UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
| x | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 |
FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 28, 2003
OR
| ¨ | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 |
FOR THE TRANSITION PERIOD FROM TO
COMMISSION FILE NUMBER 000-22869
HALL, KINION & ASSOCIATES, INC.
(Exact name of registrant as specified in its charter)
| Delaware | 77-0337705 | |
| (State or other jurisdiction of incorporation or organization) | (I.R.S. Employer Identification No.) | |
75 Rowland Way Suite 200 Novato, California | 94945 | |
| (Address of principal executive offices) | (zip code) | |
Registrant’s telephone number, including area code: (415) 895-2200
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) had been subject to such filing requirements for the past 90 days. Yes x No ¨
Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes ¨ No x
Indicate the number of shares outstanding of each of the issuer’s classes of common stock as of November 6, 2003: 12,585,963 shares of common stock.
HALL, KINION & ASSOCIATES, INC.
FORM 10-Q
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HALL, KINION & ASSOCIATES, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands, except par value amounts)
(Unaudited)
| September 28, 2003 | December 29, 2002 | |||||||
| ASSETS | ||||||||
Current Assets: | ||||||||
Cash and cash equivalents | $ | 2,755 | $ | 8,571 | ||||
Accounts receivable, net of allowance for doubtful accounts of $2,054 at September 28, 2003 and $2,544 at December 29, 2002 | 20,908 | 17,804 | ||||||
Prepaid expenses and other current assets | 2,240 | 1,554 | ||||||
Deferred income taxes | 3,925 | 3,925 | ||||||
Total current assets | 29,828 | 31,854 | ||||||
Property and equipment, net | 3,939 | 7,511 | ||||||
Property held for sale | 1,771 | — | ||||||
Goodwill | 11,806 | 11,849 | ||||||
Intangible assets, net | 10,201 | 10,859 | ||||||
Deferred income taxes and other assets | 12,929 | 12,833 | ||||||
Total assets | $ | 70,474 | $ | 74,906 | ||||
| LIABILITIES AND STOCKHOLDERS’ EQUITY | ||||||||
Current Liabilities: | ||||||||
Line of credit | $ | — | $ | 10,000 | ||||
Accounts payable | 4,053 | 2,874 | ||||||
Accrued compensation and payroll taxes | 3,072 | 2,774 | ||||||
Accrued employee benefits | 1,508 | 1,713 | ||||||
Accrued liabilities | 3,026 | 4,563 | ||||||
Reserve for restructuring costs | 2,424 | 3,014 | ||||||
Total current liabilities | 14,083 | 24,938 | ||||||
Line of credit | 10,904 | |||||||
Accrued compensation and deferred rent | 2,725 | 3,046 | ||||||
Reserve for non-current restructuring costs | 2,466 | 3,155 | ||||||
Total liabilities | 30,178 | 31,139 | ||||||
Commitments and contingencies | ||||||||
Stockholders’ Equity: | ||||||||
Common stock; $0.001 par value; 100,000 shares authorized; shares issued and outstanding: 12,583 at September 28, 2003 and 12,684 at December 29, 2002 | 84,713 | 85,036 | ||||||
Stockholder notes receivable | (500 | ) | (800 | ) | ||||
Accumulated other comprehensive loss | (101 | ) | (103 | ) | ||||
Accumulated deficit | (43,816 | ) | (40,366 | ) | ||||
Total stockholders’ equity | 40,296 | 43,767 | ||||||
Total liabilities and stockholders’ equity | $ | 70,474 | $ | 74,906 | ||||
See notes to condensed consolidated financial statements.
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HALL, KINION & ASSOCIATES, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except per share amounts)
(Unaudited)
| Three months ended | Nine months ended | |||||||||||||||
| September 28, 2003 | September 29, 2002 | September 28, 2003 | September 29, 2002 | |||||||||||||
Net revenues: | ||||||||||||||||
Contract services | $ | 40,623 | $ | 30,630 | $ | 119,875 | $ | 77,267 | ||||||||
Permanent placement | 1,085 | 1,313 | 3,423 | 4,005 | ||||||||||||
Total net revenues | 41,708 | 31,943 | 123,298 | 81,272 | ||||||||||||
Cost of contract services | 29,606 | 21,168 | 87,213 | 53,554 | ||||||||||||
Gross profit | 12,102 | 10,775 | 36,085 | 27,718 | ||||||||||||
Operating expenses: | ||||||||||||||||
Selling, general and administrative | 11,383 | 10,819 | 36,362 | 33,501 | ||||||||||||
Restructuring costs, net | 340 | (876 | ) | 2,906 | (876 | ) | ||||||||||
Income (loss) from operations | 379 | 832 | (3,183 | ) | (4,907 | ) | ||||||||||
Interest expense | (163 | ) | (67 | ) | (404 | ) | (76 | ) | ||||||||
Interest income | 2 | 58 | 32 | 311 | ||||||||||||
Other income/(expense), net | 10 | 9 | 105 | 43 | ||||||||||||
Net income (loss) before income taxes | 228 | 832 | (3,450 | ) | (4,629 | ) | ||||||||||
Income tax provision (benefit) | 588 | (1,634 | ) | |||||||||||||
Net income (loss) | $ | 228 | $ | 244 | $ | (3,450 | ) | $ | (2,995 | ) | ||||||
Net income (loss) per share: | ||||||||||||||||
Basic | $ | 0.02 | $ | 0.02 | $ | (0.27 | ) | $ | (0.23 | ) | ||||||
Diluted | $ | 0.02 | $ | 0.02 | $ | (0.27 | ) | $ | (0.23 | ) | ||||||
Shares used in per share computation: | ||||||||||||||||
Basic | 12,582 | 12,556 | 12,594 | 13,054 | ||||||||||||
Diluted | 12,753 | 12,627 | 12,594 | 13,054 | ||||||||||||
See notes to condensed consolidated financial statements.
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HALL, KINION & ASSOCIATES, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
(Unaudited)
| Nine months ended | ||||||||
| September 28, 2003 | September 29, 2002 | |||||||
Cash flows from operating activities: | ||||||||
Net loss | $ | (3,450 | ) | $ | (2,995 | ) | ||
Adjustments to reconcile net loss to net cash used for operating activities: | ||||||||
Depreciation and amortization | 2,425 | 2,731 | ||||||
Deferred income taxes | 2,365 | |||||||
Non-cash restructuring costs | 2,908 | (876 | ) | |||||
Stockholder note receivable forgiveness | 300 | 300 | ||||||
Changes in assets and liabilities: | ||||||||
Accounts receivable | (3,104 | ) | (3,479 | ) | ||||
Prepaid expenses and other assets | (1,580 | ) | (93 | ) | ||||
Accounts payable and accrued liabilities | (4,455 | ) | (5,187 | ) | ||||
Income taxes receivable | 928 | 5,987 | ||||||
Net cash used for operating activities | (6,028 | ) | (1,247 | ) | ||||
Cash flows from investing activities: | ||||||||
Maturity of investments | 8,200 | |||||||
Purchase of property and equipment | (368 | ) | (1,067 | ) | ||||
Cash paid for business acquisitions | (19,750 | ) | ||||||
Net cash used for investing activities | (368 | ) | (12,617 | ) | ||||
Cash flows provided by financing activities: | ||||||||
Borrowings from line of credit | 76,625 | 10,000 | ||||||
Repayments of line of credit | (75,721 | ) | ||||||
Repurchase of common stock | (324 | ) | (307 | ) | ||||
Proceeds from exercise of options | 404 | |||||||
Net cash provided by financing activities | 580 | 10,097 | ||||||
Net decrease in cash and cash equivalents | (5,816 | ) | (3,767 | ) | ||||
Cash and cash equivalents, beginning of period | 8,571 | 15,488 | ||||||
Cash and cash equivalents, end of period | $ | 2,755 | $ | 11,721 | ||||
Supplemental disclosures of cash flow information: | ||||||||
Cash paid during the period for: | ||||||||
Income taxes paid | $ | 84 | $ | 73 | ||||
Income taxes refunded | $ | (1,000 | ) | $ | (10,051 | ) | ||
Interest | $ | 343 | $ | 35 | ||||
Noncash investing and financing activities: | ||||||||
Common stock issued for business acquisition | $ | 2,240 | ||||||
Tax benefit related to stock options | $ | 88 | ||||||
See notes to condensed consolidated financial statements.
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HALL, KINION & ASSOCIATES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
1.Basis of Presentation.The condensed consolidated financial statements have been prepared by Hall, Kinion & Associates, Inc. (the Company) pursuant to the rules and regulations of the Securities and Exchange Commission (SEC). Certain information and note disclosures normally included in annual financial statements prepared in accordance with accounting principles generally accepted in the United States (GAAP) have been condensed or omitted pursuant to SEC rules or regulations; however, the Company believes that the disclosures made are adequate to make the information presented not misleading. You should review these condensed consolidated financial statements in conjunction with the consolidated financial statements and notes thereto included in the Company’s Form 10-K for the fiscal year ended December 29, 2002.
The unaudited interim financial information as of September 28, 2003 and for the three months and nine months ended September 28, 2003 and September 29, 2002 have been prepared in conformity with GAAP. In the opinion of management, such unaudited information includes all adjustments (consisting of normal recurring accruals plus certain adjustments disclosed in notes 5 and 6) necessary for a fair presentation of this information. Operating results for the three months and nine months ended September 28, 2003 are not necessarily indicative of the results that may be expected for the year ending December 28, 2003.
2.Stock Based Compensation. In December 2002, Statement of Financial Accounting Standards (“SFAS”) No. 148,Accounting for Stock-Based Compensation- Transition and Disclosurewas issued. This statement amends the previous standard, APB Opinion No. 25,Accounting for Stock-Based Compensation, to provide alternative methods of transition for an entity that voluntarily changes to a fair value based method of accounting for stock-based employee compensation and amends disclosure provisions of that standard to require prominent disclosure about the effects on reported net income of an entity’s accounting policy decisions with respect to such compensation. The Company intends to continue to account for stock-based compensation in accordance with APB Opinion No. 25 and will provide the prominent disclosures required.
At September 28, 2003, the Company had three stock-based employee compensation plans, all of which it accounts for under APB Opinion No. 25 and related interpretations. No stock-based employee compensation cost is reflected in net income (loss), as all options granted under those plans had an exercise price equal to the market value of the underlying common stock on the date of grant. The following table illustrates the effect on net income (loss) and earnings (loss) per share if the Company had applied the fair value recognition provisions of SFAS No. 123,Accounting for Stock-Based Compensation, to stock-based employee compensation:
| Three Months Ended | Nine Months Ended | |||||||||||||||
| September 28, 2003 | September 29, 2002 | September 28, 2003 | September 29, 2002 | |||||||||||||
| (in thousands, except per share amounts) | ||||||||||||||||
Net income (loss), as reported | $ | 228 | $ | 244 | $ | (3,450 | ) | $ | (2,995 | ) | ||||||
Deduct: Total stock-based employee compensation expense determined under fair value based method for all awards, net of related tax effects | (1,127 | ) | (1,888 | ) | (4,299 | ) | (8,524 | ) | ||||||||
Pro forma net loss | $ | (899 | ) | $ | (1,644 | ) | $ | (7,749 | ) | $ | (11,519 | ) | ||||
Earnings (loss) per share: | ||||||||||||||||
Basic—as reported | $ | 0.02 | $ | 0.02 | $ | (0.27 | ) | $ | (0.23 | ) | ||||||
Basic—pro forma | $ | (0.07 | ) | $ | (0.13 | ) | $ | (0.62 | ) | $ | (0.88 | ) | ||||
Diluted—as reported | $ | 0.02 | $ | 0.02 | $ | (0.27 | ) | $ | (0.23 | ) | ||||||
Diluted—pro forma | $ | (0.07 | ) | $ | (0.13 | ) | $ | (0.62 | ) | $ | (0.89 | ) | ||||
3. Line of Credit. The Company entered into an agreement dated June 13, 2003 with CIT Business Credit for a new three-year renewable credit facility of $16 million that replaced an existing credit facility of $12 million and is used primarily to fund operations. Significant terms and conditions of the agreement are as follows:
| • | Availability is determined by the lesser of (i) 85% of eligible accounts receivable, less certain receivable balances as defined in the agreement that totaled $5.5 million as of September 28, 2003, (ii) cash collected during the most recent 45-day period, or (iii) the full amount of the facility, less letters of credit and certain payables as defined in the agreement that totaled approximately $327,000 as of September 28, 2003. |
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| • | Interest is at prime plus 1.25% and starting June 27, 2004, the interest rate may be reduced to a rate that is as low as prime plus 0.5%, contingent upon the Company meeting specified levels of profitability. |
| • | Financial covenants require meeting specific ratios of fixed charge coverage and maintaining a minimum combined average balance of cash and credit line availability of $2 million, calculated on a monthly basis. |
| • | Borrowings are collateralized by all of the Company’s assets. |
| • | The Company may not declare or pay any dividends or distribution of any kind nor acquire, redeem, or retire any of its own capital stock. |
| • | A bank lockbox was established, whereby all Company cash receipts are first applied to the line of credit. |
As of September 28, 2003, outstanding borrowings under the line of credit were $10,904,000 and additional available borrowings were $2,620,000.
4.Restricted Cash. Approximately $954,000 of restricted cash to cover outstanding letters of credit related to leases and self-insurance programs is reflected on the condensed consolidated balance sheet as of September 28, 2003 under deferred income taxes and other assets.
5.Restructuring Costs.During the quarter ended March 30, 2003, the Company closed 13 offices and terminated the employment of 69 employees and recorded a restructuring charge of $2,261,000 that consisted of $1,551,000 of lease termination costs, $517,000 of severance and other costs, and $193,000 for asset impairment. During the quarter ended June 29, 2003, the Company closed its London and Seattle offices and reduced management positions, recording a charge of $830,000, which consisted of $204,000 for lease termination costs, $522,000 for severance and other costs, and $104,000 for asset impairment. These costs were partially offset by favorable adjustments of $525,000 in the second quarter of 2003 resulting from finalizing certain lease termination, severance, and other liabilities accrued in prior years. During the quarter ended September 28, 2003, the Company recorded a charge to restructuring of $340,000 resulting primarily from lower than anticipated sublease income for sales office closures during the first and second quarters of 2003. The remaining restructuring costs are anticipated to be paid out during the next twelve months, except for the rental payments related to long-term facility leases that require settlement in 2004 and beyond and are reserved as non-current restructuring costs.
The reserve for restructuring costs as of September 28, 2003 is as follows:
| Lease Termination Costs | Severance and Other Costs | Total | ||||||||||
| (in thousands) | ||||||||||||
Balance as of December 29, 2002 | $ | 5,495 | $ | 674 | $ | 6,169 | ||||||
Additions | 1,551 | 517 | 2,068 | |||||||||
Paid | (670 | ) | (676 | ) | (1,346 | ) | ||||||
Balance as of March 30, 2003 | 6,376 | 515 | 6,891 | |||||||||
Additions | 204 | 522 | 726 | |||||||||
Paid | (1,064 | ) | (466 | ) | (1,530 | ) | ||||||
Adjustments | 4 | (529 | ) | (525 | ) | |||||||
Balance as of June 29, 2003 | 5,520 | 42 | 5,562 | |||||||||
Additions | — | — | — | |||||||||
Paid | (992 | ) | (20 | ) | (1,012 | ) | ||||||
Adjustments | 340 | — | 340 | |||||||||
Balance as of September 28, 2003 | $ | 4,868 | $ | 22 | $ | 4,890 | ||||||
6. Change in Accounting Estimate Related to Employment Agreement.The Company has an employment agreement with its Chief Executive Officer (“CEO”) entered into on January 1, 2001. Under the terms of the agreement, upon the CEO becoming Chairman Emeritus, she will receive a payment equal to three times her base salary and bonus paid for the immediately preceding year. From 2001 through June 30, 2003, management had estimated such compensation accrual based upon its expectation that the maximum bonus allowable under the agreement would be paid. During the quarter ended September 28, 2003, management changed its estimate to reflect its belief that no bonus would be paid or is payable to the CEO. As a result of this change in accounting estimate, the Company recognized income of $696,000 that is reflected as a reduction in selling, general and administrative expenses in the three months and nine months ended September 28, 2003.
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7. Net Income (Loss) per Share. Basic net income (loss) per share is calculated using only the weighted average number of common shares outstanding. Diluted net income (loss) per share also includes in the calculation the dilution that could occur if convertible securities and contracts to issue common stock were converted or exercised. In calculating the net income (loss) per share for the three months ended September 28, 2003 and September 29, 2002, 3,725,000 and 2,855,000 options, respectively, were excluded because they are antidilutive. For the nine months ended September 28, 2003 and September 29, 2002, 3,988,000 and 3,196,000 options, respectively, were excluded because they are antidilutive.
A reconciliation of basic weighted average common shares to diluted weighted average common shares follows:
| Three Months Ended | Nine Months Ended | |||||||
| September 28, 2003 | September 29, 2002 | September 28, 2003 | September 29, 2002 | |||||
| (in thousands) | ||||||||
Basic weighted average common shares outstanding | 12,582 | 12,556 | 12,594 | 13,054 | ||||
Common stock equivalents—Stock options | 171 | 71 | — | — | ||||
Diluted weighted average common shares outstanding | 12,753 | 12,627 | 12,594 | 13,054 | ||||
8.Comprehensive Loss.SFAS No. 130,Reporting Comprehensive Income, requires reporting by major components and as a single total, the change in the Company’s net assets during the period from nonowner sources. For the three months and nine months ended September 28, 2003 and September 29, 2002, the components of comprehensive income (loss), net of tax, are as follows:
| Three Months Ended | Nine Months Ended | |||||||||||||
| September 28, 2003 | September 29, 2002 | September 28, 2003 | September 29, 2002 | |||||||||||
| (in thousands) | ||||||||||||||
Reported net income (loss) | $ | 228 | $ | 244 | $ | (3,450 | ) | $ | (2,995 | ) | ||||
Other comprehensive income: | ||||||||||||||
Change in net unrealized gains on investments and foreign currency translation adjustments | — | — | 2 | 3 | ||||||||||
Total comprehensive income (loss) | $ | 228 | $ | 244 | $ | (3,448 | ) | $ | (2,992 | ) | ||||
9.Acquisition of OnStaff. On August 9, 2002, the Company acquired certain net assets and assumed certain liabilities of OnStaff, a privately held group of companies that provided temporary and full-time employees in the real estate, finance and healthcare industries. In addition to the purchase price of $22.1 million, the Company agreed to pay OnStaff up to $13.0 million over three years, contingent upon the achievement of certain milestones.
The following pro forma information is based upon the historical results of the Company and OnStaff as if the acquisition had occurred on January 1, 2002:
| Three Months Ended September 29, 2002 | Nine Months Ended September 29, 2002 | |||||||
| (in thousands, except per share amounts) | ||||||||
Net revenues | $ | 35,377 | $ | 103,958 | ||||
Net loss | $ | (8 | ) | $ | (4,873 | ) | ||
Diluted loss per share | $ | (0.00 | ) | $ | (0.37 | ) | ||
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10.Business Segment Reporting.The Company’s operations are divided into two business segments, Contract Professional Staffing and Permanent Placement Services. The Contract Professional Staffing segment provides temporary staffing to clients on a contract basis. The cost of revenues for this segment is the salaries, employment taxes and other direct labor costs for the contracted employees. The Permanent Placement Services segment recruits and delivers professionals for direct hire by our clients. This segment has no cost of revenues; all expenses are included in operating costs. Management evaluates segment performance based primarily on segment revenues, cost of revenue, and gross profit. The Company does not segregate its assets by business segments. Results of operations by business segments are as follows:
| Three Months Ended | Nine Months Ended | |||||||||||
| September 28, 2003 | September 29, 2002 | September 28, 2003 | September 29, 2002 | |||||||||
| (in thousands) | ||||||||||||
Contract Services: | ||||||||||||
Net revenues | $ | 40,623 | $ | 30,630 | $ | 119,875 | $ | 77,267 | ||||
Cost of revenues | 29,606 | 21,168 | 87,213 | 53,554 | ||||||||
Gross Profit | $ | 11,017 | $ | 9,462 | $ | 32,662 | $ | 23,713 | ||||
Permanent Placement: | ||||||||||||
Net revenues | $ | 1,085 | $ | 1,313 | $ | 3,423 | $ | 4,005 | ||||
Cost of revenues | — | — | — | — | ||||||||
Gross Profit | $ | 1,085 | $ | 1,313 | $ | 3,423 | $ | 4,005 | ||||
ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
GENERAL
The following discussion and analysis describes the principal factors affecting the results of operations, liquidity, and capital resources of the Company. This discussion should be read in conjunction with the accompanying condensed consolidated financial statements and our Annual Report on Form 10-K for the year ended December 29, 2002 which include additional information about significant accounting policies, practices, and transactions that underlie our financial results.
We source and deliver the most critical component of industry—human capital. As a leading talent source, we provide specialized professionals on a short-term contract and permanent basis primarily to clients in information technology (in technology and other industries), real estate (title, escrow, and mortgage lending), consumer finance, and healthcare. As of September 28, 2003, we had 54 offices in 47 cities.
The key factors that affect our operating results include the demand for and number of temporary employees placed in our target markets (and consequently the economic conditions in those markets), the rate of change in information technology and the impact it has on staffing demands and structure, interest rates as they affect the real estate industry, competitive pressures within the staffing industry and their impact on temporary staffing rates and gross margins, the quality of our recruitment and sales staff and their ability to find and place candidates, and our ability to manage our cost structure and operating costs.
SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS
Some of the statements under Management’s Discussion and Analysis of Financial Condition and Results of Operations and elsewhere in this report constitute forward-looking statements that involve substantial uncertainties. These statements include, among others, statements concerning the following:
| • | our business and growth strategies; |
| • | the markets we serve; and |
| • | financing and liquidity. |
We have based these forward-looking statements on our current expectations and projections about future events. In some cases, you can identify forward-looking statements by terms such as “may”, “hope”, “will”, “should”, “expect”, “plan”, “anticipate”, “intend”, “believe”, “estimate”, “predict”, “potential” or “continue”, the negative of these terms or other comparable terminology. The forward-looking statements contained in this report involve known and unknown risks, uncertainties and other factors that may cause industry trends or our actual results, performance or achievements to be materially different from any future trends, results, performance or achievements expressed or implied by these statements. These factors include, among others, the rate of hiring and productivity of sales and sales support personnel, the availability of and changes in demand for qualified professionals for temporary or permanent placement, changes in the general economic conditions of the North American markets as well as the regional markets in which the Company operates, changes in the demand for mortgages which are affected by interest rates, housing prices and other economic conditions, changes in the relative mix between our contract services and permanent placement services, changes in the
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pricing of our services, the timing and rate of entrance into and exit from vertical and geographic markets, the addition or closing of offices, the structure and timing of acquisitions, and others listed under “Risk Factors”, elsewhere in this report, and in our other Securities and Exchange Commission filings. See Management’s Discussion and Analysis of Financial Condition and Results of Operations in our Form 10-K for information regarding critical accounting policies and estimates.
We cannot guarantee future results, performance or achievements. We do not intend to update this report to conform any forward-looking statements to actual results. You should not place undue reliance on these forward-looking statements, which apply only as of the date of this report.
OVERVIEW
Our Contract Services group provides specialized corporate professionals on a short-term contract basis and accounted for 97.4% and 97.2% of our net revenues for the three months and nine months ended September 28, 2003 and 95.9% and 95.1% for the three months and nine months ended September 29, 2002, respectively. Our Permanent Placement Services group provides specialized information technology and other professionals on a permanent basis and accounted for 2.6% and 2.8% of net revenues for the three months and nine months ended September 28, 2003 and 4.1% and 4.9% for the three months and nine months ended September 29, 2002.
Our net revenues are derived principally from the hourly billings of our corporate professionals on contract assignments and from fees received for permanent placements. Contract services assignments typically last four to nine months, and revenues are recognized as services are provided. We derive contract services revenues when our consultants are working, and therefore our operating results may be adversely affected when client facilities are closed due to holidays or inclement weather. As a result, we typically experience relatively lower net revenues in our first and fourth fiscal quarter compared to our other fiscal quarters. We derive permanent placement revenues upon permanent placement of each corporate professional candidate. The fee is typically structured as a percentage of the placed professional’s first-year annual compensation. Permanent placement revenues are recognized when a corporate professional commences employment or, in the case of retained searches, upon completion of our contractual obligations. We have a broad client base and no single customer provided more than 8% of our total net revenues during the three months and nine months ended September 28, 2003.
Primarily as a result of the acquisition of OnStaff in August 2002, we reported an increase in net revenues and gross profit in the third quarter of 2003 and for the nine months ended September 28, 2003. Because OnStaff assets were acquired in August 2002, two months of OnStaff operations are included in our results for the three months and nine months ended September 29, 2002 while OnStaff operations are included for the entire three and nine month periods ended September 28, 2003. Net revenues increased to $41.7 million for the three months ended September 28, 2003 from $31.9 million for the three months ended September 29, 2002, representing a 30.7% increase. OnStaff contributed $21.0 million of the net revenues for the three months ended September 28, 2003 compared to $8.3 million for the two months it was operating as part of our Company in the three months ended September 29, 2002. For the nine months ended September 28, 2003 and September 29, 2002, net revenues were $123.3 million and $81.3 million, respectively, a 51.7% increase. OnStaff contributed $59.2 million of the net revenues during the first nine months in 2003 compared to $8.3 million for the similar period in 2002. The number of contract employees placed with our clients increased 8.1%, from 2,425 as of September 29, 2002 to 2,621 as of September 28, 2003. The higher net revenues and increase in contract employees were obtained and serviced while decreasing sales, sales support, and administrative staffing 21.5% from 376 on September 29, 2002 to 295 on September 28, 2003.
Results of Operations for the Three Months and Nine Months Ended September 28, 2003 and September 29, 2002
Net Revenues
Net revenues increased 30.7% to $41.7 million for the three months ended September 28, 2003 from $31.9 million for the three months ended September 29, 2002. Net revenues from our Contract Services group increased 32.7% to $40.6 million for the three months ended September 28, 2003 from $30.6 million for the three months ended September 29, 2002. Net revenues from our Permanent Placement Services group were $1.1 million for the three months ended September 28, 2003 and $1.3 million for the three months ended September 29, 2002. For the nine months ended September 28, 2003, net revenues increased 51.7% to $123.3 million from $81.3 million for the nine months ended September 29, 2002. Net revenues from our Contract Services group increased 55.1% to $119.9 million for the nine months ended September 28, 2003 from $77.3 million for the nine months ended September 29, 2002. Net revenues from our Permanent Placement Services group were $3.4 million for the nine months ended September 28, 2003 and $4.0 million for the nine months ended September 29, 2002. The increase in net revenues from our Contract Services group for both the three and nine months ended September 28, 2003 was due to the acquisition of OnStaff in August 2002.
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Gross Profit
Gross profit for our Contract Services group represents revenues less direct costs of services, which consist of direct payroll, payroll taxes, and insurance and benefit costs for IT and corporate professionals. Gross profit for our Permanent Placement Services group is essentially equal to revenues, since there are no direct costs associated with such revenues. Gross profit was $12.1 million or 29.0% of net revenues for the three months ended September 28, 2003 compared to $10.8 million or 33.9% of net revenues for the three months ended September 29, 2002. Gross profit was $36.1 million or 29.3% of net revenues for the nine months ended September 28, 2003 compared to $27.7 million or 34.1% of net revenues for the nine months ended September 29, 2002. Gross profit increased in 2003 for both periods due to the addition of OnStaff. Gross margin percentages decreased for both periods due to the addition of OnStaff with lower Contract Services gross margin rates, a decline in Permanent Placement Services, and lower margins on IT Contract Services.
Operating Expenses
Operating expenses consist primarily of employee and facilities costs. Operating expenses were $11.7 million for the three months ended September 28, 2003 compared to $9.9 million for the three months ended September 29, 2002. Operating expenses increased $1.8 million or 18.2% over the same quarter last year primarily as a result of the acquisition of OnStaff, partially offset by Technology Professional Division staff and sales office cost reductions. Operating expenses for the three months ended September 28, 2003 included a favorable adjustment of $696,000 due to a change in estimate for the bonus liability to the Company’s Chief Executive Officer, partially offset by net restructuring costs of $340,000 related to an adjustment to sublease income. For the nine months ended September 28, 2003, operating expenses increased by 20.6% to $39.3 million compared to $32.6 million for the nine months ended September 29, 2002. The $6.7 million increase for that period was due to the acquisition of OnStaff and costs incurred restructuring the Technology Professional Division, partially offset by Technology Professional Division staff and sales office cost reductions and a further cost reduction of $696,000 due to a change in estimate for the bonus liability to the Company’s Chief Executive Officer. Operating expenses as a percentage of net revenues decreased to 28.1% for the three months ended September 28, 2003 from 31.0% for the three months ended September 29, 2002. For the nine months ended on September 28, 2003 and September 29, 2002, operating expenses as a percentage of net revenues decreased to 31.9% from 40.1%. The restructuring charges related to office closures in the first and second quarters of 2003. During the quarter ended March 30, 2003, the Company closed 13 offices and terminated the employment of 69 employees and recorded a restructuring charge of $2.3 million that consisted of $1.6 million of lease termination costs, $517,000 of severance and other costs, and $193,000 for asset impairment. During the quarter ended June 29, 2003, the Company closed its London and Seattle sales offices and reduced management positions, recording a charge of $830,000, which consisted of $204,000 for lease termination costs, $522,000 for severance and other costs, and $104,000 for asset impairment. These costs were partially offset by a favorable adjustment of $525,000 in the second quarter of 2003 resulting from finalizing certain lease termination, severance, and other liabilities accrued in prior years. During the quarter ended September 28, 2003, the Company recorded a charge to restructuring of $340,000 relating primarily to the adjustment to sublease income.
Interest Expense, Interest Income, and Other Income/(Expense)
Interest expense increased $96,000 for the three months ended September 28, 2003 compared to the three months ended September 29, 2002 and increased $328,000 for the nine months ended September 28, 2003 compared to the nine months ended September 29, 2002, as a result of the debt incurred to fund the addition of OnStaff.
Interest income decreased $56,000 for the three months ended September 28, 2003 compared to the three months ended September 29, 2002 and decreased $279,000 for the nine months ended September 28, 2003 compared to the nine months ended September 29, 2002, as a result of the cash used to fund the addition of OnStaff.
For the nine months ended September 28, 2003, other income (expense) increased $62,000 compared to the nine months ended September 29, 2002 primarily as a result of a net increase of $78,000 earned on the deferred compensation plan.
Income Taxes
No income tax benefit was recorded for the nine months ended September 28, 2003. The Company recorded a 100% valuation allowance against the income tax benefit due to the uncertainty of realizing such net operating loss carryforwards. Management currently expects to record no income tax benefit or provision for the fiscal year ending December 28, 2003. The effective tax rate for the three months and nine months ended September 29, 2002 was 40.7%.
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Net Income (Loss)
Net income for the three months ended September 28, 2003 was $228,000. Net income for the comparable three months period in 2002 was $244,000. The net loss for the nine months ended September 28, 2003 was $3.4 million, primarily due to restructuring costs of $2.9 million. The net loss for the comparable nine-month period in 2002 was $3.0 million.
LIQUIDITY AND CAPITAL RESOURCES
Historically, we funded our operations and working capital needs through cash generated from operations, periodically supplemented by borrowings under a revolving line of credit. Our operating activities used $6.0 million for the nine months ended September 28, 2003. The use of these funds is primarily attributable to funding a $3.1 million increase in accounts receivable related to increased revenue and a decrease of $5.6 million in accrued liabilities, primarily from restructuring.
Net cash used by investing activities for the nine months ended September 28, 2003 was $0.4 million, primarily reflecting payments for software licenses and leasehold improvements.
Net cash provided by financing activities for the nine months ended September 28, 2003 was $0.6 million, primarily reflecting net additional borrowing on the credit line. The Company’s banking arrangement requires that all cash deposits received be applied to reduce the outstanding balance on the bank line of credit. The Company then draws against the available line of credit the estimated amount required for operations.
The Company entered into an agreement dated June 13, 2003 with CIT Business Credit for a new three-year renewable credit facility of $16 million that replaced an existing credit facility of $12 million and is used primarily to fund operations. Significant terms and conditions of the agreement are as follows:
| • | Availability is determined by the lesser of (i) 85% of eligible accounts receivable, less certain receivable balances as defined in the agreement that totaled $5.5 million as of September 28, 2003, (ii) cash collected during the most recent 45-day period, or (iii) the full amount of the facility, less letters of credit and certain payables as defined in the agreement that totaled approximately $327,000 as of September 28, 2003. |
| • | Interest is at prime plus 1.25% and starting June 27, 2004, the interest may be reduced to a rate that is as low as prime plus 0.5%, contingent upon the Company meeting specified levels of profitability. |
| • | Financial covenants require meeting specific ratios of fixed charge coverage and maintaining a minimum combined average balance of cash and credit line availability of $2 million, calculated on a monthly basis. |
| • | Borrowings are collateralized by all of the Company’s assets. |
| • | The Company may not declare or pay any dividends or distribution of any kind nor acquire, redeem, or retire any of its own capital stock. |
| • | A bank lockbox was established, whereby all Company cash receipts are first applied to the line of credit. |
As of September 28, 2003, outstanding borrowings under the line of credit were $10,904,000 and additional available borrowings were $2,620,000.
The Company expects to be able to fund current operations from cash flow from operations, its existing credit facility, and securing additional availability under the line of credit from the sale of real property not currently used in the operation of the business. The OnStaff acquisition agreement provides for an earnout with payments over a three-year period provided that certain revenue, gross margin, earnings and productivity targets are satisfied. The first earnout period will end on December 28, 2003, with payment of any earnout due on February 15, 2004. The maximum earnout payment for the first period is $4.3 million. If the maximum payment is earned, the Company will likely need to seek additional sources of funds in order to make the payment. The Company’s cash flow is not sufficient to fund operations and cover the payment of the earnout. No additional sources of liquidity have been identified, and no assurance can be given that additional financing will be available.
Item 3. Quantitative and Qualitative Disclosures About Market Risk
There have been no material changes since disclosures made in our Form 10-K for year ended December 29, 2002.
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Item 4. Controls and Procedures
We carried out an evaluation required by Rule 13a-15(b) of the Securities Exchange Act of 1934, under the supervision and with the participation of our principal executive officer and principal financial officer, of the effectiveness of the design and operation of our disclosure controls and procedures as of the end of the period covered by this report. Based on this evaluation, our principal executive officer and principal financial officer concluded that our disclosure controls and procedures are effective in timely alerting them to material information required to be included in our periodic SEC reports. During the most recent fiscal quarter, there has not occurred any change in our internal control over financial reporting that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
We are from time to time engaged in or threatened with litigation in the ordinary course of our business. We are not currently a party to any material litigation.
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits:
| 2.1 | OSI Asset Purchase Agreement by and among Hall, Kinion & Associates, Inc. and OnStaff Acquisition Corp., on the one hand, and OnStaff, Jeffrey A. Evans, Matthew Johnston Grantor Retained Annuity Trust dated April 23, 2001, Diane Prince Johnston Grantor Retained Annuity Trust dated April 23, 2001, Matthew and Diane Johnston 2001 Irrevocable Gift Trust dated April 23, 2001, Johnston Living Trust dated March 27, 2001 and Matthew Johnston, as Seller Representative, on the other hand, dated August 9, 2002, incorporated by reference to exhibit 2.1 to the Company’s Report on Form 8-K dated August 23, 2002. | |
| 2.2 | HCSR Asset Purchase by and among Hall, Kinion & Associates, Inc. and OnStaff Acquisition Corp., on the one hand, and Healthcare Staffing Resources, Jeffrey A. Evans, Matthew Johnston Grantor Retained Annuity Trust dated April 23, 2001, Diane Prince Johnston Grantor Retained Annuity Trust dated April 23, 2001, Matthew and Diane Johnston 2001 Irrevocable Gift Trust dated April 23, 2001, Johnston Living Trust dated March 27, 2001 and Matthew Johnston, as Seller Representative, on the other hand, dated August 9, 2002, incorporated by reference to exhibit 2.2 to the Company’s Report on Form 8-K dated August 23, 2002. | |
| 2.3 | BNI Asset Purchase Agreement by and among Hall, Kinion & Associates, Inc. and OnStaff Acquisition Corp., on the one hand, and Boardnetwork.com, Jeffrey A. Evans, Matthew Johnston Grantor Retained Annuity Trust dated April 23, 2001, Diane Prince Johnston Grantor Retained Annuity Trust dated April 23, 2001, Matthew and Diane Johnston 2001 Irrevocable Gift Trust dated April 23, 2001, Johnston Living Trust dated March 27, 2001 and Matthew Johnston, as Seller Representative, on the other hand, dated August 9, 2002, incorporated by reference to exhibit 2.3 to the Company’s Report on Form 8-K dated August 23, 2002. | |
| 3.1 | Amended and Restated Certificate of Incorporation of the Registrant filed August 8, 1997, incorporated by reference to exhibit 3.2 to the Registrant’s Registration Statement on Form S-1, as amended, declared effective by the Securities and Exchange Commission on August 4, 1997. | |
| 4.1 | Investors’ Rights Agreement, dated January 26, 1996, among the Registrant, certain stockholders and investors named therein, incorporated by reference to exhibit 4.2 to the Registrant’s Registration Statement on Form S-1, as amended, declared effective by the Securities and Exchange Commission on August 4, 1997. | |
| 4.2 | Specimen Common Stock certificate, incorporated by reference to exhibit 4.4 to the Registrant’s Registration Statement on Form S-1, as amended, declared effective by the Securities and Exchange Commission on August 4, 1997. | |
| 4.3 | Registration Rights Agreement incorporated by reference to exhibit 4.4 to the Company’s Report on Form 8-K dated August 23, 2002. | |
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| 10.1 | Form of Indemnification Agreement entered into between the Registrant and each of its directors and certain officers, incorporated by reference to exhibit 10.1 to the Registrant’s Registration Statement on Form S-1, as amended, declared effective by the Securities and Exchange Commission on August 4, 1997. | |
| 10.2 | The Registrant’s 1997 Stock Option Plan, incorporated by reference to exhibit 10.2 to the Registrant’s Registration Statement on Form S-1, as amended, declared effective by the Securities and Exchange Commission on August 4, 1997. | |
| 10.3 | The Registrant’s Employee Stock Purchase Plan, incorporated by reference to exhibit 10.3 to the Registrant’s Registration Statement on Form S-1, as amended, declared effective by the Securities and Exchange Commission on August 4, 1997. | |
| 10.4 | Promissory Note Secured by Deed of Trust, dated August 5, 1996, made by Rita S. Hazell and Quentin D. Hazell in favor of the Registrant, incorporated by reference to exhibit 10.23 to the Registrant’s Registration Statement on Form S-1, as amended, declared effective by the Securities and Exchange Commission on August 4, 1997. | |
| 10.5 | Employment Agreement dated January 1, 2001 between the Registrant and Brenda C. Rhodes, incorporated by reference to exhibit 10.14 to the Registrant’s Report on Form 10-Q, filed August 15, 2001. | |
| 10.6 | Promissory Note dated January 25, 1999 made by Brenda C. Rhodes in favor of the Registrant, incorporated by reference to exhibit 10.15 to the Registrant’s Report on Form 10-Q, filed August 15, 2001. | |
| 10.7 | The Registrant’s 2000 Stock Option Plan, incorporated by reference to exhibit 4.0 to the Registrant’s Registration Statement on Form S-8, declared effective by the Securities and Exchange Commission on June 9, 2000. | |
| 10.8 | The Registrant’s E2 Equity Edge Cash Equity Plan, incorporated by reference to exhibit 10.19 to the Registrant’s Report on Form 10-K filed March 27, 2001. | |
| 10.9 | Employment and Non-Competition Agreement dated August 9, 2002 between the Registrant and Jeffrey A. Evans, incorporated by reference to exhibit 10.13 filed with the Company’s Report on Form 10-K filed March 31, 2003. | |
| 10.10 | Financing and Security Agreement between the Registrant and The CIT Group/Business Credit, Inc., incorporated by reference to exhibit 99.2 to the Registrant’s Report on Form 8-K, filed June 23, 2003. | |
| 10.11 | Restated Offer Letter dated July 31, 2003 between the Registrant and Rita Hazell. | |
| 10.12 | Restated Offer Letter dated July 31, 2003 between the Registrant and Martin A. Kropelnicki. | |
| 21.1 | Subsidiaries of the Registrant, incorporated by reference to exhibit 21.1 filed with the Company’s Report on Form 10-K filed March 31, 2003. | |
| 31.1 | Certification of Chief Executive Officer Pursuant to Section 302(a) of the Sarbanes-Oxley Act of 2002. | |
| 31.2 | Certification of Chief Financial Officer Pursuant to Section 302(a) of the Sarbanes-Oxley Act of 2002. | |
| 32 | Certification of Chief Executive and Chief Financial Officers pursuant to 18 U. S. C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. | |
(b) Reports on Form 8-K:
On October 29, 2003 we filed a Report on Form 8-K announcing financial results for the third quarter ended September 28, 2003.
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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.
HALL, KINION & ASSOCIATES, INC. | ||
By: | /s/ MARTIN A. KROPELNICKI | |
Martin A. Kropelnicki Vice President, Corporate Services and Chief Financial Officer (Duly Authorized Officer and Principal Financial Officer) | ||
Date: November 12, 2003
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