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, 1998
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from ______________ to ______________________
Commission file number 000-23147
OUTSOURCE INTERNATIONAL, INC.
------------------------------------------------------
(Exact Name of Registrant as Specified in Its Charter)
FLORIDA 65-0675628
- - ------------------------------- ------------------------------------
(State or Other Jurisdiction of (I.R.S. Employer Identification No.)
Incorporation or Organization)
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 13, 1998
- - --------------------------------------- --------------------------------
Common Stock, par value $.001 per share 8,657,913
<PAGE>
OUTSOURCE INTERNATIONAL, INC.
INDEX
PART I - FINANCIAL INFORMATION
<TABLE>
Item 1 - Financial Statements Page
----
<S> <C>
Consolidated Balance Sheets as of September 30, 1998 and
December 31, 1997........................................................ 3
Consolidated Statements of Income for the three and nine months
ended September 30, 1998 and 1997........................................ 4
Consolidated Statements of Shareholders' Equity (Deficit) for
the nine months ended September 30, 1998 and 1997 ....................... 5
Consolidated Statements of Cash Flows for the nine months
ended September 30, 1998 and 1997........................................ 6
Notes to Consolidated Financial Statements................................. 7
Item 2 - Management's Discussion and Analysis of Financial
Condition and Results of Operations......................................... 16
PART II - OTHER INFORMATION
Item 5 - Other Information ........................................................... 29
Item 6 - Exhibits and Reports on Form 8-K............................................. 29
Signatures............................................................................ 31
</TABLE>
2
<PAGE>
PART I - FINANCIAL INFORMATION
ITEM 1 - FINANCIAL STATEMENTS
OUTSCOURCE INTERNATIONAL, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
September 30, December 31,
1998 1997
------------ ------------
<S> <C> <C>
ASSETS
CURRENT ASSETS:
Cash ................................................................... $ 3,541,678 $ 1,685,474
Trade accounts receivable, net of allowance for doubtful accounts of
$1,669,995 and $1,639,767........................................ 16,361,828 47,297,608
Funding advances to franchises.......................................... 1,100,219 2,186,150
Deferred income taxes and other current assets.......................... 6,743,644 5,909,960
----------- ------------
Total current assets............................................... 27,747,369 57,079,192
PROPERTY AND EQUIPMENT, net............................................. 17,041,077 14,953,118
GOODWILL AND OTHER INTANGIBLE ASSETS, net............................... 65,342,563 30,426,731
OTHER ASSETS............................................................ 4,771,617 3,283,817
------------ ------------
Total assets....................................................... $114,902,626 $105,742,858
============ ============
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable........................................................ $ 4,414,689 $ 1,498,275
Accrued expenses:
Payroll............................................................ 8,800,165 5,382,295
Payroll taxes...................................................... 3,360,904 2,181,722
Workers' compensation and insurance................................ 10,322,576 9,086,007
Other.............................................................. 2,753,056 1,863,666
Other current liabilities............................................... 2,141,941 907,975
Current maturities of long-term debt to related parties................. 528,988 100,000
Current maturities of other long-term debt.............................. 6,670,770 2,408,060
------------ ------------
Total current liabilities.......................................... 38,993,089 23,428,000
NON-CURRENT LIABILITIES:
Revolving credit facility............................................... 19,835,125 33,800,000
Long-term debt to related parties, less current maturities.............. 884,496 -
Other long-term debt, less current maturities........................... 10,786,067 7,736,981
------------ ------------
Total liabilities.................................................. 70,498,777 64,964,981
------------ ------------
COMMITMENTS AND CONTINGENCIES (NOTES 2 AND 5)
SHAREHOLDERS' EQUITY:
Preferred stock, $.001 par value; 10,000,000 shares authorized, none
issued............................................................... -- --
Common stock, $.001 par value; 100,000,000 shares authorized;
8,657,913 and 8,448,788 issued and outstanding at September 30, 1998
and December 31, 1997................................................ 8,658 8,449
Additional paid-in capital ............................................. 53,546,580 53,200,988
Retained earnings (deficit)............................................. (9,151,389) (12,431,560)
------------ ------------
Total shareholders' equity......................................... 44,403,849 40,777,877
------------ ------------
Total liabilities and shareholders' equity......................... $114,902,626 $105,742,858
============ ============
</TABLE>
See notes to consolidated financial statements.
3
<PAGE>
OUTSOURCE INTERNATIONAL, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(UNAUDITED)
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
September 30, September 30,
----------------------------- --------------------------------
1998 1997 1998 1997
------------- -------------- -------------- -------------
<S> <C> <C> <C> <C>
Net revenues......................................... $ 153,415,899 $ 121,975,957 $ 409,198,193 $ 315,173,329
Cost of revenues..................................... 130,649,354 102,923,824 347,117,232 268,762,184
------------- -------------- -------------- -------------
Gross profit......................................... 22,766,545 19,052,133 62,080,961 46,411,145
------------- -------------- ------------- -------------
Selling, general and administrative expenses:
Shareholders' compensation....................... - - - 292,001
Amortization of intangible assets ................ 978,178 472,552 2,700,020 1,365,125
Other selling, general and administrative......... 18,175,380 15,268,901 50,939,859 38,645,590
------------- -------------- ------------- -------------
Total selling, general and administrative
expenses......................... 19,153,558 15,741,453 53,639,879 40,302,716
------------- -------------- ------------- -------------
Operating income .................................... 3,612,987 3,310,680 8,441,082 6,108,429
------------- -------------- ------------- -------------
Other expense:
Interest expense (net)........................... 1,590,694 2,500,404 4,107,970 6,013,289
Put warrants valuation adjustment................ - 597,673 - 1,841,625
Other expense (income)........................... 55,593 8,054 17,025 (16,925)
------------- -------------- ------------- -------------
Total other expense.......................... 1,646,287 3,106,131 4,124,995 7,837,989
------------- -------------- ------------- -------------
Income (loss) before provision (benefit) for
income taxes ................................... 1,966,700 204,549 4,316,087 (1,729,560)
Provision (benefit) for income taxes................. 454,766 111,091 1,035,916 (682,493)
------------- -------------- ------------- -------------
Net income (loss).................................... $ 1,511,934 $ 93,458 $ 3,280,171 $ (1,047,067)
============= ============== ============== =============
Pro forma data:
Income (loss) before provision (benefit)
for income taxes................................ $ 1,966,700 $ 204,549 $ 4,316,087 $ (1,729,560)
Provision (benefit) for income taxes................. 454,766 111,091 1,035,916 (356,000)
------------- -------------- -------------- -------------
Net income (loss).................................... $ 1,511,934 $ 93,458 $ 3,280,171 $ (1,373,560)
============= =============== ============== =============
Weighted average common shares:
Basic........................................... 8,657,913 5,448,788 8,584,836 5,511,637
============= ============== ============== =============
Diluted......................................... 9,864,592 6,940,713 9,960,013 5,511,637
============= ============== ============== =============
Earnings (loss) per share:
Basic........................................... $ 0.17 $ 0.02 $ 0.38 $ (0.25)
============= ============== ============== =============
Diluted......................................... $ 0.15 $ 0.01 $ 0.33 $ (0.25)
============= ============== ============== =============
</TABLE>
See notes to consolidated financial statements.
4
<PAGE>
OUTSOURCE INTERNATIONAL, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY (DEFICIT)
(UNAUDITED)
<TABLE>
<CAPTION>
Additional Retained
Common Paid-In Earnings
Stock Capital (Deficit) (Deficit) Total
------ ----------------- ------------ -----------
<S> <C> <C> <C> <C>
Balance, December 31, 1997................................ $8,449 $53,200,988 $(12,431,560) $40,777,877
Issuance of common stock.................................. 58 774,942 -- 775,000
Exercise of warrants...................................... 151 2,177 -- 2,328
Distributions in connection with the Reorganization....... -- (431,527) -- (431,527)
Net income for the nine months ended September 30, 1998 .. -- -- 3,280,171 3,280,171
------ ----------- ------------ -----------
Balance, September 30, 1998 .............................. $8,658 $53,546,580 $ (9,151,389) $44,403,849
====== =========== ============ ===========
Balance, December 31, 1996................................ $5,785 $ 95,315 $ 4,394,125 $ 4,495,225
Net loss for the period from January 1, 1997
through February 21, 1997............................... -- -- (172,497) (172,497)
Distributions and other payments in connection with the
Reorganization.......................................... (336) (11,879,636) (4,221,628) (16,101,600)
Contribution of notes payable by shareholders............. -- 4,300,000 -- 4,300,000
Net loss for the period from February 22, 1997
through September 30, 1997............................... -- -- (874,570) (874,570)
------ ----------- ------------ -----------
Balance, September 30, 1997 .............................. $5,449 $(7,484,321) $ (874,570) $(8,353,442)
====== =========== ============ ===========
</TABLE>
See notes to consolidated financial statements.
5
<PAGE>
OUTSOURCE INTERNATIONAL, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
<TABLE>
<CAPTION>
Nine Months Ended
September 30,
-----------------------------
1998 1997
----------- -----------
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss)................................................. $ 3,280,171 $(1,047,067)
Adjustments to reconcile net income (loss) to net cash
provided by (used in) operating activities:
Depreciation and amortization.................................. 4,922,831 2,889,216
Amortization of debt discount and issuance costs............... - 808,749
Put warrants valuation adjustment.............................. - 1,841,625
Deferred income taxes.......................................... 128,775 (2,081,320)
Gain on disposal of property and equipment..................... - (77,134)
Changes in assets and liabilities (excluding effects of acquisitions):
(Increase) decrease in:
Trade accounts receivable............................. 33,327,869 (21,866,137)
Prepaid expenses and other current assets............. (830,935) (69,854)
Other assets.......................................... 14,323 (1,788,107)
Increase (decrease) in:
Accounts payable...................................... (476,205) 558,925
Accrued expenses:
Payroll........................................... 3,170,870 1,638,711
Payroll taxes..................................... 978,659 1,000,210
Workers' compensation and insurance............... 1,157,569 2,638,559
Other............................................. 889,390 3,154,863
Other current liabilities............................. 432,083 (1,162,060)
----------- -----------
Net cash provided by (used in) operating activities. 46,995,400 (13,560,821)
----------- -----------
CASH FLOWS FROM INVESTING ACTIVITIES:
Funding repayments from franchises, net........................... 1,085,931 891,990
Property and equipment expenditures............................... (3,846,352) (2,332,471)
Expenditures for acquisitions..................................... (27,842,031) (21,385,000)
----------- -----------
Net cash used in investing activities............... (30,602,452) (22,825,481)
----------- -----------
CASH FLOWS FROM FINANCING ACTIVITIES:
Increase in excess of outstanding checks over
bank balance, included in accounts payable..................... 3,353,382 461,603
Net proceeds from (repayment of) line of credit and
revolving credit facility..................................... (13,964,875) 30,404,494
Related party borrowings (repayments)............................. (354,562) 1,821,201
Proceeds of senior notes and put warrants, net of
issuance costs................................................ - 22,614,984
Repayment of long-term debt....................................... (3,141,490) (3,918,061)
Payments in connection with the Reorganization.................... (431,527) (14,356,600)
Deferred offering costs........................................... - (623,075)
Exercise of warrants.............................................. 2,328 --
----------- -----------
Net cash provided by (used in) financing activities.. (14,536,744) 36,404,546
------------ -----------
Net increase in cash.............................................. 1,856,204 18,244
Cash, beginning of period......................................... 1,685,474 44,790
----------- -----------
Cash, end of period............................................... $ 3,541,678 $ 63,034
=========== ===========
SUPPLEMENTAL CASH FLOW INFORMATION:
Interest paid..................................................... $ 3,724,083 $ 4,198,116
=========== ===========
</TABLE>
See notes to consolidated financial statements.
6
<PAGE>
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, 1998 and for the three and nine months ended
September 30, 1998 and 1997 are unaudited. Such interim consolidated financial
statements have been prepared on the same basis as the audited consolidated
financial statements and, in the opinion of management, reflect all adjustments
(including normal accruals) necessary for a fair presentation of the financial
position, results of operations and cash flows for the interim periods
presented. The results of operations for the interim periods presented are not
necessarily indicative of the results to be expected for the full year. The
interim financial statements should be read in conjunction with the audited
financial statements for the year ended December 31, 1997, included in the
Company's Form 10-K/A filed with the Securities and Exchange Commission on April
2, 1998.
In June 1997, Statement of Financial Accounting Standards ("SFAS") No. 131,
"Disclosures about Segments of an Enterprise and Related Information," was
issued. SFAS No. 131 establishes standards for the way that public companies
report selected information about operating segments in annual financial
statements and requires that those companies report selected information about
segments in interim financial reports issued to shareholders. It also
establishes standards for related disclosures about products and services,
geographic areas, and major customers. SFAS No. 131 is effective for financial
statements for periods beginning after December 15, 1997, although interim
period application is not required. The Company intends to first implemement
SFAS No. 131 in its consolidated financial statements as of and for the year
ended December 31, 1998, and will provide any required disclosures at that time.
In June 1998, SFAS No. 133, "Accounting for Derivative Instruments and
Hedging Activities" was issued. SFAS No. 133 defines derivatives and establishes
accounting and reporting standards requiring that every derivative instrument
(including certain derivative instruments embedded in other contracts) be
recorded in the balance sheet as either an asset or liability measured at its
fair value. SFAS No. 133 also requires that changes in the derivative's fair
value be recognized currently in earnings unless specific hedge accounting
criteria are met. Special accounting for qualifying hedges allows a derivative's
gains and losses to offset related results on the hedged item in the income
statement, and requires that a company must formally document, designate and
assess the effectiveness of transactions that receive hedge accounting. SFAS No.
133 is effective for all fiscal quarters of fiscal years beginning after June
15, 1999, and cannot be applied retroactively. The Company intends to first
implement SFAS No. 133 in its consolidated financial statements as of and for
the three months ended March 31, 2000, although it has not determined the
effects, if any, that implementation will have. However, SFAS No. 133 could
increase volatility in earnings and other comprehensive income.
NOTE 2. ACQUISITIONS
During the first quarter of 1998, the Company purchased the franchise
rights for a total of six flexible staffing locations from Freuhling and
Jackson, Inc., F.J.R. Enterprises, Inc., EJ Services, Inc. and EAZY Temporary,
Inc., and converted these locations to Company-owned locations. The total
purchase price was $5,531,050, with $3,365,525 paid at closing and notes issued
for $2,165,525, payable over two years plus interest at 6.0% per annum (imputed
at 8.75% for financial statement purposes). The principal amount due under one
of these notes may increase or decrease by an amount not to exceed $250,000,
based on the gross profit from the acquired locations for the year following the
acquisition.
During the first quarter of 1998, the Company purchased flexible staffing
operations with a total of 18 locations from Tempus, Inc. and Grafton, Inc.
(none previously affiliated with the Company). The total purchase price was
$4,835,000, with $3,335,000 paid at closing plus a $1,500,000 note payable over
two years plus interest at 6.5% per annum (imputed at 8.75% for financial
statement purposes). The principal amount due under the note may decrease by up
to $300,000, based on the 1997 gross profit of the acquired locations.
Immediately following the acquisition from Tempus, Inc., the Company sold four
of the acquired locations to Cruel Dave Enterprises, LLC (a franchisee of the
Company) in exchange for the issuance of a $780,000 note, payable over five
years plus interest at 8.0% per annum.
7
<PAGE>
OUTSOURCE INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
(UNAUDITED)
NOTE 2. ACQUISITIONS (CONTINUED)
During the first quarter of 1998, the Company purchased 100% of the common
stock of Employment Consultants, Inc., X-Tra Help, Inc. and Co-Staff, Inc. (none
previously affiliated with the Company), which were flexible staffing operations
with a total of four locations. The total purchase price (which includes
$2,100,000 for the excess of net tangible assets over liabilities assumed) was
$11,259,500, with $7,509,500 in cash and $775,000 in the Company's common stock
(57,809 shares) delivered at closing. The remainder of the purchase price was
satisfied by the issuance of notes totaling $2,975,000 and payable over two
years plus interest at 6.0% per annum (imputed at 8.75% for financial statement
purposes). However, one of the notes may increase without limit or decrease by
up to $875,000 based on the gross profit from the acquired locations for the two
years following the acquisition. For example, in the event gross profit for
those two years was equal to 1997 gross profit, the note would decrease by
approximately $125,000 or, in the event gross profit increased by 25% in each of
those two years as compared to the prior year, the note would increase by
approximately $150,000. Certain sellers received options to purchase a total of
6,000 shares of the Company's common stock at fair market value on the date of
issuance. Such options were issued January 31, 1998 and were still outstanding
at September 30, 1998.
Effective February 16, 1998, the Company purchased the franchise rights for
four flexible staffing locations from LM Investors, Inc. and converted these
locations to Company-owned locations. The shareholders of the franchises are
shareholders of the Company but do not hold a controlling interest in the
Company. The purchase price was $6,910,000, with $5,000,000 paid in cash at
closing plus the issuance of a note for $1,700,000 bearing interest at 7.25% per
annum (imputed at 8.75% for financial statement purposes) and payable quarterly
over three years. The remaining $210,000 of purchase price represents the
Company's assumption of approximately $100,000 of the seller's liabilities under
certain employment contracts and the Company's agreement to reduce by
approximately $110,000 the sellers' obligation to the Company in connection with
the termination of their remaining franchise agreements with the Company (See
Note 6). See Note 5 regarding options for certain franchise territories also
granted in connection with this transaction.
During the second quarter of 1998, the Company purchased the franchise
rights for a total of five flexible staffing locations from Deb-Lar, Inc., BLM
Enterprises, Inc. and Century Investors, Inc., and converted these locations to
Company-owned locations. The total purchase price was $1,634,904, with
$1,040,000 paid at closing and notes issued for $594,904, payable over two years
plus interest at 6.0% per annum (imputed at 8.75% for financial statement
purposes).
During the second quarter of 1998, the Company purchased flexible staffing
operations with a total of five locations from Pro Select, Inc., Ready Help,
Inc., Mid-West Temps, Inc. and Resource Dimensions, Inc. (none previously
affiliated with the Company). The total purchase price was $9,406,800, with
$7,096,800 paid in cash at closing (which included $946,800 placed in escrow)
plus notes issued for $2,110,000, payable over a nineteen and one half month
period plus interest at 6.0% per annum (imputed at 8.75% for financial statement
purposes). Payment of the remaining $200,000 is contingent primarily upon the
gross profit of one of the acquired locations for the twelve months following
the acquisition. The escrowed portion is payable to one of the sellers
approximately fourteen months after closing, less any portion paid to the
Company as compensation for any losses resulting from certain breaches of one of
the asset purchase agreements. The Company is obligated for an additional
payment to one of the sellers equivalent to any increase in the amount of gross
profit of the locations acquired from such seller for the twelve months ending
May 31, 1999, as compared to the greater of a contractually defined amount or
the gross profit of those locations for the twelve months ended March 31, 1998.
8
<PAGE>
OUTSOURCE INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
(UNAUDITED)
NOTE 2. ACQUISITIONS (CONTINUED)
During the third quarter of 1998, the Company (i) purchased the franchise
rights for one flexible staffing location from ALPAP, Inc. and converted this
location to a Company-owned location and (ii) purchased certain PEO operations
from Hamilton-Ryker Co., Inc., which were immediately transferred to existing
Company locations. The total purchase price was $820,000, with $730,000 paid in
cash at closing and assumption by the Company of approximately $90,000 of
liabilities. The Company is obligated for additional payments to one of the
sellers of (i) up to $50,000 in the event of any increase in the amount of gross
profit of the location acquired from such seller for the twelve months ended
December 31, 1998, as compared to a contractually defined amount and (ii) up to
$75,000 based on the workers' compensation premium with relation to the acquired
location for the six months ended December 31, 1998.
The above acquisitions have been accounted for as purchases. The results of
operations of the acquired businesses are included in the Company's consolidated
statements of income from the effective date of acquisition. The additional
payments based on future gross profit of certain acquired businesses are not
contingent on the continued employment of the sellers. Such additional amounts,
if paid, will be recorded as additional purchase price and increase goodwill.
The above purchase prices are stated before adjustments to reflect imputed
interest on acquisition financing and do not include acquisition related
professional fees and other costs capitalized as additional purchase price.
The costs of each acquisition have been allocated to the assets acquired
and liabilities assumed based on their fair values on the date of acquisition as
determined by management with the assistance of an independent valuation
consultant. The costs of the acquisitions in 1998 have been allocated on a
preliminary basis while the Company obtains final information regarding the fair
value of assets acquired and liabilities assumed. Although the allocation and
amortization periods are subject to adjustment, the Company does not expect that
such adjustments will have a material effect on its consolidated financial
statements.
The following unaudited pro forma results of operations have been prepared
assuming the acquisitions described above as well as the acquisitions completed
by the Company during 1997 (and described in the Company's audited consolidated
financial statements for that year), had occurred as of the beginning of the
periods presented, including adjustments to the historical financial statements
for additional amortization of intangible assets, increased interest on
borrowings to finance the acquisitions and discontinuance of certain
compensation previously paid by the acquired businesses to their shareholders.
The unaudited pro forma operating results are not necessarily indicative of
operating results that would have occurred had these acquisitions been
consummated as of the beginning of the periods presented, or of future operating
results. In certain cases, the operating results for periods prior to the
acquisition are based on (a) unaudited financial statements provided by the
seller or (b) an estimate of revenues, cost of revenues and/or selling, general
and administrative expenses based on information provided by the seller or
otherwise available to the Company. In these cases, the Company has made a
reasonable attempt to obtain the most complete and reliable financial
information and believes that the financial information it used is reasonably
accurate, although the Company has not independently verified such information.
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
September 30, September 30,
----------------------------- -------------------------------
1998 1997 1998 1997
------------ ------------ ------------ ------------
<S> <C> <C> <C> <C>
Unaudited pro forma:
Net revenues............................... $153,615,860 $145,509,749 $426,766,828 $389,294,070
Operating income........................... 3,624,863 4,818,418 9,450,825 9,734,086
Income (loss) before provision (benefit)
for income taxes....................... 1,970,793 611,734 4,660,740 (1,817,448)
Net income (loss).......................... 1,514,483 299,248 3,462,706 (1,260,778)
</TABLE>
9
<PAGE>
OUTSOURCE INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
(UNAUDITED)
NOTE 2. ACQUISITIONS (CONTINUED)
The following unaudited pro forma information, as adjusted, has been
prepared on the same basis as the preceding data and also reflects the pro forma
adjustment for income taxes and weighted average shares outstanding as discussed
in Note 9, except that the number of weighted average shares has been increased
by 57,809 basic shares for the three and nine months ended September 30, 1997,
and 58,542 and 57,809 diluted shares for the three and nine months ended
September 30, 1997 and 6,564 basic and 6,542 diluted shares for the nine months
ended September 30, 1998, in order to reflect adjustments for (i) the
calculation of proceeds from the exercise of warrants associated with certain
debt utilized to finance the above acquisitions as well as the acquisitions
completed by the Company during 1997 (and described in the Company's audited
consolidated financial statements for that year) and (ii) the timing of the
issuance of common stock and options in connection with those acquisitions:
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
September 30, September 30,
--------------------------- -------------------------
1998 1997 1998 1997
---------- ----------- ---------- -----------
<S> <C> <C> <C> <C>
Unaudited pro forma, as adjusted:
Income (loss) before provision (benefit) for
income taxes........................... $1,970,793 $ 611,734 $4,660,740 $(1,817,448)
Pro forma provision (benefit) for
income taxes........................... 456,310 312,486 1,198,034 (230,170)
---------- ----------- ---------- -----------
Pro forma net income (loss).................. $1,514,483 $ 299,248 $3,462,706 $(1,587,271)
========== =========== ========== ===========
Weighted average common shares outstanding:
Basic.................................... 8,657,913 5,506,597 8,591,400 5,569,446
========== =========== ========== ===========
Diluted.................................. 9,864,592 6,999,255 9,966,555 5,569,446
========== =========== ========== ===========
Earnings (loss) per share:
Basic.................................... $ 0.17 $ 0.05 $ 0.40 $ (0.28)
========== =========== ========== ===========
Diluted.................................. $ 0.15 $ 0.04 $ 0.35 $ (0.28)
========== =========== ========== ===========
</TABLE>
Goodwill and other intangible assets consist of the following:
<TABLE>
<CAPTION>
As of As of
September 30, December 31,
1998 1997
----------- -----------
<S> <C> <C>
Goodwill.............................................. $31,861,589 $11,940,120
Territory rights...................................... 25,826,059 14,729,752
Customer lists........................................ 10,086,376 4,672,178
Covenants not to compete.............................. 2,183,218 1,204,841
Employee lists........................................ 401,980 196,479
----------- -----------
Goodwill and other intangible assets.................. 70,359,222 32,743,370
Less accumulated amortization......................... 5,016,659 2,316,639
----------- ------------
Goodwill and other intangible assets, net............. $65,342,563 $30,426,731
=========== ===========
</TABLE>
During the fourth quarter of 1998, the Company purchased the franchise
rights for two flexible staffing locations from Sterling Temporaries, Inc. and
converted these locations to Company-owned locations. The purchase price is
based on a percentage of gross margin from the acquired locations for the three
years after the closing and is limited to $650,000. At closing, $200,000 was
paid as an advance against the terms of the earnout.
10
<PAGE>
OUTSOURCE INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
(UNAUDITED)
NOTE 3. INCOME TAXES
The Company's effective tax rate for the three and nine months ended
September 30, 1998 differed from the statutory federal rate of 35%, as follows:
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
September 30, 1998 September 30, 1998
------------------ ---------------------
Amount Rate Amount Rate
-------- ------ ---------- ------
<S> <C> <C> <C> <C>
Statutory rate applied to income before income taxes.... $688,344 35.0% $1,510,630 35.0%
Increase (decrease) in income taxes resulting from:
State income taxes, net of federal benefit.......... 82,427 4.3 209,932 4.9
Employment tax credits.............................. (302,364) (15.4) (752,615) (17.4)
Other............................................... (13,641) (0.8) 67,969 1.5
-------- ----- ---------- -----
Total............................................... $454,766 23.1% $1,035,916 24.0%
======== ===== ========== =====
</TABLE>
NOTE 4. DEBT
Effective July 27, 1998, the Company entered into a five year financing
arrangement pursuant to which it can sell up to a $50,000,000 secured interest
in its eligible accounts receivable to EagleFunding Capital Corporation
("Eagle"), which uses the receivables to secure A-1/P-1 rated commercial paper
(the "Securitization Facility"). In connection with the Securitization Facility,
the Company's revolving credit facility with a syndicate of commercial banks led
by BankBoston N.A. ("Revolving Credit Facility") was amended, primarily to
reduce the maximum amount available for borrowing from $85,000,000 to
$34,000,000 and to extend the remaining term of the Revolving Facility to five
years from the date of that amendment. Eagle is an affiliate of BankBoston, N.A.
Under the Securitization Facility, the Company receives cash equivalent to
the gross outstanding balance of the accounts receivable being sold, less
reserves which are adjusted on a monthly basis based on collection experience
and other defined factors. There is no recourse to the Company for the initial
funds received. Amounts collected in excess of the reserves are retained by
the Company. The Company's interest rate, payable on the balance of the
outstanding commercial paper, is determined by prevailing interest rates in the
commercial paper market and was approximately 5.6% as of September 30, 1998. As
of September 30, 1998, a $45,533,000 interest in the Company's uncollected
accounts receivable had been sold under this agreement, which is excluded from
the accounts receivable balance presented in the Company's consolidated
financial statements.
The Securitization Facility contains certain minimum default, delinquency
and dilution ratios with respect to the Company's receivables and requires bank
liquidity commitments ("Liquidity Facility") totaling no less than $51,000,000.
A default under the Securitization Facility constitutes a default under the
Revolving Credit Facility. The Liquidity Facility has been provided by the
syndicate of commercial banks that participate in the Revolving Credit Facility
for a one year term expiring July 26, 1999 at 0.375% per annum, and is expected
to be renewed annually. Eagle may draw against the Liquidity Facility to fund
cash shortfalls caused by an inability for any reason to issue commercial paper
based on the Company's receivables. There is no recourse to the Company for
amounts drawn under the Liquidity Facility, although such amounts would be
repaid from and to the extent receivables sold by the Company were collected.
Amounts drawn under the Liquidity Facility bear interest at the same rates
incurred under the Revolving Credit Facility.
11
<PAGE>
OUTSOURCE INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
(UNAUDITED)
NOTE 5. COMMITMENTS AND CONTINGENCIES
Effective February 21, 1997, the Company acquired all of the outstanding
capital stock of nine companies under common ownership and management, in
exchange for shares of the Company's common stock and distribution of previously
undistributed taxable earnings of those nine companies (the "Reorganization").
That distribution was subject to adjustment based upon the final determination
of taxable income through February 21, 1997. In September 1998, the Company
completed and filed its Federal and state tax returns for the period from
January 1, 1997 through February 21, 1997. Based on that filing, the Company
made an additional distribution of $431,527 to the shareholders at the time of
the Reorganization. The distribution was recorded as a reduction of the
Company's paid-in capital. Further distributions may be required in the event
the taxable income for any period through February 21, 1997 is adjusted due to
audits or any other reason.
As of September 30, 1998, options issued prior to 1998 to purchase 527,949
shares of the Company's common stock were still outstanding. The Company also
granted options during 1998 to purchase 870,699 shares of the Company's common
stock, as follows:
Month of Issuance Number of Options Exercise Price Per Share
----------------- ----------------- ------------------------
January 265,646 $13.88
March 71,700 $18.88
May 18,375 $19.50 to $20.13
June 4,432 $16.75
August 75,000 $10.38 to $13.88
August 52,500 $6.00 to $7.25
November 383,046 $6.00
The above exercise prices were equal to the market price of the shares at
the grant date, except the exercise prices for the August 1998 grant of 75,000
options, which represented the cancellation of a May 1998 grant and reissuance
at exercise prices in excess of the market price of the shares at the new grant
date. The above options vest over a four year period from the date of issuance,
except 89,896 options issued in January 1998, which vested immediately upon
grant.
During February 1998 and in connection with the Company's acquisition of
certain franchise rights from LM Investors, Inc. (see Note 2), the Company
granted one of the principals of the sellers (and a minority shareholder in the
Company) the exclusive option to purchase franchise rights in five specifically
identified geographic areas. These options expire at various times from 12 to 42
months after the February 1998 acquisition date.
In February 1998, the Company entered into an interest rate collar
agreement with BankBoston, N.A., which involves the exchange of 30 day floating
rate interest payments periodically over the life of the agreement without the
exchange of the underlying principal amounts. The differential to be paid or
received is accrued as interest rates change and is recognized over the life of
the agreement as an adjustment to interest expense. The agreement is a five year
notional $42.5 million interest rate collar, whereby the Company receives
interest on that notional amount to the extent 30 day LIBOR exceeds 6.25% per
annum, and pays interest on that amount to the extent 30 day LIBOR is less than
5.43% per annum. This derivative financial instrument is being used by the
Company to reduce interest rate volatility and the associated risks arising from
the floating rate structure of its Revolving Credit Facility and its
Securitization Facility, and is not held or issued for trading purposes.
On July 27, 1998, the Company redesignated a portion of this hedge, no
longer applicable to its Revolving Credit Facility, to anticipated transactions
under the Securitization Facility. The Company adjusted the carrying value of
the redesignated portion of the hedge from zero to its fair value based
primarily on information from BankBoston, resulting in a $635,000 liability as
of September 30, 1998 which is included with other long-term debt on the
Company's balance sheet. The associated loss, which may never be realized due to
the volatility of interest rates and the Company's intention not to terminate
the interest rate collar agreement, has been deferred and is included in Other
Assets. The unrealized loss related to the portion of the hedge designated to
the Revolving Credit Facility and not reflected on the Company's balance sheet
as of September 30, 1998 was approximately $565,000. The Company reevaluates the
portion of the hedge designated to the Revolving Credit Facility and the
Securitization Facility on a monthly basis.
12
<PAGE>
OUTSOURCE INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
(UNAUDITED)
NOTE 5. COMMITMENTS AND CONTINGENCIES (CONTINUED)
In accordance with the guidance of SFAS No. 80, "Accounting for Futures
Contracts", the Company has identified net proceeds from the Company's weekly
sale of receivables under the Securitization Facility as anticipated
transactions which will vary with high correlation to changes in the 30 day
LIBOR interest rates that are the subject of the Company's interest rate collar
agreement. Accordingly, the collar fixes within a certain range the variability
in those net proceeds and is accounted for as a hedge in accordance with SFAS
No. 80.
During April 1998, the Company entered into an employment agreement with
its new Chief Financial Officer, in addition to the employment agreements
already existing with the Chief Executive Officer ("CEO") and five other
officers. Under the terms of those agreements, in the event that the Company
terminates any of those officers without cause or the officer resigns for good
reason, the terminated officer will receive, among other things, severance
compensation, including a multiple of the officer's annual base salary and
bonus. In addition, all incentive stock options become immediately exercisable.
Similar severance provisions apply if any of those officers is terminated within
two years (three years for the CEO) after the occurrence of a "change of
control", as defined in the employment agreements.
For the three and nine months ended September 30, 1998, approximately nine
percent of the Company's revenues 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 addition, the Company is aware of pending litigation
against that corporate employer regarding its use of PEO services. 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.
The Company is involved in litigation with regards to one of the service
marks used in its operations. The Company believes that an adverse decision in
the case would not have a material adverse effect on its financial condition or
results of operations.
Pursuant to the terms of a now inactive 401(k) plan (containing previous
contributions still managed by the Company), highly compensated employees were
not eligible to participate. However, as a result of administrative errors in
1996 and prior years, some highly compensated employees were inadvertently
permitted to make elective salary deferral contributions. The Company has sought
IRS approval regarding the proposed correction under the Voluntary Closing
Agreement Program ("VCAP"). There will be a penalty payable by the Company,
associated with a correction under the VCAP, although the Company believes this
penalty will be insignificant.
NOTE 6. RELATED PARTY TRANSACTIONS
Effective August 31, 1998, certain Company shareholders owning franchises
with a total of four locations entered into a buyout agreement with the Company.
Buyouts are early terminations of 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. The Company will continue to receive payments from the former
franchisee primarily based on the gross revenues of the formerly franchised
locations for two years after the termination date. These terms were generally
consistent with the terms of previous buyout agreements between the Company and
unrelated third parties. In addition, the Company agreed to not compete (except
by acquisition) for six months in the territories being bought out. During the
three and nine months ended September 30, 1998, the Company recognized revenues
of $717,360 and $1,004,338, respectively, from all franchises owned by
shareholders of the Company, which includes royalties and payments under the
buyout agreement.
13
<PAGE>
OUTSOURCE INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
(UNAUDITED)
NOTE 7. 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:
<TABLE>
<CAPTION>
Nine Months Ended September 30,
-----------------------------------
1998 ` 1997
------------ -------------
<S> <C> <C>
Acquisitions:
Tangible and intangible assets acquired... $ 41,471,006 $ 25,067,375
Liabilities assumed....................... (1,457,643) (54,455)
Debt issued............................... (11,396,332) (3,627,920)
Common stock issued....................... (775,000) -
------------ -------------
Net cash paid for acquisition................. $ 27,842,031 $ 21,385,000
============ =============
Deferred loss on interest rate collar
agreement................................. $ 635,000 $ --
============ =============
Increase in property and equipment and
long-term debt, primarily capitalized
leases...................................... $ -- $ 875,199
============ =============
Debt to shareholders for distributions
and amounts in connection with the
Reorganization.............................. $ -- $ 1,745,000
============ =============
Shareholders' contribution to
additional paid-in capital in
connection with the Reorganization........ $ -- $ 4,300,000
============ =============
</TABLE>
NOTE 8. COMPREHENSIVE INCOME (LOSS)
Comprehensive income (loss) includes all changes in equity during a period,
except those changes in equity resulting from investment by owners and
distribution to owners. Comprehensive income (loss) totaled $1,511,934 and
$93,458 for the three months ended September 30, 1998 and 1997, respectively,
and $3,280,171 and $(1,047,067) for the nine months ended September 30, 1998 and
1997, respectively, and consists solely of the Company's net income (loss) for
the respective periods.
14
<PAGE>
OUTSOURCE INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
(UNAUDITED)
NOTE 9. PRO FORMA DATA
Pro forma net income includes adjustments made to historical net income for
pro forma income taxes computed as if the Company had been fully subject to
federal and applicable state income taxes. The Company calculates pro forma
earnings per share in accordance with the requirements of SFAS No. 128,
"Earnings Per Share". The pro forma weighted average shares outstanding used to
calculate pro forma basic and diluted earnings (loss) per share were calculated
as follows:
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
September 30, September 30,
----------------------- -------------------------
1998 1997 1998 1997
--------- --------- --------- ---------
<S> <C> <C> <C> <C>
Shares issued in connection with the Reorganization.. 5,448,788 5,448,788 5,448,788 5,448,788
Equivalent shares represented by shares
of common stock of certain subsidiaries
purchased in the Reorganization................... -- -- -- 62,849
Shares sold by the Company in October 1997........... 3,000,000 -- 3,000,000 --
Shares issued in connection with a February 1998
Acquisition (see Note 2).......................... 57,809 -- 51,245 --
Warrants exercised in May 1998....................... 151,316 -- 84,803 --
--------- --------- ---------- ----------
Weighted average common shares - basic............... 8,657,913 5,448,788 8,584,836 5,511,637
Outstanding options and warrants to purchase common
stock - remaining shares after assumed repurchase
using proceeds from exercise...................... 1,206,679 1,491,925 1,375,177 --
--------- --------- --------- ----------
Weighted average common shares - diluted............. 9,864,592 6,940,713 9,960,013 5,511,637
========= ========= ========= =========
</TABLE>
Certain of the outstanding options and warrants to purchase common stock
were anti-dilutive for the three and nine month periods presented above.
15
<PAGE>
ITEM 2 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
GENERAL
The Company is a leading national provider of human resource services
focusing on the flexible industrial ("staffing") market through its Tandem
division and on the professional employer organization ("PEO") market through
its Synadyne division. To implement its growth strategies, the Company completed
36 acquisitions, primarily staffing companies, from January 1, 1995 through
November 13, 1998. These acquisitions included 89 offices and collectively
generated approximately $189.0 million in revenue for the twelve months
preceding each acquisition. The Company acquired 30 of those offices in 1997
(the "1997 Acquisitions") and 41 of those offices in 1998 (the "1998
Acquisitions"). See "-Acquisitions" below. Due to these acquisitions, as well as
new offices opened by the Company, during this period the number of
Company-owned staffing and PEO offices increased from 10 to 127 and the number
of metropolitan markets (measured by Metropolitan Statistical Areas, or MSAs)
served by Company-owned locations increased from one to 45. In order to support
its growth, the Company implemented new information systems, further developed
back office capabilities and invested in other infrastructure enhancements.
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.
Because the Company is at risk for all of its direct costs, independent of
whether payment is received from its clients, and consistent with industry
practice, all amounts billed to clients for gross salaries and wages, related
employment taxes, health benefits and workers' compensation coverage are
recognized as revenue by the Company, net of credits and allowances. The
Company's primary direct costs are (i) the salaries and wages of worksite
employees (payroll cost), (ii) employment related taxes, (iii) health benefits
and (iv) workers' compensation benefits and insurance.
RESULTS OF OPERATIONS
Effective February 21, 1997, the Company acquired all of the outstanding
capital stock of nine companies under common ownership and management (the
"Reorganization"). The historical operating results of the Company presented and
discussed herein also include the historical operating results of those acquired
companies for the periods noted. The following tables set forth, on an unaudited
basis, the amounts and percentage of net revenues of certain items in the
Company's consolidated statements of income for the indicated periods.
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
September 30, September 30,
------------------------ ------------------------
1998 1997 1998 1997
--------- --------- --------- ---------
(In thousands, except employees and offices)
<S> <C> <C> <C> <C>
Net revenues:
Flexible industrial staffing ................... $ 81,763 $ 60,197 $ 215,094 $ 143,496
PEO ............................................ 67,397 57,553 182,760 161,073
Franchise royalties and other .................. 4,256 4,226 11,344 10,604
--------- --------- --------- ---------
Total net revenues ............................. $ 153,416 $ 121,976 $ 409,198 $ 315,173
========= ========= ========= =========
Gross profit ................................... $ 22,767 $ 19,052 $ 62,081 $ 46,411
Selling, general and administrative
expenses (1)............................... 19,154 15,741 53,640 40,303
--------- --------- --------- ---------
Operating income ............................... 3,613 3,311 8,441 6,108
Net interest and other expenses (1) ............ 1,646 3,107 4,125 7,838
--------- --------- --------- ---------
Income (loss) before provision (benefit) for
income taxes .............................. 1,967 204 4,316 (1,730)
Pro forma income taxes (benefit) (1) ........... 455 111 1,036 (356)
--------- --------- --------- ---------
Pro forma net income (loss) (1) ................ $ 1,512 $ 93 $ 3,280 $ (1,374)
========= ========= ========= =========
System Operating Data:
System Revenues (2) ............................ $ 176,562 $ 151,268 $ 473,517 $ 399,840
========= ========= ========= =========
Number of employees (end of period) ............ 37,100 32,400 37,100 32,400
========= ========= ========= =========
Number of offices (end of period) .............. 174 162 174 162
========= ========= ========= =========
</TABLE>
16
<PAGE>
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
September 30, September 30,
------------------ -----------------
1998 1997 1998 1997
----- ----- ----- -----
<S> <C> <C> <C> <C>
Net revenues:
Flexible industrial staffing ................... 53.3% 49.4% 52.5% 45.5%
PEO ............................................ 43.9 47.2 44.7 51.1
Franchise royalties and other .................. 2.8 3.4 2.8 3.4
----- ----- ----- -----
Total net revenues ............................. 100.0% 100.0% 100.0% 100.0%
===== ===== ===== =====
Gross profit ................................... 14.8% 15.6% 15.2% 14.7%
Selling, general and administrative
expenses (1).................................. 12.5 12.9 13.1 12.8
----- ----- ----- -----
Operating income ............................... 2.4 2.7 2.1 1.9
Net interest and other expense (income) (1) .... 1.1 2.5 1.0 2.4
----- ----- ----- -----
Income (loss) before provision (benefit) for
income taxes ................................. 1.3 0.2 1.1 (0.5)
Pro forma income taxes (benefit) (1) ........... 0.3 0.1 0.3 (0.1)
----- ----- ----- -----
Pro forma net income (loss) (1) ................ 1.0% 0.1% 0.8% (0.4)%
===== ===== ===== =====
</TABLE>
- - ----------
(1) For the eight week period ended February 21, 1997, the Company elected to
be treated as a subchapter S corporation and, accordingly, the Company's
income was taxed at the shareholder level. In addition, during that period,
the Company paid compensation to the Company's founding shareholders and to
the Company's President, Chief Executive Officer, and Chairman of the
Board, who was also a shareholder of the Company ("Shareholder
Compensation"). All of the compensation for the founding shareholders and a
portion of the compensation for the Company's President was discontinued
after the Reorganization. The discontinued Shareholder Compensation was
$262,000 for the nine months ended September 30, 1997. During the three and
nine months ended September 30, 1997, the Company recorded non-operating
expense of approximately $0.6 million and $1.8 million, respectively,
related to a put warrants valuation adjustment. The following table sets
forth the amounts and the percentage of certain items in the Company's
consolidated statements of income, with 1997 amounts and percentages
adjusted for the above items as follows: (i) selling, general and
administrative expenses excludes discontinued Shareholder Compensation;
(ii) operating income excludes discontinued Shareholder Compensation and
(iii) net income and earnings per share excludes discontinued Shareholder
Compensation and the put warrants valuation adjustment and is calculated
assuming the Company had been subject to federal and state income taxes and
taxed as a C corporation during the period.
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
September 30, September 30,
---------------------- ---------------------
1998 1997 1998 1997
------- ------- ------- -------
(In thousands, except for percentages and per share data)
<S> <C> <C> <C> <C>
Selling general and administrative expenses, as adjusted... $19,154 $15,741 $53,640 $40,042
As a percentage of net revenues............................ 12.5% 12.9% 13.1% 12.7%
Operating income, as adjusted............................. $3,613 $ 3,311 $ 8,441 $ 6,369
As a percentage of net revenues............................ 2.4% 2.7% 2.1% 2.0%
Net income, as adjusted.................................... $1,512 $ 626 $ 3,280 $ 350
As a percentage of net revenues............................ 1.0% 0.5% 0.8% 0.1%
Earnings per diluted share, as adjusted.................... $ 0.15 $ 0.09 $ 0.33 $ 0.05
EBITDA, as adjusted........................................ $5,331 $ 4,517 $13,347 $ 9,524
</TABLE>
17
<PAGE>
EBITDA is income before the effect of interest income and expense, income
tax benefit and expense, depreciation expense and amortization expense. EBITDA
as adjusted excludes discontinued shareholder compensation and the 1997 put
warrants valuation adjustment. EBITDA is presented because it is a widely
accepted financial indicator used by many investors and analysts to analyze and
compare companies on the basis of operating performance. EBITDA is not intended
to represent cash flows for the period, nor has it been presented as an
alternative to operating income or as an indicator of operating performance and
should not be considered in isolation or as a substitute for measures of
performance prepared in accordance with generally accepted accounting
principles.
- - --------------------------------------------------------------------------------
(2) System revenues represent the sum of the Company's net revenues (excluding
revenues from franchise royalties and services performed for franchisees) and
the net revenues of the franchisees. System revenues provide information
regarding the Company's penetration of the market for its services, as well as
the scope and size of the Company's operations, but are not an alternative to
revenues determined in accordance with generally accepted accounting principles
as an indicator of operating performance. The net revenues of franchisees, which
are not earned by or available to the Company, are derived from reports that are
unaudited. System revenues consist of the following:
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
September 30, September 30,
------------------------ -----------------------
1998 1997 1998 1997
-------- -------- --------- --------
(In Thousands)
<S> <C> <C> <C> <C>
Company's net revenues ...... $153,416 $121,976 $409,198 $315,173
Less Company revenues from:
Franchise royalties ....... (2,011) (2,212) (4,960) (5,117)
Services to franchisees ... (5,968) (8,173) (19,043) (25,176)
Add franchisees' net revenues 31,125 39,677 88,323 114,960
-------- -------- -------- --------
System revenues ............ $176,562 $151,268 $473,517 $399,840
======== ======== ======== ========
</TABLE>
- - --------------------------------------------------------------------------------
THREE MONTHS ENDED SEPTEMBER 30, 1998 COMPARED TO THREE MONTHS ENDED
SEPTEMBER 30, 1997
NET REVENUES. Net revenues increased $31.4 million, or 25.8%, to $153.4
million in the three months ended September 30, 1998 ("Q3 1998") from $122.0
million in the three months ended September 30, 1997 ("Q3 1997"). This increase
resulted from growth in staffing revenues in Q3 1998 of $21.6 million, or 35.8%,
and PEO revenues growth of $9.8 million, or 17.1%, compared to Q3 1997. Staffing
revenues increased due to (i) the 1998 Acquisitions and (ii) internal growth due
to development of existing Company-owned locations and an increase in the number
of Company-owned offices. The Company-owned staffing offices increased by 25
locations to 115 locations as of September 30, 1998. This increase was the
result of the 38 additional locations acquired in the 1998 Acquisitions,
partially offset by offices closed and consolidated into other Company-owned
locations. The increase in PEO revenues was primarily due to new PEO clients, as
well as an increase in the number of worksite employees at certain existing PEO
clients.
System revenues, which include franchise revenues not earned by or
available to the Company, increased $25.3 million, or 16.7%, to $176.6 million
in Q3 1998 from $151.3 million in Q3 1997. The increase in system revenues was
attributable to the $31.4 million increase in the Company's net revenues
discussed above. Franchise revenues of franchisees operating as of September 30,
1998 increased $6.8 million, or 33.3%, in Q3 1998 as compared to Q3 1997, but
that increase was offset by a $15.4 million decrease in the same period
resulting from other franchisees no longer operating. The result is a net
decrease of franchise revenues of $8.6 million. The Company acquired and
converted 29 franchise locations to Company-owned locations during 1997 and 1998
and also allowed the early termination of franchise agreements (in order to
allow the Company's development of the related territories) related to another
28 locations in 1997 and 1998. At the time the Company agrees to terminate a
franchise agreement, it receives an initial buyout payment from the former
franchisee. The Company continues to receive payments from the former
franchisees based on the gross revenues of the formerly franchised locations for
up to three years after the termination dates. Although those gross revenues are
not included in the Company's franchisee or system revenues totals, the initial
buyout payment, as well as subsequent payments from the former franchisees, are
reflected in total royalties reported by the Company.
18
<PAGE>
GROSS PROFIT. Gross profit (margin) increased $3.7 million, or 19.5%, to
$22.8 million in Q3 1998 from $19.1 million in Q3 1997. Gross profit as a
percentage of net revenues decreased to 14.8% in Q3 1998 from 15.6% in Q3 1997.
Gross profit margin percent for the Company's staffing operations decreased
to 22.0% in Q3 1998 from 23.4% in Q3 1997, primarily due to the impact of (i)
the increased wages necessary to recruit staffing employees in areas of
historically low unemployment, (ii) continued execution of a strategy to obtain
larger contracts which have higher per hour billing and pay rates but lower
gross profit margin percentages and (iii) an increase in the minimum wage on
September 1, 1997, for which the Company increased billing rates without a
related profit increase. The proportion of the larger contracts discussed above
was relatively more significant in Q3 1998 as compared to the first two quarters
of the year. Gross profit per hour was approximately nine cents lower in Q3 1998
than in Q3 1997, although approximately three cents of that decrease was due to
the September 1997 minimum wage increase. The Company anticipates these factors
will continue to affect margins from staffing operations, although in many cases
the Company expects the impact to be offset by lower selling, general and
administrative expenses (measured as a percentage of gross profit) due to the
economies of scale in servicing larger contracts.
PEO margin percent decreased to 3.1% in Q3 1998 from 3.6% in Q3 1997,
primarily because of the payment to a client's employee of a one-time bonus on
which no margin was earned by the Company and a one-time increase in workers'
compensation expense due to pre-1997 claims. Since 1997, the Company has
purchased caps on the potential annual liability for workers' compensation
claims and it accrues a liability and expense equal to that cap. For claims
which arose prior to 1997, management used estimates from an independent
third-party administrator and applied industry standard development factors to
establish an appropriate reserve; however during Q3 1998 reserves for a few of
those claims increased beyond the reserves calculated in this manner.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES. Selling, general and
administrative expenses ("SG&A") increased $3.5 million, or 21.7%, to $19.2
million in Q3 1998 from $15.7 million in Q3 1997. This increase was primarily a
result of operating costs related to the 1998 Acquisitions and sales costs
associated with increased staffing volume at existing locations and the 1997
Acquisitions. Total direct operating costs associated with the 1998 Acquisition
locations were $2.7 million in Q3 1998, not including indirect costs incurred by
the Company for infrastructure to support the larger customer base.
SG&A, expressed as a percentage of gross profit, was 84.1% for Q3 1998 as
compared to 82.6% for Q3 1997. However, the Q3 1998 percentage represents a
decline from 89.4% for the first quarter of 1998 and 86.3% for the second
quarter of 1998, which the Company attributes to improved leverage of its fixed
costs over the increased revenue and gross profit base and the lower cost of
servicing larger customers. As a percentage of net revenues, SG&A also
decreased, to 12.5% in Q3 1998 from 12.9% in Q3 1997.
NET INTEREST AND OTHER EXPENSE . Net interest and other expense decreased
by $1.5 million, to $1.6 million in Q3 1998 from $3.1 million in Q3 1997. This
decrease was primarily due to a $0.9 million reduction in interest expense,
arising from a decrease in total debt outstanding and a decrease in the average
interest rate which resulted from the Company's October 1997 IPO, plus
non-operating expense in Q3 1997 of $0.6 million attributable to a put warrants
valuation adjustment, with no corresponding item in Q3 1998.
NET INCOME (LOSS). Net income (loss) increased by $1.4 million, to $1.5
million in Q3 1998 from $0.1 million in Q3 1997. This increase was primarily due
to the $1.5 million decrease in net interest and other expense discussed above
and an increase of $0.3 million in operating income as a result of increases in
net revenues and gross profit discussed above, partially offset by the related
income taxes.
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NINE MONTHS ENDED SEPTEMBER 30, 1998 COMPARED TO NINE MONTHS ENDED
SEPTEMBER 30, 1997
NET REVENUES. Net revenues increased $94.0 million, or 29.8%, to $409.2
million in the nine months ended September 30, 1998 ("YTD 1998") as compared to
the nine months ended September 30, 1997 ("YTD 1997"). This increase resulted
from growth in staffing revenues in YTD 1998 of $71.6 million, or 49.9%, and PEO
revenues growth of $21.7 million, or 13.5%, compared to YTD 1997. Staffing
revenues increased due to (i) the 1998 Acquisitions, (ii) the 1997 Acquisitions
(which were primarily consummated in late February and March) and (iii) internal
growth due to development of existing Company-owned locations and an increase in
the number of Company-owned offices. The Company-owned staffing offices
increased by 25 locations to 115 locations as of September 30, 1998. This
increase was the result of the 38 additional locations acquired in the 1998
Acquisitions, partially offset by offices closed and consolidated into other
Company-owned locations. The increase in PEO revenues was primarily due to new
PEO clients, as well as an increase in the number of worksite employees at
certain existing PEO clients.
System revenues, which include franchise revenues not earned by or
available to the Company, increased $73.7 million, or 18.4%, to $473.5 million
in YTD 1998 from $399.8 million in YTD 1997. The increase in system revenues was
attributable to the $94.0 million increase in the Company's net revenues
discussed above. Franchise revenues of franchisees operating as of September 30,
1998 increased $18.0 million, or 34.8%, in YTD 1998 as compared to YTD 1997, but
that increase was offset by a $44.6 million decrease in the same period
resulting from other franchisees no longer operating. The result is a net
decrease of franchise revenues of $26.6 million. The Company acquired and
converted 29 franchise locations to Company-owned locations during 1997 and 1998
and also allowed the early termination of franchise agreements (in order to
allow the Company's development of the related territories) related to another
28 locations in 1997 and 1998.
GROSS PROFIT. Gross profit (margin) increased $15.7 million, or 33.8%, to
$62.1 million in YTD 1998, from $46.4 million in YTD 1997. Gross profit as a
percentage of net revenues increased to 15.2% in YTD 1998 from 14.7% in YTD
1997. This increase was primarily due to the significantly higher growth rate
for staffing revenues as compared to the growth rate for PEO revenues, which
generate lower gross profit margins. In YTD 1998, PEO operations generated gross
profit margins of 3.7% as compared to gross profit margins of 22.5% generated by
staffing operations.
Gross profit margin percent for the Company's staffing operations decreased
to 22.5% in YTD 1998 from 23.6% in YTD 1997, primarily due to the impact of (i)
the increased wages necessary to recruit staffing employees in areas of
historically low unemployment, (ii) continued execution of a strategy to obtain
larger contracts which have higher per hour billing and pay rates but lower
gross profit margin percentages and (iii) an increase in the minimum wage on
September 1, 1997, for which the Company increased billing rates without a
related profit increase. Gross profit per hour was approximately thirteen cents
lower in YTD 1998 than in YTD 1997, although approximately seven cents of that
decrease was due to the September 1997 minimum wage increase. The Company
anticipates these factors will continue to affect margins from staffing
operations, although in many cases the Company expects the impact to be offset
by lower selling, general and administrative expenses (measured as a percentage
of gross profit) due to the economies of scale in servicing larger contracts.
PEO margin percent increased to 3.7% in YTD 1998 from 3.4% in YTD 1997
primarily due to an increase in the percentage of total PEO revenues related to
PEO services provided to industrial staffing clients. The gross profit margin
percentage for PEO services provided to industrial staffing clients is higher
than the gross profit margin from most other PEO clients, although the gross
profit amount per employee is relatively consistent. An industrial staffing
employee generally receives lower wages and benefits than other PEO employees
and the Company receives correspondingly lower revenue. See "-General" above for
a discussion of the effect of these costs on the Company's revenue calculation.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES. SG&A increased $13.3 million,
or 33.1%, to $53.6 million in YTD 1998 from $40.3 million in YTD 1997. This
increase was primarily a result of operating costs related to the 1998 and 1997
Acquisitions and sales costs associated with increased staffing volume at
existing locations and, for part of the year, the 1997 Acquisitions. Total
direct operating costs associated with the 1998 Acquisition locations and the
1997 Acquisition locations (for the portion of 1998 for which there was no
corresponding 1997 activity) were $7.9 million in YTD 1998, not including
indirect costs incurred by the Company for infrastructure to support the larger
customer base.
SG&A, expressed as a percentage of gross profit, decreased to 86.4% for YTD
1998 from
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86.8% for YTD 1997. The Company attributes this decline to improved leverage of
its fixed costs over the increased revenue and gross profit base and the lower
cost of servicing larger customers. As a percentage of net revenues, SG&A
increased to 13.1% in YTD 1998 from 12.8% in YTD 1997. In addition to the items
previously discussed, this percentage increase was also due to the significant
increase in 1998 of the staffing revenues in proportion to total Company
revenues. The staffing operations have higher associated SG&A (as a percentage
of revenues) than PEO operations.
NET INTEREST AND OTHER EXPENSE. Net interest and other expense decreased by
$3.7 million, to $4.1 million in YTD 1998 from $7.8 million in YTD 1997. This
decrease was primarily due to a $1.9 million reduction in interest expense,
arising from a decrease in total debt outstanding as well as a decrease in the
average interest rate which resulted from the Company's October 1997 IPO., plus
non-operating expense in YTD 1997 of $1.8 million attributable to a put warrants
valuation adjustment, with no corresponding item in YTD 1998.
NET INCOME (LOSS). Net income (loss) increased by $4.7 million, to $3.3
million in YTD 1998 from a $1.4 million loss in YTD 1997. This increase was
primarily due to the $3.7 million decrease in interest and other expense
discussed above and an increase of $2.3 million in operating income as a result
of increases in sales and gross profit discussed above, partially offset by the
related income taxes.
ADDITIONAL OPERATING INFORMATION
Flexible Industrial Staffing:
Net revenues from the Company's staffing services increased $71.6 million,
or 49.9%, to $215.1 million for YTD 1998 from $143.5 million for YTD 1997. This
increase represented an increasing share of the Company's total net revenues, to
52.5% for YTD 1998 from 45.5% for YTD 1997, reflecting the Company's focus on
growth of these staffing operations through acquisitions as well as new office
openings. The Company expects this focus to continue for the foreseeable future.
Gross profit from the Company's staffing services increased $14.5 million,
or 42.8%, to $48.4 million for YTD 1998 from $33.9 million for YTD 1997. This
represented an increasing share of the Company's total gross profit, to 77.9%
for YTD 1998, from 73.0% for YTD 1997. The Company's staffing division generates
significantly higher gross profit margins than its PEO division. The higher
staffing division margin reflects compensation for recruiting, training and
other services not required as part of many PEO relationships, where the
employees have already been recruited by the client and are trained and in place
at the beginning of the relationship.
PEO:
Net revenues from the Company's PEO services increased $21.7 million, or
13.5%, to $182.8 million for YTD 1998 from $161.1 million for YTD 1997. Because
of the lower growth rate in PEO revenues as compared to staffing, this
represented a decreasing share of the Company's total net revenues, to 44.7% for
YTD 1998 from 51.1% for YTD 1997, reflecting the Company's greater focus on
growth of its flexible industrial staffing operations during this period as well
as conditions that resulted in changes made in the PEO management structure and
marketing approach, beginning in 1997. The Company expects that PEO sales growth
will continue at its present rate during 1998 and 1999. During the third quarter
of 1998, the Company terminated or commenced negotiations to terminate the three
existing Synadyne franchise agreements and suspended sales of additional
Synadyne franchises, pending its overall determination of the best mix of all
PEO distribution channels, including franchising.
Approximately 21% of the Company's YTD 1998 PEO 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 addition, the Company is aware of pending
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litigation against that corporate employer regarding its use of PEO services.
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 $1.2 million, or
21.5%, to $6.7 million for YTD 1998 from $5.5 million for YTD 1997. Because of
the lower gross profit percentage from PEO as compared to staffing, as well as
the lower growth rate in PEO revenues as compared to staffing, this represented
a decreasing share of the Company's total gross profit, to 10.8% for YTD 1998
from 11.9% for YTD 1997.
Franchise and Other:
Net revenues from the Company's franchise and other services increased $0.7
million, or 7.0%, to $11.3 million for YTD 1998 from $10.6 million for YTD 1997.
This increase represented a decreasing share of the Company's total net
revenues, to 2.8% in YTD 1998 from 3.4% for YTD 1997, reflecting the Company's
greater focus on growth of its Company-owned staffing operations during this
period, including the Company's conversion of 28 franchise locations to
Company-owned locations and the termination of franchise agreements related to
another 27 locations. The Company expects to continue to convert franchise
locations to Company-owned locations in strategic markets or to allow
terminations of franchise agreements in key markets, subject to the Company's
ability to negotiate these acquisitions or terminations on acceptable terms. The
Company also expects to continue to sell new franchises in smaller, less
populated geographic areas, subject to, among other factors, the success of the
Company's marketing efforts in this regard.
Gross profit from the Company's franchise and other services of $7.0
million for YTD 1998 was unchanged from YTD 1997. As a result, this area
represented a decreasing share of the Company's total gross profit, to 11.3% for
YTD 1998 from 15.1% for YTD 1997.
LIQUIDITY AND CAPITAL RESOURCES
The Company's primary sources of funds for working capital and other needs
are a $34.0 million credit line with a syndicate of lenders led by BankBoston,
N.A. (the "Revolving Facility") and a $50.0 million accounts receivable
securitization facility with a BankBoston affiliate.
Effective July 27, 1998, the Company entered into a five year financing
arrangement under which it can sell up to a $50.0 million secured interest in
its eligible accounts receivable to EagleFunding Capital Corporation ("Eagle"),
which uses the receivables to secure A-1/P-1 rated commercial paper (the
"Securitization Facility"). Under this arrangement, the Company receives cash
equivalent to the gross outstanding balance of the accounts receivable being
sold, less reserves which are adjusted on a monthly basis based on collection
experience and other defined factors. There is no recourse to the Company for
the initial funds received. Amounts collected in excess of the reserves are
retained by the Company. The Company's interest rate, payable on the balance of
the outstanding commercial paper, is determined by prevailing interest rates in
the commercial paper market and was approximately 5.6% as of September 30, 1998.
As of September 30, 1998, a $45.5 million interest in the Company's uncollected
accounts receivable had been sold under this agreement, which is excluded from
the accounts receivable balance presented in the Company's consolidated
financial statements.
The Securitization Facility contains certain minimum default, delinquency
and dilution ratios with respect to the Company's receivables and requires bank
liquidity commitments ("Liquidity Facility") totaling no less than $51.0
million. A default under the Securitization Facility constitutes a default under
the Revolving Credit Facility. The Liquidity Facility has been provided by the
syndicate of commercial banks that participate in the Revolving Credit Facility
for a one year term expiring July 26, 1999 at 0.375% per annum, and is expected
to be renewed annually. Eagle may draw against the Liquidity Facility to fund
cash shortfalls caused by an inability for any reason to issue commercial paper
based on the Company's receivables. There is no recourse to the Company for
amounts drawn under the Liquidity Facility, although such amounts would be
repaid from and to the extent receivables sold by the Company were collected.
Amounts drawn under the Liquidity Facility bear interest at the same rates
incurred under the Revolving Credit Facility.
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Concurrent with the Securitization Facility, the Revolving Facility was
amended, primarily to reduce the maximum amount available for borrowing from
$85.0 million to $34.0 million and to extend the remaining term of the Revolving
Facility to five years from the date of that amendment. Outstanding amounts
under the Revolving Facility are secured by substantially all of the Company's
assets and the pledge of all of the outstanding shares of common stock of each
of its subsidiaries. Amounts borrowed under the Revolving Facility bear interest
at BankBoston's base rate or Eurodollar rate (at the Company's option) plus a
margin based upon the ratio of the Company's total indebtedness to the Company's
earnings (as defined in the Revolving Facility). As of September 30, 1998, the
Company had outstanding borrowings under the Revolving Facility of $19.8
million, bearing interest at an annualized rate of 7.9%. The Revolving Facility
contains certain affirmative and negative covenants relating to the Company's
operations.
In February 1998, the Company entered into a five year notional $42.5
million interest rate collar agreement with BankBoston, N.A., whereby the
Company receives interest on that notional amount to the extent 30 day LIBOR
exceeds 6.25% per annum, and pays interest on that amount to the extent 30 day
LIBOR is less than 5.43% per annum. This derivative financial instrument is
being used by the Company to reduce interest rate volatility and the associated
risks arising from the floating rate structure of its Revolving Credit Facility
and its Securitization Facility, and is not held or issued for trading purposes.
While it is not the Company's intention to terminate this instrument, BankBoston
has informed the Company that the Company would have incurred a loss of
approximately $1.2 million if the instrument were to have been terminated on
September 30, 1998. This loss is not required to be and has not been recognized
in the Company's results of operations.
As of September 30, 1998, the Company had (i) bank standby letters of
credit outstanding, in the aggregate amount of $9.4 million under a $15.0
million letter of credit facility (which is part of the Revolving Facility) to
secure certain workers' compensation obligations already recorded as a liability
on the Company's balance sheet; (ii) $11.7 million of promissory notes
outstanding in connection with certain acquisitions, primarily bearing interest
at rates from 4.0% to 7.25% per annum and payable during the next two years, and
subordinated to the repayment of the Revolving Facility; (iii) obligations under
capital leases for property and equipment in the aggregate amount of $2.3
million; and (iv) obligations under mortgages totaling $4.3 million.
The Company's principal uses of cash are for wages and related payments to
temporary and PEO employees, operating costs, acquisitions, capital
expenditures, advances made to certain Tandem franchise associates to fund their
payroll obligations and repayment of debt and interest thereon. For YTD 1998,
cash provided by operations was approximately $47.0 million, compared with $13.6
million used in YTD 1997. The significant 1998 increase in cash from operations
was due to the Company's sale of a significant portion of its trade accounts
receivable under the Securitization Facility. Cash used in investing activities
during YTD 1998 was approximately $30.6 million, principally expenditures of
$27.9 million for acquisitions (primarily intangible assets), compared with
$22.8 million in YTD 1997, primarily expenditures of $21.4 million for
acquisitions. Cash used in financing activities during YTD 1998 was
approximately $14.5 million, comprised primarily of $14.0 million in net
repayments of the Revolving Facility and $3.5 million of repayments of long term
debt, offset by an increase in outstanding checks over bank balance (i.e., bank
overdraft) of $3.4 million. The net reduction of the Revolving Facility balance
during 1998 was primarily due to the Company's application of proceeds received
from the sale of its trade accounts receivable under the Securitization
Facility. Cash provided by financing activities during YTD 1997 was
approximately $36.4 million, comprised primarily of $22.6 million net proceeds
from senior notes and warrants and $30.4 million from borrowings under the
Revolving Facility, offset by payments of $14.4 million in connection with the
Reorganization and $2.1 million of repayments of long-term debt (net of note
repayments from related parties).
One of the key elements of the Company's strategy is expansion through
acquisitions, which will require significant sources of financing. These
financing sources include cash from operations, seller financing, bank financing
and issuances of the Company's common stock. The Company will monitor equity
market conditions in order to determine when the sale of additional shares of
its common stock is appropriate. Until then, the Company expects to continue to
fund its acquisition strategy primarily with the Revolving Facility, subject to
an increase in the limit of that facility from $34.0
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million to $58.7 million which is being actively negotiated. The Company is also
actively negotiating an increase in the Securitization Facility from $50.0
million to $65.3 million. The Company's previous acquisitions have been
primarily in the industrial staffing area, and the Company expects this trend to
continue due to the more favorable pricing for those businesses (as a multiple
of EBITDA) as compared to PEO businesses. See Note 2 to the Company's
Consolidated Financial Statements.
The Company is a service business and therefore a majority of its tangible
assets are customer accounts receivable. Staffing employees are paid by the
Company on a daily or weekly basis. The Company, however, receives payment from
customers for these services, on average, 45 to 50 days from the presentation
date of the invoice. As new staffing offices are established or acquired, or as
existing offices expand, there will be increasing requirements for cash to fund
operations. The Company pays its PEO employees on a weekly, bi-weekly,
semi-monthly or monthly basis for their services, and currently receives
payments on a simultaneous basis from approximately 90% of its existing
customers.
The Company anticipates spending up to approximately $4.0 million during
the next twelve months for new staffing locations, improvements to its
management information and operating systems, upgrades of existing and acquired
locations, and other capital expenditures. This amount does not include
expenditures for potential staffing and acquisitions, which the Company believes
could be at a similar magnitude to the recent historical rate over the next
twelve months and will primarily be for goodwill and other intangible assets.
The Company believes that funds provided by operations, including sales of
accounts receivable under the Securitization Facility, borrowings under the
Revolving Facility and current cash balances will be sufficient to meet its
presently anticipated needs for working capital and capital expenditures, not
including new acquisitions, for the next twelve months. Significant new
acquisitions will require expanded or new borrowing facilities, issuance of
common stock and/or additional debt or equity offerings. The ability of the
Company to make significant future acquisitions is also subject to the Company's
ability to successfully negotiate more flexible leverage (e.g., debt to EBITDA)
covenants compared to those presently contained in the Revolving Facility and/or
the Company's ability to finance future acquisitions by issuance of its common
stock rather than the debt financing primarily used by the Company for previous
acquisitions. There can be no assurance that additional capital will be
available to the Company on acceptable terms.
ACQUISITIONS
During 1995, the Company made four flexible industrial staffing
acquisitions with five offices and approximately $7.0 million in revenues for
the twelve months preceding the acquisition ("annual historical revenue").
During 1996, the Company made five flexible industrial staffing acquisitions
with 13 offices and approximately $16.0 million in annual historical revenue.
During 1997, the Company made eight flexible industrial staffing acquisitions
with 30 offices and approximately $61.0 million in annual historical revenue.
From January 1, 1998 through September 30, 1998, the Company made 16 flexible
industrial staffing acquisitions with 38 offices and approximately $93.0 million
in annual
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historical revenue. These acquisitions have resulted in a significant increase
in goodwill and other intangible assets which has resulted and will continue to
result in increased amortization expense. In addition, the amount of these
intangible assets as a percentage of the Company's total assets and
shareholders' equity has increased significantly and while the net unamortized
balance of intangible assets as of September 30, 1998 is not considered to be
impaired, any future determination requiring the write off of a significant
portion of unamortized intangible assets could have a material adverse effect on
the Company's financial condition and results of operations. See Note 2 to the
Company's Consolidated Financial Statements.
SEASONALITY
The Company's quarterly results of operations reflect the seasonality of
higher customer demand for 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 has been lower than that experienced in
prior years, which the Company attributes to slower economic activity in U.S.
manufacturing and distribution, and expects this slower seasonal increase to
continue through the fourth quarter of 1998. Even though there is a seasonal
reduction of industrial staffing revenues in the first quarter of a year as
compared to the fourth quarter of the prior year, the Company does not reduce
the related core personnel and other operating expenses proportionally 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 traditionally experiences operating
income in the first quarter of a year that is significantly less than (i) the
fourth quarter of the preceding year and (ii) the subsequent three quarters of
the same year.
INFLATION
The effects of inflation on the Company's operations were not significant
during the periods presented in the financial statements. Throughout the periods
discussed above, the increases in revenues have resulted primarily from higher
volumes, rather than price increases.
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. 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, it also will result in software that
properly interprets dates beyond the year 1999 ("Year 2000 Compliant").
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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 is substantially complete. All operating divisions
have identified the Information Systems that may require remediation or
replacement and established priorities for repair or replacement. Those
Information Systems considered most critical to continuing operations are being
given the highest priority. The second component of the Y2K readiness program
involves the actual remediation and replacement of Information Systems. The
Company is using both internal and external resources to complete this process.
Information Systems ranked highest in priority, such as the corporate accounting
and billing software, have either been remediated or replaced or scheduled for
remediation or replacement. The Company's objectives are to complete
substantially all remediation and replacement of internal Information Systems by
March 1999, and to complete final testing and certification for Y2K readiness by
June 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 steps are underway to reasonably ascertain their respective stages of
Y2K readiness through the use of questionnaires, interviews, on-site visits and
other available means. The Company will take appropriate action based on those
responses, but there can be no assurance 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 are not
made on a timely basis by the Company or its materially-significant customers or
vendors, the Company could be affected by business 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, is in the process of developing such plans
and the cost estimates to implement them. Contingency plans may include
purchasing or developing alternative software programs, the purchase of computer
hardware and peripheral equipment, and other appropriate measures. Once
developed, contingency plans and related cost estimates will be continually
refined as additional information becomes available. The Y2K project team
expects to conclude the development of these contingency plans by December 31,
1998.
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Y2K Costs:
The total cost to the Company of these Y2K compliance activities has not
been and is not anticipated to be material to the Company's business, results of
operations or financial condition. The costs and time necessary to complete the
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, most of which
had been incurred as of September 30, 1998, but will expense the costs of the
modifications to existing software made solely for purposes of Y2K compliance,
most of which will be incurred during 1998. 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.
NEW ACCOUNTING PRONOUNCEMENTS
In June 1997, SFAS No. 131, "Disclosures about Segments of an Enterprise
and Related Information," was issued, which establishes standards for the way
that public companies report selected information about operating segments in
annual financial statements and requires that those companies report selected
information about segments in interim financial reports issued to shareholders.
SFAS No. 131 is effective for financial statements for periods beginning after
December 15, 1997. The Company intends to first implement SFAS No. 131 in its
consolidated financial statements as of and for the year ended December 31,
1998, and will provide any required disclosures at that time.
In June 1998, SFAS No. 133, "Accounting for Derivative Instruments and
Hedging Activities" was issued. SFAS No. 133 defines derivatives and establishes
accounting and reporting standards requiring that every derivative instrument
(including certain derivative instruments embedded in other contracts) be
recorded in the balance sheet as either an asset or liability measured at its
fair value. SFAS No. 133 also requires that changes in the derivative's fair
value be recognized currently in earnings unless specific hedge accounting
criteria are met. SFAS No. 133 is effective for all fiscal quarters of fiscal
years beginning after June 15, 1999, and cannot be applied retroactively. The
Company intends to first implement SFAS No. 133 in its consolidated financial
statements as of and for the three months ended March 31, 2000, although it has
not determined the effects, if any, that implementation will have. However, SFAS
No. 133 could increase volatility in earnings and other comprehensive income.
FORWARD-LOOKING INFORMATION: CERTAIN CAUTIONARY STATEMENTS
Certain statements contained in this "Management's Discussion and Analysis
of Financial Condition and Results of Operations" and elsewhere in this Form
10-Q are forward looking statements, including but not limited to, statements
regarding the Company's expectations or beliefs concerning the Company's
strategy and objectives, expected sales and other operating results, the effect
of changes in the Company's gross margin, the Company's liquidity, anticipated
capital spending, the availability of financing, equity and working capital to
meet the Company's future needs, economic conditions in the Company's market
areas, the potential for and effect of future acquisitions, the Company's
ability to resolve the Year 2000 issue and the related costs and the
tax-qualified status of the Company's 401(k) and 413(c) plans. The words "aim,"
"believe," "expect," "anticipate," "intend," "estimate," "will," "should,"
"could" and other expressions which indicate future events and trends identify
forward looking statements. Such forward-looking statements involve known and
unknown risks and are also based upon assumptions of future events, which may
not prove to be accurate.
27
<PAGE>
Therefore, actual results may differ materially from any future results
expressed or implied in the forward looking statements. These known and unknown
risks and uncertainties, include, but are not limited to the Company's
dependence on regulatory approvals, its future cash flows, sales, gross margins
and operating costs, the effect of changing market and other conditions in the
staffing industry, the ability of the Company to continue to grow, legal
proceedings, including those related to the actions of the Company's temporary
or leased employees, the availability and cost of credit, the Company's ability
to raise capital in the public equity markets, the Company's ability to identify
suitable acquisition candidates and to successfully negotiate and complete those
acquisitions on favorable terms, the ability to successfully integrate past and
future acquisitions into the Company's operations, the recoverability of the
recorded value of goodwill and other intangible assets arising from past and
future acquisitions, the general level of economic activity and unemployment in
the Company's markets, specifically within the construction, manufacturing,
distribution and other light industrial trades, increased price competition,
changes in government regulations or interpretations thereof, particularly those
related to employment, the continued availability of qualified temporary
personnel, the financial condition of the Company's clients and their demand for
the Company's services (which in turn may be affected by the effects of, and
changes in, 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, changes in the workers' compensation, liability and other insurance
markets, inclement weather, interruption, impairment or loss of data integrity
or malfunction of information processing systems, uncertainties regarding
government regulation of PEOs, including the possible adoption by the IRS of an
unfavorable position as to the tax-qualified status of employee benefit plans
maintained by PEOs and other risks detailed from time to time by the Company or
in its press releases or in its filings with the Securities and Exchange
Commission.
In addition, the market price of the Company's stock may from time to time
be significantly volatile as a result of, among other things, the Company's
operating results, the operating results of other temporary staffing and PEO
companies, economic conditions, the proportion of the Company's stock available
for active trading and the performance of the stock market in general.
Any forward-looking statement speaks only as of the date on which such
statement is made, and the Company undertakes no obligation to update any
forward-looking statement or statements to reflect events or circumstances after
the date on which such statement is made or to reflect the occurrence of
unanticipated events. New factors emerge from time to time, and it is not
possible for management to predict all of such factors. Further, management
cannot assess the impact of each such factor on the business or the extent to
which any factor, or combination of factors, may cause actual results to differ
materially from those contained in any forward-looking statements.
Subsequent written and oral forward-looking statements attributable to the
Company or persons acting on its behalf are expressly qualified in their
entirety by cautionary statements in this paragraph and elsewhere in this Form
10-Q, and in other reports filed by the Company with the Securities and Exchange
Commission, including, but not limited to, (i) the Company's Registration
Statement on Form S-1 (File No. 333-33443), including the "Risk Factors" section
thereof, filed with the Securities and Exchange Commission on August 12, 1997,
as amended by Amendments No. 1 through 3 thereto, and declared effective on
October 23, 1997 and (ii) the Company's Form 10-K/A filed with the Securities
and Exchange Commission on April 2, 1998.
28
<PAGE>
PART II - OTHER INFORMATION
ITEM 5 - OTHER INFORMATION
In July 1998, Robert A. Lefcort, resigned as the Company's Executive Vice
President and Secretary, and was appointed President of the Company's Synadyne
division and the Company's Assistant Secretary. Mr. Lefcort replaced Benjamin J.
Cueto, who resigned as President of Synadyne to pursue other interests. Brian M.
Nugent was appointed as the Company's Secretary.
On November 9, 1998, the board of directors elected Lawrence Chimerine,
Ph.D. to the board of directors for a term expiring at the annual meeting of the
shareholders in 2000. Dr. Chimerine, formerly Chairman, Chief Executive, and
Chief Economist of Chase Econometrics, is currently Managing Director and Chief
Economist at the Economic Strategy Institute in Washington, DC, President of
Radnor International Consulting, Inc. located in Newton Square, Pennsylvania,
and Senior Economic Advisor to the WEFA Group.
ITEM 6 - EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits:
EXHIBIT
NUMBER EXHIBIT DESCRIPTION
- - ------- -------------------
3.1 Amended and Restated Articles of Incorporation of the Company(2)
3.2 Amended and Restated Bylaws of the Company(3)
4.3 Shareholder Protection Rights Agreement(3)
4.6 Warrant Dated February 21, 1997 Issued to Triumph-Connecticut Limited
Partnership(1)
4.7 Warrant Dated February 21, 1997 Issued to Bachow Investment Partners
III, L.P.(1)
4.8 Warrant Dated February 21, 1997 Issued to State Street Bank and Trust
Company of Connecticut, N.A., as Escrow Agent(1)
10.18 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)
27 Financial Data Schedule
- - --------------------------------------------------------------------------------
(1) Incorporated by reference to the Exhibits to the Company's
Registration Statement on Form S-1 (Registration Statement No.
333-33443) as filed with the Securities and Exchange Commission on
August 12, 1997.
(2) Incorporated by reference to the Exhibits to Amendment No. 3 to the
Company's Registration Statement on Form S-1 (Registration Statement
No. 333-33443) as filed with the Securities and Exchange Commission on
October 21, 1997.
29
<PAGE>
(3) Incorporated by reference to the Exhibits to Amendment No. 1 to the
Company's Registration Statement on Form S-1 (Registration Statement
No. 333-33443) as filed with the Securities and Exchange Commission on
September 23, 1997.
(4) Incorporated by reference to 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.
- - --------------------------------------------------------------------------------
(b) Reports on Form 8-K:
The following reports were filed on Form 8-K during the quarter ended
September 30, 1998:
A Form 8-K/A dated July 28, 1998 related to the Company's acquisition
of Mid-West Temps, Inc. and Resource Dimensions, Inc. The related Form 8-K was
filed on May 29, 1998.
30
<PAGE>
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 13, 1998 By: /s/ Paul M. Burrell
--------------------------------------
Paul M. Burrell
President, Chief Executive Officer
and Chairman of the Board of Directors
Date: November 13, 1998 By: /s/ Scott R. Francis
--------------------------------------
Scott R. Francis
Chief Financial Officer
(Principal Financial Officer)
Date: November 13, 1998 By: /s/ Robert E. Tomlinson
--------------------------------------
Robert E. Tomlinson
Chief Accounting Officer
(Principal Accounting Officer)
31
<PAGE>
EXHIBIT INDEX
Exhibit No. Description
- - ----------- -----------
27 Financial Data Schedule
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