1
================================================================================
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(MARK ONE)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 1997
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 0-26970
-------------------------------
CORESTAFF, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
DELAWARE 76-0407849
(STATE OF INCORPORATION) (I.R.S. EMPLOYER IDENTIFICATION NUMBER)
4400 POST OAK PARKWAY, SUITE 1130
HOUSTON, TEXAS 77027
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES)
(ZIP CODE)
(713) 548-3400
(REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE)
-------------------------------
INDICATE BY CHECK MARK WHETHER THE REGISTRANT (1) HAS FILED ALL REPORTS
REQUIRED TO BE FILED BY SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF
1934 DURING THE PRECEDING 12 MONTHS AND (2) HAS BEEN SUBJECT TO SUCH FILING
REQUIREMENTS FOR THE PAST 90 DAYS. YES x NO
--- ---
AS OF NOVEMBER 10, 1997, THE COMPANY HAD 31,781,708 SHARES OF COMMON STOCK,
PAR VALUE $0.01 PER SHARE, AND 440,749 SHARES OF CLASS B (NON-VOTING) COMMON
STOCK, PAR VALUE $0.01 PER SHARE, OUTSTANDING.
================================================================================
2
CORESTAFF, INC. AND SUBSIDIARIES
INDEX
Page
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements 3
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations 9
PART II. OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K 17
2
3
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
CORESTAFF, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(dollars in thousands)
SEPTEMBER 30, DECEMBER 31,
1997 1996
------------- ------------
ASSETS (Unaudited)
Current Assets:
Cash and cash equivalents $ 10,753 $ 6,521
Accounts receivable, net of allowance of $3,299 and $1,637 191,798 126,302
Prepaid expenses and other 10,035 10,450
Deferred income taxes and other 3,637 2,817
--------- ---------
Total current assets 216,223 146,090
Fixed Assets, net 42,341 16,503
Intangible Assets, net of accumulated amortization of $13,271 and $8,106 289,689 231,475
Investments and Other 6,112 2,329
========= =========
Total Assets $ 554,365 $ 396,397
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities:
Current maturities of long-term debt $ 1,863 $ 456
Accounts payable 9,258 17,089
Payroll and related taxes 47,057 21,045
Self-insurance reserve 1,459 2,374
Amounts due sellers of acquired businesses 227 9,615
Other 5,016 1,196
--------- ---------
Total current liabilities 64,880 51,775
Non-current Self-insurance Reserve 1,394 2,279
Long-term Debt, net of current maturities 226,383 107,839
Deferred Income Taxes and Other 6,734 3,587
Commitments and Contingencies
Stockholders' Equity:
Preferred stock, par value $.01; 5,000,000 shares authorized;
none issued
Common stock, par value $.01 --
Common Stock - 100,000,000 shares authorized;
32,406,245 and 31,944,657 shares issued 324 319
Class B (non-voting) - 3,000,000 shares authorized;
440,749 and 707,232 shares issued 4 7
Additional paid-in capital 212,291 210,034
Retained earnings 43,463 21,767
--------- ---------
256,082 232,127
--------- ---------
Less - 684,000 shares of common stock in treasury, at cost (188) (188)
Less - notes receivable from stockholders (787) (787)
Less - deferred compensation (133) (235)
--------- ---------
Total stockholders' equity 254,974 230,917
--------- ---------
Total Liabilities and Stockholders' Equity $ 554,365 $ 396,397
========= =========
See notes to unaudited consolidated financial statements.
3
4
CORESTAFF, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)
(in thousands, except per share amounts)
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
--------------------------------------- ---------------------------------
1997 1996 1997 1996
----------------- ---------------- --------------- --------------
Revenues from Services $ 268,521 $ 163,284 $ 726,820 $ 400,829
Cost of Services 200,421 123,599 548,692 302,824
----------------- ---------------- --------------- --------------
Gross Profit 68,100 39,685 178,128 98,005
Operating Costs and Expenses:
Selling, general and administrative 46,236 27,504 122,615 68,499
Depreciation and amortization 3,368 1,949 9,019 5,088
----------------- ---------------- --------------- --------------
49,604 29,453 131,634 73,587
----------------- ---------------- --------------- --------------
Operating Income 18,496 10,232 46,494 24,418
Other Income (Expense):
Interest expense (3,711) (492) (8,792) (3,319)
Other, net (70) 55 (293) 258
----------------- ---------------- --------------- --------------
(3,781) (437) (9,085) (3,061)
----------------- ---------------- --------------- --------------
Income before Income Taxes 14,715 9,795 37,409 21,357
Provision for Income Taxes 6,181 4,126 15,713 8,981
----------------- ---------------- --------------- --------------
Net Income $ 8,534 $ 5,669 $ 21,696 $ 12,376
================= ================ =============== ==============
Earnings per Common Share $ 0.26 $ 0.18 $ 0.67 $ 0.42
================= ================ =============== ==============
Number of Shares Used to Compute
Earnings per Common Share 32,779 32,340 32,558 29,643
================= ================ =============== ==============
See notes to unaudited consolidated financial statements.
4
5
CORESTAFF, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
(in thousands)
NINE MONTHS ENDED
SEPTEMBER 30,
---------------------------------
1997 1996
------------- -------------
Cash Flows from Operating Activities:
Net income $ 21,696 $ 12,376
Adjustments to reconcile net income to net cash
used in operating activities:
Depreciation and amortization 9,019 5,088
Amortization of deferred loan costs 123 177
Amortization of deferred compensation 102 --
Provision for doubtful accounts 2,254 694
Deferred income taxes 1,663 682
Self-insurance reserve (1,800) (513)
Gain on disposal of assets -- (27)
Changes in assets and liabilities net of effects of acquisitions:
Accounts receivable (49,188) (28,779)
Prepaid expenses and other 2,490 (1,064)
Accounts payable (13,663) 2,316
Accrued liabilities 16,117 1,761
------------- -------------
Net cash used in operating activities (11,187) (7,289)
------------- -------------
Cash Flows from Investing Activities:
Cash paid for acquisitions, net of cash acquired (78,560) (111,572)
Capital expenditures (24,866) (7,513)
Investment in affiliates (1,559) --
Proceeds from sale of physical therapy staffing business 2,500 --
Proceeds from sale of assets -- 116
Other (1,881) 23
------------- -------------
Net cash used in investing activities (104,366) (118,946)
------------- -------------
Cash Flows from Financing Activities:
Principal payments on long-term debt (406,876) (113,642)
Net proceeds from issuance of long-term debt 335,853 106,910
Net proceeds from issuance of convertible subordinated notes 188,549 --
Net proceeds from sale of common stock 2,259 137,802
------------- -------------
Net cash provided by financing activities 119,785 131,070
------------- -------------
Net Increase in Cash and Cash Equivalents 4,232 4,835
Cash and Cash Equivalents at Beginning of Year 6,521 4,091
------------- -------------
Cash and Cash Equivalents at End of Period $ 10,753 $ 8,926
============= =============
Cash paid during the period for:
Interest, net of amounts capitalized $ 7,537 $ 3,119
Income taxes $ 14,644 $ 7,695
See notes to unaudited consolidated financial statements.
5
6
CORESTAFF INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
1. GENERAL
The consolidated financial statements of CORESTAFF, Inc. and its
wholly-owned subsidiaries (the "Company") included herein have been prepared
without audit pursuant to the rules and regulations of the Securities and
Exchange Commission. Accordingly, certain information and disclosures normally
included in financial statements prepared in accordance with generally accepted
accounting principles have been omitted. The Company believes that the
presentations and disclosures herein are adequate to make the information not
misleading. The consolidated financial statements reflect all adjustments
(consisting of normal recurring adjustments) necessary for a fair presentation
of the interim periods.
The results of operations for the interim periods are not necessarily
indicative of the results of operations to be expected for the full year. These
consolidated financial statements should be read in conjunction with the
Company's audited consolidated financial statements included in its Annual
Report on Form 10-K for the year ended December 31, 1996.
2. EARNINGS PER SHARE
In February 1997, the Financial Accounting Standards Board issued
Statement No. 128, "Earnings per Share," which is required to be adopted for
periods ending after December 15, 1997. At that time, the Company will be
required to change the method currently used to compute earnings per share and
to restate all prior periods. Under the new requirements for calculating primary
earnings per share, the dilutive effect of common stock equivalents ("CSE") will
be excluded. The exclusion of CSE from the calculation would not have had a
material effect on primary earnings per share for the three and nine-month
periods ended September 30, 1997 and 1996.
3. INCOME TAXES
The Company follows the liability method of accounting for income
taxes. Under this method, deferred income tax assets and liabilities are
determined based on differences between the financial statement and income tax
bases of assets and liabilities using enacted tax rates in effect for the year
in which the differences are expected to reverse. The Company's interim
provisions for income taxes were computed using its estimated effective tax rate
for the year.
4. ACQUISITIONS
Summary information on the businesses acquired by the company during
the nine months ended September 30, 1997, including a brief description of the
material acquisitions, follows. All acquisitions made by the Company have been
accounted for using the purchase method of accounting. Accordingly, the results
of operations of the acquired businesses are included in the Company's
consolidated results of operations from the date of acquisition.
Acquisitions completed:
Information Technology ("IT") Services - -
IT Staff Augmentation 4
IT Solutions 3
Staffing Services 1
----------
Total 8
==========
Purchase consideration (in thousands):
Cash paid $ 80,115
Liabilities assumed 11,839
----------
Fair value of assets acquired (including intangibles) $ 91,954
==========
6
7
CORESTAFF INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
In March 1997, the Company acquired Metamor Technologies, Ltd., an
Illinois-based IT solutions business, for $16.1 million in cash. In April 1997,
the Company acquired Business Management Data, Inc., a California-based IT
solutions business, and its India-based affiliate, Sriven Computer Solutions
(PVT.), Ltd., for $16.8 million in cash. In June 1997, the Company acquired
Millennium Computer Corp., a New York-based IT solutions business, and its
affiliate, CompuCorps Resources, Inc., a New York-based IT staff augmentation
business, for $19.7 million in cash.
In certain transactions, the sellers of the acquired businesses are
also entitled to contingent consideration based on the post acquisition increase
in earnings before interest and taxes ("EBIT"), as defined. As of September 30,
1997, the maximum aggregate contingent consideration based on EBIT for future
periods was $63.5 million and the payment of any contingent consideration will
increase goodwill.
In January 1997, the Company sold its non-core physical therapy
staffing business, which accounted for less than two percent of the Company's
1996 consolidated revenues and operating income. A loss of $1.4 million on the
sale was recognized in the fourth quarter of 1996.
The following unaudited results of operations have been prepared
assuming the acquisitions made through September 30, 1997 and the sale of the
Company's physical therapy staffing business had occurred as of the beginning of
the periods presented. The unaudited pro forma operating results are not
necessarily indicative of future operating results nor of results that would
have occurred had the acquisitions been consummated as of the beginning of the
periods presented.
NINE MONTHS ENDED
SEPTEMBER 30,
------------------------------------
1997 1996
----------------- -----------------
(in thousands, except
per share amounts)
Revenues $ 757,821 $ 587,429
Net income $ 23,720 $ 15,478
Earnings per common share $ 0.73 $ 0.52
5. LONG-TERM DEBT
The Company can borrow under its Senior Credit Agreement (the "Senior
Credit Agreement") the lesser of $350 million or 3.0 times Pro Forma Adjusted
EBITDA (earnings before interest, income taxes, depreciation and amortization of
all acquired businesses for the preceding twelve-month period). The Company may
request that the commitment be raised to $400 million. The agreement contains
certain covenants which, among other things, limit total debt to 4.25 times Pro
Forma Adjusted EBITDA, limit the payment of dividends and require the
maintenance of certain financial ratios. The agreement is secured by a pledge of
the stock of the Company's material subsidiaries.
As of September 30, 1997, the Company had outstanding borrowings under
the Senior Credit Agreement of $37.3 million and remaining availability (after
deducting outstanding letters of credit of $10.3 million) of $302.4 million.
Borrowings under the Senior Credit Agreement bear interest, at the Company's
option, at LIBOR or the bank's base rate, plus the applicable margin. A fee of
0.175% to 0.3% is payable on the unused portion of the commitment. The weighted
average interest rate at September 30, 1997 was 6.75%.
On August 15, 1997, the Company sold $230 million of 2.94% convertible
subordinated notes due 2004. The notes were issued at an original price of
83.991% of the principal amount at maturity. The notes are convertible
7
8
CORESTAFF INC. AND SUSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS-CONTINUED
into common stock of the Company at a conversion rate of 23.7397 shares per
$1,000 principal amount at maturity of the notes. At September 30, 1997, the
carrying value of the notes was $188.9 million.
On June 24, 1997, the Company entered into a three-year interest rate
swap agreement to reduce a portion of its interest rate exposure on borrowings
under the Senior Credit Agreement. Under terms of the agreement, the Company
will pay the counterparty 6.05% on notional principal of $25.0 million and the
counterparty will pay the Company interest at a variable rate based on LIBOR.
6. COMMON STOCK
On July 14, 1997, the Company increased the number of authorized shares
of the Company's common stock from 40,000,000 shares to 100,000,000 shares.
On August 15, 1997, certain stockholders of the Company sold an
aggregate of 6.9 million shares of the Company's common stock at a price to the
public of $29 per share. The Company did not receive any proceeds from the sale.
8
9
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
The following discussion should be read in conjunction with the
Company's Consolidated Financial Statements.
INTRODUCTION
Through September 30, 1997, the Company had completed 34 acquisitions,
including 19 information technology ("IT") services and 12 staffing services
businesses. The remaining three acquisitions were of physical therapy staffing
businesses, a non-core business unit that was sold by the Company in January
1997. All acquisitions completed by the Company have been accounted for under
the purchase method of accounting. Accordingly, the historical Consolidated
Financial Statements of the Company include the operating results of the
acquired businesses from the date of acquisition.
Because the Company's historical consolidated operating results have
been significantly affected by the number, timing and size of the acquisitions,
pro forma financial data are provided herein for a more meaningful
period-to-period comparison of the Company's operating results. The pro forma
financial data have been prepared assuming all acquisitions completed through
September 30, 1997 were consummated as of the beginning of the periods
presented. The pro forma results of operations are not necessarily indicative of
the results that would have occurred had the acquisitions been consummated as of
the beginning of the periods presented or that might be attained in the future.
RESULTS OF OPERATIONS
THREE MONTHS ENDED SEPTEMBER 30, 1997
COMPARED WITH THE THREE MONTHS ENDED SEPTEMBER 30, 1996
HISTORICAL PRO FORMA
--------------------------------- ---------------------------------
1997 1996 1997 1996
------------ ------------ ------------- -------------
(in thousands, except per share amounts)
Revenues:
IT Services $ 144,363 $ 72,319 $ 145,989 $ 108,991
Staffing Services 124,158 88,976 124,158 107,221
Other -- 1,989 -- --
------------ ------------ ------------- -------------
Total $ 268,521 $ 163,284 $ 270,147 $ 216,212
Gross profit:
IT Services $ 42,629 $ 20,836 $ 43,139 $ 33,273
Staffing Services 25,471 18,350 25,471 21,794
Other -- 499 -- --
------------ ------------ ------------- -------------
Total $ 68,100 $ 39,685 $ 68,610 $ 55,067
Operating income $ 18,496 $ 10,232 $ 18,721 $ 16,280
Net income $ 8,534 $ 5,669 $ 8,626 $ 7,287
Earnings per share $ 0.26 $ 0.18 $ 0.26 $ 0.23
9
10
COMPARISON OF HISTORICAL OPERATING RESULTS
SUMMARY. Net income for the current quarter increased 50.5% to $8.5
million, or $0.26 per share, from $5.7 million, or $0.18 per share, for the
third quarter of 1996. Revenues in the current quarter increased 64.5% to $268.5
million from $163.3 million in the third quarter of 1996. Gross margin for the
current quarter was 25.4% compared with 24.3% for the third quarter of 1996. The
expansion in gross margin related to the shift in business mix toward
higher-growth, higher-margin IT services. Operating income increased 80.8% to
$18.5 million from $10.2 million in the same period a year ago. Operating margin
for the current quarter was 6.9% compared with 6.3% for the third quarter of
1996. The higher operating margin was due, in part, to the expansion in gross
margin.
IT SERVICES GROUP. The IT Services Group accounted for 53.8% and 62.6%
of the Company's consolidated revenues and gross profit, respectively, up from
44.3% and 52.5%, respectively, in the third quarter of 1996. These increases
reflect the higher internal growth rate of this group compared with the Staffing
Services Group and the effects of the businesses acquired in this sector, which
included three IT solutions businesses in 1997. Revenues and gross profit for
the current quarter were up 99.6% and 104.6%, respectively, over the third
quarter of 1996. Gross margin for the current quarter was 29.5% compared with
28.8% for the third quarter of 1996, primarily due to the acquisitions of the IT
solutions businesses, which have higher growth rates and margins than the
group's IT staff augmentation business. The IT Solutions unit, which was formed
in the first quarter of 1997, accounted for 13.2% of the group's revenues and
20.2% of its gross profit in the third quarter of 1997.
STAFFING SERVICES GROUP. For the current quarter, the Staffing Services
Group accounted for 46.2% and 37.4% of the Company's consolidated revenues and
gross profit, respectively, down from 54.5% and 46.2%, respectively, in the
third quarter of 1996. Revenues and gross profit for the current quarter were up
39.5% and 38.8%, respectively, over the third quarter of 1996. Gross margin for
the current quarter was 20.5%, down slightly from 20.6% in the third quarter of
1996.
OPERATING COSTS AND EXPENSES. Selling, general and administrative
("SG&A") expenses for the third quarter of 1997 totaled $46.2 million, compared
with $27.5 million for the third quarter of 1996. The increase in SG&A expenses
primarily related to (i) the effects of the acquisitions, (ii) internal growth
of the operating companies post-acquisition, (iii) investments made to improve
infrastructure and to develop technical practices in the IT Services Group and
(iv) higher expenses at the corporate level to support the growth of the
Company.
Depreciation totaled $1.4 million and $0.7 million for the third
quarter of 1997 and 1996, respectively. The increase primarily related to the
fixed assets of the businesses acquired and, to a lesser extent, depreciation on
capital expenditures made post-acquisition. Amortization of $1.9 million and
$1.2 million for the third quarter of 1997 and 1996, respectively, related to
amortization of intangible assets (goodwill and non-compete agreements) of the
acquired businesses.
NON-OPERATING COSTS AND EXPENSES. Interest expense for the current
quarter totaled $3.7 million compared with $0.5 million for 1996. The $3.2
million increase was primarily due to increased borrowings for acquisitions and
lower long-term debt levels during the third quarter of 1996 as a result of the
repayment of indebtedness with proceeds from the Company's public equity
offering in May 1996.
PROVISION FOR INCOME TAXES. The provision for income taxes for the
current quarter was $6.2 million (an effective tax rate of 42.0%), as compared
with $4.1 million (an effective tax rate of 42.1%) for 1996. The Company's
effective tax rate includes the effects of state income taxes and the portion of
goodwill amortization not deductible for federal income tax purposes.
NET INCOME. Due to the factors described above, net income for 1997 was
$8.5 million compared with $5.7 million for 1996. Net income as a percentage of
revenues ("Net Income Margin") decreased to 3.2% for the third quarter of 1997,
from 3.5% for the third quarter of 1996 primarily due to the increase in
interest expense.
10
11
COMPARISON OF PRO FORMA OPERATING RESULTS
SUMMARY. Pro forma operating results, which assume all acquisitions
consummated through September 30, 1997, and the sale of the physical therapy
staffing business in January 1997 occurred as of the beginning of the periods
presented, demonstrate the high internal growth rate of the Company's business
units during the current quarter. Pro forma revenues for the current quarter
were $270.1 million, up 24.9% from $216.2 million in the third quarter of 1996.
Pro forma net income rose 18.4% to $8.6 million, or $0.26 per share, compared
with pro forma net income of $7.3 million, or $0.23 per share, in 1996.
IT SERVICES GROUP. Pro forma revenues and gross profit for the current
quarter increased 33.9% and 29.7%, respectively, from the third quarter of 1996.
These improvements reflect the continued strong demand for the Company's IT
services. Pro forma gross margin for the current quarter was 29.5% compared with
30.5% for 1996, related to a higher proportion of revenues from large IT staff
augmentation customers. These large customers generally have lower gross
margins than the group's other staff augmentation customers, but comparable or
higher operating margins due to operating leverage. The effects of this change
in business mix were partially offset by the higher internal growth rate of
the higher-margin IT Solutions unit.
STAFFING SERVICES GROUP. Pro forma revenues and gross profit for the
current quarter increased 15.8% and 16.9%, respectively, from the third quarter
of 1996. These improvements primarily reflect the increase in revenues from the
VIP programs, including new programs that were added in 1997. Pro forma gross
margin for the current quarter was 20.5%, compared with 20.3% for the third
quarter of 1996.
OPERATING COSTS AND EXPENSES. Pro forma SG&A expenses for the third
quarter of 1997 totaled $46.5 million compared with $35.7 million for the third
quarter of 1996. The increase in pro forma SG&A expenses primarily related to
(i) internal growth of the operating groups, (ii) investments made to
infrastructure and to develop technical practices in the IT Services Group and
(iii) higher expenses at the corporate level. The pro forma SG&A expenses
reflect historical SG&A expenses at the corporate and operating subsidiary
level and consequently do not include the pro forma effects of personnel
additions made subsequent to the beginning of each period to support the
growth of the Company.
Depreciation of $1.4 million and $1.0 million for 1997 and 1996,
respectively, related primarily to the fixed assets of the acquired companies.
Amortization of $1.9 million and $2.0 million for 1997 and 1996, respectively,
related to amortization of intangible assets (goodwill and non-compete
agreements) of the acquired businesses.
NON-OPERATING COSTS AND EXPENSES. Pro forma interest expense totaled
$3.8 million for both the third quarter of 1997 and 1996.
PROVISION FOR INCOME TAXES. The Company's pro forma effective tax rate
for the current quarter was 42.0%, which was also the rate for the third quarter
of 1996. The Company's effective tax rate includes the effects of state income
taxes and the portion of goodwill amortization not deductible for federal income
tax purposes.
NET INCOME. Due to the factors described above, pro forma net income
for the current quarter was $8.6 million compared with $7.3 million for the
third quarter of 1996. The pro forma Net Income Margin for the current quarter
was 3.2% compared with 3.4% for 1996.
11
12
NINE MONTHS ENDED SEPTEMBER 30, 1997
COMPARED WITH THE NINE MONTHS ENDED SEPTEMBER 30, 1996
HISTORICAL PRO FORMA
------------------------------ ---------------------------------
1997 1996 1997 1996
------------ ------------ ------------- -------------
Revenues:
IT Services $ 373,719 $ 168,926 $ 404,720 $ 295,449
Staffing Services 353,101 225,593 353,101 291,980
Other -- 6,310 -- --
------------ ------------ ------------- -------------
Total $ 726,820 $ 400,829 $ 757,821 $ 587,429
Gross profit:
IT Services $ 106,407 $ 48,518 $ 119,284 $ 87,682
Staffing Services 71,721 47,919 71,721 60,426
Other -- 1,568 -- --
------------ ------------ ------------- -------------
Total $ 178,128 $ 98,005 $ 191,005 $ 148,108
Operating income $ 46,494 $ 24,418 $ 51,768 $ 40,794
Net income $ 21,696 $ 12,376 $ 23,720 $ 15,478
Earnings per share $ 0.67 $ 0.42 $ 0.73 $ 0.52
COMPARISON OF HISTORICAL OPERATING RESULTS
SUMMARY. Net income for the first nine months of 1997 increased 75.3%
to $21.7 million, or $0.67 per share, from $12.4 million, or $0.42 per share, in
1996. Revenues in the first nine months of 1997 increased 81.3% to $726.8
million from $400.8 million in the first nine months of 1996. Gross margin was
24.5% for both the first nine months of 1997 and the same period in 1996.
Operating income increased 90.4% to $46.5 million from $24.4 million in the same
period a year ago. Operating margin for the first nine months of 1997 was 6.4%,
which was higher than the margin of 6.1% for the first nine months of 1996. This
was the result of the higher operating leverage and the higher proportion of
revenues from the IT Services Group.
IT SERVICES GROUP. The IT Services Group accounted for 51.4% and 59.7%
of the Company's consolidated revenues and gross profit, respectively, up from
42.1% and 49.5%, respectively, for the first nine months of 1996. These
increases reflect the higher internal growth rate of this group compared with
the Staffing Services Group and the effects of the businesses acquired in this
sector, which included three IT solutions businesses in 1997. Revenues and gross
profit for the first nine months of 1997 were up 121.2% and 119.3%,
respectively, over the first nine months of 1996. Gross margin for the first
nine months of 1997 was 28.5% compared with 28.7% for the first nine months of
1996. This was related to a higher proportion of revenues from large IT staff
augmentation customers, which generally have lower gross margins than other IT
staff augmentation customers, but comparable operating margins due to operating
leverage. The gross margin was positively affected by the acquisitions of the IT
solutions businesses, which have higher growth rates and margins than the
group's IT Staff Augmentation unit.
STAFFING SERVICES GROUP. For the first nine months of 1997, the
Staffing Services Group accounted for 48.6% and 40.3% of the Company's
consolidated revenues and gross profit, respectively, down from 56.3% and 48.9%,
respectively, in the first nine months of 1996. Revenues and gross profit for
the first nine months of 1997 were up 56.5% and 49.7%, respectively, over the
first nine months of 1996. Gross margin for the first nine months of 1997 was
20.3%, down from 21.2% for the first nine months of 1996. The lower gross margin
primarily related to the acquisition of a low margin staffing services business
in January 1997 and a higher proportion of revenues being generated from the
Company's large on-site programs (VIP programs). VIP programs have lower gross
margins than the Group's other staffing services business, but higher operating
leverage.
12
13
OPERATING COSTS AND EXPENSES. SG&A expenses for the first nine months
of 1997 totaled $122.6 million, compared with $68.5 million for the first nine
months of 1996. The increase in SG&A expenses primarily related to (i) the
effects of the acquisitions, (ii) internal growth of the operating companies
post-acquisition, (iii) investments made to improve infrastructure and to
develop technical practices in the IT Services Group and (iv) higher expenses at
the corporate level to support the growth of the Company.
Depreciation totaled $3.6 million and $2.0 million for the first nine
months of 1997 and 1996, respectively. The increase primarily related to the
fixed assets of the businesses acquired and, to a lesser extent, depreciation on
capital expenditures made post-acquisition. Amortization of $5.5 million and
$3.1 million for 1997 and 1996, respectively, related to amortization of
intangible assets (goodwill and non-compete agreements) of the acquired
businesses.
NON-OPERATING COSTS AND EXPENSES. Interest expense for the first nine
months of 1997 totaled $8.8 million compared with $3.3 million for the first
nine months of 1996. The $5.5 million increase was primarily due to higher debt
levels in 1997 related to borrowings for acquisitions.
PROVISION FOR INCOME TAXES. The provision for income taxes for the
first nine months of 1997 was $15.7 million (an effective tax rate of 42.0%), as
compared with $9.0 million (an effective tax rate of 42.1%) for the first nine
months of 1996. The Company's effective tax rate includes the effects of state
income taxes and the portion of goodwill amortization not deductible for federal
income tax purposes.
NET INCOME. Due to the factors described above, net income for the
first nine months of 1997 was $21.7 million compared with $12.4 million for the
first nine months of 1996. Net Income Margin decreased to 3.0% for the first
nine months of 1997 from 3.1% for the first nine months of 1996 primarily due to
the increase in interest expense.
COMPARISON OF PRO FORMA OPERATING RESULTS
SUMMARY. Pro forma operating results, which assume all acquisitions
consummated through September 30, 1997, and the sale of the physical therapy
staffing business in January 1997, occurred as of the beginning of the periods
presented, demonstrate the high internal growth rate of the Company's business
units during the first nine months of 1997. Pro forma revenues for the first
nine months of 1997 were $757.8 million, up 29.0% from $587.4 million for the
first nine months of 1996. Pro forma net income rose 53.2% to $23.7 million, or
$0.73 per share, from $15.5 million, or $0.52 per share, in 1996.
IT SERVICES GROUP. Pro forma revenues and gross profit for the first
nine months of 1997 increased 37.0% and 36.0%, respectively, from the first nine
months of 1996. These improvements reflect the continued strong demand for the
Company's IT services. Pro forma gross margin for the first nine months of 1997
was 29.5%, down slightly from 29.7% for 1996, related to the higher proportion
of revenues from large IT staff augmentation customers, partially offset by
the higher growth rates and margins of the IT solutions businesses.
STAFFING SERVICES GROUP. Pro forma revenues and gross profit for the
first nine months of 1997 increased 20.9% and 18.7%, respectively, from the
first nine months of 1996. These improvements primarily related to the increase
in revenues from the VIP programs, including new programs that were added in
1997. Pro forma gross margin for the first nine months of 1997 was 20.3%,
compared with 20.7% for the first nine months of 1996. The lower gross margin
reflects the higher proportion of revenues from the Company's VIP programs,
which have lower gross margins, but higher operating leverage.
OPERATING COSTS AND EXPENSES. Pro forma SG&A expenses for the first
nine months of 1997 totaled $129.4 million compared with $98.4 million for the
first nine months of 1996. The increase in pro forma SG&A expenses primarily
related to (i) internal growth of the operating groups, (ii) investments made to
infrastructure and
13
14
developing technical practices in the IT Services Group and (iii) higher
expenses at the corporate level. The pro forma SG&A expenses reflect historical
SG&A expenses at the corporate and operating subsidiary level and consequently
do not include the pro forma effects of personnel additions made subsequent to
the beginning of each period to support the growth of the Company.
Depreciation of $3.9 million and $2.8 million for the first nine months
of 1997 and 1996, respectively, related primarily to the fixed assets of the
acquired companies. Amortization of $6.0 million and $6.1 million for the first
nine months of 1997 and 1996, respectively, related to amortization of
intangible assets (goodwill and non-compete agreements) of the acquired
businesses.
NON-OPERATING COSTS AND EXPENSES. Pro forma interest expense for the
first nine months of 1997 totaled $10.6 million compared with $14.6 million for
1996. The decrease related to lower pro forma long-term debt levels in 1997 as a
result of the repayment of indebtedness with proceeds from the Company's public
equity offering in May 1996.
PROVISION FOR INCOME TAXES. The Company's pro forma effective tax rate
for the first nine months of 1997 was 42.0%, which was also the rate for the
first nine months of 1996. The Company's effective tax rate includes the effects
of state income taxes and the portion of goodwill amortization not deductible
for federal income tax purposes.
NET INCOME. Due to the factors described above, pro forma net income
for the first nine months of 1997 was $23.7 million compared with $15.5 million
for the first nine months of 1996. The pro forma Net Income Margin for the first
nine months of 1997 was 3.1% compared with 2.6% for the first nine months of
1996.
ANTICIPATED FOURTH-QUARTER RESTRUCTURING CHARGE. The Company
anticipates recording in the fourth quarter of 1997 a non-recurring, pre-tax
charge for approximately $5.0 million to $7.0 million, or $0.09 to $0.12 per
share after tax. This charge relates to the effect of deploying a new integrated
front and back office system. This system is expected to improve the
productivity of the Company's business units and effectively manage anticipated
future growth.
LIQUIDITY AND CAPITAL RESOURCES
The Company's capital requirements have principally related to the
acquisition of businesses and capital expenditures. These requirements have been
met through a combination of bank debt, issuances of securities and internally
generated funds.
During the first nine months of 1997 and 1996, the Company made cash
payments for acquisitions of $78.6 million and $111.6 million, respectively.
Capital expenditures totaled $24.9 million and $7.5 million for the nine months
ended September 30, 1997 and 1996, respectively. The Company estimates that its
capital expenditures for 1997 will be approximately $40.0 million. The majority
of these expenditures relate to (i) the development of an integrated front and
back office information system, which is expected to be operational in 1998,
(ii) the roll-out of proprietary software to the staffing services branches,
(iii) up-grading of computer hardware to facilitate the new integrated
information system and new software tools and (iv) furniture, fixtures and
equipment for new offices. The Company expects to fund the expenditures
primarily with borrowings under its Senior Credit Agreement (the "Senior Credit
Agreement") and cash flows from operations.
The Company had working capital of $151.3 million and $94.3 million at
September 30, 1997 and December 31, 1996, respectively. The Company had cash and
cash equivalents of $10.8 million and $6.5 million at September 30, 1997 and
December 31, 1996, respectively. The Company's operating cash flows and working
capital requirements are significantly affected by the timing of payroll and the
receipt of payment from the customer. Generally, the Company pays the temporary
employees of its Staffing Services Group weekly and the employees of its IT
Services Group semi-monthly. Payments from customers are generally received
within 30 to 65 days from the date of invoice. Cash flows used in operating
activities were $(11.2) million and $(7.3) million for the nine months ended
September 30, 1997 and 1996, respectively. The decrease in operating cash flows
for 1997
14
15
reflected the significant growth in revenues in the first nine months
of 1997 from a number of the Company's larger accounts, which generally have a
longer billing and collection cycle.
On July 31, 1997, the Company amended its Senior Credit Agreement.
Under terms of this agreement, the Company may borrow the lesser of $350 million
or 3.0 times Pro Forma Adjusted EBITDA (earnings before interest, income taxes,
depreciation and amortization of all acquired companies for the preceding
twelve-month period). Borrowings under the agreement bear interest, at the
Company's option, at LIBOR or the bank's base rate, plus the applicable margin.
A fee of 0.175% to 0.3% is payable on the unused portion of the commitment. The
Senior Credit Agreement contains certain covenants which, among other things,
limit total debt to 4.25 times Pro Forma Adjusted EBITDA, limit the payment of
dividends and require the maintenance of certain financial ratios. As of
September 30, 1997, the Company had outstanding borrowings under the Senior
Credit Agreement of $37.3 million and remaining availability (after deducting
outstanding letters of credit of $10.3 million) of $302.4 million. The weighted
average interest rate of the Company's outstanding borrowings under the Senior
Credit Agreement was 6.75% at September 30, 1997.
On August 15, 1997, the Company sold $230 million of 2.94% convertible
subordinated notes due 2004. The notes were issued at an original price of
83.991% of the principal amount at maturity. The notes are convertible into
common stock of the Company at a conversion rate of 23.7397 shares per $1,000
principal amount at maturity of the notes. Net proceeds of approximately $187.9
million from the sale of the notes were used to repay a portion of the
indebtedness under the Senior Credit Agreement. At September 30, 1997, the
carrying value of the notes was $188.9 million.
On June 24, 1997, the Company entered into a three-year interest rate
swap agreement to reduce a portion of its interest rate exposure on borrowings
under the Senior Credit Agreement. Under terms of this agreement, the Company
will pay the counterparty 6.05% on notional principal of $25.0 million and the
counterparty will pay the Company interest at a variable rate based on the LIBOR
rate.
The Company's acquisition program will require significant additional
capital resources. The Company intends to seek additional capital as necessary
to fund such acquisitions through one or more funding sources that may include
borrowings under the Senior Credit Agreement or the issuance of equity
securities. Cash flows from operations, to the extent available, may also be
used to fund acquisitions. Although management believes that the Company will be
able to obtain sufficient capital to fund acquisitions, there can be no
assurance that such capital will be available to the Company at the time it is
required or on terms acceptable to the Company.
SEASONALITY
The Company's quarterly operating results are affected primarily by the
number of billing days in the quarter and the seasonality of its customers'
businesses. Demand for services in the Staffing Services Group has historically
been lower during the year-end holidays through February of the following year,
showing gradual improvement over the remainder of the year. Although less
pronounced than in the Staffing Services Group, the demand for services in the
IT Services Group is typically lower during the first quarter until customers'
operating budgets are finalized. The Company believes that the effects of
seasonality will be less severe in the future as revenues contributed by the IT
Services Group continue to increase as a percentage of the Company's
consolidated revenues.
INFLATION
The effects of inflation on the Company's operations were not
significant during the periods presented in the financial statements.
STATEMENT REGARDING FORWARD-LOOKING INFORMATION
This Form 10-Q contains forward-looking statements and information that
are based on management's beliefs, as well as assumptions made by, and
information currently available to, management. When used in this document, the
words "believe," "anticipate," "estimate," "project," "expect," and similar
expressions are intended to identify forward-looking statements. Although the
Company believes that the expectations reflected in such
15
16
forward-looking statements are reasonable, it can give no assurance that such
expectations will prove to have been correct. Such statements are subject to
certain risks, uncertainties and assumptions. Should one or more of these risks
or uncertainties materialize, or should underlying assumptions prove incorrect,
actual results may vary materially from those anticipated, estimated, projected
or expected. Among the key factors that may have a direct bearing on the
Company's operating results are fluctuations in the economy, the degree and
nature of competition, demand for the Company's services, and the Company's
ability to acquire businesses that are accretive to earnings, to integrate the
operations of acquired businesses, to recruit and place temporary professionals,
to expand into new markets, to complete fixed price agreements in accordance
with their terms and to maintain profit margins in the face of pricing
pressures. In addition, important factors that could cause results to differ
materially are set forth under the caption "Risk Factors" in the Company's
Registration Statement on Form S-3 (File No. 333-31509) and Annual Report on
Form 10-K for the year ended December 31, 1996.
16
17
PART II - OTHER INFORMATION
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) EXHIBITS
10.1 Amended and Restated Credit Agreement dated as of July
31, 1997
10.2 Form of Senior Executive Employment Agreement
10.3 Form of First Amendment to Option Agreement
10.4 Form of First Amendment to Restricted Stock Agreement
10.5 Second Amendment to CORESTAFF, Inc. 1995 Long-Term
Incentive Plan
27 Financial Data Schedule
17
18
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 hereunto duly authorized.
CORESTAFF, INC.
(REGISTRANT)
Date: November 11, 1997 By: /s/ EDWARD L. PIERCE
--------------------------------------
Edward L. Pierce
Senior Vice President, Chief Financial
Officer and Assistant Secretary
(Duly Authorized Officer and Principal
Financial Officer)
18
19
EXHIBIT INDEX
EXHIBIT
NUMBER EXHIBIT DESCRIPTION
------- -------------------
10.1 Amended and Restated Credit Agreement dated as of July 31,
1997
10.2 Form of Senior Executive Employment Agreement
10.3 Form of First Amendment to Option Agreement
10.4 Form of First Amendment to Restricted Stock Agreement
10.5 Second Amendment to CORESTAFF, Inc. 1995 Long-Term
Incentive Plan
27 Financial Data Schedule
19