the electric utility industry; (ii) deep-rooted client relationships supporting multiple engagements; (iii) proprietary knowledge base that the Company has developed internally and continuously refines for incorporation into analysis for new engagements; (iv) wide range of industry-specific services that enables the Company to be a single-source provider of consulting services to utilities while maintaining advanced skill sets in each area; and (v) strategic planning methodology using a high-level modeling tool developed by Metzler to support the comprehensive strategic planning process of utilities.
Metzler's growth strategy includes the following elements: (i) further penetrating its existing client base; (ii) seeking new clients and expanding its geographic presence; (iii) continuing to recruit highly skilled
professionals with skill sets and client relationships complementary to the Company's existing professional base; (iv) pursuing strategic acquisitions that provide the Company with an expeditious and cost-effective method of increasing its number of consultants, broadening its client base, expanding its skill sets or expanding its presence in a geographic region; and (v) expanding its service offerings to include other service areas that the Company believes will be in demand as the industry continues its move toward a more competitive environment.
SERVICES
The Company offers its consulting services in four principal areas: information technology, process/operations management, strategy, and marketing and sales. In order to understand the basic characteristics of a client, organizational unit or project, the Company generally performs more than 75% of the engagement at the client's site. This on-site presence helps avoid the development of conclusions drawn from limited exposure to company personnel, processes and facilities and enables Metzler consultants to be available to service further or expanded client needs as they may evolve. Although extensive time is spent on site, all Metzler consultants have portable computers running common software for word processing and tabular and graphic presentations, thereby allowing the project team to remain relatively independent of and non-intrusive into the client's daily business operations.
The table below provides examples of the Company's service offerings in each of these areas.
MARKETING AND SALES
The Company markets its services directly to senior executives of utilities from its headquarters near Chicago, Illinois. The Company employs a variety of business development and marketing techniques to communicate directly with current and prospective clients, including on-site presentations to senior utility executives, industry seminars featuring presentations by Metzler personnel and authoring of articles and other publications regarding the utility industry and the Company's methodologies.
A significant portion of new business arises from prior client engagements. Clients frequently expand the scope of engagements during delivery to include follow-on complementary activities. Also, the Company's on-site presence affords it the opportunity to become aware of, and to help define, additional project opportunities as they are identified by the client. The strong client relationships arising out of many engagements often facilitate the Company's ability to market additional capabilities to its clients in the future. In addition, the Metzler senior management teamis actively engaged in meeting with utilities that have not yet engaged the Company and newly appointed senior managers in utilities where the Company has worked in the past to make them aware of the Company's capabilities.
CLIENTS AND REPRESENTATIVE SERVICES
The Company has performed consulting assignments for more than 120 utility industry clients, principally investor-owned electric utilities. The Company's clients also include gas and water companies and other ownership structures such as holding companies, electric cooperatives, public power agencies and state regulatory commissions. The Company also serves independent power producers, co-generators and power marketers and suppliers to the utility industry.
Because of the nature and scope of many of the Company's projects, the Company derives a significant portion of its revenues from a relatively limited number of clients that operate exclusively in the electric utility
industry. For example, during 1996, revenues from the Company's ten most significant clients accounted for approximately 80.1% of its revenues. In 1996, a group of affiliated clients and the Company's then largest single client accounted for approximately 20.5% and 15.5% of the Company's revenues, respectively. The Company's largest clients typically engage the Company on consulting projects that span from twelve to eighteen months and thereafter the Company may not be rehired for a significant project for varying periods of time. This typical engagement cycle causes the Company's ten most significant clients, absent project carryovers, to change from year to year. For these reasons, the Company believes that it is not materially dependent on any particular client.
HUMAN RESOURCES
As of March 14, 1997, the Company's personnel consisted of 67 employees. The Company's success depends in large part on attracting, retaining and motivating talented, creative and experienced professionals at all levels. In connection with its hiring efforts, the Company employs a full-time human resources director, retains executive search firms and relies on personal and business contacts to recruit professionals with significant utility industry or consulting experience. The Company's hiring focus is not on finding a large number of employees, but rather on identifying candidates who are well suited by background and temperament to serve the Company's utility client base. The Company's consultants are drawn from utility and related industries such as engineering, construction and telecommunications, and from accounting and other consulting organizations. The Company's fifteen senior most managers each average a total of fifteen years of utility industry and consulting experience. The Company has experienced consultant attrition of approximately 15% over each of the last two years, predominately at the associate level.
The Company has developed mentoring programs to assist in training its employees, and intends to further enhance its focus on employee training in the future. The Company also develops its consultants through a training program, as well as review of precedent from prior Company engagements.
The Company promotes loyalty and continuity of its consultants by offering packages of base and incentive compensation and benefits that it believes are significantly more attractive than those offered by the consulting industry in general. In addition, to attract and retain consultants, the Company has established several employee benefit plans.
In addition to the employees discussed above, Metzler supplements its consultants on certain engagements with independent contractors, many of whom are former employees of the Company. The Company is responsible for selecting these individuals and integrating their work product into a total solution for the Company's utility client. The Company believes that its practice of retaining independent contractors on a per-engagement basis provides it with greater flexibility in adjusting professional personnel levels in response to changes in demand for its services.
COMPETITION
The market for consulting services to electric utilities is intensely competitive, highly fragmented and subject to rapid change. The market includes a large number of participants from a variety of market segments, including general management consulting firms, the consulting practices of "Big Six" accounting firms, and local or regional firms specializing in utility services. Many information technology consulting firms also maintain significant practice groups devoted to the utility industry. Many of these companies are national and international in scope and have greater financial, technical and marketing resources than the Company. The Company believes that its experience, reputation, industry focus and broad range of services will enable it to compete effectively in its marketplace.
ITEM 2
ITEM 2 -- PROPERTIES
Metzler currently operates from 10,000 square feet of leased office space located in Deerfield, Illinois. The Company believes that additional space will be required as its business expands geographically and that it will be able to obtain suitable space as needed.
ITEM 3
ITEM 3 -- LEGAL PROCEEDINGS
The Company is not a party to any litigation and is not aware of any pending or threatened litigation that would have a material adverse effect on the Company or its business.
ITEM 4
ITEM 4 -- SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
During the fourth quarter of 1996 and prior to the effective date of its initial public offering, the Company submitted the approval of a Long Term Incentive Plan (the "Plan") and the granting of options pursuant to the Plan to its stockholders in anticipation of the offering. On October 2, 1996, holders of 100% of the issued and outstanding shares of Common Stock of the Company approved the Plan and the options granted thereunder by unanimous written consent.
PART II
ITEM 5
ITEM 5 -- MARKET FOR THE REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER MATTERS
The Company's Common Stock is traded on the Nasdaq National Market under the symbol "METZ". The following table shows the range of reported high and low bid quotations for the Company's Common Stock, for the fiscal periods indicated, as reported on the Nasdaq National Market.
The Company had 10 holders of record of its Common Stock at March 14, 1997 and approximately 1,400 beneficial owners. The Company has never paid a cash dividend on its Common Stock and does not expect to pay a cash dividend on its Common Stock in the foreseeable future.
ITEM 6
ITEM 6 -- SELECTED FINANCIAL DATA
The selected financial data set forth below should be read in conjunction with the Company's Financial Statements and related Notes thereto and with "Item 7.
ITEM 7 -- MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Statements included in Management's Discussion and Analysis of Financial Condition and Results of Operations which are not historical in nature, are intended to be, and are hereby identified as, "forward looking statements" for purposes of the safe harbor provided by Section 21E of the Securities Exchange Act of 1934, as amended by Public Law 104-67. Forward-looking statements may be identified by words including "anticipate," "believe," "intends," "estimates," "expect" and similar expressions. The Company cautions readers that forward-looking statements, including without limitation, those relating to the Company's future business prospects, revenues, working capital, liquidity, and income, are subject to certain risks and uncertainties that could cause actual results to differ materially from those indicated in the forward looking statements, due to several important factors herein identified, among others, and other risks and factors identified from time to time in the Company's reports filed with the SEC.
OVERVIEW
The Metzler Group, Inc. is a leading nationwide provider of consulting services to electric utilities and other energy-related businesses. The Company offers a wide range of consulting services related to information technology, process/operations management, strategy, and marketing and sales designed to assist its clients in succeeding in a business environment of changing regulation, increasing competition and evolving technology.
The Company derives substantially all of its revenues from fees for professional services, which are billed at standard daily rates or provided on a fixed-bid basis. Over the last three years, the substantial majority of the Company's revenues has been generated under standard daily rates billed on a time and expenses basis. Clients are typically invoiced on a monthly basis with revenue recognized as the services are provided. Fixed-bid revenue is recognized by the percentage of completion method based on the ratio of costs incurred to total estimated project costs. Although fixed-bid projects subject the Company to the risk of cost overruns, the Company has not incurred a loss on a fixed-bid contract during the last three years.
The Company's most significant expenses are project personnel costs, which consist of consultant salaries and benefits, and travel-related direct project expenses. Project personnel are typically full-time professionals employed by the Company, although the Company supplements its project professional personnel through the use of independent contractors. The Company retains contractors for specific client engagements on a task-specific, per diem basis during the period their expertise or skills are required. The Company believes that retaining contractors on a per-engagement basis provides it with greater flexibility in adjusting professional personnel levels in response to changes in demand for its services.
RESULTS OF OPERATIONS
The following table sets forth, for the periods indicated, selected statements of operations data as a percentage of revenues:
1996 COMPARED TO 1995
Revenues. Revenues increased 64% to $22.1 million in 1996 from $13.5 million in 1995. This increase was caused by increased demand for management consulting services in the electric utility industry and a change in the Company's management compensation structure that places more emphasis on the generation of new client engagements. These factors generated increases in both the number of client projects and the average size of client projects.
Gross Profit. Gross profit consists of revenues less cost of services, which includes consultant salaries, benefits and travel-related direct project expenses. Gross profit increased 56% to $11.0 million in 1996 from $7.0 million in 1995. Gross profit as a percentage of revenues was 50% in 1996 compared to 52% in 1995. The year over year decrease in the gross profit percentage was due to lower utilization rates for full time professional personnel and a higher proportion of subcontracted labor in 1996. Utilization rates in 1995 exceeded the Company's expected standard levels and were reduced to levels that the Company considers to be sustainable.
Selling, General and Administrative Expenses. Selling, general and administrative expenses include salaries and benefits of management and support personnel, facilities costs, training, direct selling, outside professional fees and all other corporate costs. Selling, general and administrative expenses decreased 51% to $3.7 million in 1996 from $7.6 million in the prior year. As a percentage of revenues, selling, general and administrative expenses decreased to 17% in 1996 from 57% in 1995. The decrease is attributable primarily to the change in the taxable status of the Company from a C-corporation to an S-corporation commencing January 1, 1996, with the Company's profits being distributed to its principal executives. In conjunction with the change in taxable status, the Company eliminated all other incentive compensation programs for these key executives. Effective July 1, 1996, in contemplation of the termination of the Company's S-corporation status in connection with the closing of the Company's initial public offering of common stock, the Company adopted a new executive compensation plan. The pro forma adjustments for 1996 and 1995 reflect the impact of this compensation plan. The pro forma adjustment for 1996 includes an increase in officer compensation of $1.0 million while the pro forma adjustment for 1995 incorporates a decrease in officer compensation of $2.8 million. After giving effect to these pro forma adjustments, selling, general and administrative expenses would represent $4.8 million, or 22% of revenues, in 1996 and $4.9 million, or 36% of revenues, in 1995. Although selling, general and administrative expenses generally increase as the Company's revenues increase, the Company believes it can continue to leverage its existing overhead structure to lower selling, general and administrative expenses as a percentage of revenue in the future.
Operating Income (Loss). Operating income for 1996 was $7.2 million, as opposed to an operating loss for 1995 of $0.6 million. The improvement is attributable to the increased revenues and the decrease in selling, general and administrative expenses resulting from the change in compensation for the Company's key executives, as described above.
Income Taxes. Effective January 1, 1996, the stockholders of the Company elected to be taxed under Subchapter S of the Internal Revenue Code. As an S-corporation, the net income of the Company from January 1, 1996 was taxable for federal (and some state) income tax purposes directly to the Company's stockholders. The Company's S-corporation status was terminated October 4, 1996 upon the completion of the Company's initial public offering of its common stock. Accordingly, the consolidated statement of operations for 1996 does not include a provision for federal or certain state income taxes for the period January 1, 1996 through October 3, 1996.
1995 COMPARED TO 1994
Revenues. Revenues increased 29% to $13.5 million in 1995 from $10.4 million in 1994. The increase in revenues was attributable to a 10% increase in the Company's standard daily rates, an increase in the number of client projects and an increase in the average size of client projects. The rate increase was applicable to new client engagements that commenced after the third quarter of 1994, but the full effect was not evident until 1995 because of the high level of work in process for the fourth quarter of 1994.
Gross Profit. Gross profit increased 36% to $7.0 million in 1995 from $5.2 million in 1994. Gross profit as a percentage of revenues increased to 52% in 1995 from 49% in 1994. This increase is attributable to higher utilization rates for professional personnel, higher standard daily rates and reduced reliance on independent subcontractors in 1995.
Selling, General and Administrative Expenses. Selling, general and administrative expenses increased 44% to $7.7 million in 1995 from $5.3 million in 1994. This increase is attributable to higher 1995 compensation for the Company's principal executive officers. The Company's 1995 executive incentive plan provided for compensation payments that were largely commensurate with increased gross profits generated from incremental revenues. Selling, general and administrative expenses, as a percentage of revenues, increased to 57% in 1995 from 51% in 1994. Excluding the incentive compensation expense for key executives, the remaining selling, general and administrative expenses were 11% and 13% of revenues in 1995 and 1994, respectively.
Operating Income (Loss). The operating loss increased to $0.6 million in 1995 from $0.2 million in 1994. The higher operating loss in 1995 was driven by increased compensation for the Company's principal executive officers, mitigated to some degree by improved gross margins.
LIQUIDITY AND CAPITAL RESOURCES
The Company's primary source of liquidity has been cash flow from operations, periodically supplemented by borrowings under a bank line of credit and by loans from stockholders. Cash flow from operations amounted to $5,140,000, $112,000 and $254,000 for 1996, 1995 and 1994, respectively. The increase in cash flows from operations for 1996 is largely commensurate with the increase in revenues and the decrease in selling, general and administrative expenses for the period, as described above. Operating cash flows for 1995 and 1994 reflect the operating income and net income levels during those years and the effects of changes in two key elements of working capital: accounts receivable and accrued compensation and related costs. Accounts receivable decreased in 1994 as improvements in year-end collections reduced the days revenue outstanding at year end. At year end 1995, accounts receivable increased as a result of higher revenues and billings, partially offset by improvements in collections which further reduced the days revenue outstanding. The Company has a substantial level of accrued compensation at each year end because salaries are paid monthly, in arrears, and because annual incentives and bonuses earned and accrued during the calendar year are typically paid in the first quarter of the subsequent year. Incentives and bonuses are based on individual as well as overall business performance and represent a significant proportion of total compensation for both project personnel and executive management. In 1994, accrued compensation decreased with the reduction in
full time equivalent consultants. Accrued compensation for 1995 increased in line with the growth in professional personnel and higher utilization rates.
Investing activities have not required significant cash flows historically.
Cash flow provided by financing activities was $27.6 million for 1996. On October 4, 1996 the Company completed an initial offering of 2,585,000 shares of its common stock which resulted in proceeds of approximately $37 million after deducting underwriting discounts and commissions and other offering expenses. Concurrent with this offering and pursuant to an agreement negotiated in July 1996, the Company redeemed 1,714,285 shares of common stock held by its founding shareholder in exchange for a promissory note in the amount of $7,975,000. The promissory note was repaid within 30 days after the effective date of the offering. In January 1996, the Company issued notes payable to two shareholders in the aggregate amount of $1.0 million. The notes, each with a principal amount of $0.5 million, bear interest at a rate of 10%. The proceeds from these notes were used to repay $406,000 in debt outstanding under a line of credit and to provide working capital for operations during the interim periods prior to the stock offering. During the period from January 1, 1996 to October 4, 1996 the Company was taxed as an S-corporation. As an S-corporation, all the Company's net income from that period will be distributed to its key executives and included in their personal taxable income. During 1996, the Company distributed $2.2 million of S-corporation earnings. Undistributed S-corporation earnings amount to $3.5 million as of December 31, 1996.
The Company believes the net proceeds from the initial offering of its common stock, together with funds generated by operations, will provide adequate cash to fund its anticipated cash needs, which may include future acquisitions of complementary businesses, at least through the next eighteen months. Thereafter, the Company anticipates that its cash requirements related to future operations and potential acquisitions will be funded with cash generated from operations and short-term borrowings. The Company currently has no agreements, understandings or commitments regarding future acquisitions. Pending such uses, the net proceeds are invested in short-term, interest-bearing investment grade securities. The Company currently anticipates that it will retain all of its earnings for development of the Company's business and does not anticipate paying any cash dividends in the foreseeable future.
ITEM 8
ITEM 8 -- CONSOLIDATED FINANCIAL STATEMENTS AND SUPPLEMENTAL DATA
The Consolidated Financial Statements of the Company are annexed to the report as pages through. An index to such materials appears on page.
ITEM 9
ITEM 9 -- CHANGES IN AND DISAGREEMENT WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCUSSIONS
Not applicable
PART III
The information required by this Part III will be provided in the definitive proxy statement for the Company's 1997 Annual Meeting of Stockholders (involving the election of directors), which definitive proxy statement (the 'Proxy Statement") will be filed pursuant to Regulation 14A no later than 120 days following the Company's fiscal year ended December 31, 1996, and is incorporated herein by this reference to the extent provided below.
ITEM 10
ITEM 10 -- DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
Information in response to this item is incorporated by reference herein from the section of the Proxy Statement captioned "Board of Directors -- Director Compensation," "Management Compensation" and "Compliance with Section 16(a) of the Exchange Act."
ITEM 11
ITEM 11 -- EXECUTIVE COMPENSATION
Information in response to this item is incorporated by reference herein from the section of the Proxy Statement captioned "Board of Directors" -- Director Compensation" and "Management Compensation."
ITEM 12
ITEM 12 -- SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
Information in response to this item is incorporated by reference herein from the section of the Proxy Statement captioned "Stock Ownership of Directors, Executive Officers and Principal Holders."
ITEM 13
ITEM 13 -- CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Information in response to this item is incorporated by reference herein from the section of the Proxy Statement captioned "Certain Relationships and Related Transactions."
PART IV
ITEM 14
ITEM 14 -- EXHIBITS, FINANCIAL STATEMENTS AND REPORTS ON FORM 8-K
The consolidated financial statements filed as part of this report are listing in the accompanying Index to Consolidated Financial Statements. The exhibits filed as part of this report are listed in the accompanying Exhibit Index. No reports of Form 8-K were filed by the Company during the last quarter of the period covered by this report. All financial statement schedules have been omitted because the information is not required.
THE METZLER GROUP, INC.
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
INDEPENDENT AUDITORS' REPORT
The Stockholders and Board of Directors The Metzler Group, Inc.
We have audited the accompanying consolidated balance sheets of The Metzler Group, Inc. and subsidiary as of December 31, 1996 and 1995 and related consolidated statements of operations, stockholders' equity and cash flows for each of the years in the three-year period ended December 31, 1996. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of The Metzler Group, Inc. and subsidiary as of December 31, 1996 and 1995, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 1996 in conformity with generally accepted accounting principles.
KPMG Peat Marwick LLP
Chicago, Illinois February 6, 1997
THE METZLER GROUP, INC.
CONSOLIDATED BALANCE SHEETS
See accompanying Notes to Consolidated Financial Statements.
THE METZLER GROUP, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
See accompanying Notes to Consolidated Financial Statements.
THE METZLER GROUP, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY FOR THE YEARS ENDED DECEMBER 31, 1996, 1995, AND 1994
See accompanying Notes to Consolidated Financial Statements.
THE METZLER GROUP, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
See accompanying Notes to Consolidated Financial Statements.
THE METZLER GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. DESCRIPTION OF BUSINESS
The Metzler Group, Inc. (the "Company") is a leading provider of consulting services to electric utilities and other energy-related businesses.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Principles of Consolidation
The consolidated financial statements include the accounts of the Company and its wholly-owned subsidiary. Intercompany accounts and transactions have been eliminated.
Cash and Cash Equivalents
Cash equivalents are comprised of highly liquid instruments with original maturities of 90 days or less.
Property and Equipment
Property and equipment are recorded at cost. Depreciation and amortization are computed using the straight-line method based on the estimated useful lives, ranging from three to five years, of the various classes of property and equipment. Depreciation related to capital lease obligations is amortized over the shorter of their useful lives or the term of the related leases by use of the straight-line method.
Fair Value of Financial Instruments
The carrying amount of the Company's financial instruments approximates fair value because of the short maturity of those instruments.
Revenue Recognition
The Company recognizes revenues as the related services are performed.
Stock Based Compensation
The Company utilizes the intrinsic value-based method of accounting for its stock-based compensation arrangements.
Income Taxes
Income taxes, including pro forma calculations, are accounted for in accordance with Statement of Financial Accounting Standards No. 109, "Accounting for Income Taxes" (Statement 109). Under the asset and liability method of Statement 109, deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets
THE METZLER GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date.
Prior to January 1, 1996, the Company had operated as a C-corporation. Effective January 1, 1996, the stockholders of the Company elected to be taxed under Subchapter S of the Internal Revenue Code. Federal income taxes are the responsibility of the Company's stockholders as are certain state income taxes. As of the effective date of the election, the Company is responsible for Federal built-in-gain taxes to the extent applicable. Accordingly, the consolidated statement of operations for the year ended December 31, 1996 provides for such taxes. The S-corporation election terminated in connection with the consummation of the initial public offering of the Company's common stock on October 4, 1996.
Pro Forma Net Income Per Share
Pro forma net income per common and common equivalent share is computed based on the weighted average of 10,046,218 common and common equivalent shares outstanding during the year ended December 31, 1996 and 9,781,051 common and common equivalent shares outstanding during the year ended December 31, 1995.
Net income per share is computed using the weighted average number of shares of common stock and dilutive common equivalent shares resulting from the grant of 363,666 common stock options during the period from June 30, 1996 to September 30, 1996 (using the treasury stock method). Pursuant to Securities and Exchange Commission Staff Accounting Bulletin No. 83, common and common equivalent shares issued by the Company during the twelve-month period prior to the initial public offering have been included in the calculation of common and common equivalent shares using the treasury stock method and the initial public offering price per share as if they were outstanding for all periods presented.
The pro forma adjustments during the years 1996 and 1995 reflect the impact of a compensation plan effective July 1, 1996. The pro forma adjustments for 1996 include an increase to officer compensation expense of $1,019,460. The pro forma adjustments for 1995 include a decrease to officer compensation expense of $2,775,293.
The pro forma adjustments for 1996 include federal and additional state income tax expense of $1,799,403 that would have been required had the Company not made the S-corporation election effective January 1, 1996. The pro forma adjustments for 1995 include additional federal and state income tax expense of $1,110,117, that would have been required had the Company's compensation expense decreased in 1995 to the level commensurate with the compensation plan adopted effective July 1, 1996, as noted above.
Use of Estimates
The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
3. INITIAL PUBLIC OFFERING
On October 4, 1996 the Company completed an initial public offering of its common stock in which 2,300,000 shares were sold by the Company, along with an additional over-allotment of 285,000 shares, resulting in net proceeds of approximately $37 million, net of issuance costs of approximately $4 million.
THE METZLER GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
Concurrent with the completion of the initial public offering and in accordance with an agreement entered into during July 1996 between the Company and its founding shareholder, the Company redeemed 1,714,285 shares of the shareholder's common stock and issued to the shareholder a promissory note for $7,975,000. See Note 10 of the Notes to Consolidated Financial Statements regarding repayment of the promissory note.
4. NOTE PAYABLE
The Company had a line of credit with a bank which provided for maximum borrowings limited to 65% of eligible accounts receivable. The line of credit, which expired on December 31, 1996, had maximum borrowing of $1,200,000 and bore interest at the bank's prime rate (8.25% at December 31, 1996) plus 1/2%. There were no outstanding borrowings under the line of credit were at December 31, 1996. At December 31, 1995 the line of credit had maximum borrowing of $800,000 and bore interest at the bank's prime rate (8.5% at December 31, 1995) plus 1%. Outstanding borrowings under the line of credit were $405,740 at December 31, 1995.
5. REVENUES AND ACCOUNTS RECEIVABLE FROM SIGNIFICANT CUSTOMERS
The Company's customers are located throughout the United States and Canada. In 1996, 1995, and 1994 the Company's five largest clients accounted for approximately, 58%, 55% and 58% of the Company's total revenues, respectively. The balance due from the largest single customer represented 17% and 15% of the Company's accounts receivable at December 31, 1996 and 1995, respectively.
6. LEASE COMMITMENTS
The Company leases its office facilities and certain equipment under operating and capital lease arrangements which expire at various dates through January 31, 2002.
Operating Leases
The Company leases office facilities under a noncancelable operating lease which includes scheduled base rent increases over the term of the lease and provides for monthly payments of real estate taxes, insurance and other operating expenses applicable to the property. The total amount of the base rent payments is being charged to expense as incurred. In addition, the Company leases equipment under a noncancelable operating lease.
Future minimum annual lease payments, for the years subsequent to 1996 and in the aggregate, are as follows:
Rent expense for operating leases entered into by the Company and charged to operations amounted to $186,000 for the year 1996, and $156,000 for each of the years 1995 and 1994.
THE METZLER GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
Capital Lease
The Company leases equipment which is classified within the Company's consolidated financial statements as a capital lease. Included in the property, plant and equipment in the accompanying consolidated balance sheets is the following asset held under capital lease:
The future minimum annual lease payments under the noncancelable capital lease are as follows:
7. INCOME TAX EXPENSE (BENEFIT)
Income tax expense (benefit) consists of the following:
THE METZLER GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
Income tax expense (benefit) differs from the amounts estimated by applying the statutory income tax rates to income (loss) before income tax expense (benefit) as follows:
Deferred income taxes result from temporary differences between years in the recognition of certain expense items for income tax and financial reporting purposes. The source and income tax effect of these differences are as follows:
8. LONG-TERM INCENTIVE PLAN
On June 30, 1996, the Company adopted a Long-Term Incentive Plan which provides for common stock, common stock-based, and other performance incentives to employees, consultants, directors, advisors, and independent contractors of the Company. The maximum number of shares of common stock which may be issued and sold under the plan is 1,300,000 shares. As of December 31, 1996, the Company has granted 458,166 options at a weighted average exercise price of $15.53 per share which was equal to the estimated fair market value of common stock at the dates of grant. As of December 31, 1996 no options were exercisable. In general, the options are exercisable in three or four annual installments commencing on the second anniversary of the date of grant.
The Company applies APB Opinion 25, Accounting for Stock Issued to Employees, and related Interpretations in accounting for its plan. Accordingly, no compensation cost has been recognized. Had compensation cost for the plan been determined based on the fair value at the grant dates for awards under the plan consistent with the method of FASB Statement 123, Accounting for Stock-Based Compensation, (FASB 123), the Company's compensation expense for the year ended December 31, 1996 would have been increased by $102,000, net of related income taxes. As a result,the Company's proforma net earnings, available to common stockholders and earnings
THE METZLER GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
per common and common equivalent shares would have been reduced to the pro forma amounts indicated below:
For purposes of calculating compensation cost under FASB 123, the fair value of each option grant is estimated as of the date of grant using the Black-Scholes option pricing model. The following weighted average assumptions were used in the model for grants made in 1996:
Additional information on the shares subject to options is as follows:
The following table summarizes information about stock options outstanding at December 31, 1996:
9. EMPLOYEE BENEFIT PLANS
The Company has a Profit Sharing and Savings Plan and Trust ("Savings Plan"). The Savings Plan covers employees upon the completion of one year of service. Participants may contribute up to 15% of their eligible compensation. The Company, at its discretion, matches participant contributions as defined within the
THE METZLER GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
Savings Plan. In addition, the Company, at its discretion, makes profit sharing contributions. Company contributions to the Savings Plan which were charged to operations were the following:
10. RELATED-PARTY TRANSACTIONS
During January 1996, the Company entered into note payable agreements with two officers. The notes, each with a principal amount of $500,000, bear interest at a rate of 10%. The notes matured on December 31, 1996 and were repaid on January 2, 1997.
In May 1996, the Company made an advance of $725,000 to an officer as part of an employment agreement and entered into a note receivable agreement with the officer. The note receivable bore interest at a rate of 6%. The note, plus accrued interest, was repaid on November 8, 1996.
During July 1996, the Company entered into an agreement with its founding shareholder, who, at that time, was the beneficial owner of 15% of the Company's common stock, to redeem 1,714,285 shares of the shareholder's common stock in exchange for a promissory note in the amount of $7,975,000. The redemption value per share was negotiated by the Company's other executive officers, who collectively owned the remaining 85% of the Company's common stock at the time of the agreement. The Company redeemed the stock on October 4, 1996 in accordance with the agreement and repaid the note promissory within 30 days of the redemption.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities and Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
Dated: March 31, 1997
THE METZLER GROUP, INC.
By: /s/ ROBERT P. MAHER
------------------------------------ Robert P. Maher Chairman, President and Chief Executive Officer
By: /s/ JAMES F. HILLMAN
------------------------------------ James F. Hillman Chief Financial Officer
By: /s/ GERALD R. LANZ
------------------------------------ Gerald R. Lanz Chief Operating Officer
By: /s/ PETER B. POND
------------------------------------ Peter B. Pond Director
By: /s/ JAMES T. RUPRECHT
------------------------------------ James T. Ruprecht Director
By: /s/ MITCHELL H. SARANOW
------------------------------------ Mitchell H. Saranow Director
EXHIBIT INDEX
- ------------------------- (1) Incorporated by reference from the Registrant's Form S-1 Registration Statement No. 333-9019 as filed with the SEC on July 26, 1996.
(2) Incorporated by reference from the Registrant's Amendment No. 1 to Form S-1 Registration Statement No. 333-9019 as filed with the SEC on September 4, 1996.
(3) Incorporated by reference from the Registrant's Amendment No. 2 to Form S-1 Registration Statement No. 333-9019 as filed with the SEC on September 20, 1996.