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 September 30, 1999
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
------- ----------
(State or Other Jurisdiction of (I.R.S. Employer
Incorporation or Organization) IdentificationNo.)
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 November 8, 1999
----- -------------------------------
Common Stock, par value $.001 per share 8,657,913
OUTSOURCE INTERNATIONAL, INC.
TABLE OF CONTENTS
PART I - FINANCIAL INFORMATION
Page
----
Item 1 - Financial Statements
Consolidated Balance Sheets as of September 30, 1999 and December 31, 1998.................. 2
Consolidated Statements of Income for the three months
ended September 30, 1999 and 1998........................................................... 3
Consolidated Statements of Income for the nine months
ended September 30, 1999 and 1998........................................................... 4
Consolidated Statements of Cash Flows for the nine months
ended September 30, 1999 and 1998........................................................... 5
Notes to Consolidated Financial Statements.................................................. 6
Item 2 - Management's Discussion and Analysis of Financial
Condition and Results of Operations......................................................... 22
Item 3 - Quantitative and Qualitative Disclosures about Market Risk........................... 39
PART II - OTHER INFORMATION
Item 1 - Legal Proceedings.................................................................... 40
Item 3 - Defaults Upon Senior Securities...................................................... 40
Item 5 - Other Information.................................................................... 40
Item 6 - Exhibits and Reports on Form 8-K..................................................... 40
Signatures.................................................................................... 43
TANDEM (R), SYNADYNE (R) and OFFICE OURS (R) are registered trademarks of Outsource
International, Inc. and its subsidiaries.
1
PART I: FINANCIAL INFORMATION
Item 1: Financial Statements
----------------------------
OUTSOURCE INTERNATIONAL, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
SEPTEMBER 30, 1999 AND DECEMBER 31, 1998
(AMOUNTS IN THOUSANDS)
ASSETS SEPTEMBER 30, 1999 DECEMBER 31, 1998
------------------ -----------------
(UNAUDITED)
Current Assets:
Cash................................................................. $ 1,226 $ 5,501
Trade accounts receivable, net of allowance for doubtful accounts of
$5,488 and $1,924................................................ 14,004 12,946
Funding advances to franchises....................................... 147 441
Assets held for disposition.......................................... 8,392 --
Deferred income taxes and other current assets....................... 13,465 7,795
---------- ----------
Total current assets............................................. 37,234 26,683
Property and equipment, net.......................................... 9,968 17,628
Goodwill and other intangible assets, net............................ 54,175 64,262
Other assets......................................................... 2,782 3,429
---------- ----------
Total assets..................................................... $ 104,159 $ 112,002
========== ===========
LIABILITIES AND SHAREHOLDERS' EQUITY
Current Liabilities:
Accounts Payable..................................................... $ 5,599 $ 5,217
Accrued expenses:
Payroll.......................................................... 11,024 4,322
Payroll taxes.................................................... 4,751 4,067
Workers' compensation and insurance.............................. 7,461 10,659
Other............................................................ 3,468 2,482
Reserve for restructuring charges.................................... 1,227 --
Other current liabilities............................................ 1,059 1,312
Current maturities of long-term debt to related parties.............. 1,195 541
Current maturities of other long-term debt........................... 13,286 6,782
Revolving credit facility............................................ 17,814 --
---------- ----------
Total current liabilities........................................ 66,884 35,382
Non-Current Liabilities:
Revolving credit facility............................................ -- 20,980
Long-term debt to related parties, less current maturities........... -- 745
Other long-term debt, less current maturities........................ 2,587 9,257
Other non-current liabilities........................................ 250 1,050
---------- ----------
Total liabilities................................................ 69,721 67,414
---------- ----------
Commitments and Contingencies (Notes 4 and 6)
Shareholders' Equity:
Preferred stock, $.001 par value; 10,000,000 shares authorized, no shares
issued or outstanding............................................ -- --
Common stock, $.001 par value; 100,000,000 shares authorized; 8,657,913
issued and outstanding........................................... 9 9
Additional paid-in capital........................................... 53,546 53,546
Accumulated deficit.................................................. (19,117) (8,967)
---------- ---------
Total shareholders' equity....................................... 34,438 44,588
---------- ----------
Total liabilities and shareholders' equity....................... $ 104,159 $ 112,002
========== ==========
See accompanying notes to consolidated financial statements.
2
OUTSOURCE INTERNATIONAL, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
FOR THE THREE MONTHS ENDED SEPTEMBER 30, 1999 AND 1998
(UNAUDITED)
(AMOUNTS IN THOUSANDS, EXCEPT PER SHARE DATA)
THREE MONTHS ENDED SEPTEMBER 30,
--------------------------------
1999 1998
Net revenues..................................................... $ 159,124 $ 153,416
Cost of revenues................................................. 138,069 130,649
---------- ----------
Gross profit................................................ 21,055 22,767
---------- ----------
Selling, general and administrative expenses:
Amortization of intangible assets........................... 1,013 978
Provision for doubtful accounts............................. 3,238 352
Other selling, general and administrative................... 21,257 17,824
---------- ----------
Total selling, general and administrative expenses.......... 25,508 19,154
---------- ----------
Restructuring and impairment charges:
Restructuring............................................... 5,104 --
Reserve for impairment of goodwill and other long-lived assets 2,450 --
---------- ----------
Total restructuring and impairment charges.................. 7,554 --
---------- ----------
Operating (loss) income..................................... (12,007) 3,613
---------- ----------
Other expense (income):
Interest expense (net)...................................... 1,853 1,591
Disposition of assets and other income (net)................ (541) 55
---------- ----------
Total other expense (income)................................ 1,312 1,646
---------- ----------
(Loss) income before (benefit) provision for income taxes (13,319) 1,967
(Benefit) provision for income taxes............................. (4,999) 455
---------- ----------
Net (loss) income................................................ $ (8,320) $ 1,512
========== ==========
Weighted average common shares outstanding:
Basic....................................................... 8,657,913 8,657,913
========== ==========
Diluted..................................................... 8,657,913 9,864,592
========== ==========
(Loss) earnings per share:
Basic....................................................... $ (0.96) $ 0.17
========= ==========
Diluted..................................................... $ (0.96) $ 0.15
========= ==========
See accompanying notes to consolidated financial statements.
3
OUTSOURCE INTERNATIONAL, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1999 AND 1998
(UNAUDITED)
(AMOUNTS IN THOUSANDS, EXCEPT PER SHARE DATA)
NINE MONTHS ENDED SEPTEMBER 30,
-------------------------------
1999 1998
Net revenues..................................................... $ 436,692 $ 409,198
Cost of revenues................................................. 375,592 347,117
---------- ----------
Gross profit.................................................. 61,100 62,081
---------- ----------
Selling, general and administrative expenses:
Amortization of intangible assets........................... 2,871 2,700
Provision for doubtful accounts............................. 4,329 902
Other selling, general and administrative................... 58,348 50,038
---------- ----------
Total selling, general and administrative expenses.......... 65,548 53,640
---------- ----------
Restructuring and impairment charges:
Restructuring............................................... 5,104 --
Reserve for impairment of goodwill and other long-lived assets 2,450 --
---------- ----------
Total restructuring and impairment charges.................. 7,554 --
---------- ----------
Operating (loss) income..................................... (12,002) 8,441
---------- ----------
Other expense (income):
Interest expense (net)...................................... 5,136 4,108
Disposition of assets and other income (net)................ (605) 17
---------- ----------
Total other expense (income)................................ 4,531 4,125
---------- ----------
(Loss) income before (benefit) provision for income taxes (16,533) 4,316
(Benefit) provision for income taxes............................. (6,384) 1,036
---------- ----------
Net (loss) income................................................ $ (10,149) $ 3,280
========== ==========
Weighted average common shares outstanding:
Basic....................................................... 8,657,913 8,584,836
========== ==========
Diluted..................................................... 8,657,913 9,960,013
========== ==========
(Loss) earnings per share:
Basic....................................................... $ (1.17) $ 0.38
========= ==========
Diluted..................................................... $ (1.17) $ 0.33
========= ==========
See accompanying notes to consolidated financial statements.
4
OUTSOURCE INTERNATIONAL, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1999 AND 1998
(UNAUDITED)
(AMOUNTS IN THOUSANDS)
NINE MONTHS ENDED SEPTEMBER 30,
-------------------------------
1999 1998
CASH FLOWS FROM OPERATING ACTIVITIES:
Net (loss) income................................................................ $ (10,149) $ 3,280
Adjustments to reconcile net (loss) income to net cash provided by
operating activities:
Depreciation and amortization............................................... 5,548 4,923
Reserve for impairment of goodwill and other long-lived assets ............. 2,450 --
Write-down of assets held for disposition .................................. 2,547 --
Deferred income taxes....................................................... (5,018) 129
Notes received from franchises.............................................. (107) --
(Gain) loss on asset sales as part of Restructuring and related matters..... (472) --
---------- --------
(5,201) 8,332
Changes in assets and liabilities (excluding effects of
acquisitions and dispositions):
(Increase) decrease in:
Trade accounts receivable............................................... (1,375) 33,328
Prepaid expenses and other current assets............................... (1,098) (831)
Other assets............................................................ 343 14
Increase (decrease) in:
Accounts payable........................................................ 745 (476)
Accrued expenses:
Payroll............................................................... 6,702 3,171
Payroll taxes......................................................... 684 979
Workers' compensation and insurance................................... (3,198) 1,157
Other................................................................. 2,358 889
Other current liabilities............................................... 53 432
--------- --------
Net cash provided by operating activities................................... 13 46,995
--------- --------
CASH FLOWS FROM INVESTING ACTIVITIES:
Proceeds from asset sales as part of Restructuring and related matters .......... 1,965 --
Proceeds from property and equipment sales....................................... 1,600 --
Funding repayments from franchises, net.......................................... 295 1,086
Property and equipment expenditures.............................................. (1,368) (3,846)
Expenditures for acquisitions.................................................... (40) (27,842)
--------- -------
Net cash provided by (used in) investing activities......................... 2,452 (30,602)
--------- -------
CASH FLOWS FROM FINANCING ACTIVITIES:
(Decrease) increase in excess of outstanding checks over bank balance,
included in accounts payable................................................... (363) 3,353
Repayments under revolving credit facility....................................... (3,165) (13,965)
Proceeds from interest collar termination........................................ 250 --
Related party debt repayments.................................................... (131) (355)
Repayment of other long-term debt................................................ (3,331) (3,141)
Payments in connection with the Reorganization................................... -- (431)
Exercise of warrants............................................................. -- 2
-------- --------
Net cash used in financing activities....................................... (6,740) (14,537)
--------- --------
Net (decrease) increase in cash.................................................. (4,275) 1,856
Cash, beginning of period........................................................ 5,501 1,685
-------- --------
Cash, end of period.............................................................. $ 1,226 $ 3,541
========= ========
SUPPLEMENTAL CASH FLOW INFORMATION:
Interest paid.................................................................... $ 4,417 $ 3,724
========= ========
See accompanying 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 September 30, 1999 and for the three
and nine months ended September 30, 1999 and 1998 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, 1998,
included in the Company's Form 10-K filed with the Securities and
Exchange Commission on March 31, 1999.
In June 1998, Statement of Financial Accounting Standards ("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, as modified by SFAS No. 137, is effective for all fiscal
quarters of fiscal years beginning after June 15, 2000, and cannot be
applied retroactively. The Company intends to implement SFAS No. 133 in
its consolidated financial statements as of and for the three months
ended March 31, 2001, 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. RESTRUCTURING, SALE OF OPERATIONS AND ASSETS HELD FOR
DISPOSITION
On August 6, 1999, the Company announced the following actions to
improve its short-term liquidity, concentrate its operations within one
core segment (Tandem, its industrial staffing division) and improve its
operating performance within that segment:
(i) the sale of Office Ours, the Company's clerical staffing division,
effective August 30, 1999. The Company received proceeds at closing of
$1.9 million, not including $0.1 million to be held in escrow until
December 31, 1999 and subject to verification of sold accounts
receivable, and another $0.1 million to be held in escrow until August
31, 2000 and subject to compliance with warranties and representations.
Approximately $0.5 million of the proceeds was used to satisfy
obligations under the Securitization Facility and the remainder was
applied to the Revolving Credit Facility. A gain of $0.5 million has
been included as a component of other income in the Company's
consolidated statement of income for the three and nine months ended
September 30, 1999. Revenues of office ours, prior to the sale, were
$1.3 million and $5.2 million for the three and nine months ended
September 30, 1999, respectively. The income (loss) before taxes for
these operations, on a basis consistent with the segment information
presented in Note 10, was a $0.1 million loss and a $0.2 million loss
for the three and nine months ended September 30, 1999, respectively.
(ii) the engagement of an investment banking firm to assist in the
evaluation of the possible sale of, or other strategic options for,
Synadyne, the Company's professional employer organization ("PEO")
division. The Company has been and is currently in discussions with
prospective purchasers and is seeking to sell these operations as soon
as possible; however, the sale is not expected prior to December 31,
1999.
6
OUTSOURCE INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
NOTE 2. RESTRUCTURING, SALE OF OPERATIONS AND ASSETS HELD FOR
DISPOSITION (CONTINUED)
(iii) a reduction of the Company's industrial staffing and support
operations (the "Restructuring"), consisting primarily of: the sale,
closure, consolidation or franchising, during the third and fourth
quarters of 1999, of 20 of the 117 Tandem branch offices existing as of
June 30, 1999; an immediate reduction of the Tandem and corporate
support center employee workforce by 75 and 29 employees, respectively
(approximately 11 percent of the Company's workforce); and an
additional 22 employee reduction of the corporate support center
workforce by early 2000. As a result of the corporate support center
workforce reductions and the anticipated disposition of Synadyne, the
corporate support center building will be sold. The 20 branch offices
to be eliminated are (a) locations not now nor expected to be
adequately profitable in the near future or (b) locations which are
inconsistent with the Company's operating strategy of clustering
offices within specific geographic regions.
The 20 Tandem offices to be sold or closed include some of the
businesses acquired by the Company during 1996, 1997 and 1998; however,
there was no plan to exit these businesses at the time of their
acquisition by the Company and, as a result, no restructuring
liabilities were included in the capitalized acquisition cost.
In connection with the Restructuring, the Company has included a charge
of $5.1 million in its results of operations for the three and nine
months ended September 30, 1999. This restructuring charge and its
utilization are as follows, with all amounts presented in thousands:
ORIGINAL UTILIZED THROUGH BALANCE AT
CHARGE SEPTEMBER 30, 1999 SEPTEMBER 30, 1999
Employee severance and other termination benefits $ 1,375 $ 474 $ 901
Professional fees................................ 717 587 130
Lease termination and write-down of leasehold
improvements at closed offices................. 309 113 196
Other restructuring costs........................ 156 156 --
-------- -------- --------
Reserve for restructuring charges................ 2,557 1,330 1,227
Write-down of assets identified for disposition to net
realizable value............................... 2,547 385 2,162
-------- -------- --------
Total restructuring charge activity.............. $ 5,104 $ 1,715 $ 3,389
======== ======== ========
The $2.5 million write-down of assets identified for disposition
relates to 12 Tandem offices, as follows:
(i) a $0.4 million loss related to two staffing offices in Las
Vegas purchased by the Company in 1998 - one office closed by
the Company and one office sold on September 6, 1999 to Carcor
Group, Inc., which paid a nominal amount and entered into a
standard franchise agreement with the Company for the
territory,
(ii) a $1.4 million loss related to four staffing offices in
Raleigh, North Carolina and Greenville, South Carolina,
purchased by the Company in 1998 - one office closed by the
Company and three offices sold on October 18, 1999 to Eric
Feinstein and E.J. Services, Inc. (the former franchisee and
seller) for $1.8 million. The sales price was comprised of
$0.2 million in cash, a promissory
7
OUTSOURCE INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
NOTE 2. RESTRUCTURING, SALE OF OPERATIONS AND ASSETS HELD FOR
DISPOSITION (CONTINUED)
note of $0.3 million, and cancellation of the Company's
remaining indebtedness from the original acquisition of $1.3
million. As part of this transaction, the Company cancelled
covenants not to compete previously given to it by the buyers
and certain affiliates and agreed not to compete for 39 months
(27 months in the case of franchising) in the counties where
the assets are located. This transaction also included an
option, which was exercised on November 8, 1999, to purchase,
for nominal consideration, one staffing office in Virginia,
which had been purchased by the Company from a related party
in 1996, and
(iii) a $0.7 million write-down related to five staffing offices in
Washington, Minnesota (purchased by the Company in 1997) and
Tennessee (purchased by the Company in 1998) and based on
management's estimate of the ultimate sales prices that will
be negotiated for these assets.
The remaining liability of $0.9 million for severance and other
termination benefits consists of (i) $0.3 million for employees
terminated in the third quarter of 1999, to be paid in the fourth
quarter of 1999 and the year 2000 and (ii) $0.6 million for employees
to be terminated in the first quarter of 2000. In connection with the
Restructuring, the Company has entered into additional agreements
obligating it to pay retention bonuses of $0.7 million to approximately
100 individuals if they remain employed with the Company through
December 31, 1999. The Company will record its ultimate liability under
these agreements as a restructuring charge in the fourth quarter of
1999.
Professional fees of $0.7 million included in the restructuring charge
are primarily amounts paid to Crossroads Capital Partners, LLC
("Crossroads") for their services related to the Restructuring during
the third quarter of 1999 - see Note 6. The Company also expects to
record restructuring charges in the fourth quarter of 1999 for services
relating to Restructuring activities to be rendered by Crossroads
during that period.
As of September 30, 1999, the Company had closed, sold or consolidated
into other existing Company-owned locations 10 of the 20 staffing
offices identified as part of the Restructuring, including $0.3 million
in the restructuring charge for the costs of terminating the related
leases as well as the carrying value of leasehold improvements and
other assets not usable in other Company operations.
As of September 30, 1999, 10 Tandem offices remained to be sold as part
of the Restructuring, and the Company has classified the related
tangible and intangible assets (excluding cash, accounts receivable and
deferred income taxes), along with the assets of the Synadyne division
and the corporate support center building, as assets held for
disposition. The Company discontinued the related depreciation and
amortization for these assets as of August 6, 1999, which reduced
operating expenses by approximately $89,000 per month. The estimated
net realizable value of these assets held for disposition was based, in
some cases, on management's judgment; accordingly, actual results could
vary significantly from such estimates.
8
OUTSOURCE INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
NOTE 2. RESTRUCTURING, SALE OF OPERATIONS AND ASSETS HELD FOR
DISPOSITION (CONTINUED)
The Company's assets held for disposition as of September 30, 1999 are
stated at the lower of original cost (net of accumulated depreciation
or amortization) or fair value (net of selling and disposition costs)
and presented in thousands, as follows:
ORIGINAL COST, NET
------------------------------------------------- LOWER OF
PROPERTY GOODWILL AND OTHER COST OR
AND EQUIPMENT INTANGIBLE ASSETS TOTAL FAIR VALUE
Tandem branch offices.................. $ 158 $ 3,953 $ 4,111 $ 1,949
Corporate support center building...... 5,104 -- 5,104 5,104
Synadyne division...................... 1,182 157 1,339 1,339
--------- ---------- --------- ---------
$ 6,444 $ 4,110 $ 10,554 $ 8,392
========= ========== ========= =========
As described above, the Company has sold Tandem branch offices with a
carrying value of $1.8 million during the fourth quarter of 1999 and it
expects to sell the remainder of the assets held for disposition before
March 31, 2000. The Company has hired a professional real estate firm
to assist with the sale of the corporate support center building.
The Tandem operations held for sale as of September 30, 1999, as well
as those sold as part of the Restructuring prior to that date, recorded
revenues of $3.5 million and $9.8 million for the three and nine months
ended September 30, 1999, respectively. The income (loss) before taxes
for these operations, on a basis consistent with the segment
information presented in Note 10, was $21,000 income and a $357,000
loss, for the three and nine months ended September 30, 1999,
respectively. These results included amortization of goodwill and
other intangible assets of $69,000 and $220,000, respectively. See Note
10 for Synadyne segment information.
NOTE 3. ACQUISITIONS
The Company has made no acquisitions during the nine months ended
September 30, 1999.
The following pro forma results of operations for the three months and
nine months ended September 30, 1998 have been prepared assuming the
acquisitions completed by the Company during 1998 (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, as
well as the related income tax effects.
The pro forma operating results include 1998 acquisitions which have
been disposed of or identified as subject to disposition as part of the
Restructuring (see Note 2). These 1998 acquisitions, as well as the
Wisconsin operations discussed below, recorded historical revenues for
the three and nine months ended September 30, 1999 of $3.6 million and
$10.5 million, respectively, and the pro forma results include revenues
for these operations for the three and nine months ended September 30,
1998 of $4.0 million and $12.1 million, respectively. The Company sold
the operating assets of its 1998 Tandem staffing office acquisition in
Wisconsin to Mr. Mark S. Gigot, an affiliate of the former owner, on
October 25, 1999 for $2.4 million, comprised of $0.4 million in cash, a
promissory note of $1.1 million and cancellation of the Company's
remaining indebtedness to Mr. Gigot of $0.9 million arising from the
original acquisition. As part of this transaction, the Company
cancelled covenants not to compete previously given to it by the buyers
and certain affiliates and agreed not to compete for 60 months in
certain Wisconsin counties and Mr. Gigot agreed not to compete in
certain
9
OUTSOURCE INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
NOTE 3. ACQUISITIONS (CONTINUED)
other Wisconsin counties for 60 months and granted the Company a seven
year first right-of-refusal on any subsequent sale by Mr. Gigot of the
acquired business.
The pro forma operating results are not necessarily indicative of what
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
acquisitions 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. The following
amounts are in thousands, except per share data:
THREE MONTHS ENDED SEPTEMBER 30, NINE MONTHS ENDED SEPTEMBER 30,
1999 1998 1999 1998
---- ---- ---- ----
(HISTORICAL) (PRO FORMA) (HISTORICAL) (PRO FORMA)
Net revenues........................... $ 159,124 $ 154,300 $ 436,692 $ 428,741
Operating (loss) income................ (12,007) 3,655 (12,002) 9,543
Net (loss) income...................... (8,320) 1,541 (10,149) 3,562
Weighted average common shares outstanding:
Basic.................................. 8,657,913 8,657,913 8,657,913 8,591,400
========= ========= ========= =========
Diluted................................ 8,657,913 9,864,592 8,657,913 9,966,555
========= ========= ========= =========
Earnings (loss) per share:
Basic.................................. $ (0.96) $ 0.18 $ (1.17) $ 0.41
========= ========= ========== =========
Diluted................................ $ (0.96) $ 0.16 $ (1.17) $ 0.36
========== ========= ========== =========
Earnings (loss) per share included in the above 1998 information has
been prepared on the same basis as discussed in Note 9, except for an
increase by 6,564 basic and 6,542 diluted shares, for the nine months
ended September 30, 1998. Such increase in shares reflects adjustments
for the timing of the issuance of common stock and options in
connection with the acquisitions.
In accordance with SFAS No. 121, "Accounting for the Impairment of
Long-Lived Assets and for Long-Lived Assets to be Disposed of",
management assesses on an ongoing basis if there has been an impairment
in the carrying value of its long-lived assets, and during the third
quarter of 1999, determined that since the undiscounted future cash
flows over the remaining amortization period of certain intangible
assets indicated that the value assigned to the intangible asset might
not be recoverable, the carrying value of the respective intangible
asset should be reduced. The operating results of these acquired
offices had declined over time, primarily due to the attrition of
customers existing as of the respective acquisition dates. The amount
of the impairment ($2.5 million included in operating expenses for the
three and nine months ended September 30, 1999) was primarily
determined by comparing anticipated discounted future cash flows from
the acquired businesses with the carrying value of the related assets.
In performing this analysis, management considered such factors as
current results, trends and future prospects, in addition to other
relevant factors.
10
OUTSOURCE INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
NOTE 3. ACQUISITIONS (CONTINUED)
The original carrying value of the goodwill and other intangible assets
exceeded the discounted projected cash flow by approximately $2.1
million for four 1997 and 1998 Tandem acquisitions located in
Massachusetts, Ohio and California. In addition to recording the
impairment resulting from this analysis as of September 30, 1999, the
Company also recorded at that date an impairment of $0.4 million based
on the October 1999 sale of its 1998 Tandem acquisition in Wisconsin,
as discussed above.
Goodwill and other intangible assets consist of the following amounts,
which are presented in thousands and, with respect to the September 30,
1999 balances, are after the effect of (i) the impairment reduction
discussed above, (ii) the reclassification of assets identified for
disposition, including the sale of a former Tandem office in Las Vegas
(see Note 2) and (iii) the sale of the Office Ours division (see Note
2):
AS OF AS OF
SEPTEMBER 30, 1999 DECEMBER 31, 1998
Goodwill.................................................. $ 30,721 $ 32,806
Territory rights.......................................... 20,475 24,743
Customer lists............................................ 8,755 10,105
Covenants not to compete.................................. 1,953 2,191
Employee lists............................................ 335 417
-------- --------
Goodwill and other intangible assets...................... 62,239 70,262
Less: Accumulated amortization............................ 8,064 6,000
-------- --------
Goodwill and other intangible assets, net................. $ 54,175 $ 64,262
======== ========
NOTE 4. INCOME TAXES
The Company's effective tax rate differed from the statutory federal
rate of 35% as follows (amounts presented in thousands, except for
percentages):
THREE MONTHS ENDED SEPTEMBER 30, NINE MONTHS ENDED SEPTEMBER 30,
1999 1998 1999 1998
---- ---- ---- ----
AMOUNT RATE AMOUNT RATE AMOUNT RATE AMOUNT RATE
Statutory rate applied to income (loss)
before income taxes............ $(4,662) (35.0)% $688 35.0% $(5,787) (35.0)% $1,511 35.0%
Increase (decrease) in income taxes
resulting from:
State income taxes, net of federal benefit (564) (4.2) 83 4.3 (674) (4.1) 210 4.9
Employment tax credits............ (106) (0.8) (302) (15.4) (396) (2.4) (753) (17.4)
Other............................. 333 2.5 (14) (0.8) 473 2.9 68 1.5
----- ----- ---- ----- ------- ----- ------ ----
Total............................. $(4,999) (37.5)% $455 23.1% $(6,384) (38.6)% $1,036 24.0%
======= ===== ==== ==== ======= ===== ====== ====
Deferred income taxes and other current assets at September 30, 1999
includes (i) $4.6 million of net operating loss and employment tax
credit carrybacks and carryforwards, which are applicable to the
Company's future taxable income, but subject to certain limitations and
(ii) $7.5 million of deferred tax benefits subject to realization based
on future events, primarily the sale of reserved receivables discussed
in Note 11 and payments of accrued workers' compensation and other
liabilities. The $5.0 million adjustment to net income (loss) for
deferred income taxes in arriving at cash provided by operating
activities in the Company's statement of cash flows for the nine months
ended September 30, 1999 includes the excess of the above benefits
recognized in net income during that period over the amount that could
be utilized based on taxable income through that date.
11
OUTSOURCE INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
NOTE 4. INCOME TAXES (CONTINUED)
Management has determined, based on the Company's history of prior
taxable earnings and its expectations for the future, including the
intended sales of assets discussed in Note 2, that taxable income will
more likely than not be sufficient to fully realize deferred tax assets
and accordingly, has not reduced tax assets by a valuation allowance.
The employment tax credit carryforward of $2.6 million as of September
30, 1999 will expire during the years 2012 through 2019. The employment
tax credits recorded by the Company from February 21, 1997 through
September 30, 1999 include Federal Empowerment Zone ("FEZ") credits
which represent a net tax benefit of approximately $0.6 million.
Although the Company believes that these FEZ credits have been
reasonably determined, the income tax law addressing how FEZ credits
are determined for staffing companies is evolving. As a result, the
Company's position with regards to the calculation of the FEZ credits
has been challenged by the Internal Revenue Service ("IRS"), as
discussed below.
During April 1999, the Company received a report from an IRS agent
proposing adjustments to the previously reported taxable income and tax
credits for certain of the Company's subsidiaries for the years ended
December 31, 1994, 1995 and 1996. The Company is currently disputing
these proposed adjustments and as a result, the IRS agent's supervisor
has met with the Company's management to discuss these adjustments and
has agreed to hold more meetings with the Company before the IRS makes
a final determination and assessment, if any, with respect to these
matters. Since the subsidiaries were "S" corporations for the periods
under examination, the proposed adjustments, if ultimately proven to be
appropriate, would not result in a materially unfavorable effect on the
Company's results of operations although shareholder distributions of
up to approximately $5.0 million in cash could result as discussed in
Note 6.
NOTE 5. DEBT
As of September 30, 1999, the Company's primary sources of funds for
working capital and other needs were a $29.9 million credit line (which
included letters of credit of $8.4 million) with a syndicate of lenders
led by BankBoston, N.A. (the "Revolving Credit Facility") and a $50.0
million accounts receivable securitization facility with a BankBoston
affiliate (the "Securitization Facility"). As of October 5, 1999, the
Company and its syndicate of lenders finalized various agreements
that (a) replaced the previously existing securitization facility with
a $50.0 million credit facility based on and secured by the Company's
accounts receivable, expiring December 31, 1999, (the "Receivable
Facility") and (b) amended the previously existing $29.9 million
revolving credit facility to (i) reduce the maximum availability to
$28.4 million, including existing letters of credit of $6.4 million,
(ii) modify the expiration date from July 27, 2003 to December 31,
1999, (iii) eliminate certain financial covenants and (iv) add events
of default, including a provision enabling the lenders syndicate to
increase the stated interest rate and/or accelerate the maturity date
of the facility if, in their sole discretion, the banks are not
satisfied with Company's business operations or prospects. The new
agreements also contain terms that increase the weighted average
interest rate payable on the outstanding balances during the period,
exclusive of related fees and expenses and not including a higher
default rate, from approximately 7.1% per annum to approximately 10.8%
per annum.
The Receivable Facility bears interest at BankBoston's base (prime)
rate plus 2.0% per annum (currently 10.25%), while the Revolving Credit
Facility bears interest at base plus 2.5% per annum in October 1999,
base plus 4.0% per annum in November 1999 and base plus 5.0% per annum
thereafter. In addition, the Company paid an initial fee related to the
Receivable Facility that is approximately equal to another 1.0% per
annum for the three-month term of that loan plus legal fees and other
expenses related to both facilities totaling approximately $0.3
million, most of which was expensed in the third quarter of 1999.
12
OUTSOURCE INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
NOTE 5. DEBT (CONTINUED)
Other noncurrent assets as of September 30, 1999 includes $1.4 million
of unamortized deferred costs, incurred in connection with the
establishment of the Revolving Credit Facility and the Securitization
Facility, which will be written off and classified as interest expense
in the fourth quarter of 1999, based on when the Revolving Credit
Facility was substantially modified and the Securitization Facility was
terminated.
The previously existing Securitization Facility was a financing
arrangement under which the Company could sell up to a $50.0 million
secured interest in its eligible accounts receivable to EagleFunding
Capital Corporation ("Eagle"), which used the receivables to secure A-1
rated commercial paper. The Company's cost for this arrangement was
classified as interest expense and was based on the interest paid by
Eagle on the balance of the outstanding commercial paper, which in turn
was determined by prevailing interest rates in the commercial paper
market and was approximately 5.45% as of September 30, 1999. As of
September 30, 1999, a $46.9 million interest in the Company's
uncollected accounts receivable had been sold under this agreement,
which amount is excluded from the accounts receivable balance presented
in the Company's consolidated financial statements.
Outstanding amounts under the Revolving Credit 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 Credit Facility incurred interest
primarily at the Eurodollar rate prior to June 30, 1999 and at
BankBoston's base rate plus 0.75% thereafter. As of September 30, 1999,
the Company had outstanding borrowings under the Revolving Credit
Facility of $17.8 million, bearing interest at an annualized rate of
9.0%.
As of September 30, 1999, the Company had bank standby letters of
credit outstanding in the aggregate amount of $6.4 million (which are
issued as part of the Revolving Credit Facility, although reduction of
letters of credit does not currently result in additional borrowing
capacity) to secure the pre-1999 portion ($4.8 million) of workers'
compensation obligations recorded as a current liability on the
Company's balance sheet. The Company expects that in November 1999 the
outstanding letters of credit will be reduced by approximately $2.0
million, to more closely correlate with the accrued liability supported
by the letters of credit.
In order to remain in compliance with certain covenants in the
Revolving Credit Facility, and to reduce the cash impact of scheduled
payments under its subordinated acquisition debt, during 1999, the
Company had negotiated extensions of the payment dates and modified the
interest rates and other terms of certain of its acquisition notes
payable subordinated to the Revolving Credit Facility. As of August 12,
1999, the Company had not made all of the scheduled payments due and,
as a result, at that time became in default of this debt having a total
principal outstanding of $9.2 million (including related party amounts
as discussed in Note 7) as of September 30, 1999, but subsequently
reduced to $6.9 million in connection with the Company's sale of
certain operations as part of the Restructuring and related actions.
See Notes 2 and 3. Due to the subordinated status and other terms of
the debt, the remaining payees are unable to take collection actions
against the Company for at least six months. Although acceleration of
this debt requires prior written notice to the Company by the various
payees, which has been received from five of the fourteen remaining
payees as of November 8, 1999, this entire debt is classified as
current in the Company's consolidated financial statements as of
September 30, 1999, since the Company expects to refinance or
substantially restructure this debt within one year.
13
OUTSOURCE INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
NOTE 5. DEBT (CONTINUED)
During April 1999, the Company received $1.6 million from a financial
institution in connection with a sale/leaseback transaction, which
amount exceeded, at that time of the transaction, the net book value of
property and equipment previously purchased by the Company. The
unrealized gain is being deferred and amortized over the life of the
assets. The capital lease obligation is repayable over three years at
an imputed interest rate of approximately 10% per annum.
Effective June 30, 1999, the Company terminated an interest rate collar
agreement with BankBoston, N.A., which resulted in proceeds to the
Company of $250,000. Since the underlying debt and receivable
securitization facility previously being hedged by this agreement were
still in place at the time of the collar termination, the proceeds were
recorded as deferred income, to be amortized against interest expense
over the remaining life of those underlying financing arrangements. As
the amortization was to be based on what benefits the Company would
receive if the hedge still existed, no amortization was recorded in the
third quarter of 1999. Since the underlying financing arrangements were
terminated (including a substantial modification treated as a
termination) in October 1999, the deferred income of $250,000 reflected
on the Company's September 30, 1999 balance sheet will be recognized as
a reduction of interest expense in the fourth quarter of 1999.
NOTE 6. COMMITMENTS AND CONTINGENCIES
AVAILABILITY OF WORKING CAPITAL FINANCING: As discussed in Note 5, the
Company's current bank financing expires as of December 31, 1999 and
the Company is also in default in repayment of certain acquisition debt
subordinated to that bank financing. The Company is currently
negotiating with the lenders syndicate and potential new lenders to
provide financing for some period after December 31, 1999, under a
mutually acceptable structure and terms. The Company could experience
liquidity problems depending on the ability and willingness of the
lenders syndicate to continue lending to the Company, and the
availability and cost of financing from alternative sources. If
long-term financing is not obtained by the Company, its financial
condition, cash flows and results of operations could be materially and
adversely affected.
SHAREHOLDER DISTRIBUTION: 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"). Such
distribution, supplemented by an additional distribution made in
September 1998, is subject to adjustment based upon the final
determination of taxable income through February 21, 1997. Although the
Company has completed and filed its Federal and state tax returns for
all periods through February 21, 1997, further cash distributions may
be required in the event the Company's taxable income for any period
through February 21, 1997 is adjusted due to audits or any other
reason (see Note 4).
LITIGATION: On September 24, 1998, an action was commenced against the
Company for breach of contract in connection with a purported services
arrangement, seeking damages of approximately $0.6 million. The Company
filed an answer denying any breach of contract and moved to transfer
the action to Florida. The motion for removal was granted and the case
has been transferred to, and is now pending in, the Southern District
of Florida, Fort Lauderdale division. No trial date has been set. The
Company believes that the claim is without merit and the resolution of
this lawsuit will not have a material adverse
14
OUTSOURCE INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
NOTE 6. COMMITMENTS AND CONTINGENCIES (CONTINUED)
effect on its financial position or future operating results; however,
no assurance can be given as to the ultimate outcome of this lawsuit.
On November 12, 1997, an action was commenced against the Company,
alleging state law claims of pregnancy/maternity discrimination and
violations of the Family and Medical Leave Act as a result of an
alleged demotion following the plaintiff's return from maternity leave.
The complaint also asserted a claim for unpaid overtime based on both
state law and the Fair Labor Standards Act. The plaintiff and the
Company settled this case in the third quarter of 1999, with no
material impact on the Company's past or future financial condition or
results of operations.
UNEMPLOYMENT TAXES: Federal and state unemployment taxes represent a
significant component of the Company's cost of revenues. State
unemployment taxes are determined as a percentage of covered wages.
Such percentages are determined in accordance with the laws of each
state and usually take into account the unemployment history of the
Company's employees in that state. The Company has realized reductions
in its state unemployment tax expense as a result of changes in its
organizational structure from time to time. Although the Company
believes that these expense reductions were achieved in compliance with
applicable laws, taxing authorities of a particular state have recently
indicated that they may challenge these reductions. The Company is
unable, at this time, to reasonably estimate the effect of such a
challenge by this state or by other states.
The Company has made arrangements with several states to pay quarterly
unemployment tax payments originally due in July and October, 1999 in
monthly installments over one year, bearing interest at rates ranging
from 12.0% to 24.0% per annum. The unpaid balance, included in accrued
payroll taxes on the Company's September 30, 1999 balance sheet, was
approximately $0.8 million.
FEDERAL EMPLOYMENT TAX REPORTING PENALTIES: During September 1999, the
Company was notified by the IRS of its intent to assess penalties of
$500,000 related to a significant number of incorrect Social Security
numbers provided by temporary employees and appearing on the W-2s
issued by the Company for 1997. The final penalty will be determined
once the Company formally responds to the IRS. This response is
currently due on or before December 31, 1999. Although the Company has
not received communication from the IRS related to its 1998 W-2s, and
1999 W-2s will not be issued until the January 2000 due date, the
Company believes that the same factors causing incorrect Social
Security numbers to be reported for 1997 could also exist for 1998 and
1999. The Company is currently evaluating these factors in order to
determine the most cost effective actions to take to be in compliance
for 2000 and subsequent years. Although the statutory penalty for
incorrect Social Security numbers on W-2s for 1997 through 1999 could
be as high as $2.0 million, if the level of exceptions noted in 1997 is
determined to have continued in 1998 and 1999, the Company does not
currently expect that the penalty ultimately charged will exceed
$300,000, which amount was included in selling, general and
administrative expenses in the third quarter of 1999 and is reflected
as a current liability on the September 30, 1999 balance sheet,
although there can be no assurance that the Company will not be
required to ultimately pay a higher penalty in connection with this
matter.
UNCLAIMED PROPERTY AUDIT: The Company has recently been notified that a
state in which the Company conducts a significant portion of its
operations intends to perform an audit of the Company's compliance with
escheat (unclaimed property) statutes in the near future. The
applicable state escheat laws cover a wide scope of situations and
property types and have a ten-year statute of limitations. In addition,
it is common for states to share information in this area. At this
time, the Company is unable to estimate any liability that may result
from this audit and has made no provisions in its financial statements
related to this matter.
15
OUTSOURCE INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
NOTE 6. COMMITMENTS AND CONTINGENCIES (CONTINUED)
INS AUDITS: The United States Immigration and Naturalization Service
("INS") has recently begun audits at several of the Company's locations
as to the Company's compliance in obtaining the necessary documentation
before employing certain individuals. Although the audits are not
complete, it appears that the Company will be required to pay an
estimated penalty arising from non-compliance of at least $100,000,
which amount was included in selling, general and administrative
expenses in the third quarter of 1999 and is reflected as a current
liability on the September 30, 1999 balance sheet.
WORKERS' COMPENSATION: During 1997 and 1998, the Company's workers'
compensation expense for claims was effectively capped at a
contractually agreed percentage of payroll, which the Company's expense
was limited to, since the estimated ultimate cost of the actual claims
experience was greater than the cap. Effective January 1, 1999, the cap
was increased to 2.7% of initially estimated 1999 payroll, reflecting
the inclusion of general and automobile liability coverage as well as
an adjustment based on the changing business mix of the Company. The
1999 cap rate is subject to an absolute dollar minimum and as a result
of lower than initially estimated payroll in 1999 due to the
Restructuring and other events, the Company estimates the ultimate 1999
cap rate to be approximately 3.0% of actual payroll. For the nine
months ended September 30, 1999, the estimated ultimate cost of the
actual claims experience was used as the basis of the Company's expense
related to 1999 claims experience, since it was approximately $1.1
million less than the cap based on the estimated ultimate rate of 3.0%.
The estimated ultimate cost of the 1999 claims experience was
determined based on information from an independent third-party
administrator employed by the Company plus an allowance for claims
incurred but not reported, based on prior experience and other relevant
data.
The Company routinely adjusts on an ongoing basis the accruals made in
prior years for workers' compensation claims and expenses, based on
updated information from its insurance carriers, its independent
third-party administrator and its own analysis. These adjustments are
included as a component of cost of sales in the period in which they
are made. As a result of updated information related to claims and
expenses recorded in prior years, the Company reduced cost of sales by
approximately $0.4 million for the three and nine months ended
September 30, 1999.
SIGNIFICANT CUSTOMER: For the nine months ended September 30, 1999,
revenues representing approximately nine and 24 percent of total
revenues of the Company and the Synadyne segment, respectively, were
from PEO services performed for individual insurance agent offices
under a preferred provider designation previously granted to the
Company on a regional basis by the agents' common corporate employer.
The corporate employer recently began granting that designation on a
national basis only and the Company has been granted that designation
for 1999.
In November 1999, the common corporate employer announced its intent to
convert approximately 43% of its agents to independent contractor
status, and to terminate approximately 10% of its non-agent workforce,
beginning in May 2000. These changes could affect the preferred
provider program, reduce the number of agents utilizing the Company's
services and/or the level of services utilized by those agents.
Approximately 21% of the above revenue attributed to this, common
corporate employee comes from agents that were already independent
contracted as of September 30, 1999. In addition, the Company is aware
of litigation that has been pending for more than one year against that
corporate employer regarding its use of professional employer
organization and staffing services in general and the need to provide
additional benefits to those employees in particular. The Company has
not determined what impact, if any, the ultimate result of these
developments will have on its financial position or results of
operations.
EMPLOYMENT AGREEMENTS: As of September 30, 1999, the Company had
certain obligations under employment agreements it had entered into
with its Chief Executive Officer ("CEO") and ten other officers. Under
the terms of those agreements, in the event that the Company terminates
the employment of 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 portion (ranging from
three months to
16
OUTSOURCE INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
NOTE 6. COMMITMENTS AND CONTINGENCIES (CONTINUED)
two years) of the officer's annual base salary and bonus. In addition,
all incentive stock options held by such employees would become
immediately exercisable. More substantial severance provisions apply if
any of those officers are terminated within two years (three years for
the CEO) after the occurrence of a "change of control", as defined in
the employment agreements. In February 1999, August 1999 and November
1999, three of the ten officers referred to above resigned their
positions, which resulted in the Company's agreement to pay two of
those officers' salaries for one year and one of those officers' salary
for six months, in exchange for their agreement, among other things,
not to compete with the Company during that period.
During the third quarter of 1999, the Company entered into employment
agreements with six senior Tandem operating executives, which included
provisions obligating the Company to pay severance equal to six month's
salary under certain conditions.
RETENTION BONUSES: In connection with the Restructuring, the Company
has entered into agreements obligating it to pay $0.7 million to
approximately 100 individuals if they remain employed with the Company
through December 31, 1999. The Company will record its ultimate
liability under these agreements as a restructuring charge in the
fourth quarter of 1999 (see Note 2).
CONSULTING CONTRACT: In May 1999, the Company engaged Crossroads
Capital Partners, LLC ("Crossroads"), a consulting firm based in
Newport Beach, California, to review the Company's existing business
plan and make recommendations for adjustments to strategy as well as
financial and operational improvements. In June 1999, the Crossroads
engagement was further extended to include its assistance in verifying
the Company's cash flow projections and requiring Crossroads to report
to management and the lenders syndicate. In July 1999, the engagement
was further modified to add additional services, including working with
management to develop a revised business plan based on the restructured
company (see Note 2), assisting in extending the existing Revolving
Credit Facility and Securitization Facility, arranging for new
financing, and periodically reporting to the Company's Board of
Directors and lenders syndicate. In August 1999, a representative of
Crossroads was appointed as the Company's interim chief operating
officer and the interim President of the Tandem division. The Company
has paid or accrued $612,380 for services rendered by Crossroads
through September 30, 1999. This amount was included in the
restructuring charge recorded by the Company for the three and nine
months ended September 30, 1999 and the Company also expects to record
restructuring charges in the fourth quarter of 1999 for services
relating to Restructuring activities to be rendered by Crossroads
during that period (see Note 2). The Company's contract with Crossroads
for the four-month period ended October 31, 1999 provides for a monthly
fee of $125,000 plus expenses, which fee is subject to renegotiation
for the period after October 31, 1999. In addition, the Company is
obligated to compensate Crossroads for financing sources found by it,
and subject to closing on such financing, a fee of one percent of
senior financing obtained and four percent of subordinated financing
obtained, subject to a $150,000 and $300,000 minimum fee, respectively.
STOCK OPTIONS AND WARRANTS: As of September 30, 1999, 901,702 stock
options and 1,208,988 warrants issued prior to 1999 to purchase shares
of the Company's common stock remained outstanding. During January
1999, the Company granted options to purchase 72,500 shares of the
Company's common stock, vesting over a four year period from the grant
date and with an exercise price of $6.00 per share. During March 1999,
the Company granted options to purchase 121,825 shares of the Company's
common stock, of which 26,150 shares vest over a four year period from
the grant date and the remainder vest immediately upon grant. All have
an exercise price of $4.125 per share. During May 1999, the Company
granted options to purchase 98,343 shares of the Company's common
stock, vesting over a four-year period from the grant date and with an
exercise price of $4.563 per share. As of September 30, 1999, 242,918
of the options issued during 1999 to purchase shares of the Company's
common stock remained outstanding. During November 1999, the Company
granted options to purchase 20,000 shares of the Company's common
stock, vesting over a four-year period from the grant date and with an
exercise price of $1.00 per share. All exercise prices for 1999 grants
were based on the market price of the shares at the grant date.
17
OUTSOURCE INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
NOTE 6. COMMITMENTS AND CONTINGENCIES (CONTINUED)
The total number of shares of common stock reserved for issuance under
the stock option plan as of September 30, 1999 was 2,000,000, as agreed
to by the Company's Board of Directors in April 1999 and approved by
the Company's shareholders at their May 1999 annual meeting.
EMPLOYEE BENEFIT PLAN: 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 inadvertently permitted to make
elective salary deferral contributions. In the third quarter of 1999
the Company obtained IRS approval regarding the proposed correction
under the Voluntary Closing Agreement Program ("VCAP"). The Company
paid an insignificant penalty associated with this VCAP correction, and
believes that this matter will have no future material impact on its
financial condition or results of operations.
NOTE 7. RELATED PARTY TRANSACTIONS
Effective August 31, 1998, certain shareholders of the Company owning
franchises entered into a buyout agreement with the Company. Buyouts
are early termination of the franchise agreements entered into by the
Company in order to allow the Company to develop the related
territories. At the time of the buyout, the Company received an initial
payment from the former franchisee and was to have continued to receive
quarterly payments from the former franchisee based on the gross
revenues of the formerly franchised locations for two years after the
termination date, which was generally consistent with the terms of
buyout agreements between the Company and unrelated third parties.
Effective March 31, 1999, the Company received another payment from the
former franchisee in consideration of the elimination of the equivalent
of the last five months of payments under the initial agreement. The
amount of this payment was generally consistent with the terms of
similar agreements between the Company and unrelated third parties.
During the nine months ended September 30, 1999, the Company recognized
revenue of $1.1 million from all franchises owned by significant
shareholders of the Company, which included royalties and payments
under the buyout agreement.
Effective February 16, 1998, the Company purchased certain staffing
locations and the related franchise rights from certain Company
shareholders. The $6.9 million purchase price included the issuance of
a $1.7 million note bearing interest at 7.25% per annum and payable
quarterly over three years. Effective February 1, 1999, the note was
renegotiated so that the remaining principal balance of $1.3 million
would bear interest at 8.50% per annum and would be payable in monthly
payments totaling $0.3 million in the first year and $0.6 million in
the second year, plus a $0.4 million payment at the end of the two year
term. As discussed in Note 5, as of August 12, 1999, the Company had
not made the renegotiated payments on this and its other subordinated
acquisition notes, and, as a result, at that time became in default of
this note. Furthermore, the payee has provided the required notice to
the Company accelerating the entire balance due, which as a result is
classified as current in the Company's consolidated financial
statements as of September 30, 1999.
18
OUTSOURCE INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
NOTE 8. 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. The following amounts are presented in
thousands:
NINE MONTHS ENDED SEPTEMBER 30,
1999 1998
---- ----
Acquisitions:
Tangible and intangible assets acquired............... $ 117 $ 41,471
Liabilities assumed................................... -- (1,458)
Debt issued........................................... (77) (11,396)
Common stock issued................................... -- (775)
------ -------
Net cash paid for acquisitions.............................. $ 40 $ 27,842
====== ========
Increase in long term debt, primarily due to sale/leaseback. $1,862 $ --
====== ========
Increase (reduction) of deferred loss
on interest rate collar agreement..................... ($ 413) $ 635
===== ========
Insurance premium financing................................. $ 503 $ --
====== ========
Decrease in accrued interest due to inclusion in
renegotiated long term debt........................... $ 448 $ --
====== ========
Increase in long term debt due to renegotiation at higher
interest rate and removal of imputed discount......... $ 275 $ --
====== ========
Proceeds from asset sale held in escrow..................... $ 205 $ --
====== ========
Increase in notes receivable from franchises for buyouts.... $ 107 $ --
====== ========
In addition to the above transactions, as a result of the
Restructuring, during the three and nine months ended September 30,
1999, long-lived assets of $8.4 million were identified as assets held
for disposition, and reclassified as a current asset on the Company's
balance sheet (see Note 2).
NOTE 9. EARNINGS (LOSS) PER SHARE
The Company calculates earnings (loss) per share in accordance with the
requirements of SFAS No. 128, "Earnings Per Share". The weighted
average shares outstanding used to calculate basic and diluted earnings
(loss) per share were calculated as follows:
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
1999 1998 1999 1998
---- ---- ---- ----
Shares issued in connection with the Reorganization......... 5,448,788 5,448,788 5,448,788 5,448,788
Shares sold by the Company in October 1998.................. 3,000,000 3,000,000 3,000,000 3,000,000
Shares issued in connection with a February 1998 acquisition 57,809 57,809 57,809 51,245
Warrants exercised in May 1998.............................. 151,316 151,316 151,316 84,803
-------- --------- --------- --------
Weighted average common shares - basic...................... 8,657,913 8,657,913 8,657,913 8,584,836
Outstanding options and warrants to purchase common stock-
remaining shares after assumed repurchase using
proceeds from exercise.................................... -- 1,206,679 -- 1,375,177
--------- --------- --------- ---------
Weighted average common shares - diluted.................... 8,657,913 9,864,592 8,657,913 9,960,013
========= ========= ========= =========
19
OUTSOURCE INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
NOTE 9. EARNINGS (LOSS) PER SHARE (CONTINUED)
Certain of the outstanding options and warrants to purchase common
stock were anti-dilutive for certain of the periods presented above and
accordingly were excluded from the calculation of diluted weighted
average common shares for those periods, including the equivalent of
1,201,470 and 1,204,001 shares excluded for the three and nine months
ended September 30, 1999, respectively, solely because the results of
operations was a net loss instead of net income.
NOTE 10. OPERATING SEGMENT INFORMATION
The Company's reportable operating segments are as follows:
TANDEM: This segment derives revenues from recruiting, training and
deployment of temporary industrial personnel and from providing payroll
administration, risk management and benefits administration services.
SYNADYNE: This segment derives revenues from providing a comprehensive
package of PEO services to its clients including payroll
administration, risk management, benefits administration and human
resource consultation. See Note 2 related to the Company's planned
disposition of these operations and Note 6 for information regarding a
significant customer.
FRANCHISING: This segment derives revenues under agreements with
industrial staffing franchisees that provide those franchises with,
among other things, exclusive geographical areas of operations,
continuing advisory and support services and access to the Company's
confidential operating manuals. Franchising revenues also include
revenues from early terminations of franchise agreements, called
buyouts. As of September 30, 1999 there was $107,000 in outstanding
notes receivable from these former franchises for buyout revenue
recognized during the nine months then ended.
Transactions between segments affecting their reported income are
immaterial. Differences between the reportable segments' operating
results and the Company's consolidated financial statements relate
primarily to other operating divisions of the Company and items
excluded from segment operating measurements, such as corporate support
center expenses, interest expense in excess of interest charged to the
segments based on their outstanding receivables (before deducting
amounts sold under the Securitization Facility) and, for the three and
nine months ended September 30, 1999, a $2.7 million increase in the
Company's provision for doubtful accounts arising from the anticipated
sale of certain older accounts receivable to third parties, including
the transaction discussed in Note 11. Financial information for the
Company's operating segments, reconciled to Company totals and
presented in thousands, is as follows:
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
1999 1998 1999 1998
---- ---- ---- ----
REVENUES
Tandem............................................ $ 93,010 $ 88,093 $ 245,961 $ 232,461
Synadyne.......................................... 59,324 55,099 167,484 146,350
Franchising....................................... 1,036 2,011 5,477 4,960
Other Company revenues............................ 5,754 8,213 17,770 25,427
---------- --------- --------- ---------
Total Company Revenues............................ $ 159,124 $ 153,416 $ 436,692 $ 409,198
========== ========= ========= =========
20
OUTSOURCE INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
NOTE 10. OPERATING SEGMENT INFORMATION (CONTINUED)
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
1999 1998 1999 1998
---- ---- ---- ----
(LOSS) INCOME BEFORE TAXES
Tandem............................................ $ 404 $ 4,113 $ 1,676 $ 9,766
Synadyne.......................................... 364 132 1,141 727
Franchising....................................... 882 1,671 4,870 3,981
Restructuring and asset impairment charges........ (7,554) -- (7,554) --
Other Company (loss) income, net.................. (7,415) (3,949) (16,666) (10,158)
--------- --------- --------- ---------
Total Company (loss) income before taxes.......... $ (13,319) $ 1,967 $ (16,533) $ 4,316
========= ========= ========= =========
NOTE 11. SUBSEQUENT EVENTS
On November 4, 1999, the Company sold certain trade accounts
receivable, with a face value of approximately $4.3 million and
primarily more than 180 days past due, to unrelated third parties for
proceeds of approximately $220,000. As of September 30, 1999, the
Company had recorded an additional $2.7 million in the provision for
doubtful accounts and as a result these receivables were fully reserved
for the difference between the face value and the proceeds.
During the fourth quarter of 1999, the Company sold certain tangible
and intangible assets acquired by it primarily in 1998, related to its
former Tandem operations in North Carolina, South Carolina, Virginia
and Wisconsin, as more fully described in Notes 2 and 3. The sales
price was equal to the carrying values of the assets as of September
30, 1999. In connection with these sales, certain subordinated debts
outstanding as of September 30, 1999 were cancelled.
During the fourth quarter of 1999, the Company changed its fiscal year
from the calendar year ending December 31 to the 52 or 53 week period
ending on the Sunday closest to March 31. The reporting period
containing the transition will be from January 1, 2000 through April 2,
2000.
21
ITEM 2 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
The following information should be read in conjunction with
"__Forward-looking information: certain cautionary statements" below.
GENERAL
The Company is a national provider of human resource services focusing
on the flexible industrial staffing ("staffing") market through its
Tandem division and on the professional employer organization ("PEO")
market primarily through its Synadyne division. The Company provides
its industrial staffing services through locations owned or leased by
the Company (collectively identified as "Company-owned") and franchise
locations, and its PEO services through Company-owned locations.
Industrial staffing services include recruiting, training and
deployment of temporary industrial personnel as well as payroll
administration, risk management and benefits administration services.
PEO services include payroll administration, risk management, benefits
administration and human resource consultation.
The Company's revenues are based on the salaries and wages of worksite
employees. 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
staffing and PEO services. Since the Company is at risk for all of its
direct costs, independent of whether payment is received from its
clients, 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, which is consistent with industry practice. The Company's
primary direct costs are (i) the salaries and wages of worksite
employees (payroll cost), (ii) employment related taxes, (iii) health
benefits, (iv) workers' compensation benefits and insurance and (v)
worksite employee transportation.
The Company's staffing operations generate significantly higher gross
profit margins than its PEO operations. The higher staffing 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 Company acquired 40 industrial staffing offices during 1998 (the
"1998 Acquisitions") and 48 additional offices during the three years
prior to that - see "_Acquisitions" below. The Company discontinued its
acquisition program in October 1998 primarily due to a desire to focus
on and improve existing operations plus a lack of capital for new
acquisitions. Up to that time, the Company had made a significant
investment in new information systems, additional back office
capabilities and other infrastructure enhancements in order to support
the prior growth as well as the future growth that was being
anticipated at that time. The Company does not anticipate making any
acquisitions during the next twelve months. During the third quarter of
1999, the Company wrote off approximately $5.0 million of intangible
assets primarily arising from the 1998 Acquisitions, of which $2.5
million related to a restructuring discussed below and another $2.5
million was based on its analysis of anticipated discounted future cash
flows. See Note 3 to the Company's Consolidated Financial Statements.
On August 6, 1999, the Company announced the following actions to
improve its short-term liquidity, concentrate its operations within one
core segment (Tandem, its industrial staffing division) and improve its
operating performance within that segment:
(i) the sale of Office Ours, the Company's clerical staffing division,
which was accomplished effective August 30, 1999.
(ii) the engagement of an investment banking firm to assist in the
evaluation of the possible sale of, or other strategic options for,
Synadyne, the Company's PEO division. The Company has been and is
currently in discussions with prospective purchasers and is seeking to
sell these operations as soon as possible; however, the sale is not
expected prior to December 31, 1999.
22
(iii) a reduction of the Company's industrial staffing and support
operations (the "Restructuring"), consisting primarily of: the sale,
closure, consolidation or franchising, during the third and fourth
quarters of 1999, of 20 of the 117 Tandem branch offices existing as of
June 30, 1999; an immediate reduction of the Tandem and corporate
support center employee workforce by 75 and 29 employees, respectively
(approximately 11 percent of the Company's workforce); and an
additional 22 employee reduction of the corporate support center
workforce by early 2000. As a result of the corporate support center
workforce reductions and the anticipated disposition of Synadyne, the
corporate support center building will be sold. The 20 branch offices
to be eliminated are (a) locations not now nor expected to be
adequately profitable in the near future or (b) locations inconsistent
with the Company's operating strategy of clustering offices within
specific geographic regions. Many of these branch offices were acquired
by the Company during 1996, 1997 and 1998.
In connection with the Restructuring, the Company has included a charge
of $5.1 million in its results of operations for the three and nine
months ended September 30, 1999. This restructuring charge included a
$2.5 million write-down of assets related to 12 of the 20 Tandem
offices identified for disposition. Seven offices, located in Las
Vegas, North Carolina, South Carolina and Virginia and representing
$1.8 million of this write-down, have been disposed of as of November
8, 1999 and were sold for total proceeds of $1.8 million, primarily
cancellation of Company debt. The remaining $0.7 million write-down,
related to five offices located in Washington, Minnesota and Tennessee,
is based on management's estimate of the ultimate sales prices that
will be negotiated for these assets.
The remaining eight of the 20 Tandem offices identified for disposition
have been closed or consolidated into other Company-owned locations and
the restructuring charge includes $0.3 million for the costs of
terminating the related leases as well as the carrying value of
leasehold improvements and other assets not usable in other Company
operations.
In addition to the write-down of assets identified for disposition and
leasehold termination costs, the $5.1 million restructuring charge
includes $1.4 million for severance and other termination benefits,
$0.7 million for professional fees and $0.2 million of other costs.
The Company expects to sell the remainder of the assets held for
disposition before March 31, 2000. The Company has hired a professional
real estate firm to assist with the sale of the corporate support
center building.
See Note 2 to the Company's Consolidated Financial Statements.
The Company's current bank financing expires as of December 31, 1999
and the Company is currently negotiating with its current syndicate of
lenders, and potential new lenders, to provide financing for some
period after December 31, 1999, under a mutually acceptable structure
and terms. Furthermore, the Company is in default of certain other
subordinated indebtedness. If long-term financing is not obtained by
the Company, its financial condition, cash flows and results of
operations could be materially and adversely affected. See Notes 5 and
6 to the Company's Consolidated Financial Statements and "_Liquidity
and Capital Resources" below.
23
RESULTS OF OPERATIONS
The following tables set forth the amounts and percentages of net
revenues of certain items in the Company's consolidated statements of
income for the indicated periods. The amounts presented are in
thousands (except employees and offices) and are unaudited:
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
1999 1998 1999 1998
---- ---- ---- ----
Net revenues:
Flexible industrial staffing (1)................... $ 84,965 $ 81,763 $ 221,391 $ 215,094
PEO (1)............................................ 71,837 67,397 204,524 182,760
Franchising........................................ 1,036 2,011 5,477 4,960
Other.............................................. 1,286 2,245 5,300 6,384
---------- -------- --------- ---------
Total net revenues................................. $ 159,124 $153,416 $ 436,692 $ 409,198
=========== ======== ========= =========
Gross profit....................................... $ 21,055 $ 22,767 $ 61,100 $ 62,081
Selling, general and administrative expenses (2)... 25,508 19,154 65,548 53,640
Restructuring and asset impairment charges......... 7,554 -- 7,554 --
---------- -------- --------- ---------
Operating (loss) income (2)........................ (12,007) 3,613 (12,002) 8,441
Net interest and other expense .................... 1,312 1,646 4,531 4,125
---------- -------- --------- ---------
(Loss) income before (benefit) provision for
income taxes (2)................................. (13,319) 1,967 (16,533) 4,316
(Benefit) provision for income taxes............... (4,999) 455 (6,384) 1,036
--------- -------- -------- ---------
Net (loss) income (2).............................. $ (8,320) $ 1,512 $(10,149) $ 3,280
========= ======== ======== =========
SYSTEM OPERATING DATA:
System Revenues (3)................................ $ 176,143 $176,562 $ 482,892 $ 473,518
========= ======== ========= =========
System employees (number at end of period)......... 38,200 37,100 38,200 37,100
========= ======== ========= =========
System offices (number at end of period)........... 161 174 161 174
========= ======== ========= =========
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
1999 1998 1999 1998
---- ---- ---- ----
Net revenues:
Flexible industrial staffing (1)................... 53.4% 53.3% 50.7% 52.5%
PEO (1)............................................ 45.1 43.9 46.8 44.7
Franchising........................................ 0.7 1.3 1.3 1.2
Other.............................................. 0.8 1.5 1.2 1.6
------- ------- -------- --------
Total net revenues................................. 100.0% 100.0% 100.0% 100.0%
======= ======= ======== ========
Gross profit....................................... 13.2% 14.8% 14.0% 15.2%
Selling, general and administrative expenses (2)... 16.0 12.5 15.0 13.1
Restructuring and asset impairment charges......... 4.7 -- 1.7 --
------- ------- -------- --------
Operating (loss) income (2)........................ (7.5) 2.4 (2.7) 2.1
Net interest and other expense..................... 0.9 1.1 1.1 1.0
------- ------- -------- --------
(Loss) income before (benefit) provision for
income taxes.................................... (8.4) 1.3 (3.8) 1.1
(Benefit) provision for income taxes............... (3.2) 0.3 (1.5) 0.3
------- ------- -------- --------
Net (loss) income (2).............................. (5.2)% 1.0% (2.3)% 0.8%
======= ======= ======== ========
24
-----------------------------------------------------------------------
(1) SFAS No. 131, "Disclosures about Segments of an Enterprise and
Related Information", establishes standards for reporting information
about operating segments in financial statements. Operating segments
are defined as components of an enterprise about which separate
financial information is available that is evaluated regularly by the
chief operating decision maker, or decision making group, in deciding
how to allocate resources and in assessing performance. The Company's
reportable operating segments under SFAS No. 131 include the Tandem
segment and the Synadyne segment. PEO revenues, as reported above,
include certain industrial revenues that the Company believes are
operationally consistent with the PEO business and operational model,
but are not includable in the Synadyne segment due to the way the
Company is organized. Following is a reconciliation of Flexible
Industrial Staffing net revenues and the PEO net revenues, as shown
above, to the revenues reported by the Company in accordance with the
requirements of SFAS No. 131 - see Note 10 to the Company's
Consolidated Financial Statements. The following amounts are presented
in thousands:
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
1999 1998 1999 1998
---- ---- ---- ----
Flexible Industrial Staffing revenues............... $84,965 $81,763 $ 221,391 $215,094
Add: Industrial staffing client payrolling.......... 8,045 6,330 24,570 17,367
------- ------ -------- --------
Tandem operating segment revenues................... $93,010 $88,093 $245,961 $232,461
======= ======= ======== ========
PEO Revenues........................................ $71,837 $67,397 $204,524 $182,760
Less: Industrial staffing client payrolling......... (8,045) (6,330) (24,570) (17,367)
Less: PEO services to industrial staffing franchises (4,468) (5,968) (12,470) (19,043)
------- ------- -------- --------
Synadyne operating segment revenues................. $59,324 $55,099 $167,484 $146,350
======= ======= ======== ========
-----------------------------------------------------------------------
(2) During the three and nine months ended September 30, 1999, the
Company recorded a restructuring reserve of $5.1 million as well as a
non-operating gain of $523,000 from the sale of Office Ours, its former
clerical staffing division - see Note 2 to the Company's Consolidated
Financial Statements. During the three and nine months ended September
30, 1999, the Company recognized an operating expense of $2.5 million
for the write-down of impaired goodwill and other long-lived assets -
see Note 3 to the Company's Consolidated Financial Statements. During
the three and nine months ended September 30, 1999, the Company
recognized a $2.7 million increase in its provision for doubtful
accounts, arising from the anticipated sale to third parties of certain
accounts receivable primarily more than 180 days past due, including
the transactions discussed in note 11 to the Company's Consolidated
Financial Statements. The following table sets forth the amounts (in
thousands, except for per share data) and the percentage of certain
items in the Company's consolidated statements of income, with 1999
amounts and percentages adjusted for the above items as follows: (i)
selling, general and administrative expenses excludes the increase in
the provision for doubtful accounts; (ii) operating (loss) income
excludes the restructuring reserve, the write-down of impaired goodwill
and other assets and the increase in the provision for doubtful
accounts; and (iii) net loss (income) and (loss) earnings per share
excludes the restructuring reserve, the write-down of impaired goodwill
and other assets, the increase in the provision for doubtful accounts
and the non-operating gain on sale, after a related adjustment to the
(benefit) provision for income taxes.
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
1999 1998 1999 1998
---- ---- ---- ----
Selling general and administrative expenses, as adjusted $22,841 $19,154 $62,881 $53,640
As a percentage of net revenues..................... 14.4% 12.5% 14.4% 13.1%
Operating (loss) income, as adjusted................ ($1,788) $3,613 ($1,781) $8,441
As a percentage of net revenues..................... (1.1)% 2.4% (0.4)% 2.1%
Net (loss) income, as adjusted...................... ($2,193) $1,512 ($4,022) $3,280
As a percentage of net revenues..................... (1.4)% 1.0% (0.9)% 0.8%
(Loss) earnings per diluted share, as adjusted...... ($0.25) $ 0.15 ($0.46) $ 0.33
EBITDA, as adjusted................................. $ 84 $5,331 $ 3,849 $13,347
EBITDA is earnings (net income) before the effect of interest income
and expense, income tax benefit and expense, depreciation expense and
amortization expense. EBITDA as adjusted excludes the restructuring
reserve, the write-down of impaired goodwill and other assets, the
increase in the provision for doubtful accounts and the non-operating
gain on sale. 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.
-----------------------------------------------------------------------
25
(3) System revenues are the sum of the Company's net revenues
(excluding revenues from franchise royalties and services performed for
the 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
amounts reported in thousands:
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
1999 1998 1999 1998
---- ---- ---- ----
Company's Net Revenue............................... $159,124 $153,416 $436,692 $409,198
Less Company revenues from:
Franchise Royalties.............................. (1,036) (2,011) (5,477) (4,960)
Services to Franchises........................... (4,468) (5,968) (12,470) (19,043)
Add: Franchisee's net revenues...................... 22,523 31,125 64,147 88,323
-------- ------- -------- --------
System revenues..................................... $176,143 $176,562 $482,892 $473,518
======== ======== ======== ========
-----------------------------------------------------------------------
THREE MONTHS ENDED SEPTEMBER 30, 1999 AS COMPARED TO THE THREE MONTHS
ENDED SEPTEMBER 30, 1998
Net Revenues. Net revenues increased $5.7 million, or 3.7%, to $159.1
million in the three months ended September 30, 1999 ("Q3 1999") from
$153.4 million in the three months ended September 30, 1998 ("Q3
1998"). This increase resulted primarily from growth in PEO revenues in
Q3 1999 of $4.4 million, or 6.6%, compared to Q3 1998, as well as
growth in staffing revenues of $3.2 million, or 3.9%, during the same
periods. Tandem revenues, which are comprised of staffing revenues plus
industrial staffing client payrolling revenues that are currently
reported as part of PEO revenues but will be retained by the Company
after the sale of Synadyne, increased $4.9 million, or 5.6%, in Q3 1999
as compared to Q3 1998. The increase in PEO revenues was primarily due
to new PEO clients, as well as an increase in the number of work-site
employees at certain existing PEO clients. The increase in Tandem and
staffing revenues was primarily due to new customers and growth with
existing customers in certain geographic markets that recorded double
digit growth, although the Company also experienced lower growth or
declining revenues in other geographic markets due to the loss or
cancellation by the Company of some large customers, high employee
turnover and Company locations not operating consistently with the
Company's strategy.
System revenues, which include franchise revenues not earned by or
available to the Company, decreased $0.5 million, or 0.3%, to $176.1
million in Q3 1999 from $176.6 million in Q3 1998. The decrease in
system revenues was attributable to a net decrease of franchise
revenues of $8.6 million, offset by the increase in the Company's net
revenues discussed above. Although total franchise revenues declined
during this period, franchise revenues of franchisees operating as of
September 30, 1999 increased $2.2 million, or 10.9%, in Q3 1999 as
compared to Q3 1998. This increase was offset by a $10.8 million
decrease in revenues for the same period resulting from other
franchisees no longer operating. The Company acquired and converted 17
franchise locations to Company-owned locations during 1998 and also
allowed the early termination of franchise agreements in 1998 and 1999
attributable to another 18 locations to enable the Company to develop
the related territories. At the time the Company agrees to terminate a
franchise agreement, it receives an initial buyout payment (of which a
portion may be in the form of a note) from the former franchisee. The
Company continues to receive payments from the former franchisees based
on that initial note and/or a percentage of 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, is
reflected in total royalties reported by the Company.
Gross Profit. Gross profit (margin) decreased $1.7 million, or 7.5%, to
$21.1 million in Q3 1999, from $22.8 million in Q3 1998. Gross profit
as a percentage of net revenues decreased to 13.2% in Q3 1999 from
14.8% in Q3 1998. This decrease was primarily due to (i) decreased
gross profit margin percent for the Company's staffing operations and
(ii) the lower growth rate for staffing revenues as compared to the
growth rate for PEO revenues, which generate lower gross profit
margins. In Q3 1999, PEO operations generated gross profit margins of
3.5% as compared to gross profit margins of 20.2% generated by staffing
operations.
26
Margin percent for the Company's staffing operations decreased to 20.2%
in Q3 1999 from 22.0% in Q3 1998. Margin percent for Tandem, as defined
above, decreased to 19.4% from 21.0% for the same periods. The
decreases were primarily due to the impact of (i) fewer small contracts
of a just-in-time nature or shorter duration for which the Company
historically earned higher margins and (ii) the increased wages
necessary to recruit staffing employees in areas of historically low
unemployment. The Company anticipates stabilization in margin by the
end of 1999, with margin improvement occurring in 2000 as a result of
refocusing sales efforts on just-in-time business in those locations
where such business is more typical of the local market, as well as
pricing to reflect local market conditions.
PEO gross profit margin percent increased to 3.5% in Q3 1999 from 3.1%
in Q3 1998, primarily due to an increase in the volume of PEO services
provided to industrial clients having higher gross profit margins than
the more typical white-collar clients, as well as a one-time increase
in Q3 1998 workers' compensation expense due to pre-1997 claims. Gross
profit margin for the Synadyne division, the largest component of the
Company's PEO operations, also increased, to 2.8% in Q3 1999 from 2.6%
in Q3 1998.
Selling, General and Administrative Expenses. Selling, general and
administrative expenses ("SG&A") increased $6.3 million, or 33.2%, to
$25.5 million in Q3 1999 from $19.2 million in Q3 1998. This increase
was primarily a result of a $2.9 million increase in the provision for
doubtful accounts and a $1.4 million increase in variable compensation
based on employee performance. This increased variable compensation,
intended to create incertives for immediate improvements during the
Restructuring period, is expected to continue in the fourth quarter of
1999 as well as in subsequent periods, depending on performance. . The
remainder of the increase was primarily due to short-term increases in
professional fees and legal and regulatory settlements. The increase in
the provision for doubtful accounts was comprised primarily of a $2.7
million non-recurring charge arising from the anticipated sale to third
parties of certain accounts receivable primarily more than 180 days
past due, including the transaction discussed in Note 11 to the
Company's Consolidated Financial Statements, which was consummated in
November 1999. As a result of the Restructuring and related actions
already taken, the Company expects SG&A costs to decrease from
pre-Restructuring levels by approximately $8.9 million per annum. In
the fourth quarter of 1999, SG&A should decrease by approximately $4.2
million as compared to SG&A for Q3 1999, which included a non-recurring
increase in the provision for doubtful accounts.
Restructuring and Asset Impairment Charges. During Q3 1999, the Company
recorded a Restructuring reserve of $5.1 million as well an expense of
$2.5 million for the write-down of impaired goodwill and other
long-lived assets. The Company anticipates that restructuring charges,
including professional consulting fees and retention bunuses, will
continue at a reduced level in the fourth quarter of 1999. See Notes 2
and 3 to the Company's Consolidated Financial Statements.
Net Interest and Other Expense. Net interest and other expense
decreased by $0.3 million, to $1.3 million in Q3 1999 from $1.6 million
in Q3 1998. This decrease was primarily due to a non-operating gain of
$0.5 million from the sale of Office Ours, the Company's former
clerical staffing division (see Note 2 to the Company's Consolidated
Financial Statements), offset by a $0.2 million increase in interest
expense arising from higher interest rates paid on the Revolving Credit
Facility in Q3 1999 as compared to Q3 1998.
Net (Loss) Income. Net (loss) income decreased by $9.8 million, to an
$8.3 million loss in Q3 1999 from $1.5 million net income in Q3 1998.
This decrease was due to a $15.6 million reduction in operating income
(resulting from $7.6 million of Restructuring and asset impairment
charges, a $6.3 million increase in SG&A and a $1.7 million decrease in
gross profit), a $0.2 million increase in interest expense and a $0.5
million non-operating gain on sale, all discussed above, partially
offset by a related $5.5 million decrease in income taxes. The
effective tax rate increased to 37.5% in Q3 1999, from 23.1% in Q3
1998, primarily due to the tax benefit of employment tax credits in Q3
1999 being added to the tax benefit of a net loss in Q3 1999, as
compared to those credits being deducted from the tax expense related
to net income in Q3 1998.
27
NINE MONTHS ENDED SEPTEMBER 30, 1999 AS COMPARED TO THE NINE MONTHS
ENDED SEPTEMBER 30, 1998
Net Revenues. Net revenues increased $27.5 million, or 6.7%, to $436.7
million in the nine months ended September 30, 1999 ("YTD 1999") from
$409.2 million in the nine months ended September 30, 1998 ("YTD
1998"). This increase resulted primarily from PEO revenue growth of
$21.7 million, or 11.9%, as well as growth in staffing revenues of $6.3
million, or 2.9%, during the same periods. Tandem revenues, which are
comprised of staffing revenues plus industrial staffing client
payrolling revenues that are currently reported as part of PEO revenues
but will be retained by the Company after the sale of Synadyne,
increased $13.5 million, or 5.8%, in YTD 1999 as compared to YTD 1998.
The increase in PEO revenues was primarily due to new PEO clients, as
well as an increase in the number of work-site employees at certain
existing PEO clients. The increase in Tandem and staffing revenues was
primarily due to new customers and growth with existing customers in
certain geographic markets that recorded double digit growth, although
the Company also experienced lower growth or declining revenues in
other geographic markets due to the loss or cancellation by the Company
of some large customers, high employee turnover and Company locations
not operating consistently with the Company's strategy.
System revenues, which include franchise revenues not earned by or
available to the Company, increased $9.4 million, or 2.0%, to $482.9
million in YTD 1999 from $473.5 million in YTD 1998. The increase in
system revenues was attributable to the $27.5 million increase in the
Company's net revenues discussed above. Franchise revenues of
franchisees operating as of September 30, 1999 increased $9.4 million,
or 18.7%, YTD 1999 as compared to YTD 1998, offset by a $33.6 million
decrease in revenues for the same period resulting from other
franchisees no longer operating. The result is a net decrease of
franchise revenues of $24.2 million. The Company acquired and converted
17 franchise locations to Company-owned locations during 1998 and also
allowed the early termination of franchise agreements in 1998 and 1999
attributable to another 18 locations to enable the Company to develop
the related territories.
Gross Profit. Gross profit (margin) decreased $1.0 million, or 1.6%, to
$61.1 million in YTD 1999, from $62.1 million in YTD 1998. Gross profit
as a percentage of net revenues decreased to 14.0% in YTD 1999 from
15.2% in YTD 1998. This decrease was primarily due to (i) decreased
gross profit margin percent for the Company's staffing operations and
(ii) the lower growth rate for staffing revenues as compared to the
growth rate for PEO revenues, which generate lower gross profit
margins. In YTD 1999, PEO operations generated gross profit margins of
3.9% as compared to gross profit margins of 20.8% generated by staffing
operations.
Margin percent for the Company's staffing operations decreased to 20.8%
in YTD 1999 from 22.5% in YTD 1998. Margin percent for Tandem, as
defined above, decreased to 19.8% from 21.5% for the same periods. The
decreases were primarily due to the impact of (i) fewer small contracts
of a just-in-time nature or shorter duration for which the Company
historically earned higher margins and (ii) the increased wages
necessary to recruit staffing employees in areas of historically low
unemployment. The Company anticipates some stabilization in margin by
the end of 1999, with margin improvement occurring in 2000 as a result
of refocusing sales efforts on just-in-time business in those locations
where such business is more typical of the local market, as well as
pricing to reflect local market conditions.
PEO gross profit margin percent increased to 3.9% in YTD 1999 from 3.7%
in YTD 1998, primarily due to an increase in the volume of PEO services
provided to industrial clients at higher gross profit margins than the
more typical white-collar clients. Gross profit margin for the Synadyne
division, the largest component of the Company's PEO operations, was
3.2% in Q3 1999 and Q3 1998.
Selling, General and Administrative Expenses. SG&A increased $11.9
million, or 22.2%, to $65.5 million in YTD 1999 from $53.6 million in
YTD 1998. This increase was primarily a result of a $3.4 million
increase in the provision for doubtful accounts, $3.2 million in direct
operating costs related to the 1998 Acquisitions (for the portion of
YTD 1999 for which there was no corresponding YTD 1998 activity), a
$1.6 million increase in variable compensation based on employee
performance and a $1.5 million short-term increase in professional
fees. The increased variable compensation, intended to create
incentives for immediate improvements during the Restructuring period,
is expected to continue in the fourth quarter of 1999 as well as in
subseqent periods, depending on performance. The remainder of the
increase was primarily due to costs for telecommunication (primarily
for the new field operating system), recruiting key management and
service employees and legal and regulatory settlements. The increase in
the provision for doubtful accounts was comprised primarily of a $2.7
million non-recurring charge
28
arising from the anticipated sale to third parties of certain accounts
receivable primarily more than 180 days past due, including the
transaction discussed in Note 11 to the Company's Consolidated
Financial Statements, which was consummated in November 1999. As a
result of the Restructuring and related actions already taken, the
Company expects SG&A costs to decrease from pre-Restructuring levels by
approximately $8.9 million per annum. In the fourth quarter of 1999,
SG&A should decrease by approximately $4.2 million as compared to SG&A
for Q3 1999, which included a non-recurring increase in the provision
for doubtful accounts.
Restructuring and Asset Impairment Charges. During YTD 1999, the
Company recorded a Restructuring reserve of $5.1 million as well an
expense of $2.5 million for the write-down of impaired goodwill and
other long-lived assets. The Company anticipates that restructuring
charges, including professional consulting fees and retention bonuses,
will continue at a reduced level in the fourth quarter of 1999. See
Notes 2 and 3 to the Company's Consolidated Financial Statements.
Net Interest and Other Expense. Net interest and other expense
increased by $0.4 million, to $4.5 million in YTD 1999 from $4.1
million in YTD 1998. This increase was primarily due to a $1.0 million
increase in interest expense, arising from (i) an increase in total
debt outstanding related to the purchases of the 1998 Acquisitions,
(ii) financing costs related to increased accounts receivable arising
from increased staffing revenues and (iii) higher interest rates paid
on the Revolving Credit Facility in Q3 1999 as compared to Q3 1998. The
effect of these items was partially offset by a decrease in the average
interest rate as a result of the Securitization Facility, effective
July 1998. The increase in interest expense was offset by a
non-operating gain of $0.5 million from the sale of Office Ours, the
Company's former clerical staffing division - see Note 2 to the
Company's Consolidated Financial Statements.
Net (Loss) Income. Net (loss) income decreased by $13.4 million, to a
$10.1 million loss in YTD 1999 from $3.3 million net income in YTD
1998. This decrease was primarily due to a $20.5 million reduction in
operating income (resulting from $7.6 million of Restructuring and
asset impairment charges, an $11.9 million increase in SG&A and a $1.0
million decrease in gross profit), a $1.0 million increase in interest
expense and a $0.5 million non-operating gain on sale, all discussed
above, partially offset by a related $7.4 million decrease in income
taxes. The effective tax rate increased to 38.6% in YTD 1999, from
24.0% in YTD 1998, primarily due to the tax benefit of employment tax
credits in Q3 1999 being added to the tax benefit of a net loss in Q3
1999, as compared to those credits being deducted from the tax expense
related to net income in Q3 1998.
ADDITIONAL OPERATING AND SEGMENT INFORMATION
SFAS No. 131, "Disclosure about Segments of an Enterprise and Related
Information", establishes standards for reporting information about
operating segments in financial statements. Operating segments are
defined as components of an enterprise about which separate financial
information is available that is evaluated regularly by the chief
operating decision maker, or decision making group, in deciding how to
allocate resources and in assessing performance. The Company's
reportable operating segments under SFAS No. 131 differ from the
operating information presented below, as explained in footnote 1 to
the table in "_Results of Operations" above. Gross profit amounts and
percentages discussed below are also calculated on a consistent basis
with the revenues reported below. See Note 10 to the Company's
Consolidated Financial Statements.
FLEXIBLE INDUSTRIAL STAFFING:
Net revenues from the Company's staffing services increased $6.3
million, to $221.4 million for YTD 1999 from $215.1 million for YTD
1998, or an annualized growth rate of 2.9%. Staffing's share of the
Company's total net revenues decreased to 50.7% for YTD 1999 from 52.6%
for YTD 1998, reflecting a lower internal growth rate for staffing
services as well as the Company's discontinuance of staffing
acquisitions since October 1998. The Company expects this relatively
lower internal growth rate and the absence of acquisition activity to
29
continue for the remainder of 1999 and at least the first six months of
2000. Also, in connection with the Restructuring, as of September 30,
1999 the Company has sold or identified for sale to third parties 12
Tandem offices. As a result, the Company expects industrial staffing's
share of the Company's total net revenues to continue to decline
throughout 1999, unless and until Synadyne, the PEO division, is sold.
Gross profit from the Company's staffing services decreased $2.3
million, to $46.1 million for YTD 1999 from $48.4 million for YTD 1998,
or an annualized decrease of 4.7%. Consistent with the revenue trend
discussed above, this represented a decreased share of the Company's
total gross profit, to 75.5% for YTD 1999 from 77.9% for YTD 1998.
PEO:
Net revenues from the Company's PEO services increased $21.7 million,
to $204.5 million for YTD 1999 from $182.8 million for YTD 1998, or an
annualized growth rate of 11.9%. Due to a higher internal growth rate
for PEO services as well as the Company's discontinuance of staffing
acquisitions since October 1998, PEO revenues represented an increased
share of the Company's total net revenues, to 46.8% for YTD 1999 from
44.7% for YTD 1998. The Company expects that PEO sales growth will
continue at its present rate during most of 1999. The Company is
currently attempting to sell the Synadyne division, which is the
largest component of the Company's PEO operations.
Approximately 20% of the Company's YTD 1999 PEO revenues (24% of
Synadyne's YTD 1999 revenues) were from services performed for
individual insurance agent offices under a preferred provider
designation previously granted to the Company on a regional basis by
the agents' common corporate employer. The corporate employer recently
began granting that designation on a national basis only and the
Company has been granted that designation for 1999. In November 1999,
the common corporate employer announced its intent to convert
approximately 43% of its agents to independent contractor status, and
to terminate approximately 10% of its non-agent workforce, beginning in
May 2000. These changes could affect the preferred provider program,
reduce the number of agents utilizing the Company's services and/or the
level of services utilized by those agents. Approximately 21% of the
above revenue attributed to this common corporate employer comes from
agents that were already independent contractors as of September 30,
1999. In addition, the Company is aware of litigation that has been
pending for more than one year against that corporate employer
regarding its use of professional employer organization and staffing
services in general and the need to provide additional benefits to
those employees in particular. The Company has not determined what
impact, if any, that the ultimate result of these developments will
have on its financial position or results of operations.
Gross profit from the Company's PEO services increased $1.4 million, to
$8.1 million for YTD 1999 from $6.7 million for YTD 1998, or an
annualized growth rate of 19.7%. This also represented an increased
share of the Company's total gross profit, to 13.2% for YTD 1999 from
10.8% for YTD 1998.
FRANCHISING:
Net revenues from the Company's franchising operations increased $0.5
million, to $5.5 million for YTD 1999 from $5.0 million for YTD 1998,
or an annualized growth rate of 10.4%. Franchising operations
represented an increased share of the Company's total net revenues, to
1.3% in YTD 1999 from 1.2% for YTD 1998, reflecting buyout payments
received in 1999 from former franchisees and the 18.7% growth in
revenues of franchises operating as of September 30, 1999. The Company
allowed the early termination (buyout) of certain franchise agreements
in 1998 and 1999, attributable to 18 locations, to enable the Company
to develop the related territories. Due to the reduced number of
remaining franchises, the Company does not anticipate buyout payments
in the future to be of the magnitude recorded in YTD 1999, although the
Company expects to continue to convert select franchise locations to
Company-owned locations after 1999 and to allow terminations of
franchise agreements in key markets that the Company believes it can
develop further. Such acquisitions and terminations will be subject to
the Company's ability to negotiate them on acceptable terms. The
Company also expects to continue to sell new franchises in smaller,
less populated geographic areas, and to sell franchise rights to
certain existing Company-owned locations that the Company believes are
30
not sufficiently profitable or no longer fit in its clustering market
strategy. See "__General" above. Franchise sales will be subject to,
among other factors, the success of the Company's marketing efforts in
this regard. The Company has sold 12 new franchise locations in YTD
1999 (seven in Q3 1999), as compared to 11 new franchise locations in
1998 and seven new franchise locations in 1997. The Company expects its
base franchising revenues from existing and new franchises to continue
growing at the present rate for the remainder of 1999 and 2000,
although total franchising revenue trends may be affected by variations
in buyout revenue.
Gross profit from the Company's franchising operations increased $0.5
million, to $5.5 million for YTD 1999 from $5.0 million for YTD 1998,
or an annualized growth rate of 10.4%. Consistent with the revenue
trend discussed above, this area represented an increased share of the
Company's total gross profit, to 9.0% for YTD 1999 from 8.0% for YTD
1998.
SEASONALITY
The Company's quarterly results of operations reflect the seasonality
of higher customer demand for industrial staffing services in the last
two quarters of the year, as compared to the first two quarters. In
1998, the seasonal increase in industrial staffing revenue was lower
than that experienced in prior years, which the Company attributes to
slower economic activity in U.S. manufacturing and distribution. The
Company believes there is evidence that this sector has begun to
improve in 1999, although there can be no assurance that this trend
exists or will continue.
Though there is a seasonal reduction of industrial staffing revenues in
the first two quarters of a year as compared to the third and fourth
quarters of the prior year, the Company does not reduce the related
core personnel and other operating expenses proportionally. The related
core personnel and other operating expenses are not reduced because
most of 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 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 industrial staffing revenues. As a result of the above
factors, the Company historically experiences operating income in the
first two quarters of a year that is significantly less than (i) the
third and fourth quarters of the preceding year and (ii) the subsequent
quarters of the same year, although this will not be the case in 1999
due to charges related to the Restructuring and the impairment of
goodwill and other long-lived assets, among other things.
LIQUIDITY AND CAPITAL RESOURCES
DEBT AND OTHER FINANCING
The Company's primary sources of funds for working capital and other
needs are (i) a $28.4 million credit line (the "Revolving Credit
Facility") and (ii) a $50.0 million credit facility, based on and
secured by the Company's accounts receivable (the "Receivable
Facility"). Both facilities are provided by a syndicate of lenders led
by BankBoston, N.A. and expire on December 31, 1999. The Company is
currently negotiating with the lenders syndicate and potential new
lenders to provide financing for some period after December 31, 1999,
under a mutually acceptable structure and terms. See "__Future
Liquidity".
The above agreements, which were finalized on October 5, 1999 (a)
replaced the previously existing $50.0 million securitization facility
and (b) amended the previously existing $29.9 million revolving credit
facility (which included letters of credit of $8.4 million) to (i)
reduce the maximum availability to $28.4 million, including existing
letters of credit of $6.4 million, (ii) eliminate certain financial
covenants and (iii) add events of default, including a provision
enabling the lenders syndicate to increase the stated interest rate
and/or accelerate the maturity date of the facility if, in their sole
discretion, the lenders are not satisfied with the Company's business
operations or prospects. The new agreements also contain terms that
increase the weighted average interest rate payable on the outstanding
balances during the period, exclusive of related fees and expenses and
not including a higher default rate, to approximately 10.8% per annum,
compared to approximately 7.1% per annum under the old agreements.
The Receivable Facility bears interest at BankBoston's base (prime)
rate plus 2.0% per annum (currently 10.25%), while the Revolving Credit
Facility bears interest at base plus 2.5% per annum in October 1999,
base plus 4.0% per annum in November 1999 and base plus 5.0% per annum
thereafter. In addition, the Company paid an initial fee related to the
31
Receivable Facility that is approximately equal to another 1.0% per
annum for the three-month term of that loan plus legal fees and other
expenses related to both facilities totaling approximately $0.3
million, most of which was expensed in the third quarter of 1999.
The previously existing securitization facility was a financing
arrangement under which the Company could sell up to a $50.0 million
secured interest in its eligible accounts receivable to EagleFunding
Capital Corporation ("Eagle"), which used the receivables to secure A-1
rated commercial paper (the "Securitization Facility"). The Company's
cost for this arrangement was classified as interest expense and was
based on the interest paid by Eagle on the balance of the outstanding
commercial paper, which in turn was determined by prevailing interest
rates in the commercial paper market and was approximately 5.45% as of
September 30, 1999. As of September 30, 1999, a $46.9 million interest
in the Company's uncollected accounts receivable had been sold under
this agreement, which amount is excluded from the accounts receivable
balance presented in the Company's consolidated financial statements.
Outstanding amounts under the Revolving Credit 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 Credit Facility incurred interest
primarily at the Eurodollar rate prior to June 30, 1999 and at
BankBoston's base rate plus a margin based upon the ratio of the
Company's total indebtedness to the Company's earnings (as defined in
the Revolving Credit Facility). As of September 30, 1999, the Company
had outstanding borrowings under the Revolving Credit Facility of $17.8
million, bearing interest at an annualized rate of 9.0%.
In order to remain in compliance with certain covenants in the
Revolving Credit Facility, and to reduce the cash impact of scheduled
payments under its subordinated acquisition debt, during 1999 the
Company had negotiated extensions of the payment dates and modified the
interest rates and other terms of certain of its acquisition notes
payable subordinated to the Revolving Credit Facility. As of August 12,
1999 the Company had not made all of the scheduled payments due and, as
a result, at that time became in default of this debt having a total
principal outstanding of $9.2 million as of September 30, 1999, but
subsequently reduced to $6.9 million in connection with the Company's
sale of certain operations as part of the Restructuring and related
actions. See Notes 2 and 3 to the Company's Consolidated Financial
Statements. Due to the subordinated status and other terms of the debt,
the remaining payees are unable to take collection actions against the
Company for at least six months. Acceleration of this debt requires
prior written notice to the Company by the various payees, which has
been received from five of fourteen remaining payees as of November 8,
1999. See Notes 5 and 7 to the Company's Consolidated Financial
Statements.
In addition to the indebtedness discussed above, as of September 30,
1999 the Company had (i) bank standby letters of credit outstanding in
the aggregate amount of $6.4 million (which are issued as part of the
Revolving Credit Facility, although reduction of letters of credit does
not currently result in additional borrowing capacity) to secure the
pre-1999 portion ($4.8 million) of the workers' compensation
obligations recorded as a current liability on the Company's balance
sheet; (ii) obligations under capital leases for property and equipment
in the aggregate amount of $3.3 million; (iii) obligations under
mortgages totaling $4.1 million and (iv) obligations for insurance
premiums and other matters totaling $0.6 million. The Company expects
that in November 1999 the outstanding letters of credit will be reduced
by approximately $2.0 million, to more closely correlate with the
accrued liability supported by the letters of credit.
HISTORICAL SUMMARY OF CASH FLOWS
The Company's principal uses of cash are for wages and related payments
to temporary and PEO employees, operating costs, acquisitions, capital
expenditures and repayment of debt and interest thereon. For YTD 1999,
no cash was provided by operations, primarily due to restructuring
costs, short-term increases in professional fees, additional cash
payments caused by the change in the Company's workers' compensation
program described below, and operating losses. Cash provided by
operations was $47.0 million in YTD 1998, primarily due to the
Company's sale of a significant portion of its trade accounts
receivable under the Securitization Facility when it was first
established in 1998 see "__Debt and Other Financing". Cash provided by
investing activities during YTD 1999 was approximately $2.5 million,
compared to $30.6 million used in YTD 1998, primarily expenditures of
$27.9 million for
32
acquisitions (primarily intangible assets). Cash used in financing
activities during YTD 1999 was approximately $6.7 million, comprised
primarily of a $3.2 million net repayment of the Revolving Credit
Facility and $3.5 million of repayments of long-term debt. Cash used in
financing activities during YTD 1998 was approximately $14.5 million,
composed primarily of $14.0 million in net repayments of the Revolving
Credit Facility and $3.5 million of repayments of long-term debt,
offset by a $3.4 million increase in the Company's liability for
outstanding payroll checks (in excess of the funded bank balances). The
net reduction of the Revolving Credit Facility during YTD 1998 was
primarily due to the Company's application of proceeds received from
the sale of its trade accounts receivable under the Securitization
Facility.
WORKERS' COMPENSATION
Prior to 1999, the Company secured its workers' compensation
obligations by the issuance of bank standby letters of credit to its
insurance carriers, minimizing the required current cash outflow for
such items. In 1999, the Company selected a pre-funded deductible
program whereby expected claims expenses are funded in advance in
exchange for reductions in administrative costs. The required advance
funding is provided through either cash flows from operations or
additional borrowings under the Revolving Credit Facility.
In July and November 1999, the Company renegotiated the schedule of
payments due under the pre-funded deductible program, in order to
improve its liquidity. As a result of both negotiations, the original
$13.3 million total of the 1999 payments was reduced to $11.4 million,
the originally scheduled May and June payments were deferred and
incorporated into revised monthly payments for the remainder of the
year and the originally scheduled December payment was substantially
eliminated. The revised schedule resulted in payment of 27% of the
revised annual total in the third quarter and calls for 46% of the
revised annual total to be paid in the fourth quarter. The Company is
evaluating whether to continue this pre-funded deductible program in
2000, which may have a cost advantage or to revert to letter of credit
backing for its unfunded liabilities, which may have a liquidity
advantage.
ACCOUNTS RECEIVABLE
The Company is a service business and therefore a majority of its
tangible assets are customer accounts receivable. 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, 30 to 60 days from the presentation date of the invoice.
Beginning in the fourth quarter of 1998, the Company experienced an
increase in the percentage of its staffing accounts receivable that are
past due. As a result, the Company has taken several actions including,
among other things, increasing the number of employees focusing on
accounts receivable issues and establishing employee compensation plans
based on satisfactory collections, which it believes has begun to
satisfactorily address this issue so that there is no adverse long-term
impact to the Company. In the event that new staffing offices are
established or acquired, or as existing offices expand, there will be
increasing requirements for cash to fund operations, primarily
receivables. However, the disposition of 20 staffing offices as part of
the Restructuring during the third and fourth quarters of 1999, will
decrease the requirements for cash to fund operations, unless the
customer activity handled in a closed location is transferred to
another Company-owned location. The Company currently expects its
accounts receivable to decrease by approximately $2.0 million related
to the 12 staffing offices being sold to third parties, although the
working capital benefit will be substantially less due to the
corresponding reduction in liabilities such as accrued payroll, payroll
taxes and workers' compensation.
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 80% (based on revenues) of its
existing customers, with the remainder paying on average 30 to 45 days
33
from the presentation date of the invoice. If and when Synadyne is
sold, the Company expects its accounts receivable to decrease by
approximately $8.0 million, although the working capital benefit will
be substantially offset by the corresponding reduction in liabilities
such as accrued payroll, payroll taxes and workers' compensation.
On November 4, 1999, the Company sold certain trade accounts
receivable, with a face value of approximately $4.3 million and
primarily more than 180 days past due, to unrelated third parties for
proceeds of approximately $220,000. As of September 30, 1999, the
Company had recorded an additonal $2.7 million in the provision for
doubtful accounts and as a result these receivables were fully reserved
for the difference between the face value and the proceeds.
CAPITAL EXPENDITURES
One of the key elements of the Company's growth strategy in 1997 and
1998 had been expansion through acquisitions, which require significant
sources of financing. The Company has decided not to complete further
acquisitions until its internal revenue growth rate and the resulting
operating performance of its existing locations improve. The financing
sources for its acquisitions had been cash from operations, seller
financing, bank financing and issuances of the Company's Common Stock.
The Company's acquisitions were primarily in the industrial staffing
area, and, if and when it resumes acquisition activity, the Company
expects this trend to continue, consistent with a primary objective of
the current Restructuring, which is to focus the Company's operations
within the industrial staffing area.
The Company anticipates spending up to $2.0 million during the next
twelve months to improve its management information and operating
systems, upgrade existing locations and other capital expenditures
including, but not limited to, opening new staffing locations.
FUTURE LIQUIDITY
The Company has announced several recent actions that are expected to
improve the Company's liquidity, both immediately and over a longer
period of time, including the divestiture of certain Company operations
and reduction of its workforce (see "__General" above and Note 2 to the
Company's Consolidated Financial Statements). Although there can be no
assurances, the Company expects that the current lenders syndicate will
continue to extend adequate financing through December 31, 1999 to meet
the Company's needs, based on this ongoing restructuring of Company
operations. The Company is currently negotiating with the lenders
syndicate and potential new lenders to provide financing for some
period after December 31, 1999, under a mutually acceptable structure
and terms. The Company could experience liquidity problems depending on
the ability and willingness of the lenders syndicate to continue
lending to the Company, and the availability and cost of financing from
alternative sources.
Based on its recent discussions with the lenders syndicate and other
financing sources, the Company believes that it will be able to replace
or extend the Receivable Facility under similar terms, including
interest rates, for a period subsequent to December 31, 1999; however,
the Company believes that the Revolving Credit Facility, which had a
$24.2 million outstanding balance (including letters of credit of $6.4
million) as of September 30, 1999, will need to be replaced by a
combination of medium-term debt secured primarily by property and
equipment and a second lien on accounts receivable ("Term Debt") and
medium-term subordinated debt ("Subordinated Debt"). The Term Debt
would be expected to bear interest between 8.0% to 10.0% per annum and
the Subordinated Debt would be expected to bear interest between 10.0%
to 13.0% per annum, plus warrants providing an ownership interest in
the Company sufficient to increase the total yield to 25.0% to 30.0%
per annum. The Company expects that the combined Term Debt and
Subordinated Debt will be approximately $15.0 to $20.0 million based on
and subject to the following items affecting liquidity in addition to
the results of the Company's operations in the fourth quarter of 1999:
(i) net after-tax proceeds from the sale of the corporate support
center building, the Synadyne division and the Tandem branches
identified for disposition, (ii) successful renegotiation of the
payment schedules for the defaulted and/or accelerated subordinated
acquisition debt and (iii) higher working capital requirements due to
increased workers' compensation payments for the 1999 program in the
fourth quarter of 1999, as discussed above.
34
The Company believes that funds provided by operations, asset sales,
borrowings under the Revolving Credit Facility and the Receivable
Facility, or replacement facilities, and current cash balances will be
sufficient to meet its presently anticipated needs for working capital
and capital expenditures, not including new acquisitions, for the next
twelve months. Significant new acquisitions, which the Company does not
expect to pursue during the next twelve months, would require expanded
or new borrowing facilities, issuance of Common Stock and/or additional
debt or equity offerings. There can be no assurance that additional or
replacement capital will be available to the Company on the above
described terms or on any other acceptable terms. If long-term
financing is not obtained by the Company, its financial condition, cash
flows and results of operations could be materially and adversely
affected.
ACQUISITIONS
From 1995 to 1998, the Company made 34 staffing acquisitions including
88 offices and approximately $180.0 million in revenues for the twelve
months preceding each acquisition. These acquisitions have resulted in
a significant increase in goodwill and other intangible assets and
correspondingly have 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.
During the third quarter of 1999, the Company wrote off approximately
$5.0 million of these intangible assets, $2.5 million representing the
excess of the book value over the expected net realizable value of
assets identified for disposition and expensed as part of the third
quarter 1999 restructuring charge and another $2.5 million related to
assets to be retained by the Company that were considered impaired
based on its analysis of anticipated discounted future cash flows at
that time. See Notes 2 and 3 to the Company's Consolidated Financial
Statements. While the remaining net unamortized balance of intangible
assets as of September 30, 1999 is not considered to be impaired, any
future determination requiring the write-down of a significant portion
of unamortized intangible assets could have a material adverse effect
on the Company's financial condition and results of operations.
As of November 8, 1999, no acquisitions were made during 1999 and it is
not anticipated that any acquisitions will be made in the next twelve
months.
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.
NEW ACCOUNTING PRONOUNCEMENTS
In June 1998, Statement of Financial Accounting Standards ("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, as modified by SFAS No. 137, is effective for all fiscal
quarters of fiscal years beginning after June 15, 2000, and cannot be
applied retroactively. The Company intends to implement SFAS No. 133 in
its consolidated financial statements as of and for the three months
ended March 31, 2001, 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.
35
YEAR 2000 ISSUE
As many computer systems, software programs and other equipment with
embedded chips or processors (collectively, "Information Systems") use
only two digits rather than four to define the applicable year, they
may be unable to process accurately certain data, during or after the
year 2000. As a result, business and governmental entities are at risk
for possible miscalculations or systems failures causing disruptions in
their business operations. This is commonly known as the Year 2000
("Y2K") issue. The Y2K issue concerns not only Information Systems used
solely within a company but also concerns third parties, such as
customers, vendors and creditors, using Information Systems that may
interact with or affect a company's operations.
The Y2K issue can affect the Company's flexible staffing and PEO
operations, including, but not limited to, payroll processing, cash and
invoicing transactions, and financial reporting and wire transfers from
and to the Company's banking institutions. 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 ("Core Applications"). Although this
conversion was undertaken for the primary purpose of achieving a common
data structure for all significant Company applications as well as
enhancing processing capacity and efficiency, the Company believes that
it also will result in software that properly interprets dates beyond
the year 1999 ("Y2K Compliant").
THE COMPANY'S STATE OF READINESS:
The Company has implemented a Y2K readiness program with the objective
of having all of the Company's significant Information Systems
functioning properly with respect to Y2K before January 1, 2000. The
first component of the Company's readiness program was to identify the
internal Information Systems of the Company that are susceptible to
system failures or processing errors as a result of the Y2K issue. This
effort was completed during the second quarter of 1999. The second
component of the Y2K readiness program involved the actual remediation
and replacement of Information Systems. The Company has used both
internal and external resources to complete this process. Information
Systems ranked highest in priority, such as the corporate accounting
and billing software, have been remediated or replaced. The remediation
and replacement of internal Information Systems and Information Systems
utilized in franchise locations, including the final testing and
certification for Y2K readiness, was completed in the third quarter of
1999. The Company has retained a consulting firm to perform a third
party review of its Core Applications, which review was completed
recently and no additional remediation needs were identified. The
Company also completed the final phase of remediation for its
desktop-related hardware in October 1999.
As to the third component of the Y2K readiness program, the Company has
identified its significant customers, vendors and creditors that are
believed, at this time, to be critical to business operations
subsequent to January 1, 2000, and has requested and received
assurances that these companies are Y2K ready. The Company has been
notified by the bank which is responsible for processing payroll
transactions for all Synadyne customers and core Company employees that
it is unable to electronically load the Company's existing payee
database into the Y2K Compliant version of their automated clearing
house (ACH) payment software. The Company believes that it will be able
to manually load this database in sufficient time to avoid disruptions
in these processes or if not, that it will be able to adequately
process payrolls using alternative methods such as checks until the
database is loaded. There can be no assurance, however, that the
Information Systems provided by or utilized by other companies which
affect the Company's operations will be timely converted in such a way
as to allow them to continue normal business operations or furnish
products, services or data to the Company without disruption.
RISKS:
If needed remediations and conversions to the Information Systems were
not properly completed by the Company or its materially-significant
customers or vendors, the Company could be affected by business
36
disruption, operational problems, financial loss, legal liability to
third parties and similar risks, any of which could have a material
adverse effect on the Company's operations, liquidity or financial
condition. Although not anticipated, the most reasonably likely worst
case scenario in the event the Company or its key customers or vendors
fail to resolve the Y2K issue would be an inability on the part of the
Company to perform its core functions of payroll administration, tax
reporting, unemployment and insurance claims filings, billing and
collections, and health benefits administration. Factors which could
cause material differences in results, many of which are outside the
control of the Company, include, but are not limited to, the Company's
ability to identify and correct all relevant computer software, the
accuracy of representations by manufacturers of the Company's
Information Systems that their products are Y2K Compliant, the ability
of the Company's customers and vendors to identify and resolve their
own Y2K issues and the Company's ability to respond to unforeseen Y2K
complications.
CONTINGENCY PLANS:
While the Company continues to focus on solutions for Y2K issues, and
expects to be Y2K Compliant in a timely manner, the Company,
concurrently with the Y2K readiness measures described above, has
established a Y2K project team whose mission is to develop contingency
plans intended to mitigate the possible disruption in business
operations that may result from the Y2K issue. The Company's Y2K
project team, consisting of personnel from management, information
systems/technology and legal areas, has developed such plans and the
cost estimates to implement them. Contingency plans include purchasing
or developing alternative software programs, the purchase of computer
hardware and peripheral equipment, and other appropriate measures.
Contingency plans and related cost estimates will be continually
refined, as additional information becomes available.
Y2K COSTS:
The Company's management estimates that the total cost to the Company
of its Y2K compliance activities will not exceed $200,000, which is not
considered material to the Company's business, results of operations or
financial condition. The costs and time necessary to complete the Y2K
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 Y2K Compliant Information Systems, but
will expense the costs of the modifications to existing hardware and
software made solely for purposes of Y2K compliance. Most of the cost
of purchasing or modifying software in this regard had been incurred as
of March 31, 1999. Any remaining capitalized balance for Information
Systems no longer utilized because of replacement by Y2K Compliant
Information Systems will be expensed at the time such hardware and
software is replaced. The Company's Y2K readiness program is an ongoing
process and the estimates of costs and completion dates for various
components of the Y2K readiness program described above are subject to
change.
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, the
Restructuring and related actions, expected sales and other operating
results, seasonality, inflation, the effect of changes in the Company's
gross margin and operating expenses, the Company's liquidity,
anticipated capital spending, the availability and cost of financing,
equity and working capital to meet the Company's future needs, economic
conditions in the Company's market areas, the exposure to certain
regulatory and tax issues, 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 changes in U.S. economic
conditions, particularly in the manufacturing sector; the Company's
dependence on regulatory approvals; its future cash flows, sales, gross
margins and operating costs, including the Company's ability to
implement and maintain cost reductions in connection with the
Restructuring; the Company's ability to sell or otherwise dispose of
non-strategic assets under satisfactory terms and timing; the effect of
changing market and other conditions in the staffing industry; the
ability of the Company to continue to grow; legal proceedings,
including those related to the actions of the Company's temporary or
leased employees; the availability and cost of financing; the ability
to maintain existing banking relationships and to establish new ones;
the Company's ability to raise capital in the public equity markets;
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,
manufacturing, distribution and other light industrial trades;
increased price competition; changes in and the Company's ability to
comply with government regulations or interpretations thereof,
particularly those related to employment; the continued availability of
qualified temporary personnel; the financial condition of the Company's
37
clients and their demand for the Company's services (which in turn may
be affected by the effects of, and changes in, U.S. and worldwide
economic conditions); 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; volatility in the
workers' compensation, liability and other insurance markets; inclement
weather; interruption, impairment or loss of data integrity or
malfunction of information processing systems; changes in government
regulations or interpretations thereof, particularly those related to
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, the proportion of the
Company's stock available for active trading, the exchange listing
options available to and/or chosen by the Company 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, the
Company's Form 10-K for the year ended December 31, 1998, Form 10-Q for
the quarters ended March 31, 1999 and June 30, 1999 and the Company's
Registration Statement on Form S-3 (File No. 333-69125), including the
"Risk Factors" section thereof, filed with the Securities and Exchange
Commission on December 17, 1998, and declared effective on January 6,
1999.
38
ITEM 3 - QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
In seeking to minimize the risks and/or costs associated with its
borrowing activities, the Company had entered into a derivative
financial instrument transaction to maintain the desired level of
exposure to the risk of interest rate fluctuations and to minimize
interest expense. This financial instrument was terminated on June 30,
1999 - See Note 5 to the Company's Consolidated Financial Statements
for additional information. This hedge did not result in a material
change in the Company's recorded interest expense while it was in
effect, as the underlying interest rates were below the ceiling
designated in the hedge. Furthermore, these underlying interest rates
as of September 30, 1999 were also below the ceiling designated in the
hedge.
As part of recent changes made to the Revolving Credit Facility,
subsequent to June 30, 1999 the lenders syndicate did not allow the
Company to choose Euro rate borrowings, which resulted in an effective
increase in the Company's borrowing rate under that facility of
approximately 0.8% per annum. In addition, new banking agreements
entered into by the Company on October 5, 1999 contain terms that
increased the weighted average interest rate payable on the outstanding
balances, exclusive of related fees and expenses and not including a
higher default rate, from approximately 7.1% per annum to approximately
10.8% per annum. See Note 5 to the Company's Consolidated Financial
Statements. These increases were based on the bank's credit assessment
of the Company and were not as a result of or reflective of market
risk.
Although the proportion of the Company's interest bearing debt
classified as a current liability has increased significantly since
December 31, 1998, this is primarily a reflection of acceleration or
modification of debts due to the Company's payment or covenant default
and does not indicate a significant change in the relative proportion
of fixed rate versus variable rate debt carried by the Company since
December 31, 1998.
Accordingly, there has been no material change in the Company's
assessment of its sensitivity to market risk as of September 30, 1999,
as compared to the information included in Part II, Item 7A,
"Quantitative and Qualitative Disclosures About Market Risk", of the
Company's Form 10-K for the year ended December 31, 1998, as filed with
the Securities and Exchange Commission on March 31, 1999.
39
PART II - OTHER INFORMATION
ITEM 1 - LEGAL PROCEEDINGS
As previously disclosed in the Company's 10-K filed with the Securities
and Exchange Commission on March 31, 1999, on November 12, 1997, an
action was commenced against the Company in the Circuit Court for
Oakland County, Michigan under the title Vervaecke vs. OutSource
International, Inc., et al (Case No. 97-1283-CL). The plaintiff and the
Company settled this case in the third quarter of 1999, with no
material impact on the Company's past or future financial condition or
results of operations.
ITEM 3 - DEFAULTS UPON SENIOR SECURITIES
As discussed in Note 5 to the Company's Consolidated Financial
Statements, the Company was not in compliance with the financial
covenants included in its Revolving Credit Facility as of June 30,
1999, although the lenders syndicate waived such non-compliance until
amendments and replacement agreements were executed on October 5, 1999.
These agreements, among other things, eliminated those financial
covenants.
ITEM 5 - OTHER INFORMATION
Effective August 2, 1999, J.G. (Pete) Ball, a principal of Crossroads
Capital Partners, LLC, agreed to serve in the newly created position of
interim chief operating officer of the Company and President of the
Tandem division during the restructuring process. Mr. Ball will work
with the Board of Directors and senior management to ensure the
Company's new business plan, as a result of the restructuring, is
implemented. See Note 6 to the Company's Consolidated Financial
Statements.
Effective August 5, 1999, Ronald Blain resigned his position as
Tandem's chief operating officer. The Company has contracted with an
executive search firm to identify a new President and CEO of Tandem.
Effective August 4, 1999, Carolyn Noonan joined the Company as Vice
President and Controller, the Company's principal accounting officer,
and Robert Tomlinson, formerly Chief Accounting Officer, was appointed
as Vice President and the Company's Treasurer.
In order to maintain listing on the Nasdaq National Market, the
Company's common stock must be in compliance with various criteria,
including a minimum level of market value of public float. In November
1999, the Company was notified by Nasdaq-Amex that unless the Company's
common stock demonstrates compliance with the required level of market
value of public float prior to January 27, 2000, the Company will have
to apply for listing on The Nasdaq SmallCap Market. The Company is
considering all its options, including the right to appeal.
40
ITEM 6 - EXHIBITS AND REPORTS ON FORM 8-K
(A) EXHIBITS:
Number Description
3.1 Amended and Restated Articles of Incorporation of the
Company (1)
3.2 Amended and Restated Bylaws of the Company (2)
4.3 Shareholder Protection Rights Agreement (2)
4.6 Warrant Dated February 21, 1997 Issued to Triumph-Connecticut
Limited Partnership (3)
4.7 Warrant Dated February 21, 1997 Issued to Bachow Investment
Partners III, L.P. (3)
4.8 Warrant Dated February 21, 1997 Issued to State Street Bank
and Trust Company of
Connecticut, N.A., as Escrow Agent (3)
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. (4)
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.(4)
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 (4)
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. (4)
10.50 First Amendment to Third Amended and Restated Credit Agreement
among OutSource International, Inc., each of the banks party to
the Credit Agreement and BankBoston, N.A., as agent for the
banks, dated as of February 22, 1999. (5)
10.51 Temporary Waiver and Second Amendment to Third Amended and
Restated Credit Agreement among OutSource International, Inc.,
its subsidiaries, each of the banks party to the Credit
Agreement and BankBoston, N.A., as agent for the banks, dated
as of June 30, 1999. (6)
10.53 Third Temporary Waiver to Third Amended and Restated Credit
Agreement among outsource International, Inc., its
subsidiaries, each of the banks party to the Credit Agreement
and BankBoston, N.A., as agent for the banks, dated as of
August 5, 1999. (6)
10.55 Third Amendment to Third Amended and Restated Credit Agreement
among Outsource International, Inc., Capital Staffing Fund,
Inc., Outsource Franchising, Inc., Synadyne I, Inc., Synadyne
II, Inc., Synadyne III, Inc., Synadyne IV, Inc., Synadyne V,
Inc., Employees Insurance Services, Inc., Outsource
International of America, Inc., Mass Staff, Inc., Staff All,
Inc., Outsource of Nevada, Inc., Employment Consultants, Inc.,
X-tra Help, Inc., Co-Staff, Inc., Guardian Employer East, LLC,
Guardian Employer West, LLC, each of the bank parties to the
Credit Agreement and BankBoston, N.A., as Agent for the banks,
dated as of October 1, 1999. (7)
10.56 Revolving Credit Agreement among Outsource Funding Corporation,
the banks from time to time parties thereto, and BankBoston,
N.A., as Agent for the banks, dated as of October 1, 1999. (7)
10.57 Amended and Restated Receivables Purchase and Sale Agreement
dated as of October 1, 1999 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. (7)
10.90 Engagement Letter between OutSource International, Inc. and
Crossroads Capital Partners LLC, dated as of May 7, 1999 and
three addenda dated June 18, July 1 and August 2, 1999. (6)
10.91 Finder Services Agreement between OutSource International, Inc.
and Crossroads Capital Partners LLC dated as of June 30, 1999.
(6)
27 Financial Data Schedule
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(1) 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.
(2) 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.
(3) 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.
(4) Incorporated by reference to the exhibits to the Company's Form
10-Q for the quarterly period ended June 30, 1998, as filed with the
Securities and Exchange Commission on August 14, 1998.
41
(5) Incorporated by reference to the exhibits to the Company's Form
10-K for the year ended December 31, 1998, as filed with the Securities
and Exchange Commission on March 31, 1999.
(6) Incorporated by reference to the exhibits to the Company's Form
10-Q for the quarterly period ended June 30, 1999, as filed with the
Securities and Exchange Commission on August 16, 1999.
(7) Incorporated by reference to the exhibits to the Company's Form
8-K, as filed with the Securities and Exchange Commission on October
19, 1999.
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(B) REPORTS ON FORM 8 - K:
No reports were filed on Form 8-K during the quarter ended September
30, 1999. However, the Company filed an 8-K on October 19, 1999 that
included information with regards to the following:
(i) various banking agreements entered into during October 1999 that,
among other things, (a) replaced the previously existing securitization
facility with a $50.0 million credit facility based on and secured by
the registrant's accounts receivable, expiring December 31, 1999 and
(b) amended the previously existing $29.9 million revolving credit
facility to reduce the maximum availability to $28.4 million, including
existing letters of credit of $6.4 million, and modified the expiration
date from July 27, 2003 to December 31, 1999 and
(ii) a change in the Company's fiscal year from the calendar year
ending December 31 to the 52 or 53 week period ending on the Sunday
closest to March 31. The report covering the transition period (from
January 1, 2000 through April 2, 2000) will be filed on Form 10-K.
42
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: November 15, 1999 By: /s/ Paul M. Burrell
---------------------
Paul M. Burrell
President, Chief Executive Officer and
Chairman of the Board of Directors
Date: November 15, 1999 By: /s/ Scott R. Francis
----------------------
Scott R. Francis
Chief Financial Officer
(Principal Financial Officer)
43
EXHIBIT INDEX
Exhibit No. Description
27 Financial Data Schedule