UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-K [X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934: For the fiscal year ended December 31, 2002 [ ] 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 1-16025 HEADWAY CORPORATE RESOURCES, INC. (Exact name of registrant as specified in its charter) Delaware 75-2134871 (State or Other Jurisdiction of (IRS Employer Incorporation or Organization) Identification No.) 317 Madison Avenue New York, NY 10017 (Address of Principal Executive Offices and Zip Code) Registrant's Telephone Number: (212) 672-6501 Securities registered pursuant to Section 12(b) of the Act: Common Stock, Par Value $0.0001 American Stock Exchange Securities registered pursuant to section 12(g) of the Act: None Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [ X ] No [ ] Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [ X ] Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12(b)-2 of the Act). Yes [ ] No [ X ] The aggregate market value of the voting and non-voting common equity held by non-affiliates of the registrant based of the last sale price on June 28, 2002 is $787,000. The number of shares outstanding of each of the registrant's classes of common stock as of March 31, 2003, was 13,914,627. DOCUMENTS INCORPORATED BY REFERENCE Portions of the definitive proxy statement of Headway for the 2003 annual meeting of stockholders are incorporated by reference in Part III of this report. FORWARD LOOKING STATEMENTS This Annual Report on Form 10-K contains forward-looking statements that are subject to certain risks, uncertainties or assumptions and may be affected by certain other factors, including but not limited to the specific factors discussed in Part II, Item 5 under "Market for Registrant's Common Equity and Related Stockholder Matters", "Liquidity and Capital Resources", and "Factors Which May Impact Future Results and Financial Condition". In some cases, you can identify forward-looking statements by terminology such as "may," "should," "could," "expects," "plans," "projected," "anticipates," "believes," "estimates," "predicts," "potential," or "continues," or the negative of these terms or other comparable terminology. In addition, except for historical facts, all information provided in Part II, Item 7A, under "Quantitative and Qualitative Disclosures About Market Risk" should be considered forward-looking statements. Should one or more of these risks, uncertainties or other factors materialize, or should underlying assumptions prove incorrect, actual results, performance or achievements of Headway may vary materially from any future results, performance or achievements expressed or implied by such forward-looking statements. Forward-looking statements are based on beliefs and assumptions of Headway's management and on information currently available to such management. Forward-looking statements speak only as of the date they are made, and Headway undertakes no obligation to update publicly any of them in light of new information or future events. Undue reliance should not be placed on such forward-looking statements, which are based on current expectations. Forward-looking statements are not guarantees of performance. 2 TABLE OF CONTENTS ITEM NUMBER AND CAPTION Page Part I 1. Business 4 2. Properties 8 3. Legal Proceedings 9 4. Submission of Matters to a Vote of Security Holders 9 Part II 5. Market for Registrant's Common Equity and Related Stockholder 9 Matters 6. Selected Financial Data 11 7. Management's Discussion and Analysis of Financial Condition 12 and Results of Operations 7A. Quantitative and Qualitative Disclosures About Market Risk 18 8. Financial Statements and Supplementary Data 18 9. Changes in and Disagreements with Accountants 19 on Accounting and Financial Disclosure Part III 10. Directors and Executive Officers of the Registrant 19 11. Executive Compensation 19 12. Security Ownership of Certain Beneficial Owners and Management and 19 Related Stockholder Matters 13. Certain Relationships and Related Transactions 19 Part IV 14. Controls and Procedures 19 15. Exhibits, Financial Statement Schedule, and Reports on Form 8-K 20 3 PART I Item 1. Business General Headway Corporate Resources, Inc. ("Headway") is a leading provider of staffing services to businesses in a variety of industries, including, financial services, media, entertainment, biotechnology, information technology and telecommunications. Headway established its human resource business through 20 acquisitions of staffing and professional services companies from 1996 through 1999. Headquartered in New York City, we operate domestically from regional and local offices in, California, Connecticut, Florida, New York, North Carolina, Virginia and, until recently, Texas. Until recently, Headway was also a leading provider of executive search services to the financial services through its Whitney subsidiaries. In March 2003, Headway exited the executive search segment through a sale of the Whitney subsidiaries so that it could focus on its core staffing business. Headway's goal is to build a national human resource business focused on providing staffing services to the industries identified above. Headway's strategy for achieving this goal is to emphasize programs that generate internal growth and market penetration in the industries and geographical areas we service. Effective January 1, 2002, the Company adopted Statements of Financial Accounting Standards No. 142, "Goodwill and Other Intangible Assets" ("SFAS 142"). Under the new rules, goodwill and intangible assets deemed to have indefinite lives are no longer amortized but are subject to annual impairment tests in accordance with SFAS 142. Other intangible assets continue to be amortized over their useful lives. Under SFAS 142, goodwill impairment is deemed to exist if the net carrying value of a reporting unit's goodwill exceeds its estimated fair value. Upon adoption of SFAS 142 in the first quarter of 2002, the Company recorded a non-cash charge of $45 million to reduce the carrying value of its goodwill. Such charge is non-operational in nature and is reflected as a cumulative effect of an accounting change in the 2002 consolidated statement of operations. Based on the results of our annual goodwill impairment test in the fourth quarter of 2002 and the estimated implied value of the Company based on the various restructuring proposals received by the Company, it was determined that there was a further impairment of the remaining goodwill and accordingly the balance of $42,471,000 was written off. This amount is reflected in impairment of goodwill and long-lived assets in the 2002 consolidated statement of operations. The Company has a working capital deficiency and, as more fully described in the Liquidity and Capital Resources section of Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations, the Company is in default on its Senior Credit Facility, Senior Subordinated Notes and Series G Convertible Preferred Stock. Management is negotiating with its lenders to restructure these liabilities and for other potential sources of financing. There can be no assurance that such negotiation will be concluded on favorable terms or at all. Market Overview In the recent years prior to 2001, the temporary employment service industry experienced significant growth in response to the changing work environment in the United States. Employers developed increasingly stringent criteria for permanent employees, while moving toward project-oriented temporary and contract hiring. These changes were the result of increasing automation that resulted in shorter technological cycles, and global competitive pressures. Many employers 4 responded to these challenges by turning to temporary and contract personnel to keep personnel costs variable, achieve maximum flexibility, outsource highly specialized skills, and avoid the negative effects of layoffs. However, in 2002 and 2001 the temporary employment service industry experienced a significant slow down in demand in response to unfavorable conditions in the overall economy. Many companies initiated layoffs of both temporary and permanent workers, and implemented hiring freezes. Due to substantial economic uncertainty, we cannot predict when this trend will change or improve. However, we believe that when the economy does begin to recover, employers will look to use temporary and contract workers as a way to keep their personnel costs variable and maintain maximum flexibility, and that this will fuel growth in the temporary employment service industry. Growth Strategy We intend to focus on internal growth as the key element of our growth strategy. We will continue to concentrate on existing market locations, customer segments, and skill areas that value high levels of service to improve growth. Further, we will endeavor to increase penetration of existing markets, expand existing specialties into new and contiguous geographic markets to the ones we service, and identify new service areas that complement our current services that we believe will be attractive to the industries we serve. Finally, we will continue our practice of enhancing the knowledge and skills of our consultants and employees to strengthen our existing relationships with clients and enhance our reputation for providing highly skilled personnel. Services The human resource management services offered by Headway include o temporary staffing and value added services o IT/professional staff services o permanent placement services, and o human resource administration services. Temporary Staffing and Value Added Services. Headway provides employees to clients for periods ranging from one day to several months to satisfy a specific job skill need arising from absenteeism, special projects, fluctuations in the client's volume of business inherent in the business cycle, technology and business system changes, and other causes. The job skills required by clients and offered by Headway range from entry-level clerks and secretaries to master administrative assistants. Under vendor-on-premise programs, Headway assumes administrative responsibility for coordinating some or all staffing services at a client's location or organization, including recruiting activities, skills testing and training. Headway also provides payroll services to its clients for its permanent employees, thereby mitigating the administrative burden of employment. By using Headway's services, clients can make changes in workforce quickly without the administrative burden and cost of hiring and firing. IT/Professional Staff Services. Rapid changes in technology and competitive pressures in the financial services industry create demand by employers for computer programmers and technicians, desktop publishing operators, network administrators, and computer graphic specialists to help implement the systems 5 required to meet these challenges. Headway offers to its clients IT/professional staff services in which persons with these special skills are placed on a temporary, contract, or permanent basis. Executive Search and Permanent Placement. Headway provides permanent placement services to its clients for office/clerical positions and IT/professional personnel. Clients use Headway's temporary staffing services as a means for locating and evaluating new personnel with a view to permanent employment. Clients are able to evaluate the abilities and productivity of workers during temporary employment through Headway and make informed decisions on whether to retain the workers on a permanent basis, all without the administrative burden associated with adding the workers to their workforce from the outset. Headway, through its Whitney subsidiaries, also provided search services to the financial services industry. In March 2003, Headway exited the executive search business through the sale of its Whitney subsidiaries so that it could focus on its core staffing business. Human Resource Administration Services. Many of Headway's clients use long-term contingent workers on a regular basis to satisfy recurring needs for highly skilled workers in the areas of accounting, finance, business administration, marketing, computer programming, computer graphics, and other areas requiring a high level of business or technical expertise. The use of contingent workers on a regular basis can create a number of problems for clients. The possibility always exists that these workers will accept employment elsewhere that prevents them from being available to the client when needed. Furthermore, there is always a risk contingent workers will be viewed by federal and state taxing authorities as employees rather than contingent workers for income tax withholding and benefits purposes. To mitigate these potential problems, Headway offers a service where it assumes the position of employer for the independent contractors. As an employer, Headway manages the scheduling of these people to make them available to service the needs of the clients, and implements income tax withholding and other employee benefit programs to ensure compliance with the legal requirements of employment under applicable federal and state laws. Operating Strategy In 2002, Headway continued its program to diversify its specialization outside of financial services to include media, entertainment, biotechnology and information technology and continued to expand its service offerings to include accounting and finance, legal and mortgage underwriters. Headway has a strong presence in the financial services industry. Headway will continue to focus on this industry, because Headway believes there is a substantial untapped market for its services in this industry and because its core strengths of industry experience and human resources expertise enable it to develop unique, value-added staffing solutions for the financial services industry. Headway will work to maintain its relationships with existing clients in the financial services industry, expand service offerings in existing locations and cross-sell services to existing clients. It will also look to complete small but strategic acquisitions. Although Headway expects to focus on this industry, it expects that it will continue to have a diversified client base, with no more than 50% of its annual revenues being derived from financial services clients. Headway employs a decentralized, Hub-Spoke management model. Local regional managers manage Headway's operations in each market, including any satellite offices in that market. Headway believes it has a strong market presence in each of its major markets largely due to the commitment, ability, and creativity of its regional managers who drive each local business. Headway fosters this entrepreneurial environment by giving its regional managers the authority to respond quickly and creatively to client needs. Regional managers are responsible for achieving operational and financial objectives, including revenues and earnings growth, and have authority over hiring, recruiting, 6 compensation, pricing, and sales management. Headway believes that accountability and authority, combined with the support of Headway's corporate level support services, enables its regional managers to compete successfully in the local marketplace. Headway also believes this entrepreneurial environment allows Headway to attract talented managers and successfully serve its clients' needs. Headway emphasizes recruiting, training, and retaining experienced sales consultants and providing highly qualified temporary employees. Headway trains its sales consultants to operate as partners with their clients in evaluating and meeting the client's staffing requirements. Headway promotes and monitors quality of service in a number of ways. It seeks highly qualified temporary employees through referrals from existing temporary employees and conducts in-depth interviews by Headway personnel experienced in the temporary employees' field. Headway performs skill evaluations and offers programs to its temporary employees to improve their skills. Headway contacts clients within hours of the beginning of a project to receive a preliminary determination of satisfaction, and obtains client satisfaction reports upon the completion of projects. Headway seeks to understand and proactively assess clients' needs, respond promptly to clients' requests, and continually monitor job performance and client satisfaction. Headway believes that its commitment to providing quality service has enabled it to establish and maintain long-term relationships with clients. Headway's services are marketed through its network of Hubs whose managers and placement coordinators make regular personal sales visits to clients and prospective clients. Headway emphasizes long-term personal relationships with clients who are developed through regular assessment of client requirements and constant monitoring of temporary staff performance. New clients are obtained through sales calls, consultation meetings with target companies, and client referrals. Headway's management and regional managers participate in national and regional trade associations, local chambers of commerce, and other civic associations. Headway monitors sales, marketing, and recruiting functions to identify opportunities to deliver high value-added quality services. Headway believes that its client's select service providers principally on the basis of quality of service, range of services offered, specialized expertise, and ability to service multiple locations, and Headway is striving to satisfy these criteria in its marketing efforts. Human Resources As of December 31, 2002, Headway had approximately 309 full-time employees. In the fourth quarter of 2002, Headway employed approximately 7,400 temporary employees in a typical week. None of Headway's employees, including its temporary employees, is represented by a collective bargaining agreement. Headway believes its employee relations to be strong. Hourly wages for Headway's temporary employees are determined according to local market conditions. Headway pays mandated costs of employment, including the employer's share of social security taxes, federal and state unemployment taxes, unemployment compensation insurance, general payroll expenses and workers' compensation insurance. Headway offers access to various insurance programs and other benefits, such as vacations, holidays and 401(k) programs to qualified temporary employees and professionals. Competition The staffing industry is intensely competitive and fragmented and has limited barriers to entry. Headway competes for employees and clients in national, regional, and local markets with full-service and specialized temporary staffing service businesses. A significant number of Headway's competitors have greater marketing, financial, and other resources and more established operations than Headway. Price competition in the staffing industry 7 is intense and pricing pressures from competitors and customers are increasing. Many of Headway's clients have relationships with more than one staffing service company. However, in recent years, an increasing number of companies have consolidated their staffing services purchases and entered into exclusive contracts with a single temporary staffing company or small number of temporary staffing companies. If current or potential clients enter into exclusive contracts with competitors of Headway, it will be difficult or impossible for Headway to obtain business from such clients. Headway expects that the level of competition will remain high in the future, which could limit Headway's ability to maintain or increase its market share or maintain or increase gross margins. However, Headway believes that its strategy of becoming a dominant provider in each of its markets will allow it to remain competitive in this environment. Regulation Generally, Headway's operations are not subject to state or local licensing requirements or other regulations specifically governing the provision of commercial and professional staffing services. There can be no assurance, however, that states in which Headway operates or may operate in the future will not adopt such licensing or other regulations affecting Headway. The laws of various states require Headway to maintain workers' compensation and unemployment insurance coverage for its temporary employees. Headway maintains state mandated workers' compensation and unemployment insurance coverage. The extent and type of health insurance benefits that employers are required to provide employees has been the subject of intense scrutiny and debate in recent years at both the national and state levels. Proposals have been made to mandate that employers provide health insurance benefits to staffing employees. In addition, some states could impose sales taxes, or raise sales tax rates, on staffing services. Further increases in such premiums or rates, or the introduction of new regulatory provisions, could substantially raise the costs associated with hiring and employing staffing employees. Intellectual Property Headway maintains a number of trademarks, trade names, service marks and other intangible rights. Headway believes that it has all rights to trademarks and trade names necessary for the conduct of its business and is not currently aware of any infringing uses or other conditions that would materially and adversely affect its use of proprietary rights. Availability of Reports and Other Information Our corporate website is http://headwaycorp.com. We make available on this website, free of charge, access to our Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, Proxy Statement on Schedule 14A and amendments to those materials filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934 as soon as reasonably practicable after we electronically submit such material to the Securities Exchange and Commission. In addition, the Commission's website is http://www.sec.gov. The Commission makes available on its website, free of charge, reports, proxy and information statements, and other information regarding issuers, such as us, that file electronically with the Commission. Information provided on our website or on the Commission's website is not part of this Annual Report on Form 10-K. Item 2. Properties Headway's corporate headquarters are located at 317 Madison Avenue, New York, NY 10017. Headway believes that space at its corporate headquarters will be adequate for its needs. 8 In March 2003, Headway exited the executive search business through the sale of its Whitney subsidiaries. Headway is the tenant of record for the office space currently occupied by Whitney's New York office. In connection with the sale, Headway entered into a sublease agreement with Whitney's New York subsidiary, under which Whitney will be responsible for the rent for the space it occupies through the term of the underlying lease, unless earlier terminated by Headway. Headway leases space for all of its Hub-Centers and does not own any real property. Headway believes that its facilities are adequate for its needs and does not anticipate inordinate difficulty in replacing such facilities or opening additional facilities, if needed. Item 3. Legal Proceedings In the ordinary course of its business, Headway is periodically threatened with or named as a defendant in various lawsuits, including discrimination, harassment, and other similar claims. Headway maintains insurance in such amounts and with such coverage and deductibles as management believes are reasonable. In May 2000, a lawsuit was filed in the Judicial District Court of Dallas County, Texas alleging breach of contract, fraud, negligence, negligent retention and supervision, civil conspiracy and harmful access by computer. In July 2002, a judgment was entered in the amount of $790,000 against Headway and the other defendants. This judgment is reflected in the net loss for the nine months ended September 30, 2002. In January 2003, the lawsuit was settled for a substantially lesser amount with Headway's insurance covering all but $60,000. During the quarter ending December 31, 2002, $730,000 of such accrual was reversed. Item 4. Submission of Matters to a Vote of Security Holders No matter was submitted to a vote of security holders in the fourth quarter of 2002. PART II Item 5. Market for Registrant's Common Equity and Related Stockholder Matters Market Price Information Headway's common stock is traded on the American Stock Exchange under the symbol "HEA." The following table sets forth the high and low closing sale prices for the common stock as reported on the American Stock Exchange for 2001 and 2002. Calendar Quarter Ended High ($) Low ($) March 31, 2001 2.400 1.375 June 30, 2001 1.850 0.950 September 30, 2001 1.100 0.400 December 31, 2001 0.700 0.300 March 31, 2002 0.520 0.220 June 30, 2002 0.280 0.060 September 30, 2002 0.150 0.040 December 31, 2002 0.120 0.040 9 Headway has recently received inquiries from the American Stock Exchange regarding whether Headway continues to meet the criteria for listing on the exchange. In light of the current market price of Headway common stock, we believe this will be an on-going concern and may ultimately result in termination of our listing on the American Stock Exchange. Should this occur, it is likely we would seek to have quotations for our common stock in the over-the-counter market reported on the OTC Bulletin Board, but there is no assurance that an active market for our common stock will develop in the over-the-counter market. Since its inception, no dividends have been paid on Headway's common stock. Headway intends to retain any earnings for use in its business activities, so it is not expected that any dividends on the common stock will be declared and paid in the foreseeable future. As of March 31, 2003, Headway had approximately 244 stockholders of record. 10 Item 6. Selected Financial Data The selected consolidated financial data set forth below as of and for the years ended December 31, 2002, 2001, 2000, 1999, and 1998, were derived from audited consolidated financial statements of Headway. Statement of Operations Data In Thousands, Except Share and Per Share Data For Year Ended December 31 -------------------------- 1998 1999 2000 2001 2002 ---- ---- ---- ---- ---- Revenues $ 291,303 $ 360,742 $ 371,115 $ 323,037 $ 267,784 Direct costs 224,993 274,360 272,872 253,354 219,830 Selling, general and administrative expenses 48,638 63,349 74,690 62,587 49,596 Impairment of goodwill and long-lived assets - - - - 43,639 Termination of employment contract - 2,329 - - - Depreciation and amortization 2,952 4,411 5,337 5,787 2,267 ---------------------------------------------------------------- Total operating expenses 276,583 344,449 352,899 321,728 315,332 Operating income (loss) 14,720 16,293 18,216 1,309 (47,548) Other (income) expenses: Interest expense 4,515 6,331 8,049 10,879 11,998 Interest income (152) (122) (105) (113) (70) (Gain) on sale of investment (901) - - - - ---------------------------------------------------------------- 3,462 6,209 7,944 10,766 11,928 ---------------------------------------------------------------- Income (loss) before income tax expense (benefit), cumulative effect of accounting change and extraordinary item 11,258 10,084 10,272 (9,457) (59,476) Income tax expense (benefit) 4,639 4,299 4,388 (3,778) (5,938) ---------------------------------------------------------------- Income (loss) before cumulative effect of accounting change and extraordinary item 6,619 5,785 5,884 (5,679) (53,538) Cumulative effect of accounting change - - - - (45,000) ---------------------------------------------------------------- Income (loss) before extraordinary item 6,619 5,785 5,884 (5,679) (98,538) Extraordinary (loss) (1,557) - - - - ---------------------------------------------------------------- Net income (loss) 5,062 5,785 5,884 (5,679) (98,538) ---------------------------------------------------------------- Preferred dividend requirements (866) (1,100) (1,414) (1,500) (2,159) ---------------------------------------------------------------- Net income (loss) available for common stockholders $ 4,196 $ 4,685 $ 4,470 $ (7,179) $ (100,697) ================================================================ Basic earnings (loss) per common share: Income (loss) before cumulative effect of accounting change and extraordinary item $ 0.58 $ 0.46 $ 0.42 $ (0.67) $ (4.45) Cumulative effect of accounting change - - - - (3.60) Extraordinary item (0.15) - - - - ---------------------------------------------------------------- Net income (loss) $ 0.43 $ 0.46 $ 0.42 $ (0.67) $ (8.05) ================================================================ Diluted earnings (loss) per common share: Income (loss) before cumulative effect of accounting change and extraordinary item $ 0.47 $ 0.40 $ 0.41 $ (0.67) $ (4.45) Cumulative effect of accounting change - - - - (3.60) Extraordinary item (0.11) - - - - ---------------------------------------------------------------- Net income (loss) $ 0.36 $ 0.40 $ 0.41 $ (0.67) $ (8.05) ================================================================ Average shares outstanding Basic 9,853,354 10,287,978 10,590,461 10,729,627 12,504,969 Diluted 14,157,012 14,328,754 14,248,902 10,729,627 12,504,969 11 Balance Sheet Data In Thousands As of December 31 ----------------- 1998 1999 2000 2001 2002 ---- ---- ---- ---- ---- Working capital $ 32,139 $ 30,566 $ 27,457 $ 34,813 $(54,581) Total assets 126,946 148,419 154,186 149,164 48,357 Long term debt, excluding current portion 60,959 72,750 69,700 82,000 - Stockholders' equity (deficit) 42,571 48,001 32,739 26,429 (73,121) Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations Liquidity and Capital Resources As of December 31, 2002, $72.0 million in aggregate principal amount was outstanding under the Senior Credit Facility, $10.0 million in aggregate principal amount was outstanding under the Senior Subordinated Notes due 2006 and $20.0 million in face amount of Series G Convertible Preferred Stock of the Company (the "Preferred Stock") was outstanding. The Company failed to comply with certain financial ratios during the fourth quarter of 2002, creating an event of default under the Senior Credit Facility, the Indenture for the Senior Subordinated Notes and the Certificate of Designations for the Preferred Stock. On December 20, 2002, the Company entered into an amendment of the Senior Credit Facility and obtained a waiver of the events of default. The amendment provided a waiver of the events of default and reduced the amount of the monthly cash interest payment through March 31, 2003. The amendment expired on March 31, 2003, causing the Company to be in default of its Senior Credit Facility. The existence of events of default under the Senior Credit Facility creates cross-defaults under the Indenture for the Senior Subordinated Notes and the Certificate of Designations for the Preferred Stock. Upon the occurrence and during the continuation of an event of default under the Certificate of Designations, holders of the Preferred Stock may require redemption of the Preferred Stock by the Company. The Senior Credit Facility expires on June 30, 2003, with all outstanding amounts then due. The Company is currently in negotiations with its Senior Lenders and the holders of its Senior Subordinated Notes and Preferred Stock (collectively, the "Senior Creditors") to further amend the Senior Credit Facility, Indenture and Certificate of Designations, which would include a waiver and an extended maturity date as well as modified financial covenants that would give the Company greater flexibility to operate. The Company is also currently in negotiations with the Senior Creditors concerning a possible restructuring of the Company's outstanding debt and equity. Any such restructuring would likely involve a significant reduction in the Company's debt, new debt and equity financing and a significant dilution in the percentage of the outstanding common stock held by the Company's current common stockholders. No assurances can be given that any restructuring will be accomplished or as to the terms thereof. If such waivers and amendments or restructuring is not achieved and the Senior Creditors exercise their rights and remedies as a result of the pending events of default or upon the maturity of the Senior Credit Facility on June 30, 2003, the Company would not have sufficient liquidity to meet its obligations, and may need to file for bankruptcy pursuant to chapter 11 of the Bankruptcy Code. Net cash provided by operating activities was $0.5 million in 2002 compared to $4.5 million in 2001. Our net loss of $66.8 million in 2002 was primarily offset by non-cash charges of $45 million and $12.0 million related to the write-off of goodwill and long-lived assets, respectively and depreciation and amortization of $5.3 million. Furthermore, the net loss was offset by a decrease in accounts receivable. The resulting cash provided by operating activities was offset by a decrease in accrued payroll and an increase in prepaid and 12 refundable income taxes, and prepaid expenses and other current assets. Net cash provided by operating activities was $4.5 million in 2001 compared to $15.3 million in 2000. This is primarily due to a decrease in accounts receivable partially offset by a decrease in accrued payroll and income taxes payable. Net cash used in investing activities of $3.7 million in 2002 and $7.1 million in 2001 was primarily the result of the earnout payments related to the acquisitions completed during 1999, 1998 and 1997, as well as capital expenditures. Additionally during 2002 there was a purchase of a short-term investment. Net cash used in financing activities of $2.7 million in 2002 related primarily to the payments of fees for loan amendments. Net cash provided by financing activities of $9.6 million in 2001 related to additional borrowings made on Headway's revolving credit facility, partially offset by payments of loan acquisition fees, dividends and capital lease obligations. Headway's contractual obligations and commercial commitments are summarized below, and are fully disclosed in the Notes to Consolidated Financial Statements. The following table includes aggregate information about Headway's contractual obligations as of December 31, 2002 and the periods in which payments are due: - ------------------------------------------------------------------------------ Contractual Obligations Payments Due by Period ---------------------- (in thousands) - ------------------------------------------------------------------------------ Total Less than 1 - 3 4 - 5 After 5 1 year years years years - ------------------------------------------------------------------------------ Loans Payable $82,000 $82,000 $ - $ - $ - - - ------------------------------------------------------------------------------ Capital Lease Obligations 128 123 5 - - - ------------------------------------------------------------------------------ Operating Leases 8,343 2,494 3,163 1,880 806 - ------------------------------------------------------------------------------ Unconditional Purchase Obligations None - ------------------------------------------------------------------------------ Other Long Term 2 2 - - - Obligations - ------------------------------------------------------------------------------ Total Contractual Cash Obligations $90,473 $84,619 $ 3,168 $ 1,880 $ 806 - ------------------------------------------------------------------------------ Preferred Stock (1) $23,285 $23,285 $ - $ - $ - - ------------------------------------------------------------------------------ (1) In default of its terms, therefore, currently redeemable. The following table includes aggregate information about Headway's commercial commitments as of December 31, 2002. Commercial commitments are items that Headway could be obligated to pay in the future. They are not required to be included in the consolidated balance sheet. - ------------------------------------------------------------------------------------- Other Commercial Total Amount of Commitment Expiration Per Period Commitments Amounts (in thousands) Committed ------------------------------------------ Less than 1 - 3 4 - 5 Over 5 1 year years years years - ------------------------------------------------------------------------------------- Lines of Credit None - ------------------------------------------------------------------------------------- Standby Letters of Credit $1,687 $1,687 $ - $ - $ - - ------------------------------------------------------------------------------------- Guarantees None - ------------------------------------------------------------------------------------- Standby Repurchase Obligations None - ------------------------------------------------------------------------------------- Other Commercial Commitments None - ------------------------------------------------------------------------------------- Total Commercial Commitments $1,687 $1,687 $ - $ - $ - - ------------------------------------------------------------------------------------- 13 Overview Headway is a leading provider of staffing services to businesses in a variety of industries, including, financial services, media, entertainment, biotechnology, information technology and telecommunications. Headway established its human resource business through 20 acquisitions of staffing and professional services companies from 1996 through 1999. Headway's goal is to continue to build a national staffing business focused on providing these services to a variety of industries. Headway's strategy for achieving this goal is to emphasize programs that generate internal growth. In 2002 and 2001, Headway focused its efforts on reducing costs in response to the weakened economy. This included a reduction of headcount and operating expenses as well as the consolidation of certain business lines. Recent Transaction On March 13, 2003, Headway Corporate Resources, Inc. exited the executive search segment of its business through a sale of its Whitney subsidiaries. All of Headway's interest in the Whitney subsidiaries were sold to Whitney Group, LLC, a New York limited liability company (the Whitney Group"). Gary S. Goldstein, who had resigned his positions as an officer and director of Headway and its subsidiaries, is an officer and principal owner of membership interest in the Whitney Group. In consideration for the sale, the Whitney Group (i) issued to the Company a 15 percent membership interest in the Whitney Group (subject to adjustment in certain circumstances), (ii) issued a promissory note in the principal amount of $2,000,000, and (iii) is obligated to pay an earnout equal to five percent of Whitney Group's gross revenues, as defined, during a five-year period commencing January 1, 2003. The note bears interest at the Prime Lending Rate as in effect from time to time, plus two percent per annum. Interest is payable quarterly and the full principal amount of the note is payable in January 2005. The Whitney Group may, at its election, prepay and terminate the promissory note and earnout obligation through a lump sum payment of $5,000,000 less the actual amount of principal previously paid on the promissory note and earnout payments. The Whitney Group is obligated to prepay the promissory note and earnout obligation on the foregoing terms if one or more specified events occur prior to January 1, 2006, that constitute a change in control or ownership of the Whitney Group. The Company has estimated the fair market value of the promissory note at $1,400,000 and the 15% equity interest at $45,000. This transaction will be recorded in the 2003 financial statements and is not expected to result in a material gain or loss on the Company's results of operations. Critical Accounting Policies Revenue Recognition Information technology staffing, temporary staffing and human resource staffing revenue is recognized when the temporary personnel perform the related services. Permanent placement revenue is recognized when the placement is employed. Provisions are made for estimated losses in realization (principally due to applicants not remaining in employment for the guaranteed period, usually 90 days) and for bad debts. These provisions are reviewed periodically and have always been found to be adequate based on the Company's experience in this regard. Executive search services are primarily engaged on a retainer basis. Income from retainer contracts which provide for periodic billings over periods of up to one year, is recognized as earned based on the terms of the contract. 14 Goodwill and Long-lived Assets Goodwill prior to January 1, 2002 was amortized utilizing the straight-line method over a period of 20 to 30 years. Headway periodically evaluated the carrying value and the periods of amortization of goodwill based on the current and expected future non-discounted income from operations of the entities giving rise to the goodwill to determine whether events and circumstances warranted revised estimates of carrying value or useful lives. No such write-downs were made. Effective January 1, 2002, the Company adopted Statements of Financial Accounting Standards No. 142, "Goodwill and Other Intangible Assets" ("SFAS 142"). Under the new rules, goodwill and intangible assets deemed to have indefinite lives are no longer amortized but are subject to annual impairment tests in accordance with SFAS 142. Other intangible assets continue to be amortized over their useful lives. Under SFAS 142, goodwill impairment is deemed to exist if the net carrying value of a reporting unit's goodwill exceeds its estimated fair value. Upon adoption of SFAS 142 in the first quarter of 2002, the Company recorded a non-cash charge of $45 million to reduce the carrying value of its goodwill. Such charge is non-operational in nature and is reflected as a cumulative effect of an accounting change in the 2002 consolidated statement of operations. Based on the results of our annual goodwill impairment test in the fourth quarter of 2002 and the estimated implied value of the Company based on the various restructuring proposals received by the Company, it was determined that there was a further impairment of the remaining goodwill and accordingly the balance of $42,471,000 was written off. This amount is reflected in impairment of goodwill and long-lived assets in the 2002 consolidated statement of operations. In August 2001, the FASB issued SFAS No. 144, "Accounting for the Impairment or Disposal of Long-lived Assets", effective for fiscal years beginning after December 15, 2001. This standard supersedes SFAS No. 121 and provides a single accounting model for long-lived assets to be disposed of. Based on the results of our long-lived asset impairment test in the fourth quarter of 2002, it was determined that there was an impairment to property and equipment in the amount of $1,168,000 ($854,000 and $314,000 related to the Executive Search and Technology Staffing asset groups, respectively). This amount is reflected in impairment of goodwill and long-lived assets on the 2002 consolidated statement of operations. In calculating the impairment charges, the fair value of the impaired asset groups (see Note 16 to the consolidated financial statements) were estimated using a discounted cash flow methodology. In March 2003, the Company exited the executive search segment of its business through a sale of its Whitney subsidiaries. In connection with this transaction, the Company recognized impairment charges to write-off the goodwill and fixed assets relating to this segment. These charges are reflected in the 2002 consolidated statement of operations. The transaction will be recorded in the 2003 financial statements and is not expected to have a material gain or loss on the Company's results of operations. Results of Operations Years Ended December 31, 2002 and 2001 Revenue decreased $55.2 million to $267.8 million for the year ended December 31, 2002, from $323.0 million for the year ended December 31, 2001. The decrease in revenue for 2002 is attributable to the soft economy and is consistent with the performance of the other staffing and executive search companies in the sector. Many companies have instituted hiring freezes for both temporary and permanent positions. The financial services industry reduced its 15 demand for the Company's executive search services as a direct result of the poor financial performance across the financial services industry in 2002. The Whitney executive search segment contributed $14.4 million to consolidated revenues in 2002, a decrease of $11.7 million from $26.1 million in 2001. This decrease reflects a sharp decline in the demand for new hires in the financial services industry. The staffing subsidiary, Headway Corporate Staffing Services, Inc. (HCSS) contributed revenues of $253.3 million, a decrease of $43.6 million from $296.9 million in 2001. The decline in revenues was a result of negative impact of the unfavorable economic conditions on the demand for information technology and clerical staffing services. Total operating expenses decreased $6.4 million to $315.3 million for 2002 from $321.7 million for 2001. The decrease is the result of a $33.5 million decrease in direct costs, a $13.0 million decrease in selling, general and administrative expenses, a $3.5 million decrease in depreciation and amortization offset by a $43.6 million impairment of goodwill and long-lived assets. Direct costs increased as a percentage of revenues to 82.1% in 2002 from 78.4% in 2001. This increase in direct costs as a percentage of revenues is a result of a change in Headway's business mix in 2002. Specifically, the executive search and permanent placement businesses that have no direct costs experienced more significant declines than the staffing business, therefore reducing its percentage of our total revenues. Selling, general and administrative expenses decreased as a percentage of revenues from 19.4% in 2001 to 18.5% in 2002. The decrease in selling, general and administrative expenses is primarily attributed to the lower commission expenses associated with the reduction in revenues, as well as staff reductions and other cost-cutting initiatives implemented in the latter half of 2001 in response to the unfavorable economic conditions. The decrease in depreciation and amortization for 2002 as compared to 2001 is a result of the adoption of Statements of Financial Accounting Standards No. 142, "Goodwill and Other Intangible Assets" ("SFAS 142"), effective January 1, 2002. Under the new rules, goodwill and intangible assets deemed to have indefinite lives are no longer amortized but are subject to annual impairment tests in accordance with the Statement. Amortization of goodwill recorded for 2001 was $4.0 million. The impairment of goodwill and long-lived assets of $43.6 million is a result of the deterioration in the Company's results of operations. The selling, general and administrative expenses for the executive search segment decreased $5.9 million to $17.5 million for the year ended December 31, 2002 as compared to $23.4 million for the same period last year. The decrease relates primarily to the reduced commissions related to the lower executive search revenues. HCSS' selling, general and administrative expenses decreased $6.7 million to $30.3 million for the year ended December 31, 2002 as compared to $37.0 million for the same period last year. The decrease in selling, general and administrative expenses is primarily attributable to the lower commission expense associated with the decline in revenues, as well as staff reductions and other cost-cutting initiatives that were implemented in the latter half 2001. Interest expense increased $1.1 million to $12.0 million for the year ended December 31, 2002 as compared to $10.9 million for the same period last year. The increase in interest expense is due to increased amortization of deferred financing costs relating to the amendments completed in April 2002 and August 2001, and an increase in the applicable margin for base rate loans under the Amended Senior Credit Facility. As a result of the foregoing factors, Headway had a net loss of $98.5 million for the year ended December 31, 2002 compared to a net loss of $5.7 million for the year ended December 31, 2001. 16 Years Ended December 31, 2001 and 2000 Revenue decreased $48.1 million to $323.0 million for the year ended December 31, 2001, from $371.1 million for the year ended December 31, 2000. The decrease in revenue for 2001 is attributable to the slowing of the economy in 2001 and the resulting decline in demand for staffing services. In addition, the tragic events of September 11, 2001 had a profound impact on two of Headway's primary markets: the financial services industry and the New York metropolitan area. The Whitney executive search segment contributed $26.1 million to consolidated revenues in 2001, a decrease of $11.5 million from $37.7 million in 2000. This decrease is attributable to the economic slowdown in 2001. The Whitney subsidiaries primarily serve the financial services industry, which was significantly impacted by the events of September 11th. Many of our executive search clients experienced significant layoffs and implemented hiring freezes during 2001. The staffing subsidiary, Headway Corporate Staffing Services, Inc. (HCSS) contributed revenues of $296.9 million, a decrease of $36.6 million from $333.5 million in 2000. The decline in revenues was a result of negative impact of the unfavorable economic conditions on the demand for information technology and clerical staffing services. Total operating expenses decreased $31.2 million to $321.7 million for 2001 from $352.9 million for 2000. The decrease is the result of a $19.5 million decrease in direct costs, a $12.1 million decrease in selling, general and administrative expenses, offset by a $0.5 million increase in depreciation and amortization. Direct costs increased as a percentage of revenues to 78.4% in 2001 from 73.5% in 2000. This increase in direct costs as a percentage of revenues is a result of a change in Headway's business mix in 2001, as well as pricing pressure that we experienced in some of our markets. Specifically, the executive search business that has no direct costs experienced more significant declines than the staffing business, therefore reducing its percentage of our total revenues. The decrease in selling, general and administrative expenses is primarily attributed to the lower commission expenses associated with the reduction in revenues, as well as staff reductions and other cost-cutting initiatives implemented this year in response to the unfavorable economic conditions. The selling, general and administrative expenses of the executive search segment decreased $5.0 million to $23.4 million for the year ended December 31, 2001 as compared to $28.4 million for the same period last year. The decrease relates primarily to the reduced commissions related to the lower executive search revenues. HCSS' selling, general and administrative expenses decreased $5.9 million to $37.0 million for the year ended December 31, 2001 as compared to $42.9 million for the same period last year. The decrease in selling, general and administrative expenses is primarily attributable to the lower commission expense associated with the decline in revenues, as well as staff reductions and other cost-cutting initiatives that were implemented in 2001. Interest expense increased $2.9 million to $10.9 million for the year ended December 31, 2001 as compared to $8.0 million for the same period last year. The increase in interest expense related to increased amortization of deferred financing costs relating to the amendment completed in August 2001, an increase in the applicable margin for base rate loans under the Amended Senior Credit Facility, the default penalty on the Senior Credit Facility during the fourth quarter of 2001, and expense relating to Headway's interest rate swap. 17 Headway had a net loss of $5.7 million for the year ended December 31, 2001 compared to net income of $5.9 million for the year ended December 31, 2000. New Accounting Standards In April 2002, the FASB issued SFAS No. 145, "Rescission of FASB Statements No. 4, 44, and 62, Amendment of FASB Statement No. 13, and Technical Corrections". SFAS No. 145 eliminates the requirement under SFAS No. 4, "Reporting Gains and Losses from Extinguishment of Debt," to report gains and losses from extinguishments of debt as extraordinary items in the income statement. Accordingly, gains or losses from extinguishments of debt for fiscal years beginning after May 15, 2002 shall not be reported as extraordinary items unless the extinguishment qualifies as an extraordinary item under the provisions of APB 30. Upon adoption of this pronouncement, any gain or loss on extinguishment of debt previously classified as an extraordinary item in prior periods presented that does not meet the criteria of Opinion 30 for such classification should be reclassified to conform with the provisions of SFAS No. 145. Management does not believe the adoption of this standard will have a material impact on the consolidated financial statements. In July 2002, the FASB issued SFAS No. 146, "Accounting for Costs Associated with Exit or Disposal Activities" and nullifies EITF Issue No. 94-3, "Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring)" ("EITF No. 94-3"). SFAS No. 146 requires that a liability for a cost associated with an exit or disposal activity be recognized when the liability is incurred, whereas EITF No. 94-3 had recognized the liability at the commitment date to an exit plan. The Company is required to adopt the provisions of SFAS No. 146 effective for exit or disposal activities initiated after December 31, 2002. Management does not believe the adoption of this standard will have a material impact on the consolidated financial statements. In December 2002, the FASB issued SFAS No. 148, "Accounting for Stock-Based Compensation - Transition and Disclosure." SFAS No. 148 amends SFAS No. 123 to provide alternative methods of transition for a voluntary change to the fair value based methods of accounting for stock-based employee compensation. In addition, SFAS No. 148 amends the disclosure requirements of SFAS No. 123 to require more prominent disclosures in both annual and interim financial statements about the method of accounting for stock-based employee compensation and the effect of the method used on reported results. The Company has elected to continue to follow the intrinsic value method of accounting as prescribed by APB Opinion No. 25 to account for stock options. Item 7A. Quantitative and Qualitative Disclosures About Market Risk Headway used interest rate swap contracts for hedging purposes. Headway had entered into interest rate swap agreements that effectively converted a portion of its floating-rate debt to a fixed-rate basis through April 18, 2002, thus reducing the impact of interest-rate changes on interest expense. As of December 31, 2002, there were no such instruments outstanding. See Note 7 to the consolidated financial statements. Item 8. Financial Statements and Supplementary Data The consolidated financial statements and supplementary data of Headway appear at the end of this report beginning with the Index to Consolidated Financial Statements on page F-1. 18 Item 9. Changes In and Disagreements With Accountants on Accounting and Financial Disclosure There were no changes in or disagreements with Headway's independent auditors during the preceding two calendar years. PART III Item 10. Directors and Executive Officers of the Registrant Information required by "Item 10. Directors and Executive Officers of the Registrant," is incorporated by reference to the proposed caption "Directors and Executive Officers" in the definitive proxy statement of Headway for the 2003 annual meeting of stockholders. Item 11. Executive Compensation Information required by "Item 11. Executive Compensation," is incorporated by reference to the proposed caption "Executive Compensation" in the definitive proxy statement of Headway for the 2003 annual meeting of stockholders. Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters Information required by "Item 12. Security Ownership of Certain Beneficial Owners and Management," is incorporated by reference to the proposed caption "Security Ownership of Management and Principal Stockholders" in the definitive proxy statement of Headway for the 2003 annual meeting of stockholders. Item 13. Certain Relationships and Related Transactions Information required by "Item 13. Certain Relationships and Related Transactions," is incorporated by reference to the proposed caption "Certain Relationships and Related Transactions" in the definitive proxy statement of Headway for the 2003 annual meeting of stockholders. Part IV Item 14. Controls and Procedures Within 90 days prior to the filing of this report, an evaluation was performed under the supervision and with the participation of the Company's management, including the President and Chief Financial Officer, of the effectiveness of the design and operation of the Company's disclosure controls and procedures. Based on that evaluation, the Company's management, including the President and Chief Financial Officer, concluded that the Company's disclosure controls and procedures were 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 of their evaluation. 19 Item 15. Exhibits, Financial Statement Schedules, and Reports on Form 8-K Financial Statements and Financial Statement Schedules The information required by this subsection of this item is presented in the index to the financial statements on page F-1. Reports on Form 8-K No reports on Form 8-K were filed by Headway during the last calendar quarter of 2002. Exhibits Copies of the following documents are included as exhibits to this report pursuant to Item 601 of Regulation S-K. Exhibit No. Title of Document Location 3.1 Certificate of Incorporation (1) Ex. No. 1 3.2 By-Laws (1) Ex. No. 2 3.3 By-Law Amendments (2) Ex. No. 5 4.1 Series F Preferred Stock Designation (2) Ex. No. 4 4.6 Securities Purchase Agreement dated March 19, 1998 (2) Ex. No. 6 4.7 Registration Rights Agreement dated March 19, 1998 (2) Ex. No. 7 4.8 Indenture dated March 19, 1998 (2) Ex. No. 8 4.9 Fourth Supplemental Indenture, dated as of August 24, Ex. No. 4.1 2001 (3) 4.10 Limited Waiver and Amendment dated as of August 24, Ex. No. 4.3 2001 (3) 4.11 Form of Senior Subordinated Note (2) Ex. No. 9 4.12 Guaranty Agreement dated March 19, 1998 (2) Ex. No. 10 4.13 Credit Agreement dated March 19, 1998, including Ex. No. 11 Exhibit A - Commitment Percentage, and Exhibit F - Form of Revolving Note (2) 4.14 Seventh Amendment and Limited Waiver to Credit Ex. No. 4.2 Agreement dated as of August 24, 2001, to the Credit Agreement dated as of March 19, 1998 (3) 4.15 Guaranty Agreement dated March 19, 1998 (2) Ex. No. 12 4.16 Security Agreement dated March 19, 1998 (2) Ex. No. 13 4.17 Pledge Agreement dated March 19, 1998 (2) Ex. No. 14 20 4.18 LC Account Agreement dated March 19, 1998 (2) Ex. No. 15 4.19 Intellectual Property Security Agreement dated March Ex. No. 16 19, 1998 (2) 4.20 Amended and Restated Indenture dated April 18, 2002 (4) Ex. No. 4.8 4.21 Amended and Restated Credit Agreement dated April 17, Ex. No. 4.10 2002 (4) 10.1 Purchase Agreement between Headway Corporate Ex. No. 10.1 Resources, Inc., and Whitney Group, LLC dated March 7, 2003 (5) 21.1 Subsidiaries of Headway (6) Ex. No. 16 99.1 Certification of the Chief Executive Officer pursuant E-1 to Section 906 of the Sarbanes-Oxley Act of 2002 99.2 Certification of the Chief Financial Officer pursuant E-2 to Section 906 of the Sarbanes-Oxley Act of 2002 (1) These exhibits are included in Headway's annual report on Form 10-KSB, for the fiscal year ended December 31, 1996, and filed with the Securities and Exchange Commission on March 27, 1997, and are incorporated herein by this reference. The reference under the column "Location" is to the exhibit number in the report on Form 10-KSB. (2) These exhibits are included in Headway's current report on Form 8-K, dated March 19, 1998, and filed with the Commission on April 3, 1998, and are incorporated herein by this reference. The reference under the column "Location" is to the exhibit number in the report on Form 8-K. (3) These exhibits are included in Headway's quarterly report on Form 10-Q, for the quarter ended September 30, 2001, and filed with the Securities and Exchange Commission on November 14, 2001, and are incorporated herein by this reference. The reference under the column "Location" is to the exhibit number in the report on Form 10-Q. (4) These exhibits are included in Headway's annual report on Form 10-K/A for the fiscal year ended December 31, 2001, and filed with the Securities and Exchange Commission on April 30, 2002, and is incorporated herein by this reference. The reference under the column "Location" is to the exhibit number in the report on Form 10-K. (5) This exhibit is included in Headway's current report on Form 8-K dated March 13, 2003, and filed with the Securities and Exchange Commission on March 28, 2003, and is incorporated herein by this reference. The reference under the column "Location" is to the exhibit number in the report on Form 8-K. (6) This exhibit is included in Headway's annual report on Form 10-K for the fiscal year ended December 31, 2000, and filed with the Securities and Exchange Commission on March 30, 2001, and is incorporated herein by this reference. The reference under the column "Location" is to the exhibit number in the report on Form 10-K. 21 Signatures Pursuant to the requirements of Section 13 or 15(d) of the Exchange Act, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. Headway Corporate Resources, Inc. Date: April 17, 2003 By: /s/ Barry S. Roseman, President and Chief Executive Officer Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated. Dated: April 17, 2003 /s/ Barry S. Roseman, Director Dated: April 17, 2003 /s/ Ehud D. Laska, Director Dated: April 17, 2003 /s/ Richard B. Salomon, Director Date: April 17, 2003 /s/ Philicia G. Levinson, Chief Financial Officer (Principal Financial and Accounting Officer) 22 CERTIFICATION I, Barry S. Roseman, certify that: 1. I have reviewed this annual report on Form 10-K of Headway Corporate Resources, Inc.; 2. Based on my knowledge, this annual report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this annual report; 3. Based on my knowledge, the financial statements, and other financial information included in this annual report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this annual report; 4. The registrant's other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and have: a) designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this annual report is being prepared; b) evaluated the effectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this annual report (the "Evaluation Date"); and c) presented in this annual report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date; 5. The registrant's other certifying officer and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent functions): a) all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant's ability to record, process, summarize and report financial data and have identified for the registrant's auditors any material weaknesses in internal controls; and b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls; and 6. The registrant's other certifying officer and I have indicated in this annual report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses. Date: April 17, 2003 By: /s/ Barry S. Roseman ---------------------------------- Barry S. Roseman, President 23 CERTIFICATION I, Philicia G. Levinson, certify that: 1. I have reviewed this annual report on Form 10-K of Headway Corporate Resources, Inc.; 2. Based on my knowledge, this annual report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this annual report; 3. Based on my knowledge, the financial statements, and other financial information included in this annual report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report; 4. The registrant's other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and have: a) designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this annual report is being prepared; b) evaluated the effectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this annual report (the "Evaluation Date"); and c) presented in this annual report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date; 5. The registrant's other certifying officer and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent functions): a) all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant's ability to record, process, summarize and report financial data and have identified for the registrant's auditors any material weaknesses in internal controls; and b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls; and 6. The registrant's other certifying officer and I have indicated in this annual report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses. Date: April 16, 2003 By: /s/ Philicia G. Levinson ---------------------------------- Philicia G. Levinson, Chief Financial Officer 24 Form 10-K Item 15(a)(1) and (2) Headway Corporate Resources, Inc. and Subsidiaries List of Financial Statements and Financial Statement Schedules The following consolidated financial statements of Headway Corporate Resources, Inc. and Subsidiaries are included in Item 8: Report of Independent Auditors..............................................F-2 Consolidated Balance Sheets as of December 31, 2002 and 2001................F-3 Consolidated Statements of Operations for the years ended December 31, 2002, 2001 and 2000..........................................F-4 Consolidated Statements of Stockholders' Equity (Deficit) for the years ended December 31, 2002, 2001 and 2000......................F-5 Consolidated Statements of Cash Flows for the years ended December 2002, 2001 and 2000..............................................F-8 Notes to Consolidated Financial Statements..................................F-9 The following consolidated financial statement schedule of Headway Corporate Resources, Inc. and Subsidiaries is included in Item 15(a)(2): Schedule II - Valuation and Qualifying Accounts.............................F-33 All other schedules for which provision is made in the applicable accounting regulation of the Securities and Exchange Commission are not required under the related instructions or are inapplicable and, therefore, have been omitted. F-1 Report of Independent Auditors To the Board of Directors and Stockholders Headway Corporate Resources, Inc. We have audited the accompanying consolidated balance sheets of Headway Corporate Resources, Inc. and Subsidiaries (the "Company") as of December 31, 2002 and 2001, and the related consolidated statements of operations, stockholders' equity (deficit) and cash flows for each of the three years in the period ended December 31, 2002. Our audits also included the financial statement schedule listed in the Index at Item 15(a). These financial statements and schedule are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements and schedule based on our audits. We conducted our audits in accordance with auditing standards generally accepted in the United States. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of Headway Corporate Resources, Inc. and Subsidiaries at December 31, 2002 and 2001, and the consolidated results of their operations and their cash flows for each of the three years in the period ended December 31, 2002 in conformity with accounting principles generally accepted in the United States. Also, in our opinion, the related financial statement schedule, when considered in relation to the basic financial statements taken as a whole, presents fairly in all material respects the information set forth therein. The accompanying financial statements have been prepared assuming that the Company will continue as a going concern. As more fully described in Note 1, the Company has a working capital deficiency and is in default on its Senior Credit Facility, Senior Subordinated Notes and Series G Convertible Preferred Stock. These conditions raise substantial doubt about the Company's ability to continue as a going concern. Management's plans in regard to these matters are also described in Note 1. The financial statements do not include any adjustments to reflect the possible future effects on the recoverability and classification of assets or the amounts and classification of liabilities that may result from the outcome of this uncertainty. As discussed in Notes 2 and 6 to the consolidated financial statements, on January 1, 2002, the Company adopted Statement of Financial Accounting Standards No. 142, "Goodwill and Other Intangible Assets." ERNST & YOUNG LLP New York, New York March 21, 2003 F-2 Headway Corporate Resources, Inc. and Subsidiaries Consolidated Balance Sheets (Dollars in Thousands, except for share data) December 31 2002 2001 ------------------- Assets Current assets: Cash and cash equivalents $ 2,635 $ 8,641 Short-term investments 1,200 - Accounts receivable, trade, net of allowance for doubtful accounts of $2,127 (2002) and $1,430 (2001) 29,919 37,713 Prepaid expenses and other current assets 2,460 2,181 Deferred financing costs, current 1,156 979 Prepaid and refundable income taxes 5,325 4,279 ------------------- Total current assets 42,695 53,793 Property and equipment, net 3,302 5,691 Goodwill - 87,313 Deferred financing costs 413 509 Other assets 1,947 1,858 ------------------- Total assets $ 48,357 $149,164 =================== Liabilities and stockholders' (deficit) equity Current liabilities: Accounts payable $ 1,093 $ 1,302 Accrued interest 3,323 1,130 Accrued expenses 4,144 5,593 Accrued payroll 6,591 8,319 Capital lease obligations, current portion 123 224 Loans payable in default 82,000 - Earnouts payable 2 1,287 ------------------- Total current liabilities 92,276 17,855 Capital lease obligations, less current portion 5 111 Long-term debt - 82,000 Deferred rent 912 1,073 Deferred income taxes - 307 Other liabilities - 264 Commitments and contingencies Preferred stock--$.0001 par value, 5,000,000 shares authorized: Series G, convertible preferred stock--$.0001 par value, 1,000 shares authorized, issued and outstanding (aggregate liquidation value $23,285 (2002) currently redeemable by its terms) 23,285 21,125 Stockholders' (deficit) equity: Common stock--$.0001 par value, 80,000,000 shares authorized; 13,914,627 shares issued and outstanding at December 31, 2002, and 10,914,627 shares issued and outstanding at December 31, 2001 1 1 Additional paid-in capital 18,920 18,268 Notes receivable (71) (71) Deferred compensation (267) (382) (Accumulated deficit) retained earnings (91,477) 9,220 Other comprehensive (loss) (227) (607) ------------------- Total stockholders' (deficit) equity (73,121) 26,429 ------------------- Total liabilities and stockholders' (deficit) equity $ 48,357 $149,164 =================== See accompanying notes. F-3 Headway Corporate Resources, Inc. and Subsidiaries Consolidated Statements of Operations (Dollars in Thousands, except per share data) Year ended December 31 2002 2001 2000 ------------------------------- Revenues $ 267,784 $323,037 $371,115 Operating expenses: Direct costs 219,830 253,354 272,872 Selling, general and administrative 49,596 62,587 74,690 Impairment of goodwill and long-lived assets 43,639 - - Depreciation and amortization 2,267 5,787 5,337 ------------------------------- 315,332 321,728 352,899 ------------------------------- Operating (loss) income (47,548) 1,309 18,216 Other (income) expenses: Interest expense 11,998 10,879 8,049 Interest income (70) (113) (105) ------------------------------- 11,928 10,766 7,944 ------------------------------- (Loss) income before income tax (benefit) expense and cumulative effect of accounting change (59,476) (9,457) 10,272 Income tax (benefit) expense (5,938) (3,778) 4,388 ------------------------------- (Loss) income before cumulative effect of accounting change (53,538) (5,679) 5,884 Cumulative effect of accounting change (45,000) - - ------------------------------- Net (loss) income (98,538) (5,679) 5,884 Preferred dividend requirements (2,159) (1,500) (1,414) ------------------------------- Net (loss) income available or common stockholders $(100,697) $ (7,179) $ 4,470 =============================== Basic and diluted (loss) earnings per share: Basic and diluted (loss) earnings per share before cumulative effect of accounting change $ (4.45) $ (.67) $ .42 Cumulative effect of accounting change (3.60) - - ------------------------------- Basic (loss) earnings per common share $ (8.05) $ (.67) $ .42 =============================== Diluted (loss) earnings per common share before cumulative effect of accounting change $ (4.45) $ (.67) $ .41 Cumulative effect of accounting change (3.60) - - ------------------------------- Diluted (loss) earnings per common share $ (8.05) $ (.67) $ .41 =============================== See accompanying notes. F-4 Headway Corporate Resources, Inc. and Subsidiaries Consolidated Statements of Stockholders' Equity (Deficit) (Dollars in Thousands, except share data) Series F Convertible Additional Preferred Stock Common Stock Paid-in ---------------- ----------------- ---------- Shares Amount Shares Amount Capital --------------------------------------------- Balance at December 31, 1999 1,000 $20,000 11,372,561 $1 $19,820 Repayment of notes receivable - - - - - Issuance of stock for acquisitions - - 157,166 - 416 Issuance of common stock to an employee for services - - 60,000 - 143 Amortization of stock-based compensation - - - - - Preferred stock dividends - - - - - Treasury stock - - - - - Comprehensive income: Translation adjustment - - - - - Net income - - - - - Comprehensive income - - - - - --------------------------------------------- Balance at December 31, 2000 1,000 20,000 11,589,727 1 20,379 Retirement of treasury stock - - (675,100) - (3,211) Repayment of notes receivable - - - - - Amortization of stock-based compensation - - - - - Preferred stock dividends - - - - - Issuance of warrants - - - - 1,100 Transfer to temporary equity (1,000) (20,000) - - - Comprehensive (loss): Translation adjustment - - - - - Cumulative effect of change in accounting for derivative financial instrument, net of applicable income tax of $187 - - - - - Change in fair value of derivative, net of applicable income tax of $12 - - - - - Net (loss) - - - - - Comprehensive (loss) - - - - - --------------------------------------------- Balance at December 31, 2001 - - 10,914,627 1 18,268 Amortization of stock-based compensation - - - - - Preferred stock dividends - - - - - Exercise of warrants - - 3,000,000 - 474 Repricing of warrants 73 Issuance of warrants - - - - 105 Comprehensive (loss): Translation adjustment - - - - - Change in fair value of derivative, net of applicable income tax of $199 - - - - - Net (loss) - - - - - Comprehensive (loss) - - - - - --------------------------------------------- Balance at December 31, 2002 - $ - 13,914,627 $1 $18,920 ============================================= See accompanying notes. F-5 Headway Corporate Resources, Inc. and Subsidiaries Consolidated Statements of Stockholders' Equity (Deficit) (continued) (Dollars in Thousands, except share data) Treasury Stock ------------------ Notes Deferred Shares Amount Receivable Compensation ------------------------------------------ Balance at December 31, 1999 (670,100) $(3,191) $(126) $(440) Repayment of notes receivable - - 42 - Issuance of stock for acquisitions - - - - Issuance of common stock to an employee for services - - - (143) Amortization of stock-based compensation - - - 86 Preferred stock dividends - - - - Treasury stock (5,000) (20) - - Comprehensive income: Translation adjustment - - - - Net income - - - - Comprehensive income - - - - ------------------------------------------ Balance at December 31, 2000 (675,100) (3,211) (84) (497) Retirement of treasury stock 675,100 3,211 - - Repayment of notes receivable - - 13 - Amortization of stock-based compensation - - - 115 Preferred stock dividends - - - - Issuance of warrants - - - - Transfer to temporary equity - - - - Comprehensive (loss): Translation adjustment - - - - Cumulative effect of change in accounting for derivative financial instrument, net of applicable income tax of $187 - - - - Change in fair value of derivative, net of applicable income tax of $12 - - - - Net (loss) - - - - Comprehensive (loss) - - - - ------------------------------------------ Balance at December 31, 2001 - - (71) (382) Amortization of stock-based compensation - - - 115 Preferred stock dividends - - - - Exercise of warrants - - - - Repricing of warrants - - - - Issuance of warrants - - - - Comprehensive (loss): Translation adjustment - - - - Change in fair value of derivative, net of applicable income tax of $199 - - - - Net (loss) - - - - Comprehensive (loss) - - - - ------------------------------------------ Balance at December 31, 2002 - $ - $ (71) $(267) ========================================== See accompanying notes. F-6 Headway Corporate Resources, Inc. and Subsidiaries Consolidated Statements of Stockholders' Equity (Deficit) (continued) (Dollars in Thousands) Other Total Retained Earnings Comprehensive Stockholders' (Accumulated Deficit) Income (Loss) Equity (Deficit) ------------------------------------------------------ Balance at December 31, 1999 $ 11,929 $ 8 $ 48,001 Repayment of notes receivable - - 42 Issuance of stock for acquisitions - - 416 Issuance of common stock to an employee for services - - - Amortization of stock-based compensation - - 86 Preferred stock dividends (1,414) - (1,414) Treasury stock - - (20) Comprehensive income: Translation adjustment - (256) (256) Net income 5,884 - 5,884 ------------- Comprehensive income - - 5,628 ------------------------------------------------------ Balance at December 31, 2000 16,399 (248) 52,739 Retirement of treasury stock - - - Repayment of notes receivable - - 13 Amortization of stock-based compensation - - 115 Preferred stock dividends (1,500) - (1,500) Issuance of warrants - - 1,100 Transfer to temporary equity - - (20,000) Comprehensive (loss): Translation adjustment - (95) (95) Cumulative effect of changein accounting for derivative financial instrument, net of applicable ) income tax of $187 - (248) (248 Change in fair value of derivative, net of applicable income tax of $12 - (16) (16) Net (loss) (5,679) - (5,679) ------------- Comprehensive (loss) - - (6,038) ------------------------------------------------------ Balance at December 31, 2001 9,220 (607) 26,429 Amortization of stock-based compensation - - 115 Preferred stock dividends (2,159) - (2,159) Exercise of warrants - - 474 Repricing of warrants - - 73 Issuance of warrants - - 105 Comprehensive (loss): Translation adjustment - 116 116 Change in fair value of derivative, net of applicable income tax of $199 - 264 264 Net (loss) (98,538) - (98,538) ------------- Comprehensive (loss) - - (98,158) ------------------------------------------------------ Balance at December 31, 2002 $ (91,477) $(227) $(73,121) ====================================================== See accompanying notes. F-7 Headway Corporate Resources, Inc. and Subsidiaries Consolidated Statements of Cash Flows (Dollars in Thousands) Year ended December 31 2002 2001 2000 -------------------------- Operating activities Net (loss) income $(98,538) $(5,679) $ 5,884 Adjustments to reconcile net (loss) income to net cash provided by operating activities: Cumulative effect of accounting charge 45,000 - - Impairment of goodwill 43,639 - - Depreciation and amortization, including deferred financing costs 5,268 7,218 5,864 Amortization of deferred compensation 115 115 86 Provision for bad debt 1,619 611 297 Deferred income taxes (307) (149) 403 Changes in assets and liabilities, net of effects of acquisitions: Accounts receivable 7,329 15,229 (732) Prepaid expenses and other current assets (700) 33 (181) Prepaid and refundable income taxes (882) - - Other assets (91) (667) (199) Accounts payable, accrued interest and expenses (165) 43 2,224 Accrued payroll (1,662) (8,838) 3,102 Income taxes payable - (3,358) (1,378) Deferred rent (161) (70) (103) --------------------------- Net cash provided by operating activities 464 4,488 15,267 --------------------------- Investing activities Expenditures for property and equipment (1,035) (1,442) (1,750) Repayment from notes receivable - 13 42 Purchase of short-term investment (1,200) - - Cash paid for acquisitions (1,423) (5,638) (7,787) --------------------------- Net cash used in investing activities (3,658) (7,067) (9,495) Financing activities Net change in revolving credit line - 12,300 (3,050) Repayment of long-term debt - - (152) Payment of capital lease obligations (207) (333) (426) Payments of loan acquisition fees (2,512) (1,610) (289) Payment of other loans - - (1,020) Purchase of treasury stock - - (20) Cash dividends paid - (750) (1,039) --------------------------- Net cash (used in) provided by financing activities (2,719) 9,607 (5,996) Effect of exchange rate changes on cash and cash equivalents (93) 64 (94) Net increase (decrease) in cash and cash equivalents (6,006) 7,092 (318) Cash and cash equivalents at beginning of year 8,641 1,549 1,867 --------------------------- Cash and cash equivalents at end of year $ 2,635 $ 8,641 $ 1,549 =========================== Supplemental disclosure of cash flow information Cash paid during the year for: Interest $ 6,340 $ 8,074 $ 8,511 =========================== Income taxes $ 37 $ 844 $ 5,388 =========================== Supplemental disclosure of noncash investing and financing activities In May 2002, the holders of the Senior Subordinated Notes and the Series G Convertible Preferred Stock exchanged $474,000 in accrued and unpaid interest on the Senior Subordinated Notes to exercise the Series G Warrants. In connection with this exercise, the Company issued 3.0 million shares of common stock to the Holders. In 2000 the Company issued 157,166 shares of its common stock valued at $416,000 for acquisitions. In 2000, the Company purchased property and equipment under capital leases amounting to approximately $136,000. See accompanying notes. F-8 Headway Corporate Resources, Inc. and Subsidiaries Notes to Consolidated Financial Statements (continued) December 31, 2002 1. Organization and Basis of Presentation Headway Corporate Resources, Inc. and its wholly owned subsidiaries (the "Company") provide strategic staffing solutions and personnel worldwide. Its operations include information technology staffing, temporary staffing, human resource staffing, permanent placement and executive search. Headquartered in New York, the Company has temporary staffing offices in California, Connecticut, Florida, New Jersey, North Carolina, Virginia, and, until recently, Texas and had executive search offices in New York, Illinois, the United Kingdom and Hong Kong. In March 2003, the Company exited its executive search segment through the sale of its Whitney subsidiaries (see Note 17). The Company's financial statements have been presented on the basis that it is a going concern, which contemplates the realization of assets and satisfaction of liabilities in the normal course of business. The Company has a working capital deficiency and as more fully described in Note 8, the Company is in default on its Senior Credit Facility , Senior Subordinated Notes and Series G Convertible Preferred Stock. These conditions raise substantial doubt about the Company's ability to continue as a going concern. The accompanying financial statements do not include any adjustment to reflect the possible future effects on the recoverability and classification of assets or the amounts and classifications of liabilities that may result from the outcome of this uncertainty. As more fully described in Note 8, management is negotiating with its lenders to restructure these obligations and for other potential sources of financing. There can be no assurance that such negotiation will be concluded on favorable terms or at all. 2. Summary of Significant Accounting Policies Principles of Consolidation The consolidated financial statements include the accounts of Headway Corporate Resources, Inc. and its subsidiaries after elimination of intercompany accounts and transactions. Revenue Recognition Information technology staffing, temporary staffing and human resource staffing revenue is recognized when the temporary personnel perform the related services. Permanent placement revenue is recognized when the placement is employed. Provisions are made for estimated losses in realization (principally due to applicants not remaining in employment for the guaranteed period, usually 90 days). F-9 Headway Corporate Resources, Inc. and Subsidiaries Notes to Consolidated Financial Statements (continued) Executive search services are primarily engaged on a retainer basis. Income from retainer contracts which provide for periodic billings over periods of up to one year, is recognized as earned based on the terms of the contract. Cash Equivalents Cash equivalents are comprised of certain highly liquid investments with a maturity of three months or less when purchased. Short-Term Investments Short-term investments are comprised of a certificate of deposit. The maturity of the certificate of deposit at acquisition was one year. The book value of the investment approximates the market value as a result of the short-term nature and the low level of risk of the investment. Property and Equipment Property and equipment are stated at cost. Depreciation is computed utilizing the straight-line method over the estimated useful lives of the assets which range from three to seven years. Leasehold improvements are amortized utilizing the straight-line method over the lesser of the useful life of the leasehold or the term of the lease. Deferred Rent The Company leases premises under leases which provide for periodic increases over the lease term. Pursuant to Statement of Financial Accounting Standards ("SFAS") No. 13, "Accounting for Leases," the Company records rent expense on a straight-line basis. The effect of these differences is recorded as deferred rent. Deferred Taxes The Company provides for deferred taxes pursuant to SFAS No. 109, "Accounting for Income Taxes," which requires the recognition of deferred taxes utilizing the liability method. Foreign Currency Translation Balance sheet accounts of the Company's United Kingdom, and Asian subsidiaries are translated using year-end exchange rates. Statement of operations accounts are translated at monthly average exchange rates. The resulting translation adjustment is reported as other comprehensive income (loss) in stockholders' equity (deficit). Foreign exchange gains and losses for all the years presented were not significant. F-10 Headway Corporate Resources, Inc. and Subsidiaries Notes to Consolidated Financial Statements (continued) Goodwill During 2001 and 2000, goodwill was amortized utilizing the straight-line method over periods of 20 to 30 years. The Company periodically evaluated the carrying value and the periods of amortization of goodwill based on the current and expected future un-discounted cash flow from operations of the entities giving rise to the goodwill to determine whether events and circumstances warrant revised estimates of carrying value or useful lives. No such write-downs were made during 2001 and 2000. On January 1, 2002, the Company adopted SFAS No. 142, "Goodwill and Other Intangible Assets". Under the new rules, goodwill and intangible assets deemed to have indefinite lives will no longer be amortized but will be subject to annual impairment tests in accordance with the SFAS No. 142. Other intangible assets will continue to be amortized over their useful lives. Deferred Financing Costs Deferred financing costs are amortized utilizing the straight-line method over the term of the related debt. Concentration of Credit Risk Financial instruments that potentially subject the Company to concentration of credit risk include cash and cash equivalents, short-term investments and accounts receivable arising from its normal business activities. The Company places its cash and cash equivalents and short-term investments with high credit quality financial institutions. The Company believes that its credit risk regarding accounts receivable is limited due to the large number of entities comprising the Company's customer base. In addition, the Company routinely assesses the financial strength of its customers and, based upon factors surrounding the credit risk of its customers, establishes an allowance for uncollectible accounts, where appropriate and, as a consequence, believes that its accounts receivable credit risk exposure is limited. Fair Value of Financial Instruments The carrying amount of the Company's cash and cash equivalents, short-term investments, accounts receivable, accounts payable and accrued expenses approximates fair value. It is not practicable to estimate the fair value of the borrowings under the Senior Credit Facility and Senior Subordinated Notes and the Series G Preferred Stock. (See Note 8). F-11 Headway Corporate Resources, Inc. and Subsidiaries Notes to Consolidated Financial Statements (continued) Use of Estimates The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ from those estimates. Segment Information The Company reports segment information in accordance with SFAS No. 131, "Disclosures about Segments of an Enterprise and Related Information". SFAS No. 131 establishes standards for the way companies report information about operating segments in annual financial statements. SFAS No. 131 also establishes standards for related disclosures about products and services, geographic areas, and major customers (see Note 16). Stock-Based Compensation The Company grants stock options for a fixed number of shares to employees with an exercise price equal to the fair value of the shares at the date of grant. The Company accounts for stock option grants in accordance with APB Opinion No. 25, "Accounting for Stock Issued to Employees" ("APB 25") and related interpretations because the Company believes the alternative fair value accounting provided for under SFAS No. 123, "Accounting for Stock-Based Compensation", requires the use of option valuation models that were not developed for use in valuing employee stock options. Under APB 25, because the exercise price of the Company's employee stock options equals the market price of the underlying stock on the date of grant, no compensation expense is recognized on the date of grant. In December 2002, the FASB issued SFAS No. 148, "Accounting for Stock-Based Compensation - Transition and Disclosure." SFAS No. 148 amends SFAS No. 123 to provide alternative methods of transition for a voluntary change to the fair value based methods of accounting for stock-based employee compensation. In addition, SFAS No. 148 amends the disclosure requirements of SFAS No. 123 to require more prominent disclosures in both annual and interim financial statements about the method of accounting for stock-based employee compensation and the effect of the method used on reported results. The Company has elected to continue to follow the intrinsic value method of accounting as prescribed by APB Opinion No. 25 to account for stock options. For purposes of pro forma disclosures, the estimated fair value of the options is amortized to expense over the vesting period of the options. The Company's pro forma information is as follows: F-12 Headway Corporate Resources, Inc. and Subsidiaries Notes to Consolidated Financial Statements (continued) Year ended December 31 2002 2001 2000 --------------------------------------- Net (loss) income available for common stockholders as reported $(100,697,000) $(7,179,000) $4,470,000 Pro forma SFAS 123 compensation income (expense), net of income tax expense $ 122,000 $ (283,000) $ (431,000) --------------------------------------- Pro forma net (loss) income available for common stockholders $(100,575,000) $(7,462,000) $4,039,000 ======================================= (Loss) earnings per share as reported Basic $ (8.05) $ (.67) $ 0.42 Diluted $ (8.05) $ (.67) $ 0.41 Pro forma SFAS 123 compensation income (expense), net of income taxes per share Basic .01 (.03) (0.04) Diluted .01 (.03) (0.03) Pro forma (loss) earnings per basic share Basic $ (8.04) $ (.70) $ .38 Diluted $ (8.04) $ (.70) $ .38 Reclassifications Certain items previously reported in specific financial statement captions have been reclassified to conform with the 2002 presentation. New Accounting Standards In July 2001, the FASB issued SFAS No. 141, "Business Combinations, and No. 142, Goodwill and Other Intangible Assets", effective for fiscal years beginning after December 15, 2001. Under the new rules, goodwill and intangible assets deemed to have indefinite lives are no longer amortized, but are subject to annual impairment tests in accordance with the statements. Other intangible assets continue to be amortized over their useful lives. Upon adoption of SFAS No. 142 in the first quarter of 2002, the Company recorded a non-cash charge of $45 million to reduce the carrying value of its goodwill. Based on the results of the Company's annual goodwill impairment test in the fourth quarter of 2002 and the estimated implied value of the Company based on the various restructuring proposals received by the Company, it was determined that there was a further impairment of the remaining goodwill and accordingly the balance of $42,471,000 was written off (see Note 6). The adoption of SFAS No. 141 did not have a material impact on the Company's results of operations or financial position. F-13 Headway Corporate Resources, Inc. and Subsidiaries Notes to Consolidated Financial Statements (continued) In August 2001, the FASB issued SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets" which addresses financial accounting and reporting for the impairment or disposal of long-lived assets and supersedes SFAS No. 121, "Accounting for the Impairment of Long-Lived Assets and Long-Lived Assets to be Disposed of", and the accounting and reporting provisions of APB Opinion No. 30, "Reporting the Results of Operations for a Disposal of a Segment of a Business" ("APB 30"). The Company evaluates whether there has been an impairment in any of its long-lived assets on an annual basis or if certain circumstances indicate that a possible impairment may exist. An impairment in value exits where the carrying value of a long-lived asset exceeds its fair value. If it is determined that an impairment in value has occurred, the carrying value is written down for its fair value. The Company adopted SFAS No. 144 in 2002 (see Note 6). In April 2002, the FASB issued SFAS No. 145, "Rescission of FASB Statements No. 4, 44, and 62, Amendment of FASB Statement No. 13, and Technical Corrections". SFAS No. 145 eliminates the requirement under SFAS No. 4, "Reporting Gains and Losses from Extinguishment of Debt," to report gains and losses from extinguishments of debt as extraordinary items in the income statement. Accordingly, gains or losses from extinguishments of debt for fiscal years beginning after May 15, 2002 shall not be reported as extraordinary items unless the extinguishment qualifies as an extraordinary item under the provisions of APB 30. Upon adoption of this pronouncement, any gain or loss on extinguishment of debt previously classified as an extraordinary item in prior periods presented that does not meet the criteria of Opinion 30 for such classification should be reclassified to conform with the provisions of SFAS No. 145. Management does not believe the adoption of this standard will have a material impact on the consolidated financial statements. In July 2002, the FASB issued SFAS No. 146, "Accounting for Costs Associated with Exit or Disposal Activities" and nullifies EITF Issue No. 94-3, "Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring)" ("EITF No. 94-3"). SFAS No. 146 requires that a liability for a cost associated with an exit or disposal activity be recognized when the liability is incurred, whereas EITF No. 94-3 had recognized the liability at the commitment date to an exit plan. The Company is required to adopt the provisions of SFAS No. 146 effective for exit or disposal activities initiated after December 31, 2002. Management does not believe the adoption of this standard will have a material impact on the consolidated financial statements. F-14 Headway Corporate Resources, Inc. and Subsidiaries Notes to Consolidated Financial Statements (continued) 3. Property and Equipment Property and equipment consists of the following: December 31 2002 2001 ------------------------- Leasehold improvements $ 544,000 $ 1,720,000 Furniture and fixtures 539,000 1,884,000 Office and computer equipment 6,719,000 8,141,000 ------------------------- 7,802,000 11,745,000 Less accumulated depreciation and amortization 4,500,000 6,054,000 ------------------------- $3,302,000 $ 5,691,000 ========================= See Note 6 for a discussion of impairment of property and equipment. 4. Related Party Transactions In August 2000, the Company issued 60,000 shares of common stock to an employee for services. These shares vest in August 2003. Such shares were valued at $143,000, the then current market value. Deferred compensation is being amortized on a straight-line basis through August 2003. In July 1999, the Company granted 125,000 shares of common stock to the Company's Chairman. These shares vest at the earlier of i) the Company's common stock price reaching a certain level, as defined, or ii) on July 1, 2006. Such shares were valued at $475,000 and the related deferred compensation is being amortized on a straight-line basis through July 1, 2006. During the years ended December 31, 2002, 2001 and 2000, the Company incurred fees of approximately $82,000, $61,000 and $204,000, respectively, for legal services to an entity, whose partner is a member of the Company's Board of Directors. 5. Acquisitions In connection with acquisitions the Company made in 1997, 1998 and 1999 in addition to the purchase price paid at closing, the Company was obligated to pay additional cash and common stock earnout consideration to the sellers based on future earnings. In 2002, 2001 and 2000, additional consideration of approximately $158,000, $2,966,000 and $8,062,000, respectively, was recorded. As consideration for a portion of the earnouts recorded in 2000, the Company issued 157,166 shares of the Company's common stock, valued at $416,333. F-15 Headway Corporate Resources, Inc. and Subsidiaries Notes to Consolidated Financial Statements (continued) 6. Goodwill and Long-lived Assets Upon adoption of SFAS No. 142 in the first quarter of 2002, the Company recorded a non-cash charge of $45 million to reduce the carrying value of its goodwill. Such charge is non-operational in nature and is reflected as a cumulative effect of an accounting change in the accompanying 2002 consolidated statement of operations. Based on the results of the Company's annual goodwill impairment test in the fourth quarter of 2002 and the estimated implied value of the Company based on the various restructuring proposals received by the Company, it was determined that there was a further impairment of the remaining goodwill and accordingly the balance of $42,471,000 was written off. This amount is reflected as impairment of goodwill and long-lived assets in the 2002 consolidated statement of operations. A summary of the change in the Company's goodwill during the year ended December 31, 2002, by reporting units is as follows: Goodwill ---------------------------------------------------------- January 1, December 31, Reporting Units 2002 Adjustments(i) Impairments 2002 - --------------- ------------- ------------- -------------- ------------ Executive Search $11,086,000 $ 92,000 $(11,178,000) $ - Temporary Staffing 42,415,000 66,000 (42,481,000) - Technology Staffing 33,812,000 - (33,812,000) - ------------- ------------- -------------- ------------ Total $87,313,000 $158,000 $(87,471,000) $ - ============= ============= ============== ============ (i) During the year ended December 31, 2002, additional purchase price of $158,000 was recorded as goodwill upon the determination that the earnouts had been met on certain acquisitions made in 1997, 1998 and 1999. The 2001 and 2000 results on a historical basis do not reflect the provisions of SFAS No. 142. Had the Company adopted SFAS No. 142 on January 1, 2000 and ceased to amortize goodwill at such date, the historical net (loss) income and basic and diluted net (loss) income per common share would have been changed to the adjusted amounts indicated below: Year Ended December 31, 2001 ------------------------------------ Net loss per basic and Net loss diluted common share ------------------------------------ As reported--historical basis $(7,179,000) $ (.67) Add: Goodwill amortization 4,013,000 .37 Income tax impact (1,746,000) (.16) ------------------------------------ Adjusted $(4,912,000) $ (.46) ==================================== F-16 Headway Corporate Resources, Inc. and Subsidiaries Notes to Consolidated Financial Statements (continued) Year Ended December 31, 2000 ----------------------------------------------------- Net income per basic Net income per Net income common share diluted common share ----------------------------------------------------- As reported--historical basis $4,470,000 $ .42 $ .41 Add: Goodwill amortization 3,891,000 .37 .27 Income tax impact (1,673,000) (.16) (.11) ----------------------------------------------------- Adjusted $6,688,000 $ .63 $ .57 ===================================================== In accordance with the provisions of SFAS No. 144, in the fourth quarter of 2002, the Company determined that there was an impairment to property and equipment in the amount of $1,168,000 ($854,000 and $314,000 related to the Executive Search and Technology Staffing asset groups, respectively). This amount is reflected in impairment of goodwill and long-lived assets in the 2002 consolidated statements of operations. In calculating the impairment charges, the fair value of the impaired asset groups (see Note 16) were estimated using a discounted cash flow methodology. 7. Derivative Financial Instruments As of January 1, 2001, the Company adopted SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities," which was issued in June 1998. The Company accounted for the accounting change as a cumulative effect of a change in an accounting principle. The adoption of Statement 133 resulted in a cumulative effect of an accounting change of $248,000, net of an applicable income tax benefit of $187,000, which was recognized as a charge to other comprehensive income (loss) in 2001. The Company used interest rate swap contracts for hedging purposes. The Company had entered into interest rate swap agreements that effectively converted a portion of its floating-rate debt to a fixed-rate basis through April 18, 2002, thus reducing the impact of interest-rate changes on interest expense. Approximately $30,000,000 of the Company's outstanding debt was designated as the hedged item to an interest rate swap agreement which expired on April 18, 2002. For interest rate swaps, the net amounts paid or received and net amounts accrued through the end of the accounting period were included in interest expense. Unrealized gains or losses on interest rate swap contracts were not recognized in income. During the years ended December 31, 2002 and 2001, the Company recognized a change in fair value of the derivative of $264,000 and $16,000, respectively, related to the change in fair value of the interest rate swap contract net of applicable income taxes of $199,000 and $12,000, respectively, as a component of other comprehensive income. 8. Long-Term Debt and Credit Facilities In March 1998, the Company obtained $105 million of financing consisting of a $75 million senior credit facility ("the Senior Credit Facility") which was subsequently increased to $100 million, $10 million of senior subordinated notes F-17 Headway Corporate Resources, Inc. and Subsidiaries Notes to Consolidated Financial Statements (continued) (the "Senior Subordinated Notes"), and $20 million of Series F Convertible Preferred Stock (see Note 9). In August 2000, the Senior Credit Facility was amended and the amount that could be borrowed was reduced to $85,000,000. In August 2001, the Company further amended the Senior Credit Facility, reducing the amount that could be borrowed to $72,000,000. In April 2002, the Company further amended the Senior Credit Facility, which extended the maturity date to June 30, 2003, waived compliance with certain financial ratios, which the Company had failed, and required the Company to issue warrants to purchase 2,455,522 shares of common stock at $0.25 per share (the "Bank Warrants") to the lenders. As of December 31, 2002, $72,000,000 in aggregate principal amount was outstanding under the Company's Senior Credit Facility. The Company's Senior Credit Facility expires in June 2003 with all outstanding amounts then due. Substantially all assets of the Company have been pledged as collateral for the senior credit facility. In December 2002, the Company further amended the Senior Credit Facility and obtained a waiver of compliance with certain financial covenants, which the Company had failed as of that date, including maintenance of a minimum level of EBITDA and the requirement that the Company make a partial repayment of the loan if the accounts receivable is below a certain level. The amendment provided a waiver and reduced the amount of the monthly cash interest payment through March 31, 2003. Although the Company was in compliance with the Amendment as of December 31, 2002, the waiver expired on March 31, 2003 causing the Company to be in default of the Senior Credit Facility. The existence of events of default under the Senior Credit Facility creates cross-defaults under the Indenture for the Senior Subordinated Notes and the Certificate of Designations for the Preferred Stock. Upon the occurrence and during the continuation of an event of default under the Certificate of Designations, holders of the Preferred Stock may require redemption of the Preferred Stock by the Company. The Company is currently in negotiations with its Senior Lenders and the holders of its Senior Subordinated Notes and Preferred Stock (collectively, the "Senior Creditors") to further amend the Senior Credit Facility, Indenture and Certificate of Designations, which would include a waiver and an extended maturity date as well as modified financial covenants that would give the Company greater flexibility to operate. The Company is also currently in negotiations with the Senior Creditors concerning a possible restructuring of the Company's outstanding debt and equity. Any such restructuring would likely involve a significant reduction in the Company's debt, new debt and equity financing and a significant dilution in the percentage of the outstanding common stock held by the Company's current common stockholders. No assurances can be given that any restructuring will be accomplished or as to the terms thereof. If such waivers and amendments or restructuring is not achieved and the Senior Creditors exercise their rights and remedies as a result of the pending events of default or upon the maturity of the F-18 Headway Corporate Resources, Inc. and Subsidiaries Notes to Consolidated Financial Statements (continued) Senior Credit Facility on June 30, 2003, the Company would not have sufficient liquidity to meet its obligations, and may need to file for bankruptcy pursuant to chapter 11 of the Bankruptcy Code. As of December 31, 2002, the Company had a working capital deficit of approximately $54,581,000 compared to working capital of $34,813,000 at December 31, 2001. The deficiency was a direct result of the classification of the Senior Credit Facility and Senior Subordinated Notes as current liabilities. As of December 31, 2002, $10,000,000 in aggregate principal amount was outstanding under the Senior Subordinated Notes and $20,000,000 in face amount of Preferred Stock was outstanding. The Senior Subordinated Notes are payable in March 2006 and originally bore interest at 12% per annum until March 2001, increasing to 14% per annum thereafter. In January 2001, the terms of the Senior Subordinated Notes were amended, including increasing the effective interest rate to 13% until March 2001 and 15% thereafter. In August 2001, the Company entered into a Limited Waiver and Amendment with the Senior Subordinated Notes Holders and the Preferred Stockholders, which provided the following, among other things: i. A waiver of the events of default on the Senior Subordinated Notes and the Preferred Stock. ii. A waiver of the payment of (but not the accrual of) interest and dividends under the Senior Subordinated Notes and the Preferred Stock, respectively. iii. An increase in the interest rate on the Senior Subordinated Notes to 20% per annum (which increase has since been waived). iv. An increase in the annual dividend rate to 10%. v. A reduction in the conversion price of the Preferred Stock to $1.00 per share. vi. The issuance of warrants in the aggregate, exercisable into 3,000,000 shares of the Company's common stock (the "Series G Warrants"). vii. Required maintenance of a certain amount of EBITDA, as defined, and maximum amonts of capital expenditures. Such EBITDA requirement was not met as of December 31, 2001. viii.The reduction of the exercise price of all Series G Warrants to $.01 per share if certain requirements are not met (see below). ix. The exchange of the Series F Preferred Stock in to an equal number of shares of a newly created Series G Convertible Preferred Stock. Such exchange took place as of September 7, 2001. The Series G Preferred Stock has the same features as the Series F Preferred Stock, other than the reduction in the conversion price under the conditions described above. On April 17, 2002, the Senior Subordinated Notes were further amended and the Company entered into the Second Limited Waiver with the holders of the Senior Subordinated Notes Holders and Preferred Stock, which provided the following: F-19 Headway Corporate Resources, Inc. and Subsidiaries Notes to Consolidated Financial Statements (continued) i) A waiver of the events of default on the Senior Subordinated Notes from March 31, 2002 through the "Recap Amendment Termination Date", defined as the earliest of (1) June 30, 2003 or such earlier on date on which the Senior Credit Facility may mature; (2) the date on which all amounts due under the Senior Credit Facility shall have been paid in full in cash; (3) the date on which the Senior Credit Facility is amended or modified in a manner that (A) increases the Base Rate, the Default Rate, the Applicable Margin or any other interest rate on the Senior Indebtedness (B) decreases the PIK Amount (C) increases the amount of fees or other payments due to the agent or any lender under the Senior Credit Facility (other than increases made in connection with events of default under the Senior Credit Facility that do not exceed, in the aggregate, 0.50% of the outstanding payment obligations under the Senior Credit Facility), or (D) in consideration of which, the agent or any lender under the Senior Credit Facility is issued any additional equity interest in the Company; and (4) the acceleration of any indebtedness under the Senior Credit Facility or the exercise of any rights or remedies by any of the lenders under the Senior Credit Facility. (ii) A waiver of the payment of interest (but not the accrual of interest) under the Senior Subordinated Notes from March 31, 2002 through the Recap Amendment Termination Date. (iii)A waiver of the Preferred Stock events of default and a waiver of the payment of dividends (but not the accrual of dividends) on the Preferred Stock from March 31, 2002 through the Recap Amendment Termination Date. Under the terms of the Second Limited Waiver, dividends on the Preferred Stock accrue as additional liquidation preference. Accordingly, the accrued dividend balance as of December 31, 2001 has been re-classified from accrued expenses to preferred stock. (iv) A waiver of the increase in interest rate on the Senior Subordinated Notes from 15% to 20% retroactive to July 1, 2001. (v) An adjustment to the exercise price of certain of the Series G Warrants to $0.25 per share. The re-pricing of the Series G Warrants resulted in deferred financing costs based on the fair value of the warrants of $73,000, which is being amortized through June 2003. (vi) Required maintenance of certain amounts of EBITDA, as defined, and maximum amounts of capital expenditures, as defined. Such EBITDA covenant was not met as of December 31, 2002. (vii)That the Company take all actions necessary to obtain common stockholder approval of an increase in the number of authorized common shares of the Company to 80,000,000 at a stockholder meeting to be held no later than July 15, 2002, subject to extension under certain circumstances. Such approval was obtained on July 15, 2002. (viii) That the Company issue Bank Warrants to purchase 2,455,522 shares of common stock at $0.25 per share to the lenders in connection with the amendment of its Senior Credit Facility. Such warrants were issued in April 2002. The issuance of these warrants resulted in deferred financing costs based on the fair value of the warrants of $105,000, which is being amortized through June 2003. F-20 Headway Corporate Resources, Inc. and Subsidiaries Notes to Consolidated Financial Statements (continued) In May 2002, the holders of the Senior Subordinated Notes and the Preferred Stock exchanged $474,000 in accrued and unpaid interest on the Senior Subordinated Notes to exercise the Series G Warrants. In connection with this exercise, the Company issued 3.0 million shares of common stock to the holders. As of December 31, 2002, the unpaid aggregate dividend was $3,285,000 of which $2,160,000 and $1,125,000 relate to the years ended December 31, 2002 and 2001. The unpaid interest on the Senior Credit Facility at December 31, 2002 is $1,138,000, which is included in accrued interest. The unpaid interest on the Senior Subordinated Notes at December 31, 2002 is $2,151,000, which is included in accrued interest. 9. Stockholders' Equity In March 1998, the Company authorized and issued 1,000 shares of Series F Convertible Preferred Stock for $20,000,000. The Series F Convertible Preferred Stock is non-voting, accrues dividends at the rate of 5.5% (increased to 7.5% in March 2000) per annum and was convertible into common stock at an initial conversion price of $5.58 per share (the market value of the Company's common stock at closing). On September 7, 2001, the Series F Convertible Preferred Stock were exchanged into an equal number of the newly created Series G Convertible Preferred Stock. Expenses in connection with the issuance of the preferred stock amounted to $1,367,000 and were accounted for as share issuance expenses. The Series F and Series G Convertible Preferred Stock requires redemption for cash upon the occurrence of a change of control, as defined. The change of control event which triggers redemption at the option of the holder is not deemed solely within the control of the Company. Accordingly, the Company has classified the Series G Convertible Preferred Stock outside of permanent stockholders' equity on the December 31, 2002 and December 31, 2001 balance sheets. In September 1998, the Company authorized a stock repurchase program of up to 1,000,000 shares of the Company's common stock. The Company did not make any purchases under this program in 2002 and 2001. In 2000, the Company repurchased 5,000 shares of the Company's common stock for approximately $20,000. At December 31, 2002, approximately 28,982,000 shares of common stock have been reserved for future issuance as follows: Convertible Preferred Stock 23,285,000 Bank Warrants 2,456,000 Stock Incentive Plan (see Note 10) 3,241,000 ---------- 28,982,000 ========== F-21 Headway Corporate Resources, Inc. and Subsidiaries Notes to Consolidated Financial Statements (continued) At December 31, 2002, the Bank Warrants are fully vested, have an exercise price of $0.25 per share and expire in April 2007. During 2002, 3,000,000 shares of the Company's common stock were issued in connection with the exercise of the Series G Warrants. The holders of the Senior Subordinated Notes and the Series G Convertible Preferred Stock exchanged $474,000 in accrued and unpaid interest on the Senior Subordinated Notes to exercise the Series G Warrants. During 2001, no warrants were exercised and approximately 270,000 warrants expired. During 2000, no warrants were exercised and approximately 102,000 warrants that were issued upon the conversion of Series D convertible preferred stock were cancelled. 10. (Loss) Earnings Per Share The following table sets forth the computation of basic and diluted (loss) earnings per share for the years ended December 31, 2002, 2001 and 2000: F-22 Headway Corporate Resources, Inc. and Subsidiaries Notes to Consolidated Financial Statements (continued) 2002 2001 2000 --------------------------------------- Numerator: Net (loss) income $ (98,538,000) $(5,679,000) $ 5,884,000 Cumulative effect of accounting change 45,000,000 Preferred stock dividend requirements (2,159,000) (1,500,000) (1,414,000) --------------------------------------- Numerator for basic (loss) earnings per share - net (loss) income available for common stockholders before cumulative effect of accounting change (55,697,000) (7,179,000) 4,470,000 Cumulative effect of accounting change (45,000,000) - - --------------------------------------- Numerator for basic (loss) earnings per share - net (loss) income available for common stockholders (100,697,000) (7,179,000) 4,470,000 Effect of dilutive securities: Preferred dividend requirements - - 1,414,000 --------------------------------------- Numerator for diluted (loss) earnings per share - net (loss) income available for common stockholders after assumed conversions (2000) $(100,697,000) $(7,179,000) $ 5,884,000 ======================================= Denominator: Denominator for basic (loss) earnings per share - weighted average shares 12,504,969 10,729,627 10,590,461 Effect of dilutive securities: Stock options, warrants and restricted shares - - 74,142 Convertible preferred stock - - 3,584,299 --------------------------------------- Dilutive potential common stock - - 3,658,441 --------------------------------------- Denominator for diluted (loss) earnings per share - adjusted weighted-average shares and assumed conversions 12,504,969 10,729,627 14,248,902 ======================================= Basic (loss) earnings per share before cumulative effect of accounting change $ (4.45) $ (.67) $ .42 ======================================= Basic (loss) earnings per share $ (8.05) $ (.67) $ .42 ======================================= Diluted (loss) earnings per share before cumulative effect of accounting change $ (4.45) $ (.67) $ .41 ======================================= Diluted (loss) earnings per share $ (8.05) $ (.67) $ .41 ======================================= The calculation of diluted (loss) earnings per share excludes potential common shares. During the years ended December 31, 2002 and December 31, 2001, Series G and Series F preferred stock, restricted common stock, warrants and stock options were outstanding but were excluded because to include them would be antidilutive. F-23 Headway Corporate Resources, Inc. and Subsidiaries Notes to Consolidated Financial Statements (continued) 11. Income Taxes Pre-tax (loss) income from foreign operations was $(2,734,000), $(1,053,000) and $1,718,000 for the years ended December 31, 2002, 2001 and 2000, respectively. Income tax (benefit) expense from continuing operations consists of the following: Year ended December 31 2002 2001 2000 ------------------------------------------- Current: Domestic $(5,696,000) $(3,745,000) $3,368,000 Foreign 65,000 116,000 443,000 ------------------------------------------- (5,631,000) (3,629,000) 3,811,000 ------------------------------------------- Deferred expense: Domestic (506,000) 50,000 577,000 Foreign 199,000 (199,000) - ------------------------------------------- Total deferred expense (307,000) (149,000) 577,000 ------------------------------------------- $(5,938,000) $(3,778,000) $4,388,000 =========================================== The components of deferred tax assets and liabilities are as follows: December 31 2002 2001 --------------------------- Deferred tax assets: Deferred rent $ 400,000 $ 462,000 Allowances for doubtful accounts 857,000 559,000 Net operating loss carryforwards 2,632,000 932,000 Depreciation 410,000 - Intangibles 19,391,000 - Other 299,000 47,000 --------------------------- 23,989,000 2,000,000 Deferred tax liabilities: Depreciation - (216,000) Intangibles - (2,091,000) --------------------------- - (2,307,000) --------------------------- Valuation allowance (23,989,000) - --------------------------- $ - $ (307,000) =========================== Realization of deferred tax assets is dependent on future earnings. Due to the uncertainty of realization of the net deferred tax assets, the Company has provided a valuation allowance. F-24 Headway Corporate Resources, Inc. and Subsidiaries Notes to Consolidated Financial Statements (continued) A reconciliation of the statutory Federal income tax rate to the effective rates is as follows: Year ended December 31 2002 2001 2000 ------------------------------ Statutory rate (34)% (34)% 34% State and local income taxes (net of federal tax benefit) (5) (7) 7 Impact of valuation allowance 28% 0% 0% Other 1 1 2 ------------------------------ Effective tax rate (10)% (40)% 43% ============================== The Company has a federal net operating loss in the current year of approximately $17,000,000, which will be carried back for federal income tax purposes. At December 31, 2002, the Company also has state and local operating loss carryforwards of approximately $28,000,000, which will be carried forward for state tax purposes. These carryforwards expire at various dates through December 31, 2022, depending on the state or local tax jurisdiction. 12. Stock Incentive Plan Pursuant to the Company's Stock Incentive Plan (the "Plan"), up to 3,771,567 options to purchase common stock were reserved for grant. The Plan provides for the granting of stock options, stock appreciation rights and stock awards. Stock options intended to be incentive stock options will be granted at prices equal to at least market price on the date of the grant. A summary of the activity in the Plan is as follows: Number of Weighted Average Shares Exercise Price -------------------------------- Outstanding at December 31, 1999 1,985,231 $ 4.47 Granted 282,500 3.34 Canceled (345,000) 4.59 -------------- Outstanding at December 31, 2000 1,922,731 4.27 Granted 20,000 0.60 Canceled (95,950) 5.23 -------------- Outstanding at December 31, 2001 1,846,781 4.19 Canceled (210,500) 4.56 -------------- Outstanding at December 31, 2002 1,636,281 4.14 ============== Exercisable at December 31, 2000 1,276,896 4.13 ============== Exercisable at December 31, 2001 1,460,948 4.20 ============== Exercisable at December 31, 2002 1,571,281 4.17 ============== Options granted vest equally over three years or cliff vest at the end of a three-year term and are exercisable for a period not to exceed ten years from the date of grant. F-25 Headway Corporate Resources, Inc. and Subsidiaries Notes to Consolidated Financial Statements (continued) Information regarding options outstanding under the Plan at December 31, 2002 is as follows: Options Outstanding Options Exercisable ------------------------------------- ---------------------- Weighted- Weighted- Average Weighted- Exercise Number of Average Remaining Number of Average Price Options exercise Contractual Options Exercise Range Outstanding Price Life Exercisable Price - ----------------------------------------------------------------------------- $ 0.60 15,000 $ 0.60 8.7 years 15,000 $0.60 2.38 - 3.50 537,500 2.81 3.4 years 510,833 2.83 3.62 - 5.38 935,231 4.30 5.5 years 896,898 4.31 5.50 - 8.00 65,000 6.36 5.7 years 65,000 6.36 9.88 83,550 9.88 5.6 years 83,550 9.88 ----------- ---------- 1,636,281 1,571,281 =========== ========== There were no options granted during the year ended December 31, 2002. The weighted average fair value of options granted during the years ended December 31, 2001 and 2000 was $0.28 and $2.12, respectively. The weighted average remaining contractual life of options exercisable at December 31, 2002 is 4.17 years. 13. Stock-Based Compensation Pro forma information regarding net (loss) income and (loss) earnings per share is required by SFAS No. 123 and has been determined as if the Company had accounted for its employee stock options under the fair value method of SFAS No. 123. The fair value for the options granted in 2001 and 2000 was estimated at the date of grant using a Black-Scholes option-pricing model with the following weighted-average assumptions: Year ended December 31 2001 2000 ---------------------- Assumptions Risk-free rate 4.61% 6.72% Dividend yield 0% 0% Volatility factor of the expected market price of the Company's common stock .47 .70 Average life 5 years 5 years The Black-Scholes option valuation model was developed for use in estimating the fair value of traded options which have no vesting restrictions and are fully transferable. In addition, option valuation models require the input of highly subjective assumptions, including the expected stock price volatility. Because the Company's employee stock options have characteristics significantly different from those of traded options, and because changes in the subjective F-26 Headway Corporate Resources, Inc. and Subsidiaries Notes to Consolidated Financial Statements (continued) input assumptions can materially affect the fair value estimate, in management's opinion, the existing models do not necessarily provide a reliable single measure of the fair value of its employee stock options. 14. Commitments and Contingencies The Company leases office space under operating leases which have various expiration dates through October 2009. The leases provide for additional rent based on increases in operating costs and real estate taxes. The Company also leases equipment under capital leases expiring at various times through January 2004. Future minimum lease payments at December 31, 2002 under capital leases and noncancelable operating leases (shown net of $563,000 of sublease income per annum through 2009) with remaining terms of one year or more are as follows: Capital Operating Leases Leases -------------------------------- 2003 $ 126,000 $ 2,494,000 2004 5,000 1,822,000 2005 - 1,341,000 2006 -- 1,206,000 2007 -- 674,000 Thereafter - 806,000 -------------------------------- Total minimum lease payments 131,000 $ 8,343,000 ================ Less amounts representing interest 3,000 ---------------- Present value of net minimum lease payments 128,000 Less current portion 123,000 ---------------- Long-term portion $ 5,000 ================ Included in property and equipment at December 31, 2002 and 2001 is equipment recorded under capital leases with a cost of $1,026,000 and $1,170,000, respectively, and accumulated depreciation and amortization of $756,000 and $693,000, respectively. Amortization of equipment recorded under capital leases is included with depreciation expense. Rent expense, including escalation charges, and net of sublease income of $563,000, $563,000 and $514,000 for the years ended December 31, 2002, 2001 and 2000 were $3,145,000, $3,070,000 and $2,976,000, respectively. The Company has letters of credit outstanding aggregating $1,687,000 in connection with various guarantees relating to its workers compensation insurance policy, office leases and capital leases. F-27 Headway Corporate Resources, Inc. and Subsidiaries Notes to Consolidated Financial Statements (continued) In February 1999, a lawsuit was filed in the Superior Court of California alleging breach of contract, interference with prospective business relations, misappropriation of trade secrets and unfair competition. In February 2002, the lawsuit was settled. The settlement did not have a material effect on the financial position, results of operations or cash flows of the Company. In May 2000, a lawsuit was filed in the Judicial District Court of Dallas County, Texas alleging breach of contract, fraud, negligence, negligent retention and supervision, civil conspiracy and harmful access by computer. In July 2002, a judgment was entered in the amount of $790,000 against Headway and the other defendants. This judgment was reflected in the net loss for the nine months ended September 30, 2002. In January 2003, the lawsuit was settled for a substantially lesser amount with Headway's insurance covering all but $60,000. During the quarter ending December 31, 2002, $730,000 of such accrual was reversed. The Company is party to litigation arising out of the normal course of its business. In the opinion of management, all matters are without merit or are of such kind or involve such amounts, as would not have a material adverse effect on the financial position, results of operations or cash flows of the Company. 15. Retirement Plan The Company has a 401(k) plan covering substantially all its domestic employees. The plan does not require a matching contribution by the Company. 16. Segment Information Major Customers For the years ended December 31, 2002 and 2001, one staffing services customer accounted for 19% and 12% of the Company's revenues, respectively. For the year ended December 31, 2000, no customer accounted for more than 10% of the Company's revenues. Geographic Information For the years ended December 31, 2002, 2001 and 2000, the Company derived substantially all of its revenues from businesses located in the United States, and no other country accounted for more than 10% of the Company's revenues. F-28 Headway Corporate Resources, Inc. and Subsidiaries Notes to Consolidated Financial Statements (continued) Business Segments The Company classifies its business into two fundamental areas, staffing and executive search. Staffing consists of the placement and payrolling of temporary and permanent office, clerical and information technology professional personnel. Executive search focuses on placing middle to upper level management positions. The Company evaluates performance based on the segments' profit or loss from operations before unallocated corporate overhead. The accounting policies of the reportable segments are the same as those described in the summary of significant accounting policies (see Note 2). Year ended December 31, 2002 Executive Staffing Search Services Services Total ---------------------------------- (Dollars in Thousands) Revenues $253,344 $14,440 $267,784 Impairment of goodwill and long-lived assets 39,807 3,832 43,639 Depreciation and amortization 1,874 393 2,267 Interest expense 7,948 661 8,609 Interest income (70) - (70) Segment (loss) before income tax (benefit) and cumulative effect of accounting change (46,167) (8,060) (54,227) Income tax (benefit) (1,351) (905) (2,256) Cumulative effect of accounting change (36,800) (8,200) (45,000) Segment (loss) (81,616) (15,355) (96,971) Segment assets 38,591 3,693 42,284 Expenditures for long lived assets 813 222 1,035 Year ended December 31, 2001 Executive Staffing Search Services Services Total ----------------------------------- (Dollars in Thousands) Revenues $296,921 $26,116 $323,037 Depreciation and amortization 4,979 808 5,787 Interest expense 9,203 443 9,646 Interest income (41) - (41) Segment (loss) income before income tax (benefit) expense (7,824) 1,496 (6,328) Income tax (benefit) expense (3,244) 688 (2,556) Segment (loss) profit (4,580) 808 (3,772) Segment assets 120,419 19,579 139,998 Expenditures for long lived assets 1,157 285 1,442 F-29 Headway Corporate Resources, Inc. and Subsidiaries Notes to Consolidated Financial Statements (continued) 16. Segment Information (continued) Year ended December 31, 2000 Executive Staffing Search Services Services Total ----------------------------------- (Dollars in Thousands) Revenues $333,465 $37,650 $371,115 Depreciation and amortization 4,479 858 5,337 Interest expense 6,818 253 7,071 Interest income (98) - (98) Segment income before income tax expense 6,141 8,127 14,268 Income tax expense 2,641 3,413 6,054 Segment profit 3,500 4,714 8,214 Segment assets 128,478 23,356 151,834 Expenditures for long lived assets 1,435 315 1,750 Year ended December 31 2002 2001 2000 ----------------------------------- (Dollars in Thousands) Reconciliation to net income Total (loss) profit for $(96,971) $(3,772) $ 8,214 reportable segments Unallocated amounts: Interest expense (3,389) (1,233) (978) Interest income - 72 7 Corporate overhead (1,860) (1,968) (3,025) Income tax benefit 3,682 1,222 1,666 ----------------------------------- Net (loss) income $(98,538) $(5,679) $ 5,884 =================================== December 31 2002 2001 2000 ----------------------------------- (Dollars in Thousands) Reconciliation to total assets Total assets for reportable segments $ 42,284 $139,998 $151,834 Other assets 6,073 9,166 2,352 ----------------------------------- Total assets $ 48,357 $149,164 $154,186 =================================== F-30 Headway Corporate Resources, Inc. and Subsidiaries Notes to Consolidated Financial Statements (continued) 17. Subsequent Event On March 13, 2003, Headway Corporate Resources, Inc. exited the executive search segment of its business through a sale of its Whitney subsidiaries. All of Headway's interest in the Whitney subsidiaries were sold to Whitney Group, LLC, a New York limited liability company (the Whitney Group"). Gary S. Goldstein, who had resigned his positions as an officer and director of Headway and its subsidiaries, is an officer and principal owner of membership interest in the Whitney Group. In consideration for the sale, the Whitney Group (i) issued to the Company a 15 percent membership interest in the Whitney Group (subject to adjustment in certain circumstances), (ii) issued a promissory note in the principal amount of $2,000,000, and (iii) is obligated to pay an earnout equal to five percent of Whitney Group's gross revenues, as defined, during a five-year period commencing January 1, 2003. The note bears interest at the Prime Lending Rate as in effect from time to time, plus two percent per annum. Interest is payable quarterly and the full principal amount of the note is payable in January 2005. The Whitney Group may, at its election, prepay and terminate the promissory note and earnout obligation through a lump sum payment of $5,000,000 less the actual amount of principal previously paid on the promissory note and earnout payments. The Whitney Group is obligated to prepay the promissory note and earnout obligation on the foregoing terms if one or more specified events occur prior to January 1, 2006, that constitute a change in control or ownership of the Whitney Group. The Company has estimated the fair market value of the promissory note at $1,400,000 and the 15% equity interest at $45,000. This transaction will be recorded in the 2003 financial statements and is not expected to have a material gain or loss on the Company's results of operations. The assets and liabilities of the executive search segment consists of the following: December 31, 2002 2001 ----------------------- Cash and cash equivalents $ 134 $ 1,041 Accounts receivable 1,600 3,336 Prepaid expenses and other current assets 1,146 528 Prepaid and refundable income taxes 572 722 Property and equipment - 973 Goodwill - 11,086 Other assets 102 962 ----------------------- Total Assets $3,554 $18,648 ======================= Accounts payable 191 384 Accrued expenses 398 905 Accrued payroll 1,367 3,349 Capital lease obligations, current portion 3 5 Deferred rent 773 876 ----------------------- Total liabilities $2,732 $ 5,519 ======================= F-31 Headway Corporate Resources, Inc. and Subsidiaries Notes to Consolidated Financial Statements (continued) 18. Quarterly Results of Operations (Unaudited) The following is a summary of the quarterly results for the years ended December 31, 2002 and 2001. 2002 Quarter Ended --------------------------------------------------- March June September December --------------------------------------------------- (Dollars in Thousands, except per share data) Revenues $ 69,641 $ 65,877 $66,560 $ 65,706 Operating (loss) income (1,225) 103 (663) (45,763) (Loss) before cumulative effect of accounting change (3,509) (1,900) (1,855) (46,274) Net (loss) (48,509) (1,900) (1,855) (46,274) Basic and diluted net (loss) available for common stockholders $ (4.57) $ (.21) $ (.18) $ (3.41) ========= ========= ======== ========= 2002 Quarter Ended --------------------------------------------------- March June September December --------------------------------------------------- (Dollars in Thousands, except per share data) Revenues $ 89,713 $ 83,181 $76,140 $ 74,003 Operating income (loss) 5,755 370 (557) (4,259) Net income (loss) 1,984 (906) (2,017) (4,740) Net income (loss) available for common stockholders: -Basic $ .15 $ (.12) $ (.22) $ (.48) ========= ========= ======== ========= -Diluted $ .14 $ (.12) $ (.22) $ (.48) ========= ========= ======== ========= F-32 Schedule II - Valuation And Qualifying Accounts Headway Corporate Resources, Inc. and Subsidiaries December 31, 2002 - --------------------------------------------------------------------------------------------- COL. A COL. B COL. C COL. D COL. E - --------------------------------------------------------------------------------------------- Additions -------------------- Balance at Charged to Charged Balance Description Beginning Costs and to Other Deductions (a) at End of Period Expense Accounts of Period - --------------------------------------------------------------------------------------------- Year Ended December 31, 2002: Deducted from asset account Allowance for doubtful accounts $1,430,000 $1,619,000 $ - $922,000 $2,127,000 Year Ended December 31, 2001: Deducted from asset account Allowance for doubtful accounts $1,156,000 $ 611,000 $ - $337,000 $1,430,000 Year Ended December 31, 2000: Deducted from asset account Allowance for doubtful accounts $ 958,000 $ 297,000 $ - $ 99,000 $1,156,000 (a) Uncollectible accounts written off. F-33