SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
------------
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 1998
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from __________________ to_________________
Commission file number 000-23147
OUTSOURCE INTERNATIONAL, INC.
(Exact Name of Registrant as Specified in Its Charter)
FLORIDA 65-0675628
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(State or Other Jurisdiction of Incorporation or Organization) (I.R.S. Employer Identification No.)
1144 East Newport Center Drive, Deerfield Beach, Florida 33442
--------------------------------------------------------------
(Address of Principal Executive Offices, Zip Code)
Registrant's Telephone Number, Including Area Code: (954) 418-6200
Indicate 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
-- --
APPLICABLE ONLY TO ISSUERS INVOLVED IN BANKRUPTCY
PROCEEDINGS DURING THE PRECEDING FIVE YEARS:
Indicate by check mark whether the registrant has filed all documents
and reports required to be filed by Section 12, 13 or 15(d) of the Securities
Exchange Act of 1934 subsequent to the distribution of securities under a plan
confirmed by a court. Yes_____ No _____
APPLICABLE ONLY TO CORPORATE ISSUERS:
Indicate the number of shares outstanding of each of the issuer's
classes of common stock, as of the latest practicable date:
Class Outstanding at August 12, 1998
----- ------------------------------
Common Stock, par value $.001 per share 8,657,913
OUTSOURCE INTERNATIONAL, INC.
INDEX
PART I - FINANCIAL INFORMATION
Page
----
Item 1 - Financial Statements
Consolidated Balance Sheets as of June 30, 1998 and
December 31, 1997....................................................................... 2
Consolidated Statements of Income for the three and six months
ended June 30, 1998 and 1997............................................................ 3
Consolidated Statements of Shareholders' Equity (Deficit) for
the six months ended June 30, 1998 and 1997 ............................................ 4
Consolidated Statements of Cash Flows for the six months
ended June 30, 1998 and 1997............................................................ 5
Notes to Consolidated Financial Statements.............................................. 6
Item 2 - Management's Discussion and Analysis of Financial
Condition and Results of Operations.............................................................. 13
PART II - OTHER INFORMATION
Item 2 - Changes in Securities and Use of Proceeds........................................................ 24
Item 4 - Submission of Matters to a Vote of Security Holders.............................................. 24
Item 5 - Other Information ............................................................................... 25
Item 6 - Exhibits and Reports on Form 8-K................................................................. 25
Signatures................................................................................................ 27
1
PART I - FINANCIAL INFORMATION
ITEM 1 - FINANCIAL STATEMENTS
OUTSOURCE INTERNATIONAL, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(UNAUDITED)
June 30, December 31,
1998 1997
------------ -----------
ASSETS
CURRENT ASSETS:
Cash ................................................................... $ 2,007,089 $ 1,685,474
Trade accounts receivable, net of allowance for doubtful accounts of
$1,666,686 and $1,639,767............................................. 52,770,989 47,297,608
Funding advances to franchises.......................................... 1,194,561 2,186,150
Deferred income taxes and other current assets.......................... 5,538,001 5,909,960
------------- ------------
Total current assets................................................. 61,510,640 57,079,192
PROPERTY AND EQUIPMENT, net............................................. 16,422,289 14,953,118
GOODWILL AND OTHER INTANGIBLE ASSETS, net............................... 65,337,953 30,426,731
OTHER ASSETS............................................................ 4,136,758 3,283,817
------------- ------------
Total assets......................................................... $147,407,640 $105,742,858
============= ============
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable........................................................ $ 4,009,543 $ 1,498,275
Accrued expenses:
Payroll............................................................ 9,660,886 5,382,295
Payroll taxes...................................................... 4,229,023 2,181,722
Workers' compensation and insurance................................ 9,976,261 9,086,007
Other.............................................................. 1,441,761 1,863,666
Other current liabilities............................................... 1,314,016 907,975
Current maturities of long-term debt to related parties................. 517,665 100,000
Current maturities of other long-term debt.............................. 6,040,237 2,408,060
------------- ------------
Total current liabilities............................................ 37,189,392 23,428,000
NON-CURRENT LIABILITIES:
Revolving credit facility............................................... 54,502,265 33,800,000
Long-term debt to related parties, less current maturities.............. 1,021,066 -
Other long-term debt, less current maturities........................... 11,371,475 7,736,981
------------- ------------
Total liabilities.................................................... 104,084,198 64,964,981
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COMMITMENTS AND CONTINGENCIES (NOTES 2, 4 AND 8)
SHAREHOLDERS' EQUITY:
Preferred stock, $.001 par value; 10,000,000 shares authorized, none
issued................................................................ - -
Common stock, $.001 par value; 100,000,000 shares authorized;
8,657,913 and 8,448,788 issued and outstanding at June 30, 1998
and December 31, 1997................................................. 8,658 8,449
Additional paid-in capital ............................................. 53,978,107 53,200,988
Retained earnings (deficit)............................................. (10,663,323) (12,431,560)
------------- ------------
Total shareholders' equity........................................... 43,323,442 40,777,877
------------- ------------
Total liabilities and shareholders' equity........................... $147,407,640 $105,742,858
============= ============
See notes to consolidated financial statements.
2
OUTSOURCE INTERNATIONAL, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(UNAUDITED)
For the three months ended For the six months ended
--------------------------------------------------------------------
June 30, June 30, June 30, June 30,
1998 1997 1998 1997
--------------------------------------------------------------------
Net revenues......................................... $ 134,795,907 $ 107,823,178 $ 255,782,294 $ 193,197,372
Cost of revenues..................................... 113,519,631 91,599,151 216,467,878 165,838,360
--------------- -------------- ---------------- --------------
Gross profit......................................... 21,276,276 16,224,027 39,314,416 27,359,012
--------------- -------------- ---------------- --------------
Selling, general and administrative expenses:
Shareholders' compensation..................... - - - 292,001
Amortization of intangible assets ............. 976,528 562,467 1,721,842 892,573
Other selling, general and administrative...... 17,388,562 13,439,262 32,764,479 23,376,689
--------------- ------------- ------------- ------------
Total selling, general and administrative
expenses ................................ 18,365,090 14,001,729 34,486,321 24,561,263
--------------- -------------- ---------------- --------------
Operating income .................................... 2,911,186 2,222,298 4,828,095 2,797,749
--------------- -------------- ---------------- --------------
Other expense:
Interest expense (net)......................... 1,437,758 2,186,055 2,517,276 3,512,885
Put warrants valuation adjustment.............. - 3,127,234 - 1,243,952
Other expense (income)......................... (33,042) 43,570 (38,568) (24,979)
-------------- -------------- ---------------- --------------
Total other expense........................ 1,404,716 5,356,859 2,478,708 4,731,858
--------------- -------------- ---------------- --------------
Income (loss) before provision (benefit) for
income taxes ...................................... 1,506,470 (3,134,561) 2,349,387 (1,934,109)
Provision (benefit) for income taxes................. 411,389 (387,375) 581,150 (793,584)
--------------- -------------- ---------------- --------------
Net income (loss)................................... $ 1,095,081 $ (2,747,186) $ 1,768,237 $ (1,140,525)
=============== =============== ================ ==============
Pro forma data:
Income (loss) before provision (benefit)
for income taxes................................... $ 1,506,470 $ (3,134,561) $ 2,349,387 $ (1,934,109)
Provision (benefit) for income taxes................. 411,389 (434,000) 581,150 (467,000)
--------------- -------------- ---------------- --------------
Net income (loss).................................... $ 1,095,081 $ (2,700,561) $ 1,768,237 $ (1,467,109)
=============== ============== ================ ==============
Weighted average common shares:
Basic............................................ 8,609,155 5,448,788 8,546,856 5,543,583
=============== ============== ================ ==============
Diluted.......................................... 10,120,871 5,448,788 10,077,485 5,543,583
=============== ============== ================ ==============
Earnings (loss) per share:
Basic............................................ $ 0.13 $ (0.50) $ 0.21 $ (0.26)
=============== ============== ================ ==============
Diluted.......................................... $ 0.11 $ (0.50) $ 0.18 $ (0.26)
=============== ============== ================ ==============
See notes to consolidated financial statements.
3
OUTSOURCE INTERNATIONAL, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY (DEFICIT)
(UNAUDITED)
Additional Retained
Common Paid-In Earnings
Stock Capital (Deficit) Total
----- ------- --------- -----
Balance, December 31, 1997................................. $ 8,449 $53,200,988 $ (12,431,560) $40,777,877
Issuance of common stock................................... 58 774,942 - 775,000
Exercise of Warrants....................................... 151 2,177 - 2,328
Net income for the six months ended June 30, 1998.......... - - 1,768,237 1,768,237
-------- ------------ -------------- -------------
Balance, June 30, 1998 .................................... $ 8,658 $53,978,107 $(10,663,323) $43,323,442
======== ============ ============== =============
Balance, December 31, 1996................................. $ 5,785 $ 95,315 $ 4,394,125 $ 4,495,225
Net loss for the period from January 1, 1997
through February 21, 1997................................ - - (172,497) (172,497)
Distributions and other payments in connection with the
Reorganization........................................... (336) (11,879,636) (4,221,628) (16,101,600)
Contribution of notes payable by shareholders.............. - 4,300,000 - 4,300,000
Net loss for the period from February 22, 1997
through June 30, 1997..................................... - - (968,028) (968,028)
-------- ------------ -------------- --------------
Balance, June 30, 1997 .................................... $ 5,449 $ (7,484,321) $ (968,028) $ (8,446,900)
======== ============ ============== ==============
See notes to consolidated financial statements.
4
OUTSOURCE INTERNATIONAL, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
For the six months ended
---------------------------------
June 30, June 30,
1998 1997
---------------------------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss)................................................. $ 1,768,237 $ (1,140,525)
Adjustments to reconcile net income (loss) to net cash............
provided by (used in) operating activities:
Depreciation and amortization................................... 3,149,977 1,877,072
Amortization of debt discount & issuance costs.................. - 430,050
Put warrants valuation adjustment............................... - 1,243,952
Deferred income taxes........................................... 595,324 (1,525,978)
Loss on disposal of property and equipment...................... - 2,686
Changes in assets and liabilities (excluding effects of acquisitions):
(Increase) decrease in:
Trade accounts receivable.................................. (3,081,292) (14,317,696)
Prepaid expenses and other current assets.................. (66,453) (137,862)
Other assets............................................... 852 (1,509,066)
Increase (decrease) in:
Accounts payable........................................... (416,808) 333,720
Accrued expenses:
Payroll.................................................. 4,031,591 1,062,198
Payroll taxes............................................ 1,846,778 956,820
Workers' compensation and insurance...................... 811,254 1,950,814
Other.................................................... (421,905) 2,303,691
Other current liabilities.................................. (395,842) (1,113,974)
--------------- -------------
Net cash provided by (used in) operating activities..... 7,821,713 (9,584,098)
--------------- -------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Funding repayments from franchises, net.......................... 991,589 547,134
Property and equipment expenditures.............................. (2,494,946) (1,804,708)
Expenditures for acquisitions.................................... (26,891,603) (21,385,000)
--------------- -------------
Net cash used in investing activities.................... (28,394,960) (22,642,574)
--------------- -------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Increase in excess of outstanding checks over
bank balance, included in accounts payable..................... 2,888,839 973,227
Net proceeds from line of credit and
revolving credit facility...................................... 20,702,265 25,225,078
Related party borrowings (repayments)............................ (229,315) 1,844,179
Proceeds of senior notes and put warrants, net of
issuance costs................................................. - 22,614,984
Repayment of long-term debt...................................... (2,469,255) (2,940,371)
Repayments in connection with the Reorganization................. - (14,356,600)
Exercise of warrants............................................. 2,328 -
---------------- -------------
Net cash provided by financing activities................ 20,894,862 33,360,497
---------------- -------------
Net increase in cash............................................. 321,615 1,133,825
Cash, beginning of period........................................ 1,685,474 44,790
---------------- -------------
Cash, end of period.............................................. $ 2,007,089 $ 1,178,615
================ =============
SUPPLEMENTAL CASH FLOW INFORMATION:
Interest paid.................................................... $ 2,391,339 $ 1,973,998
================ =============
See notes to consolidated financial statements.
5
OUTSOURCE INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
NOTE 1. INTERIM FINANCIAL STATEMENTS
The interim consolidated financial statements and the related
information in these notes as of June 30, 1998 and for the three and six months
ended June 30, 1998 and 1997 are unaudited. Such interim consolidated financial
statements have been prepared on the same basis as the audited consolidated
financial statements and, in the opinion of management, reflect all adjustments
(including normal accruals) necessary for a fair presentation of the financial
position, results of operations and cash flows for the interim periods
presented. The results of operations for the interim periods presented are not
necessarily indicative of the results to be expected for the full year. The
interim financial statements should be read in conjunction with the audited
financial statements for the year ended December 31, 1997, included in the
Company's Form 10-K/A filed with the Securities and Exchange Commission on April
2, 1998.
In June 1997, Statement of Financial Accounting Standards ("SFAS") No.
131, "Disclosures about Segments of an Enterprise and Related Information," was
issued. SFAS No. 131 establishes standards for the way that public companies
report selected information about operating segments in annual financial
statements and requires that those companies report selected information about
segments in interim financial reports issued to shareholders. It also
establishes standards for related disclosures about products and services,
geographic areas, and major customers. SFAS No. 131 is effective for financial
statements for periods beginning after December 15, 1997, although interim
period application is not required. The Company has not determined the effects,
if any, that SFAS No. 131 will have on the disclosures in its consolidated
financial statements.
In June 1998, SFAS No. 133, "Accounting for Derivative Instruments and
Hedging Activities" was issued. SFAS No. 133 defines derivatives and establishes
accounting and reporting standards requiring that every derivative instrument
(including certain derivative instruments embedded in other contracts) be
recorded in the balance sheet as either an asset or liability measured at its
fair value. SFAS No. 133 also requires that changes in the derivative's fair
value be recognized currently in earnings unless specific hedge accounting
criteria are met. Special accounting for qualifying hedges allows a derivative's
gains and losses to offset related results on the hedged item in the income
statement, and requires that a company must formally document, designate and
assess the effectiveness of transactions that receive hedge accounting. SFAS No.
133 is effective for all fiscal quarters of fiscal years beginning after June
15, 1999, and cannot be applied retroactively. The Company intends to first
implement SFAS No. 133 in its consolidated financial statements as of and for
the three months ended March 31, 2000, although it has not determined the
effects, if any, that implementation will have. However, SFAS No. 133 could
increase volatility in earnings and other comprehensive income.
NOTE 2. ACQUISITIONS
During the first quarter of 1998, the Company purchased the franchise
rights for a total of six flexible staffing locations from Freuhling and
Jackson, Inc., F.J.R. Enterprises, Inc., EJ Services, Inc. and EAZY Temporary,
Inc., and converted these locations to Company-owned locations. The total
purchase price was $5,531,050, with $3,365,525 paid at closing and notes issued
for $2,165,525, payable over two years plus interest at 6.0% per annum (imputed
at 8.75% for financial statement purposes). The principal amount due under one
of these notes may increase or decrease by an amount not to exceed $250,000,
based on the gross profit from the acquired locations for the year following the
acquisition.
During the first quarter of 1998, the Company purchased flexible
staffing operations with a total of 18 locations from Tempus, Inc. and Grafton,
Inc. (none previously affiliated with the Company). The total purchase price was
$4,835,000, with $3,335,000 paid at closing plus a $1,500,000 note payable over
two years plus interest at 6.5% per annum (imputed at 8.75% for financial
statement purposes). The principal amount due under the note may decrease by up
to $300,000, based on the 1997 gross profit of the acquired locations.
Immediately following the acquisition from Tempus, Inc., the Company sold four
of the acquired locations to Cruel Dave Enterprises, LLC (a franchisee of the
Company) in exchange for the issuance of a $780,000 note, payable over five
years plus interest at 8.0% per annum.
6
OUTSOURCE INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
(UNAUDITED)
NOTE 2. ACQUISITIONS (CONTINUED)
During the first quarter of 1998, the Company purchased 100% of the
common stock of Employment Consultants, Inc., X-Tra Help, Inc. and Co-Staff,
Inc. (none previously affiliated with the Company), which were flexible staffing
operations with a total of four locations. The total purchase price (which
includes $2,100,000 for the excess of net tangible assets over liabilities
assumed) was $11,259,500, with $7,509,500 in cash and $775,000 in the Company's
common stock (57,809 shares) delivered at closing. The remainder of the purchase
price was satisfied by the issuance of notes totaling $2,975,000 and payable
over two years plus interest at 6.0% per annum (imputed at 8.75% for financial
statement purposes). However, one of the notes may increase without limit or
decrease by up to $875,000 based on the gross profit from the acquired locations
for the two years following the acquisition. For example, in the event gross
profit for those two years was equal to 1997 gross profit, the note would
decrease by approximately $125,000 or, in the event gross profit increased by
25% in each of those two years as compared to the prior year, the note would
increase by approximately $150,000. Certain sellers received options to purchase
a total of 6,000 shares of the Company's common stock at fair market value on
the date of issuance. Such options were issued January 31, 1998 and were still
outstanding at June 30, 1998.
Effective February 16, 1998, the Company purchased the franchise rights
for four flexible staffing locations from LM Investors, Inc. and converted these
locations to Company-owned locations. The shareholders of the franchises are
shareholders of the Company but do not hold a controlling interest in the
Company. The purchase price was $6,800,000, with $5,000,000 paid in cash at
closing plus the issuance of a note for $1,700,000 bearing interest at 7.25% per
annum (imputed at 8.75% for financial statement purposes) and payable quarterly
over three years. The remaining $100,000 of purchase price represents the
Company's assumption of the seller's liabilities under certain employment
contracts. In addition in the event the sellers wish to terminate their
remaining franchise agreements (representing four flexible staffing locations)
with the Company, the Company has agreed to concessions amounting to
approximately $60,000 and agreements not to compete (except by acquisition) of
up to six months after the applicable franchise termination date. See Note 4
regarding options for certain franchise territories granted in connection with
this transaction.
During the second quarter of 1998 the Company purchased the franchise
rights for a total of five flexible staffing locations from Deb-Lar, Inc., BLM
Enterprises, Inc. and Century Investors, Inc., and converted these locations to
Company-owned locations. The total purchase price was $1,634,904, with
$1,040,000 paid at closing and notes issued for $594,904, payable over two years
plus interest at 6.0% per annum (imputed at 8.75% for financial statement
purposes).
During the second quarter of 1998 the Company purchased flexible
staffing operations with a total of five locations from Pro Select, Inc., Ready
Help, Inc., Mid-West Temps, Inc. and Resource Dimensions, Inc. (none previously
affiliated with the Company). The total purchase price was $9,406,800, with
$7,096,800 paid in cash at closing (which included $946,800 placed in escrow)
plus notes issued for $2,110,000, payable over a nineteen and one half month
period plus interest at 6.0% per annum (imputed at 8.75% for financial statement
purposes). Payment of the remaining $200,000 is contingent primarily upon the
gross profit of one of the acquired locations for the twelve months following
the acquisition. The escrowed portion is payable to one of the sellers
approximately fourteen months after closing, less any portion paid to the
Company as compensation for any losses resulting from certain breaches of one of
the asset purchase agreements. The Company is obligated for an additional
payment to one of the sellers equivalent to any increase in the amount of gross
profit of the locations acquired from such seller for the twelve months ending
May 31, 1999, as compared to the greater of a contractually defined amount or
the gross profit of those locations for the twelve months ended March 31, 1998.
The above acquisitions have been accounted for as purchases. The
results of operations of the acquired businesses are included in the Company's
consolidated statements of income from the effective date of acquisition. The
additional payments based on future gross profit of certain acquired businesses
are not contingent on the continued employment of the sellers. Such additional
amounts, if paid, will be recorded as additional purchase price and increase
goodwill. The above purchase prices are stated before adjustments to reflect
imputed interest on acquisition financing and do not include acquisition related
professional fees and other costs capitalized as additional purchase price.
7
OUTSOURCE INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
(UNAUDITED)
NOTE 2. ACQUISITIONS (CONTINUED)
The costs of each acquisition have been allocated to the assets
acquired and liabilities assumed based on their fair values on the date of
acquisition as determined by management with the assistance of an independent
valuation consultant. The costs of the acquisitions in 1998 have been allocated
on a preliminary basis while the Company obtains final information regarding the
fair value of assets acquired and liabilities assumed Although the allocation
and amortization periods are subject to adjustment, the Company does not expect
that such adjustments will have a material effect on its consolidated financial
statements.
The following unaudited pro forma results of operations have been
prepared assuming the acquisitions described above as well as the acquisitions
completed by the Company during 1997 (and described in the Company's audited
consolidated financial statements for that year), had occurred as of the
beginning of the periods presented, including adjustments to the historical
financial statements for additional amortization of intangible assets, increased
interest on borrowings to finance the acquisitions and discontinuance of certain
compensation previously paid by the acquired businesses to their shareholders.
The unaudited pro forma operating results are not necessarily indicative of
operating results that would have occurred had these acquisitions been
consummated as of the beginning of the periods presented, or of future operating
results. In certain cases, the operating results for periods prior to the
acquisition are based on (a) unaudited financial statements provided by the
seller or (b) an estimate of revenues, cost of revenues and/or selling, general
and administrative expenses based on information provided by the seller or
otherwise available to the Company. In these cases, the Company has made a
reasonable attempt to obtain the most complete and reliable financial
information and believes that the financial information it used is reasonably
accurate, although the Company has not independently verified such information.
Three Months Ended June 30, Six Months Ended June 30,
--------------------------- -------------------------
1998 1997 1998 1997
---- ---- ---- ----
Unaudited pro forma:
Net revenues............................... $137,795,242 $128,509,139 $ 272,194,010 $ 242,471,436
Operating income........................... 3,344,739 3,295,597 5,963,388 4,870,660
Income (loss) before provision (benefit)
for income taxes......................... 1,807,843 (3,114,408) 2,855,259 (2,429,055)
Net income (loss).......................... 1,282,746 (2,857,588) 2,051,165 (1,635,471)
The following unaudited pro forma information, as adjusted, has been
prepared on the same basis as the preceding data and also reflects the pro forma
adjustment for income taxes and weighted average shares outstanding as discussed
in Note 7, except that the number of weighted average shares has been increased
by 57,809 basic and diluted shares for the three and six months ended June 30,
1997, and 9,901 basic and 10,088 diluted shares for the three and six months
ended June 30, 1998, in order to reflect adjustments for (i) the calculation of
proceeds from the exercise of warrants associated with certain debt utilized to
finance the above acquisitions as well as the acquisitions completed by the
Company during 1997 (and described in the Company's audited consolidated
financial statements for that year) and (ii) the timing of the issuance of
common stock and options in connection with those acquisitions:
Three Months Ended June 30, Six Months Ended June 30,
--------------------------- -------------------------
1998 1997 1998 1997
---- ---- ---- ----
Unaudited pro forma, as adjusted:
Income (loss) before provision (benefit) for
income taxes............................. $ 1,807,843 $(3,114,408) $2,855,259 $(2,429,055)
Pro forma provision (benefit) for income taxes 525,097 (379,063) 804,095 (542,618)
------------- ----------- --------- -----------
Pro forma net income (loss)................ $ 1,282,746 $(2,735,345) $2,051,164 $(1,886,437)
============= =========== ========== ===========
Weighted average common shares outstanding:
Basic.................................. 8,609,155 5,506,597 8,556,757 5,601,392
============= ============ ========== ===========
Diluted................................ 10,120,871 5,506,597 10,087,573 5,601,392
============= ============ ========== ===========
Earnings (loss) per share:
Basic.................................. $ 0.15 $ (0.50) $ 0.24 $ (0.34)
============= =========== =========== ===========
Diluted................................ $ 0.13 $ (0.50) $ 0.20 $ (0.34)
============= =========== =========== ===========
8
OUTSOURCE INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
(UNAUDITED)
NOTE 2. ACQUISITIONS (CONTINUED)
Goodwill and other intangible assets consist of the following:
As of As of
June 30, 1998 December 31, 1997
---------------------- -----------------
Goodwill.................................................... $30,809,451 $11,940,120
Territory rights............................................ 26,119,026 14,729,752
Customer lists.............................................. 9,899,827 4,672,178
Covenants not to compete.................................... 2,141,151 1,204,841
Employee lists.............................................. 406,979 196,479
------------ -------------
Goodwill and other intangible assets........................ 69,376,434 32,743,370
Less accumulated amortization............................... 4,038,481 2,316,639
------------ -------------
Goodwill and other intangible assets, net $65,337,953 $30,426,731
============ =============
NOTE 3. INCOME TAXES
The Company's effective tax rate for the three and six months ended
June 30, 1998 differed from the statutory federal rate of 35%, as follows:
Three Months Ended June 30, 1998 Six Months Ended June 30, 1998
-------------------------------- ------------------------------
Amount Rate Amount Rate
------ ---- ------ ----
Statutory rate applied to income before income taxes $ 527,265 35.0% $ 822,286 35.0%
Increase (decrease) in income taxes resulting from:
State income taxes, net of federal benefit........ 77,991 5.2 127,505 5.4
Employment tax credits............................ (246,658) (16.4) (450,251) (19.2)
Other............................................. 52,791 3.5 81,610 3.4
--------- ------- ---------- ----
Total............................................. $ 411,389 27.3% $ 581,150 24.6%
========= ======= ========== ====
NOTE 4. COMMITMENTS AND CONTINGENCIES
The Company is involved in litigation with regards to one of the
service marks used in its operations. Although this matter is in very
preliminary stages, the Company believes that an adverse decision in the case
would not have a material adverse effect on its financial condition or results
of operations.
Pursuant to the terms of a now inactive 401(k) plan (containing
previous contributions still managed by the Company), highly compensated
employees were not eligible to participate. However, as a result of
administrative errors in 1996 and prior years, some highly compensated employees
were permitted to make elective salary deferral contributions. The Company has
sought IRS approval regarding the proposed correction under the Voluntary
Closing Agreement Program ("VCAP"). There will be a penalty payable by the
Company, associated with a correction under the VCAP, although the Company
believes this penalty will be insignificant.
During the first quarter of 1998 and in connection with the Company's
acquisition of certain franchise rights from LM Investors, Inc. (see Note 2),
the Company granted one of the principals of the sellers (and a minority
shareholder in the Company) the exclusive option to purchase franchise rights in
five specifically identified geographic areas. These options pire at various
times from 12 to 42 months after the February 1998 acquisition date.
9
OUTSOURCE INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
(UNAUDITED)
NOTE 4. COMMITMENTS AND CONTINGENCIES (CONTINUED)
In February 1998, the Company entered into an interest rate collar
agreement with BankBoston, N.A., which involves the exchange of fixed and
floating rate interest payments periodically over the life of the agreement
without the exchange of the underlying principal amounts. The differential to be
paid or received is accrued as interest rates change and is recognized over the
life of the agreement as an adjustment to interest expense. The agreement is a
five year notional $42.5 million interest rate collar, whereby the Company
receives interest on that notional amount to the extent 30 day LIBOR exceeds
6.25% per annum, and pays interest on that amount to the extent 30 day LIBOR is
less than 5.43% per annum. This derivative financial instrument is being used by
the Company to reduce interest rate volatility and the associated risks arising
from the floating rate structure of its revolving credit facility, and is not
held or issued for trading purposes. The Company believes that unrealized gains
or losses related to the instrument are immaterial.
During April 1998, the Company entered into an employment agreement
with its new Chief Financial Officer, in addition to the employment agreements
already existing with the Chief Executive Officer ("CEO") and five other
officers. Under the terms of those agreements, in the event that the Company
terminates any of those officers without cause or the officer resigns for good
reason, the terminated officer will receive, among other things, severance
compensation, including a multiple of the officer's annual base salary and
bonus. In addition, all incentive stock options become immediately exercisable.
Similar severance provisions apply if any of those officers is terminated within
two years (three years for the CEO) after the occurrence of a "change of
control", as defined in the employment agreements.
During January 1998, the Company granted options to purchase 265,646
shares of the Company's common stock, with an exercise price of $13.88 per
share, equal to the public market price of the shares at the grant date. 89,896
of those options vested immediately upon grant. During March 1998, the Company
granted options to purchase 71,700 shares of the Company's common stock, with an
exercise price of $18.88 per share, equal to the public market price of the
shares at the grant date. During May 1998, the Company granted options to
purchase 93,375 shares of the Company's common stock, with the exercise prices
ranging from $19.50 to $20.13 per share, equal to the public market price of the
shares at the grant date. In August 1998, the Company cancelled and reissued
75,000 of these options with exercise prices ranging from $10.38 to $13.88 per
share, all such exercise prices in excess of the public market price of the
shares at the new grant date. During June 1998 the Company granted options to
purchase 4,432 shares of the Company's common stock, with an exercise price of
$16.75 per share, equal to the public market price of the shares at the grant
date. During August 1998, the Company granted options to purchase 43,500 shares
of the Company's common stock with an exercise price of $7.25 per share, equal
to the public market price of the shares at the grant date. All options vest
over a four year period, unless otherwise indicated.
Effective February 21, 1997, the Company acquired all of the
outstanding capital stock of nine companies under common ownership and
management, in exchange for shares of the Company's common stock and
distribution of previously undistributed taxable earnings of those nine
companies (the "Reorganization"). That distribution is subject to adjustment
based upon the final determination of taxable income through February 21, 1997.
10
OUTSOURCE INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
(UNAUDITED)
NOTE 5. SUPPLEMENTAL INFORMATION ON NONCASH INVESTING AND FINANCING ACTIVITIES
The consolidated statements of cash flows do not include the following
noncash investing and financing transactions, except for the net cash paid for
acquisitions:
Six Months Ended June 30,
-------------------------
1998 1997
---- ----
Acquisitions:
Tangible and intangible assets acquired......... $ 40,438,218 $ 25,067,375
Liabilities assumed............................. (1,367,643) ( 54,455)
Debt issued..................................... (11,403,972) (3,627,920)
Common stock issued............................. (775,000) -
--------------- --------------
Net cash paid for acquisitions.................... $ 26,891,603 $ 21,385,000
=============== ==============
Increase in property and equipment and long-term
debt, primarily capitalized leases............. $ - $ 720,815
=============== ==============
Debt to shareholders for distributions
and amounts in connection with the
Reorganization................................. $ - $ 1,745,000
=============== ==============
Shareholders' contribution to
additional paid-in capital in
connection with the Reorganization............. $ - $ 4,300,000
=============== ==============
NOTE 6. COMPREHENSIVE INCOME (LOSS)
Comprehensive income (loss) includes all changes in equity during a
period, except those changes in equity resulting from investment by owners and
distribution to owners. Comprehensive income (loss) totaled $1,095,081 and
$(2,747,186) for the three months ended June 30, 1998 and 1997, respectively,
and $1,768,237 and $(1,140,525) for the six months ended June 30, 1998 and 1997,
respectively, and consists solely of the Company's net income (loss) for the
respective periods.
NOTE 7. PRO FORMA DATA
Pro forma net income includes adjustments made to historical net income
for pro forma income taxes computed as if the Company had been fully subject to
federal and applicable state income taxes. The Company calculates pro forma
earnings per share in accordance with the requirements of SFAS No. 128,
"Earnings Per Share".
The pro forma weighted average shares outstanding (8,609,155 and
8,546,856, respectively, for the three and six months ended June 30, 1998 and
5,448,788 and 5,543,583, respectively, for the three and six months ended June
30, 1997) used to calculate pro forma basic earnings per share includes (a) the
5,448,788 shares of common stock issued in connection with the Reorganization
and (b) for the periods prior to the Reorganization, the equivalent number of
shares (-0- for the three months ended June 30, 1997 and 94,795 for the six
months ended June 30, 1997) of common stock represented by the shares of common
stock of nine companies purchased from certain shareholders for cash and notes
in the Reorganization. For the three and six months ended June 30, 1998, the
calculation also includes (c) the 3,000,000 shares sold by the Company in
October 1997, (d) the weighted portion of warrants exercised in May 1998
(102,558 and 50,160, respectively, for the three and six months ended June 30,
1998) and (e) the weighted portion of shares issued in connection with a
February 1998 acquisition (57,809 and 47,908, respectively, for the three and
six months ended June 30, 1998) (see Note 2).
The pro forma weighted average shares outstanding (10,120,871 and
10,077,485, respectively, for the three and six months ended June 30, 1998 and
5,448,788 and 5,543,583, respectively, for the three and six months ended June
30, 1997) used to calculate pro forma diluted earnings per share includes the
above items plus all outstanding options and warrants to purchase common stock
calculated using the treasury stock method (1,511,715 and 1,530,628,
respectively, for the three and six months ended June 30, 1998). These common
stock equivalents were not dilutive for the three and six months ended June 30,
1997.
11
OUTSOURCE INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
(UNAUDITED)
NOTE 8. SUBSEQUENT EVENTS
During the third quarter of 1998 the Company (i) purchased the
franchise rights for one flexible staffing location from ALPAP, Inc. and
converted this location to a Company-owned location and (ii) purchased certain
PEO operations from Hamilton-Ryker Co., Inc, which were immediately transferred
to existing Company locations. The total purchase price was $820,000, with
$730,000 paid in cash at closing and assumption by the Company of $90,000 of
liabilities. The Company is obligated for additional payments to one of the
sellers of (i) up to $50,000 of any increase in the amount of gross profit of
the location acquired from such seller for the twelve months after the closing,
as compared to a contractually defined amount and (ii) $75,000 in the event the
Company obtains certain favorable workers' compensation rates with relation to
the acquired location by January 1, 1999.
The Company had a contingent liability as an actual or implied
guarantor of mortgages having an outstanding principal balance of approximately
$1.6 million at March 31, 1998. These mortgages were secured by a building and
land previously leased by the Company from SMSB Associates ("SMSB"), a Florida
limited partnership comprised of Company shareholders, including the CEO. In
June 1998, SMSB sold this property to an unrelated third party at which time one
of these mortgages was repaid and a portion of the sales proceeds, approximately
equal to the outstanding balance of the remaining mortgage, was placed in
escrow. These funds were released from escrow and applied to pay this
outstanding mortgage in August 1998.
Effective July 27, 1998, the Company entered into a financing
arrangement pursuant to which it can sell up to a $50,000,000 secured interest
in its eligible accounts receivable to EagleFunding Capital Corporation
("Eagle"), which uses the receivables to secure A-1/P-1 rated commercial paper
(the "Securitization Facility"). In connection with the Securitization Facility,
the Company's revolving credit facility with a syndicate of commercial banks led
by BankBoston N.A. ("Revolving Credit Facility") was amended, primarily to
reduce the maximum amount available for borrowing from $85,000,000 to
$34,000,000 and to extend the remaining term of the Revolving Facility to five
years from the date of that amendment. Eagle is an affiliate of BankBoston, N.A.
Under the Securitization Facility, the Company receives cash equivalent
to the gross outstanding balance of the accounts receivable being sold, less
reserves which are adjusted on a monthly basis based on collection experience
and other defined factors. There is no recourse to the Company for the initial
funds received and amounts collected in excess of the reserves are retained by
the Company. The Company's interest rate, payable on the balance of the
outstanding commercial paper, is determined by prevailing interest rates in the
commercial paper market and approximated the Eurodollar rate at the commencement
of the Securitization Facility.
The Securitization Facility contains certain minimum default,
delinquency and dilution ratios with respect to the Company's receivables and
requires bank liquidity commitments ("Liquidity Facility") totaling no less than
$51,000,000. A default under the Securitization Facility constitutes a default
under the Revolving Credit Facility. The Liquidity Facility has been provided by
the syndicate of commercial banks that participate in the Revolving Credit
Facility for a one year term expiring July 26, 1999 at 0.375% per annum. Eagle
may draw against the Liquidity Facility to fund cash shortfalls caused by an
inability for any reason to issue commercial paper based on the Company's
receivables. There is no recourse to the Company for amounts drawn under the
Liquidity Facility, although such amounts would be repaid from and to the extent
receivables sold by the Company were collected. Amounts drawn under the
Liquidity Facility bear interest at the same rates incurred under the Revolving
Credit Facility.
12
ITEM 2 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
GENERAL
The Company is a rapidly growing national provider of human resource
services focusing on the flexible industrial staffing market through its Tandem
division and on the professional employer organization ("PEO") market through
its Synadyne division. To implement its growth strategies, the Company completed
35 acquisitions, primarily industrial staffing companies, from January 1, 1995
through August 12, 1998, with 87 offices and approximately $185.0 million in
annual historical revenue, including 30 offices in 1997 (the "1997
Acquisitions") and 39 offices in 1998 (the "1998 Acquisitions"). See
"-Acquisitions". Due to these acquisitions as well as new offices opened by the
Company during this period, the number of Company-owned flexible staffing and
PEO offices increased from 10 to 124, the number of metropolitan markets
(measured by Metropolitan Statistical Areas, or MSAs) served by Company-owned
locations increased from one to 45, and the Company implemented new information
systems, further developed back office capabilities and invested in other
infrastructure enhancements necessary to support its future growth.
The Company's revenues are derived from the salaries and wages of
worksite employees. Flexible staffing and PEO revenues, and related costs of
wages, salaries, employment taxes and benefits related to worksite employees,
are recognized in the period in which those employees perform the flexible
staffing and PEO services. Because the Company is at risk for all of its direct
costs, independent of whether payment is received from its clients, and
consistent with industry practice, all amounts billed to clients for gross
salaries and wages, related employment taxes, health benefits and workers'
compensation coverage are recognized as revenue by the Company, net of credits
and allowances. The Company's primary direct costs are (i) the salaries and
wages of worksite employees (payroll cost), (ii) employment related taxes, (iii)
health benefits and (iv) workers' compensation benefits and insurance.
RESULTS OF OPERATIONS
Effective February 21, 1997, the Company acquired all of the
outstanding capital stock of nine companies under common ownership and
management (the "Reorganization"). The historical operating results of the
Company presented and discussed herein also include the historical operating
results of those acquired companies for the periods noted.
The following tables set forth the amounts and percentage of net
revenues of certain items in the Company's consolidated statements of income for
the indicated periods.
Three Months Ended Six Months Ended
June 30, June 30,
-------- --------
1998 1997 1998 1997
---- ---- ---- ----
(In thousands, except employees and offices)
Net revenues:
Flexible industrial staffing......................... $ 72,699 $ 50,835 $ 133,331 $ 83,298
PEO.................................................. 58,050 53,529 115,363 103,520
Franchise royalties and other........................ 4,047 3,459 7,088 6,379
------------- ------------- ------------- ------------
Total net revenues................................... $ 134,796 $ 107,823 $ 255,782 $ 193,197
============= ============= ============= ============
Gross profit......................................... $ 21,276 $ 16,224 $ 39,314 $ 27,359
Selling, general and administrative expenses (1) 18,365 14,001 34,486 24,561
------------- ------------- ------------- ------------
Operating income..................................... 2,911 2,223 4,828 2,798
Net interest and other expenses (1).................. 1,405 5,357 2,479 4,732
------------- ------------- ------------- ------------
Income (loss) before provision (benefit) for
income taxes....................................... 1,506 (3,134) 2,349 (1,934)
Pro forma income taxes (benefit) (1)................. 411 (434) 581 (467)
------------- ------------- ------------- -------------
Pro forma net income (loss) (1)...................... $ 1,095 $ (2,700) $ 1,768 $ (1,467)
============= ============= ============= =============
System Operating Data:
System Revenues (2).................................. $ 156,920 $ 137,858 $ 296,981 $ 248,572
============= ============= ============= =============
Number of employees (end of period).................. 34,000 28,000 34,000 28,000
============= ============= ============= =============
Number of offices (end of period).................... 178 163 178 163
============= ============= ============= =============
13
Three Months Ended Six Months Ended
June 30, June 30,
-------- --------
1998 1997 1998 1997
---- ---- ---- ----
Net revenues:
Flexible industrial staffing....................... 53.9% 47.2% 52.1% 43.1%
PEO................................................ 43.1 49.6 45.1 53.6
Franchise royalties and other...................... 3.0 3.2 2.8 3.3
---------- -------- --------- -------
Total net revenues................................. 100.0% 100.0% 100.0% 100.0%
========== ======== ========= =======
Gross profit....................................... 15.8% 15.1% 15.4% 14.2%
Selling, general and administrative expenses (1)... 13.6 13.0 13.5 12.7
---------- -------- --------- -------
Operating income................................... 2.2 2.1 1.9 1.5
Net interest and other expense (income) (1)........ 1.1 5.0 1.0 2.5
---------- -------- --------- -------
Income (loss) before provision (benefit) for
income taxes..................................... 1.1 (2.9) 0.9 (1.0)
Pro forma income taxes (benefit) (1)............... 0.3 (0.4) 0.2 0.2
---------- -------- --------- -------
Pro forma net income (loss) (1).................... 0.8% (2.5)% 0.7% (0.8)%
========== ======== ========= =======
- --------------
(1) For the eight week period ended February 21, 1997, the Company elected to be
treated as a subchapter S corporation and, accordingly, the Company's income was
taxed at the shareholder level. In addition, during that period, the Company
paid compensation to the Company's founding shareholders and to the Company's
President, Chief Executive Officer, and Chairman of the Board, who is also a
shareholder of the Company ("Shareholder Compensation"). All of the compensation
for the founding shareholders and a portion of the compensation for the
Company's President was discontinued after the Reorganization. The discontinued
Shareholder Compensation was $262,000 for the six months ended June 30, 1997.
During the three and six months ended June 30, 1997, the Company recorded
non-operating expense of approximately $3.1 million and $1.2 million,
respectively, related to a put warrants valuation adjustment. The following
table sets forth the amounts and the percentage of certain items in the
Company's consolidated statements of income, with 1997 amounts and percentages
adjusted for the above items as follows: (i) selling, general and administrative
expenses excludes discontinued Shareholder Compensation; (ii) operating income
excludes discontinued Shareholder Compensation and (iii) net income and earnings
per share excludes discontinued Shareholder Compensation and the put warrants
valuation adjustment and is calculated assuming the Company had been subject to
federal and state income taxes and taxed as a C corporation during the period.
Three Months Ended Six Months Ended
June 30, June 30,
-------- ---- ---
1998 1997 1998 1997
---- ---- ---- ----
(In thousands, except for percentages and per share data)
Selling general and administrative expenses, as adjusted... $18,365 $14,001 $34,486 $24,299
As a percentage of net revenues............................ 13.6% 13.0% 13.5% 12.6%
Operating income, as adjusted............................. $ 2,911 $2,223 $4,828 $3,060
As a percentage of net revenues............................ 2.2% 2.1% 1.9% 1.6%
Net income (loss), as adjusted............................. $ 1,095 $ (5) $ 1,768 $(276)
As a percentage of net revenues............................ 0.8% 0.0% 0.7% (0.1)%
Earnings (loss) per diluted share, as adjusted............. $ 0.11 $ 0.00 $ 0.18 $(0.05)
EBITDA, as adjusted........................................ $ 4,677 $3,271 $ 8,017 $5,007
EBITDA is income before the effect of interest income and expense,
income tax benefit and expense, depreciation expense and amortization expense.
EBITDA as adjusted excludes discontinued shareholder compensation and the 1997
put warrants valuation adjustment. EBITDA is presented because it is a widely
accepted financial indicator used by many investors and analysts to analyze and
compare companies on the basis of operating performance. EBITDA is not intended
to represent cash flows for the period, nor has it been presented as an
alternative to operating income or as an indicator of operating performance and
should not be considered in isolation or as a substitute for measures of
performance prepared in accordance with generally accepted accounting
principles.
14
- ----------------
(2) System revenues represent the sum of the Company's net revenues (excluding
revenues from franchise royalties and services performed for franchisees)
and the net revenues of the franchisees. System revenues provide
information regarding the Company's penetration of the market for its
services, as well as the scope and size of the Company's operations, but
are not an alternative to revenues determined in accordance with generally
accepted accounting principles as an indicator of operating performance.
The net revenues of franchisees, which are not earned by or available to
the Company, are derived from reports that are unaudited. System revenues
consist of the following:
Three Months Ended Six Months Ended
June 30, June 30,
-------- --------
1998 1997 1998 1997
---- ---- ---- ----
(In thousands)
Company's net revenues............................$134,796 $ 107,823 $255,782 $193,197
Less Company revenues from:.......................
Franchise royalties............................. (1,829) (1,619) (2,924) (2,905)
Services to franchisees......................... (6,010) (8,046) (13,075) (17,003)
Add franchisees' net revenues..................... 29,963 39,700 57,198 75,283
-------- ---------- ---------- --------
System revenues...................................$156,920 $137,858 $296,981 $248,572
======== ========== ========== ========
THREE MONTHS ENDED JUNE 30, 1998 COMPARED TO THREE MONTHS ENDED JUNE 30, 1997
NET REVENUES. Net revenues increased $27.0 million, or 25.0%, to $134.8
million in the three months ended June 30, 1998 from $107.8 million in the three
months ended June 30, 1997. This increase resulted from growth in flexible
industrial staffing revenues in the three months ended June 30, 1998 of $21.9
million, or 43.0%, and PEO revenues growth of $4.5 million, or 8.4%, compared to
the three months ended June 30, 1997. Flexible industrial staffing revenues
increased due to (i) internal growth due to development of existing
Company-owned locations and an increase in the number of Company-owned offices
and (ii) the 1998 Acquisitions. The Company-owned flexible industrial staffing
offices increased to 112 locations as of June 30, 1998 from 80 locations as of
June 30, 1997, with 28 (net of 10 acquired locations combined with pre-existing
Company-owned locations) of the 32 additional locations resulting from the 1998
Acquisitions. The increase in PEO revenues was primarily due to a broadening of
the Company's PEO client base.
System revenues, which include franchise revenues which are not earned
by or available to the Company, increased $19.0 million, or 13.8%, to $156.9
million in the three months ended June 30, 1998 from $137.9 million in the three
months ended June 30, 1997. The increase in system revenues was attributable to
the $27.0 million increase in the Company's net revenues discussed above. The
increase in franchise revenues of franchisees operating as of June 30, 1998 of
$5.6 million, or 24.3%, in the 1998 period as compared to the 1997 period, was
offset by a $15.3 million decrease in the same period resulting from other
franchisees no longer operating, resulting in a net decrease of franchise
revenues of $9.7 million. Franchisees discontinued operations as a result of the
Company's acquisition and conversion of 13 franchise locations to Company-owned
locations during the first quarter of 1997, the Company's acquisition and
conversion of 15 franchise locations to Company-owned locations during the first
half of 1998 and the Company's early termination of franchise agreements (in
order to allow the Company's development of the related territories) related to
another 21 locations in 1997, primarily during the second and third quarters,
and two locations in 1998. At the time the Company terminates a franchise
agreement, it receives an initial buyout payment from the former franchisee. The
Company continues to receive payments from the former franchisees based on the
gross revenues of the formerly franchised locations for up to three years after
the termination dates. Although those gross revenues are not included in the
Company's franchisee or system revenues totals, the initial buyout payment, as
well as subsequent payments from the former franchisees, are reflected in total
royalties reported by the Company.
GROSS PROFIT. Gross profit increased $5.1 million, or 31.1%, to $21.3
million in the three months ended June 30, 1998, from $16.2 million in the three
months ended June 30, 1997. Gross profit as a percentage of net revenues
increased to 15.8% in the three months ended June 30, 1998 from 15.0% in the
three months ended June 30, 1997. This increase was primarily due to the
significantly higher growth rate for flexible industrial staffing revenues as
compared to the growth rate for PEO revenues, which generate lower gross profit
margins. In the three months ended June 30, 1998, PEO net revenues generated
gross profit margins of 4.0% as compared to gross profit margins of 22.5%
generated by flexible industrial staffing revenues.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES. Selling, general and
administrative expenses increased $4.4 million, or 31.2%, to $18.4 million in
the three months ended June 30, 1998 from $14.0 million in the three months
ended June 30, 1997. This increase was primarily a result of operating costs
associated with increased flexible industrial staffing volume at existing
locations, the 1997 Acquisitions and the 1998 Acquisitions. Selling, general and
administrative expenses, expressed as a percentage of gross profit, was 86.3%
for the three months ended June 30, 1998, equivalent to the comparable 1997
period. This represents a decline from 89.4% for the first three months of 1998,
which the Company attributes to increased efficiency of its operations as well
as improved leverage of its fixed costs over an increased revenue and gross
profit base arising from internal growth as well as the 1997 and 1998
Acquisitions. As a percentage of net revenues, selling, general and
administrative expenses increased to 13.6% in the three months ended June 30,
1998 from 13.0% in the three months ended June 30, 1997. In addition to the
items previously discussed, this percentage increase was also due to the
significant increase in 1998 of the flexible industrial staffing revenues in
proportion to total
15
Company revenues. The flexible industrial staffing operations have higher
associated selling, general and administrative expenses (as a percentage of
revenues) than PEO operations.
NET INTEREST AND OTHER EXPENSE . Net interest and other expense
decreased by $4.0 million, to $1.4 million in the three months ended June 30,
1998 from $5.4 million in the three months ended June 30, 1997. This decrease
was primarily due to non-operating expense in 1997 of $3.1 million attributable
to a put warrants valuation adjustment, with no corresponding item in 1998. In
addition, interest expense for the three months ended June 30, 1998 was $0.7
million less than the corresponding period in 1997, due to a decrease in total
debt outstanding as well as a decrease in the average interest rate.
NET INCOME (LOSS). Net income (loss) increased by $3.8 million, to $1.1
million in the three months ended June 30, 1998 from a $2.7 million loss in the
three months ended June 30, 1997. This increase was primarily due to the $3.1
million decrease in non-operating expense and the $0.7 million decrease in
interest expense discussed above. In addition, operating income increased by
$0.7 million as a result of increases in net revenues and gross profit discussed
above.
SIX MONTHS ENDED JUNE 30, 1998 COMPARED TO SIX MONTHS ENDED JUNE 30, 1997
NET REVENUES. Net revenues increased $62.6 million, or 32.4%, to $255.8
million in the six months ended June 30, 1998 from $193.2 million in the six
months ended June 30, 1997. This increase resulted from growth in flexible
industrial staffing revenues in the six months ended June 30, 1998 of $50.0
million, or 60.1%, and PEO revenues growth of $11.9 million, or 11.4%, compared
to the six months ended June 30, 1997. Flexible industrial staffing revenues
increased due to (i) internal growth due to development of existing
Company-owned locations and an increase in the number of Company-owned offices
and (ii) the 1997 Acquisitions (which were primarily consummated in late
February and March) and the 1998 Acquisitions. The Company-owned flexible
industrial staffing offices increased to 112 locations as of June 30, 1998 from
80 locations as of June 30, 1997, with 28 of the 32 additional locations
resulting from the 1998 Acquisitions. The increase in PEO revenues was primarily
due to a broadening of the Company's PEO client base.
System revenues, which include franchise revenues which are not earned
by or available to the Company, increased $48.4 million, or 19.5%, to $297.0
million in the six months ended June 30, 1998 from $248.6 million in the six
months ended June 30, 1997. The increase in system revenues was attributable to
the $62.6 million increase in the Company's net revenues discussed above. The
increase in franchise revenues of franchisees operating as of June 30, 1998 of
$9.3 million, or 22.3%, in the 1998 period as compared to the 1997 period, was
offset by a $27.4 million decrease in the same period resulting from other
franchisees no longer operating, resulting in a net decrease of franchise
revenues of $18.1 million. Franchisees discontinued operations as a result of
the Company's acquisition and conversion of 13 franchise locations to
Company-owned locations during the first quarter of 1997, the Company's
acquisition and conversion of 15 franchise locations to Company-owned locations
during the first half of 1998 and the Company's early termination of franchise
agreements (in order to allow the Company's development of the related
territories) related to another 21 locations in 1997, primarily during the
second and third quarters, and two locations in 1998.
GROSS PROFIT. Gross profit increased $11.9 million, or 43.7%, to $39.3
million in the six months ended June 30, 1998, from $27.4 million in the six
months ended June 30, 1997. Gross profit as a percentage of net revenues
increased to 15.4% in the six months ended June 30, 1998 from 14.2% in the six
months ended June 30, 1997. This increase was primarily due to the significantly
higher growth rate for flexible industrial staffing revenues as compared to the
growth rate for PEO revenues, which generate lower gross profit margins. In the
six months ended June 30, 1998, PEO net revenues generated gross profit margins
of 4.0% as compared to gross profit margins of 22.8% generated by flexible
industrial staffing revenues.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES. Selling, general and
administrative expenses increased $9.9 million, or 40.4%, to $34.5 million in
the six months ended June 30, 1998 from $24.6 million in the six months ended
June 30, 1997. This increase was primarily a result of operating costs
associated with increased flexible industrial staffing volume at existing
locations, the 1997 Acquisitions and the 1998 Acquisitions. Selling, general and
administrative expenses, expressed as a percentage of gross profit, decreased to
87.7% for the first six months of 1998 from 89.8% for the comparable 1997
period. The Company attributes this decline to increased efficiency of its
operations as well as improved leverage of its existing fixed costs over an
increased revenue and gross profit base arising from internal growth as well as
the 1997 and 1998 Acquisitions. As a percentage of net revenues, selling,
general and administrative expenses increased to 13.5% in the six months ended
June 30, 1998 from 12.7% in the six months ended June 30, 1997. In addition to
the items previously discussed, this percentage increase was also due to the
significant increase in 1998 of the flexible industrial staffing revenues in
proportion to total Company revenues. The flexible industrial staffing
operations have higher associated selling, general and administrative expenses
(as a percentage of revenues) than PEO operations.
16
NET INTEREST AND OTHER EXPENSE. Net interest and other expense
decreased by $2.3 million, to $2.5 million in the six months ended June 30, 1998
from $4.7 million in the six months ended June 30, 1997. This decrease was
primarily due to non-operating income in 1997 of $1.2 million attributable to a
put warrants valuation adjustment, with no corresponding item in 1998. In
addition, interest expense for the six months ended June 30, 1998 was $1.0
million less than the corresponding period in 1997, due to a decrease in total
debt outstanding as well as a decrease in the average interest rate.
NET INCOME (LOSS). Net income (loss) increased by $3.3 million, to $1.8
million in the six months ended June 30, 1998 from a $1.5 million loss in the
six months ended June 30, 1997. This increase was primarily due to the $1.2
million decrease in non-operating expense and the $1.0 million decrease in
interest expense discussed above. In addition, operating income increased by
$2.0 million as a result of increases in sales and gross profit discussed above.
ADDITIONAL OPERATING INFORMATION
The following table sets forth the gross profit margins for the
Company's two primary areas of operations for the indicated periods.
Three Months Ended Six Months Ended
June 30, June 30,
-------- --------
1998 1997 1998 1997
---- ---- ---- ----
Flexible industrial staffing.......................... 22.5% 24.1% 22.8% 23.8%
PEO................................................... 4.0 3.3 4.0 3.3
The Company's flexible industrial staffing division generates
significantly higher gross profit margins than its PEO division. The higher
flexible industrial staffing division margin reflects compensation for
recruiting, training and other services not required as part of many PEO
relationships, where the employees have already been recruited by the client and
are trained and in place at the beginning of the relationship.
The decrease in the gross profit margin for the Company's flexible
industrial staffing operations for the three and six month periods ended June
30, 1998 compared to the same periods in 1997 is primarily due to the impact of
(i) larger contracts obtained by the Company which have lower gross profit
margin percentages (but the impact on net income is mitigated by correspondingly
lower selling, general and administrative expenses due to the economies of scale
in servicing a larger contract), (ii) the increased wages necessary to recruit
flexible industrial staffing employees in areas of historically low
unemployment, (iii) adjusted pricing in the second quarter of 1998 to
stimulate sales and (iv) an increase in the minimum wage on September 1, 1997,
for which the Company recovered much of the increased payroll costs via
increased billing rates but without a related profit increase. The Company
anticipates these factors will continue to affect gross margins from flexible
industrial staffing operations, although in many cases the Company expects the
impact to be offset by lower selling, general and administrative expenses
(measured as a percentage of gross profit) as mentioned above.
The increase in the gross profit margin for the Company's PEO
operations for the three and six month periods ended June 30, 1998 compared to
the same periods in 1997 is primarily due to an increase in the percentage of
total PEO revenues related to PEO services provided to industrial staffing
clients. The gross profit margin percentage for PEO services provided to
industrial staffing clients is higher than the gross profit margin from most
other PEO clients although the gross profit amount per employee is relatively
consistent. An industrial staffing employee generally receives lower wages and
benefits than other PEO employees and the Company receives correspondingly lower
revenue. See "-General" for a discussion of the effect of these costs on the
Company's revenue calculation.
Flexible Industrial Staffing:
Net revenues from the Company's flexible industrial staffing services
increased $50.0 million, or 60.1%, to $133.3 million for the six months ended
June 30, 1998 from $83.3 million for the six months ended June 30, 1997. This
increase represented an increasing share of the Company's total net revenues, to
52.1% in the 1998 period from 43.1% in the 1997 period, reflecting the Company's
focus on growth of these flexible industrial staffing operations through
acquisitions as well as new office openings.
The Company expects this focus to continue for the foreseeable future.
Gross profit from the Company's flexible industrial staffing services
increased $10.6 million, or 53.3%, to $30.4 million for the six months ended
June 30, 1998 from $19.8 million for the six months ended June 30, 1997. This
represented an increasing share of the Company's total gross profit, to 77.3%
for the six months ended June 30, 1998, from 72.4% for the six months ended June
30, 1997.
17
PEO:
Net revenues from the Company's PEO services increased $11.9 million,
or 11.4%, to $115.4 million for the six months ended June 30, 1998 from $103.5
million for the six months ended June 30, 1997. Because of the lower growth rate
in PEO revenues as compared to flexible industrial staffing, this represented a
decreasing share of the Company's total net revenues, to 45.1% in the 1998
period from 53.6% in the 1997 period, reflecting the Company's greater focus on
growth of its flexible industrial staffing operations during this period as well
as the effect of changes made in the PEO management structure and marketing
approach, beginning in 1997. The Company expects that PEO sales growth will be
modest during 1998 while these two conditions continue.
Gross profit from the Company's PEO services increased $1.2 million, or
35.0%, to $4.7 million for the six months ended June 30, 1998 from $3.5 million
for the six months ended June 30, 1997. Because of the lower gross profit
percentage from PEO as compared to flexible industrial staffing, as well as the
lower growth rate in PEO revenues as compared to flexible industrial staffing,
this represented a decreasing share of the Company's total gross profit, to
11.8% for the six months ended June 30, 1998 from 12.5% for the six months ended
June 30, 1997.
Franchise and Other:
Net revenues from the Company's franchise and other services increased
$0.7 million, or 11.3%, to $7.1 million for the six months ended June 30, 1998
from $6.4 million for the six months ended June 30, 1997. This increase
represented a decreasing share of the Company's total net revenues, to 2.8% in
the 1998 period from 3.3% in the 1997 period, reflecting the Company's greater
focus on growth of its Company-owned flexible industrial staffing operations
during this period, including the Company's conversion of 28 franchise locations
to Company-owned locations and the termination of franchise agreements related
to another 23 locations. The Company expects to continue to convert franchise
locations to Company-owned locations in strategic markets, subject to the
Company's ability to negotiate these acquisitions at acceptable prices. However,
the Company also expects to continue to sell new franchises in smaller, less
populated geographic areas, subject to the success of the Company's marketing
efforts in this regard.
Gross profit from the Company's franchise and other services increased
$0.2 million, or 4.2%, to $4.3 million for the six months ended June 30, 1998,
from $4.1 million for the six months ended June 30, 1997. This increase
represented a decreasing share of the Company's total gross profit, to 10.9% for
the six months ended June 30, 1998 from 15.1% for the six months ended June 30,
1997.
LIQUIDITY AND CAPITAL RESOURCES
The Company's primary sources of funds for working capital and other
needs have been an $85.0 million credit line with a syndicate of lenders led by
BankBoston, N.A. (the "Revolving Facility"), senior notes and borrowings from
related parties. On October 24, 1997, the Company sold 3,000,000 shares of its
common stock in an initial public offering for net proceeds, after deducting all
expenses, of approximately $40.3 million, which proceeds were used to repay the
senior notes and borrowings from related parties, as well as a portion of the
Revolving Facility.
Effective July 27, 1998, the Company entered into a financing
arrangement under which it can sell up to a $50,000,000 secured interest in its
eligible accounts receivable to EagleFunding Capital Corporation ("Eagle"),
which uses the receivables to secure A-1/P-1 rated commercial paper (the
"Securitization Facility"). Under this arrangement, the Company receives cash
equivalent to the gross outstanding balance of the accounts receivable being
sold, less reserves which are adjusted on a monthly basis based on collection
experience and other defined factors. There is no recourse to the Company for
the initial funds received and amounts collected in excess of the reserves are
retained by the Company. The Company's interest rate, payable on the balance of
the outstanding commercial paper, is determined by prevailing interest rates in
the commercial paper market and approximated the Eurodollar rate at the
commencement of the Securitization Facility.
The Securitization Facility contains certain minimum default,
delinquency and dilution ratios with respect to the Company's receivables and
requires bank liquidity commitments ("Liquidity Facility") totaling no less than
$51,000,000. A default under the Securitization Facility constitutes a default
under the Revolving Credit Facility. The Liquidity Facility has been provided by
the syndicate of commercial banks that participate in the Revolving Credit
Facility for a one year term expiring July 26, 1999 at 0.375% per annum. Eagle
may draw against the Liquidity Facility to fund cash shortfalls caused by an
inability for any reason to issue commercial paper based on the Company's
receivables. There is no recourse to the Company for amounts drawn under the
Liquidity Facility, although such amounts would be repaid from and to the extent
receivables sold by the Company were collected. Amounts drawn under the
Liquidity Facility bear interest at the same rates incurred under the Revolving
Credit Facility.
18
In connection with the Securitization Facility, the Revolving Facility
was amended, primarily to reduce the maximum amount available for borrowing from
$85,000,000 to $34,000,000 and to extend the remaining term of the Revolving
Facility to five years from the date of that amendment. Outstanding amounts
under the Revolving Facility are secured by substantially all of the Company's
assets and the pledge of all of the outstanding shares of common stock of each
of its subsidiaries. Amounts borrowed under the Revolving Facility bear interest
at BankBoston's base rate or Eurodollar rate (at the Company's option) plus a
margin based upon the ratio of the Company's total indebtedness to the Company's
earnings (as defined in the Revolving Facility). As of June 30, 1998, the
Company had outstanding borrowings under the Revolving Facility of $54.5
million, bearing interest at an annualized rate of 7.5%. The Revolving Facility
contains certain affirmative and negative covenants relating to the Company's
operations.
On February 21, 1997, the Company issued senior notes in the principal
amount of $25.0 million, which were repaid in full from the proceeds of the
Company's October 1997 initial public offering. The Company used the proceeds of
the senior notes primarily to fund flexible industrial staffing acquisitions and
to pay shareholder distributions and other amounts in connection with the
Reorganization. In connection with the issuance of the senior notes, the Company
issued 786,517 warrants to the holders of the senior notes and placed an
additional 573,787 warrants in escrow. The warrants are exercisable at a price
of $.015 per share. 180,891 warrants were released from escrow in 1997 and
151,316 of those warrants were exercised in May 1998.
As of June 30, 1998, the Company had (i) bank standby letters of credit
outstanding, in the aggregate amount of $8.4 million under a $15.0 million
letter of credit facility (which is part of the Revolving Facility) to secure
certain workers' compensation obligations; (ii) $12.1 million of promissory
notes outstanding in connection with certain acquisitions, bearing interest at
rates ranging from 4.0% to 10.0%, which are payable primarily during the next
two years, and are subordinated to the repayment of the Revolving Facility;
(iii) obligations under capital leases for property and equipment in the
aggregate amount of $2.6 million; and (iv) obligations under mortgages totaling
$4.3 million.
The Company's principal uses of cash are for wages and related payments
to temporary and PEO employees, operating costs, acquisitions, capital
expenditures, advances made to certain Tandem franchise associates to fund their
payroll obligations and repayment of debt and interest thereon. During the six
months ended June 30, 1998, cash provided by operations was approximately $7.8
million, compared with $9.6 million used in the first six months of 1997. Cash
used in investing activities during the six months ended June 30, 1998 was
approximately $28.4 million, principally expenditures of $26.9 million for
acquisitions (primarily intangible assets), compared with $22.6 million in the
first six months of 1997 (which included expenditures of $21.4 million for
acquisitions). Cash provided by financing activities during the six months ended
June 30, 1998 was approximately $20.9 million, comprised primarily of $20.7
million from borrowings under the Revolving Facility and an increase in
outstanding checks over bank balance of $2.9 million, offset by $2.5 million of
repayments of long term debt. Cash provided by financing activities during the
six months ended June 30, 1997 was approximately $33.4 million, comprised
primarily of $22.6 million net proceeds from senior notes and warrants and $25.2
million from borrowings under the Revolving Facility, offset by payments of
$14.4 million in connection with the Reorganization and $1.1 million of
repayments of long-term debt (net of note repayments from related parties).
One of the key elements of the Company's strategy is expansion through
acquisitions, which will require significant sources of financing. These
financing sources include cash from operations, seller financing, bank financing
and issuances of the Company's common stock. In May 1998, the Company announced
that it intended to sell shares of its common stock in a public offering,
although in June 1998, the Company determined that equity market conditions were
no longer favorable and it would not attempt to sell additional shares of its
common stock. The Company will monitor equity market conditions in order to
determine when the sale of additional shares of its common stock is appropriate.
Until then, the Company expects to continue to fund its acquisition strategy
primarily with the Revolving Facility, as well as an increase in the limit of
that facility which would be negotiated as needed. The Company's previous
acquisitions have been primarily in the flexible industrial staffing area, and
the Company expects this trend to continue due to the more favorable pricing for
those businesses (as a multiple of EBITDA) as compared to PEO businesses. See
Note 2 to the Company's Consolidated Financial Statements.
The Company is a service business and therefore a majority of its
tangible assets are customer accounts receivable. Flexible industrial staffing
employees are paid by the Company on a daily or weekly basis. The Company,
however, receives payment from customers for these services, on average, 45 to
50 days from the presentation date of the invoice. As new flexible staffing
offices are established or acquired, or as existing offices expand, there will
be increasing requirements for cash to fund operations. The Company pays its PEO
employees on a weekly, bi-weekly, semi-monthly or monthly basis for their
services, and currently receives payments on a simultaneous basis from
approximately 90% of its existing customers.
19
The Company anticipates spending up to approximately $6.0 million
during the next twelve months for new flexible staffing locations, improvements
to its management information and operating systems, upgrades of existing and
acquired locations, and other capital expenditures. This amount does not include
expenditures for potential industrial staffing and PEO acquisitions, which the
Company believes could be at a similar magnitude equivalent to the recent
historical rate over the next twelve months and will primarily be for goodwill
and other intangible assets.
The Company believes that funds provided by operations, borrowings
under the Revolving Facility and current cash balances will be sufficient to
meet its presently anticipated needs for working capital and capital
expenditures, not including acquisitions for the next twelve months. Depending
on the amount and timing of future acquisitions and their financial structure,
the Company also believes that sufficient liquidity for such acquisitions as
well as its long-term operating requirements will be provided by funds from
operations, expanded or new borrowing facilities, issuance of common stock
and/or additional debt or equity offerings. However, the ability of the Company
to make acquisitions consistent with the recent historical rate is subject to
the Company's ability to successfully negotiate more flexible leverage (e.g.,
debt to EBITDA) covenants and increased borrowing limits compared to those
presently contained in the Revolving Facility and/or the Company's ability to
finance future acquisitions by issuance of its common stock rather than the debt
financing primarily used by the Company for previous acquisitions.
ACQUISITIONS
During 1995, the Company made four flexible industrial staffing
acquisitions with five offices and approximately $7.0 million in annual
historical revenue. During 1996, the Company made five flexible industrial
staffing acquisitions with 13 offices and approximately $16.0 million in annual
historical revenue. During 1997, the Company made eight flexible industrial
staffing acquisitions with 30 offices and approximately $61.0 million in annual
historical revenue. From January 1, 1998 through June 30, 1998, the Company made
16 flexible industrial staffing acquisitions with 38 offices and approximately
$91.0 million in annual historical revenue. These acquisitions have resulted in
a significant increase in goodwill and other intangible assets which has
resulted and will continue to result in increased amortization expense. In
addition, the amount of these intangible assets as a percentage of the Company's
total assets and shareholders' equity has increased significantly and while the
net unamortized balance of intangible assets as of June 30, 1998 is not
considered to be impaired, any future determination requiring the write off of a
significant portion of unamortized intangible assets could have a material
adverse effect on the Company's financial condition and results of operations.
See Note 2 to the Company's Consolidated Financial Statements.
SEASONALITY
The Company's quarterly results of operations reflect the seasonality
of higher customer demand for flexible industrial staffing services in the last
two quarters of the year, as compared to the first two quarters. Even though
there is a seasonal reduction of flexible industrial staffing revenues in the
first quarter of a year as compared to the fourth quarter of the prior year, the
Company does not reduce the related core personnel and other operating expenses
since that infrastructure is needed to support anticipated increased revenues in
subsequent quarters. PEO revenues are generally not subject to seasonality to
the same degree as flexible industrial staffing revenues although the net income
contribution of PEO revenues expressed as a percentage of sales is significantly
lower than the net income contribution of flexible industrial staffing revenues.
As a result of the above factors, the Company traditionally experiences
operating income in the first quarter of a year that is significantly less than
(i) the fourth quarter of the preceding year and (ii) the subsequent three
quarters of the same year.
INFLATION
The effects of inflation on the Company's operations were not
significant during the periods presented in the financial statements. Throughout
the periods discussed above, the increases in revenues have resulted primarily
from higher volumes, rather than price increases.
20
YEAR 2000 ISSUE
Many computer programs ("software") now being used in business were
written using two digits rather than four to define the applicable year. Such
software may be unable to properly interpret dates beyond the year 1999, which
could lead to business disruptions including but not limited to an inability to
process payroll, cash and invoicing transactions using that software (the "Year
2000" issue). The Year 2000 issue concerns not only software used solely within
a company but also concerns third parties, such as customers, vendors and
creditors, using software that may interact with or affect a company's
operations.
In 1996, the Company initiated a conversion of the primary software
being used in its flexible staffing and PEO operations, as well as its
corporate-wide accounting and billing software. Although this conversion was
undertaken for the primary purposes of achieving a common data structure for all
significant Company applications as well as enhancing processing capacity and
efficiency, it also will result in software that properly interprets dates
beyond the year 1999 ("Year 2000 Compliant"). As of June 30, 1998, this
conversion had been completed, except for (i) the installation of currently
existing and Year 2000 Compliant software in Company-owned and franchised
flexible staffing locations, which the Company has initiated in the second
quarter of 1998 and expects to complete within one year from that date, but no
later than December 31, 1999 and (ii) programming modifications to its corporate
accounting and billing software, which the Company expects to complete by
December 31, 1998, but no later than December 31, 1999.
The Company is in the process of initiating formal communications with
all of its significant customers, vendors and creditors to determine the extent
to which the Company's interface with software provided by or utilized by those
third parties could be adversely affected by the Year 2000 issue and what
actions those third parties are taking to address that issue on a timely basis.
The Company will take appropriate action based on those responses, but there can
be no assurance that the software provided by or utilized by other companies
which affect the Company's operations will be timely converted and would not
have an adverse effect on the Company.
The Company has already begun internal testing of the adequacy of its
Year 2000 compliance activities to date, and will utilize both internal and
external resources to further test the adequacy of those activities during 1998.
The Company expects to complete the majority of its effort in this area by early
1999 leaving adequate time to assess and correct any significant issues that may
materialize.
The total cost to the Company of these Year 2000 compliance activities
has not been and is not anticipated to be material to the Company's business,
results of operations or financial condition. The costs and time necessary to
complete the Year 2000 modification and testing processes are based on
management's best estimates, which were derived utilizing numerous assumptions
of future events including the continued availability of certain resources,
third party modification plans and other factors. However, there can be no
assurance that these estimates will be achieved and actual results could differ
from the estimates.
The Company has capitalized and will continue to capitalize the costs
of purchasing and developing new Year 2000 Compliant software, most of which had
been incurred as of June 30, 1998, but will expense the costs of the
modifications to existing software made solely for purposes of Year 2000
compliance, most of which will be incurred during 1998. Any remaining
capitalized balance for software no longer utilized because of replacement by
Year 2000 Compliant software will be expensed at the time such software is
replaced.
21
NEW ACCOUNTING PRONOUNCEMENTS
In June 1997, SFAS No. 131, "Disclosures about Segments of an
Enterprise and Related Information," was issued. SFAS No. 131 establishes
standards for the way that public companies report selected information about
operating segments in annual financial statements and requires that those
companies report selected information about segments in interim financial
reports issued to shareholders. It also establishes standards for related
disclosures about products and services, geographic areas, and major customers.
SFAS No. 131, which supersedes SFAS No. 14, "Financial Reporting for Segments of
a Business Enterprise", but retains the requirement to report information about
major customers, requires that a public company report financial and descriptive
information about its reportable operating segments. Operating segments are
components of an enterprise about which separate financial information is
available that is evaluated regularly by the chief operating decision maker in
deciding how to allocate resources and in assessing performance. Generally,
financial information is required to be reported on the basis that it is used
internally for evaluating segment performance and deciding how to allocate
resources to segments. SFAS No. 131 requires that a public company report a
measure of segment profit or loss, certain specific revenue and expense items,
and segment assets. However, SFAS No. 131 does not require the reporting of
information that is not prepared for internal use if reporting it would be
impracticable. SFAS No. 131 also requires that a public company report
descriptive information about the way that the operating segments were
determined, the products and services provided by the operating segments,
differences between the measurements used in reporting segment information and
those used in the enterprise's general-purpose financial statements, and changes
in the measurement of segment amounts from period to period. SFAS No. 131 is
effective for financial statements for periods beginning after December 15,
1997. The Company intends to first implement SFAS No. 131 in its Consolidated
Financial Statements as of and for the year ended December 31, 1998, although it
has not determined the effects, if any, that implementation will have.
In June 1998, SFAS No. 133, "Accounting for Derivative Instruments and
Hedging Activities" was issued. SFAS No. 133 defines derivatives and establishes
accounting and reporting standards requiring that every derivative instrument
(including certain derivative instruments embedded in other contracts) be
recorded in the balance sheet as either an asset or liability measured at its
fair value. SFAS No. 133 also requires that changes in the derivative's fair
value be recognized currently in earnings unless specific hedge accounting
criteria are met. Special accounting for qualifying hedges allows a derivative's
gains and losses to offset related results on the hedged item in the income
statement, and requires that a company must formally document, designate and
assess the effectiveness of transactions that receive hedge accounting. SFAS No.
133 effective for all fiscal quarters of fiscal years beginning after June 15,
1999, and cannot be applied retroactively. The Company intends to first
implement SFAS No. 133 in its Consolidated Financial Statements as of and for
the three months ended March 31, 2000, although it has not determined the
effects, if any, that implementation will have. However, SFAS No. 133 could
increase volatility in earnings and other comprehensive income.
22
FORWARD-LOOKING INFORMATION: CERTAIN CAUTIONARY STATEMENTS
Certain statements contained in this "Management's Discussion and
Analysis of Financial Condition and Results of Operations" and elsewhere in this
Form 10-Q are forward looking statements, including but not limited to,
statements regarding the Company's expectations or beliefs concerning the
Company's strategy and objectives, expected sales and other operating results,
the effect of changes in the Company's gross margin, the Company's liquidity,
anticipated capital spending, the availability of financing, equity and working
capital to meet the Company's future needs, economic conditions in the Company's
market areas, the potential for and effect of future acquisitions, the Company's
ability to resolve the Year 2000 issue and the related costs and the
tax-qualified status of the Company's 401(k) and 413(c) plans. The words "aim,"
"believe," "expect," "anticipate," "intend," "estimate," "will," "should,"
"could" and other expressions which indicate future events and trends identify
forward looking statements. Such forward looking statements involve known and
unknown risks and are also based upon assumptions of future events, which may
not prove to be accurate. Therefore, actual results may differ materially from
any future results expressed or implied in the forward looking statements. These
known and unknown risks and uncertainties, include, but are not limited to the
Company's dependence on regulatory approvals, its future cash flows, sales,
gross margins and operating costs, the effect of changing market and other
conditions in the staffing industry, the ability of the Company to continue to
grow at its historical levels, legal proceedings, including those related to the
actions of the Company's temporary or leased employees, the availability and
cost of credit, the Company's ability to raise capital in the public equity
markets, the Company's ability to successfully identify suitable acquisition
candidates and to complete those acquisitions on favorable terms, the ability to
successfully integrate past and future acquisitions into the Company's
operations, the recoverability of the recorded value of goodwill and other
intangible assets arising from past and future acquisitions, the general level
of economic activity and unemployment in the Company's markets, specifically
within the construction and light industrial trades, increased price
competition, changes in government regulations or interpretations thereof,
particularly those related to employment, the continued availability of
qualified temporary personnel, the financial condition of the Company's clients
and their demand for the Company's services (which in turn may be affected by
the effects of, and changes in, worldwide economic conditions, particularly in
Japan and the Asia region), collection of accounts receivable, the Company's
ability to retain large clients, the Company's ability to recruit, motivate and
retain key management personnel, the costs of complying with government
regulations (including occupational safety and health provisions, wage and hour
and minimum wage laws and workers' compensation and unemployment insurance laws)
and the ability of the Company to increase fees charged to its clients to offset
increased costs relating to these laws and regulations, inclement weather,
interruption, impairment or loss of data integrity or malfunction of information
processing systems, uncertainties regarding government regulation of PEOs,
including the possible adoption by the IRS of an unfavorable position as to the
tax-qualified status of employee benefit plans maintained by PEOs and other
risks detailed from time to time by the Company or in its press releases or in
its filings with the Securities and Exchange Commission.
In addition, the market price of the Company's stock may from time to
time be significantly volatile as a result of, among other things, the Company's
operating results, the operating results of other temporary staffing and PEO
companies, economic conditions and the performance of the stock market in
general.
Any forward-looking statement speaks only as of the date on which such
statement is made, and the Company undertakes no obligation to update any
forward-looking statement or statements to reflect events or circumstances after
the date on which such statement is made or to reflect the occurrence of
unanticipated events. New factors emerge from time to time, and it is not
possible for management to predict all of such factors. Further, management
cannot assess the impact of each such factor on the business or the extent to
which any factor, or combination of factors, may cause actual results to differ
materially from those contained in any forward-looking statements.
Subsequent written and oral forward looking statements attributable to
the Company or persons acting on its behalf are expressly qualified in their
entirety by cautionary statements in this paragraph and elsewhere in this Form
10-Q, and in other reports filed by the Company with the Securities and Exchange
Commission, including, but not limited to, (i) the Company's Registration
Statement on Form S-1 (File No. 333-33443) filed with the Securities and
Exchange Commission on August 12, 1997, as amended by Amendments No. 1 through 3
thereto, and declared effective on October 23, 1997 and (ii) the Company's Form
10-K/A filed with the Securities and Exchange Commission on April 2, 1998.
23
PART II - OTHER INFORMATION
ITEM 2 - CHANGES IN SECURITIES AND USE OF PROCEEDS
During the three months ended June 30, 1998, the Company issued the
following securities without registration under the Securities Act:
On April 15, 1998, the Company issued an aggregate of 5,716 shares of
its common stock to Mr. Robert A. Lefcort and the Robert A. Lefcort Trust, in
connection with the exercise of warrants entitling those parties to purchase
shares of the Company's common stock at $0.015 per share. The aggregate exercise
price of $87.94 was received by the Company in cash at the time of exercise. The
securities were issued pursuant to Section 4(2) of the Securities Act. No
underwriting commissions were paid in connection with the foregoing issuances of
stock.
On May 12, 1998, the Company issued 20,929 shares of its common stock
to Paul M. Burrell, in connection with the exercise of warrants entitling him to
purchase shares of the Company's common stock at $0.015 per share. The exercise
price of $321.99 was received by the Company in cash at the time of exercise.
The securities were issued pursuant to Section 4(2) of the Securities Act. No
underwriting commissions were paid in connection with the foregoing issuances of
stock.
On May 12, 1998, the Company issued an aggregate of 124,671 shares of
its common stock to the Lawrence H. Schubert Trust, the Nadya Schubert Trust,
Alan E. Schubert, Mindi Wagner, the Matthew Schubert Trust, the Jason D.
Schubert Trust and Louis A. Morelli., in connection with the exercise of
warrants entitling those parties to purchase shares of the Company's common
stock at $0.015 per share. The aggregate exercise price of $1,918.01 was
received by the Company in cash at the time of exercise. The securities were
issued pursuant to Section 4(2) of the Securities Act. No underwriting
commissions were paid in connection with the foregoing issuances of stock.
Immediately subsequent to issuance, these shares were deposited in a voting
trust, of which Paul M. Burrell, the Company's CEO and a director, and Richard
J. Williams, a director of the Company, are the trustees. The voting trust
expires on February 20, 2007 and the trustees have the sole and exclusive right
to vote the shares of common stock deposited in the voting trust. For a complete
discussion of this voting trust and the related shareholders' agreement, see
Amendment No. 3 to the Company's Registration Statement on Form S-1
(Registration Statement No. 333-33443) as filed with the Securities and Exchange
Commission on October 21, 1997.
ITEM 4 - SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
The annual meeting of the shareholders of the Company (the "Meeting")
was held on May 8, 1998. The Company solicited proxies for the Meeting and there
was no solicitation in opposition to management's nominees for directors.
However, Robert E. Tomlinson, one of management's nominees, withdrew his name
from consideration for re-election immediately prior to the Meeting. David S.
Hershberg, the other management nominee, was re-elected. At the Meeting,
shareholders voted:
(1) To elect director David S. Hershberg for a three-year term:
Votes For 5,898,577
Votes Against 118,232
Votes Abstained --
Votes Withheld 2,489,788
The names of the directors whose term of office continued after the
Meeting are Paul M. Burrell, Robert A. Lefcort, Richard J. Williams and Samuel
H. Schwartz. At a meeting of the board of directors immediately following the
Meeting, the board of directors elected Scott R. Francis to a three-year term on
the board of directors to fill the vacancy created by the withdrawal by Mr.
Tomlinson from consideration for re-election.
(2) To ratify the appointment of Deloitte & Touche LLP as the
Company's independent auditors for the fiscal year ending December
31, 1998:
Votes For 6,012,529
Votes Against 1,700
Votes Abstained 2,580
Votes Withheld 2,489,788
24
(3) To approve an amendment to the Company's Stock Option Plan, which
amendment provides for grants of non qualified options to
non-employee directors in accordance with a prescribed formula.
Votes For 5,476,629
Votes Against 535,900
Votes Abstained 4,280
Votes Withheld 2,489,788
At a meeting of the board of directors immediately following the
Meeting, the board of directors approved an amendment to the Stock Option Plan
approved by the shareholders that clarified the definition of owned shares
eligible for consideration in the above formula to include warrants.
ITEM 5 - OTHER INFORMATION
In April 1998, Scott R. Francis joined the Company as Chief Financial
Officer. Mr. Francis succeeded Robert E. Tomlinson, who remained with the
Company as Chief Accounting Officer.
In July 1998, Robert A. Lefcort, formerly the Company's Executive Vice
President, was appointed President of the Company's Synadyne division. Mr.
Lefcort replaced Benjamin J. Cueto, who resigned as President of Synadyne to
pursue other interests.
ITEM 6 - EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits:
EXHIBIT
NUMBER EXHIBIT DESCRIPTION
3.1 Amended and Restated Articles of Incorporation of the Company(2)
3.2 Amended and Restated Bylaws of the Company(3)
4.3 Shareholder Protection Rights Agreement(3)
4.6 Warrant Dated February 21, 1997 Issued to Triumph-Connecticut Limited
Partnership(1)
4.7 Warrant Dated February 21, 1997 Issued to Bachow Investment
Partners III, L.P.(1)
4.8 Warrant Dated February 21, 1997 Issued to State Street Bank and Trust
Company of Connecticut, N.A., as Escrow Agent(1)
10.17 Employment Agreement between Scott R. Francis and the Company dated as of
April 1, 1998*
10.18 Stock Option Plan, As Amended Effective May 8, 1998*
10.19 Third Amended and Restated Credit Agreement among OutSource
International, Inc., the banks from time to time parties hereto and
BankBoston, N.A., successor by merger to Bank of Boston, Connecticut,
as agent - Revolving Credit Facility dated as of July 27, 1998.
10.34 Receivables Purchase and Sale Agreement dated July 27, 1998 among
Outsource International, Inc., Outsource Franchising, Inc., Capital
Staffing Fund, Inc., Synadyne I, Inc., Synadyne II, Inc., Synadyne III,
Inc., Synadyne IV, Inc., Synadyne V, Inc., and Outsource International of
America, Inc., each as an originator, and Outsource Funding Corporation,
as the buyer, and Outsource International, Inc., as the servicer.
10.35 Receivables Purchase Agreement dated July 27, 1998 among Outsource
Funding Corporation, as the seller, and EagleFunding Capital Corporation,
as the purchaser, and BancBoston Securities, Inc., as the deal agent and
Outsource International, Inc., as the servicer
10.36 Intercreditor Agreement dated July 27, 1998 by and among BankBoston,
N.A., as lender agent; Outsource Funding Corporation, OutSource
International, Inc., OutSource Franchising, Inc., Capital Staffing Fund,
Inc., Synadyne I, Inc., Synadyne II, Inc., Synadyne III, Inc., Synadyne
IV, Inc., Synadyne V, Inc. and Outsource International of America, Inc.,
as originators; OutSource International, in its separate capacity as
servicer; EagleFunding Capital Corporation, as purchaser; and BancBoston
Securities Inc., individually and as purchaser agent.
10.51 Asset Purchase Agreement, dated May 14, 1998, by and among OutSource
International of America, Inc., Mid-West Temps, Inc., Teresa Usher and
Deborah Weiss. (4)
25
EXHIBIT
NUMBER EXHIBIT DESCRIPTION
10.52 Asset Purchase Agreement, dated May 15, 1998, by and among OutSource
International of America, Inc., Resource Dimensions, Inc., and Earl M.
Pick.(4)
27 Financial Data Schedule
- ------------------------
* Compensatory plan or arrangement.
(1) Incorporated by reference to the Exhibits to the Company's Registration
Statement on Form S-1 (Registration Statement No. 333-33443) as filed
with the Securities and Exchange Commission on August 12, 1997.
(2) Incorporated by reference to the Exhibits to Amendment No. 3 to the
Company's Registration Statement on Form S-1 (Registration Statement No.
333-33443) as filed with the Securities and Exchange Commission on
October 21, 1997.
(3) Incorporated by reference to the Exhibits to Amendment No. 1 to the
Company's Registration Statement on Form S-1 (Registration Statement No.
333-33443) as filed with the Securities and Exchange Commission on
September 23, 1997.
(4) Incorporated by reference to Exhibits 2.1 and 2.2 to the Company's Form
8-K as filed with the Securities and Exchange Commission on May 29,
1998.
- ------------------------
(b) Reports on Form 8 - K:
The following reports were filed on Form 8-K during the quarter ended
June 30, 1998:
A Form 8-K/A dated May 4, 1998 related to the Company's acquisition of
LM Investors, Inc. The related Form 8-K was filed on March 5, 1998.
A Form 8-K dated May 29, 1998 related to the Company's acquisition of
Mid-West Temps, Inc. and Resource Dimensions, Inc. The related Form 8-K/A was
filed on July 28, 1998.
26
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934,
the registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
OUTSOURCE INTERNATIONAL, INC.
Date: August 14, 1998 By: /s/Paul M. Burrell
----------------------------------------
Paul M. Burrell
President, Chief Executive Officer
and Chairman of the Board of Directors
Date: August 14, 1998 By: /s/Scott R. Francis
----------------------------------------
Scott R. Francis
Chief Financial Officer
(Principal Financial Officer)
Date: August 14, 1998 By: /s/Robert E. Tomlinson
----------------------------------------
Robert E. Tomlinson
Chief Accounting Officer
(Principal Accounting Officer)
27
EXHIBIT INDEX
Exhibit No. Description
- ---------- -----------
10.17 Employment Agreement between Scott R. Francis and the Company dated
as of April 1, 1998.
10.18 Stock Option Plan, As Amended Effective May 8, 1998.
10.19 Third Amended and Restated Credit Agreement among OutSource
International, Inc., the banks from time to time parties hereto and
BankBoston, N.A., successor by merger to Bank of Boston, Connecticut,
as agent - Revolving Credit Facility dated as of July 27, 1998.
10.34 Receivables Purchase and Sale Agreement dated July 27, 1998 among
Outsource International, Inc., Outsource Franchising, Inc., Capital
Staffing Fund, Inc., Synadyne I, Inc., Synadyne II, Inc., Synadyne
III, Inc., Synadyne IV, Inc., Synadyne V, Inc., and Outsource
International of America, Inc., each as an originator, and Outsource
Funding Corporation, as the buyer, and Outsource International, Inc.,
as the servicer.
10.35 Receivables Purchase Agreement dated July 27, 1998 among Outsource
Funding Corporation, as the seller, and EagleFunding Capital
Corporation, as the purchaser, and BancBoston Securities, Inc., as the
deal agent and Outsource International, Inc., as the servicer.
10.36 Intercreditor Agreement dated July 27, 1998 by and among BankBoston,
N.A., as lender agent; Outsource Funding Corporation, Outsource
International, Inc., OutSource Franchising, Inc., Capital Staffing
Fund, Inc., Synadyne I, Inc., Synadyne II, Inc., Synadyne III, Inc.,
Synadyne IV, Inc., Synadyne V, Inc. and Outsource International of
America, Inc., as originators; OutSource International, in its
separate capacity as servicer; EagleFunding Capital Corporation, as
purchaser; and BancBoston Securities Inc., individually and as
purchaser agent.
27 Financial Data Schedule