UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
[x] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 29, 2003
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from _________to__________
Commission File Number 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 by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act). Yes [ ] No [ ]
Indicate the number of shares outstanding of each of the issuer's classes
of common stock, as of the last practicable date.
Class of Common Stock Outstanding at August 11, 2003
--------------------- ------------------------------
Common Stock, $0.01 par value 12,691,398
1
TABLE OF CONTENTS
PART I - FINANCIAL INFORMATION
Item 1. Condensed Consolidated Financial Statements
Condensed Consolidated Balance Sheets
As of June 29, 2003 and December 29, 2002 3
Condensed Consolidated Statements of Operations
For the 13 and 26 Weeks Ended June 29, 2003 and June 30, 2002 5
Condensed Consolidated Statements of Cash Flows
For the 26 Weeks Ended June 29, 2003 and June 30, 2002 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 22
Item 4. Controls and Procedures 23
PART II - OTHER INFORMATION
Item 1. Legal Proceedings 24
Item 4. Submission of Matters to a Vote of Security Holders 24
Item 6. Exhibits and Reports on Form 8-K 24
Signatures 25
Certifications 26
2
PART I - FINANCIAL INFORMATION
Item 1. Condensed Consolidated Financial Statements
SOS STAFFING SERVICES, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(Unaudited)
ASSETS
(in thousands)
June 29, December 29,
2003 2002
--------- ------------
CURRENT ASSETS
Cash and cash equivalents $ 1,123 $ 495
Accounts receivable, less allowances of
$881 and $1,031, respectively 16,856 15,130
Prepaid insurance 1,893 200
Prepaid expenses and other 599 541
Income tax receivable 8 3,806
-------- --------
Total current assets 20,479 20,172
-------- --------
PROPERTY AND EQUIPMENT, at cost
Computer equipment 4,710 4,899
Office equipment 2,845 2,855
Leasehold improvements and other 887 1,351
-------- --------
8,442 9,105
Less accumulated depreciation and amortization (6,169) (6,182)
-------- --------
Total property and equipment, net 2,273 2,923
-------- --------
OTHER ASSETS
Intangible assets, net 17,208 17,340
Restricted cash 2,658 1,333
Deposits and other assets 1,203 1,485
-------- --------
Total other assets 21,069 20,158
-------- --------
Total assets $ 43,821 $ 43,253
-------- --------
See accompanying notes to condensed consolidated financial statements.
3
SOS STAFFING SERVICES, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS (Continued)
(Unaudited)
LIABILITIES AND SHAREHOLDERS' EQUITY
(in thousands)
June 29, December 29,
2003 2002
-------- -----------
CURRENT LIABILITIES
Current portion of notes payable $ 10,478 $ 1,374
Current portion of workers' compensation reserve 3,729 3,713
Accrued liabilities 2,886 1,775
Line of credit 2,262 --
Accrued payroll costs 2,150 1,766
Accounts payable 645 666
-------- --------
Total current liabilities 22,150 9,294
-------- --------
LONG-TERM LIABILITIES
Notes payable, less current portion 12,352 21,967
Line of credit -- 994
Workers' compensation reserve, less current portion 1,741 1,747
Deferred compensation liabilities and other long-term
liabilities 645 719
-------- --------
Total long-term liabilities 14,738 25,427
-------- --------
COMMITMENTS AND CONTINGENCIES
(Notes 1, 6 and 8)
SHAREHOLDERS' EQUITY
Common stock 127 127
Additional paid-in capital 91,693 91,693
Accumulated deficit (84,887) (83,288)
-------- --------
Total shareholders' equity 6,933 8,532
-------- --------
Total liabilities and shareholders' equity $ 43,821 $ 43,253
-------- --------
See accompanying notes to condensed consolidated financial statements.
4
SOS STAFFING SERVICES, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
(in thousands)
13 Weeks Ended 26 Weeks Ended
------------------------------- ----------------------------------
June 29, 2003 June 30, 2002 June 29, 2003 June 30, 2002
--------------- --------------- ----------------- ----------------
SERVICE REVENUES $ 41,963 $ 46,288 $ 77,830 $ 88,226
DIRECT COST OF SERVICES 33,616 37,050 62,475 70,832
-------- -------- -------- --------
Gross profit 8,347 9,238 15,355 17,394
-------- -------- -------- --------
OPERATING EXPENSES
Selling, general and administrative 6,968 7,916 13,938 15,827
Depreciation and amortization 521 392 1,012 835
Finance advisory costs 322 -- 493 --
Restructuring charges -- 264 -- 609
-------- -------- -------- --------
Total operating expenses 7,811 8,572 15,443 17,271
-------- -------- -------- --------
INCOME (LOSS) FROM OPERATIONS 536 666 (88) 123
-------- -------- -------- --------
OTHER INCOME (EXPENSE)
Interest expense (763) (867) (1,483) (1,789)
Interest income 4 3 8 9
Other, net 37 (14) 57 8
-------- -------- -------- --------
Total other expense, net (722) (878) (1,418) (1,772)
-------- -------- -------- --------
LOSS FROM CONTINUING OPERATIONS BEFORE INCOME TAXES
(186) (212) (1,506) (1,649)
INCOME TAX BENEFIT -- -- -- 7,927
-------- -------- -------- --------
(LOSS) INCOME FROM CONTINUING OPERATIONS
(186) (212) (1,506) 6,278
LOSS FROM DISCONTINUED OPERATIONS (Note 5)
(86) (1,221) (93) (1,636)
CUMULATIVE EFFECT OF CHANGE IN ACCOUNTING PRINCIPLE, net -- -- -- (16,083)
-------- -------- -------- --------
NET LOSS $ (272) $ (1,433) $ (1,599) $(11,441)
-------- -------- -------- --------
BASIC AND DILUTED (LOSS) INCOME PER COMMON SHARE
(Loss) income from continuing operations $ (0.01) $ (0.02) $ (0.12) $ 0.49
Loss from discontinued operations (0.01) (0.09) (0.01) (0.12)
Loss from cumulative effect of change in accounting
principle -- -- -- (1.27)
-------- -------- -------- --------
Net loss $ (0.02) $ (0.11) $ (0.13) $ (0.90)
-------- -------- -------- --------
See accompanying notes to condensed consolidated financial statements.
5
SOS STAFFING SERVICES, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
(in thousands)
26 Weeks Ended
June 29, June 30,
2003 2002
-------- ----------
CASH FLOWS FROM OPERATING ACTIVITIES
Net loss $ (1,599) $(11,441)
Adjustments to reconcile net loss
to net cash provided by operating activities:
Depreciation and amortization 1,012 835
Loss on disposal of discontinued operations -- 1,065
Loss on cumulative change in accounting principle -- 16,083
Changes in operating assets and liabilities:
Restricted cash (1,325) (1,033)
Accounts receivable, net (1,726) 3,492
Prepaid expenses and other (1,751) (378)
Deposits and other assets 282 (183)
Accounts payable (21) (972)
Accrued payroll costs 384 (982)
Workers' compensation reserve 10 (206)
Accrued liabilities 1,050 (1,674)
Income taxes receivable 3,798 (3,487)
-------- --------
Net cash provided by operating activities 114 1,119
-------- --------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of property and equipment (243) (425)
Proceeds from sale of property and equipment -- 10
-------- --------
Net cash used in investing activities (243) (415)
-------- --------
See accompanying notes to condensed consolidated financial statements.
6
SOS STAFFING SERVICES, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (Continued)
(Unaudited)
(in thousands)
29 Weeks Ended
June 29, June 30,
2003 2002
-------- --------
CASH FLOWS FROM FINANCING ACTIVITIES
Proceeds from borrowings $ 2,900 $ 8,821
Principal payments on long-term borrowings (2,143) (9,473)
------- -------
Net cash provided by (used in) financing
activities 757 (652)
------- -------
NET INCREASE IN CASH
AND CASH EQUIVALENTS 628 52
CASH AND CASH EQUIVALENTS AT
BEGINNING OF PERIOD 495 879
------- -------
CASH AND CASH EQUIVALENTS AT
END OF PERIOD $ 1,123 $ 931
------- -------
SUPPLEMENTAL CASH FLOW INFORMATION Cash paid (received)
during the period for:
Interest $ 1,287 $ 2,534
Income taxes (3,814) (4,440)
See accompanying notes to condensed consolidated financial statements.
7
SOS STAFFING SERVICES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
Note 1. Basis of Presentation and Nature of Operations
The accompanying unaudited interim 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
of America 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 29, 2002.
As required by both the Company's lenders and noteholders, the Company
has retained a financial advisor to assist in refinancing, restructuring or
recapitalizing the Company (see Note 9).
The Company believes that funds available under its existing revolving
credit agreement plus cash reserves and cash flow from operations will be
sufficient to meet anticipated needs for working capital, capital expenditures
and debt service obligations, at least through fiscal year 2003. However, the
Company's current revolving credit agreement expires in April 2004. The Company
believes that if the revolving credit agreement is renewed or replaced then
these sources of funds plus cash reserves and cash flow from operations will be
sufficient to meet anticipated needs for working capital, capital expenditures
and debt service obligations. If the Company is unable to extend or renew the
revolving credit facility prior to maturity, or if the Company experiences a
significant downturn in its business, additional capital would be required in
order to continue operations. If the Company is unable to find alternative or
additional sources of capital, then the Company will be required to consider a
number of strategic alternatives, including closure of certain locations or the
sale of certain or all of its assets. In the current economic environment,
management believes that any such sale would be at depressed prices that could
be significantly lower than the net book value of assets sold and may not be
sufficient to satisfy its liabilities.
The results of operations for the interim periods are not necessarily
indicative of the results to be expected for the full year.
Note 2. Cash
Bank overdrafts: Under the Company's cash management system,
outstanding checks pending clearance that are considered for accounting purposes
to be overdraft balances are included as part of the Company's line of credit.
Restricted cash: The Company's workers' compensation insurance policy
for fiscal year 2003 requires the Company to provide letters of credit not to
exceed $10.0 million, an overline letter of credit of $1.3 million secured by
$1.3 million of collateral held as restricted cash, plus restricted cash of $1.3
million as collateral for future claims payments under the insurance plan. The
total $2.6 million 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 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):
8
13 Weeks Ended June 29, 2003 13 Weeks Ended June 30, 2002
-------------------------------------------------------------------------------------------
Loss from Loss from
continuing Per Share continuing Per Share
operations Shares Amount operations Shares Amount
-------------------------------------------------------------------------------------------
Basic $ (186) 12,691 $ (0.01) $ (212) 12,691 $ (0.02)
Effect of stock options -- --
---------------------------- --------------------------------
Diluted $ (186) 12,691 $ (0.01) $ (212) 12,691 $ (0.02)
---------------------------- --------------------------------
26 Weeks Ended June 29, 2003 26 Weeks Ended June 30, 2002
------------------------------------------- -----------------------------------------------
Loss from Income from
continuing Per Share continuing Per Share
operations Shares Amount operations Shares Amount
Basic $ (1,506) 12,691 $ (0.12) $ 6,278 12,691 $ 0.49
Effect of stock options -- 2
---------------------------- --------------------------------
Diluted $ (1,506) 12,691 $ (0.12) $ 6,278 12,693 $ 0.49
---------------------------- --------------------------------
For the 13- and 26-week periods ended June 29, 2003, there were
outstanding options to purchase 1,563,000 shares of common stock that were not
included in the computation of diluted loss from continuing operations per
common share because of the Company's loss from continuing operations. For the
13-week period ended June 30, 2002, there were outstanding options to purchase
1,587,000 shares of common stock that were not included in the computation of
loss income from continuing operations per common share because of the Company's
loss from continuing operations. For the 26-week period ended June 30, 2002,
there were outstanding options to purchase approximately 1,583,600 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.
On July 23, 2003, the Company received a Nasdaq Staff Determination
(the "Staff Determination"), stating that the Company did not meet Nasdaq's
$1.00 minimum closing bid price requirement for continued listing set forth in
Marketplace Rule 4450(a)(5) and that its common stock, therefore, would be
subject to delisting from The Nasdaq SmallCap Market (the "SmallCap Market")
effective August 1, 2003. As permitted by the Staff Determination, the Company
requested, and was granted, a hearing before the Nasdaq Listing Qualifications
Panel to appeal the delisting. The scheduled date of the hearing was postponed
from August 28, 2003 to September 11, 2003. After receiving the Staff
Determination, the Company's board of directors approved a five-to-one reverse
stock split, which is expected to become effective on or about August 22, 2003.
The Company believes such reverse stock split will bring it into compliance with
Nasdaq's minimum closing bid price per share requirement. The Company's
shareholders previously approved such reverse stock split at the Company's
annual meeting in May 2003. Pending Nasdaq's final ruling, delisting will be
stayed and the Company's common stock will continue to be listed on the SmallCap
Market.
Note 4. Accounting for Stock-Based Compensation
The Company measures compensation cost for employee stock options and
similar equity instruments using the intrinsic value-based method of accounting
prescribed by Accounting Principles Board Opinion No. 25, "Accounting for Stock
Issued to Employees." No stock-based employee compensation cost is reflected in
net loss, as all options granted had an exercise price equal to the market value
of the underlying common stock on the date of grant.
Had compensation cost been determined consistent with SFAS No. 123,
"Accounting for Stock-Based Compensation," the Company's income (loss) from
continuing operations and earnings per share for the 13- and 26-week periods
ended June 29, 2003 and June 30, 2002 would approximate the pro forma amounts
reflected below (in thousands, except per share data):
9
13 Weeks Ended 26 Weeks Ended
---------------------------------- ----------------------------------
June 29, 2003 June 30, 2002 June 29, 2003 June 30, 2002
----------------- ---------------- ----------------- ----------------
(Loss) income from continuing operations-
As reported $ (186) $ (212) $ (1,506) $ 6,278
Total fair-value-based option compensation
expense, net of income tax -- 2 318 708
----------------- ---------------- ----------------- ----------------
Pro forma $ (186) $ (214) $ (1,824) $ 5,570
----------------- ---------------- ----------------- ----------------
Basic and diluted EPS from continuing
operations-
As reported $ (0.01) $ (0.02) $ (0.12) $ 0.49
Pro forma (0.01) (0.02) (0.14) 0.44
In determining the fair-value-based option compensation expense in the
table above, the fair market value of each option was estimated on the date of
grant using the Black-Scholes option-pricing model based on the following
weighted average assumptions:
2003 2002
--------------- --------------
Risk free rate of return 2.9% 5.1%
Expected dividend yield 0.0% 0.0%
Volatility 93% 93%
Expected life for director options 5 years 5 years
Expected life for employee options 7 years 7 years
No option grants were made during the 13-week period ended June 29,
2003. The weighted-average fair value of options granted was $0.48 per share for
grants made during the 13-week period ended June 30, 2002. The weighted-average
fair value of options granted was $0.28 and $0.66 per share for grants made
during the 26-week periods ended June 29, 2003 and June 30, 2002, respectively.
Note 5. Discontinued Operations
IT Consulting
On December 29, 2000, the Company's wholly owned subsidiary Inteliant
Corporation ("Inteliant") sold to Herrick Douglass, Inc. ("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.
In conjunction with the sale of the IT consulting business, the Company
assigned certain lease agreements to different sub-tenants, with the respective
landlords reserving their rights against the Company in the event of default by
such sub-tenant. During the 26-week period ended June 29, 2003, the Company was
informed by one of its sub-tenants that such sub-tenant would more likely than
not default on its sublease obligation. Consequently, for the 13- and 26-week
periods ended June 29, 2003, the Company recorded an additional charge of
$100,000 and $163,000, respectively, to discontinued operations for expected
losses related to the sublease.
IT Staffing and ServCom
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, 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, and treated these actions as discontinued
operations beginning in fiscal 2001. Contingent consideration is recorded in
discontinued operations when received. Subsequently, during fiscal 2002, the
Company disposed of its remaining operations with respect to its discontinued IT
staffing business.
In addition, during fiscal 2001, the Company formalized a plan to sell
its wholly owned subsidiary ServCom Staff Management, Inc., now known as
Industrial Specialists, Inc. ("ServCom"), and during fiscal 2002, the Company
sold substantially all of the assets of this business to an unrelated party.
10
For the 13-week period ended June 29, 2003, the Company incurred an
additional $13,000 in closure costs, primarily related to additional workers'
compensation costs incurred on behalf of ServCom to resolve all outstanding
claims. Contingent payments received relating to the sale of the IT staffing and
ServCom assets were $26,000 and $75,000 for the 13- and 26-week periods ended
June 29, 2003, respectively.
Truex
During the second quarter of fiscal 2002, due to declining revenues and
the continued economic downturn in the San Francisco, California, region, the
Company determined to sell its Truex division ("Truex"), located in northern
California. In August 2002, the Company entered into an agreement pursuant to
which the Company transferred the Truex business and trade name to an unrelated
party for contingent payments not to exceed $300,000 in the aggregate over one
year following the closing date of the transaction, based on the gross profit of
the business acquired. Any contingent consideration will be recorded by the
Company in discontinued operations when received.
During the 13-week period ended June 29, 2003, the Company incurred
$5,000 in closure costs associated with Truex, primarily related to increases in
the estimates for facility costs. The Company received contingent payments
relating to the transfer of the Truex business of $6,000 and $13,000 for the 13-
and 26-week periods ended June 29, 2003, respectively.
Operating results of the discontinued operations for the 13- and
26-week periods ended June 29, 2003 and June 30, 2002 have been classified as
discontinued operations in the accompanying condensed consolidated financial
statements as follows (in thousands):
13 Weeks Ended 26 Weeks Ended
June 29, 2003 June 30, 2002 June 29, 2003 June 30, 2002
--------------- ---------------- --------------- ----------------
IT Consulting
Loss on disposal of discontinued operations $ (100) $ (507) $ (163) $ (507)
--------------- ---------------- --------------- ----------------
IT Staffing and ServCom
Gain (loss) on disposal of discontinued operations 13 129 62 (183)
--------------- ---------------- --------------- ----------------
Truex
Revenue -- 159 -- 377
Direct cost of services -- 102 -- 237
--------------- ---------------- --------------- ----------------
Gross profit -- 57 -- 140
Operating and other expenses -- 900 -- 1,086
--------------- ---------------- --------------- ----------------
Loss from discontinued operations -- (843) -- (946)
--------------- ---------------- --------------- ----------------
Gain on disposal of discontinued operations 1 -- 8 --
--------------- ---------------- --------------- ----------------
Total loss from discontinued operations, net $ (86) $ (1,221) $ (93) $ (1,636)
--------------- ---------------- --------------- ----------------
For the 13-weeks ended June 29, 2003, the total loss from discontinued
operations was due primarily to a charge of $100,000 for anticipated losses on
one of the Company's subleased facilities plus additional closure costs of
approximately $18,000, offset by the receipt of $32,000 in contingent payments.
At June 29, 2003, the Company's remaining accrual for discontinued operations
was $527,000, primarily related to accrued lease costs, net of any anticipated
sublease income, on unused facilities for which the Company still has a
contractual obligation.
Note 6. Non-cancelable Operating Leases
The Company leases office facilities under non-cancelable operating
leases. Some of these leases have renewal options for periods ranging from one
to five years and contain provisions for escalation of rent payments based on
increases in certain costs incurred by the landlord and on Consumer Price Index
adjustments. Management expects that, in the normal course of business, leases
that expire will be renewed or replaced by other leases.
11
The Company has subleased some of the facilities that are not used by
the Company for which the lease is still in effect and in some instances has
reduced the amount of the liability carried on the Company's balance sheet by
the anticipated sublease payments relating to such properties. However, if any
of the sublessees defaults on its lease obligations, the Company would be liable
for any outstanding lease payments. Certain defaults could have a material
adverse impact on the Company's results of operations.
In addition to the $130,000 of accrued lease obligations discussed in
Note 10 below, the Company has $451,000 accrued at June 29, 2003 for offices of
discontinued operations, which amount is included in accrued liabilities in the
accompanying condensed consolidated balance sheets. The amount of lease
obligations accrued for offices that are no longer occupied by the Company is
net of expected sublease payments over the remaining term of the lease. The
following table presents the Company's future lease obligations and the expected
sublease payments by year for its subleased facilities (in thousands):
Fiscal Year Lease Lease payments Lease payments on
Ending payments on on closed discontinued Total lease Expected sublease
active offices offices operations payments payments
- -------------- ----------------- ----------------- -------------------- ------------------- --------------------
2003 $ 763 $ 92 $ 366 $ 1,221 $ 180
2004 851 54 295 1,200 157
2005 380 10 209 599 128
2006 123 -- 77 200 60
2007 and
beyond 58 -- 13 71 10
----------------- ----------------- -------------------- ------------------- --------------------
$ 2,175 $ 156 $ 960 $ 3,291 $ 535
----------------- ----------------- -------------------- ------------------- --------------------
Note 7. Intangible Assets
As of June 29, 2003 and December 29, 2002, intangible assets consisted
of the following:
June 29, 2003 December 29, 2002
------------------- ----------------------
Goodwill $ 14,724 $ 14,724
Trademarks and trade names 2,569 2,569
Other definite-lived intangibles 1,994 1,994
------------------- ----------------------
19,287 19,287
Less accumulated amortization (2,079) (1,947)
------------------- ----------------------
Net intangible assets $ 17,208 $ 17,340
------------------- ----------------------
As of December 29, 2002, the Company determined to replace the Century
trade name with the SOS Staffing(R) trade name. Consequently, the remaining
value of the Century trade name of $119,000 was fully amortized over the first
six months of fiscal 2003.
Note 8. 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,
employment practices liability and general liability.
There is no pending litigation that the Company currently anticipates
will have a material adverse effect on the Company's financial condition or
results of operations.
Note 9. Credit Facility and Notes Payable
On March 31, 2003, the Company entered into the Sixth Credit Amendment
to the Amended and Restated Credit Agreement and Waiver (the "Sixth Credit
Amendment") with its lenders to extend the Company's line of credit. Pursuant to
the Sixth Credit Amendment, the maturity date of the Company's line of credit
was extended to April 30, 2004. In addition, certain financial covenants under
12
the Company's credit facility were modified. As provided in the Sixth Credit
Amendment, the Company will pay to its lenders four equal payments of $156,500
in successive months beginning in September 2003. Such payments will permanently
reduce the line of credit available to the Company. However, any such reductions
in the aggregate commitment shall not apply if they would reduce the cash
available for borrowing below $2.5 million. As of June 29, 2003, the Company had
outstanding borrowings under the revolving credit facility of approximately $2.3
million.
Additionally, under the terms of the Company's amended credit facility,
the Company has letters of credit available of up to $11.3 million, to be issued
solely as required by the Company's workers' compensation insurance provider. Of
the $11.3 million letters of credit, $1.3 million is an overline letter of
credit secured by $1.3 million in restricted cash.
Also on March 31, 2003, the Company entered into Amendment No. 4 to
Note Purchase Agreement ("Amendment No. 4") with its senior noteholders,
pursuant to which the noteholders modified certain financial covenants under the
Company's existing note purchase agreements. Amendment No. 4 provides that the
Company will pay to the noteholders four equal payments of $343,500 in
successive months beginning in September 2003, to be applied pro rata among the
holders of the Series A and Series B notes. Additionally, the maturity date of
the Series A notes was extended to April 30, 2004. As consideration for
Amendment No. 4, the Company paid all fees and expenses of the noteholders'
special counsel.
Amendment No. 4 and the Sixth Credit Agreement also provide that the
Company shall 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 June 30, 2003 among US
Bank N.A. as successor to State Street Bank and Trust Company, as collateral
agent, Wells Fargo Bank, National Association, as administrative agent and as a
lender, and the noteholders (the "Amended Intercreditor Agreement"). However, of
the tax refund arising from the Job Creation and Work Assistance Act of 2002
(the "2002 Job Act") relating to net operating loss carrybacks, the Company
retained $3.8 million: $1.8 million was used for working capital purposes, $1.3
million was used for additional collateral to secure the Company's workers'
compensation policy, and the remainder of $700,000 was applied against the
Company's long-term debt and credit facility.
As required by both the credit facility and the note purchase
agreements, the Company has retained a financial advisor to assist in
refinancing, restructuring or recapitalizing the Company. As required by
Amendment No. 4 and the Sixth Credit Amendment, the Company has prepared and has
distributed to prospective investors an offering memorandum for the
recapitalization of the Company's debt obligations. Additionally, the Company
was required to use its best efforts to obtain a firm commitment or signed
letter of intent regarding such recapitalization prior to July 31, 2003. As of
July 31, 2003, the lenders and the noteholders agreed to extend such deadline
until August 29, 2003. In the event the Company does not have a firm commitment
or signed letter of intent by such date, the Company will be required to pay
$250,000, in the aggregate, to be distributed pursuant to the Amended
Intercreditor Agreement. Additionally, the Company was required to pay on
September 1, 2003 a supplemental fee of $250,000 to the lenders, in the
aggregate, and $250,000 to the noteholders, in the aggregate. As of July 31,
2003, the lenders and the noteholders agreed to extend such deadline until
October 1, 2003. Such supplemental fee will be waived if the Company has paid
all amounts due and outstanding under its financing agreements prior to such
date.
Note 10. Restructuring
At June 29, 2003, the Company's accrued restructuring charges totaled
approximately $130,000 and are included in accrued liabilities in the
accompanying condensed consolidated balance sheet. The activity impacting the
accrual for restructuring charges is summarized in the table below (in
thousands):
Contractual
lease
obligations
----------------
Balance at December 29, 2002 $ 155
Charges utilized (25)
----------------
Balance at June 29, 2003 $ 130
----------------
13
Note 11. Income Taxes
During the 13-week period ended June 29, 2003, the Company received
$3.8 million in federal income tax refunds with respect to the 2002 fiscal year.
The refunds are primarily a result of the Company's recognition, during the
first quarter of fiscal 2002, of a federal tax benefit of $7.9 million due
primarily to the enactment of the 2002 Job Act, which was signed into law on
March 9, 2002. In accordance with SFAS No. 109, "Accounting for Income Taxes,"
the effect of the change in the law was accounted for in the first quarter of
the 2002 fiscal year, the period in which the law became effective. Of the $3.8
million, the Company was able to retain $1.8 million for working capital
purposes, $1.3 million was used for additional collateral to secure its workers'
compensation policy, as discussed below, and the remaining $700,000 was applied
against the Company's long-term debt and credit facility.
Management has concluded that it is more likely than not that the
Company will not have sufficient taxable income to allow for the realization of
certain carryforwards and other tax attributes generating the net deferred tax
asset. Therefore, a valuation allowance has been provided against the net
deferred tax asset of approximately $24.0 million.
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.
Critical Accounting Policies and Estimates
The Company's critical accounting policies for its continuing
operations include the following:
o allowance for doubtful accounts receivable;
o reserves for workers' compensation costs;
o impairment of goodwill and intangibles; and
o reserves for leased facility obligations.
The Company provides customary credit terms to its customers and
generally does not require collateral. The Company performs ongoing credit
evaluations of the financial condition of its customers and maintains an
allowance for doubtful accounts receivable based upon historical collection
experience and expected collectibility of accounts. As of June 29, 2003, the
Company had recorded an allowance for doubtful accounts of $881,000, which
represents 5.0% of the Company's total outstanding accounts receivable. The
actual bad debts may exceed such allowance and the difference could be
significant.
The Company maintains workers' compensation insurance with ACE, USA
("ACE"), an insurance carrier, with a deductible of $300,000 per occurrence and
no aggregate cap. Under the terms of the insurance policy with ACE, the Company
has deposited, and is required to maintain on deposit, with ACE an amount equal
to eleven days of claims expenses based on actual expenditures by ACE during the
prior three-month period. The Company also is required to fund into an account,
on a weekly basis, an amount equal to the actual payments made by ACE on claims
during the previous week as reimbursement to ACE for such payments. If claims
payments on any specific claim exceed the deductible amount of $300,000, the
Company is not required to reimburse the fund for those payments over and above
the deductible. Some states in which the Company operates do not permit private
insurance for workers' compensation; where this is the case, the Company is
covered by appropriate state insurance funds.
The Company has established reserve amounts based upon information
provided by ACE as to the status of claims plus development factors for incurred
but not yet reported claims and anticipated future changes in underlying case
reserves. On an annual basis, the Company's claims history is subjected to an
independent actuarial review to determine appropriate development factors, which
are used in developing the Company's reserve estimates. As of June 29, 2003, the
Company's workers' compensation reserve totaled $5.5 million. If the development
factors used by the Company were to increase by 10%, the Company's indicated
reserves would increase approximately $192,000 while a reduction in the
development factors of 10% would reduce the indicated reserves by approximately
$290,000. Such reserve amounts are only estimates; the Company's future workers'
compensation obligations may exceed the amount of its reserves and the
difference could be significant.
In accordance with SFAS No. 142, "Goodwill and Other Intangible
Assets," the Company does not amortize goodwill and identifiable intangible
assets that have indefinite useful lives. Intangible assets that have finite
useful lives, such as non-competition agreements, are amortized over their
useful lives. 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. The valuation process employed by
the Company to determine fair value uses a combination of present value and
multiple of earnings valuation techniques. Such valuation methods contain
significant assumptions regarding future financial performance of the Company as
well as assumptions regarding the Company's performance with respect to existing
competitors. There can be no assurance that the Company will be able to achieve
such financial performance and, consequently, future valuations may be
significantly different from the Company's current expectations. Such future
valuations could have a significant impact on the financial results of the
Company.
15
The Company leases office facilities under noncancelable operating
leases. With respect to offices the Company has vacated while the lease is still
in effect, the Company records its estimated liability in the period it leaves
the office space. In some instances, the Company has subleased the facilities
that currently are not used by the Company and has reduced the amount of such
liability carried on the Company's books by the estimated sublease payments
relating to such properties. However, if a subleasee defaults on its lease
obligations, the Company is liable for any outstanding lease payments. Certain
defaults could have a material impact on the Company's results of financial
operations. As of June 29, 2003, the Company had reduced its lease liability for
closed offices by approximately $581,000 as a result of estimated sublease
income.
Recent Developments
On July 23, 2003, the Company received a Nasdaq Staff Determination
(the "Staff Determination"), stating that the Company did not meet Nasdaq's
$1.00 minimum closing bid price requirement for continued listing set forth in
Marketplace Rule 4450(a)(5) and that its common stock therefore, would be
subject to delisting from The Nasdaq SmallCap Market (the "SmallCap Market")
effective August 1, 2003. As permitted by the Staff Determination, the Company
requested, and was granted, a hearing before the Nasdaq Listing Qualifications
Panel to appeal the delisting. The scheduled date of the hearing has been
postponed from August 28, 2003 to September 11, 2003. After receiving the Staff
Determination, the Company's board of directors approved a five-to-one reverse
stock split to become effective on or about August 22, 2003. The Company
believes such reverse stock split will bring it into compliance with Nasdaq's
minimum closing bid price per share requirement. The Company's shareholders
previously approved such reverse stock split at the Company's annual meeting in
May 2003. Pending Nasdaq's final ruling, delisting will be stayed and the
Company's common stock will continue to be listed on the SmallCap Market.
During the 13-week period ended June 29, 2003, the Company received
$3.8 million in federal income tax refunds with respect to the 2002 fiscal year.
The refunds are primarily a result of the Company's recognition, during the
first quarter of the 2002 fiscal year, of a federal tax benefit of $7.9 million,
due primarily to the enactment of the 2002 Job Act, which was signed into law on
March 9, 2002. In accordance with SFAS No. 109, "Accounting for Income Taxes,"
the effect of the change in the law was accounted for in the first quarter of
fiscal 2002, the period in which the law became effective. Of the $3.8 million,
the Company was able to retain $1.8 million for working capital purposes, $1.3
million was used for additional collateral to secure its workers' compensation
policy, as discussed below, and the remaining $700,000 was applied against the
Company's long-term debt and credit facility.
The Company renewed its workers' compensation insurance policy with ACE
for fiscal 2003. As part of the renewal, in January 2003, the Company was
required to pay in advance $1.8 million in premium and administrative costs for
a six-month policy. Additionally, the aggregate cap was eliminated. The Company
also was required to pay higher premium costs under the renewed policy. In June
2003, the Company paid an additional $660,000 to renew the policy through
December 2003. The Company also was required to post additional collateral in
the form of restricted cash of approximately $1.3 million in order to renew the
policy.
On March 31, 2003, the Company entered into the Sixth Credit Amendment
with its lenders to extend the Company's line of credit. Pursuant to the Sixth
Credit Amendment, the maturity date of the Company's line of credit was extended
to April 30, 2004. In addition, certain financial covenants under the Company's
credit facility were modified. As provided in the Sixth Credit Amendment, the
Company will pay to its lenders four equal payments of $156,500 in successive
months beginning in September 2003. Such payments will permanently reduce the
line of credit available to the Company in cash. However, any such reductions in
the aggregate commitment shall not apply if they would reduce the cash available
for borrowing below $2.5 million. As of June 29, 2003, the Company had
outstanding borrowings under the revolving credit facility of approximately $2.3
million.
Also on March 31, 2003, the Company entered into Amendment No. 4 with
its senior noteholders, pursuant to which the noteholders modified certain
financial covenants under the Company's existing note purchase agreements.
Amendment No. 4 provides that the Company will pay to its noteholders four equal
payments of $343,500 in successive months beginning in September 2003, to be
applied pro rata among the holders of the Series A and Series B notes.
Additionally, the maturity date of the Series A notes was extended to April 30,
2004. As consideration for Amendment No. 4, the Company paid all fees and
expenses of the noteholders' special counsel.
Amendment No. 4 and the Sixth Credit Amendment also provide that the
Company shall 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 Intercreditor Agreement. However, of the $3.8 million tax refund the
Company received arising from the 2002 Job Act relating to net operating loss
16
carrybacks, the Company was able to retain $1.8 million of such refund for
working capital purposes; an additional $1.3 million was utilized as collateral
for additional letters of credit issued on behalf of the Company workers'
compensation insurance carrier; and the remaining $700,000 was applied against
the Company's long-term debt and credit facility. 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.
As required by both the credit facility and the note purchase
agreements, the Company has retained a financial advisor to assist in
refinancing, restructuring or recapitalizing the Company. As required by
Amendment No. 4 and the Sixth Credit Amendment, the Company has prepared and has
distributed to prospective investors an offering memorandum for the
recapitalization of the Company's debt obligations. Additionally, the Company is
required to use its best efforts to obtain a firm commitment or signed letter of
intent regarding such recapitalization prior to July 31, 2003. As of July 31,
2003, the Company's lenders and noteholders agreed to extend such deadline until
August 29, 2003. In the event the Company does not have a firm commitment or
signed letter of intent by such date, the Company would be required to pay
$250,000, to be distributed pursuant to the Amended Intercreditor Agreement.
Additionally, the Company was required to pay on September 1, 2003 a
supplemental fee of $250,000 to the lenders, in the aggregate, and $250,000 to
the noteholders, in the aggregate. As of July 31, 2003 the Company's lenders and
noteholders agreed to extend such deadline until October 1, 2003. Such
supplemental fee will be waived if the Company has paid all amounts due and
outstanding under its financing agreements prior to such date.
Discontinued Operations
IT Consulting
On December 29, 2000, Inteliant sold to 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.
In conjunction with the sale of the IT consulting business, the Company
assigned certain lease agreements to different sub-tenants, with the respective
landlords reserving their rights against the Company in the event of default by
such sub-tenant. During the 13-week period ended June 29, 2003, the Company was
informed by one of its sub-tenants that such sub-tenant would more likely than
not default on its sublease obligation. Consequently, for the 13- and 26-week
periods ended June 29, 2003, the Company recorded an additional charge of
$100,000 and $163,000, respectively, to discontinued operations for expected
losses related to the sublease.
IT Staffing and ServCom
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, 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,and treated these actions as discontinued
operations beginning in fiscal 2001. Contingent consideration is recorded in
discontinued operations when received. Subsequently, during the 52-week period
ended December 29, 2002, the Company disposed of its remaining operations with
respect to its discontinued IT staffing business.
In addition, during fiscal 2001, the Company formalized a plan to sell
ServCom and during fiscal 2002, the Company sold substantially all of the assets
of this business to an unrelated party.
For the 13-week period ended June 29, 2003, the Company incurred an
additional $13,000 in closure costs, primarily related to additional workers'
compensation costs incurred on behalf of ServCom to resolve all outstanding
claims. Contingent payments received relating to the sale of the IT staffing and
ServCom assets were $26,000 and $51,000 for the 13- and 26-week periods ended
June 29, 2003, respectively.
Truex
During the second quarter of fiscal 2002, due to declining revenues and
the continued economic downturn in the San Francisco, California, region, the
Company determined to sell Truex. In August 2002, the Company entered into an
agreement pursuant to which the Company transferred the Truex business and trade
name to an unrelated party for contingent payments not to exceed $300,000 in the
aggregate over one year following the closing date of the transaction, based on
the gross profit of the business acquired. Any contingent consideration will be
recorded by the Company in discontinued operations when received.
17
During the 13-week period ended June 29, 2003, the Company incurred
$5,000 in closure costs associated with Truex, primarily related to increases in
the estimates for facility costs. The Company received contingent payments
relating to the transfer of the Truex business of $6,000 and $13,000 for the 13-
and 26-week periods ended June 29, 2003, respectively.
For the 13- and 26-week periods ended June 29, 2003, the Company
received aggregate contingent payments of $32,000 and $86,000, respectively, for
its discontinued operations.
Results of Continuing Operations
The following table sets forth, for the periods indicated, the
percentage relationship to service revenues of selected continuing operations
items for the Company on a consolidated basis:
13 Weeks Ended 26 Weeks Ended
----------------------------------- ------------------------------------
June 29, 2003 June 30, 2002 June 29, 2003 June 30, 2002
------------------ ---------------- ------------------ -----------------
Service revenues 100.0% 100.0% 100.0% 100.0%
Direct cost of services 80.1 80.0 80.3 80.3
------------------ ---------------- ------------------ -----------------
Gross profit 19.9 20.0 19.7 19.7
------------------ ---------------- ------------------ -----------------
Operating expenses:
Selling, general and administrative expenses 16.6 17.1 17.9 17.9
Depreciation and amortization 1.2 0.8 1.3 1.0
Finance advisory costs 0.8 -- 0.6 --
Restructuring charges -- 0.6 -- 0.7
------------------ ---------------- ------------------ -----------------
Total operating expenses 18.6 18.5 19.8 19.6
------------------ ---------------- ------------------ -----------------
Income (loss) from operations 1.3% 1.5% (0.1%) 0.1%
------------------ ---------------- ------------------ -----------------
Revenues: Revenues for the 13-week period ended June 29, 2003 were
$42.0 million, a decrease of $4.3 million, or 9.3%, compared to revenues of
$46.3 million for the 13-week period ended June 30, 2002. The decrease is due in
part to and exiting less profitable business while focusing on retaining and
attracting higher margin accounts. Furthermore, service revenues were lower in
certain geographic areas due to office consolidations and closures. For the
26-week period ended June 29, 2003, revenues were $77.8 million compared to
$88.2 million for the 26-week period ended June 30, 2002, a decrease of
approximately $10.4 million, or 11.8%. The decline in revenue was due in part to
the previously discussed decline coupled with the general economic downturn and
a slowdown in construction labor requirements within key operating areas.
Gross Profit: The Company defines gross profit as revenues less the
cost of providing services, which includes: temporary associates wages,
permanent placement commissions, employer payroll taxes for temporary associates
(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 related to placement of
temporary associates. Gross profit for the 13-week periods ended June 29, 2003
and June 30, 2002 was $8.3 million and $9.2 million, respectively, a decrease of
$900,000, or 9.8%. For the 13-week periods ended June 29, 2003 and June 30,
2002, gross profit margin was 19.9% and 20.0%, respectively. For the 26-week
period ended June 29, 2003, gross profit was $15.4 million, compared to $17.4
million for the corresponding period of the prior fiscal year, a decrease of
$2.0 million, or 11.5%. Gross profit margin for each of the 26-week periods
ended June 29, 2003 and June 30, 2002, was 19.7%. Gross profit margin remained
constant for both the 13- and 26-week periods ended June 29, 2003 as compared to
the prior year comparable periods as a result of the Company's efforts to focus
on higher margin business notwithstanding increased workers' compensation and
state unemployment costs.
Operating Expenses: Operating expenses include, among other things,
staff employee compensation and benefits, facility costs, information and
communication systems, depreciation, amortization of intangibles and
advertising. Total operating expenses as a percentage of revenues was 18.6% for
the 13-week period ended June 29, 2003, compared to 18.5% for the 13-week period
ended June 30, 2002. For the 26-week period ended June 29, 2003, total operating
expenses as a percentage of revenues was 19.8%, compared to 19.6% for the
26-week period ended June 30, 2002. The change in total operating expense as a
percentage of revenues was attributable primarily to the factors set forth
below:
19
- Selling, general and administrative expenses ("SG&A") for the
13-week period ended June 29, 2003 were $7.0 million, compared to
$7.9 million for the 13-week period ended June 30, 2002. As a
percentage of revenues, SG&A decreased for the 13-week period ended
June 29, 2003 to 16.6%, compared to 17.1% for the 13-week period
ended June 30, 2002. The decrease in SG&A was primarily the result
of the cost containment efforts of the Company, including the
closing and/or consolidation of a number of underperforming
branches. For the 26-week period ended June 29, 2003, SG&A were
$13.9 million, a reduction of $1.9 million, or 12.0%, compared to
$15.8 million for the 26-week period ended June 30, 2002. For each
of the 26-week periods ended June 29, 2003 and June 30, 2002, SG&A
as a percentage of revenues was 17.9%.
- As a percentage of revenues, depreciation and amortization for the
13-week period ended June 29, 2003 was 1.2%, compared to 0.8% for
the 13-week period ended June 30, 2002. For the 26-week period
ended June 29, 2003, depreciation and amortization as a percentage
of revenues was 1.3%, compared to 1.0% for the 26-week period ended
June 30, 2002. As of December 29, 2002, the Company determined to
replace the Century trade name with the SOS Staffing(R) trade name.
Consequently, the remaining value of the Century trade name has
been amortized over the first six months of fiscal 2003. As of June
29, 2003, the Company had fully amortized the value of the Century
trade name.
- As required by both the credit facility and the note purchase
agreements, the Company has retained a financial advisor to assist
in refinancing, restructuring or recapitalizing the Company. As
required by the Company's amended credit facility and amended note
purchase agreements, the Company has prepared and has distributed
to prospective investors an offering memorandum for the
recapitalization of the Company's debt obligations. The cost to the
Company of such financial advisor and preparation of such offering
memorandum added an additional $322,000 and $493,000 to operating
expenses for the 13- and 26-week periods ended June 29, 2003,
respectively. The Company expects to incur similar financial
advisory costs through the third quarter of fiscal 2003. The
Company has notified its financial advisor that effective August
31, 2003, the Company will terminate the retention agreement.
However, in the event that the Company consummates a transaction
with any of the parties identified by its financial advisor within
the next 12 months, the Company would be required to pay a
contingent transaction fee to its financial advisor, which could be
material.
Income (Loss) from Operations: Income from operations for the 13-week
period ended June 29, 2003 was $536,000, compared to $666,000 for the 13-week
period ended June 30, 2002. Despite the increased costs associated with the
recapitalization, operating margin was generally consistent at 1.3% for the
13-week period ended June 29, 2003, compared to 1.5% for the comparable period
of the prior year. For the 26-week period ended June 29, 2003, loss from
operations was ($88,000) compared to income from operations of $123,000 for the
26-week period ended June 30, 2002. Operating margin was (0.1%) for the 26-week
period ended June 29, 2003, compared to 0.1% for the 26-week period ended June
30, 2002. The decrease in operating margin as a percentage of revenues was due
primarily to additional costs associated with the preparation and distribution
of the Company's offering memorandum as well as the increase in depreciation and
amortization costs previously discussed. These increases were offset partially
by a reduction in restructuring costs.
Interest Expense: Interest expense for the 13-week period ended June
29, 2003 was $763,000, compared to $867,000 for the 13-week period ended June
30, 2002, a decrease of $104,000. For the 26-week period ended June 29, 2003,
interest expense was $1.5 million, a decrease of $300,000, from $1.8 million for
the 26-week period ended June 30, 2002. The decrease in interest expense was due
primarily to the reduction of principal of the higher interest senior notes
carried by the Company.
Income Taxes: As of June 29, 2003, the Company had recorded a tax
valuation allowance for its entire net deferred income tax assets of
approximately $24.0 million. The valuation allowance was recorded because of the
cumulative losses incurred by the Company and the Company's belief that it is
more likely than not that the Company will be unable to recover the net deferred
tax assets.
20
Liquidity and Capital Resources
For the 26-week period ended June 29, 2003, net cash provided by
operating activities was $114,000, compared to $1.1 million for the 26-week
period ended June 30, 2002. The change in operating cash flow was largely a
result of a change in the Company's net loss, coupled with a change in cash
provided from certain working capital components, including collections on
accounts receivable and collections on income taxes receivable.
Additionally, the Company renewed its workers' compensation insurance
policy with ACE for fiscal 2003. As part of the renewal, in January 2003, the
Company was required to pay in advance $1.8 million in premium and
administrative costs for a six-month policy. Additionally, the aggregate cap was
eliminated. In June 2003, the Company paid an additional $660,000 to renew the
policy through December 2003. The Company also was required to post additional
collateral of approximately $1.3 million in restricted cash in order to renew
the policy. The Company also is required to pay higher premium costs under the
renewed policy.
In December 2003, the Company will be required to renew its workers'
compensation policy for fiscal year 2004, which may require additional cash
payments or additional collateral. There can be no assurance that the Company
will be able to post all of the collateral that might be required by ACE. In the
event the policy is not renewed by ACE, the Company would be required to seek
workers' compensation coverage from other carriers, including carriers of last
resort, which typically have higher premium costs. The Company anticipates that
increasing workers' compensation costs will continue to have a negative impact
on future operating capital.
The Company has subleased some of the facilities for which it is
contractually obligated and in such instances has reduced the amount of the
liability carried on the Company's books by the anticipated sublease payments
from such properties. However, if any subleasee defaults on its lease
obligations, the Company is liable for any remaining lease payments, which could
have a negative impact on the Company's future profitability. Currently, the
Company has entered into sublease agreements with respect to seven facilities,
which will generate approximately $535,000 in sublease payments to the Company.
During the 13-week period ended June 29, 2003, the Company received
$3.8 million in federal income tax refunds with respect to the 2002 fiscal year.
The refunds are primarily a result of the Company's recognition, during the
first quarter of the 2002 fiscal year, of a federal tax benefit of $7.9 million
due primarily to the enactment of the 2002 Job Act, which was signed into law on
March 9, 2002. In accordance with SFAS No. 109, "Accounting for Income Taxes,"
the effect of the change in the law was accounted for in the first quarter of
fiscal 2002, the period in which the law became effective. Of the $3.8 million,
the Company was able to retain $1.8 million for working capital purposes, $1.3
million was used for additional collateral to secure its workers' compensation
policy, and the remaining $700,000 was applied against the Company's long-term
debt and credit facility.
The Company's investing activities for the 26-week period ended June
29, 2003 used approximately $243,000, compared to $415,000 for the 26-week
period ended June 30, 2002. The Company's investing activities were related to
the purchase of property and equipment.
Net cash provided by the Company's financing activities for the 26-week
period ended June 29, 2003 was approximately $757,000, primarily due to
borrowings on the Company's revolving credit facility. Net cash used by the
Company's financing activities for the comparable period ended June 30, 2002,
was approximately $652,000, primarily due to payments to the Company's senior
noteholders and to payments on the Company's revolving credit facility.
As of June 29, 2003, the Company had outstanding borrowings under its
revolving credit facility, as amended, of approximately $2.3 million, with a
maturity date of April 30, 2004. Furthermore, under the terms of the Company's
revolving credit facility, the Company has letters of credit available of up to
$11.3 million to be issued solely as required by the Company's workers'
compensation insurance provider. Of the $11.3 million letters of credit, $1.3
million is an overline letter of credit secured by $1.3 million in restricted
cash. As of June 29, 2003, the Company had outstanding letters of credit of
$11.3 million, in the aggregate. The Company's outstanding borrowings on the
senior notes were approximately $22.8 million. As of June 30, 2003, the Company
was in compliance with all covenants under the terms of both the amended senior
note agreements and the revolving credit facility.
On March 31, 2003, the Company entered into the Sixth Credit Amendment
with its lenders to extend the Company's line of credit. Pursuant to the Sixth
Credit Amendment, the maturity date of the Company's line of credit was extended
21
to April 30, 2004. In addition, certain financial covenants under the Company's
credit facility were modified. As provided in the Sixth Credit Amendment, the
Company will pay to its lenders four equal payments of $156,500 in successive
months beginning in September 2003. Such payments will permanently reduce the
line of credit available to the Company in cash. However, any such reductions in
the aggregate commitment shall not apply if they would reduce the cash available
for borrowing below $2.5 million. As of June 29, 2003, the Company had
outstanding borrowings under the revolving credit facility of approximately $2.3
million.
Also on March 31, 2003, the Company entered into Amendment No. 4 with
its noteholders, pursuant to which the noteholders modified certain financial
covenants under the Company's existing note purchase agreements. Amendment No. 4
provides that the Company will pay to the noteholders four equal payments of
$343,500 in successive months beginning in September 2003, to be applied pro
rata among the holders of the Series A and Series B notes. Additionally, the
maturity date of the Series A notes was extended to April 30, 2004. As
consideration for Amendment No. 4, the Company paid all fees and expenses of the
noteholders' special counsel.
Amendment No. 4 and the Sixth Credit Agreement also provide that the
Company shall 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 Intercreditor Agreement. However, of the tax refund arising from the Job
Creation and Work Assistance Act of 2002 (the "2002 Job Act") relating to net
operating loss carrybacks, the Company retained $3.8 million: $1.8 million was
used for working capital purposes, $1.3 million was used for additional
collateral to secure the Company's workers' compensation policy, and the
remaining $700,000 was applied against the Company's long-term debt and credit
facility.
As required by both the lenders and the noteholders, the Company has
retained a financial advisor to assist in refinancing, restructuring or
recapitalizing the Company. As required by Amendment No. 4 and the Sixth Credit
Amendment, the Company has prepared and distributed to prospective investors an
offering memorandum for the recapitalization of the Company's debt obligations.
Additionally, the Company is required to use its best efforts to obtain a firm
commitment or signed letter of intent regarding such recapitalization no later
than July 31, 2003. On July 31, 2003, the Company's lenders and noteholders
extended such deadline to August 29, 2003. Although the Company is aggressively
pursuing alternate sources of capital, there can be no assurance that such
capital will be available or, if available, will be extended on terms favorable
to the Company and in amounts adequate to fund the continuing capital
requirements of the Company. In the event the Company does not have a firm
commitment or signed letter of intent by such date, the Company will be required
to pay $250,000, to be distributed to the lenders and the noteholders pursuant
to the Amended Intercreditor Agreement. Additionally, the Company was required
to pay on September 1, 2003 a supplemental fee of $250,000 to the lenders, in
the aggregate, and $250,000 to the noteholders, in the aggregate. On July 31,
2003, the Company's banks and noteholders agreed to extend such deadline to
October 1, 2003. Such supplemental fee will be waived if the Company has paid
all amounts due and outstanding under its financing agreements prior to such
date.
The Company believes that funds available under its existing revolving
credit agreement plus cash reserves and cash flow from operations will be
sufficient to meet anticipated needs for working capital, capital expenditures
and debt service obligations, at least through fiscal year 2003. However, the
Company's current revolving credit agreement expires in April 2004. The Company
believes that if the revolving credit agreement is renewed or replaced then
these sources of funds plus cash reserves and cash flow from operations will be
sufficient to meet anticipated needs for working capital, capital expenditures
and debt service obligations. If the Company is unable to extend or renew the
revolving credit facility prior to maturity, or is unable to find alternative
sources of capital, then the Company will be required to consider a number of
strategic alternatives, including closure of certain locations or the sale of
certain or all of its assets. Additionally, if the Company were to experience a
significant downturn in its business, additional capital would be required in
order to continue operations. Should this occur, the Company would be required
to consider a number of strategic alternatives, including the closure of certain
locations or the sale of certain or all of its assets. In the current economic
environment, management believes that any such sale would be at depressed prices
that could be significantly lower than the net book value of assets sold and may
not be sufficient to satisfy its liabilities
The following tables provide information on future payments under the
Company's debt agreements and capital commitments, including maturities on
borrowings and future minimum lease payments under non-cancelable operating
leases (in thousands):
22
Payments due by period
---------------------------------------------------------
Contractual Obligations
Total Less than 1 year 1-3 years 4-5 years
------------------- ------------------ ------------------ -------------------
Long-Term Debt $ 22,830 $ 10,478 $ 8,572 $ 3,780
Operating Leases 3,291 1,221 1,999 71
Lines of Credit 2,262 2,262 -- --
------------------- ------------------ ------------------ -------------------
Total Contractual Cash
Obligations $ 28,383 $ 13,961 $ 10,571 $ 3,851
------------------- ------------------ ------------------ -------------------
Commitment Expiration Period
---------------------------------------------------------
Other Commercial Total Amounts
Commitments Committed Less than 1 year 1-3 years 4-5 years
------------------- ------------------ ------------------ -------------------
Letters of Credit $ 11,325 $ 11,325 -- --
------------------- ------------------ ------------------ -------------------
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;
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,
the availability of workers' compensation insurance 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.
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 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 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 June 29, 2003, the prime rate was
4.25%. At the end of the 13-week period ended June 29, 2003, the Company had
approximately $2.3 million in advances outstanding under the revolving credit
facility.
23
Senior Notes: For the 13-week period ended June 29, 2003, the Company's
outstanding borrowings on the senior notes were $22.8 million, with a weighted
average fixed interest rate of 9.92%. 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, which was 4.25% at June 29, 2003, 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 7.25% over the expected maturities of the obligations,
is approximately $23.7 million. If the discount rate were to increase by 10% to
7.98%, the estimated fair value of the obligation on the unsecured notes would
be approximately $23.5 million. If the discount rate were to decrease by 10% to
6.53%, the estimated fair value of the obligation on the unsecured notes would
be approximately $23.9 million.
Item 4. Controls and Procedures
As required by Rule 13a-15 under the Securities Exchange Act of 1934,
as amended (the "Exchange Act"), as of June 29, 2003 the Company carried out an
evaluation of the effectiveness of the design and operation of the Company's
disclosure controls and procedures. This evaluation was carried out under the
supervision of and with the participation of the Company's management, including
the Company's Chief Executive Officer and Chief Financial Officer. Based upon
that evaluation, the Company's Chief Executive Officer and Chief Financial
Officer concluded that the Company's disclosure controls and procedures are
effective. There have been no significant changes in the Company's internal
controls or in other factors that could significantly affect internal controls
subsequent to the date the Company carried out its evaluation.
Disclosure controls and procedures are controls and other procedures
that are designed to ensure that information required to be disclosed in Company
reports filed or submitted under the Exchange Act is recorded, processed,
summarized and reported within the time periods specified in the Securities and
Exchange Commission's rules and forms. Disclosure controls and procedures
include controls and procedures designed to ensure that information required to
be disclosed in Company reports filed under the Exchange Act is accumulated and
communicated to management, including the Company's Chief Executive Officer and
Chief Financial Officer as appropriate, to allow timely decisions regarding
required disclosure.
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,
employment practices liability and general liability.
There is no 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 15, 2003, the Company held its Annual Meeting of Shareholders
(the "Annual Meeting"). At the Annual Meeting, the shareholders of the Company
elected one director of the Company, Brad L. Stewart, to serve until the 2006
annual meeting of the Company's shareholders. With respect to the election of
directors, there were 11,679,915 votes cast in favor of the election of Mr.
Stewart.
In addition to the election of Mr. Stewart, JoAnn W. Wagner and Jack A.
Henry continue to serve as directors of the Company, with terms expiring at the
Company's 2004 annual meeting of shareholders, and Stanley R. deWaal and Randolf
K. Rolf continue to serve as directors of the Company with terms expiring at the
Company's 2005 annual meeting of shareholders.
The number of directors was reduced from seven to five by board action.
Furthermore, at the Annual Meeting, the shareholders approved a
five-to-one reverse stock split of all issued and outstanding shares of Common
Stock and an amendment to the Company's amended and restated articles of
incorporation to change the par value from $0.01 per share to $0.002 per share
to be implemented, if at all, at the discretion of the board of directors upon a
determination that such reverse split is in the best interests of the
corporation and the shareholders. There were 11,843,111 votes cast in favor of
the reverse stock split, the number of votes opposed was 165,200 and the number
of abstentions and broker non-votes was 3,900.
Item 6. Exhibits and Reports on Form 8-K.
a) None.
b) None.
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: August 13, 2003 /s/ JoAnn W. Wagner
---------------------------
JoAnn W. Wagner
Chairman, President and
Chief Executive Officer
Dated: August 13, 2003 /s/ Kevin Hardy
---------------------------
Kevin Hardy
Senior Vice President and
Chief Financial Officer
26