SECURITIES AND EXCHANGE COMMISSION
                                WASHINGTON, D.C. 20549

                                      Form 10-Q


[X][ x ]  Quarterly report pursuant to Section 13 or 15(d) of the Securities 
Exchange Act of 1934 for the quarterly period ended September 30, 1996.March 31, 1997.

[   ]  Transition report pursuant to Section 13 or 15(d) of the Securities 
Exchange Act of 1934 for the transition period from ________ to ________.

Commission file number 0-27824

                           PIA MERCHANDISING SERVICES, INC.
                (Exact name of registrant as specified in its charter)

               Delaware                                       33-0684451
      (State or other jurisdiction of                      (I.R.S. Employer 
       incorporation or organization)                      Identification No.)
                

                  19900 MacArthur Blvd., Suite 900, Irvine, CA 92612
                       (Address of principal executive offices)

                                    (714) 476-2200
                 (Registrant's telephone number, including area code)

                                    NOT APPLICABLE
                (Former name, former address and former fiscal year, 
                             if changed since last report)

Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days: [X][ X ] Yes     [   ] No

Applicable only to corporate issuers:

Indicate the number of shares outstanding of each of the issuer's classes of
stock, as of the latest practicable date.

Common Stock, $.01 Par Value: 5,815,2065,899,558 shares as of October 31, 1996.April 30, 1997.


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                           PIA Merchandising Services, Inc.


PART I:             FINANCIAL INFORMATION                        PAGE 

     ----
     Item 1:  Financial Statements 

                  Condensed Consolidated Balance 
                  Sheets as of September 30, 1996March 31, 1997 (Unaudited) 
                  and December 31, 19951996

                  Condensed Consolidated Statements of 
                  Income for the NineThree Months Ended 
                  September 30, 1996March 31, 1997 (Unaudited) and
                  September 30, 1995March 31, 1996  (Unaudited)

                  Condensed Consolidated Statements of 
                  Cash Flows for the NineThree Months Ended
                  September 30, 1996March 31, 1997 (Unaudited) and 
                  September 30, 1995March 31, 1996 (Unaudited)

                  Notes to Condensed Consolidated Financial 
                  Statements

     Item 2:      Management's Discussion and Analysis of Financial 
                  Condition and Results of Operations

                  Risk Factors

PART II:          OTHER INFORMATION

     Item 6:      Exhibits and Reports on Form 8-K

SIGNATURES


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PART I:           FINANCIAL INFORMATION

PIA MERCHANDISING SERVICES, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS
- ------------------------------------------------------------------------------
(IN THOUSANDS)

September 30, December 31, 1996 1995 ---- ---- (Unaudited) ASSETS CURRENT ASSETS: Cash and cash equivalents $17,865 $ 185 Accounts receivable, net of allowance for doubtful accounts 20,682 12,213 Prepaid expenses and other current assets 860 638 Deferred income taxes 493 493 ------- ------- Total current assets 39,900 13,529 PROPERTY AND EQUIPMENT, net 1,950 2,110 OTHER ASSETS 914 447 ------- ------- $42,764 $16,086 ------- ------- ------- ------- LIABILITIES AND STOCKHOLDERS' EQUITY CURRENT LIABILITIES: Accounts payable $ 743 $ 1,838 Other current liabilities 6,478 4,105 Income taxes payable 228 455 ------- ------- Total current liabilities 7,449 6,398 DEFERRED INCOME TAXES 300 300 LONG-TERM DEBT 0 3,400 STOCKHOLDERS' EQUITY 35,015 5,988 ------- ------- $42,764 $16,086 ------- ------- ------- -------
(In Thousands) March 31, December 31, 1997 1996 --------- ------------ (Unaudited) ASSETS CURRENT ASSETS: Cash and cash equivalents $21,791 $ 19,519 Accounts receivable, net of allowance for doubtful accounts 18,914 22,630 Prepaid expenses and other current assets 1,416 564 Deferred income taxes 669 669 --------- ------------ Total current assets 42,790 43,382 PROPERTY AND EQUIPMENT, net 1,783 1,847 OTHER ASSETS 2,688 2,443 --------- ------------ $47,261 $47,672 --------- ------------ --------- ------------ LIABILITIES AND STOCKHOLDERS' EQUITY CURRENT LIABILITIES: Accounts payable $ 823 $ 772 Other current liabilities 10,517 9,762 Income taxes payable 0 111 -------- ----------- Total current liabilities 11,340 10,645 DEFERRED INCOME TAXES 309 309 STOCKHOLDERS' EQUITY 35,612 36,718 --------- ------------ $47,261 $47,672 --------- ------------ --------- ------------ See accompanying notes. 3 PIA MERCHANDISING SERVICES, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF INCOME - ------------------------------------------------------------------------------ (IN THOUSANDS, EXCEPT(In thousands, except per share amounts) (Unaudited) For the Three Months Ended March 31, ------------------------------------ 1997 1996 ---- ---- NET REVENUES $29,356 $26,259 OPERATING EXPENSES: Field service costs 26,369 20,264 Selling expenses 2,554 2,655 General and administrative expenses 2,449 1,740 Depreciation and amortization 197 147 -------- ------- Total operating expenses 31,569 24,806 -------- ------- OPERATING INCOME (LOSS) (2,213) 1,453 -------- ------- OTHER INCOME: INTEREST INCOME, NET 231 43 EQUITY IN EARNINGS OF AFFILIATE 24 0 -------- ------- TOTAL OTHER INCOME 255 43 -------- ------- INCOME BEFORE PROVISION FOR INCOME TAXES (1,958) 1,496 (PROVISION) BENEFIT FOR INCOME TAXES 790 (599) -------- ------- NET INCOME (LOSS) $ (1,168) $ 897 -------- ------- -------- ------- NET INCOME (LOSS) PER COMMON AND COMMON EQUIVALENT SHARE AMOUNTS) (UNAUDITED)
For the Three Months Ended September 30, ---------------------------------------- 1996 1995 ---- ---- NET REVENUES $33,589 $28,177 OPERATING EXPENSES: Field service costs 26,483 22,098 Selling expenses 2,885 2,731 General and administrative expenses 2,140 1,653 Depreciation and amortization 154 128$ ( 0.19) $ 0.18 -------- ------- -------- ------- WEIGHTED AVERAGE COMMON AND COMMON EQUIVALENT SHARES 6,109 4,932 -------- ------- -------- ------- ------- Total operating expenses 31,662 26,610 ------- ------- OPERATING INCOME 1,927 1,567 INTEREST INCOME (EXPENSE), NET 261 (99) ------- ------- INCOME BEFORE PROVISION FOR INCOME TAXES 2,188 1,468 PROVISION FOR INCOME TAXES 851 515 ------- ------- NET INCOME $ 1,337 $ 953 ------- ------- ------- ------- NET INCOME PER COMMON AND COMMON EQUIVALENT SHARE $ 0.21 $ 0.22 ------- ------- ------- ------- WEIGHTED AVERAGE COMMON AND COMMON EQUIVALENT SHARES 6,251 4,309 ------- ------- ------- -------
See accompanying notes. PIA MERCHANDISING SERVICES, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF INCOME - ------------------------------------------------------------------------------ (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) (UNAUDITED)
For the Nine Months Ended September 30, --------------------------------------- 1996 1995 ---- ---- NET REVENUES $86,703 $78,517 OPERATING EXPENSES: Field service costs 68,591 61,458 Selling expenses 8,508 7,711 General and administrative expenses 5,733 4,944 Depreciation and amortization 453 361 ------- ------- Total operating expenses 83,285 74,474 ------- ------- OPERATING INCOME 3,418 4,043 INTEREST INCOME (EXPENSE), NET 590 (358) ------- ------- INCOME BEFORE PROVISION FOR INCOME TAXES 4,008 3,685 PROVISION FOR INCOME TAXES 1,568 1,293 ------- ------- NET INCOME $ 2,440 $ 2,392 ------- ------- ------- ------- NET INCOME PER COMMON AND COMMON EQUIVALENT SHARE $ 0.41 $ 0.56 ------- ------- ------- ------- WEIGHTED AVERAGE COMMON AND COMMON EQUIVALENT SHARES 5,972 4,309 ------- ------- ------- -------
See accompanying notes.4 PIA MERCHANDISING SERVICES, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS - ------------------------------------------------------------------------------ (IN THOUSANDS) (UNAUDITED)
For the Nine Months Ended September 30, --------------------------------------- 1996 1995 ---- ---- CASH FLOWS FROM OPERATING ACTIVITIES: Net income $ 2,440 $ 2,392 Adjustments to reconcile net income to net cash provided by (used in) operating activities: Depreciation and amortization 453 361 Amortization of other assets and discount on subordinated debt 11 67 Provision for doubtful receivables 282 147 Deferred income taxes, net 0 46 Changes in operating assets and liabilities (8,401) (2,904) ------- ------ Net cash (used in) provided by operating activities (5,215) 109 CASH FLOWS FROM INVESTING ACTIVITIES: Capital expenditures (293) (527) CASH FLOWS FROM FINANCING ACTIVITIES: Payments of long term debt (3,400) (651) Repurchase of common stock 0 (24) Proceeds from issuance of common stock, net 26,588 0 ------- ------ Net cash provided by (used in) financing activities 23,188 (675) ------- ------ NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS 17,680 (1,093) CASH AND CASH EQUIVALENTS, beginning of period 185 1,414 ------- ------ CASH AND CASH EQUIVALENTS, end of period $17,865 $ 321 ------- ------ ------- ------ SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION: Cash paid for interest $ 0 $ 322 Cash paid for income taxes $ 1,820 $1,119
(In thousands) (Unaudited) For the Three Months Ended March 31, ------------------------------------ 1997 1996 ---- ---- CASH FLOWS FROM OPERATING ACTIVITIES: Net income (Loss) (1,168) $ 897 Adjustments to reconcile net income to net cash provided by (used in) operating activities: Depreciation and amortization 197 147 Provision for doubtful receivables 330 76 Changes in operating assets and liabilities 2,941 (1,161) -------- ------- Net cash (used in) provided by operating activities 2,300 (41) CASH FLOWS FROM INVESTING ACTIVITIES: Capital expenditures (91) (63) CASH FLOWS FROM FINANCING ACTIVITIES: Payments of long term debt 0 (3,400) Proceeds from issuance of common stock, net 63 26,753 -------- ------- Net cash provided by financing activities 63 23,353 -------- ------- NET INCREASE IN CASH AND CASH EQUIVALENTS 2,272 23,249 CASH AND CASH EQUIVALENTS, beginning of period 19,519 185 -------- ------- CASH AND CASH EQUIVALENTS, end of period $ 21,791 $ 23,434 -------- ------- -------- ------- SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION: Cash paid for interest $ 0 $ 69 Cash paid for income taxes $ 86 $ 320 See accompanying notes. 5 PIA Merchandising Services, Inc. and Subsidiaries Notes to Condensed Consolidated Financial Statements (Unaudited) The Three and Nine Months Ended September 30, 1996March 31, 1997 1. Basis of Presentation The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with generally accepted accounting principles for interim financial information and with 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 generally accepted accounting principles for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included. This financial information should be read in conjunction with the consolidated financial statements and notes thereto for the year ended December 31, 1995,1996, included in the Company's Registration StatementAnnual Report on Form S-1, which was declared effective on February 29,10-K for the year ended December 31, 1996. Operating results for the three and nine month periodsperiod ended September 30, 1996March 31, 1997 are not necessarily indicative of the results that may be expected for the year endedending December 31, 1996.1997. 2. Net Income perThe Financial Accounting Standards Board recently issued Statement of Financial Accounting Standards No. 128 "Earnings Per Share, Net income" which is effective for financial statements for both interim and annual periods ending after December 15, 1997. Early adoption of the statement is not permitted. The company has applied this statement to the 1996 first quarter and annual results and to the 1997 first quarter results and determined that the adoption of this statement would not have had a material impact on the earnings per share is based on the weighted average number of outstanding shares of common stock and dilutive common equivalent shares from stock options and warrants (using the treasury stock method). 3. Initial Public Offering In March 1996, the Company completed its initial public offering of 2,137,800 shares of unissued common stock and 544,000 shares of outstanding common stock that were offered by certain selling stockholders. The Company received net proceeds of approximately $26.6 million after deducting expenses and underwriting discounts. Concurrent with the offering, the Company was reincorporated in Delaware which resulted in an increase in authorized preferred stock to 3,000,000 shares, an increase in authorized common stock to 15,000,000 shares and a change in the par value of both the Company's common stock and preferred stock from no par value to $.01 par value. This change in par value resulted in a reclassification of $6,418,000 from common stock to additional paid-in capital. 4. Line of credit and long-term obligations In March 1996, $3.0 million of net proceeds from the initial public offering were usedcalculations for repayment of bank line of credit indebtedness. these periods. Item 2 - Management's Discussion and Analysis of Financial Condition and Results of Operations Overview PIA Merchandising Services, Inc. (the Company"Company" or PIA)"PIA") provides merchandising services to manufacturers and retailers principally in grocery, mass merchandiser and chain and deep discount drug stores. For the quarters ended September 30,March 31, 1997 and 1996, and 1995, the Company generated approximately 87.8%90.0% and 79.7%87.0% of its net revenues from manufacturer clients, and 12.2%10.0% and 20.3% from retailer clients, respectively. For the nine month periods ended September 30, 1996 and 1995, the Company generated approximately 86.8% and 79.7% of its net revenues from manufacturer clients and 13.2% and 20.3%13.0% from retailer clients, respectively. The mix of the Company's business between manufacturer and retailer clients historically has not had a material impact on the Company's cash flows or results of operations. The Company currently provides three principal types of services: syndicated services, project services and dedicated services. Syndicated services consist of regularly scheduled, routed merchandising services provided at the store level for manufacturers, primarily under one year contracts. Project services consist primarily of special in-store services initiated by retailers and manufacturers, which are typically used for large scale implementations over 30 to 60 days. Dedicated services consist of merchandising services that are performed for a specific retailer or manufacturer by a dedicated organization, primarily under multi-year contracts. 6 During 1996 and the first quarter of 1997, the Company's profitability was affected by a shift in its business from syndicated services to projects and dedicated services. The Company's syndicated services business has historically required a significant fixed management and personnel infrastructure. Due in part to industry consolidation and increased competition, the Company lost a number of syndicated services clients during 1996 and the first quarter of 1997, causing a decrease in the profitability of that business in the last two quarters of 1996 and the first quarter of 1997. PIA has not sold any sizable new syndicated business to compensate for this loss. The Company believes that revenues in the balance of 1997 from syndicated services will continue to decline as a result of the wind-down of the lost business. Because of the fixed nature of the associated costs, the loss of syndicated business has a material adverse effect on PIA's results of operations. The Company continues to experience a significant increase in the demand for project services. PIA's project revenues have grown from $7.9 in the first quarter of 1996 to $9.0 in the first quarter of 1997. This increase has required an investment in management infrastructure and systems to support this business. The Company's dedicated services business is also growing rapidly. During the first quarter of 1997, revenues from dedicated services accounted for 26.8% of total revenues, as compared to 7.1% in the first quarter of 1996. In the dedicated services business, PIA provides each manufacturer or retailer client with an organization, including a management team, that works exclusively for that client. PIA's quarterly results of operations are subject to certain variability related to the timing of retailer-mandated activity and the receipt of commission overrides.commissions. Retailer-mandated activity is typically higher in the second and third quarters of the year due to retailer scheduling of activity in off-peak shopping periods. In addition, new product introductions increase during such periods which require the reset of categories as the new products gain distribution. The amount of commissions earned by PIA under its commission-based contracts varies seasonally, and generally corresponds to the peak selling seasons of the clients that have entered into these types of contracts. Historically, the Company has recognized greater commission income in the first and fourth quarters. See "Risk Factors -- Uncertainty of Commission Income." The Company's quarterly results have in the past been subject to fluctuations and, thus, the operating results for any quarter are not necessarily indicative of results for any future period. 7 Results of Operations - ThirdFirst Quarter of Fiscal 19961997 Compared to ThirdFirst Quarter of Fiscal 1995:1996: The following table sets forth certain financial data as a percentage of net revenues for the periods indicated:
Three Months Ended September 30, -------------------------------- 1996 1995 ---- ---- Net revenues 100% 100% Operating expenses: Field service costs 78.8% 78.4% Selling expenses 8.6% 9.6% General and administrative expenses 6.4% 5.9% Depreciation and amortization 0.5% 0.5% ----- ----- Total operating expenses 94.3% 94.4% ----- ----- Operating income 5.7% 5.6% Interest (income) expense, net (0.8%) 0.4% ----- ----- Income before provision for income taxes 6.5% 5.2% Provision for income taxes 2.5% 1.8% ----- ----- Net income 4.0%Three Months Ended March 31, ---------------------------- 1997 1996 ---- ---- Net revenues 100% 100% Operating expenses: Field service costs 89.8 77.2 Selling expenses 8.7 10.1 General and administrative expenses 8.3 6.6 Depreciation and amortization 0.7 0.6 ----- ----- Total operating expenses 107.5 94.5 ----- ----- Operating income (loss) (7.5) 5.5 Interest income, net 0.8 0.2 Equity in earnings of affiliate 0.1 0.0 ----- ----- Income (loss) before provision for income taxes (6.6) 5.7 (Provision) benefit for income taxes 2.7 (2.3) ----- ----- Net income (loss) (3.9)% 3.4% ----- ----- ----- -----
Net revenuerevenues increased $5.4$3.1 million, or 19.2%11.8%, to $33.6$29.4 million in the thirdfirst quarter of 19961997 from $28.2 million for$26.3 in the thirdfirst quarter of 1995.1996. The increase in net revenue forrevenues was the third quarter includes $5.7result of revenues from new clients of $9.1 million, offset by a net decrease from other clients of $6.0 million. This net decrease is comprised of a net decrease in revenuerevenues of $.4 million from services performed for new clients. Aexisting clients, and a decline in revenues of $5.6 million due to client losses. The net revenue increase in the first quarter of 1997 was a result of an increase in project business of $1.1 million, representing a 14.4% increase in project revenues over the first quarter of 1996, and from ongoing routed coveragean increase in dedicated services of $.6$6.0 million, was partiallyrepresenting a 421.0% increase in dedicated service revenue over the first quarter of 1996. These increases were offset by increasesa decrease of $4.0 million, or 24.1%, in project revenuerevenues from syndicated services over the first quarter of $.3 million during the quarter.1996. Field service costs increased $4.4$6.1 million, or 19.8%30.1%, to $26.5$26.4 million in the thirdfirst quarter of 19961997, as compared to $22.1$20.3 million in the thirdfirst quarter of 1995.1996. Field service costs are comprised principally of field labor and related costs and expenses required to provide both routed and dedicated coverage, project activities, key account management and related technology costs, as well as the field overhead required to support the activities of these groups of employees. The increase in field service costs wasis primarily due to increases in line with the increase in net revenues.revenues from dedicated and project services. As a percentage of net revenues, field service costs were 78.8%increased to 89.8% in the thirdfirst quarter of 1997 from 77.2% in the first quarter of 1996 comparedprimarily due to 78.4%the negative leverage caused by the loss of syndicated services business; salary increases in the thirdordinary course of business; and increased travel costs associated with the larger work force. 8 Selling expenses decreased $0.1 million, or 3.8%, to $2.6 million in the first quarter of 1995.1997 from $2.7 million in the first quarter of 1996. Selling expenses decreased primarily as a result of $2.9 million were approximately the same as last year.lower staffing and travel costs. As a percentage of net revenues, selling expenses decreased to 8.6%8.7% in the thirdfirst quarter of 19961997 from 9.6%10.1% in the thirdfirst quarter of 1995.1996. General and administrative expenses increased $0.5$0.7 million, or 29.5%40.7%, to $2.1$2.4 million in the thirdfirst quarter of 19961997 from $1.6$1.7 million in the thirdfirst quarter of 1995.1996. General and administrative expenses increased primarily as a result of higher payroll costs due to increased staffing in general managementrecruitment and training and management information services that were required to support overall business growth, andincreased provision for uncollectible accounts, termination costs, as well as salary increases in the ordinary course of business. As a percentage of net revenues, general and administrative expenses amounted to 6.4%8.3% in the thirdfirst quarter 1997 compared to 6.6% in the first quarter of 1996 compared to 5.9% in the third quarter of 1995.1996. Depreciation and amortization expenses remained approximately the sameincreased slightly as a result of depreciation of computer hardware and software development costs for the third quarter of 1996shelf technology and 1995. for general business purposes. Interest income was $0.3 million during the third quarterincreased as a result of 1996. The interest income resulted from the investment of a portion ofproceeds from the Company's initial public offering proceedson March 1, 1996. Equity in earnings of affiliate represents the Company's share of the earnings of Ameritel, Inc. During 1996, the Company exercised its option to increase its ownership of Ameritel to 20%, and is now required to recognize its equity interest bearing securities. These investments produced interest earnings throughout the third quarter of 1996. The Company had no interest expense during the third quarter of 1996.in Ameritel's earnings. Income taxes were $0.9tax benefit was approximately $0.8 million in the thirdfirst quarter of 1996 and approximately $0.51997, compared to income tax expense of $0.6 million in the thirdfirst quarter of 1995,1996, representing an effective rate of 38.9%40.3% and 35.1%40.0%, respectively. The 1996 and 1995 tax rates differed from an expected combined federal and state tax rateCompany incurred a net loss of 40% due principally to interest earned in 1996 from tax exempt securities and to a $0.1 million reduction in the valuation allowance caused by the utilization of net operating loss carryforwards in 1995. Net income increased approximately $0.4 million, or 40.3%, to approximately $1.3$1.2 million in the thirdfirst quarter of 1996, from1997, compared to net income of approximately $1.0$0.9 million in the thirdfirst quarter of 1995,1996, primarily as a result of increased revenues, the reduction in operating expenses increasing at a faster rate than revenues, as a percent of salesdiscussed above. Liquidity and interest income from investment ofCapital Resources The Company's primary capital need has been to fund the proceeds ofworking capital requirements created by its growth in net revenues. On March 1, 1996, the Company completed an initial public offering. Resultsoffering of Operations - Nine Months Ended September 30, 1996 Comparedits Common Stock, raising $26.5 million. Prior to Nine Months Ended September 30, 1995: The following table sets forth certain financial data asthis offering, the Company's primary sources of financing were senior borrowings from a percentagebank under a revolving line of net revenues for the periods indicated:
Nine Months Ended September 30, ------------------------------- 1996 1995 ---- ---- Net revenues 100% 100% Operating expenses: Field service costs 79.2% 78.3% Selling expenses 9.8% 9.8% General and administrative expenses 6.6% 6.3% Depreciation and amortization 0.5% 0.5% ----- ----- Total operating expenses 96.1% 94.9% ----- ----- Operating income 3.9% 5.1% Interest (income) expense, net (0.7%) 0.5% ----- ----- Income before provision for income taxes 4.6% 4.6% Provision for income taxes 1.8% 1.6% ----- ----- Net income 2.8% 3.0% ----- ----- ----- -----
Net revenue increased $8.2 million, or 10.4%, to $86.7 million incredit and subordinated borrowings from two stockholders. During the first nine monthsquarter of 1996 from $78.5 million for1997, the corresponding period of 1995. TheCompany had a net increase in net revenue includes $6.4cash flow of $2.3 million in revenue from services performed for new clients. Revenues for the nine months ended September 30, 1996 from ongoing routed coverage increased $.3 million and project revenue increased $1.5 million from the corresponding period in 1995. Field service costs increased $7.1 million, or 11.6%, to $68.6 million in the first nine months of 1996 compared to $61.5 million for the corresponding period of 1995. The increase in field service costs was the result of increased operating costs associated with revenue growth and a reduction of marginsprincipally due to a strategic decision byreduction in accounts receivable. 9 In January 1997, the Company to maintain employment levels in field service and field management personnel in anticipationentered into a new credit agreement with a bank, which provides for an unsecured line of new businesscredit in the second quarter. Asmaximum amount of $7,000,000. Borrowings under the line of credit bear interest at the bank's reference rate, unless the Company elects the specified offshore rate. The credit agreement contains various covenants which, among other things, require compliance with certain financial tests such as working capital, tangible net worth, leverage and profitability. In addition, the credit agreement imposes certain restrictions on the Company, including the incurrence of additional indebtedness, the payment of dividends, and the ability to make acquisitions. No borrowings are currently outstanding under this facility. In March 1997, the Company's Board of Directors approved a percentagestock repurchase program under which the Company is authorized to repurchase up to 1,000,000 shares of net revenues, field service costs increasedCommon Stock from time to 79.2%time in the first nine monthsopen market, depending on market conditions. This program is funded by working capital. As of 1996 from 78.3%May 1, 1997, the Company repurchased an aggregate of 367,000 shares of Common Stock for an aggregate price of $2,149,117. The Company believes that it's working capital and available line of credit are sufficient to fund its operations for the corresponding period of 1995. Selling expenses increased $0.8 million or 10.3%, to $8.5 million in the first nine months of 1996 from $7.7 million for the corresponding period of 1995. As a percentage of net revenues, selling expenses were 9.8% in both the first nine months of 1996 and 1995. General and administrative expenses increased $0.8 million, or 16.0%, to $5.7 million in the first nine months of 1996 from $4.9 million for the corresponding period of 1995. General and administrative expenses increased primarily as a result of higher payroll costs due to increased staffing in general management and management information services that were required to support overall business growth, salary increases in the ordinary course of business, and legal expenses associated with the negotiation of a significant new contract. As a percentage of net revenues, general and administrative expenses increased to 6.6% in the first nine months of 1996 from 6.3% for the corresponding period of 1995. The increase was principally the result of the increased spending noted above and lower than anticipated net revenues. Depreciation and amortization expenses remained approximately the same for the first nine months of 1996 and 1995. Net interest income was $0.6 million during the first nine months of 1996. Interest expense in the corresponding period of 1995 was $0.4 million. The interest income resulted from the investment of a portion of the Company's initial public offering proceeds in interest bearing securities. Income taxes were $1.6 million for the first nine months of 1996 and approximately $1.3 million in the corresponding period of 1995, representing an effective rate of 39.1% and 35.1%, respectively. The 1996 and 1995 tax rates differed from an expected combined federal and state tax rate of 40% due principally to interest earned from tax exempt securities in 1996 and to a $0.2 million reduction in the valuation allowance caused by the utilization of net operating loss carryforwards in 1995. Net income remained approximately the same for the first nine months of 1996 and 1995. Increases in revenues were offset by higher field service costs and other expenses. next 12 months. RISK FACTORS The following risk factors should be carefully reviewed in addition to the other information contained in this Quarterly Report on Form 10-Q. Concentrated Client BaseHISTORY OF LOSSES During the years ended December 31, 1992 and 1993, the Company incurred significant losses and experienced substantial negative cash flow. The Company had net losses of $3.2 million and $2.6 million for the years ended December 31, 1992 and 1993, respectively. These losses resulted primarily from additional field service costs to provide routed coverage in grocery stores for relatively few clients in newly-opened regions during the Company's continuing national expansion in 1992 and 1993, and from the write-off of $1.7 million in goodwill in 1992. In addition, the Company incurred a net loss of $1.2 million for the first quarter of 1997, and expects its 1997 operating results to be substantially less than the prior year. There can be no assurance that the Company will not sustain further losses. 10 LOSS OF SYNDICATED BUSINESS PIA's business mix has changed significantly over 1996 and the first quarter of 1997, and is expected to continue to change during the balance of 1997 in response to client needs and the evolving third party merchandising industry. Due in part to industry consolidation and increased competition, the Company has lost a substantial amount of syndicated services business over the last 15 months, and has not sold any sizeable new syndicated business to compensate for this loss. This business has historically required a significant fixed management and personnel infrastructure. Accordingly, the loss of syndicated business, without offsetting gains, has a material adverse effect on the Company's results of operations. INDUSTRY CONSOLIDATION; CONCENTRATED CLIENT BASE The retail industry is undergoing a consolidation process that is resulting in fewer, larger retailers. The Company's success is dependent in part upon its ability to maintain its existing clients and to obtain new clients. As a result of industry consolidation, the Company has lost certain clients, and this trend could continue to have a negative effect on the Company's client base and results of operations. The Company's ten largest clients generated approximately 61.3%74.0% and 59.8%58.4% of the Company's net revenuerevenues for the quarters ended September 30,March 31, 1996 and 1995, respectively, and 58.1% and 59.8% of net revenue for the nine month periods ended September 30, 1996 and 1995,1997, respectively. During these periods, none of the Company's manufacturer or retailer clients accounted for greater than 10% of net revenues, other than (i) Buena Vista Home Video and S.C. Johnson which accounted for approximately 16.9%25.6% and 10.7% of net revenues, respectively, for the quarter ended September 30, 1996; (ii)March 31, 1997, and S.C. Johnson Wax, which accounted for approximately 11.5%13.2% of net revenues for the nine month period ended September 30, 1996, and 10.6% for the quarter ended September 30, 1995; and (iii) Thrifty Payless, Inc. which accounted for approximately 15.0% and 14.4% for the quarter and for the nine month period ended September 30, 1995, respectively.March 31, 1996. The Company's contracts with its clients rangehave terms ranging from one to five years. PIA believes that the uncollectibility of amounts due from any of its large clients, the loss of one or more of such clients, a significant reduction in business from such clients, or the inability to attract new clients, couldwould have a material adverse effect on the Company's results of operations. IncreaseCOMPETITION The third party merchandising industry is highly competitive and is comprised of an increasing number of merchandising companies with either specific retailer, retail channel or geographic coverage, and food brokers. These competitors tend to compete with the Company primarily in Services Required Under Fixed Price Contractsthe retail grocery channel, and some of them may have a greater presence in certain of the retailers in whose stores the Company performs its services. The Company also competes with several companies that are national in scope, such as Powerforce, Spar/Marketing Force, Pimms and Alpha One. These companies compete with PIA principally in the mass merchandiser, chain drug and deep discount drug retail channels. The Company believes that the principal competitive factors within its industry include quality of service, cost and the ability to execute specific client priorities rapidly and consistently over a wide geography. If any of the Company's major competitors were to seek to gain or retain market share by reducing its prices, the Company could experience downward pressure on the prices that it charges for certain elements of its services. The Company has been forced periodically to adjust its prices to retain certain business. There can be no assurance that these competitors will not reduce their prices, or that in the future the Company will not face greater competition from other national or regional merchandising companies or food brokers. 11 INCREASE IN SERVICES REQUIRED UNDER FIXED PRICE CONTRACTS Manufacturers who sell their products through retail grocery stores generally are required by the retailer to provide labor support inside these stores for a variety of purposes, including new store sets and existing store resets, remerchandisings, remodels and category implementations. The Company has historically contracted with its manufacturer clients to provide these services, among others, for a monthly flat fee or, in some cases, for a commission. Substantially all of the Company's current contracts provide for one of these two types of arrangements. As requests for retailer-mandated services and new product introductions by manufacturers have increased over the past several years, the Company's labor expense has increased without any related increase in its revenue. Consequently, the Company has reevaluated its approach to contracting with its clients, and is currently engaged in an effort to revisehas revised certain of its existing contracts upon their renewal to implement provisions that charge for retailer-mandated services separately from traditional merchandising and shelf maintenance tasks. In addition, the Company has recently developed a new, standard contract that provides this activity-based approach to pricing for the Company's more recent customers. The Company has recently renewed its contracts with two of its major manufacturer clients using activity-based pricing, and is currently in the process of renegotiating contracts upon their annual renewal with certain of its other major clients. However, noNo assurance can be given that PIAthe Company will be successful in renewing its otherthe remaining contracts on this basis. If PIA is not successful in so renegotiating its major contracts, its margins could be adversely affected. Uncertainty of Commission IncomeUNCERTAINTY OF COMMISSION INCOME Approximately 15.3% and 18.4%15.0% of the Company's net revenues for the quarter and nine month period ended September 30, 1996, respectively,March 31, 1997 was earned under commission-based contracts. These contracts provide for commissions based on a percentage of the client's net sales of certain of its products to designated retailers. Some of these contracts also provide for a guaranteed minimum compensation to the Company. CommissionsCommission paid to PIA under these contracts have had a significant effect on the Company's profitability in certain quarters. Under certain of these contracts, the Company generally receives a draw on a monthly or quarterly basis, which is then applied against commissions earned. Adjustments are made on a monthly or quarterly basis upon receipt of reconciliations between commissions earned from the client and the draws previously received. The reconciliations typically result in commissions owed to the Company in excess of previous draws; however, the Company cannot predict with accuracy the level of its clients' commission-based sales. Accordingly, the amount of commissions in excess of or less than the draws previously received will fluctuate and can significantly affect the Company's operating results in any quarter. In addition, the amount of commissions earned by the Company under these contracts varies seasonally, and generally corresponds to the peak selling seasons of the clients whothat have entered into these types of contracts. Historically, the Company has recognized greater commission income in its first and fourth quarters due to the timing of such clients' sales. DEPENDENCE ON SENIOR MANAGEMENT The Company is dependent upon the services of its officers and the key management personnel involved in its field organization. The loss of the services of one or more of these individuals could have a material adverse effect on the Company. The Company carries term life insurance on Clinton E. Owens, the Company's Chairman and Chief Executive Officer. 12 PIA Merchandising Services, Inc. PART II: OTHER INFORMATION Item 1: Legal Proceedings None Item 2: Changes in Securities None Item 3: Defaults Upon Senior Securities None Item 4: Submission of Matters to a Vote of Security Holders None Item 5: Other Information None Item 6: Exhibits and Reports on Form 8-K. (27) Financial Data SchedulesSchedule The Company did not file any reports on Form 8-K during the three months ended September 30, 1996.March 31, 1997. 13 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. PIA MERCHANDISING SERVICES, INC. (Registrant) By: /s/ Clinton E. Owens ------------------------------------------------------------------ Clinton E. Owens Chairman of the Board and Chief Executive Officer By: /s/ Roy L. Olofson ------------------------------------------------------------------ Roy L. Olofson Executive Vice President and Chief Financial Officer Dated: NovemberMay , 1997 14 1996