1
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
---------
[x] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 2002
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from _________to__________
Commission File Number 0-26094
SOS STAFFING SERVICES, INC.
---------------------------
(Exact name of registrant as specified in its charter)
Utah 87-0295503
- ---------------------------- ----------------------
(State or other jurisdiction (.R.S. Employer ID No.)
of incorporation)
1415 South Main Street
Salt Lake City, Utah 84115
----------------------------------------
(Address of principal executive offices)
(801) 484-4400
------------------
(Telephone number)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities and Exchange Act of 1934
during the preceding 12 months (or for such shorter period that the registrant
was required to file such reports), and (2) has been subject to such filings
requirements for the past 90 days.
Yes [ X ] No [ ]
-
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date.
Class of Common Stock Outstanding at August 6, 2002
--------------------- -----------------------------
Common Stock, $0.01 par value 12,691,398
1
TABLE OF CONTENTS
-----------------
PART I - FINANCIAL INFORMATION
Item 1. Unaudited Financial Statements
Condensed Consolidated Balance Sheets
As of June 30, 2002 and December 30, 2001 3
Condensed Consolidated Statements of Operations
For the 13- and 26-week periods ended June 30, 2002 and July 1, 2001 5
Condensed Consolidated Statements of Cash Flows
For the 13- and 26-week periods ended June 30, 2002 and July 1, 2001 6
Notes to Condensed Consolidated Financial Statements 8
Item 2. Management's Discussion and Analysis
of Financial Condition and Results of Operations 17
Item 3. Qualitative and Quantitative Disclosures About Market Risk 23
PART II - OTHER INFORMATION
Item 1. Legal Proceedings 24
Item 4. Submission of Matters to a Vote of Security Holders 23
Item 6. Exhibits and Reports on Form 8-K 24
Signatures 25
2
The accompanying notes
are an integral part of these condensed consolidated statements
4
PART I - FINANCIAL INFORMATION
Item 1. Financial Statements
SOS STAFFING SERVICES, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(Unaudited)
ASSETS
------
(in thousands)
June 30, 2002 December 30, 2001
------------- ------------------
CURRENT ASSETS
Cash and cash equivalents $ 931 $ 879
Restricted cash 1,033 --
Accounts receivable, less allowances of
$1,213 and $2,267, respectively 18,503 21,995
Prepaid expenses and other 1,504 1,126
Income taxes receivable 3,854 367
-------- --------
Total current assets 25,825 24,367
-------- --------
PROPERTY AND EQUIPMENT, at cost
Computer equipment 5,402 6,082
Office equipment 3,439 3,808
Leasehold improvements and other 1,724 1,887
-------- --------
10,565 11,777
Less accumulated depreciation and amortization (6,682) (7,269)
-------- --------
Total property and equipment, net 3,883 4,508
-------- --------
OTHER ASSETS
Intangible assets, net 31,224 48,060
Deposits and other assets 1,991 1,808
-------- --------
Total other assets 33,215 49,868
-------- --------
Total assets $ 62,923 $ 78,743
-------- --------
The accompanying notes
are an integral part of these condensed consolidated statements
3
SOS STAFFING SERVICES, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS (Continued)
(Unaudited)
LIABILITIES AND SHAREHOLDERS' EQUITY
------------------------------------
(in thousands)
June 30, 2002 December 30, 2001
------------- -----------------
CURRENT LIABILITIES
Current portion of notes payable 4,984 5,668
Line of credit $ 2,844 $ --
Accounts payable 599 1,571
Accrued payroll costs 2,510 3,492
Current portion of workers' compensation reserve 4,286 4,484
Accrued liabilities 3,305 4,799
-------- --------
Total current liabilities 18,528 20,014
-------- --------
LONG-TERM LIABILITIES
Notes payable, less current portion 20,614 23,427
Workers' compensation reserve, less current portion 1,010 1,018
Deferred compensation and other liabilities 671 743
-------- --------
Total long-term liabilities 22,295 25,188
-------- --------
COMMITMENTS AND CONTINGENCIES
(Notes 4, 6 and 7)
SHAREHOLDERS' EQUITY
Common stock 127 127
Additional paid-in capital 91,693 91,693
Accumulated deficit (69,720) (58,279)
-------- --------
Total shareholders' equity 22,100 33,541
-------- --------
Total liabilities and shareholders' equity $ 62,923 $ 78,743
-------- --------
The accompanying notes
are an integral part of these condensed consolidated statements
4
SOS STAFFING SERVICES, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
(in thousands)
13 Weeks Ended 26 Weeks Ended
------------------------------- ---------------------------------
June 30, 2002 July 1, 2001 June 30, 2002 July 1, 2001
-------------- -------------- --------------- -------------
SERVICE REVENUES $ 46,288 $ 53,329 $ 88,226 $ 105,331
DIRECT COST OF SERVICES 37,050 41,611 70,832 82,438
-------------- -------------- --------------- -------------
Gross profit 9,238 11,718 17,394 22,893
-------------- -------------- --------------- -------------
OPERATING EXPENSES:
Selling, general and administrative 7,916 8,939 15,827 18,632
Depreciation and amortization 392 954 835 1,782
Restructuring charges 264 709 609 912
-------------- -------------- --------------- -------------
Total operating expenses 8,572 10,602 17,271 21,326
-------------- -------------- --------------- -------------
INCOME FROM OPERATIONS 666 1,116 123 1,566
-------------- -------------- --------------- -------------
OTHER INCOME (EXPENSE):
Interest expense (867) (728) (1,789) (1,548)
Interest income 3 19 9 74
Other, net (14) (13) 8 11
-------------- -------------- --------------- -------------
Total, net (878) (722) (1,772) (1,463)
-------------- -------------- --------------- -------------
(LOSS) INCOME FROM CONTINUING OPERATIONS BEFORE INCOME
TAXES (212) 394 (1,649) 104
INCOME TAX (PROVISION) BENEFIT -- (126) 7,927 (14)
(LOSS) INCOME FROM CONTINUING OPERATIONS
(212) 268 6,278 90
LOSS FROM DISCONTINUED OPERATIONS (Note 5)
(1,221) (2,346) (1,636) (3,002)
CUMULATIVE EFFECT OF CHANGE IN ACCOUNTING PRINCIPLE (net
of income tax of $0) -- -- (16,083) --
-------------- -------------- --------------- -------------
NET LOSS $ (1,433) $ ( 2,078) $ (11,441) $ ( 2,912)
============== ============== =============== =============
BASIC AND DILUTED (LOSS) INCOME PER COMMON SHARE:
(Loss) income from continuing operations $ (0.02) $ 0.02 $ 0.49 $ 0.01
Loss from discontinued operations (0.09) (0.18) (0.12) (0.24)
Loss from cumulative effect of change in accounting
principle -- -- (1.27) --
-------------- -------------- --------------- -------------
Net loss $ (0.11) $ (0.16) $ (0.90) $ (0.23)
============== ============== =============== =============
5
The accompanying notes
are an integral part of these condensed consolidated statements
SOS STAFFING SERVICES, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
(in thousands)
26 Weeks Ended
June 30, 2002 July 1, 2001
------------- -------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss $ (11,441) $ (2,912)
Adjustments to reconcile net loss
to net cash provided by operating activities:
Cumulative effect of change in accounting principle 16,083 --
Depreciation and amortization 835 2,969
Deferred income taxes -- (1,853)
Loss on disposition of assets -- 42
Loss on disposal of discontinued operations 1,065 3,307
Changes in operating assets and liabilities:
Restricted cash (1,033) --
Accounts receivable, net 3,492 15,807
Prepaid expenses and other (378) (363)
Income taxes receivable (3,487) 7,444
Deposits and other assets (183) 8
Accounts payable (972) (1,397)
Accrued payroll costs (982) (5,164)
Workers' compensation reserve (206) (513)
Accrued liabilities (1,674) (2,367)
------------- -------------
Net cash provided by operating activities 1,119 15,008
------------- -------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Issuance of notes receivable -- (2,416)
Purchases of property and equipment (425) (818)
Proceeds from sale of property and equipment 10 --
Payments of acquisition costs and earnouts -- (55)
------------- -------------
Net cash used in investing activities (415) (3,289)
------------- -------------
The accompanying notes
are an integral part of these condensed consolidated statements
6
SOS STAFFING SERVICES, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (Continued)
(Unaudited)
(in thousands)
13 Weeks Ended
June 30, 2002 July 1, 2001
------------- -------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from borrowings $ 8,821 $ 26,990
Principal payments on borrowings (9,473) (22,646)
------------- -------------
Net cash (used in) provided by financing
activities (652) 4,344
------------- -------------
NET INCREASE IN CASH
AND CASH EQUIVALENTS 52 16,063
CASH AND CASH EQUIVALENTS AT
BEGINNING OF PERIOD 879 1,185
------------- -------------
CASH AND CASH EQUIVALENTS AT
END OF PERIOD $ 931 $ 17,248
============= =============
SUPPLEMENTAL CASH FLOW INFORMATION:
Cash paid (received) during the period for:
Interest $ 2,534 $ 1,473
Income taxes (4,440) (7,444)
The accompanying notes
are an integral part of these condensed consolidated statements
7
SOS STAFFING SERVICES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
Note 1. Basis of Presentation
The accompanying unaudited condensed consolidated financial statements
have been prepared by the Company, without audit, pursuant to the rules and
regulations of the Securities and Exchange Commission. Certain information and
disclosures normally included in financial statements prepared in accordance
with accounting principles generally accepted in the United States of America
have been condensed or omitted pursuant to such rules and regulations. These
condensed consolidated financial statements reflect all adjustments (consisting
only of normal recurring adjustments) that, in the opinion of management, are
necessary to present fairly the results of operations of the Company for the
periods presented. It is suggested that these condensed consolidated financial
statements be read in conjunction with the consolidated financial statements and
the notes thereto included in the Company's Annual Report on Form 10-K for the
fiscal year ended December 30, 2001.
In order to conform to the current period presentation, certain
reclassifications have been made to the prior period financial statements. Due
to the presentation of discontinued operations for the sale of Inteliant,
ServCom and Truex, all periods in the accompanying consolidated condensed
financial statements have been presented on a comparable basis.
The results of operations for the interim periods indicated are not
necessarily indicative of the results to be expected for the full year.
Note 2. Restricted Cash
During the 26-week period ended June 30, 2002, the Company renewed its
workers' compensation policy. Under the terms of this renewed policy, the
Company is required to provide a letter of credit of $10.0 million plus $1.0
million in cash to collateralize future claims payments under the policy. The
cash amount is carried at fair value and is restricted as to withdrawal until .
The restricted cash is held in the Company's name with a major financial
institution until December 2002.
Note 3. Earnings Per Share
Basic earnings (loss) per share ("EPS") is calculated by dividing net
income (loss) by the weighted-average number of common shares outstanding for
the period. Diluted EPS is calculated by dividing net income (loss) by the
weighted-average number of common shares outstanding plus the assumed exercise
of all dilutive securities using the treasury stock method or the "as converted"
method, as appropriate. During periods of net loss from continuing operations,
all common stock equivalents are excluded from the diluted EPS calculation.
The following is a reconciliation of the numerator and denominator used
to calculate basic and diluted income (loss) from continuing operations per
common share for the periods presented (in thousands except per share amounts):
13 Weeks Ended June 30, 2002 13 Weeks Ended July 1, 2001
-------------------------------------------------------------------------------------------
Loss from Income from
continuing Per Share continuing Per Share
operations Shares Amount operations Shares Amount
-------------------------------------------------------------------------------------------
Basic $ (212) 12,691 $ (0.02) $ 268 12,691 $ 0.02
Effect of stock options -- 60
---------------------------- --------------------------------
Diluted $ (212) 12,691 $ (0.02) $ 268 12,751 $ 0.02
============================ ================================
26 Weeks Ended June 30, 2002 26 Weeks Ended July 1, 2001
Income from Income from
continuing Per Share continuing Per Share
operations Shares Amount operations Shares Amount
-------------------------------------------------------------------------------------------
Basic $ 6,278 12,691 $ 0.49 $ 90 12,691 $ 0.01
Effect of stock options 2 31
---------------------------- --------------------------------
Diluted $ 6,278 12,693 $ 0.49 $ 90 12,792 $ 0.01
============================ ================================
8
SOS STAFFING SERVICES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
At the end of the 13-week period ended June 30, 2002 there were
outstanding options to purchase approximately 1,587,000 shares of common stock
that were not included in the computation of diluted income from continuing
operations per common share because of the Company's loss from continuing
operations. At the end of the 13-week period ended July 1, 2001, there were
outstanding options to purchase approximately 869,000 shares of common stock
that were not included in the computation of diluted income from continuing
operations per common share because the exercise price of the option was greater
than the average market price of the common shares.
Note 4. Discontinued Operations
In fiscal 2000, the Company disposed of all of its assets related to
its IT consulting business. Subsequent to June 30, 2002, the Company settled an
outstanding claim, as noted in Note 6. "Legal Matters," related to the disposed
IT consulting business. In connection with the resolution of the matter, the
Company recorded an additional charge of approximately $292,000 to discontinued
operations during the 13-week period ended June 30, 2002. Additionally, as part
of the sale of the IT consulting business, the Company assigned certain lease
agreements to the acquiring company, with the respective landlords reserving
their rights against the Company in the event of default by the assignee.
Subsequent to the sale of the IT consulting business, the acquiring company
ceased operations in some areas and defaulted on some of their assumed lease
agreements; the Company believes that its claims against the assignee are of no
value, as the assignee is believed to be insolvent. Consequently, during the
13-week period ended June 30, 2002, the Company recorded an additional $215,000
charge to discontinued operations for accrued lease payments with respect to the
properties abandoned by the purchaser of the IT consulting business.
In November 2001, the Company resolved to sell or abandon the assets
of its IT staffing business, which represented the remaining assets and business
of Inteliant. During the 26-week period ended June 30, 2002, the Company
consummated the following transactions in relation to its discontinued IT
businesses:
o On February 25, 2002, the Company entered into an asset purchase agreement
with Abacab Software, Inc. ("Abacab"), pursuant to which the Company sold
certain assets of Inteliant's northern California operations for contingent
payments not to exceed $600,000 in the aggregate over three years following
the closing date of the transaction, based on the gross profit of the
business acquired by Abacab. Abacab also assumed liabilities of
approximately $40,000. The Company retained accounts receivable of
approximately $1.1 million, of which approximately $236,000 was outstanding
as of June 30, 2002. The Company originally acquired a portion of the
assets sold in the transaction from Abacab. The principal of Abacab was
engaged by the Company as an independent consultant and was managing the
Company's northern California operations at the time of the closing of the
transaction.
o Effective March 11, 2002, the Company settled a dispute with NeoSoft, Inc.
("NeoSoft"), whose assets had been acquired by Inteliant in July 1998.
During fiscal 2001, Neosoft and its principal had alleged that the Company
owed more than the final earnout payment paid by the Company pursuant to
the purchase agreement with Neosoft. Pursuant to the terms of the
settlement, the Company paid NeoSoft $550,000 and transferred the NeoSoft
operations back to NeoSoft. In return, the Company retained all of the
accounts receivable and unbilled revenue of approximately $639,000, of
which approximately $68,000 was outstanding as of June 30, 2002; however,
the Company will pay NeoSoft 15% of all accounts receivable collected as
consideration for NeoSoft's assistance in collecting the receivables.
Additionally, NeoSoft assumed approximately $53,000 in accrued paid time
off liability and assumed all operating leases. Furthermore, the parties
released all claims including, without limitation, any claims arising under
the original asset purchase agreement and under the principal's original
employment agreement. The principal of Neosoft was employed by the Company
at the time of the closing of the transaction and was managing the
Company's Neosoft operations.
o Effective May 6, 2002, the Company sold certain assets related to the
Kansas City, Missouri and Denver, Colorado ("Central States") operations of
Inteliant for contingent payments not to exceed $1,000,000 in the aggregate
over three years following the closing date of the transaction, based on
the gross profit of the business acquired by the buyer. The buyer also
assumed liabilities of approximately $40,000. Additionally, the Company
9
SOS STAFFING SERVICES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
retained accounts receivable of approximately $500,000, of which
approximately $148,000 was outstanding as of June 30, 2002. The buyer was
employed by the Company as the manager of the Central States operations at
the time of the closing of the transaction.
In addition, during fiscal 2001, the Company formalized a plan to sell
its wholly owned subsidiary, ServCom Staff Management, Inc. ("ServCom"), a
professional employee organization. On December 31, 2001, the Company sold
substantially all of the assets of this business to an unrelated entity. The
Company retained accounts receivable of approximately $480,000, of which
approximately $142,000 was outstanding as of June 30, 2002. The terms of the
transaction were immaterial to the financial results of the Company.
As a result of a number of factors primarily related to the extended
economic downturn in the San Francisco area beginning in late fiscal 2000, the
Company has been forced to make a number of changes, including reducing the
number of employees as well as closing a number of offices, in order to try to
maintain profitability of its Truex division. During the 13-week period ended
June 30, 2002, due to continued declining revenues, the Company determined to
sell its Truex division. In accordance with Statement of Financial Accounting
Standards ("SFAS") No. 144, "Accounting for the Impairment or Disposal of
Long-Lived Assets," the Company reclassified assets of its Truex operations,
including trademarks and trade names and an allocated portion of goodwill, as
assets held for sale. Likewise, SFAS No. 144 requires the carrying amount of
assets reclassified as held for sale to be reduced to the estimated fair value
less selling costs. The Company estimated that the Truex assets had no fair
value and consequently recorded a charge of approximately $40,000 for the
write-off of property and equipment; additionally, the Company wrote off the
remaining value of trademarks and trade names associated with Truex of
approximately $383,000 and wrote off goodwill of approximately $286,000. These
charges are reflected in "operating and other expenses" in the table below.
Subsequent to June 30, 2002, the Company entered into an agreement pursuant to
which the Company transferred the Truex business and trade name to an unrelated
entity for contingent payments not to exceed $300,000 in the aggregate over one
year following the closing date of the transaction, based on the gross profit of
the business acquired. Any contingent consideration will be recorded when
received.
10
SOS STAFFING SERVICES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
Operating results of the discontinued operations for the 13- and
26-week periods ended June 30, 2002 and July 1, 2001 have been classified as
discontinued operations in the accompanying consolidated financial statements as
follows (in thousands):
13 Weeks Ended 26 Weeks Ended
June 30, 2002 July 1, 2001 June 30, 2002 July 1, 2001
-------------- ------------- --------------- -------------
IT Consulting
Revenues $ -- $ -- $ -- $ --
Cost of sales -- -- -- --
-------------- ------------- --------------- -------------
Gross profit -- -- -- --
Operating and other expenses 507 3,476 507 4,328
-------------- ------------- --------------- -------------
Loss from discontinued operations before income tax
(507) (3,476) (507) (4,328)
Income tax benefit -- 1,320 -- 1,654
-------------- ------------- --------------- -------------
Loss from discontinued operations $ (507) $ (2,156) $ (507) $ (2,674)
============== ============= =============== =============
IT Staffing and ServCom
Revenues $ 374 $ 13,716 $ 2,735 $ 29,697
Cost of sales 369 10,896 2,267 23,882
-------------- ------------- --------------- -------------
Gross profit 5 2,820 468 5,815
Operating and other expenses (26) 2,972 1,005 5,957
-------------- ------------- --------------- -------------
Income (loss) from discontinued operations before
income tax 31 (152) (537) (142)
Income tax benefit -- 60 -- 56
-------------- ------------- --------------- -------------
Income (loss) from discontinued operations 31 (92) (537) (86)
Adjustment of reserves for estimated loss from
measurement date to disposal date 98 -- 354 --
-------------- ------------- --------------- -------------
$ 129 $ (92) $ (183) $ (86)
============== ============= =============== =============
Truex
Revenues $ 159 $ 567 $ 377 $ 1,286
Cost of sales 102 322 237 764
-------------- ------------- ---------------- -------------
Gross profit 57 245 140 522
Operating and other expenses 900 407 1,086 920
-------------- ------------- ---------------- -------------
Loss from discontinued operations before income tax
(843) (162) (946) (398)
Income tax benefit -- 64 -- 156
-------------- ------------- ---------------- -------------
Loss from discontinued operations (843) (98) (946) (242)
============== ============= ================ =============
Total loss from discontinued operations net of income tax
$ (1,221) $ (2,346) $ (1,636) $ (3,002)
============== ============= =============== ==============
11
SOS STAFFING SERVICES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
Note 5. Intangible Assets
As of the beginning of fiscal 2002, the Company adopted the provisions
SFAS No. 142, "Goodwill and Other Intangible Assets." The provisions of SFAS No.
142 prohibit the amortization of goodwill and certain intangible assets that are
deemed to have indefinite lives and require that such assets be tested for
impairment annually, or more frequently if events or changes in circumstances
indicate that the asset might be impaired, and written down to fair value. In
order to assess the fair value of its goodwill and indefinite-lived intangible
assets as of the adoption date, the Company engaged an independent valuation
firm to assist in determining the fair value. The valuation process appraised
the Company's assets and liabilities using a combination of present value and
multiple of earnings valuation techniques. Based upon the results of the
valuation, the Company wrote off $8.0 million of goodwill, and $8.1 million in
trademarks and trade names as a cumulative effect of the change in accounting
principle.
During the 13-week period ended June 30, 2002, as a result of the
anticipated sale of the Company's Truex operations in northern California (see
Note 4. "Discontinued Operations"), the Company wrote off additional trademarks
and trade names of approximately $383,000. Additionally, a portion of goodwill,
approximately $286,000, was allocated to the Truex assets to be disposed of and
also written off. As of June 30, 2002 and December 30, 2001, intangible assets
consisted of the following (in thousands):
June 30, 2002 December 30, 2001
------------------- -------------------
Goodwill $ 24,202 $ 37,119
Trademarks and trade names, indefinite-lived 6,959 18,046
Other definite-lived intangibles 1,994 2,426
------------------- -------------------
33,155 57,591
Less accumulated amortization (1,931) (9,531)
------------------- -------------------
Net intangible assets $ 31,224 $ 48,060
------------------- -------------------
12
SOS STAFFING SERVICES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
The following table provides a reconciliation of reported (loss) income
from continuing operations for the 13- and 26-week periods ended June 30, 2002
and July 1, 2001 to the adjusted (loss) income from continuing operations,
excluding amortization expense relating to goodwill and trademarks and trade
names:
13 Weeks 26 Weeks
-------------------------------------------------------------------
June 30, 2002 July 1, 2001 June 30, 2002 July 1, 2001
--------------- -------------- --------------- ---------------
Reported (loss) income from continuing operations $ (212) $ 268 $ 6,278 $ 90
Add back: Goodwill amortization, net of income taxes -- 187 -- 376
Add back: Trademark and trade names amortization, net
of income taxes -- 83 -- 167
--------------- -------------- --------------- ---------------
Adjusted (loss) income from continuing operations $ (212) $ 538 $ 6,278 $ 633
=============== ============== =============== ===============
Basic and diluted (loss) income from continuing
operations per common share:
Reported net (loss) income $ (0.02) $ 0.02 $ 0.49 $ 0.01
--------------- -------------- --------------- ---------------
Goodwill amortization net of income taxes -- 0.01 -- 0.03
Trademark and trade names amortization, net of
income taxes -- 0.01 -- 0.01
--------------- -------------- --------------- ---------------
Adjusted (loss) income from continuing operations $ (0.02) $ 0.04 $ 0.49 $ 0.05
=============== ============== =============== ===============
13
SOS STAFFING SERVICES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
Note 6. Legal Matters
In the ordinary course of its business, the Company is periodically
threatened with or named as a defendant in various lawsuits or administrative
proceedings. The Company maintains insurance in such amounts and with such
coverage and deductibles as management believes to be reasonable and prudent.
The principal risks covered by insurance include workers' compensation, personal
injury, bodily injury, property damage, errors and omissions, fidelity losses,
employer practices liability and general liability.
On April 11, 2001, Royalty Carpet Mills, Inc. ("Royalty") filed a
complaint against Inteliant for breach of contract for services to be provided
by Inteliant and for professional negligence in the state of California (the
"Complaint"). The Complaint requested unspecified damages, consequential
damages, and attorneys' fees and costs. Royalty sought damages of approximately
$1.9 million. Royalty subsequently raised its demand to $3.0 million. Inteliant
denied the allegations set forth in the Complaint and filed various
counterclaims against Royalty.
Subsequent to June 30, 2002, the parties negotiated a settlement
agreement regarding the litigation related to the Complaint as well as all other
claims or potential claims, whether known or unknown. Neither party admitted any
fault or wrongdoing. Under the terms of the settlement agreement, Inteliant has
paid into an escrow account $500,000 and Inteliant's insurance carrier will pay
Royalty an additional $600,000, for a total settlement of $1.1 million.
Inteliant's insurance carrier will also pay Inteliant's defense costs, including
attorneys' fees. Also in connection with the settlement, Inteliant waived all
coverage claims against its insurance carrier. The settlement is scheduled to
close on August 16, 2002 and the Company does not anticipate that there will be
any impediment to closing.
The parties have submitted a joint motion to dismiss the Complaint and
related litigation with prejudice. The matter will be dismissed upon the court's
signing and entry of the order of dismissal.
There is no other pending litigation that the Company currently
anticipates will have a material adverse effect on the Company's financial
condition or results of operations.
Note 7. Credit Facility and Notes Payable
On April 15, 2002, the Company entered into a Fifth Amendment to
Amended and Restated Credit Agreement and Waiver (the "Fifth Credit Amendment")
with its lenders to extend the Company's line of credit. Pursuant to the Fifth
Credit Amendment, the Company's line of credit was reduced from $18.0 million to
$16.0 million, $6.0 million of which is available for borrowing in cash, reduced
as provided below, with a maturity date of September 1, 2003, and $10.0 million
of which is available under letters of credit to be issued solely as required by
the Company's workers' compensation insurance providers, with a maturity date of
January 1, 2004. The Fifth Credit Amendment provides for borrowings at the prime
rate (4.75% as of June 30, 2002) plus 3.0 percentage points through and
including June 30, 2003, after which time borrowings under the facility will be
charged an interest rate equal to the then-current prime rate plus 3.5
percentage points. The Company paid its lenders approximately $78,000 upon
execution of the Fifth Credit Amendment and a supplemental fee of $250,000 will
be due on September 1, 2003, unless all amounts outstanding under the revolving
credit facility are paid in full and the facility is terminated on or before
such date. In addition, the Company paid $313,000 of the outstanding borrowings
under the revolving credit facility upon execution of the Fifth Credit
Amendment. The Company will pay an additional $470,000 and $559,000 of the
outstanding borrowings under the revolving credit facility on September 15, 2002
and December 15, 2002, respectively. Such payments will permanently reduce the
line of credit available to the Company for borrowing in cash to less than the
$6.0 million stated above. In addition, certain financial covenants of the
Company have been modified. As of August 6, 2002, the Company had outstanding
borrowings under the revolving credit facility of approximately $1.7 million and
availability of approximately $4.4 million.
Also on April 15, 2002, the Company entered into an Amendment No. 3 to
Note Purchase Agreement ("Amendment No. 3") with its noteholders. The Company's
noteholders consented to the Company entering into the Fifth Credit Amendment
described above. Pursuant to Amendment No. 3, the Company's Series A Notes bear
14
SOS STAFFING SERVICES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
interest at the rate of 9.22% per annum beginning as of April 1, 2002 through,
but excluding, June 30, 2003, and at the rate of 9.72% per annum from June 30,
2003 until the Series A Notes become due and payable. The Company's Series B
Notes bear interest at the rate of 9.45% per annum beginning as of April 1, 2002
through, but excluding, June 30, 2003, and at the rate of 9.95% per annum from
June 30, 2003 until the Series B Notes become due and payable.
Pursuant to Amendment No. 3, any overdue payments on the Series A Notes
bear interest at the greater of 2% over the interest rate currently in effect as
stated above or 2% over the prime rate of The First National Bank of Chicago.
The change in the interest rate charged on the senior notes is estimated to have
an annual impact of approximately $142,000 on the Company's financial
operations. In addition, the Company paid $687,000 of the principal amount of
the senior notes upon execution of Amendment No. 3. The Company will pay an
additional $1,030,500 and $1,227,000 of the principal amount of the senior notes
on September 15, 2002 and December 15, 2002, respectively.
Amendment No. 3 also provides for optional or mandatory prepayments, as
the case may be, upon the occurrence of certain events including, but not
limited to, a change of control, transfer of property or issuance of equity
securities of the Company. In addition, Amendment No. 3 provides that the
Company pay to its lenders and its noteholders a portion of any federal, state
or local tax refund or repayment, which amount shall be distributed pursuant to
the Amended and Restated Intercreditor Agreement dated as of April 15, 2002
among the Collateral Agent, the Company's lenders and the Company's noteholders.
Any such prepayments paid to the Company's lenders also will be treated as a
permanent reduction in the line of credit available to the Company for borrowing
in cash under the revolving credit facility. As of June 30, 2002, as a result of
income tax refunds received and accounts receivable collected from disposed
operations, the Company had paid approximately $2.8 million to its noteholders.
In addition, approximately $1.6 million was paid to its lenders, resulting in a
permanent reduction in its borrowings available under the line of credit. The
adjusted amount available for the Company under its line of credit is
approximately $4.4 million.
As consideration for their approval of Amendment No. 3, the Company
paid an amendment fee to its noteholders of $145,475, as well as fees and
expenses of the noteholders' special counsel. In addition, the Company paid to
each noteholder accrued but unpaid interest on such holder's notes for the
period beginning March 1, 2002 through and including June 30, 2002. Also
pursuant to Amendment No. 3, the Company is required to pay on September 1, 2003
a supplemental note fee of $250,000, which amount will be waived if the Company
has paid all amounts due and outstanding under the note purchase agreements
prior to such date. Also, certain financial covenants of the Company were
modified. In the event the Company fails to comply with such covenants as
modified, Amendment No. 3 provides that the noteholders may, at their discretion
and at the expense of the Company, retain a financial advisor to review and
advise the noteholders and the Company upon the financial status of the Company.
The security agreement dated as of July 30, 2001 remains in place pursuant to
Amendment No. 3.
Note 8. Restructuring Charges
For the period ended June 30, 2002, the Company continued streamlining
its corporate structure by consolidating or closing branch offices in
under-performing markets. During the 13- and 26-week periods ended June 30,
2002, the Company recorded a restructuring charge of approximately $264,000 and
$609,000, respectively, primarily related to a change in the estimate of future
lease obligations and severance costs associated with the elimination of a
senior executive position, in accordance with the Company's previously
determined restructuring plan. The Company is endeavoring to reduce potential
future lease payments by subleasing the abandoned facilities or negotiating
discounted buyouts of the lease contracts. Consequently, the Company's estimates
may change based on its ability to effectively reduce such future lease
15
SOS STAFFING SERVICES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
payments. At June 30, 2002, the remaining accrued restructuring charges totaled
approximately $667,000 and are recorded in the balance sheet as an accrued
liability. The activity impacting the accrual for restructuring charges is
summarized in the table below (in thousands):
December 30,
2001 Charges to June 30, 2002
Operations Charges Utilized
-----------------------------------------------------------------------------------
Contractual lease obligations $ 561 $ 441 $ (351) $ 651
Reductions in workforce -- 239 (239) --
Other costs -- 35 (19) 16
-----------------------------------------------------------------------------------
Total $ 561 $ 715(1) $ (609) $ 667
===================================================================================
(1) Approximately $106,000 of charges incurred to accrue for leases on closed
Truex offices has been presented in discontinued operations.
As noted previously, the Company has subleased some of the facilities
for which it is contractually obligated, and in such instances has reduced the
amount of the liability carried on the Company's books by the anticipated
sublease payments from such properties. However, as noted in Note 4.
"Discontinued Operations," if the sublesee defaults on its lease obligations,
the Company is liable for any lease payments outstanding. The following table
presents the Company's future lease obligations on facilities for which it has
entered into sublease agreements and the sublease payments the Company expects
to receive on such facilities (in thousands):
Fiscal Year Estimated Expected sublease
Ending lease obligation payments Net liability
-----------------------------------------------------------------------
2002 $ 384 $ 310 $ 74
2003 731 608 123
2004 328 209 119
2005 219 128 91
2006 80 60 20
Beyond 13 10 3
------------------------------------------------------
$ 1,755 $ 1,325 $ 430
------------------------------------------------------
Note 9. Income Taxes
On March 9, 2002, the Job Creation and Work Assistance Act of 2002 (the
"2002 Job Act"), which includes certain provisions that provide favorable tax
treatment for the Company, was signed into law. Among such provisions is the
extension of the net operating loss carryback period from two years to five
years for net operating losses arising in tax years ending in 2001 and 2002.
These provisions also allow companies to use the net operating loss carrybacks
and carryforwards to offset 100% of alternative minimum taxable income. In
accordance with SFAS No. 109, "Accounting for Income Taxes," the effect of the
change in the law was accounted for in the first quarter of fiscal 2002, the
period in which the law became effective. In accordance with the provisions of
the 2002 Job Act, the Company recognized a tax benefit of approximately $7.9
million related to expected loss carrybacks.
During the 13-week period ended June 30, 2002, the Company filed its
income tax return and received approximately $4.3 million in income tax refunds.
The Company expects that, as a result of the completion of the sale of its IT
and Truex operations, it will generate a taxable loss for fiscal 2002, a portion
of which will be available for carryback against its 1997 tax year. As a result,
the Company anticipates receiving in fiscal year 2003 an additional $3.9 million
in income tax receivable (including approximately $200,000 in state refunds)
related to the carryback of the Company's net operating loss to 1997.
The Company has recorded a tax valuation allowance for its entire net
deferred income tax assets of approximately $31.3 million. The valuation
allowance was recorded given the losses incurred by the Company and the
Company's belief that it is more likely than not that the Company will be unable
to recover the net deferred tax assets.
Note 10. Recent Accounting Pronouncements
In July 2002, the Financial Accounting Standards Board issued SFAS No.
146, "Accounting for Costs Associated with Exit or Disposal Activities." SFAS
No. 146 addresses financial accounting and reporting for costs associated with
exit or disposal activities and nullifies Emerging Issues Task Force Issue No.
94-3, "Liability Recognition for Certain Employee Termination Benefits and Other
Costs to Exit an Activity (Including Certain Costs Incurred in a
Restructuring)," ("EITF 94-3") SFAS No. 146 requires recognition of a liability
for a cost associated with an exit or disposal activity when the liability is
incurred, as opposed to when the entity commits to an exit plan under EITF 94-3.
The Company is required to adopt the provisions of SFAS No. 146 for exit or
disposal activities that are initiated after December 31, 2002. The Company is
currently evaluating the impact of this statement on the Company's future
business, results of operations, financial position, or liquidity.
16
Item 2. Management's Discussion and Analysis
of Financial Condition and Results of Operations
The following discussion and analysis should be read in conjunction
with the condensed consolidated financial statements of the Company and notes
thereto appearing elsewhere in this report. The Company's fiscal year consists
of a 52- or 53-week period ending on the Sunday closest to December 31. The
Company's critical accounting policies are described in its Annual Report on
Form 10-K for the fiscal year ended December 30, 2001.
Recent Developments
On July 24, 2002, the Company received notification from Nasdaq that
the Company is not in compliance with the minimum closing bid price listing
requirement and that its common stock is, therefore, subject to delisting from
The Nasdaq National Market (the "NNM") as of August 1, 2002. As a result, the
Company has applied to transfer its securities to The Nasdaq SmallCap Market
("SmallCap Market"). The delisting proceedings referred to in the July 24, 2002
notification will be stayed pending Nasdaq's review of the transfer application.
In order for the transfer to be approved by Nasdaq, the Company must satisfy the
continued inclusion requirements for the SmallCap Market, other than the minimum
bid price requirement. If the transfer application is approved, the Company will
have until October 21, 2002 to comply with the minimum bid price requirement,
which requires the Company to maintain a $1.00 minimum bid price for 10
consecutive trading days. If the Company meets the more stringent initial
listing requirements for the SmallCap Market, other than the minimum bid price,
it may be eligible for an additional 180-day grace period beyond October 21,
2002 in order to comply with such minimum bid price requirement.
If during any SmallCap Market grace period the closing bid price of the
Company's stock is $1.00 per share or more for 30 consecutive trading days, then
the Company will have regained compliance with Nasdaq's minimum bid price
requirement and may be eligible to transfer its common stock back to the NNM,
provided all other requirements for continued listing on that market are met. If
the Company's transfer application is not approved or if the Company fails to
meet all listing requirements at the completion of all applicable grace periods,
its securities would be subject to Nasdaq delisting proceedings, pending an
appeals process. In the event the common stock is delisted, the Company's
securities may be quoted in the over-the-counter market on either Nasdaq's OTC
Bulletin Board or the "Pink Sheets." The Company would then be subject to an SEC
rule regarding "penny stocks," under which broker-dealers who sell relevant
securities to persons who are not established customers or accredited investors
must make specified suitability determinations and must receive the purchaser's
written consent to the transaction prior to the sale. Delisting could make
trading shares of the Company's common stock difficult, potentially leading to a
further decline in the stock price. In addition, investors may find it difficult
to sell the Company's common stock or to obtain accurate quotations of the share
price of the common stock. .
Effective December 31, 2001, the Company adopted SFAS No. 142,
"Goodwill and Other Intangible Assets." In accordance with SFAS No. 142, the
Company discontinued the amortization of goodwill and identifiable intangible
assets that have indefinite useful lives. Intangible assets that have finite
useful lives, such as non-compete agreements, will continue to be amortized over
their useful lives. Pursuant to the conditions set forth in SFAS No. 142, the
Company recorded an impairment loss of approximately $16.1 million as a
cumulative effect of a change in accounting principle in the first quarter of
fiscal 2002.
Discontinued Operations
In fiscal 2000, the Company disposed of all of its assets related to
its IT consulting business. Subsequent to June 30, 2002, the Company settled an
outstanding claim, as noted in Note 6. "Legal Matters," related to the disposed
IT consulting business. In connection with the resolution of the matter, the
Company recorded an additional charge of approximately $292,000 to discontinued
operations during the 13-week period ended June 30, 2002. Additionally, as part
of the sale of the IT consulting business, the Company assigned certain lease
agreements to the acquiring company, with the respective landlords reserving
their rights against the Company in the event of default by the assignee.
Subsequent to the sale of the IT consulting business, the acquiring company
ceased operations in some areas and defaulted on some of their assumed lease
agreements; the Company believes that its claims against the assignee are of no
value, as the assignee is believed to be insolvent. Consequently, during the
13-week period ended June 30, 2002, the Company recorded an additional $215,000
charge to discontinued operations for accrued lease payments with respect to the
properties abandoned by the purchaser of the IT consulting business.
17
In November 2001, the Company resolved to sell or abandon the assets
of its IT staffing business, which represented the remaining assets and business
of Inteliant. During the 26-week period ended June 30, 2002, the Company
consummated the following transactions in relation to its discontinued IT
businesses:
o On February 25, 2002, the Company entered into an asset purchase agreement
with Abacab Software, Inc. ("Abacab"), pursuant to which the Company sold
certain assets of Inteliant's northern California operations for contingent
payments not to exceed $600,000 in the aggregate over three years following
the closing date of the transaction, based on the gross profit of the
business acquired by Abacab. Abacab also assumed liabilities of
approximately $40,000. The Company retained accounts receivable of
approximately $1.1 million, of which approximately $236,000 was outstanding
as of June 30, 2002. The Company originally acquired a portion of the
assets sold in the transaction from Abacab. The principal of Abacab was
engaged by the Company as an independent consultant and was managing the
Company's northern California operations at the time of the closing of the
transaction. The Company believes that the terms of the transaction were no
less favorable than it would have received from an unrelated third party.
o Effective March 11, 2002, the Company settled a dispute with NeoSoft, Inc.
("NeoSoft"), whose assets had been acquired by Inteliant in July 1998.
During fiscal 2001, Neosoft and its principal had alleged that the Company
owed more than the final earnout payment paid by the Company pursuant to
the purchase agreement with Neosoft. Pursuant to the terms of the
settlement, the Company paid NeoSoft $550,000 and transferred the NeoSoft
operations back to NeoSoft. In return, the Company retained all of the
accounts receivable and unbilled revenue of approximately $639,000, of
which approximately $68,000 was outstanding as of June 30, 2002; however,
the Company will pay NeoSoft 15% of all accounts receivable collected as
consideration for NeoSoft's assistance in collecting the receivables.
Additionally, NeoSoft assumed approximately $53,000 in accrued paid time
off liability and assumed all operating leases. Furthermore, the parties
released all claims including, without limitation, any claims arising under
the original asset purchase agreement and under the principal's original
employment agreement. The principal of Neosoft was employed by the Company
at the time of the closing of the transaction and was managing the
Company's Neosoft operations. The Company believes that the terms of the
transaction were no less favorable than it would have received from an
unrelated third party.
o Effective May 6, 2002, the Company sold certain assets related to the
Kansas City, Missouri and Denver, Colorado ("Central States") operations of
Inteliant for contingent payments not to exceed $1,000,000 in the aggregate
over three years following the closing date of the transaction, based on
the gross profit of the business acquired by the buyer. The buyer also
assumed liabilities of approximately $40,000. Additionally, the Company
retained accounts receivable of approximately $500,000, of which
approximately $148,000 was outstanding as of June 30, 2002. The buyer was
employed by the Company as the manager of the Central States operations at
the time of the closing of the transaction. The Company believes that the
terms of the transaction were no less favorable than it would have received
from an unrelated third party.
In addition, during fiscal 2001, the Company formalized a plan to sell
its wholly owned subsidiary, ServCom Staff Management, Inc. ("ServCom"), a
professional employee organization. On December 31, 2001, the Company sold
substantially all of the assets of this business to an unrelated entity. The
Company retained accounts receivable of approximately $480,000, of which
approximately $142,000 was outstanding as of June 30, 2002. The terms of the
transaction were immaterial to the financial results of the Company.
As a result of a number of factors primarily related to the extended
economic downturn in the San Francisco area beginning in late fiscal 2000, the
Company has been forced to make a number of changes, including reducing the
number of employees as well as closing a number of offices, in order to try to
maintain profitability of its Truex division. During the 13-week period ended
June 30, 2002, due to continued declining revenues, the Company determined to
sell its Truex division. In accordance with SFAS No. 144, "Accounting for the
Impairment or Disposal of Long-Lived Assets," the Company reclassified assets of
its Truex operations, including trademarks and trade names and an allocated
portion of goodwill, as assets held for sale. Likewise, SFAS No. 144 requires
the carrying amount of assets reclassified as held for sale to be reduced to the
estimated fair value less selling cost. The Company estimated that the Truex
assets had no fair value and consequently took a charge of approximately $40,000
for the write-off of property and equipment; additionally, the Company wrote off
the remaining value of trademarks and trade names associated with Truex of
approximately $383,000, and wrote off goodwill of approximately $286,000, in
accordance with SFAS No. 142, "Goodwill and Other Intangible Assets." Subsequent
to June 30, 2002, the Company entered into an agreement pursuant to which the
Company sold certain assets of the Truex division's operations for contingent
payments not to exceed $300,000 in the aggregate over one year following the
closing date of the transaction, based on the gross profit of the business
acquired.
18
Results of Continuing Operations
The following table sets forth, for the periods indicated, the
percentage relationship to service revenues of selected income statement items
for the Company on a consolidated basis:
13 Weeks Ended 26 Weeks Ended
========================================================================
June 30, 2002 July 1, 2001 June 30, 2002 July 1, 2001
------------------------------------------------------------------------
Service revenues 100.0% 100.0% 100.0% 100.0%
Direct cost of services 80.0 78.0 80.3 78.3
------------------------------------------------------------------------
Gross profit 20.0 22.0 19.7 21.7
------------------------------------------------------------------------
Operating expenses:
Selling, general and administrative expenses 17.1 16.8 17.9 17.7
Restructuring charges 0.6 1.3 0.7 0.8
Depreciation and amortization 0.8 1.8 1.0 1.7
------------------------------------------------------------------------
Total operating expenses 18.5 19.9 19.6 20.2
------------------------------------------------------------------------
Income from operations 1.5% 2.1% 0.1% 1.5%
=========================================================================
Service Revenues: Service revenues for the 13-week period ended June
30, 2002 were $46.3 million, a decrease of $7.0 million, or 13.2%, compared to
revenues of $53.3 million for the 13-week period ended July 1, 2001. Service
revenues for the 26-week period ended June 30, 2002 decreased approximately
$17.1 million, or 16.2%, to $88.2 million, compared to service revenues of
$105.3 million for the 26-week period ended July 1, 2002. The decrease for both
the 13- and 26-week periods ended June 30, 2002, compared to the comparable
periods of the prior year, was due primarily to reduced demand for temporary
services as a result of the broad downturn in the economy. The Company also has
experienced a significant decrease in permanent placement revenues.
Gross Profit: The Company defines gross profit as service revenues less
the cost of providing services, which includes: wages and permanent placement
commissions, employer payroll taxes (FICA, unemployment and other general
payroll taxes), workers' compensation costs related to staffing employees and
permanent placement counselors and other temporary payroll benefits; costs
related to independent contractors utilized by the Company; and other direct
costs. Gross profit for the 13-week periods ended June 30, 2002 and July 1, 2001
was $9.2 million and $11.7 million, respectively, a decrease of $2.5 million, or
21.2%. For the 13-week periods ended June 30, 2002 and July 1, 2001, gross
profit margin was 20.0% and 22.0%, respectively. Gross profit for the 26-week
periods ended June 30, 2002 and July 1, 2001 was $17.4 million and $22.9
million, respectively, a decrease of $5.5 million, or 24.0%. For the 26-week
periods ended June 30, 2002 and July 1, 2001, gross profit margin was 19.7% and
21.7%, respectively. The margin declines for both the 13- and 26-week periods
ended June 30, 2002, compared to the comparable periods of the prior year were
primarily the result of increased pricing competition for staffing services,
higher workers' compensation insurance costs and a reduction in the higher
margin permanent placement business. The Company has renewed its workers'
compensation insurance for fiscal 2002. As part of the renewal, the Company is
required to pay higher premium costs. The Company believes that some of the
increase in costs will be passed through as price increases to its customers.
However, given the competitive nature of the staffing industry, the Company is
unsure whether it will be successful in passing through all cost increases.
Accordingly, the Company believes that its gross margin could be negatively
impacted throughout fiscal 2002.
Operating Expenses: Operating expenses include, among other things,
staff employee compensation, rent, depreciation, intangibles amortization and
advertising. Total operating expenses as a percentage of service revenues
declined to 18.5% for the 13-week period ended June 30, 2002, compared to 19.9%
for the 13-week period ended July 1, 2001, due primarily to a reduction in
recognized intangible amortization related to adoption of SFAS No. 142 and a
reduction in restructuring costs incurred by the Company. Total operating
expenses as a percentage of service revenues declined to 19.6% for the 26-week
period ended June 30, 2002 compared to 20.2% for the 26-week period ended July
1, 2001. The reduction was due primarily to a reduction in recognized intangible
amortization related to adoption of SFAS No. 142, and a reduction in
restructuring costs incurred by the Company.
Selling, general and administrative expenses, as a percentage of
service revenues, for the 13-week period ended June 30, 2002 were approximately
17.1%, compared to 16.8% for the 13-week period ended July 1, 2001. The increase
19
as a percentage of service revenues was due primarily to the Company's revenues
declining more rapidly than the corresponding reduction in selling, general and
administrative expenses. For the 26-week period ended June 30, 2002, selling,
general and administrative expenses, as a percentage of service revenues, was
approximately 17.9%, compared to 17.7% for the 26-week period ended July 1,
2001. The increase was due primarily to the Company's services revenues
declining more rapidly than the corresponding decrease in selling, general and
administrative expenses.
Restructuring charges for the 13-week period ended June 30, 2002 added
approximately 0.6% in additional operating expenses, compared to 1.3% for the
13-week period ended July 1, 2001. The restructuring charges were primarily the
result of an adjustment to the Company's estimate of future lease costs
associated with closed branch offices, as well as severance charges related to
the elimination of a senior executive position, in accordance with the Company's
previously determined restructuring plan. For the 26-week period ended June 30,
2002, restructuring charges added approximately 0.7% to operating expenses
compared to 0.8% for the 26-week period ended July 1, 2001. The Company is
endeavoring to reduce potential future lease payments by subleasing the closed
facilities or negotiating discounted buyouts of the lease contracts.
Consequently, the Company's estimates may change based on its ability to
effectively reduce such future lease payments.
As noted previously, the Company has subleased some of the facilities
for which it is contractually obligated, and in such instances has reduced the
amount of the liability carried on the Company's books by the anticipated
sublease payments from such properties. However, as noted in the Company's
discussion of discontinued operations, if the sublessee defaults on its lease
obligations the Company is liable for any remaining lease payments, which could
have a negative impact on the Company's future profitability. Currently, the
Company has entered into sublease agreements with respect to eight facilities,
representing a total future lease liability of approximately $1.8 million. Such
agreements represent approximately $1.3 million in sublease income to the
Company. The Company does not currently anticipate that any of the current
sublease holders will default on their obligations.
Income from Operations: Income from operations for the 13-week period
ended June 30, 2002 was approximately $700,000, compared to income from
operations for the 13-week period ended July 1, 2001 of approximately $1.1
million, a decrease of approximately $400,000. Operating margin was 1.5%,
compared to 2.1% for the comparable period of the prior year. For the 26-week
periods ended June 30, 2002 and July 1, 2001, income from operations was
approximately $100,000 and $1.6 million, respectively. Operating margin was
approximately 0.1% and 1.5% for the same periods, respectively. The decrease in
operating margin was due largely to the decrease in gross profit.
Income Taxes: During the 13-week period ended June 30, 2002, the
Company received approximately $4.4 million in income tax refunds. The Company
anticipates receiving an additional $3.8 million in federal and state income tax
refunds in fiscal 2003 with respect to the 2002 fiscal year. The refunds are
primarily a result of the Company's recognition, during the first quarter of
fiscal 2002, of a tax benefit of approximately $7.9 million, due primarily to
the enactment of the Job Creation and Work Assistance Act of 2002 (the "2002 Job
Act"), which was signed into law on March 9, 2002. The 2002 Job Act contains
certain provisions that provide favorable tax treatment for the Company. Among
such provisions is the extension of the net operating loss carryback period from
two years to five years for net operating losses arising in tax years ending in
2001 and 2002. These provisions also allow companies to use the net operating
loss carrybacks to offset 100 percent of alternative minimum taxable income. In
accordance with SFAS No. 109, "Accounting for Income Taxes," the effect of the
change in the law has been accounted for in the first quarter of fiscal 2002,
the period in which the law became effective.
Liquidity and Capital Resources
For the 26-week period ended June 30, 2002, net cash provided by
operating activities was approximately $1.1 million, compared to net cash
provided by operating activities of approximately $15.0 million for the 26-week
period ended July 1, 2001. The change in operating cash flow was primarily a
result of the net loss of the Company coupled with a net decrease in cash
provided from certain working capital components, consisting primarily of
collections on accounts receivable (primarily related to IT consulting) and
collection of income tax receivables. Additionally, during the 26-week period
ended June 30, 2002, the Company renewed its workers' compensation policy. Under
the terms of this renewed policy, the Company is required to provide a letter of
20
credit of $10.0 million plus $1.0 million in cash to collateralize future claims
payments under the policy. The cash amount is carried at fair value and is
restricted as to withdrawal. The restricted cash is held in the Company's name
with a major financial institution.
The Company's investing activities for the 26-week period ended June
30, 2002 used approximately $400,000, compared to $3.3 million for the 26-week
period ended July 1, 2001. All investing activities for the 26-week period ended
June 30, 2002 were used to purchase property and equipment. By comparison, the
Company used approximately $800,000 to purchase property and equipment,
approximately $100,000 for payments on acquisition earnouts and approximately
$2.4 million for a working capital loan to the purchaser of certain assets of
the Company during the 26-week period ended July 1, 2001.
Net cash used by the Company's financing activities for the 26-week
period ended June 30, 2002 was approximately $700,000, primarily due to payments
to the Company's senior noteholders and on the Company's credit facility. Net
cash used in the Company's financing activities for the comparable prior year
period ended July 1, 2001 was approximately $4.3 million, attributable primarily
to payments to the Company's senior noteholders and to payments on the Company's
revolving credit facility.
As of June 30, 2002 the Company had outstanding borrowings under its
revolving credit facility, as amended, of approximately $2.8 million, with a
maturity date of September 1, 2003. Additionally, the Company's outstanding
borrowings on the senior notes, as amended, were approximately $25.6 million.
On April 15, 2002, the Company entered into a Fifth Amendment to
Amended and Restated Credit Agreement and Waiver (the "Fifth Credit Amendment")
with its lenders to extend the Company's line of credit. Pursuant to the Fifth
Credit Amendment, the Company's line of credit was reduced from $18.0 million to
$16.0 million, $6.0 million of which is available for borrowing in cash, reduced
as provided below, with a maturity date of September 1, 2003, and $10.0 million
of which is available under letters of credit to be issued solely as required by
the Company's workers' compensation insurance providers, with a maturity date of
January 1, 2004. The Fifth Credit Amendment provides for borrowings at the prime
rate (4.75% as of June 30, 2002) plus 3.0 percentage points through and
including June 30, 2003, after which time borrowings under the facility will be
charged an interest rate equal to the then-current prime rate plus 3.5
percentage points. The Company paid its lenders approximately $78,000 upon
execution of the Fifth Credit Amendment and a supplemental fee of $250,000 will
be due on September 1, 2003, unless all amounts outstanding under the revolving
credit facility are paid in full and the facility is terminated on or before
such date. In addition, the Company paid $313,000 of the outstanding borrowings
under the revolving credit facility upon execution of the Fifth Credit
Amendment. The Company will pay an additional $470,000 and $559,000 of the
outstanding borrowings under the revolving credit facility on September 15, 2002
and December 15, 2002, respectively. Such payments will permanently reduce the
line of credit available to the Company for borrowing in cash to less than the
$6.0 million stated above. In addition, certain financial covenants of the
Company have been modified. As of August 6, 2002, the Company had outstanding
borrowings under the revolving credit facility of approximately $1.7 million and
availability of approximately $4.4 million.
Also on April 15, 2002, the Company entered into an Amendment No. 3 to
Note Purchase Agreement ("Amendment No. 3") with its noteholders. The Company's
noteholders consented to the Company entering into the Fifth Credit Amendment
described above. Pursuant to Amendment No. 3, the Company's Series A Notes bear
interest at the rate of 9.22% per annum beginning as of April 1, 2002 through,
but excluding, June 30, 2003, and at the rate of 9.72% per annum from June 30,
2003 until the Series A Notes become due and payable. The Company's Series B
Notes bear interest at the rate of 9.45% per annum beginning as of April 1, 2002
through, but excluding, June 30, 2003, and at the rate of 9.95% per annum from
June 30, 2003 until the Series B Notes become due and payable.
Pursuant to Amendment No. 3, any overdue payments on the Series A Notes
bear interest at the greater of 2% over the interest rate currently in effect as
stated above or 2% over the prime rate of The First National Bank of Chicago.
The change in the interest rate charged on the senior notes is estimated to have
an annual impact of approximately $142,000 on the Company's financial
operations. In addition, the Company paid $687,000 of the principal amount of
the senior notes upon execution of Amendment No. 3. The Company will pay an
additional $1,030,500 and $1,227,000 of the principal amount of the senior notes
on September 15, 2002 and December 15, 2002, respectively.
21
Amendment No. 3 also provides for optional or mandatory prepayments, as
the case may be, upon the occurrence of certain events including, but not
limited to, a change of control, transfer of property or issuance of equity
securities of the Company. In addition, Amendment No. 3 provides that the
Company pay to its lenders and the Noteholders any federal, state or local tax
refund or repayment, which amount shall be distributed pursuant to the Amended
and Restated Intercreditor Agreement dated as of April 15, 2002 among the
Collateral Agent, its lenders and the noteholders. Any such prepayments paid to
its lenders also will be treated as a permanent reduction in the line of credit
available to the Company for borrowing in cash under the revolving credit
facility. As of June 30, 2002, the Company had paid approximately $2.8 million
to its Noteholders as a result of income tax refunds received and accounts
receivable collected from disposed operations. Additionally, the Company has
paid to its Lenders approximately $1.6 million as a permanent reduction in its
borrowings available under its line of credit. The adjusted amount available for
the Company under its line of credit is approximately $4.4 million.
As consideration for their approval of Amendment No. 3, the Company
paid an amendment fee to its noteholders of $145,475, as well as fees and
expenses of the noteholders' special counsel. In addition, the Company paid to
each noteholder accrued but unpaid interest on such holder's notes for the
period beginning March 1, 2002 through and including June 30, 2002. Also
pursuant to Amendment No. 3, the Company is required to pay on September 1, 2003
a supplemental note fee of $250,000, which amount will be waived if the Company
has paid all amounts due and outstanding under the note purchase agreements
prior to such date. Also, certain financial covenants of the Company were
modified. In the event the Company fails to comply with such covenants as
modified, Amendment No. 3 provides that the noteholders may, at their discretion
and at the expense of the Company, retain a financial advisor to review and
advise the noteholders and the Company upon the financial status of the Company.
The security agreement dated as of July 30, 2001 remains in place pursuant to
Amendment No. 3.
For the period ended June 30, 2002, the Company continued streamlining
its corporate structure and consolidating or closing branch offices in
under-performing markets. During the 13-week period ended June 30, 2002, the
Company recorded a restructuring charge of approximately $264,000, primarily
related to a change in the estimate of future lease payment reserves and
severance costs related to the elimination of a senior executive position, in
accordance with the Company's previously determined restructuring plan. The
Company is endeavoring to reduce potential future lease payments by subleasing
the abandoned facilities or negotiating discounted buyouts of the lease
contracts. Consequently, the Company's estimates may change based on its ability
to effectively reduce such future lease payments. At June 30, 2002, the
remaining accrued restructuring charges totaled approximately $667,000, and are
recorded in the balance sheet as an accrued liability. Also as noted in Item 1.
Legal Proceedings, the Company negotiated a settlement of an outstanding claim
against its subsidiary, Inteliant. As a result of the negotiated settlement,
Inteliant has paid $500,000 to an escrow account.
Restructuring costs in the future are not expected to have a material
impact on the liquidity or capital resources of the Company.
Seasonality
The Company's business follows the seasonal trends of its customers'
businesses. Historically, the Company's business has experienced lower revenues
in the first quarter with revenues accelerating during the second and third
quarters and then slowing again during the fourth quarter.
Forward-looking Statements
Statements contained in this report that are not purely historical are
"forward-looking statements" within the meaning of the Private Securities
Litigation Reform Act of 1995. All forward-looking statements involve risks and
uncertainties. Forward-looking statements contained in this report include
statements regarding the Company's opportunities, existing and proposed service
offerings, market opportunities, expectations, goals, revenues, financial
performance, strategies and intentions for the future and are indicated by the
use of words such as "believe," "expect," "intend," "anticipate," "likely,"
"plan" and other words of similar meaning. All forward-looking statements
included in this report are made as of the date hereof and are based on
information available to the Company as of such date. The Company assumes no
obligation to update any forward-looking statement. Readers are cautioned that
all forward-looking statements involve risks, uncertainties and other factors
that could cause the Company's actual results to differ materially from those
anticipated in such statements, including but not limited to the Company's
ability to attract and retain staff, temporary and other employees needed to
implement the Company's business plan and to meet customer needs; failure of the
22
Company to secure adequate finances to continue to fund its current operations;
and the successful hiring, training and retention of qualified field management.
Future results also could be affected by other factors associated with the
operation of the Company's business, including: economic fluctuations; existing
and emerging competition; changes in demands for the Company's services; the
Company's ability to maintain profit margins in the face of pricing pressures;
and the unanticipated results of future or pending litigation. Risk factors,
cautionary statements and other conditions, including economic, competitive,
governmental and technology factors that could cause actual results to differ
from the Company's current expectations, are discussed in the Company's Annual
Report on Form 10-K.
Item 3. Qualitative and Quantitative Disclosures About Market Risk
The Company is exposed to interest rate changes primarily in relation
to its revolving credit facility and its senior secured notes. The Company's
interest rate risk management objective is to limit the impact of interest rate
changes on earnings and cash flows and to lower its overall borrowing costs. The
Company's senior debt placement bears interest at a fixed interest rate. For
fixed rate debt, interest rate changes generally affect the fair value of the
debt, but not the earnings or cash flows of the Company. Changes in the fair
market value of fixed rate debt generally will not have a significant impact on
the Company unless the Company is required to refinance such debt.
Revolving Credit Facility: The Company's revolving credit facility bears
interest at the prime rate plus 3.0%; at June 30, 2002, such prime rate was
4.75%. For the period ended June 30, 2002, the Company had approximately $2.8
million in advances outstanding under the revolving credit facility.
Senior Notes: For the period ended June 30, 2002, the Company's outstanding
borrowings on the senior notes were $25.6 million, with a weighted average fixed
interest rate of 9.42%. As stated above, any changes in the fair value of the
senior notes generally will not have a significant impact on the Company unless
the Company is required to refinance the senior notes. The fair value of the
Company's senior notes is estimated by discounting expected cash flows at the
prime rate, 4.75% at June 30, 2002, plus 3.0%. Using such discount rate over the
expected maturities of the senior notes, the Company calculates that the
estimated fair value of the obligations on the senior notes, using a discount
rate of 7.75% over the expected maturities of the obligations, is approximately
$26.7 million. If the discount rate were to increase by 10% to 8.5%, the
estimated fair value of the obligation on the unsecured notes would be
approximately $26.3 million. If the discount rate were to decrease by 10% to
7.0%, the estimated fair value of the obligation on the unsecured notes would be
approximately $27.1 million.
23
PART II - OTHER INFORMATION
Item 1. Legal Proceedings
In the ordinary course of its business, the Company is periodically
threatened with or named as a defendant in various lawsuits or administrative
proceedings. The Company maintains insurance in such amounts and with such
coverage and deductibles as management believes to be reasonable and prudent.
The principal risks covered by insurance include workers' compensation, personal
injury, bodily injury, property damage, errors and omissions, fidelity losses,
employer practices liability and general liability.
On April 11, 2001, Royalty Carpet Mills, Inc. ("Royalty") filed a
complaint against Inteliant for breach of contract for services to be provided
by Inteliant and for professional negligence in the state of California (the
"Complaint"). The Complaint requested unspecified damages, consequential
damages, and attorneys' fees and costs. Royalty sought damages of approximately
$1.9 million. Royalty subsequently raised its demand to $3.0 million. Inteliant
denied the allegations set forth in the Complaint and filed various
counterclaims against Royalty.
Subsequent to June 30, 2002, the parties negotiated a settlement
agreement regarding the litigation related to the Complaint as well as all other
claims or potential claims, whether known or unknown. Neither party admitted any
fault or wrongdoing. Under the terms of the settlement agreement, Inteliant has
paid into an escrow account $500,000 and Inteliant's insurance carrier will pay
Royalty an additional $600,000, for a total settlement of $1.1 million.
Inteliant's insurance carrier will also pay Inteliant's defense costs, including
attorneys' fees. Also in connection with the settlement, Inteliant waived all
coverage claims against its insurance carrier. The settlement is scheduled to
close on August 16, 2002 and the Company does not anticipate that there will be
any impediment to closing.
There is no other pending litigation that the Company currently
anticipates will have a material adverse effect on the Company's financial
condition or results of operations.
Item 4. Submission of Matters to a Vote of Security Holders
On May 16, 2002, the Company held its Annual Meeting of Shareholders
(the "Annual Meeting"). At the Annual Meeting, the shareholders of the Company
elected two directors of the Company, Stanley R. deWaal and Randolf K. Rolf,
each of whom was elected to serve until the 2005 annual meeting of the Company's
shareholders. With respect to the election of directors, there were 11,332,494
votes cast in favor of the election of Mr. deWaal and 11,332,294 votes cast in
favor of the election of Mr. Rolf.
In addition to the election of Messrs. deWaal and Rolf, JoAnn W.
Wagner, Jack A. Henry and Brad L. Stewart continue to serve as directors of the
Company, with terms expiring at the Company's 2004 annual meeting of
shareholders, and Thomas K. Sansom continues to serve as a director of the
Company until his term expires at the Company's 2003 annual meeting of the
Company's shareholders.
Item 6. Exhibits and Reports on Form 8-K.
a) None.
b) Current Report on Form 8-K dated June 7, 2002, Changes in Registrant's
Certifying Accountant.
c) Exhibits:
Exhibit No. Incorporated by Filed
Exhibit Reference Herewith
- -------------------------------------------------------------------------------
99.1 Certification of Chief Executive Officer (1)
99.2 Certification of Chief Financial Officer (1)
(1) Filed herewith and attached to this Report following page 25 hereof.
24
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of
1934, the Registrant has duly caused this report to be signed on its behalf by
the undersigned thereunto duly authorized.
SOS STAFFING SERVICES, INC.
Dated: August 12, 2002 /s/ JoAnn W. Wagner
-----------------------------
JoAnn W. Wagner
Chairman, President and
Chief Executive Officer
Dated: August 12, 2002 /s/ Kevin Hardy
-----------------------------
Kevin Hardy
Senior Vice President and
Chief Financial Officer
25