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 30, 2001
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 0-26094
SOS STAFFING SERVICES, INC.
------------------------------------------------------
(Exact name of registrant as specified in its charter)
Utah 87-0295503
--------------------------- -----------------------
(State or other jurisdiction (I.R.S. Employer ID No.)
of incorporation)
1415 South Main Street
Salt Lake City, Utah 84115
(Address of principal executive offices)
(801) 484-4400
(Telephone number)
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 and 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 filings requirements for the past 90 days.
Yes____X______ No___________
Indicate the number of shares outstanding of each of the issuer's classes
of common stock, as
of the latest practicable date.
Class of Common Stock Outstanding at November 9, 2001
----------------------------- -------------------------------
Common Stock, $0.01 par value 12,691,398
1
TABLE OF CONTENTS
PART I - FINANCIAL INFORMATION
Item 1. Financial Statements
Condensed Consolidated Balance Sheets
As of September 30, 2001 and December 31, 2000 3
Condensed Consolidated Statements of Operations
For the 13- and 39-week periods ended September 30, 2001 and October 1, 2000 5
Condensed Consolidated Statements of Cash Flows
For the 39-week periods ended September 30, 2001 and October 1, 2000 6
Notes to Condensed Consolidated Financial Statements 8
Item 2. Management's Discussion and Analysis
of Financial Condition and Results of Operations 15
Item 3. Qualitative and Quantitative Disclosures About Market Risk 24
PART II - OTHER INFORMATION
Item 1. Legal Proceedings 25
Item 4. Submission of Matters to a Vote of Security Holders 25
Item 6. Exhibits and Reports on Form 8-K 25
Signatures 26
2
The accompanying notes to condensed consolidated
financial statements are an integral part of these
condensed consolidated balance sheets.
4
PART I - FINANCIAL INFORMATION
Item 1. Financial Statements
SOS STAFFING SERVICES, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(Unaudited)
ASSETS
------
(in thousands)
September 30, December 31,
2001 2000
--------- ---------
CURRENT ASSETS
Cash and cash equivalents $ 1,953 $ 1,185
Accounts receivable, less allowances of
$2,384 and $2,916, respectively 28,364 44,488
Current portion of workers' compensation deposit 273 213
Prepaid expenses and other 1,101 1,032
Current deferred income tax asset 3,408 5,852
Income tax receivable 126 8,088
--------- ---------
Total current assets 35,225 60,858
--------- ---------
PROPERTY AND EQUIPMENT, at cost
Computer equipment 6,045 3,935
Office equipment 4,048 4,009
Leasehold improvements and other 1,926 1,834
--------- ---------
12,019 9,778
Less accumulated depreciation and amortization (6,856) (5,456)
--------- ---------
Total property and equipment, net 5,163 4,322
--------- ---------
OTHER ASSETS
Intangible assets, less accumulated amortization
of $13,994 and $14,979, respectively 58,721 92,007
Deferred income tax asset, long-term 4,557 --
Notes receivable, less reserves
of $3,421 and $0, respectively -- 1,000
Deposits and other assets 1,735 3,201
--------- ---------
Total other assets 65,013 96,208
--------- ---------
Total assets $ 105,401 $ 161,388
--------- ---------
The accompanying notes to condensed consolidated
financial statements are an integral part of these
condensed consolidated balance sheets.
3
SOS STAFFING SERVICES, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS (Continued)
(Unaudited)
LIABILITIES AND SHAREHOLDERS' EQUITY
(in thousands)
September 30, December 31,
2001 2000
--------- ---------
CURRENT LIABILITIES
Line of credit $ 4,149 $ 9,000
Current portion of notes payable 75 8,273
Accounts payable 772 2,667
Accrued payroll costs 3,859 10,196
Current portion of workers'
compensation reserve 4,267 4,689
Accrued liabilities 6,020 5,966
Accrued acquisition earnouts -- 55
--------- ---------
Total current liabilities 19,142 40,846
--------- ---------
LONG-TERM LIABILITIES
Notes payable, less current portion 29,020 27,000
Workers' compensation reserve,
less current portion 969 1,064
Deferred income tax liability -- 652
Deferred compensation liabilities 675 941
--------- ---------
Total long-term liabilities 30,664 29,657
--------- ---------
SHAREHOLDERS' EQUITY
Common stock 127 127
Additional paid-in capital 91,693 91,693
Accumulated deficit (36,225) (935)
--------- ---------
Total shareholders' equity 55,595 90,885
--------- ---------
Total liabilities and shareholders' equity $ 105,401 $ 161,388
--------- ---------
The accompanying notes to condensed consolidated
financial statements are an integral part of these
condensed consolidated balance sheets.
4
SOS STAFFING SERVICES, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
(in thousands, except per share data)
13 Weeks Ended 39 Weeks Ended
September 30, October 1, September 30, October 1,
2001 2000 2001 2000
--------------- --------------- ---------------- ---------------
SERVICE REVENUES $ 69,660 $ 86,904 $ 205,974 $ 252,628
DIRECT COST OF SERVICES 55,622 66,775 162,706 195,802
--------------- --------------- ---------------- ---------------
Gross profit 14,038 20,129 43,268 56,826
--------------- --------------- ---------------- ---------------
OPERATING EXPENSES:
Selling, general and administrative 12,178 14,873 37,179 46,095
Restructuring charges 204 -- 1,430 --
Intangible amortization 967 1,037 2,926 3,192
Loss from impairment of intangibles 32,526 -- 32,526 --
--------------- --------------- ---------------- ---------------
Total operating expenses 45,875 15,910 74,061 49,287
--------------- --------------- ---------------- ---------------
(LOSS) INCOME FROM OPERATIONS (31,837) 4,219 (30,793) 7,539
OTHER EXPENSE (759) (997) (2,239) (3,124)
--------------- --------------- ---------------- ---------------
(LOSS) INCOME BEFORE INCOME TAXES (32,596) 3,222 (33,032) 4,415
INCOME TAX BENEFIT (PROVISION) 477 (1,300) 672 (1,708)
--------------- --------------- ---------------- ---------------
(LOSS) INCOME FROM CONTINUING OPERATIONS (32,119) 1,922 (32,360) 2,707
LOSS FROM DISCONTINUED OPERATIONS (net of income tax benefit)
(Note 3) (259) (432) (2,930) (1,417)
--------------- --------------- ---------------- ---------------
NET (LOSS) INCOME $ (32,378) $ 1,490 $ (35,290) $ 1,290
--------------- --------------- ---------------- ---------------
BASIC AND DILUTED (LOSS) INCOME PER COMMON SHARE:
(Loss) income from continuing operations $ (2.53) $ 0.15 $ (2.55) $ 0.21
Loss from discontinued operations (0.02) (0.03) (0.23) (0.11)
--------------- --------------- ---------------- ---------------
Net (loss) income $ (2.55) $ 0.12 $ (2.78) $ 0.10
--------------- --------------- ---------------- ---------------
WEIGHTED AVERAGE COMMON SHARES:
Basic and diluted 12,691 12,691 12,691 12,691
The accompanying notes to condensed consolidated
financial statements are an integral part of these
condensed consolidated statements.
5
SOS STAFFING SERVICES, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
(in thousands)
39 Weeks Ended
September 30, 2001 October 1, 2000
------------------ ---------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net (loss) income $(35,290) $ 1,291
Adjustments to reconcile net (loss) income
to net cash provided by operating activities:
Depreciation and amortization 4,486 6,435
Loss on impairment of intangibles 32,526 --
Deferred income taxes (2,765) 205
Loss on disposition of assets 77 14
Loss on disposal of discontinued operations 3,421 --
Changes in operating assets and liabilities:
Accounts receivable, net 16,124 (4,410)
Workers' compensation deposit (60) 361
Prepaid expenses and other (69) (549)
Deposits and other assets (50) 180
Accounts payable (1,895) 982
Accrued payroll costs (6,338) 1,889
Workers' compensation reserve (517) 715
Accrued liabilities 73 243
Income taxes receivable 7,963 852
-------- --------
Net cash provided by operating activities 17,686 8,208
-------- --------
CASH FLOWS FROM INVESTING ACTIVITIES:
Cash paid for equity investment in common stock -- (1,250)
Issuance of notes receivable (2,421) --
Purchases of property and equipment (1,251) (2,350)
Payments on acquisition earnouts (2,218) (3,354)
-------- --------
Net cash used in investing activities (5,890) (6,954)
-------- --------
6
SOS STAFFING SERVICES, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (Continued)
(Unaudited)
(in thousands)
39 Weeks Ended
September 30, 2001 October 1, 2000
------------------ ---------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from borrowings $ 26,992 $ 13,288
Principal payments on borrowings (38,020) (15,567)
-------- --------
Net cash used in financing activities (11,028) (2,279)
-------- --------
NET INCREASE (DECREASE) IN CASH
AND CASH EQUIVALENTS 768 (1,025)
CASH AND CASH EQUIVALENTS AT
BEGINNING OF PERIOD 1,185 2,577
-------- --------
CASH AND CASH EQUIVALENTS AT
END OF PERIOD $ 1,953 $ 1,552
-------- --------
SUPPLEMENTAL CASH FLOW INFORMATION:
Cash paid (received) during the period for:
Interest $ 3,199 $ 3,499
Income taxes (7,690) 113
7
SOS STAFFING SERVICES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
Note 1. Basis of Presentation
The accompanying condensed consolidated financial statements have been
prepared by the Company, without audit, pursuant to the rules and regulations of
the Securities and Exchange Commission. Certain information and disclosures
normally included in financial statements prepared in accordance with accounting
principles generally accepted in the United States have been condensed or
omitted pursuant to such rules and regulations. These condensed consolidated
financial statements reflect all adjustments (consisting only of normal
recurring adjustments) that, in the opinion of management, are necessary to
present fairly the results of operations of the Company for the periods
presented. It is suggested that these condensed consolidated financial
statements be read in conjunction with the consolidated financial statements and
the notes thereto included in the Company's Annual Report on Form 10-K.
The results of operations for the interim periods indicated are not
necessarily indicative of the results to be expected for the full year.
Note 2. Earnings Per Share
The following is a reconciliation of the numerator and denominator used
to calculate basic and diluted (loss) income from continuing operations per
common share for the periods presented (in thousands, except per share amounts):
-------------------------------------------------------------------------------------------
13 Weeks Ended September 30, 2001 13 Weeks Ended October 1, 2000
-------------------------------------------------------------------------------------------
Loss from Income from
continuing Per Share continuing Per Share
operations Shares Amount operations Shares Amount
-------------------------------------------------------------------------------------------
Basic $ (32,119) 12,691 $ (2.53) $ 1,922 12,691 $ 0.15
Effect of Stock Options -- --
---------------------------- --------------------------------
Diluted $ (32,119) 12,691 $ (2.53) $ 1,922 12,691 $ 0.15
---------------------------- --------------------------------
-------------------------------------------------------------------------------------------
39 Weeks Ended September 30, 2001 39 Weeks Ended October 1, 2000
-------------------------------------------------------------------------------------------
Loss from Income from
continuing Per Share continuing Per Share
operations Shares Amount operations Shares Amount
-------------------------------------------------------------------------------------------
Basic $ (32,360) 12,691 $ (2.55) $ 2,707 12,691 $ 0.21
Effect of Stock Options -- --
---------------------------- --------------------------------
Diluted $ (32,360) 12,691 $ (2.55) $ 2,707 12,691 $ 0.21
---------------------------- --------------------------------
At September 30, 2001, there were outstanding options to purchase
approximately 1,291,000 shares of common stock that were not included in the
computation of diluted income from continuing operations per common share
because of the Company's loss from continuing operations. At October 1, 2000,
there were outstanding options to purchase approximately 950,000 shares of
common stock that were not included in the computation of diluted income from
continuing operations per common share because the exercise prices of such
options were greater than the average market price of the common shares.
Note 3. Discontinued Operations
On December 29, 2000, Inteliant Corporation ("Inteliant"), a wholly
owned subsidiary of the Company, sold to Herrick Douglass ("HD") its consulting
division and related tangible and intangible assets. The consulting division
sold to HD consisted of a full suite of information technology consulting,
e-business and telecommunication services, which services were marketed to
Fortune 1000, mid-tier and early stage companies, government agencies and
educational institutions.
8
As part of the sale of the consulting division, the Company agreed to
extend a one year subordinated loan to HD of up to a maximum of $3.5 million to
meet HD's operating needs. The promissory note from HD evidencing the loan bore
interest at 10% per annum on any outstanding principal and was due and payable
on or before December 31, 2001. The note was amended in May 2001 to provide for
an accumulated interest payment on December 31, 2001, with the principal balance
to be paid in 36 monthly installments beginning in January 2002 at an annual
interest rate of 12%. As of September 30, 2001, the Company had advanced to HD
approximately $3.4 million. Additionally, the Company has established a $3.4
million bad debt reserve to reflect the Company's belief that it will not
receive the balance due on the note issued by HD. The Company also has written
off as uncollectible approximately $1.4 million in accounts receivable retained
in the transaction.
Operating results of the discontinued consulting division for the 13-
and 39-week periods ended September 30, 2001 and October 1, 2000 have been
classified as discontinued operations in the accompanying consolidated financial
statements as follows (in thousands):
13 Weeks Ended 39 Weeks Ended
September 30, October 1, September 30, October 1,
2001 2000 2001 2000
---------------- --------------- --- ----------------- ---------------
Revenues $ -- $ 9,994 $ -- $ 27,835
Cost of services -- 6,776 -- 19,669
---------------- --------------- --- ----------------- ---------------
Gross profit -- 3,218 -- 8,166
Operating and other expenses 420 3,737 1,442 10,120
---------------- --------------- --- ----------------- ---------------
Loss from discontinued operations before income
tax (420) (519) (1,442) (1,954)
Income tax benefit 161 87 553 537
---------------- --------------- --- ----------------- ---------------
Loss from discontinued operations (259) (432) (889) (1,417)
---------------- --------------- --- ----------------- ---------------
Loss on sale of discontinued operations -- -- (3,307) --
Income tax benefit -- -- 1,266 --
---------------- --------------- --- ----------------- ---------------
-- -- (2,041) --
---------------- --------------- --- ----------------- ---------------
$ (259) $ (432) $ (2,930) $ (1,417)
---------------- --------------- --- ----------------- ---------------
Note 4. Intangible Assets
Intangible assets consist of the following amounts as of September 30,
2001 and December 31, 2000 (in thousands):
September 30, 2001 December 31, 2000
--------------------- -------------------
Goodwill $ 51,690 $ 84,365
Trademarks and trade names 18,353 19,260
Non-compete agreements 1,858 2,507
Other intangible assets 814 854
--------------------- -------------------
72,715 106,986
Less:
Accumulated amortization goodwill (9,169) (10,361)
Accumulated amortization trademarks and trade names (2,508) (2,135)
Accumulated amortization non-compete agreements (1,742) (1,956)
Accumulated amortization other intangible assets (575) (527)
--------------------- -------------------
$ 58,721 $ 92,007
--------------------- -------------------
Goodwill and trademarks and trade names are amortized, using the
straight-line method, over 30 years; non-compete agreements and other intangible
assets are generally being amortized using the straight-line method over three
to six years.
9
Long-lived assets, including goodwill and other intangible assets, are
reviewed for impairment at the lowest level of indentifiable cash flows whenever
events or changes in circumstances indicate that the book value of the asset may
not be recoverable. The Company evaluates, at each balance sheet date, whether
events or circumstances have occurred that indicate possible impairment. The
Company uses an estimate of the future undiscounted net cash flows of the
related asset over the remaining life in measuring whether the assets are
recoverable. When such estimate of the future undiscounted cash flows is less
than the carrying amount of intangibles, a potential impairment exists.
During fiscal 2001, the Company experienced a significant downturn in
the operations of Inteliant. The Company implemented a plan to reduce operating
costs and increase profitability. However, during the 13-week period ended
September 30, 2001, several companies that had been acquired by Inteliant
experienced a greater than 50 percent reduction in revenues, a significant
reduction in billable hours and the loss of certain customers. Accordingly, the
Company evaluated projected non-discounted cash flows in light of estimated
operations and determined that the book value of such assets had been impaired.
The fair value of the assets was determined using an independent valuation that
considered all possible cash flows for the continued use and ultimate
disposition of such assets. Consequently, during the 13-week period ended
September 30, 2001, the Company recorded a non-cash charge to operations of
approximately $32.5 million to write off goodwill and certain other intangible
assets.
In June 2001 the Financial Accounting Standards Board issued Statement
of Financial Accounting Standards No. 142 ("SFAS No. 142"), Goodwill and Other
Intangible Assets, effective for the Company's fiscal years ending after
December 30, 2001. With the adoption of SFAS No. 142, goodwill and intangible
assets with indefinite lives are no longer subject to amortization. Rather,
goodwill and intangible assets with indefinite lives will be subject to an
annual assessment for impairment by applying a fair-value-based test rather than
the undiscounted cash flow approach currently used by the Company.
Additionally, under the new rules, an acquired intangible asset should
be separately recognized if the benefit of the intangible asset is obtained
through contractual or other legal rights, or if the intangible asset can be
sold, transferred, licensed, rented or exchanged; unless the intangible assets
identified have an indefinite life, those assets will be amortized over their
useful life. Assets of the Company that have been separately identified include,
but are not limited to, trademarks and trade names, non-compete agreements and
customer lists.
Under SFAS No. 142, the Company will continue to amortize existing
goodwill and intangible assets through the end of its current fiscal year.
However, any new goodwill acquired subsequent to June 30, 2001 will not be
amortized. Other separately identified intangible assets acquired subsequent to
June 30, 2001 may be amortized over their useful life depending on whether they
have a definite life. In addition to discontinuing amortization of existing
goodwill and other intangible assets with indefinite lives, the Company
anticipates adoption of this statement could result in an impairment of a
significant portion of the existing goodwill and indefinite lived assets
currently carried on the balance sheet when subjected to a fair-value-based
test. However, the Company is assessing SFAS No. 142 and has not yet quantified
the impact adoption will have on the results of its operations or financial
position. For the 39-week period ended September 30, 2001, amortization related
to goodwill and intangibles was approximately $2.9 million.
Note 5. Credit Facility and Notes Payable
During fiscal 2001 the Company entered into a Third Amendment to
Amended and Restated Credit Agreement (the "Credit Amendment") with Wells Fargo
Bank Northwest, N.A. ("Wells Fargo") and Bank One, NA ("Bank One")
(collectively, the "Lenders") to extend for one year the Company's line of
credit, which was scheduled to expire July 1, 2001. Pursuant to the Credit
Amendment, the Company's line of credit was reduced from $30 million to $18
million, $8 million of which is available for borrowing in cash, with a maturity
date of June 30, 2002, and $10 million of which is available under letters of
credit to be issued solely as required by the Company's workers' compensation
insurance providers, with a maturity date of January 1, 2003. Also pursuant to
the Credit Amendment, certain financial covenants of the credit facility were
modified. The Credit Amendment provides for borrowings at a federal reserve
prime rate (6.00% as of September 30, 2001) plus 2.5 percentage points. The
credit facility contains an annual commitment fee of three-eighths of one
percent on any unused portion, payable quarterly. As of September 30, 2001 the
Company had approximately $4.1 million outstanding under the credit facility.
The Company also had letters of credit of $6.7 million outstanding for purposes
of securing its workers' compensation premium obligation. Additionally, the
credit facility provides for an additional fee of $250,000 unless the Lenders
are paid in full and their credit commitment is terminated on or before June 15,
2002.
10
On September 5, 2001, the Company entered into an Amendment No. 2 to
Note Purchase Agreement (the "Amendment"), dated as of July 30, 2001, with the
holders of its $5 million aggregate principal amount of Senior Notes, Series A,
due September 1, 2003 and the holders of its $30 million aggregate principal
amount of Senior Notes, Series B, due September 1, 2008 (collectively, the
"Noteholders"), whereby the Noteholders waived the Company's temporary
noncompliance with certain financial covenants under the Company's bank credit
facility and the existing note purchase agreements with the Noteholders during
the Company's fiscal quarter ended June 30, 2001.
Pursuant to the Amendment, the Series A Notes bear interest at the rate
of 8.72% per annum and any overdue payments bear interest at the greater of
10.72% and 2% over the prime rate of The First National Bank of Chicago, while
the Series B Notes bear interest at the rate of 8.95% per annum and any overdue
payments bear interest at the greater of 10.95% and 2% over the prime rate of
The First National Bank of Chicago. The change in the interest rate charged on
the senior notes is projected to have an annual impact of approximately $0.6
million on the Company's financial operations.
In addition, as consideration for the Amendment, the Company and each
of its subsidiaries entered into a security agreement dated as of July 30, 2001
with State Street Bank and Trust Company, as collateral agent (the "Collateral
Agent"), on behalf of Wells Fargo Bank, National Association, as administration
agent under the Company's bank credit facility, the financial institutions which
from time to time are parties to the credit facility as lenders thereunder
(collectively, the "Lenders") and the Noteholders, pursuant to which the Company
offered as collateral security for the senior notes the pledge and grant by the
Company and each subsidiary of a security interest in and lien upon all of its
personal property assets including, without limitation, all accounts receivable,
intellectual property rights and shares of capital stock of the Company's
subsidiaries. Such security interests shall be a first priority security
interest to the extent such interests cover accounts receivable of the Company
and each subsidiary and, as to other items of collateral, shall have a priority
as mutually agreed by the Noteholders and the Lenders pursuant to an
intercreditor agreement among such parties and the Collateral Agent dated as of
July 30, 2001. In addition, all obligations of the Company under the credit
facility and the note purchase agreements are guaranteed by the subsidiaries.
The Amendment also provides for optional or mandatory prepayments, as
the case may be, upon the occurrence of certain events including, but not
limited to, a change in control, transfer of property or issuance of equity
securities of the Company. In addition, the Amendment provides that the Company
shall deliver certain financial statements within 30 days of the end of each
calendar month as well as an officer's certificate in connection with the
delivery of financial statements for the last month of each fiscal quarter of
the Company. Also as consideration for the Amendment and waiver by the
Noteholders, the Company paid an amendment fee to the Noteholders of $200,000 in
the aggregate, as well as fees and expenses of the Noteholders' special counsel.
The Company also shall pay on June 15, 2002 a supplemental note fee of $250,000,
which amount shall be waived if the Company has paid all amounts due and
outstanding under the note purchase agreements prior to such date. Also pursuant
to the Amendment, certain financial covenants of the Company were modified.
Also in conjunction with the Amendment, the Company entered into a
Fourth Amendment to Amended and Restated Credit Agreement with the Lenders dated
as of September 4, 2001 in order to make conforming changes with respect to the
collateralization transaction described above.
As of September 30, 2001 the Company had outstanding approximately
$29.1 million of its senior secured notes: $4.1 million due in a single payment
in September 2003 related to the series A secured notes and $25 million related
to the series B secured notes with a final payment due no later than September
2008.
The Company's revolving credit facility and note purchase agreements
contain certain restrictive covenants, including certain debt ratios and
restrictions on the sale of capital assets. As of September 30, 2001, the
Company was in compliance with such covenants.
11
Note 6. Segment Reporting
Based on the types of services offered to customers, the Company has
identified two reportable operating segments: commercial staffing and
information technology ("IT"). The commercial staffing segment provides staffing
services to companies by furnishing temporary clerical, industrial,
light-industrial, technical and professional and permanent placement services.
The IT segment provides temporary and contract-to-hire staffing services
(including computer programming, system design, analysis and administration,
network and systems management and software and documentation development).
Information concerning continuing operations by operating segment for
the 13- and 39-week periods ended September 30, 2001 and October 1, 2000 is as
follows (in thousands):
Segment Operations (unaudited)
13 Weeks Ended 39 Weeks Ended
----------------------------------------- ----------------------------------------
September 30, 2001 October 1, 2000 September 30, 2001 October 1, 2000
---------------------- ----------------- --------------------- -----------------
Service revenues (unaudited) (unaudited) (unaudited) (unaudited)
Commercial $ 63,715 $ 73,470 $ 181,433 $ 212,665
IT 5,945 13,434 24,541 39,977
Other -- -- -- (14)
----------------------------------------- --------------------- -----------------
$ 69,660 $ 86,904 $ 205,974 $ 252,628
----------------------------------------- --------------------- -----------------
(Loss) income from operations
Commercial $ 2,097 $ 3,730 $ 4,611 $ 9,299
IT (33,048) 1,305 (33,062) 1,428
Other (unallocated) (886) (816) (2,342) (3,188)
----------------------------------------- --------------------- -----------------
$ (31,837) $ 4,219 $ (30,793) $ 7,539
----------------------------------------- --------------------- -----------------
Segment Assets
September 30, 2001 December 31, 2000
---------------------- ---------------------
Identifiable assets (unaudited) (unaudited)
Commercial $ 82,036 $ 94,901
IT 15,128 60,423
Other (unallocated) 8,237 6,064
---------------------- ---------------------
$ 105,401 $ 161,388
---------------------- ---------------------
12
Note 7. Restructuring Charges
To align staff costs and branch office requirements with existing
revenue volume, the Company is streamlining its corporate structure and
consolidating and/or eliminating branch offices in under-performing markets.
During the 13-week period ended September 30, 2001, the Company recorded a
restructuring charge of approximately $204,000 related primarily to the closure
or consolidation of seven unprofitable branch offices and the Company's estimate
of future lease costs to be incurred in relation to those offices, severance
charges related to the elimination of various operational positions and certain
legal costs related to refinancing the Company's credit facility and senior note
agreements as discussed in Note 5. During the 39-week period ended September 30,
2001, the Company recorded a restructuring charge of approximately $1.4 million
related primarily to the closure or consolidation of 20 unprofitable branch
offices, as well as severance charges related to the elimination of various
operational and senior level positions. The Company is endeavoring to reduce
potential future lease payments by (i) transferring the lease liability to other
tenants, (ii) subleasing the abandoned facilities or (iii) negotiating
discounted buyouts of the lease contracts. Consequently, the Company's estimates
may change based on its ability to effectively reduce such future lease
payments. Of the approximately $1.4 million the Company has incurred in
restructuring charges, approximately $900,000 has been paid out in the form of
severance and benefits, lease payments and refinancing costs on the Company's
credit facility and note agreements. The remaining estimated net lease payments
and accrued severance payments, totaling approximately $535,000, are reflected
in the condensed consolidated balance sheet as accrued liabilities.
Note 8. Deferred Income Taxes
The components of the deferred income tax assets and liabilities at
September 30, 2001 and December 31, 2000 are as follows (in thousands):
September 30, December 31,
2001 2000
---------------- --------------------
Deferred income tax assets:
Intangibles amortization $ 8,260 $ --
Depreciation 586 534
Workers' compensation reserves 2,048 2,068
Allowance for doubtful accounts 2,380 1,339
Government sponsored tax credits carryforward 1,742 1,300
Accrued liabilities 798 912
Federal and state net operating loss carryforwards 2,715 900
Other 1,048 697
---------------- --------------------
19,577 7,750
---------------- --------------------
Less: valuation allowance (10,896) --
---------------- --------------------
8,681 7,750
---------------- --------------------
Deferred income tax liabilities:
Intangibles amortization -- (2,050)
Other (716) (500)
---------------- --------------------
(716) (2,550)
---------------- --------------------
Net deferred income tax asset $ 7,965 $ 5,200
---------------- --------------------
Balance sheet classification:
Current asset less valuation allowance of $4,341 and
$0, respectively $ 3,408 $ 5,852
Long-term asset less valuation allowance of $6,555
and $0, respectively 4,557 --
Long-term liability -- (652)
---------------- --------------------
$ 7,965 $ 5,200
---------------- --------------------
13
The Company recorded a valuation allowance of approximately $10.9
million against the net deferred tax assets as of September 30, 2001. In
recording the valuation allowance, management considered whether it is more
likely than not that some or all of the deferred tax assets will be realized.
This analysis included: considering scheduled reversals of deferred tax
liabilities; projected future taxable income; carryback potential; and tax
planning strategies.
The Company's net deferred tax assets as of September 30, 2001 were
approximately $8.0 million. Although realization of the net deferred tax assets
is not assured, the Company believes that it is more likely than not that its
future taxable income will be sufficient to realize the net deferred tax assets.
Assuming an effective tax rate of 40%, the minimum amount of future taxable
income that would have to be generated would be approximately $20 million. It is
possible that the Company's estimates could change in the near term and it may
become necessary to increase the valuation allowance in future periods, which
would adversely affect the Company's results of operations.
Note 9. Non-Cash Transactions
During fiscal 2000, the Company paid approximately $1.2 million for an
investment of 12.5% of the outstanding common stock of BioLynx, Inc.
("BioLynx"), an early stage enterprise that is developing a system of time and
attendance reporting through the Internet. The investment was included as other
long-term assets in the Company's consolidated balance sheet as of December 31,
2000 using the cost method. During the 39-week period ended September 30, 2001,
as a result of a strategic shift in market development by the management of
BioLynx, the Company determined to divest its investment in BioLynx. In exchange
and as consideration for the Company's common stock holdings, BioLynx agreed to
a perpetual royalty-free license for certain technology (including all
proprietary software and related intellectual property and all source and object
codes utilized to develop the product) used by the Company. Management has
estimated the technology value to approximate its investment in BioLynx. As
such, the investment was reclassified from other long-term assets to property,
plant and equipment and is being amortized over three years.
Note 10. Legal Matters
In the ordinary course of its business, the Company is periodically
threatened with or named as a defendant in various lawsuits or administrative
proceedings. The Company maintains insurance in such amounts and with such
coverage and deductibles as management believes to be reasonable and prudent.
The principal risks covered by insurance include workers' compensation, personal
injury, bodily injury, property damage, errors and omissions, fidelity losses,
employer practices liability and general liability.
On April 11, 2001, Royalty Carpet Mills, Inc. ("Royalty") filed a
complaint against Inteliant Corporation ("Inteliant") for breach of contract for
services to be provided by Inteliant and professional negligence (the
"Complaint") in the state of California. The Complaint requests unspecified
damages, consequential damages, and attorneys' fees and costs. To date, Royalty
has not quantified the precise amount of damages it is seeking from Inteliant,
but has informed Inteliant that it will be seeking damages of approximately $1.9
million. Inteliant denies the allegations set forth in the Complaint and is
seeking to recover in excess of $150,000 that Inteliant claims Royalty owes to
Inteliant. The case is proceeding with discovery, with the trial currently set
to commence in August 2002.
Inteliant believes that it is insured against any potential liability
for the claims filed by Royalty under its general liability coverage and has
tendered defense of Royalty's lawsuit to its insurance carrier. While its
insurance carrier has reserved its right to assert certain policy exclusions
against Inteliant, which the insurance carrier contends exclude claims based
upon an (i) express or implied warranty or guarantee, (ii) breach of contract
with respect to any agreement to perform work for a specified fee, and (iii)
claims for bodily injury or property damage, Inteliant presently believes that
the claims asserted by Royalty against Inteliant are not only without merit, but
that any judgment that potentially might be entered against Inteliant is covered
in whole or in substantial part by its policy with the insurance carrier.
There is no other pending litigation that the Company currently
anticipates will have a material adverse effect on the Company's financial
condition or results of operations.
14
Note 11. Recent Accounting Pronouncements
In August 2001, the Financial Accounting Standards Board issued SFAS
No. 144, Accounting for Impairment of Long-lived Assets. The new standard
supercedes SFAS No. 121, Accounting for the Impairment of Long-lived Assets and
for Long-lived Assets to be Disposed of. Although retaining many of the
fundamental recognition and measurement provisions of SFAS No. 121, the new
rules significantly change the criteria that would have to be met to classify an
asset as held-for-sale. The new standard also supercedes the provisions of
Accounting Principles Board No. 30, Reporting the Results of
Operations--Reporting the Effects of Disposal of a Segment of a Business, and
Extraordinary, Unusual and Infrequently Occurring Events and Transactions, and
will require expected future operating losses from discontinued operations to be
displayed in discontinued operations in the period(s) in which the losses are
incurred, rather than as of the measurement date as presently required. The
provisions of SFAS No. 144 are effective for financial statements beginning
after December 15, 2001 but allow for earlier application. The Company is
currently assessing the impact the adoption of these provisions will have on the
Company's financial position and results of operations.
15
Item 2. Management's Discussion and Analysis
of Financial Condition and Results of Operations
The following discussion and analysis should be read in conjunction
with the condensed consolidated financial statements of the Company and notes
thereto appearing elsewhere in this report. The Company's fiscal year consists
of a 52- or 53-week period ending on the Sunday closest to December 31.
Business Segments
Based on the types of services offered to customers, the Company has
identified two reportable operating segments: commercial staffing and
information technology ("IT"). The commercial staffing segment provides staffing
services to companies by furnishing temporary clerical, industrial,
light-industrial, technical and professional and permanent placement services.
The IT segment provides temporary and contract-to-hire staffing services
(including computer programming, system design, analysis and administration,
network and systems management and software and documentation development).
Results of Operations
The following table sets forth, for the periods indicated, the
percentage relationship to service revenues of selected income statement items
for the Company on a consolidated basis and by operating segment:
13 Weeks Ended 39 Weeks Ended
-------------------------------------------------------------------------
Consolidated September 30, October 1, 2000 September 30, October 1, 2000
2001 2001
----------------- ---------------- ---------------- -----------------
Service revenues 100.0% 100.0% 100.0% 100.0%
Direct cost of services 79.8 76.8 79.0 77.5
----------------- ---------------- ---------------- -----------------
Gross profit 20.2 23.2 21.0 22.5
----------------- ---------------- ---------------- -----------------
Operating expenses:
Selling, general and administrative expenses 17.5 17.1 18.0 18.2
Restructuring charges 0.3 -- 0.7 --
Intangibles amortization 1.4 1.2 1.4 1.3
Loss on impairment of intangibles 46.7 -- 15.8 --
----------------- ---------------- ---------------- -----------------
Total operating expenses 65.9 18.3 35.9 19.5
----------------- ---------------- ---------------- -----------------
(Loss) income from operations (45.7%) 4.9% (14.9%) 3.0%
----------------- ---------------- ---------------- -----------------
Commercial Staffing Segment
Service revenues 100.0% 100.0% 100.0% 100.0%
Direct cost of services 80.5 78.7 80.1 78.8
----------------- ---------------- ---------------- -----------------
Gross profit 19.5 21.3 19.9 21.2
----------------- ---------------- ---------------- -----------------
Operating expenses:
Selling, general and administrative expenses 15.1 15.4 15.6 15.9
Restructuring charges 0.3 -- 0.8 --
Intangible amortization 0.8 0.8 0.9 0.9
----------------- ---------------- ---------------- -----------------
Total operating expenses 16.2 16.2 17.3 16.8
----------------- ---------------- ---------------- -----------------
Income from operations 3.3% 5.1 2.6% 4.4%
----------------- ---------------- ---------------- -----------------
16
13 Weeks Ended 39 Weeks Ended
---------------------------------- --- ----------------------------------
September 30, October 1, 2000 September 30, October 1, 2000
2001 2001
----------------- ---------------- ---------------- -----------------
IT Segment
Service revenues 100.0% 100.0% 100.0% 100.0%
Direct cost of services 73.3 66.4 70.6 70.4
----------------- ---------------- ---------------- -----------------
Gross profit 26.7 33.6 29.4 29.6
----------------- ---------------- ---------------- -----------------
Operating expenses:
Selling, general and administrative expenses 28.2 20.7 26.3 22.9
Intangible amortization 7.3 3.2 5.3 3.1
Loss on impairment of intangibles 547.1 -- 132.5 --
----------------- ---------------- ---------------- -----------------
Total operating expenses 582.6 23.9 164.1 26.0
(Loss) income from operations (555.9%) 9.7% (134.7%) 3.6%
----------------- ---------------- ---------------- -----------------
Discontinued Operations
On December 29, 2000, Inteliant Corporation, a wholly owned subsidiary
of the Company, sold to Herrick Douglass ("HD") its consulting division and
related tangible and intangible assets. The consulting division sold to HD
consisted of a full suite of information technology consulting, e-business and
telecommunication services, which services were marketed to Fortune 1000,
mid-tier and early stage companies, government agencies and educational
institutions.
As part of the sale of the consulting division, the Company agreed to
extend a one year subordinated loan to HD of up to a maximum of $3.5 million to
meet HD's operating needs. The promissory note from HD evidencing the loan bore
interest at 10% per annum on any outstanding principal and was due and payable
on or before December 31, 2001. The note was amended in May 2001 to provide for
an accumulated interest payment on December 31, 2001, with the principal balance
to be paid in 36 monthly installments beginning in January 2002 at an annual
interest rate of 12%. As of September 30, 2001, the Company had advanced to HD
approximately $3.4 million. Additionally, the Company has established a $3.4
million bad debt reserve to reflect the Company's belief that it will not
receive the balance due on the note issued by HD. The Company also has written
off as uncollectible approximately $1.4 million in accounts receivable retained
in the transaction.
Consolidated
Service Revenues: Service revenues for the 13-week period ended
September 30, 2001 were $69.7 million, a decrease of $17.2 million, or 19.8%,
compared to service revenues of $86.9 million for the 13-week period ended
October 1, 2000. For the 39-week period ended September 30, 2001, service
revenues were $206.0 million, compared to service revenues of $252.6 million for
the 39-week period ended October 1, 2000, a decrease of $46.6 million, or 18.4%.
The Company experienced an overall reduction in all revenue categories due
primarily to a general economic slowdown. Additionally, the Company has
experienced significant underperformance in markets servicing predominately
IT-oriented clients and expects to see a continued softening in these markets.
Gross Profit: The Company defines gross profit as service revenues less
the cost of providing services, which includes wages and permanent placement
commissions, employer payroll taxes (FICA, unemployment and other general
payroll taxes), workers' compensation costs related to temporary associates and
permanent placement counselors and other temporary payroll benefits; costs
related to independent contractors utilized by the Company; and other direct
costs. Gross profit for the 13-week periods ended September 30, 2001 and October
1, 2000 was $14.0 million and $20.1 million, respectively, a decrease of $6.1
million, or 30.3%. For the 13-week periods ended September 30, 2001 and October
1, 2000, gross profit margin was 20.2% and 23.2%, respectively. Gross profit for
the 39-week periods ended September 30, 2001 and October 1, 2000 was $43.3
million and $56.8 million, respectively, a decrease of $13.5 million, or 23.8%.
For the 39-week periods ended September 30, 2001 and October 1, 2000, gross
profit margin was 21.0% and 22.5%, respectively. The decrease in gross margin
percentage between the comparable periods was primarily the result of a
reduction in higher margin permanent placement business in the commercial
staffing segment as well as increased pricing competition for staffing services.
Additionally, the Company continued to see a deterioration in margins as a
result of the substantial downturn in the IT sector of the economy and the
resulting significant layoffs due to lower demand.
17
Operating Expenses: Operating expenses include, among other things,
staff compensation, rent, recruitment and retention of consultants and temporary
associates, costs associated with opening new offices, depreciation, intangible
amortization and advertising.
Selling, general and administrative expenses, as a percentage of
revenues, for the 13-week period ended September 30, 2001 increased slightly to
17.5% from 17.1% for the 13-week period ended October 1, 2000. For the 39-week
period ended September 30, 2001, selling, general and administrative expenses,
as a percentage of revenue, were 18.0%, compared to 18.2% for the 39-week period
ended October 1, 2000.
Restructuring charges for the 13-week period ended September 30, 2001
added approximately 0.3% in additional operating expenses, while restructuring
charges for the 39-week period ended September 30, 2001 added approximately 0.7%
in additional operating expenses. The restructuring charges in both periods were
the result of the closure or consolidation of unprofitable branch offices and
related costs, the Company's estimate of future lease costs to be incurred in
relation to those offices, severance charges related to the elimination of
various operational and senior level management positions and certain legal
costs related to refinancing the Company's credit facility and senior note
agreements.
Long-lived assets, including goodwill and other intangible assets, are
reviewed for impairment whenever events or changes in circumstances indicate
that the book value of the asset may not be recoverable. The Company evaluates,
at each balance sheet date, whether events or circumstances have occurred that
indicates possible impairment. The Company uses an estimate of the future
undiscounted net cash flows of the related asset over the remaining life in
measuring whether the assets are recoverable. When such estimate of the future
undiscounted cash flows is less than the carrying amount of intangibles, a
potential impairment exists.
During fiscal 2001, the Company experienced a significant downturn in
the operations of Inteliant. The Company implemented a plan to reduce operating
costs and increase profitability. However, during the 13-week period ended
September 30, 2001, several companies that had been acquired by Inteliant
experienced a greater than 50 percent reduction in revenues, a significant
reduction in billable hours and the loss of certain customers. Accordingly, the
Company evaluated projected non-discounted cash flows in light of estimated
operations and determined that the book value of such assets had been impaired.
The fair value of the assets was determined using an independent valuation that
considered all possible cash flows for the continued use and ultimate
disposition of such assets. Consequently, during the 13-week period ended
September 30, 2001, the Company recorded a non-cash charge to operations of
approximately $32.5 million to write down goodwill and certain other intangible
assets to their estimated realizable value.
Income from Operations: Income from operations, excluding the loss on
impairment of intangible assets, for the 13-week period ended September 30, 2001
was $0.7 million, a decrease of $3.5 million, compared to income from
operations, excluding the loss on impairment of intangible assets, of $4.2
million for the 13-week period ended October 1, 2000. Operating margin,
excluding the loss on impairment of intangible assets, as a percentage of
revenues was 1.0% for the 13-week period ended September 30, 2001, compared to
4.9% for the 13-week period ended October 1, 2000. Income from operations,
excluding the loss on impairment of intangible assets, for the 39-week period
ended September 30, 2001 was approximately $1.7 million, a decrease of $5.8
million, compared to income from operations, excluding the loss on impairment of
intangible assets, of $7.5 million for the 39-week period ended October 1, 2000.
Operating margin, as a percentage of revenues, excluding the loss on impairment
of intangible assets, was 0.9% for the 39-week period ended September 30, 2001,
compared to 3.0% for the 39-week period ended October 1, 2000. The decrease in
operating margin was due primarily to the decrease in the Company's gross
margins coupled with the modest increase in selling, general and administrative
expenses as a percentage of revenue and additional restructuring charges.
Other Expense: Other expense decreased approximately 31.2%, from
approximately $1.0 million for the 13-week period ended October 1, 2000 to $0.8
million for the 13-week period ended September 30, 2001. For the 39-week period
ended September 30, 2001, other expense was approximately $2.2 million, a
decrease of approximately $0.9 million, or 28.3% from approximately $3.1 million
for the 39-week period ended October 1, 2000. The decrease was due primarily to
a decline in interest expense as a result of a reduction in interest rates
charged on the credit facility coupled with lower debt carried by the Company.
18
Income Taxes: For the 13-week period ended September 30, 2001, the
Company had a federal and state income tax benefit on income from continuing
operations of approximately 1.5% on a pre-tax loss of approximately $32.6
million, compared to an effective combined tax rate of 40.4% for the 13-week
period ended October 1, 2000. During the 39-week period ended September 30,
2001, the Company recognized a tax benefit of approximately 2.0% on a pre-tax
loss of approximately $33.0 million. The tax benefit was due primarily to the
net loss from operations incurred by the Company.
The Company recorded a valuation allowance of approximately $10.9
million against the net deferred tax assets as of September 30, 2001. In
recording the valuation allowance, management considered whether it is more
likely than not that some or all of the deferred tax assets will be realized.
This analysis included: considering scheduled reversals of deferred tax
liabilities; projected future taxable income; carryback potential; and tax
planning strategies.
The Company's net deferred tax assets as of September 30, 2001 were
approximately $8.0 million. Although realization of the net deferred tax assets
is not assured, the Company believes that it is more likely than not that its
future taxable income will be sufficient to realize the net deferred tax assets.
Assuming an effective tax rate of 40%, the minimum amount of future taxable
income that would have to be generated would be approximately $20.0 million. It
is possible that the Company's estimates could change in the near term and it
may become necessary to increase the valuation allowance in future periods,
which would adversely affect the Company's results of operations.
Commercial Staffing Segment
Service Revenues: Service revenues generated from temporary assignments
are recognized as income at the time service is provided, while service revenues
generated from permanent placement services are recognized at the time the
customer agrees to hire a candidate supplied by the Company. Service revenues
for the commercial staffing segment were $63.7 million for the 13-week period
ended September 30, 2001, compared to $73.5 million for the 13-week period ended
October 1, 2000, a decrease of $9.8 million, or 13.3%. For the 39-week period
ended September 30, 2001, service revenues for the commercial staffing segment
were $181.4 million, a decrease of $31.3 million, or 14.7%, compared to services
revenues of $212.7 million for the 39-week period ended October 1, 2000. The
decrease in revenues was generally consistent with the general economic slowdown
and the resulting lower demand for the Company's services. The Company also has
seen a significant decrease in permanent placement revenues.
Gross Profit: Gross profit margin was 19.5% for the 13-week period
ended September 30, 2001, compared to 21.3% for the 13-week period ended October
1, 2000. Gross profit margin was 19.9% for the 39-week period ended September
30, 2001, compared to 21.2% for the 39-week period ended October 1, 2000. The
decrease in gross profit margin was primarily related to a reduction in higher
margin permanent placement business coupled with increased pricing competition
for staffing services due to the general economic slowdown.
Operating Expenses: Selling, general and administrative expenses as a
percentage of service revenues were 15.1 % and 15.4% for the 13-week periods
ended September 30, 2001 and October 1, 2000, respectively; intangible
amortization as a percentage of service revenues was 0.8% for each of the
13-week periods ended September 30, 2001 and October 1, 2000. For the 39-week
periods ended September 30, 2001 and October 1, 2000, selling, general and
administrative expenses as a percentage of revenues were 15.6 % and 15.9%,
respectively.
During the 13- and 39-week periods ended September 30, 2001, the
Company continued to evaluate under-performing offices and markets in an effort
to eliminate additional operating expenses. The Company recognized restructuring
charges of approximately $0.2 million and $1.4 million, respectively, primarily
related to additional lease costs incurred with exiting or subleasing the
Company's contractual lease obligations on closed facilities, as well as
severance charges related to the elimination of several operational positions
and senior level management positions. The Company anticipates that it will
continue to evaluate under-performing operations and make additional changes as
needed.
Income from Operations: Operating margin for the 13-week period ended
September 30, 2001 was 3.3%, compared to 5.1% for the 13-week period ended
October 1, 2000. For the 39-week period ended September 30, 2001, operating
margin was 2.6%, compared to 4.4% for the 39-week period ended October 1, 2000.
The decrease in operating margin was due largely to the decrease in gross profit
margin, coupled with the increase in operating expenses associated with
restructuring charges.
19
IT Segment
Service Revenues: Service revenues for the 13-week period ended
September 30, 2001 were $5.9 million, a decrease of $7.5 million, compared to
service revenues of $13.4 million for the 13-week period ended October 1, 2000.
Service revenues for the 39-week period ended September 30, 2001 were $24.5
million, a decrease of $15.5 million, compared to service revenues of $40.0
million for the 39-week period ended October 1, 2000. The decrease in service
revenues was generally consistent with the general economic slowdown and more
specifically with the sharper downturn in the IT sector of the economy and the
resulting lower demand for the segment's services.
Gross Profit: Gross profit margin for the 13-week period ended
September 30, 2001 was 26.7%, compared to 33.6% for the 13-week period ended
October 1, 2000. The decrease in gross profit percentage was due primarily to a
sharp decline in some of the IT segment's higher margin specialty business.
Gross profit margin for the 39-week period ended September 30, 2001 was 29.4%,
substantially similar to the gross profit margin of 29.6% for the 39-week period
ended October 1, 2000.
Operating Expenses: Selling, general and administrative expenses,
excluding intangible amortization, as a percentage of service revenues were 28.2
% and 20.7% for the 13-week periods ended September 30, 2001 and October 1,
2000, respectively. Selling, general and administrative expenses, excluding
intangible amortization, as a percentage of service revenues were 26.3 % and
22.9% for the 39-week periods ended September 30, 2001 and October 1, 2000,
respectively. The increase was due primarily to increased credit losses due to
the downturn in the IT sector.
Intangible amortization as a percentage of revenues was 7.3 % for the
13-week period ended September 30, 2001 and 3.2% for the 13-week period ended
October 1, 2000. Intangible amortization as a percentage of revenues was 5.3 %
for the 39-week period ended September 30, 2001 and 3.1% for the 39-week period
ended October 1, 2000. The increase in intangible amortization as a percentage
of revenues was due primarily to the reduction in service revenues.
Long-lived assets, including goodwill and other intangible assets, are
reviewed for impairment whenever events or changes in circumstances indicate
that the book value of the asset may not be recoverable. The Company evaluates,
at each balance sheet date, whether events or circumstances have occurred that
indicate possible impairment. The Company uses an estimate of the future
undiscounted net cash flows of the related asset over the remaining life in
measuring whether the assets are recoverable. When such estimate of the future
undiscounted cash flows is less than the carrying amount of intangibles, a
potential impairment exists.
During fiscal 2001, the Company experienced a significant downturn in
the operations of Inteliant. The Company implemented a plan to reduce operating
costs and increase profitability. However, during the 13-week period ended
September 30, 2001, several companies that had been acquired by Inteliant
experienced a greater than 50 percent reduction in revenues, a significant
reduction in billable hours and the loss of certain customers. Accordingly, the
Company evaluated projected non-discounted cash flows in light of estimated
operations and determined that the book value of such assets had been impaired.
The fair value of the assets was determined using an independent valuation that
considered all possible cash flows for the continued use and ultimate
disposition of such assets. Consequently, during the 13-week period ended
September 30, 2001, the Company recorded a non-cash charge to operations of
approximately $32.5 million to write down goodwill and certain other intangible
assets to their estimated realizable value.
Loss from Operations: The operating margin, excluding the loss on
impairment of intangibles, was (8.8%) for the 13-week period ended September 30,
2001, compared to an operating margin of 9.7% for the 13-week period ended
October 1, 2000. The operating margin was (2.2%) for the 39-week period ended
September 30, 2001, compared to an operating margin of 3.6% for the 39-week
period ended October 1, 2000. The decrease in income from operations was due
primarily to the decrease in gross profit coupled with the increase in operating
expenses as a percentage of revenue.
Liquidity and Capital Resources
For the 39-week period ended September 30, 2001, net cash provided by
operating activities was $17.7 million, compared to $8.2 million for the 39-week
period ended October 1, 2000. The change in operating cash flow was primarily a
result of a net increase in cash provided from certain working capital
components, primarily accounts receivable and income tax receivable.
20
The Company's investing activities for the 39-week period ended
September 30, 2001 used approximately $5.9 million, compared to $7.0 million for
the 39-week period ended October 1, 2000. The Company's investing activities
used approximately $1.2 million to purchase property and equipment,
approximately $2.2 million in acquisition earnouts and approximately $2.4
million for notes receivable issued during the 39-week period ended September
30, 2001. By comparison, the Company used approximately $1.2 million to purchase
a 12.5% equity interest in BioLynx, Inc. common stock, $2.3 million to purchase
property and equipment and approximately $3.3 million for acquisition earnouts
during the 39-week period ended October 1, 2000.
The Company's financing activities for the 39-week period ended
September 30, 2001 used approximately $11.0 million, compared to using $2.3
million for the 39-week period ended October 1, 2000, primarily for payments,
net of borrowings, on the Company's debt instruments.
During fiscal 2001, the Company entered into a Third Amendment to
Amended and Restated Credit Agreement (the "Credit Amendment") with Wells Fargo
Bank Northwest, N.A. ("Wells Fargo") and Bank One, NA ("Bank One")
(collectively, the "Lenders") to extend the Company's line of credit, which
expired July 1, 2001. Pursuant to the Credit Amendment, the Company's line of
credit was reduced from $30.0 million to $18.0 million, $8.0 million of which is
available for borrowing in cash, with a maturity date of June 30, 2002, and
$10.0 million of which is available under letters of credit to be issued solely
as required by the Company's workers' compensation insurance providers, with a
maturity date of January 1, 2003. Also pursuant to the Credit Amendment, certain
financial covenants of the credit facility were modified. The Credit Amendment
provides for borrowings at a federal reserve prime rate (6.0% as of September
30, 2001) plus 2.5 percentage points. The credit facility contains an annual
commitment fee of three-eighths of one percent on any unused portion, payable
quarterly. As of September 30, 2001 the Company had approximately $4.1 million
outstanding under the credit facility. The Company also had letters of credit of
$6.7 million outstanding for purposes of securing its workers' compensation
premium obligation. Additionally, the credit facility provides for an additional
fee of $250,000 unless the Lenders are paid in full and their credit commitment
is terminated on or before June 15, 2002.
On September 5, 2001, the Company entered into an Amendment No. 2 to
Note Purchase Agreement (the "Amendment"), dated as of July 30, 2001, with the
holders of its $5.0 million aggregate principal amount of Senior Notes, Series
A, due September 1, 2003 and the holders of its $30.0 million aggregate
principal amount of Senior Notes, Series B, due September 1, 2008 (collectively,
the "Noteholders"), whereby the Noteholders waived the Company's temporary
noncompliance with certain financial covenants under the Company's bank credit
facility and the existing note purchase agreements with the Noteholders during
the Company's fiscal quarter ended June 30, 2001.
Pursuant to the Amendment, the Series A Notes bear interest at the rate
of 8.72% per annum and any overdue payments bear interest at the greater of
10.72% and 2% over the prime rate of The First National Bank of Chicago, while
the Series B Notes bear interest at the rate of 8.95% per annum and any overdue
payments bear interest at the greater of 10.95% and 2% over the prime rate of
The First National Bank of Chicago. The change in the interest rate charged on
the senior notes is projected to have an annual impact of approximately $0.6
million on the Company's financial operations.
In addition, as consideration for the Amendment, the Company and each
of its subsidiaries entered into a security agreement dated as of July 30, 2001
with State Street Bank and Trust Company, as collateral agent (the "Collateral
Agent"), on behalf of Wells Fargo Bank, National Association, as administration
agent under the Company's bank credit facility, the financial institutions which
from time to time are parties to the credit facility as lenders thereunder
(collectively, the "Lenders") and the Noteholders, pursuant to which the Company
offered as collateral security for the senior notes the pledge and grant by the
Company and each subsidiary of a security interest in and lien upon all of its
personal property assets including, without limitation, all accounts receivable,
intellectual property rights and shares of capital stock of the Company's
subsidiaries. Such security interests shall be a first priority security
interest to the extent such interests cover accounts receivable of the Company
and each subsidiary and, as to other items of collateral, shall have a priority
as mutually agreed by the Noteholders and the Lenders pursuant to an
intercreditor agreement among such parties and the Collateral Agent dated as of
July 30, 2001. In addition, all obligations of the Company under the credit
facility and the note purchase agreements are to be guaranteed by the
subsidiaries.
21
The Amendment also provides for optional or mandatory prepayments, as
the case may be, upon the occurrence of certain events including, but not
limited to, a change in control, transfer of property or issuance of equity
securities of the Company. In addition, the Amendment provides that the Company
shall deliver certain financial statements within 30 days of the end of each
calendar month as well as an officer's certificate in connection with the
delivery of financial statements for the last month of each fiscal quarter of
the Company. Also as consideration for the Amendment and waiver by the
Noteholders, the Company paid an amendment fee to the Noteholders of $200,000 in
the aggregate, as well as fees and expenses of the Noteholders' special counsel.
The Company also shall pay on June 15, 2002 a supplemental note fee of $250,000,
which amount shall be waived if the Company has paid all amounts due and
outstanding under the note purchase agreements prior to such date. Also pursuant
to the Amendment, certain financial covenants of the Company were modified.
Also in conjunction with the Amendment, the Company entered into a
Fourth Amendment to Amended and Restated Credit Agreement with the Lenders dated
as of September 4, 2001 in order to make conforming changes with respect to the
collateralization transaction described above.
As of September 30, 2001 the Company had outstanding approximately
$29.1 million of its senior secured notes: $4.1 million due in a single payment
in September 2003 related to the series A secured notes and $25.0 million
related to the series B secured notes with the final payment due no later than
September 2008.
The Company's revolving credit facility and note purchase agreements
contain certain restrictive covenants including certain debt ratios and
restrictions on the sale of capital assets. As of September 30, 2001, the
Company was in compliance with such covenants.
To align staff costs and branch office requirements with existing
revenue volume, the Company is streamlining its corporate structure and
consolidating and/or eliminating branch offices in under-performing markets.
During the 13-week period ended September 30, 2001, the Company recorded a
restructuring charge of approximately $204,000 related primarily to the closure
or consolidation of seven unprofitable branch offices and the Company's estimate
of future lease costs to be incurred in relation to those offices, severance
charges related to the elimination of various operational positions and certain
legal costs related to refinancing the Company's credit facility and senior note
agreements as discussed in Note 5. During the 39-week period ended September 30,
2001, the Company recorded a restructuring charge of approximately $1.4 million
related primarily to the closure or consolidation of 20 unprofitable branch
offices, as well as severance charges related to the elimination of various
operational and senior level positions. The Company is endeavoring to reduce
potential future lease payments by (i) transferring the lease liability to other
tenants, (ii) subleasing the abandoned facilities or (iii) negotiating
discounted buyouts of the lease contracts. Consequently, the Company's estimates
may change based on its ability to effectively reduce such future lease
payments. Of the approximately $1.4 million the Company has incurred in
restructuring charges, approximately $900,000 has been paid out in the form of
severance and benefits, lease payments and refinancing costs on the Company's
credit facility and note agreements. The remaining estimated net lease payments
and accrued severance payments, totaling approximately $535,000, are reflected
in the condensed consolidated balance sheet as accrued liabilities.
Restructuring costs incurred to date and future anticipated
restructuring charges have not had and are not expected to have a material
impact on the liquidity or capital resources of the Company.
The Company's amended credit facility matures in June 2002. Management believes
that the present credit facility, together with cash reserves and cash flows
from operations, will be sufficient to fund the Company's operations and meet
debt service and capital expenditure requirements until June 2002. The Company
intends to refinance its credit facility and the note purchase agreements prior
to June 2002 in order to obtain sufficient capital to continue to fund the
Company's operations after the expiration of the current credit facility.
Although management is confident that new financing can be negotiated, there can
be no assurance that the Company will be able to obtain sufficient funds at
acceptable terms. If the Company were to experience a significant downturn in
its business or fail to negotiate a new credit facility, additional capital
would be required in order to continue operations
Seasonality
The Company's business follows the seasonal trends of its customers'
businesses. Historically, the commercial staffing segment has experienced lower
revenues in the first quarter with revenues accelerating during the second and
third quarters and then slowing again during the fourth quarter. The IT segment
does not experience the same level of seasonality generally associated with the
commercial staffing segment.
22
Recent Accounting Pronouncements
In June 2001 the Financial Accounting Standards Board issued Statement
of Financial Accounting Standards No. 142 ("SFAS No. 142"), Goodwill and Other
Intangible Assets, effective for the Company's fiscal years ending after
December 30, 2001. With the adoption of SFAS No. 142, goodwill and intangible
assets with indefinite lives are no longer subject to amortization. Rather,
goodwill and intangible assets with indefinite lives will be subject to
assessment for impairment by applying a fair-value-based test rather than an
undiscounted cash flow approach currently used by the Company.
Additionally, under the new rules, an acquired intangible asset should
be separately recognized if the benefit of the intangible asset is obtained
through contractual or other legal rights, or if the intangible asset can be
sold, transferred, licensed, rented or exchanged; unless the intangible assets
identified have an indefinite life, those assets will be amortized over their
useful life. Assets of the Company that have been separately identified include,
but are not limited to, trademarks and trade names, non-compete agreements and
customer lists.
Under SFAS No. 142 the Company will continue to amortize existing
goodwill and intangible assets through the end of its current fiscal year.
However, any new goodwill acquired subsequent to June 30, 2001 will not be
amortized. Other separately identified intangible assets acquired subsequent to
June 30, 2001 may be amortized over their useful life depending on whether or
not they have a definite life. In addition to discontinuing amortization of
existing goodwill and other intangible assets with indefinite lives, the Company
anticipates adoption of SFAS No. 142 could result in an impairment of a
significant portion of the existing goodwill and assets with an indefinite life
currently carried on the balance sheet when subjected to a fair-value-based
test. However, the Company is assessing SFAS No. 142 and has not yet quantified
the impact adoption will have on its results of operations or financial
position. For the 39- week period ended September 30, 2001, amortization related
to goodwill was approximately $2.9 million.
In August 2001, the Financial Accounting Standards Board issued SFAS
No. 144, Accounting for Impairment of Long-lived Assets. The new standard
supercedes SFAS No. 121, Accounting for the Impairment of Long-lived Assets and
for Long-lived Assets to be Disposed of. Although retaining many of the
fundamental recognition and measurement provisions of SFAS No. 121, the new
rules significantly change the criteria that would have to be met to classify an
asset as held-for-sale. The new standard also supercedes the provisions of
Accounting Principles Board No. 30, Reporting the Results of
Operations--Reporting the Effects of Disposal of a Segment of a Business, and
Extraordinary, Unusual and Infrequently Occurring Events and Transactions, and
will require expected future operating losses from discontinued operations to be
displayed in discontinued operations in the period(s) in which the losses are
incurred, rather than as of the measurement date as presently required. The
provisions of SFAS No. 144 are effective for financial statements beginning
after December 15, 2001 but allow for earlier application. The Company is
currently assessing the impact the adoption of these provisions will have on the
Company's financial position and results of operations.
Forward-looking Statements
Statements contained in this report which are not purely historical are
"forward-looking statements" within the meaning of the Private Securities
Litigation Reform Act of 1995. All forward-looking statements involve risks and
uncertainties. Forward-looking statements contained in this report include
statements regarding the Company's opportunities, existing and proposed service
offerings, market opportunities, expectations, goals, revenues, financial
performance, strategies and intentions for the future and are indicated by the
use of words such as "believe," "expect," "intend," "anticipate," "likely,"
"plan" and other words of similar meaning. All forward-looking statements
included in this report are made as of the date hereof and are based on
information available to the Company as of such date. The Company assumes no
obligation to update any forward-looking statement. Readers are cautioned that
all forward-looking statements involve risks, uncertainties and other factors
that could cause the Company's actual results to differ materially from those
anticipated in such statements, including but not limited to the Company's
ability to implement its business strategy, which, in turn, is dependent upon a
number of factors, including: the availability of working capital to support
growth; failure of the Company to secure adequate financing to continue to fund
its current operations; plans to integrate the Company's offering of IT
services; the Company's ability to integrate the operations of acquired
businesses; management's ability and resources to implement its business
strategy; the Company's ability to attract and retain the staff, temporary and
other employees needed to implement the Company's business plan and meet
customer needs; and the successful hiring, training and retention of qualified
field management. Future results also could be affected by other factors
associated with the operation of the Company's business, including: the
Company's response to existing and emerging competition; demand for the
Company's services; the Company's ability to maintain profit margins in the face
of pricing pressures; the Company's efforts to develop and maintain customer and
employee relationships; economic fluctuations; employee-related costs; and the
unanticipated results of future litigation.
23
Item 3. Qualitative and Quantitative Disclosures About Market Risk
The Company is exposed to interest rate changes primarily in relation
to its revolving credit facility and its senior secured notes. The Company's
interest rate risk management objective is to limit the impact of interest rate
changes on earnings and cash flows and to lower its overall borrowing costs. The
Company's senior debt placement bears interest at a fixed interest rate. For
fixed rate debt, interest rate changes generally affect the fair value of the
debt, but not the earnings or cash flows of the Company. Changes in the fair
market value of fixed rate debt generally will not have a significant impact on
the Company unless the Company is required to refinance such debt.
Revolving Credit Facility: The Company's credit facility bears interest at a
federal reserve prime rate plus 2.5%; at September 30, 2001, such prime rate was
6.0%. For the 13-week period ended September 30, 2001, the Company had
approximately $4.1 million in advances outstanding under the revolving credit
facility.
Senior Notes: For the 39-week period ended September 30, 2001, the Company's
outstanding borrowings on the senior notes were $29.1 million, with a weighted
average fixed interest rate of 8.92%. The estimated fair value of the
obligations on the senior notes, using a discount rate of 8.5% over the expected
maturities of the obligations, is approximately $29.5 million. The fair value of
the Company's senior notes is estimated by discounting expected cash flows at a
federal reserve prime rate, 6.0% at September 30, 2001, plus 2.5%. If the
discount rate were to increase by 10% to 9.4%, the estimated fair value of the
obligation on the unsecured notes would be approximately $28.7 million. If the
discount rate were to decrease by 10% to 7.7%, the estimated fair value of the
obligation on the unsecured notes would be approximately $30.1 million.
24
PART II - OTHER INFORMATION
Item 1. Legal Proceedings
In the ordinary course of its business, the Company is periodically
threatened with or named as a defendant in various lawsuits or administrative
proceedings. The Company maintains insurance in such amounts and with such
coverage and deductibles as management believes to be reasonable and prudent.
The principal risks covered by insurance include workers' compensation, personal
injury, bodily injury, property damage, errors and omissions, fidelity losses,
employer practices liability and general liability.
On April 11, 2001, Royalty Carpet Mills, Inc. ("Royalty") filed a
complaint against Inteliant Corporation ("Inteliant") for breach of contract for
services to be provided by Inteliant and professional negligence (the
"Complaint") in the state of California. The Complaint requests unspecified
damages, consequential damages, and attorneys' fees and costs. To date, Royalty
has not quantified the precise amount of damages it is seeking from Inteliant,
but has informed Inteliant that it will be seeking damages of approximately $1.9
million. Inteliant denies the allegations set forth in the Complaint and is
seeking to recover in excess of $150,000 that Inteliant claims Royalty owes to
Inteliant. The case is proceeding with discovery, with the trial currently set
to commence in August 2002.
Inteliant believes that it is insured against any potential liability
for the claims filed by Royalty under its general liability coverage and has
tendered defense of Royalty's lawsuit to its insurance carrier. While its
insurance carrier has reserved its right to assert certain policy exclusions
against Inteliant, which the insurance carrier contends exclude claims based
upon (i) an express or implied warranty or guarantee, (ii) a breach of contract
with respect to any agreement to perform work for a specified fee, and (iii)
claims for bodily injury or property damage, Inteliant presently believes that
the claims asserted by Royalty against Inteliant are not only without merit, but
that any judgment that potentially might be entered against Inteliant is covered
in whole or in substantial part by its policy with the insurance carrier.
There is no other pending litigation that the Company currently
anticipates will have a material adverse effect on the Company's financial
condition or results of operations.
Item 4. Submission of Matters to a Vote of Security Holders
On May 18, 2001, the Company held its Annual Meeting of Shareholders
(the "Annual Meeting"). At the Annual Meeting, the shareholders of the Company
elected three directors of the Company, JoAnn W. Wagner, Jack A. Henry and Brad
L. Stewart, each of whom was elected to serve until the 2004 annual meeting of
the Company's shareholders. With respect to the election of directors, there
were 11,942,190 votes cast in favor of the election of Ms. Wagner, 12,303,013
votes cast in favor of the election of Mr. Henry and 11,956,839 votes cast in
favor of the election of Mr. Stewart.
In addition to the election of Ms. Wagner and Messrs. Henry and
Stewart, Stanley R. deWaal and Randolph K. Rolf continue to serve as directors
of the Company, with terms expiring at the Company's 2002 annual meeting of
shareholders, and R. Thayne Robson and Thomas K. Sansom continue to serve as
directors of the Company, with terms expiring at the Company's 2003 annual
meeting of the Company's shareholders.
Additionally, the shareholders of the Company approved a proposal to
ratify the appointment of Arthur Andersen LLP as independent auditors of the
Company for the year ending December 30, 2001. The number of votes cast in favor
of the proposal was 12,323,089, the number of votes opposed was 24,144 and the
number of abstentions and broker non-votes was 18,400.
Item 6. Exhibits and Reports on Form 8-K.
a) None.
b) Current Report on Form 8-K dated October 5, 2001, Other Events.
25
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.
SOS STAFFING SERVICES, INC.
Dated: November 14, 2001 /s/ JoAnn W. Wagner
JoAnn W. Wagner
Chairman, President and
Chief Executive Officer
Dated: November 14, 2001 /s/Kevin Hardy
Kevin Hardy
Senior Vice President and
Chief Financial Officer
26