1
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 March 31, 2002
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 of incorporation) (I.R.S. Employer ID No.)
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 May 4, 2001
--------------------- --------------------------
Common Stock, $0.01 par value 12,691,398
TABLE OF CONTENTS
-----------------
PART I - FINANCIAL INFORMATION
Item 1. Financial Statements
Condensed Consolidated Balance Sheets
As of March 31, 2002 and December 30, 2001 3
Condensed Consolidated Statements of Operations
For the 13-week periods Ended
March 31, 2002 and April 1, 2001 5
Condensed Consolidated Statements of Cash Flows
For the 13-week periods Ended
March 31, 2002 and April 1, 2001 6
Notes to Condensed Consolidated Financial Statements 8
Item 2. Management's Discussion and Analysis 15
Item 3. Qualitative and Quantitative Disclosures About Market Risk 20
PART II - OTHER INFORMATION
Item 1. Legal Proceedings 21
Item 6. Exhibits and Reports on Form 8-K 21
Signatures 22
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4
PART I - FINANCIAL INFORMATION
Item 1. Financial Statements
SOS STAFFING SERVICES, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(Unaudited)
ASSETS
------
(in thousands)
March 31, 2002 December 30, 2001
-------------- -----------------
CURRENT ASSETS
Cash and cash equivalents $ 5,495 $ 879
Restricted cash 1,033 --
Accounts receivable, less allowances of
$1,897 and $2,267, respectively 17,705 21,995
Prepaid expenses and other 1,539 1,126
Income tax receivable 3,999 367
-------- --------
Total current assets 29,771 24,367
-------- --------
PROPERTY AND EQUIPMENT, at cost
Computer equipment 5,615 6,082
Office equipment 3,492 3,808
Leasehold improvements and other 1,795 1,887
-------- --------
10,902 11,777
Less accumulated depreciation and amortization) (6,786) (7,269)
-------- --------
Total property and equipment, net 4,116 4,508
-------- --------
OTHER ASSETS
Intangible assets, net 31,946 48,060
Deferred income tax asset 4,240 --
Deposits and other assets 1,991 1,808
-------- --------
Total other assets 38,177 49,868
-------- --------
Total assets $ 72,064 $ 78,743
-------- --------
The accompanying notes to condensed consolidated financial statements
are an integral part of these condensed consolidated balance sheets.
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SOS STAFFING SERVICES, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS (Continued)
(Unaudited)
LIABILITIES AND SHAREHOLDERS' EQUITY
------------------------------------
(in thousands)
March 31, 2002 December 30, 2001
-------------- -----------------
CURRENT LIABILITIES
Line of credit $ 7,487 $ --
Current portion of notes payable 5,367 5,668
Accounts payable 469 1,571
Accrued payroll costs 2,312 3,492
Current portion of workers' compensation reserve 4,198 4,484
Accrued liabilities 3,560 4,799
-------- --------
Total current liabilities 23,393 20,014
-------- --------
LONG-TERM LIABILITIES
Notes payable, less current portion 23,427 23,427
Workers' compensation reserve, less current portion 963 1,018
Deferred compensation liabilities 748 743
-------- --------
Total long-term liabilities 25,138 25,188
-------- --------
COMMITMENTS AND CONTINGENCIES
(Note 5)
SHAREHOLDERS' EQUITY
Common stock 127 127
Additional paid-in capital 91,693 91,693
Accumulated deficit (68,287) (58,279)
-------- --------
Total shareholders' equity 23,533 33,541
-------- --------
Total liabilities and shareholders' equity $ 72,064 $ 78,743
-------- --------
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)
13 Weeks Ended
March 31, 2002 April 1, 2001
------------------ ------------------
SERVICE REVENUES $ 42,156 $ 52,720
DIRECT COST OF SERVICES 33,917 41,268
------------------ ------------------
Gross profit 8,239 11,452
------------------ ------------------
OPERATING EXPENSES:
Selling, general and administrative 8,510 10,437
Restructuring charges 345 245
Intangibles amortization 30 557
------------------ ------------------
Total operating expenses 8,885 11,239
------------------ ------------------
(LOSS) INCOME FROM OPERATIONS (646) 213
------------------ ------------------
OTHER INCOME (EXPENSE):
Interest expense (923) (820)
Interest income 7 55
Other, net 22 23
------------------ ------------------
Total, net (894) (742)
------------------ ------------------
LOSS FROM CONTINUING OPERATIONS BEFORE INCOME TAXES (1,540) (529)
INCOME TAX BENEFIT 7,927 205
------------------ ------------------
INCOME (LOSS) FROM CONTINUING OPERATIONS 6,387 (324)
DISCONTINUED OPERATIONS:
Loss from discontinued operations (net of income tax
benefit of $0 and $268, respectively) (312) (510)
CUMULATIVE EFFECT OF CHANGE IN ACCOUNTING PRINCIPLE (net of
income tax of $0) (16,083) --
------------------ ------------------
NET LOSS $ (10,008) $ ( 834)
================== ==================
BASIC AND DILUTED INCOME (LOSS) PER COMMON SHARE:
Income (loss) from continuing operations $ 0.50 $ (0.03)
Loss from discontinued operations (0.02) (0.04)
Loss from cumulative effect of change in accounting
principle (1.27) --
------------------ ------------------
Net loss $ (0.79) $ (0.07)
================== ==================
The accompanying notes to condensed consolidated financial statements
are an integral part of these condensed consolidated balance sheets.
-5-
SOS STAFFING SERVICES, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
(in thousands)
13 Weeks Ended
March 31, 2002 April 1, 2001
---------------------- -----------------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss $ (10,008) $ (834)
Adjustments to reconcile net loss
to net cash (used in)provided by operating activities:
Depreciation and amortization 460 1,417
Deferred income taxes (4,240) 29
Loss on disposition of assets -- 14
Loss on disposal of discontinued operations 312 --
Loss on cumulative change in accounting principle 16,083
Changes in operating assets and liabilities:
Restricted Cash (1,033) --
Accounts receivable, net 4,290 14,552
Workers' compensation deposit -- (60)
Prepaid expenses and other (413) (143)
Deposits and other assets (183) (44)
Accounts payable (1,102) (570)
Accrued payroll costs (1,180) (5,061)
Workers' compensation reserve (341) (246)
Accrued liabilities (1,342) (1,046)
Income taxes receivable (3,632) 6,508
---------------------- -----------------------
Net cash (used in) provided by operating
activities (2,329) 14,516
---------------------- -----------------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Issuance of notes receivable -- (2,277)
Purchases of property and equipment (251) (439)
Proceeds from sale of property and equipment 10 --
Payments of acquisition costs and earnouts -- (55)
---------------------- -----------------------
Net cash used in investing activities (241) (2,771)
---------------------- -----------------------
The accompanying notes to condensed consolidated financial statements
are an integral part of these condensed consolidated balance sheets.
-6-
SOS STAFFING SERVICES, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (Continued)
(Unaudited)
(in thousands)
13 Weeks Ended
March 31, 2002 April 1, 2001
---------------------- -----------------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from borrowings $ 7,487 $ --
Principal payments on long-term borrowings (301) (9,089)
---------------------- -----------------------
Net cash provided by (used in) financing
activities 7,186 (9,089)
---------------------- -----------------------
NET INCREASE IN CASH
AND CASH EQUIVALENTS 4,616 2,656
CASH AND CASH EQUIVALENTS AT
BEGINNING OF PERIOD 879 1,185
---------------------- -----------------------
CASH AND CASH EQUIVALENTS AT
END OF PERIOD $ 5,495 $ 3,841
====================== =======================
SUPPLEMENTAL CASH FLOW INFORMATION:
Cash paid (received) during the period for:
Interest $ 1,387 $ 1,456
Income taxes (55) (7,073)
The accompanying notes to condensed consolidated financial statements
are an integral part of these condensed consolidated balance sheets.
-7-
SOS STAFFING SERVICES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
Note 1. Basis of Presentation
The accompanying unaudited 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 for the
fiscal year ended December 30, 2001.
In order to conform to the current period presentation, certain
reclassifications have been made to the prior period financial statements. Due
to the presentation of discontinued operations for the sale of Inteliant, all
periods in the accompanying consolidated condensed financial statements have
been presented on a comparable basis.
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. Restricted Cash
During the 13-week period ended March 31, 2002, the Company renewed its
workers' compensation policy. Under the terms of this renewed policy, the
Company is required to provide a letter of credit of $10.0 million plus $1.0
million in cash to collateralize future claims payments under the policy. The
cash amount is carried at fair value and is restricted as to withdrawal. The
restricted cash is held in the Company's name with a major financial
institution.
Note 3. Earnings Per Share
Basic earnings (loss) per share ("EPS") is calculated by dividing net
income (loss) by the weighted-average number of common shares outstanding for
the period. Diluted EPS is calculated by dividing net income (loss) by the
weighted-average number of common shares outstanding plus the assumed exercise
of all dilutive securities using the treasury stock method or the "as converted"
method, as appropriate. During periods of net loss from continuing operations,
all common stock equivalents are excluded from the diluted EPS calculation.
The following is a reconciliation of the numerator and denominator used
to calculate basic and diluted income (loss) from continuing operations per
common share for the periods presented (in thousands except per share amounts):
13 Weeks Ended March 31, 2002 13 Weeks Ended April 1, 2001
-------------------------------------------------------------------------------------------
Income from Loss from
continuing Per Share continuing Per Share
operations Shares Amount operations Shares Amount
-------------------------------------------------------------------------------------------
Basic $ 6,387 12,691 $ 0.50 $ (324) 12,691 $ (0.03)
Effect of stock options 3 --
---------------------------- --------------------------------
Diluted $ 6,387 12,694 $ 0.50 $ (324) 12,691 $ (0.03)
============================ ================================
At the end of the 13-week period ended March 31, 2002 there were
outstanding options to purchase approximately 1,140,000 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. At the end of the
13-week period ended April 1, 2001, there were outstanding options to purchase
approximately 940,000 shares of common stock that were not included in the
-8-
computation of diluted income from continuing operations per common share
because of the Company's loss from continuing operations.
Note 4. Discontinued Operations
In November, 2001, the Company resolved to sell or abandon the assets
of its IT staffing business, which represented the remaining assets and business
of Inteliant. During the 13-week period ended March 31, 2002 the Company
consummated the following transactions in relation to its discontinued IT
businesses:
o On February 25, 2002, the Company entered into an asset purchase agreement
with Abacab Software, Inc. ("Abacab") pursuant to which the Company sold
certain assets of Inteliant's Northern California operations for contingent
payments not to exceed $600,000 in the aggregate over three years following
the closing date of the transaction based on the gross profit of the
business acquired by Abacab. Abacab also assumed liabilities of
approximately $40,000. The Company retained accounts receivable of
approximately $1.1 million, of which approximately $680,000 was outstanding
as of March 31, 2002. The Company originally acquired a portion of the
assets sold in the transaction from Abacab. The principal of Abacab was
engaged by the Company as an independent contractor and was managing the
Company's Northern California operations at the time of the closing of the
transaction.
o Effective March 11, 2002, the Company settled a dispute with NeoSoft, Inc.
("NeoSoft"), whose assets had been acquired by Inteliant in July 1998.
During fiscal 2001, Neosoft and its principal had alleged that the Company
owed more than the final earnout payment paid by the Company pursuant to
the purchase agreement with Neosoft. Pursuant to the terms of the
settlement, the Company paid NeoSoft $550,000 and transferred the NeoSoft
operations back to NeoSoft. In return, the Company retained all of the
accounts receivable and unbilled revenue of approximately $639,000, of
which approximately $433,000 was outstanding as of March 31, 2002; however,
the Company will pay NeoSoft 15% of all accounts receivable collected as
consideration for NeoSoft's assistance in collecting the receivables.
Additionally, NeoSoft assumed approximately $53,000 in accrued paid time
off liability and assumed all operating leases. Furthermore, the parties
released all claims including, without limitation, any claims arising under
the original asset purchase agreement and under the principal's original
employment agreement. The principal of Neosoft was employed by the Company
at the time of the closing of the transaction and was managing the
Company's Neosoft operations.
o Subsequent to March 31, 2002, the Company sold certain assets related to
the Kansas City, Missouri and Denver, Colorado ("Central States")
operations of Inteliant for contingent payments not to exceed $1,000,000 in
the aggregate over three years following the closing date of the
transaction based on the gross profit of the business acquired by the
buyer. The buyer also assumed liabilities of approximately $40,000.
Additionally, the Company retained accounts receivable of approximately
$500,000. The Company employed the buyer as the manager of the Central
States operations at the time of the closing of the transaction.
In addition, during fiscal 2001, the Company formalized a plan to sell
its wholly owned subsidiary, ServCom Staff Management, Inc., a professional
employee organization. On December 31, 2001, the Company sold substantially all
of the assets of this business to an unrelated entity. The Company retained
accounts receivable of approximately $480,000, of which approximately $149,000
was outstanding as of March 31, 2002. The terms of the transaction were
immaterial to the financial results of the Company.
Operating results of the discontinued operations for the 13-week
periods ended March 31, 2002 and April 1, 2001 have been classified as
discontinued operations in the accompanying consolidated financial statements as
follows (in thousands):
2002 2001
----------------- --------------
Revenues $ 2,361 $ 15,982
Cost of sales 1,898 12,986
----------------- --------------
Gross profit 463 2,996
Operating and other expenses 1,031 2,985
----------------- --------------
(Loss) income from discontinued operations before income tax (568) 11
Income tax provision -- (3)
----------------- --------------
(Loss) income from discontinued operations (568) 8
Amount charged to reserves at the initial measurement date for
discontinued operations 256 --
----------------- --------------
$ (312) $ 8
================= ==============
-9-
The loss from discontinued operations is due primarily to a change in
the estimate of operating activity from the measurement date to the planned
disposition date. Additionally, for the 13-week period ended April 1, 2001, the
Company recorded an approximate $510,000, net of income tax, loss on sale of
discontinued operations related to the sale, in fiscal 2000, of the Company's IT
consulting business. The additional loss on sale of discontinued operations was
related primarily to the greater than expected write-off of receivables retained
in that transaction.
Note 5. Intangible Assets
At the beginning of fiscal quarter ended March 31, 2002, the Company
adopted the provisions of Statement of Financial Accounting Standards ("SFAS")
No. 142, "Goodwill and Other Intangible Assets." The provisions of SFAS No. 142
prohibit the amortization of goodwill and certain intangible assets that are
deemed to have indefinite lives and require that such assets be tested for
impairment annually, or more frequently if events or changes in circumstances
indicate that the asset might be impaired, and written down to fair value. In
order to assess the fair value of its goodwill and indefinite-lived intangible
assets as of the adoption date, the Company engaged an independent valuation
firm to assist in determining the fair value. The valuation process appraised
the Company's assets and liabilities using a combination of present value and
multiple of earnings valuation techniques. Based upon the results of the
valuation, the Company wrote-off $8 million of goodwill, and $8.1 million in
trademarks and trade names as a cumulative effect of the change in accounting
principle. As of March 31, 2002 and December 30, 2001, intangible assets
consisted of the following:
March 31, 2002 December 30, 2001
------------------- ----------------------
Goodwill $ 24,480 $ 37,119
Trademarks and trade names-indefinite-lived 7,333 18,046
Other definite-lived intangibles 2,134 2,426
------------------- ----------------------
33,947 57,591
Less accumulated amortization (2,001) (9,531)
------------------- ----------------------
Net intangible assets $ 31,946 $ 48,060
=================== ======================
In conjunction with SFAS No.142 the following table provides a
reconciliation of reported income (loss) from continuing operations for the
13-week periods ended March 31, 2002 and April 1, 2001, to the adjusted income
(loss) from continuing operations excluding amortization expense relating to
goodwill and trademarks and tradenames:
March 31, 2002 April 1, 2001
--------------------- -----------------
Reported income (loss) from continuing operations $ 6,387 $ (324)
Add back: Goodwill amortization, net of income taxes -- 189
Add back: Trademark and tradenames amortization, net
of income taxes -- 91
--------------------- -----------------
Adjusted income (loss) from continuing operations $ 6,387 $ (44)
===================== =================
Basic and diluted income (loss) from continuing
operations per common share:
Reported net income $ 0.50 $ (0.03)
Goodwill amortization net of income taxes -- 0.02
Trademark and tradename amortization, net of
income taxes -- 0.01
--------------------- -----------------
Adjusted income (loss) from continuing operations $ 0.50 $ 0.00
===================== =================
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Note 6. 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 for breach of contract for services to be provided
by Inteliant and for professional negligence (the "Complaint") in the state of
California. The Complaint requests damages, consequential damages, and
attorneys' fees and costs. To date, Royalty 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 rescheduled to commence in December 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.
Note 7. Credit Facility and Notes Payable
On April 15, 2002, the Company entered into a Fifth Amendment to
Amended and Restated Credit Agreement and Waiver (the "Fifth Credit Amendment")
with the Lenders to extend the Company's line of credit. Pursuant to the Fifth
Credit Amendment, the Company's line of credit was reduced from $18.0 million to
$16.0 million, $6.0 million of which is available for borrowing in cash, reduced
as provided below, with a maturity date of September 1, 2003, 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, 2004. The Fifth Credit Amendment provides for borrowings at the prime
rate (4.75% as of March 31, 2002) plus 3.0 percentage points through and
including June 30, 2003, after which time borrowings under the facility will be
charged an interest rate equal to the then-current prime rate plus 3.5
percentage points. Additionally, the Fifth Credit Amendment provides for an
amendment fee of approximately $78,000, payable to the Lenders upon execution of
the Fifth Credit Amendment plus a supplemental fee of $250,000 payable on
September 1, 2003, unless the Lenders are paid in full and their credit
commitment is terminated on or before such date. In addition, the Company paid
$313,000 of the outstanding borrowings under the revolving credit facility upon
execution of the Fifth Credit Amendment. The Company will pay an additional
$470,000 and $559,000 of the outstanding borrowings under the revolving credit
facility on September 15, 2002 and December 15, 2002, respectively. Such
payments will permanently reduce the line of credit available to the Company for
borrowing in cash to less than the $6.0 million stated above. The Fifth Credit
Amendment also waives any violations of financial covenants under the credit
facility that may have existed at March 31, 2002. In addition, certain financial
covenants of the Company have been modified. As of April 30, 2002, the Company
had outstanding borrowings under the revolving credit facility of approximately
$2.1 million.
Also on April 15, 2002, the Company entered into an Amendment No. 3 to
Note Purchase Agreement ("Amendment No. 3") with the Noteholders, whereby the
Noteholders waived the Company's noncompliance with certain financial covenants
under the Company's bank credit facility and the existing note purchase
agreements with the Noteholders as of March 31, 2002. The Noteholders also
consented to the Company entering into the Fifth Credit Amendment described
above. Pursuant to Amendment No. 3, the Series A Notes bear interest, payable
monthly, at the rate of 9.22% per annum beginning as of April 1, 2002 through,
-11-
but excluding, June 30, 2003, and at the rate of 9.72% per annum from June 30,
2003 until the Series A Notes become due and payable. The Series B Notes bear
interest, payable monthly, at the rate of 9.45% per annum beginning as of April
1, 2002 through, but excluding, June 30, 2003, and at the rate of 9.95% per
annum from June 30, 2003 until the Series B Notes become due and payable.
Pursuant to Amendment No. 3, any overdue payments on the Series A Notes
bear interest at the greater of 2% over the interest rate currently in effect as
stated above or 2% over the prime rate of The First National Bank of Chicago.
The change in the interest rate charged on the senior notes is estimated to have
an annual impact of approximately $142,000 on the Company's financial
operations. The Company paid $687,000 of the principal amount of the senior
notes upon execution of Amendment No. 3, and will pay an additional $1,030,500
and $1,227,000 of the principal amount of the senior notes on September 15, 2002
and December 15, 2002, respectively.
Amendment No. 3 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 of control, transfer of property or issuance of equity
securities of the Company. In addition, Amendment No. 3 provides that the
Company pay to the Lenders and the Noteholders any federal, state or local tax
refund or repayment, which amount shall be distributed pursuant to the Amended
and Restated Intercreditor Agreement dated as of April 15, 2002 among the
Collateral Agent, the Lenders and the Noteholders; however, if the Company
receives any refund arising from the 2002 Job Act relating to net operating loss
carrybacks, the Company will be able to retain for working capital purposes the
lesser of $2,000,000 or 50% of the refund. Any such prepayments paid to the
Lenders also will be treated as a permanent reduction in the line of credit
available to the Company for borrowing in cash under the revolving credit
facility.
As consideration for Amendment No. 3 and the waiver by the Noteholders,
the Company paid an amendment fee to the Noteholders of $145,000, as well as
fees and expenses of the Noteholders' special counsel. In addition, the Company
paid to each Noteholder accrued but unpaid interest on such holder's notes for
the period beginning March 1, 2002 through and including March 31, 2002. Also
pursuant to Amendment No. 3, the Company is required to pay on September 1, 2003
a supplemental note fee of $250,000, which amount will be waived if the Company
has paid all amounts due and outstanding under the note purchase agreements
prior to such date. Also, certain financial covenants of the Company were
modified. In the event the Company fails to comply with such covenants as
modified, Amendment No. 3 provides that the Noteholders may, at their discretion
and at the expense of the Company, retain a financial advisor to review, and
advise the Noteholders and the Company upon, the financial status of the
Company. The security agreement dated as of July 30, 2001 remains in place
pursuant to Amendment No. 3.
Note 8. Restructuring Charges
For the period ended March 31, 2002, the Company continued streamlining
its corporate structure by consolidating or closing branch offices in
under-performing markets. During the 13-week period ended March 31, 2002, the
Company recorded a restructuring charge of approximately $345,000 primarily
related to a change in the estimate of future lease payment reserves and
severance costs associated with reductions in work force. The Company is
endeavoring to reduce potential future lease payments by subleasing the
abandoned facilities or 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. At March 31, 2002, the remaining
accrued restructuring charges totaled approximately $0.6 million, and are
recorded in the balance sheet as an accrued liability. The activity impacting
the accrual for restructuring charges is summarized in the table below (in
thousands):
Balance at Charges to Balance at
December 30, 2001 Operations Charges Utilized March 31, 2001
-------------------- -------------------- -------------------- --------------------
Contractual lease obligations $ 561 $ 206 $ (154) $ 613
Reductions in workforce -- 132 (132) --
Other costs -- 7 (7) --
-------------------- -------------------- -------------------- --------------------
Total $ 561 $ 345 $ (293) $ 613
==================== ==================== ==================== ====================
-12-
Note 9. Income Taxes
On March 9, 2002, the Job Creation and Work Assistance Act of 2002 (the
"2002 Job Act"), which includes certain provisions that will provide favorable
tax treatment for the Company, was signed into law. Among such provisions is the
extension of the net operating loss carryback period from two years to five
years for net operating losses arising in tax years ending in 2001 and 2002.
These provisions also allow companies to use the net operating loss carrybacks
and carryforwards to offset 100 percent of alternative minimum taxable income.
In accordance with SFAS No. 109, "Accounting for Income Taxes," the effect of
the change in the law has been accounted for in the first quarter of fiscal
2002, the period in which the law became effective. In accordance with the
provisions of the 2002 Job Act, the Company has recognized a tax benefit of
approximately $7.9 million related to expected loss carrybacks.
The components of the deferred income tax assets and liabilities at
March 31, 2002 and December 30, 2001 are as follows (in thousands):
2002 2001
---------------- -----------------
Deferred income tax assets:
Intangible amortization $ 17,444 $ 12,139
Depreciation 715 682
Workers' compensation reserves 2,076 2,133
Allowance for doubtful accounts 2,279 2,423
Government sponsored tax credits carryforward 2,048 2,048
Accrued liabilities 1,189 1,576
Net operating loss carryforwards 6,239 4,299
---------------- -----------------
31,990 25,300
Less: Income tax valuation allowance (27,035) (24,585)
---------------- -----------------
4,955 715
---------------- -----------------
Other deferred income tax liabilities: (715) (715)
---------------- -----------------
Net deferred income tax asset $ 4,240 $ --
================ =================
Balance sheet classification:
Current asset $ -- $ --
Long-term asset 4,240 --
---------------- -----------------
$ 4,240 $ --
================ =================
The Company's net deferred tax assets as of March 31, 2002 were
approximately $4.2 million. This was recorded during the 13-week period ended
March 31, 2002, as a result of the Company's ability to carryback taxable losses
under the provisions of the 2002 Job Act. The Company expects, that as a result
of the completion of the sale of its IT operations, that it will generate a
taxable loss for fiscal 2002, a portion of which will be available for carryback
against its 1997 tax year. Although realization of the net deferred tax assets
is not assured, the Company believes that it is more likely than not that it
will be able to realize the net deferred tax assets. 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 10. Recent Accounting Pronouncements
In August 2001, the FASB 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." 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
-13-
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 does not anticipate that SFAS No. 144 will
have a material impact on its financial operations for fiscal 2002.
-14-
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. The
Company's critical accounting policies are described in its Annual Report on
Form 10-K for the fiscal year ended December 30, 2001.
Recent Developments
On April 22, 2002, the Company received notification from Nasdaq that
the Company is not in compliance with the minimum closing-bid-price listing
requirements, and that, unless prior to July 22, 2002 the minimum closing bid
price of the common stock is at or above $1.00 for 10 consecutive trading days,
the common stock will be delisted from the Nasdaq National Market ("NNM"). If
the Company receives notification that its securities will be delisted, the
Company, at that time, may appeal the delisting determination. If the Company's
common stock is delisted from the NNM, the Company may apply to transfer its
securities to the Nasdaq SmallCap Market, or the Company's securities may be
quoted in the non-Nasdaq over-the-counter market on either Nasdaq's OTC Bulletin
Board or the "Pink Sheets." The Company would then be subject to an SEC rule
regarding "penny stocks" where broker-dealers who sell relevant securities to
persons who are not established customers or accredited investors must make
specified suitability determinations and must receive the purchaser's written
consent to the transaction prior to the sale. No assurance can be given that the
Company will be able to maintain eligibility for listing of the common stock on
the NNM or any alternative exchange or association. Delisting could make trading
shares of the Company's common stock difficult, potentially leading to a further
decline in the stock price. In addition, it would make it difficult for
investors to sell the Company's common stock or to obtain accurate quotations of
the share price of the common stock.
Effective December 31, 2001, the Company adopted SFAS No. 142,
"Goodwill and Other Intangible Assets." In accordance with SFAS No. 142, the
Company discontinued the amortization of goodwill and identifiable intangible
assets that have indefinite useful lives. Intangible assets that have finite
useful lives, such as no-compete agreements, will continue to be amortized over
their useful lives. Pursuant to the conditions set forth in SFAS No. 142, the
Company has recorded an impairment loss of approximately $16.1 million as a
cumulative effect of a change in accounting principle in its statement of
operations.
Discontinued Operations
In November, 2001, the Company resolved to sell or abandon the assets
of its IT staffing business, which represented the remaining assets and business
of Inteliant.
o On February 25, 2002, the Company entered into an asset purchase agreement
with Abacab Software, Inc. ("Abacab") pursuant to which the Company sold
certain assets of Inteliant's Northern California operations for contingent
payments not to exceed $600,000 in the aggregate over three years following
the closing date of the transaction based on the gross profit of the
business acquired by Abacab. Abacab also assumed liabilities of
approximately $40,000. The Company retained accounts receivable of
approximately $1.1 million, of which approximately $680,000 was outstanding
as of March 31, 2002. The Company originally acquired a portion of the
assets sold in the transaction from Abacab. The principal of Abacab was
engaged by the Company as an independent contractor and was managing the
Company's Northern California operations at the time of the closing of the
transaction. The Company believes that the terms of the transaction were no
less favorable than it would have received from an unrelated third party.
o Effective March 11, 2002, the Company settled a dispute with NeoSoft, Inc.
("NeoSoft"), whose assets had been acquired by Inteliant in July 1998.
During fiscal 2001, Neosoft and its principal had alleged that the Company
owed more than the final earnout payment paid by the Company pursuant to
the purchase agreement with Neosoft. Pursuant to the terms of the
settlement, the Company paid NeoSoft $550,000 and transferred the NeoSoft
operations back to NeoSoft. In return, the Company retained all of the
accounts receivable and unbilled revenue of approximately $639,000, of
which approximately $433,000 was outstanding as of March 31, 2002; however,
the Company will pay NeoSoft 15% of all accounts receivable collected as
consideration for NeoSoft's assistance in collecting the receivables.
Additionally, NeoSoft assumed approximately $53,000 in accrued paid time
off liability and assumed all operating leases. Furthermore, the parties
released all claims including, without limitation, any claims arising under
-15-
the original asset purchase agreement and under the principal's original
employment agreement. The principal of Neosoft was employed by the Company
at the time of the closing of the transaction and was managing the
Company's Neosoft operations. The Company believes that the terms of the
transaction were no less favorable than it would have received from an
unrelated third party.
o Subsequent to March 31, 2002, the Company sold certain assets related to
the Kansas City, Missouri and Denver, Colorado ("Central States")
operations of Inteliant for contingent payments not to exceed $1,000,000 in
the aggregate over three years following the closing date of the
transaction based on the gross profit of the business acquired by the
buyer. The buyer also assumed liabilities of approximately $40,000.
Additionally, the Company retained accounts receivable of approximately
$500,000. The Company employed the buyer as the manager of the Central
States operations at the time of the closing of the transaction. The
Company believes that the terms of the transaction were no less favorable
than it would have received from an unrelated third party.
In addition, during fiscal 2001, the Company formalized a plan to sell
its wholly owned subsidiary, ServCom Staff Management, Inc., a professional
employee organization. On December 31, 2001, the Company sold substantially all
of the assets of this business to an unrelated entity. The Company retained
accounts receivable of approximately $480,000, of which approximately $149,000
was outstanding as of March 31, 2002. The terms of the transaction were
immaterial to the financial results of the Company.
Results of Continuing 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:
13 Weeks Ended
------------------------------------
March 31, 2002 April 1, 2001
------------------ -----------------
Service revenues 100.0% 100.0%
Direct cost of services 80.5 78.3
------------------ -----------------
Gross profit 19.5 21.7
------------------ -----------------
Operating expenses:
Selling, general and administrative expenses 20.2 19.8
Restructuring charges 0.8 0.5
Intangible amortization 0.0 1.0
------------------ -----------------
Total operating expenses 21.0 21.3
------------------ -----------------
(Loss) income from operations (1.5%) 0.4%
================== =================
Service Revenues: Service revenues for the 13-week period ended March
31, 2002 were $42.2 million, a decrease of $10.5 million, or 19.9%, compared to
revenues of $52.7 million for the 13-week period ended April 1, 2001. The
decrease was due primarily to reduced demand for temporary services as a result
of the broad downturn in the economy. The Company also has experienced a
significant decrease in permanent placement revenues.
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 staffing employees 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 March 31, 2002 and April 1,
2001 was $8.2 million and $11.5 million, respectively, a decrease of $3.3
million, or 28.7%. For the 13-week periods ended March 31, 2002 and April 1,
2001, gross profit margin was 19.5% and 21.7%, respectively. The margin decline
from the comparable period of the prior year was primarily a result of increased
pricing competition for staffing services, higher workers' compensation
insurance costs and a reduction in the higher margin permanent placement
business. The Company has renewed its workers' compensation insurance for fiscal
2002. As part of the renewal, the Company is required to pay higher premium
costs. The Company believes that some of the increase in costs will be passed
through as price increases to its customers. However, given the competitive
nature of the staffing industry, the Company is unsure whether it will be
successful in passing through all cost increases. Accordingly, the Company
believes that its gross margin could be negatively impacted throughout fiscal
2002.
-16-
Operating Expenses: Operating expenses include, among other things,
staff employee compensation, rent, recruitment and retention of temporary
associates, depreciation, intangibles amortization and advertising. Total
operating expenses as a percentage of service revenues declined slightly to
21.0% for the 13-week period ended March 31, 2002, compared to 21.3% for the
13-week period ended April 1, 2001, due primarily to reduction in recognized
intangible amortization related to adoption of SFAS No. 142.
Selling, general and administrative expenses, as a percentage of
service revenues, for the 13-week period ended March 31, 2002 were 20.2%,
compared to 19.8% for the 13-week period ended April 1, 2001. The increase as a
percentage of service revenues is due primarily to the Company's revenues
declining more rapidly than the corresponding reduction in selling, general and
administrative expenses.
Restructuring charges for the 13-week period ended March 31, 2002 added
approximately 0.8% in additional operating expenses. The restructuring charges
were primarily the result of a change in the estimated future lease costs
associated with closed branch offices, as well as severance charges related to
the elimination of an additional 36 full-time equivalent employees. The Company
is endeavoring to reduce potential future lease payments by subleasing the
abandoned facilities or 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.
(Loss) Income from Operations: Loss from operations for the 13-week
period ended March 31, 2002 was approximately ($0.6) million, compared to income
from operations for the 13-week period ended April 1, 2001 of approximately $0.2
million, a decrease of approximately $0.8 million. Operating margin was (1.5%),
compared to 0.4% for the comparable period of the prior year. The decrease in
operating margin was due largely to the decrease in gross profit.
Income Taxes: For the 13-week period ended March 31, 2002, the Company
recognized a tax benefit of approximately $7.9 million, due primarily to the
enactment of the Job Creation and Work Assistance Act of 2002 (the "2002 Job
Act"), which was signed into law on March 9, 2002. The 2002 Job Act contains
certain provisions that provide favorable tax treatment for the Company. Among
such provisions is the extension of the net operating loss carryback period from
two years to five years for net operating losses arising in tax years ending in
2001 and 2002. These provisions also allow companies to use the net operating
loss carrybacks to offset 100 percent of alternative minimum taxable income. In
accordance with SFAS No. 109, "Accounting for Income Taxes," the effect of the
change in the law has been accounted for in the first quarter of fiscal 2002,
the period in which the law became effective.
Liquidity and Capital Resources
For the 13-week period ended March 31, 2002, net cash used by operating
activities was approximately $2.3 million, compared to net cash provided by
operating activities of approximately $14.5 million for the 13-week period ended
April 1, 2001. The change in operating cash flow was primarily a result of the
net loss of the Company coupled with a net decrease in cash provided from
certain working capital components, consisting primarily of collections on
accounts receivable and collection of income tax receivables. Additionally,
during the 13-week period ended March 31, 2002, the Company renewed its workers'
compensation policy. Under the terms of this renewed policy, the Company is
required to provide a letter of credit of $10.0 million plus $1.0 million in
cash to collateralize future claims payments under the policy. The cash amount
is carried at fair value and is restricted as to withdrawal. The restricted cash
is held in the Company's name with a major financial institution
The Company's investing activities for the 13-week period ended March
31, 2002 used approximately $0.2 million, compared to $2.8 million for the
13-week period ended April 1, 2001. The Company's investing activities used
approximately $0.2 million to purchase property and equipment during the 13-week
period ended March 31, 2002. By comparison, the Company used approximately $0.4
million to purchase property and equipment, approximately $0.1 million for
payments on acquisition earnouts and approximately $2.3 million for notes
receivable issued during the 13-week period ended April 1, 2001.
Net cash provided by the Company's financing activities for the 13-week
period ended March 31, 2002 was approximately $7.2 million, primarily due to
borrowings on the Company's credit facility. Net cash used in the Company's
financing activities for the comparable prior year period ended April 1, 2001,
was approximately $9.1 million, primarily for payments on the Company's
revolving credit facility.
-17-
As of March 31, 2002 the Company had outstanding borrowings under its
revolving credit facility, as amended, of approximately $7.5 million, with a
maturity date of June 30, 2002. Additionally, the Company's outstanding
borrowings on the senior notes, as amended, were approximately $28.8 million.
Under terms of both the existing senior note agreements and the revolving credit
facility, the Company was in violation of certain covenants.
On April 15, 2002, the Company entered into a Fifth Amendment to
Amended and Restated Credit Agreement and Waiver (the "Fifth Credit Amendment")
with the Lenders to extend the Company's line of credit. Pursuant to the Fifth
Credit Amendment, the Company's line of credit was reduced from $18.0 million to
$16.0 million, $6.0 million of which is available for borrowing in cash, reduced
as provided below, with a maturity date of September 1, 2003, 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, 2004. The Fifth Credit Amendment provides for borrowings at the prime
rate (4.75% as of March 31, 2002) plus 3.0 percentage points through and
including June 30, 2003, after which time borrowings under the facility will be
charged an interest rate equal to the then-current prime rate plus 3.5
percentage points. Additionally, the Fifth Credit Amendment provides for an
amendment fee of approximately $78,000, payable to the Lenders upon execution of
the Fifth Credit Amendment plus a supplemental fee of $250,000 payable on
September 1, 2003, unless the Lenders are paid in full and their credit
commitment is terminated on or before such date. In addition, the Company paid
$313,000 of the outstanding borrowings under the revolving credit facility upon
execution of the Fifth Credit Amendment. The Company will pay an additional
$470,000 and $559,000 of the outstanding borrowings under the revolving credit
facility on September 15, 2002 and December 15, 2002, respectively. Such
payments will permanently reduce the line of credit available to the Company for
borrowing in cash to less than the $6.0 million stated above. The Fifth Credit
Amendment also waives any violations of financial covenants under the credit
facility that may have existed as of March 31, 2002. In addition, certain
financial covenants of the Company have been modified. As of April 30, 2002, the
Company had outstanding borrowings under the revolving credit facility of
approximately $2.1 million.
Also on April 15, 2002, the Company entered into an Amendment No. 3 to
Note Purchase Agreement ("Amendment No. 3") with the Noteholders, whereby the
Noteholders waived the Company's noncompliance with certain financial covenants
under the Company's bank credit facility and the existing note purchase
agreements with the Noteholders as of March 31, 2002. The Noteholders also
consented to the Company entering into the Fifth Credit Amendment described
above. Pursuant to Amendment No. 3, the Series A Notes bear interest at the rate
of 9.22% per annum beginning as of April 1, 2002 through, but excluding, June
30, 2003, and at the rate of 9.72% per annum from June 30, 2003 until the Series
A Notes become due and payable. The Series B Notes bear interest at the rate of
9.45% per annum beginning as of April 1, 2002 through, but excluding, June 30,
2003, and at the rate of 9.95% per annum from June 30, 2003 until the Series B
Notes become due and payable.
Pursuant to Amendment No. 3, any overdue payments on the Series A Notes
bear interest at the greater of 2% over the interest rate currently in effect as
stated above or 2% over the prime rate of The First National Bank of Chicago.
The change in the interest rate charged on the senior notes is estimated to have
an annual impact of approximately $142,000 on the Company's financial
operations. In addition, the Company paid $687,000 of the principal amount of
the senior notes upon execution of Amendment No. 3. The Company will pay an
additional $1,030,500 and $1,227,000 of the principal amount of the senior notes
on September 15, 2002 and December 15, 2002, respectively.
Amendment No. 3 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 of control, transfer of property or issuance of equity
securities of the Company. In addition, Amendment No. 3 provides that the
Company pay to the Lenders and the Noteholders any federal, state or local tax
refund or repayment, which amount shall be distributed pursuant to the Amended
and Restated Intercreditor Agreement dated as of April 15, 2002 among the
Collateral Agent, the Lenders and the Noteholders; however, if the Company
receives any refund arising from the 2002 Job Act relating to net operating loss
carryforwards, the Company will be able to retain for working capital purposes
the lesser of $2,000,000 or 50% of the refund. Any such prepayments paid to the
Lenders also will be treated as a permanent reduction in the line of credit
available to the Company for borrowing in cash under the revolving credit
facility.
-18-
Pursuant to Amendment No. 3, the Company shall deliver to the
Noteholders certain financial statements within 30 days of the end of each
calendar month certified by the senior financial officer of the Company. As
consideration for Amendment No. 3 and the waiver by the Noteholders, the Company
paid an amendment fee to the Noteholders of $145,475, as well as fees and
expenses of the Noteholders' special counsel. In addition, the Company paid to
each Noteholder accrued but unpaid interest on such holder's notes for the
period beginning March 1, 2002 through and including March 31, 2002. Also
pursuant to Amendment No. 3, the Company is required to pay on September 1, 2003
a supplemental note fee of $250,000, which amount will be waived if the Company
has paid all amounts due and outstanding under the note purchase agreements
prior to such date. Also, certain financial covenants of the Company were
modified. In the event the Company fails to comply with such covenants as
modified, Amendment No. 3 provides that the Noteholders may, at their discretion
and at the expense of the Company, retain a financial advisor to review, and
advise the Noteholders and the Company upon, the financial status of the
Company. The security agreement dated as of July 30, 2001 remains in place
pursuant to Amendment No. 3.
For the period ended March 31, 2002, the Company continued reforming
its corporate structure and consolidating or closing branch offices in
under-performing markets. During the 13-week period ended March 31, 2002, the
Company recorded a restructuring charge of approximately $345,000 primarily
related to a change in the estimate of future lease payment reserves and
severance costs related to the reduction in workforce. The Company is
endeavoring to reduce potential future lease payments by subleasing the
abandoned facilities or 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. At March 31, 2002, the remaining
accrued restructuring charges totaled approximately $0.6 million, and are
recorded in the balance sheet as an accrued liability.
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.
Seasonality
The Company's business follows the seasonal trends of its customers'
businesses. Historically, the Company's business 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.
Forward-looking Statements
Statements contained in this report that 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 attract and retain staff, temporary and other employees needed to
implement the Company's business plan and to meet customer needs; failure of the
Company to secure adequate finances to continue to fund its current operations;
the Company's ability to integrate the operations of acquired businesses; 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: economic fluctuations, existing
and emerging competition, changes in demands for the Company's services, the
Company's ability to maintain profit margins in the face of pricing pressures
and the unanticipated results of future or pending litigation. Risk factors,
cautionary statements and other conditions, including economic, competitive,
governmental and technology factors that could cause actual results to differ
from the Company's current expectations are discussed in the Company's Annual
Report on Form 10-K.
-19-
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 revolving credit facility bears
interest at the prime rate plus 3.0%; at March 31, 2002, such prime rate was
4.75%. For the 13-week period ended March 31, 2002, the Company had
approximately $7.5 million in advances outstanding under the revolving credit
facility.
Senior Notes: For the 13-week period ended March 31, 2002, the Company's
outstanding borrowings on the senior notes were $28.8 million, with a weighted
average fixed interest rate of 8.92%. As stated above, any changes in the fair
value of the senior notes generally will not have a significant impact on the
Company unless the Company is required to refinance the senior notes. The fair
value of the Company's senior notes is estimated by discounting expected cash
flows at the prime rate, 4.75% at March 31, 2002, plus 3.0%. Using such discount
rate over the expected maturities of the senior notes, the Company calculates
that the estimated fair value of the obligations on the senior notes, using a
discount rate of 7.75% over the expected maturities of the obligations, is
approximately $30.1 million. If the discount rate were to increase by 10% to
8.5%, the estimated fair value of the obligation on the unsecured notes would be
approximately $29.6 million. If the discount rate were to decrease by 10% to
7.0%, the estimated fair value of the obligation on the unsecured notes would be
approximately $30.6 million.
-20-
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 for breach of contract for services to be provided
by Inteliant and for 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 rescheduled to commence in December 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.
Item 6. Exhibits and Reports on Form 8-K.
a) None.
b) None.
-21-
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: May 10, 2002 /s/ JoAnn W. Wagner
--------------------------
JoAnn W. Wagner
Chairman, President and
Chief Executive Officer
Dated: May 10, 2002 /s/ Kevin Hardy
--------------------------
Kevin Hardy
Senior Vice President and
Chief Financial Officer
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