SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
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FORM 10-K
FOR ANNUAL AND TRANSITION REPORTS
PURSUANT TO SECTIONS 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
(Mark One)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 1998
or
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES ACT
OF 1934
For the transition period from _______________ to ___________
Commission File Number 000-23147
OUTSOURCE INTERNATIONAL, INC.
(Exact name of registrant as specified in its charter)
Florida 65-0675628
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(State or jurisdiction (I.R.S. Employer
incorporation or organization) Identification No.)
1144 East Newport Center Drive, Deerfield Beach, Florida 33442
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(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (954) 418-6200
Securities Registered Pursuant to Section 12(b) of the Act: None
Securities Registered Pursuant to Section 12(g) of the Act: Common Stock, par
value $.001 per share
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding twelve months (or such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes X No__
Indicate by check mark if disclosure of delinquent filers pursuant to
Item 405 of Regulation S-K is not contained herein, and will not be contained,
to the best of registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [ ]
The aggregate market value of voting and non-voting Common Stock held
by nonaffiliates as of March 19, 1999 was approximately $11.0 million (based
upon the closing sale price of $3.75 per share on the Nasdaq Stock MarketSM on
March 19, 1999).
As of March 19, 1999, 8,657,913 shares of the Registrant's Common Stock
were outstanding.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Registrant's Definitive Proxy Statement for the 1999
Annual Meeting of Shareholders are incorporated by reference in Part III.
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OUTSOURCE INTERNATIONAL, INC.
INDEX
PART I
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Page
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Item 1 - Business ........................................................................................ 2
Item 2 - Properties....................................................................................... 10
Item 3 - Legal Proceedings................................................................................ 11
Item 4 - Submission of Matters to a Vote of Security Holders.............................................. 11
PART II
Item 5 - Market for Registrant's Common Equity and Related Stockholder Matters........................... 12
Item 6 - Selected Financial Data......................................................................... 13
Item 7 - Management's Discussion and Analysis of Financial
Condition and Results of Operations............................................................ 15
Item 7A - Quantitative and Qualitative Disclosures about Market Risk...................................... 26
Item 8 - Financial Statements and Supplementary Data..................................................... 28
Item 9 - Changes in and Disagreements with Accountants on
Accounting and Financial Disclosure............................................................ 61
PART III
Item 10 - Directors and Executive Officers of the Registrant.............................................. 61
Item 11 - Executive Compensation.......................................................................... 61
Item 12 - Security Ownership of Certain Beneficial Owners and Management.................................. 61
Item 13 - Certain Relationships and Related Transactions.................................................. 61
PART IV
Item 14 - Exhibits, Financial Statement Schedules, and Reports on Form 8-K................................ 62
Signatures................................................................................................ 65
Schedules................................................................................................. S-1
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TANDEM (R), SYNADYNE (R) and OFFICE OURS (R) are registered trademarks
of OutSource International, Inc. and its subsidiaries.
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PART 1
ITEM 1 - BUSINESS
Certain statements included in this and other sections of this Form
10-K are forward looking statements and the Company's actual results may differ
materially from those projected or implied in the forward looking statements.
Further, certain forward looking statements are based upon assumptions of future
events, which may not prove to be accurate. These forward looking statements
involve risks and uncertainties, some of which are further discussed under the
caption "Forward -Looking Statements: Certain Cautionary Statements" of Item 7 -
"Management's Discussion and Analysis of Financial Condition and Results of
Operations".
GENERAL
OutSource International, Inc. (the "Company") is a national provider of
human resource services focusing on the flexible industrial staffing
("staffing") market through its Tandem division and on the professional employer
organization ("PEO") market through its Synadyne division. The Tandem division
recruits, trains and deploys temporary industrial personnel and provides payroll
administration, risk management and benefits administration services to its
clients. Tandem's clients include businesses in the manufacturing, distribution,
hospitality and construction industries. Through its Synadyne division, the
Company offers a comprehensive package of PEO services including payroll
administration, risk management, benefits administration and human resources
consultation to companies in a wide range of industries. In addition to the
Tandem and Synadyne divisions, the Company operates an office clerical staffing
division, Office Ours, with ten offices located primarily in Florida. As of
March 19, 1999, the Company and its franchise associates operated 168 offices,
with an estimated 37,000 employees in 44 states and the District of Columbia.
As of March 19, 1999, the Tandem division provided approximately 27,000
staffing personnel daily through a nationwide network of 112 locations owned or
leased by the Company (collectively identified as "Company-owned" offices) and
44 franchised offices. The Tandem division has approximately 17,000 clients and
provides services to approximately 4,000 of such clients each day. Between 1996
and 1998, Company and franchise staffing revenues increased from $247.2 million
to $410.7 million, a compound annual growth rate of approximately 29%. The
Synadyne division, which began in 1994, has approximately 10,000 employees. The
Company's PEO services are provided from the Company's national support center
and another Synadyne office in Florida. Between 1996 and 1998, PEO revenues,
excluding revenues from the provision of PEO services to Tandem franchisees,
increased from $137.0 million to $228.1 million, also a compound annual growth
rate of approximately 29%.
While implementing its growth strategies, the Company completed 36
acquisitions, primarily staffing companies, from January 1, 1995 through March
19, 1999 - the last acquisition closed in October 1998. These acquisitions
included 89 offices and collectively generated approximately $189.0 million in
revenue for the twelve months preceding each acquisition (See "Acquisitions"
under Item 7 - Management's Discussion and Analysis of Financial Condition and
Results of Operations). 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 ten to 124 and the number of metropolitan markets
(measured by Metropolitan Statistical Areas, or MSAs) served by Company-owned
locations increased from one to 50. In order to support its growth, the Company
implemented new information systems, further developed back office capabilities
and invested in other infrastructure enhancements.
Staffing companies provide four basic services to clients: (i) flexible
staffing; (ii) PEO services; (iii) placement and search; and (iv) outplacement.
Based on information provided by the National Association of Temporary and
Staffing Services, the National Association of Professional Employer
Organizations and Staffing Industry Analysts, Inc., 1998 staffing industry
revenues were approximately $85.4 billion. According to industry sources,
flexible staffing firms and PEO firms employed approximately 5.0 million people
per day, or approximately 3.9% of the entire United States workforce, in 1998.
Over the last five years, the staffing industry has experienced significant
growth, due largely to the utilization of temporary help across a broader range
of industries as well as the emergence of the PEO sector.
According to the National Association of Temporary and Staffing
Services, the staffing industry grew from approximately $43.6 billion in 1996 to
approximately $50.3 billion in 1998, or 15.4%. During that same period, the
industrial staffing sector grew from approximately $13.9 billion to
approximately $17.3 billion, or 24.5%. During 1998, the industrial staffing
sector represented 34.4% of the staffing industry, compared to 31.8% during
1996. The Company believes that the industrial staffing market is highly
fragmented and that in excess of 75% of industrial staffing revenues are
generated by small local and regional companies.
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The PEO sector, the fastest growing sector within the staffing
industry, comprised an estimated $21.6 billion, or approximately 25.3%, of
estimated 1998 staffing industry revenues. This sector has grown at an estimated
30% compound annual rate over the last five years as small and medium size
businesses (businesses with less than 500 employees) continued to realize time
and cost savings associated with outsourcing human resources activities to PEOs.
According to industry sources, less than 2% of small and medium size businesses
in the United States utilize PEO services.
The Company's operation of both a staffing division and a PEO division
provides it with significant competitive advantages. Both Tandem and Synadyne
offer a number of common services including payroll administration, risk
management and benefits administration. The Company designs and administers
these services through common facilities, personnel and information systems
which give the Company the ability to develop and provide a wider range of
services at lower costs than its primary competitors. In addition, the Company
is able to provide a full spectrum of staffing services to its industrial
clients ranging from a temporary employee for one day to comprehensive
outsourcing of human resources functions through the Company's PEO division.
See Item 7 - Management's Discussion and Analysis of Financial
Condition and Results of Operations - for information regarding acquisitions and
other growth, revenues and other operating information for the Company's primary
areas of operations, seasonality, and practices related to working capital
items. See Note 14 to the Company's Consolidated Financial Statements for
information regarding operating segment information.
The Company's objective is to become the leading provider of staffing
and PEO services in select geographic regions. To achieve this objective, the
Company's strategy is to (i) provide a comprehensive package of single-source
human resources services, (ii) continue to focus on under-served industrial
staffing and PEO markets which provide high growth opportunities, (iii)
geographically cluster offices to leverage economic efficiencies and maintain a
stable employment base, (iv) increase market penetration through a combination
of internal growth, acquisitions, franchising and strategic alliances, (v)
continue to maximize operating efficiencies through integrated technology and
back office support and, ultimately, (vi) to become the "Guardian Employer",
whereby the Company will represent a critical mass of jobs within a defined
geographic area enabling it to commit to permanent employment, over time, for
its staffing and PEO employees.
COMPANY SERVICES
The Company offers its clients a full array of staffing services
through its Tandem and Synadyne divisions. Tandem focuses on meeting its
clients' industrial staffing needs, targeting opportunities in that fragmented,
rapidly growing market which has to date been under-served by large full service
staffing companies. Significant benefits of Tandem's services include the
client's ability to outsource the recruiting and many logistical aspects of
meeting its staffing needs, as well as the benefits of converting the fixed cost
of employees to the variable cost of outsourced services. Synadyne focuses on
providing professional employer organization services to small and medium sized
businesses (those with less than 500 employees), which achieves cost savings
arising from the economies of scale associated with this outsourcing of human
resources administration.
Because the Company serves as the employer of record with respect to
both PEO and staffing services, the Company provides certain common services to
both of these markets, utilizing a common support system. The degree of
utilization of these common services depends upon the needs of the clients and
employees. Common services offered by both Tandem and Synadyne include:
Payroll Administration. The Company assumes responsibility for payroll and
attendant record-keeping, payroll tax deposits, payroll tax reporting, and all
federal, state, county and city payroll tax reports (including 941s, 940s, W-2s,
W-3s, W-4s and W-5s), state unemployment taxes, employee file maintenance,
unemployment claims and monitoring and responding to changing regulatory
requirements. The Company develops and administers customized payroll policies
and procedures for each of its clients, which are fully integrated from the
clients' offices to the Company's central processing center.
Aggregation of Statutory and Non-Statutory Employee Benefits. Employee
benefits packages can include health care options, such as preferred provider
organizations ("PPOs") and health maintenance organizations ("HMOs"), and
supplemental benefit programs such as dental care, vision care, prescription
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drugs, an employee assistance plan and life and disability insurance options.
The Company offers multiple-employer retirement plans and cafeteria plans to its
eligible employees and provides workers' compensation and unemployment
insurance. Workers' compensation is a state-mandated comprehensive insurance
program that requires employers to fund medical expenses, lost wages and other
costs that result from work-related injuries and illnesses, regardless of fault
and without any co-payment by the employee. Unemployment insurance is an
insurance tax imposed by both federal and state governments.
As part of its service package, the Company administers all employee
benefit plans and is responsible for negotiating the benefits provided by, and
costs of, each such plan. The Company's human resources and claims
administration departments serve as liaisons for the delivery of such services
to the client employee and monitor and review workers' compensation claims for
loss control purposes. The Company believes that its ability to provide and
administer a wide variety of employee benefit plans on behalf of its clients
tends to mitigate the competitive disadvantages small businesses normally face
in the areas of employee benefits cost control and employee recruiting and
retention.
Human Resources Compliance Administration. Because the Company is the
employer of record with respect to both flexible staffing and PEO services and
assumes responsibility for compliance with many employment related regulations,
it is prepared and trained to address compliance and regulatory issues inherent
in an employment relationship. For example, the Company provides compliance
administration services with respect to unemployment claims, workers
compensation claims, and claims arising under the Fair Labor Standards Act. In
addition, the Company assists its clients in understanding and complying with
other employment-related requirements for which the Company does not assume
responsibility.
Generally, the most significant compliance administration services
provided by the Company are in the area of workers' compensation and state
unemployment laws. With respect to workers' compensation, the Company provides
claims management services which include prompt identification and reporting of
injuries to the insurance carrier and local branch office, use of designated
health care providers, case management, fee audits and aggressive back-to-work
programs. Services provided by the Company in the area of state unemployment
compliance include ensuring that only eligible personnel receive unemployment
benefits, assisting in re-employing personnel and auditing state reporting
records and rate formulas.
Proactive Human Resources Management Services. Synadyne PEO services are
referred to by the Company as "Proactive Human Resources Management Services."
PEO services are typically provided for an indefinite time frame, while staffing
assignments are normally contracted for a definite period of time with the
flexibility to meet ongoing business demands. In addition, staffing services are
often bundled for one base fee, while PEO services are characterized by a base
fee, plus additional fees for added services.
As part of its base services in both the staffing and PEO markets, the
Company conducts a human resources needs analysis for clients and client
employees. Based on the results of that review, the Company recommends basic and
additional services that the client should implement. Set forth below are
examples of suggested services included within the Company's base service fee
and other services provided on fee-for-service basis in the staffing and PEO
sectors.
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Staffing PEO
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Service Base Fee Base Fee Fee-For-Service
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o Continuous H/R Review and Analysis X X
o Screening X X
o Recruiting X X
o Training X X
o Workforce Deployment X X
o Loss Prevention and Safety Training X X
o Pre-employment Testing and Assessment X X
o Background Searches X X
o Compensation Program Design X X
o Customized Personnel Management Reports X X
o Job Profiling, Description, Application X X
o Turnover Tracking and Analysis X X
o Customer Service Training X X
</TABLE>
The Company provides certain other services to its PEO clients on a
fee-for-service basis that are also available to its staffing clients. These
services include drug testing policy administration, outplacement assistance,
relocation assistance, executive benefits, affirmative action plans, opinion
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surveys and follow-up analysis, exit interviews and follow-up analysis,
management development skills workshops, team building programs, grammar and
business correspondence skills workshops and management skills assessment.
OPERATIONS
Because of the similarities in the type of services that the Company
offers to its PEO and staffing clients, and due to technological and
communication advances, many of these services are provided from the Company's
national office and support center in Deerfield Beach, Florida.
These services include payroll processing, tax reporting, unemployment
claims, workers' compensation and other insurance claims, insurance procurement,
health and other employee benefits administration, design and production of
training programs and materials, accounting, billing and collections, customized
management reporting, employee background checks, pre-employment testing,
affirmative action plans, executive recruiting, executive benefits, compensation
program design, and turnover tracking and analysis.
Tandem
Tandem delivers its staffing services through a nationwide network of
112 Company-owned and 44 franchise recruiting and training centers. Most
Company-owned recruiting and training centers are staffed with a manager, one or
two service and recruiting coordinators, two to four staffing consultants, an
office administrator and one to four clerical assistants. Some of the centers
identified above as Company-owned are "vendor on premise" locations, where the
Company has a permanent administrative presence at a client's worksite. The
number of people in each of the positions will vary by the size of the
recruiting and training centers and degree of penetration of their territory
within the market.
The Company believes that its success is due in part to its close
familiarity with the businesses of its clients. The Company's sales consultants
visit client job sites regularly to become familiar with the skill required by
the client's business, conduct job site safety inspections and to ensure that
employees are appropriately equipped for the job. To ensure customer
satisfaction, Tandem sales consultants and service coordinators play an active
role in daily work assignments. The Company also familiarizes itself with its
pool of industrial employees. Each employee is subject to a two-day screening
process that evaluates skills, abilities and attitudes. This not only permits
the Company to institute appropriate training programs and assign its workers,
but also helps the Company retain desirable employees.
Synadyne
Synadyne delivers basic PEO services through client service teams
consisting of human resource professionals and payroll and benefits specialists
located in each of the two Florida markets the Company serves. The client
service team is assigned as soon as the Company's account executive has secured
the client, thus allowing the account executive to concentrate on sales of PEO
services to additional clients. Although the client service teams have primary
responsibility for servicing their assigned clients, they rely on the Company's
national support center staff to provide advice in specialized areas such as
workers' compensation, unemployment insurance and payroll processing. The
client's principal contact within the client service team is the human resources
professional, whose level of expertise is tailored to each client depending upon
the nature and complexity of the client's business. The Company believes that
its team approach ultimately results in maximum client satisfaction.
Sales and Marketing
The Company markets its services through two primary marketing
channels, direct sales and franchising. The Company believes this dual-channel
approach allows the Company to quickly access a pool of skilled employees,
develop regional brand awareness and ultimately become a market leader. The
Company believes its compound annual revenue growth rate of approximately 42%
from 1996 to 1998 demonstrates the success of this dual-channel approach. During
1998, the Company terminated the three existing Synadyne franchise agreements
and suspended sales of additional Synadyne franchises, pending an overall
determination of the best mix of all PEO distribution channels, including
franchising. The Company continues to market its PEO business on a direct sales
basis.
o Direct sales force. The Company believes there are significant differences
in the initial sales process and sales cycle between staffing and PEO services
sales. As a result, the Company markets these services through three distinct,
highly trained sales forces that share a common profile. Staffing services are
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marketed through sales associates located in Company-owned Tandem offices
nationwide. The Company's PEO services are marketed from the Company's national
support center, which includes a telemarketing center, as well as through sales
associates located in another Synadyne office in Florida. The Company's PEO
sales associates focus on full service PEO clients while the telemarketing
center staff concentrates on the Company's "small business" PEO clients (those
with fewer than ten employees).
Although the sales process and sales cycle are different between the
staffing and PEO businesses, the method and philosophy that the Company employs
in the selection, training and compensation of its sales force is very similar.
It is the Company's philosophy to employ the best sales force available, and all
of the Company's sales associates receive a competitive compensation package
that includes, in some cases, commissions during the life of the client's
relationship with the Company. All sales associates receive two weeks of initial
classroom and on-the-job training and attend additional training sessions on a
regular basis. The additional training is conducted by specialists and by sales
managers of the respective divisions.
Franchising. The Company offers franchising arrangements for its
industrial staffing business. Under staffing franchising agreements, the Company
grants the franchisee the exclusive right to operate under the Tandem trade name
within a select geographic market in return for a royalty on staffing services
rendered. The franchisee assumes the marketing costs and, as a result, the
Company believes franchising is a cost-effective method of building regional
brand awareness in secondary and tertiary markets. As of March 19, 1999, there
were 44 Tandem franchise locations. The Company has franchised Synadyne and
Office Ours on a limited basis in the past, but is not currently actively
marketing these franchises, and as of March 19, 1999 no such franchises were
active.
Clients
The Tandem division has approximately 17,000 clients and provides
services to approximately 4,000 of such clients each day. These clients
represent a cross-section of the industrial sector, of which no single client
represents more than 5% of the Company's total revenues. Tandem's clients
include national companies such as Browning-Ferris Industries, Inc., Michelin
Corporation, Toys "R" Us, Inc. and Waste Management, Inc., plus a number of
regional companies.
Synadyne provides PEO services to approximately 1,500 companies. These
companies represent a diverse range of industries, including insurance and
staffing. The Company's primary PEO client in the insurance industry is Allstate
Insurance. The Company provides basic PEO services for approximately 2,700
Allstate agents, each of whom has selected the Company from among Allstate's
approved providers. The Company's primary PEO clients in the staffing industry
are its Tandem franchises, in that the Company provides basic PEO services to
the employees of some of its franchises. For the year ended December 31, 1998,
approximately 20% and 10% of the Company's total PEO revenues were attributed to
services provided to Allstate Insurance and its agents and to Tandem franchises,
respectively.
The Company attempts to maintain diversity within its client base in
order to decrease its exposure to downturns or volatility in any particular
industry, but there can be no assurance that the Company will be able to
maintain such diversity or decrease its exposure to such volatility. As part of
this client selection strategy, the Company currently offers its services only
to those businesses that operate in certain industries, eliminating industries
that it believes present a higher risk of employee injury (such as roofing,
excavation, chemical manufacturing and maritime). All prospective clients
undergo a rigorous underwriting process to evaluate workers' compensation risk,
group medical history, creditworthiness, unemployment history and operating
stability. Generally, staffing clients do not sign long-term contracts.
See Note 8 to the Company's Consolidated Financial Statements for
additional information regarding significant customers and geographical
concentration.
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Competition
The staffing market is highly fragmented, characterized by many small
providers in addition to several large public companies, with at least one other
public company focused primarily on industrial staffing. There are limited
barriers to entry and new competitors frequently enter the market. Although a
large percentage of staffing providers are locally operated with fewer than five
offices, many of the large public companies have significantly greater
marketing, financial and other resources than the Company. Unlike the Company,
almost all of these companies do not focus primarily on industrial staffing. The
Company believes that by focusing primarily on industrial staffing, it enjoys a
competitive advantage over many of its competitors that attempt to provide a
broader range of temporary employees. The Company also believes that by
targeting regional and emerging companies, rather than the national companies
that are generally being pursued by its competitors, it can also gain certain
competitive advantages. The Company believes that there are several factors that
must be met in order to obtain and retain clients in the staffing market. These
factors include an adequate number of well located offices, an understanding of
clients' specific job requirements, the ability to reliably provide the correct
number of employees on time, the ability to monitor job performance, and the
ability to offer competitive prices. To attract qualified industrial candidates
for flexible employment assignments, companies must offer competitive wages,
vacations and holiday pay, positive work environments, flexibility of work
schedules, and an adequate number of available work hours. The Company believes
it is highly competitive in these areas in the Chicago market and is reasonably
competitive in the other markets in which it competes, although there can be no
assurance that such competitive standing can be maintained in the future.
Competition in the highly fragmented PEO sector is generally on a local
or regional basis, and new competitors frequently enter the market. Several
larger PEO competitors have completed initial public offerings during the past
three years. The primary competitive factors in this sector are quality of
service, choice and quality of benefits, reputation and price. The Company
believes that name recognition, regulatory expertise, financial resources, risk
management, and data processing capability distinguish leading PEOs from the
rest of the industry and that the Company is competitive in all of these areas
in the markets in which it competes. The Company's competitors include (i)
in-house human resource departments, (ii) other PEOs and (iii) providers of
discrete employment-related services such as payroll processing firms,
commercial insurance brokers, human resource consultants and temporary help
firms who might enter the PEO market. Some of these companies have greater
financial and other resources than the Company. The Company believes that
barriers to entry are increasing and are greater than those of the staffing
business. Some of the barriers to entry include: (i) the complexity of the PEO
business and the need for expertise in multiple disciplines, (ii) the number of
years of experience required to establish experience ratings in key cost areas
of workers' compensation, health insurance, and unemployment, (iii) the need for
sophisticated management information systems to track all aspects of business in
a high-growth environment and (iv) increased regulations and licensing
requirements in many states.
Risk Management Program--Workers' Compensation
The Company believes that careful client selection, pro-active accident
prevention programs, and aggressive control of claims will result in reduced
workers' compensation costs. The Company seeks to prevent workplace injuries by
implementing a variety of training, safety, and mandatory drug-free workplace
programs (including pre-employment screening, random testing, and post-accident
drug monitoring) to ensure that safety awareness is heightened at the sites to
which the Company sends its workers. Further, the Company insists that clients
adhere to ongoing safety practices at the client worksites as a necessary
condition to a continued business relationship.
Each month, the risk management team, comprised of professionals from a
variety of functional areas, reviews workplace accidents for the relevant period
to determine the appropriate reserves. Each quarter, all cases are reviewed to
reconcile the reserves, payments, and expected future costs for each case. The
Company believes it has maintained adequate reserves for all of its workers'
compensation claims. In addition, the Company has selected Special Risk Services
for third-party claims administration and Novaeon Care Management for medical
case management. Each vendor has established designated regional teams for the
handling of the Company's workers' compensation claims. A Company in-house
claims analyst manages each regional team. All claims arising within a given
region are reported to the claims analyst who verifies the employment of the
claimant and assigns the claim to Special Risk Services and Novaeon, for defense
and/or processing. Together, the team of the in-house analyst, the third-party
administrator and medical case manager aggressively follow each claim from its
origin to its conclusion. See Note 1 to the Company's Consolidated Financial
Statements for a description of the financial terms of the program.
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Information Technology
The Company believes that the effective use of technology to increase
operational efficiency and enhance client service is a key factor in remaining
competitive. The Company has developed, and continues to invest in, information
support systems at its Company-owned and franchise locations, as well as the
national office and support center. At the field level, custom developed systems
support the day-to-day operational needs of both Tandem and Office Ours. Another
specialized system provides support for Synadyne. At the national office and
support center, centralized accounting, billing and reporting applications
provide support for all of the operating divisions, including the Tandem and
Office Ours field offices.
In November 1996, the Company entered into a series of major projects
to expand its information infrastructure and replace, or re-develop, many of its
major operational systems in order to support future growth. The initial phase
of the project was an installation of a Company-wide database management system
that now provides consistency across all applications and allows information to
move between applications. This allows for consolidated reporting and analysis
across all of the Company's divisions.
The second phase of the project, completed in February 1997,
implemented an integrated financial management system for all accounting
functions to streamline the central processing of billing and financial
reporting. The third phase of the project, completed in November 1997, was the
development of a state-of-the-art system to support Synadyne. Since no
comprehensive, commercially available system exists for the PEO industry, the
Company entered into a developmental agreement with F.W. Davison, a provider of
human resource and benefit systems, to produce a system tailored to the needs of
Synadyne. The final phase of the project, now in its final implementation phase,
is the development of a new support system for the Tandem and Office Ours
offices that uses a centrally based processing resource. Each field office is or
will be connected to a central processor, via a FRAME relay network connection.
This new system will be implemented in all Company-owned offices by May 31,
1999.
INDUSTRY REGULATION
Overview
As an employer, the Company is subject to federal, state and local
statutes and regulations governing its relationships with its employees and
affecting businesses generally, including, in many respects, employees at client
worksites. In addition, as a result of its PEO operations, the Company is
affected by applicable licensing and other regulatory requirements and by
uncertainty in the application of numerous federal and state laws relating to
labor, tax and employment matters.
Uncertainty As To The Employer Relationship
By entering into a co-employment relationship with worksite employees,
the Company assumes certain obligations and responsibilities of an employer
under federal and state laws. Many of these federal and state laws were enacted
prior to the development of nontraditional employment relationships, such as
PEOs, temporary employment, and outsourcing arrangements, and do not
specifically address the obligations and responsibilities of PEOs. Whether
certain laws apply to the Company depends in many cases upon whether the Company
is deemed to be an "employer" for purposes of the law. The definition of
"employer" under these laws is not uniform and, therefore, the application of
these laws to the Company's business is not always certain. In many cases, a
person's status as an "employer" is determined by application of a common law
test involving the examination of several factors to determine an
employer/employee relationship. Uncertainty as to the application of certain
laws governing "employer" relationships is particularly important to the Company
in federal tax and employee benefit matters.
Federal and State Employment Taxes. The Company assumes the sole
responsibility and liability for the payment of federal and state employment
taxes with respect to wages and salaries paid to its employees, including
worksite employees. To date, the IRS has relied extensively on the common law
test of employment in determining employer status and the resulting liability
for failure to withhold; however, the IRS has formed an examination division
market segment specialization program for the purpose of examining selected PEOs
throughout the United States. Upon examination, the IRS may determine that a PEO
is not the employer of the worksite employees under the provisions of the
Internal Revenue Code of 1986, as amended (the "Code") applicable to federal
employment taxes and, consequently, that the client companies are exclusively
responsible for payment of employment taxes on wages and salaries paid to such
employees.
8
<PAGE>
A determination by the IRS that the Company is not the employer of the
worksite employees may impact the Company's ability to report employment taxes
for its own account rather than for the accounts of its clients and would
increase administrative burdens on the Company's payroll service function. In
addition, while the Company believes that it can contractually assume the client
company's withholding obligations, in the event the Company fails to meet these
obligations the client company may be held jointly and severally liable. The
Company's management believes that the financial condition and reputation of the
Company in the past has prevented this potential liability from discouraging
prospective clients. There can be no assurance that the Company will be able to
prevent this potential liability in the future.
Employee Benefit Plans. The Company offers various benefit plans to its
worksite employees. These plans include a multiple-employer retirement plan, a
cafeteria plan, a group health plan, a group life insurance plan, a group
disability insurance plan and an employee assistance plan. Generally, employee
benefit plans are subject to provisions of both the Code and the Employee
Retirement Income Security Act of 1974, as amended ("ERISA"). In order to
qualify for favorable tax treatment under the Code, the plans must be
established and maintained by an employer for the exclusive benefit of the
Company's employees. An IRS examination of the Company and/or a client company
may determine that the Company is not the employer of worksite employees under
Code provisions applicable to employee benefit plans. Consequently, the Company
may not be able to offer worksite employees benefit plans that qualify for
favorable tax treatment. If the IRS were to conclude that the Company is not the
employer of its worksite employees for plan purposes, those employees could not
continue to make tax favored contributions to the Company's multiple-employer
retirement plans or cafeteria plan. The Company believes that, although
unfavorable to the Company, a prospective application by the IRS of an adverse
conclusion would not have a material adverse effect on its financial position
and results of operations. If such conclusion were applied retroactively,
employees' vested account balances may become taxable immediately, the Company
would lose its tax deduction to the extent the contributions were not vested,
the plan trust would become a taxable trust and penalties could be assessed. In
such a scenario, the Company would face the risk of client dissatisfaction, as
well as potential litigation. A retroactive application by the IRS of an adverse
conclusion could have a material adverse effect on the Company's financial
position, results of operations and liquidity. While the Company believes that a
retroactive disqualification is unlikely, there can be no assurance as to the
ultimate resolution of these issues.
Employee pension and welfare benefit plans are also governed by ERISA.
The United States Supreme Court has held that the common law test of employment
must be applied to determine whether an individual is an employee or an
independent contractor under ERISA. A definitive judicial interpretation of
employer in the context of a PEO arrangement has not been established. If the
Company were found not to be an employer for ERISA purposes, its plans would not
be subject to ERISA. As a result of such finding, the Company and its plans
would not enjoy the preemption of state law provided by ERISA and could be
subject to varying state laws and regulations, as well as to claims based upon
state common laws.
Workers' Compensation
Workers' compensation is a state mandated, comprehensive insurance
program that requires employers to fund medical expenses, lost wages and other
costs resulting from work-related injuries and illnesses. In exchange for
providing workers' compensation coverage for employees, employers are generally
immune from any liability for benefits in excess of those provided by the
relevant state statutes. In most states, the extensive benefits coverage for
both medical costs and lost wages is provided through the purchase of commercial
insurance from private insurance companies, participation in state-run insurance
funds, self insurance funds or, if permitted by the state, employer
self-insurance. Workers' compensation benefits and arrangements vary on a
state-by-state basis and are often highly complex.
The Company's ability to use comprehensive workers' compensation
managed care techniques in its PEO operations depends in part on its ability to
contract with or create networks of health care providers. The Company requires
that injured workers use the Company's network of providers. Laws regulating the
operation of managed care provider networks have been adopted by a number of
states. These laws may apply to managed care provider networks having contracts
with the Company or to provider networks that the Company may organize. To the
extent the Company is governed by these regulations, it may be subject to
additional licensing requirements, financial oversight and procedural standards
for beneficiaries and providers. See "--Risk Management Program--Workers'
Compensation."
PEO Licensing Requirements
Approximately one-third of the states, including Florida, have passed
laws that have licensing or registration requirements for PEOs and several
additional states are considering such regulation. Such laws vary from state to
state but generally provide for monitoring the fiscal responsibility of PEOs.
State regulation assists in screening insufficiently capitalized PEO operations
9
<PAGE>
and, in the Company's view, has the effect of legitimizing the PEO industry
generally by resolving interpretative issues concerning employee status for
specific purposes under applicable state law. Existing regulations are
relatively new and, therefore, limited interpretive or enforcement guidance is
available. The Company cannot predict with certainty the nature or direction of
the development of federal, state and local regulations.
In Florida, the Company's PEO operations are licensed under the Florida
Employee Leasing Licensing Act of 1991 (the "Florida Licensing Act"). Among
other things, the Florida Licensing Act requires PEOs and their controlling
persons to be licensed, mandates reporting requirements, allocates several
employer responsibilities and requires the payment of an annual licensing fee
based upon gross payroll amounts. The Florida Licensing Act also requires
licensed PEOs to submit annual audited financial statements and to maintain a
tangible accounting net worth and positive working capital. In addition, the
Florida Licensing Act requires PEOs to (i) reserve the right of direction and
control over leased employees, (ii) enter into written agreements with their
clients, (iii) pay wages to leased employees, (iv) pay and collect payroll
taxes, (v) maintain authority to hire, terminate, discipline and reassign
employees and (vi) retain a right of direction and control over management of
safety, risk and hazard control at the worksite or sites affecting its leased
employees, including the responsibility to perform safety inspections, to
promulgate and administer employment and safety policies, and to manage workers'
compensation claims, claim filings, and related procedures.
TRADEMARKS AND SERVICE MARKS
The Company has registered the following marks with the United States
Patent and Trademark Office: TANDEM, LABOR WORLD, LM LABOR WORLD in conjunction
with globe logo, LABOR TECHNOLOGIES and Labor Technologies logo, OFFICE OURS,
OFFICE HOURS PLUS, Office Ours clock logo, OUTSOURCE INTERNATIONAL THE LEADER IN
HUMAN RESOURCES and design, SYNADYNE, and SYNADYNE--A PROFESSIONAL EMPLOYER and
design. These marks all expire at various times from 2002 to 2007, but are
renewable thereafter for ten year terms. The Company has applications pending
before the United States Patent and Trademark Office for federal registration of
the following marks: FIGURE OF A MAN IN BOX DESIGN, OUTSEARCH, PEOPLE PEOPLE
COMMITTED TO PEOPLE, TANDEM and double oval design, and WE HAVE YOUR FUTURE IN
MIND. In addition, the Company has registered the mark OUTSOURCE INTERNATIONAL -
THE LEADER IN HUMAN RESOURCES in 26 states, which registrations expire at
various times from 2002 to 2007, but are renewable. See Item 3 - Legal
Proceedings.
The Company has registered with the Office for Harmonization in the
Internal Market (Trademark and Designs) for the European Community registration
of the following marks: OFFICE OURS and SYNADYNE. The Company has one
application pending with the European Community for the registration of the mark
OUTSOURCE INTERNATIONAL. The Company also has registered with the Canadian
Trademarks Office for the following marks: SYNADYNE and OFFICE OURS. The Company
has one application pending with the Canadian Trademarks Office for registration
of the mark OUTSOURCE INTERNATIONAL.
The Company believes that all of its marks are important to its sales,
marketing and financial operations.
CORPORATE EMPLOYEES
As of December 31, 1998, the Company had 937 corporate employees, of
whom 677 were employed in flexible staffing service operations, 60 were employed
in PEO service operations, and 173 were employed in shared support services such
as human resources, risk management, and information systems. None of the
Company's employees are covered by collective bargaining agreements. The Company
believes that its relationships with its employees are good.
ITEM 2 - PROPERTIES
The Company owns a 50,000 square foot office building in Deerfield
Beach, Florida, which houses its national office and support center. The Company
also owns small staffing office locations in Chicago, Illinois and Waukegan,
Illinois and a condominium in Boca Raton, Florida. As of December 31, 1998 the
Company also leased 131 facilities, primarily staffing office locations, with
approximately 300,000 total square feet for an annual base rent of approximately
$2.8 million. A portion of a warehouse and a staffing office location are leased
from TMT Properties, Inc., a company controlled by Paul Burrell, the Company's
President, Chief Executive Officer, and Chairman of the Board. The warehouse
lease, which is on a month-to-month basis, and the staffing office lease, which
expires in February 2002, each have rental obligations of approximately $2,000
per month. The Company believes that its facilities are generally adequate for
its needs and does not anticipate difficulty in replacing such facilities or
locating additional facilities, if needed.
10
<PAGE>
ITEM 3 - LEGAL PROCEEDINGS
On March 21, 1997, Source Services Corporation ("SSC") filed a Petition
to Cancel Registration with the Trademark Trial and Appeal Board in which SSC
seeks cancellation of the Company's service mark "OutSource International - The
Leader in Human Resources". SSC alleged that it has been using the service mark
"Source" in various forms since 1986 and that the Company's use of the
"OutSource" service mark violates various provisions of the Lanham Act On
September 23, 1997, SSC filed an action in federal court seeking to enjoin the
Company's use of the name "OUTSOURCE", cancellation by the court of the
Company's "OutSource" service mark and damages. The Company and SSC have reached
an agreement in principle to settle this matter, resulting in no substantive
change to the Company's continued use of the "OutSource" service mark and
without any effect on the Company's financial condition or results of
operations.
On November 12, 1997, an action was commenced against the Company in
the Circuit Court for Oakland County, Michigan under the title Vervaecke vs.
OutSource International, Inc., et al (Case No. 97-1283-CL). The complaint
alleges state law claims of pregnancy/maternity discrimination and violations of
the Family and Medical Leave Act as a result of an alleged demotion following
the plaintiff's return from maternity leave. The complaint also asserts a claim
for unpaid overtime based on both state law and the Fair Labor Standards Act.
The case is presently in discovery and no trial date has been set. The Company
believes the claims are without merit and is vigorously defending this action.
On September 24, 1998, an action was commenced against OutSource
International of America, Inc. ("OutSource America"), a wholly-owned subsidiary
of the Company, in the United States District Court, Eastern District of
Louisiana, under the title Corporate Personnel Services and Temps, Inc. v.
OutSource International of America, Inc. (Case No. 85089). The complaint alleged
breach of contract in connection with a purported services arrangement and
sought damages of approximately $600,000. OutSource America filed an answer
denying any breach of contract and moved to transfer the action to Florida. The
motion for removal was granted and the case has been transferred to, and is now
pending in, the Southern District of Florida, Fort Lauderdale division. The
action is presently in discovery and no trial date has been set. The Company
believes that the claim is without merit and the resolution of this lawsuit will
not have a material adverse effect on its financial position or future operating
results; however, no assurance can be given as to the ultimate outcome of this
lawsuit.
In addition to the foregoing, the Company is involved in routine
litigation arising in the ordinary course of its business which the Company
believes will not have a material adverse effect on its financial position.
ITEM 4 - SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
11
<PAGE>
PART II
ITEM 5 - MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED
STOCKHOLDER MATTERS
The Company's $.001 par value common stock ("Common Stock") commenced
trading on the NASDAQ National Market(R) under the symbol "OSIX" on October 24,
1997. There were approximately 77 holders of record of Common Stock as of March
19, 1999. This number does not include the number of shareholders whose shares
were held in "nominee" or "street name", which the Company believes to be
approximately 3,000 as of that date. The table below sets forth, for the period
indicated, the high and low bid prices of the Company's Common Stock as reported
by the NASDAQ Stock Market(R).
Bid Prices
----------
High Low
---- ---
Fiscal Year 1997
Fourth Quarter 1997(1).................... $ 19.75 $ 10.13
Fiscal Year 1998
First Quarter 1998........................ $ 25.00 $ 10.63
Second Quarter 1998....................... $ 24.25 $ 7.75
Third Quarter 1998........................ $ 11.13 $ 3.50
Fourth Quarter 1998....................... $ 5.69 $ 3.25
- ----------------
(1) Prior to October 24, 1997, there was no public trading market for the
Common Stock.
On March 19, 1999, the closing price of the Company's Common Stock was
$3.75 per share.
The Company has never paid dividends on its Common Stock. The Company
intends to retain earnings, if any, to finance future operations and expansion
and, therefore, does not anticipate paying any cash dividends in the foreseeable
future. Any future payment of dividends will depend upon the financial
condition, capital requirements and earnings of the Company and compliance with
cash flow and other financial covenants contained in the Company's revolving
credit facility with a syndicate of lenders led by BankBoston, N.A. (the
"Revolving Credit Facility"), as well as upon other factors that the Board of
Directors may deem relevant.
Sales of Unregistered Securities
In connection with the issuance of the senior subordinated promissory
notes in February 1997, the Company issued 786,517 warrants (the "Initial
Warrants") to the Senior Note Holders and placed 573,787 warrants (the
"Additional Warrants") in escrow, pending release to either the Existing
Shareholders or the Senior Note Holders, based upon the achievement by the
Company of certain specified performance criteria. In April 1997, 180,891
Additional Warrants were released from escrow and distributed to the Existing
Shareholders and the remaining 392,896 Additional Warrants were, as of March 21,
1999, available for release to the Senior Note Holders. Upon release from
escrow, the Initial Warrants and the Additional Warrants are exercisable at a
price of $.015 per share and expire on February 20, 2002. The Company has agreed
to grant the holders of the Initial Warrants and Additional Warrants demand and
piggyback registration rights. The securities were issued pursuant to Section
4(2) of the Securities Act.
12
<PAGE>
ITEM 6 - SELECTED FINANCIAL DATA
The consolidated balance sheet data and consolidated statement of
income data set forth below as of and for each of the five years in the period
ended December 31, 1998 have been derived from the audited consolidated
financial statements of the Company. The system operating data and other data
have been derived from the Company's records. The data should be read in
conjunction with "Management's Discussion and Analysis of Financial Condition
and Results of Operations" and the Company's Consolidated Financial Statements
and related notes thereto.
<TABLE>
<CAPTION>
Years ended December 31,
------------------------
1998 1997 1996 1995 1994
---- ---- ---- ---- ----
(Dollars in thousands, except per share data)
Consolidated Statement of Income Data:
<S> <C> <C> <C> <C> <C>
Net revenues....................................... $565,394 $447,579 $280,171 $149,825 $80,647
Cost of revenues................................... 480,574 381,273 242,102 126,270 65,813
-------- -------- -------- -------- -------
Gross profit....................................... 84,820 66,306 38,069 23,555 14,834
Shareholders' compensation......................... - 292 2,321 2,370 2,245
Amortization of intangible assets.................. 3,684 1,853 424 41 -
Other selling, general and administrative expense.. 69,168 53,752 29,841 17,688 9,008
-------- -------- -------- -------- -------
Operating income................................... 11,968 10,409 5,483 3,456 3,581
Net interest expense............................... 5,529 7,877 2,175 1,259 820
Other expense (income) (1)......................... (53) 1,821 1,448 (11) (51)
-------- -------- -------- -------- -------
Income before provision (benefit)
for income taxes and extraordinary item (2)...... 6,492 711 1,860 2,208 2,812
Pro forma income taxes (3)......................... 1,611 296 757 859 1,059
-------- -------- -------- -------- -------
Pro forma income before
extraordinary item (2)(3)......................... $ 4,881 $ 415 $ 1,103 $ 1,349 $ 1,753
======== ======== ======== ======== =======
Pro forma weighted average basic common
shares outstanding (4)........................... 8,604 6,055 5,785 5,785 5,785
======== ======== ======== ======== =======
Pro forma weighted average diluted common
shares outstanding (4)........................... 9,919 7,320 5,844 5,785 5,785
======== ======== ======== ======== =======
Pro forma basic earnings per share before
extraordinary item............................... $ .57 $ .07 $ .19 $ .23 $ .30
======== ======== ======== ======== =======
Pro forma diluted earnings per share before
extraordinary item............................... $ .49 $ .06 $ .19 $ .23 $ .30
======== ======== ======== ======== =======
Other Data (5):
EBITDA, as adjusted................................ $ 18,777 $ 14,871 $ 9,027 $ 6,258 $ 5,993
======== ======== ======== ======== =======
Net income, as adjusted............................ $ 5,022 $ 2,139 $ 3,220 $ 2,586 $ 2,947
======== ======== ======== ======== =======
Pro forma diluted earnings per share, as adjusted.. $ .51 $ .29
======== ========
System Operating Data:
System Revenues (6)................................ $647,301 $555,802 $389,314 $242,681 $151,408
======== ======== ======== ======== =======
Number of employees (end of period)................ 36,000 32,000 23,000 16,200 12,200
Number of offices (end of period).................. 165 163 150 109 67
As of December 31,
------------------
1998 1997 1996 1995 1994
---- ---- ---- ---- ----
(Dollars in thousands)
Consolidated Balance Sheet Data:
Working capital (deficit).......................... $ (8,699) $ 33,651 $(3,172) $ 1,540 $1,596
Total assets....................................... 112,002 105,743 55,877 24,708 13,791
Revolving Credit Facility and line of credit....... 20,980 33,800 9,889 6,468 4,827
Long-term debt to related parties,
less current maturities........................... 745 - 2,403 - -
Other long-term debt, less current maturities...... 9,257 7,737 10,874 2,815 2,713
Other non-current liabilities...................... 1,050 - - - -
Total shareholders' equity......................... 44,588 40,778 4,495 3,603 2,701
</TABLE>
13
<PAGE>
(1) In 1997, the Company issued warrants ("Warrants") to purchase 1,360,304
shares of the Company's Common Stock. The holders of the Warrants had a
put right, as a result of which the Company recorded a put warrants
liability. Other expense (income) for the year ended December 31, 1997
includes non-operating expense of $1.8 million related to the adjustment
of the initial liability recorded at the time of the issuance of the
Warrants on February 21, 1997 and based on their fair value at that time,
to the fair value of the Warrants at the time of the Offering ("Put
Warrants Valuation Adjustment"), when the put right terminated. At the
time of the Offering, the Warrants, with an adjusted carrying value of
$20.4 million, were reclassified from debt to additional paid-in capital.
See Note 5 to the Company's Consolidated Financial Statements.
Other expense (income) for the year ended December 31, 1996 includes $1.4
million of unusual charges, primarily professional fees related to a
registration statement filed by the Company with the Securities and
Exchange Commission that was subsequently withdrawn and an internal
investigation into certain Company transactions. See Note 7 to the
Company's Consolidated Financial Statements.
(2) As a result of the use of the proceeds of the Offering to repay the full
balance of the Senior Notes, the Company recorded an extraordinary loss in
1997 of approximately $13.4 million (net of a $6.6 million income tax
benefit). This loss consists of the unamortized debt discount and the
unamortized debt issuance costs related to the Senior Notes. As a result
of the reduction of the income tax benefit included in the 1997
extraordinary loss and related to the release of certain put warrants in
1998, the Company recorded an extraordinary loss of approximately $1.4
million in 1998. See Note 4 to the Company's Consolidated Financial
Statements.
(3) On February 21, 1997, a reorganization was consummated in which nine
companies under common ownership and management became wholly-owned
subsidiaries of the Company (the "Reorganization"). Prior to the
Reorganization, each of the Subsidiaries elected to be a subchapter S
corporation and, accordingly, were not subject to income taxes; therefore,
there is no provision for income taxes for periods prior to the
Reorganization. Pro forma income taxes and net income have been computed
as if the Company had been fully subject to federal and applicable state
income taxes for such periods. The Company recognized a one-time tax
benefit of $429,000 as a result of the termination, at the time of the
Reorganization, of the Subsidiaries' elections to be treated as S
corporations. This benefit is reflected in the historical results of
operations for the year ended December 31, 1997, but has been removed from
the pro forma results presented for that period.
(4) Basic shares outstanding includes (a) the 5,448,788 shares of Common Stock
issued in connection with the Reorganization, (b) for the periods prior to
the Reorganization, the equivalent number of shares (336,430) of Common
Stock represented by the shares of Common Stock of the Subsidiaries
purchased from certain shareholders for cash and notes in the
Reorganization (c) for the periods after the Offering, the sale by the
Company of 3,000,000 shares of Common Stock and (d) for 1998, 154,733
shares representing the weighted average of 209,125 shares issued and
warrants exercised during the year. Diluted shares outstanding include the
above plus all outstanding options to purchase Common Stock and Warrants
calculated using the treasury stock method. See Notes 1, 10 and 13 to the
Company's Consolidated Financial Statements.
(5) The other data is presented to reflect the Company's historical results of
operations, before extraordinary items and adjusted to reflect (a) the
elimination of the amount of compensation expense ($0, $0.3 million, $2.0
million, $2.0 million, and $1.9 million for the years ended December 31,
1998, 1997, 1996, 1995, and 1994, respectively) for the Company's founding
shareholders and for the Company's President, Chief Executive Officer, and
Chairman of the Board, who is also a shareholder of the Company, which is
in excess of the compensation for such individuals subsequent to the
Reorganization; (b) the elimination of $1.4 million of unusual charges in
the year ended December 31, 1996 and $1.8 million of non-operating expense
arising from the 1997 Put Warrants Valuation Adjustment, both discussed in
Note 1 above; and (c) income taxes computed as if the Company had been
subject to federal and applicable state income taxes for such periods.
This adjusted computation of income taxes excludes a $141,000 expense
included in the Company's 1998 income tax provision due to the adjustment
for tax return purposes of the 1997 put warrants valuation adjustment
associated with the Warrants (see Notes 4 and 5 to the Company's
Consolidated Financial Statements). See footnote 2 to the table in
"Management's Discussion and Analysis of Financial Condition and Results
of Operations--Results of Operations" for summary operating data
reflecting these adjustments.
EBITDA is earnings (net income) before the effect of interest income and
expense, income tax benefit and expense, depreciation expense and
amortization expense. 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. Cash flows for the periods presented were as
follows:
<TABLE>
<CAPTION>
Years ended December 31,
------------------------
1998 1997 1996 1995 1994
---- ---- ---- ---- ----
(Dollars in thousands)
<S> <C> <C> <C> <C> <C>
Cash flows provided by (used in):
Operating activities................ $50,761 $(12,910) $(1,280) $2,787 $1,267
Investing activities................ (31,316) (24,744) (4,834) (2,026) (2,246)
Financing activities................ (15,629) 39,295 4,647 678 1,028
------- -------- ------- ------ ------
Net increase (decrease) in cash..... $3,816 $ 1,641 $(1,467) $1,439 $ 49
======= ======== ======= ====== ======
</TABLE>
(6) System revenues is the sum of the Company's net revenues (excluding
revenues from franchise royalties and services performed for the
franchisees) and the net revenues of the franchisees. System revenues
provide information regarding the Company's penetration of the market for
its services, as well as the scope and size of the Company's operations,
but are not an alternative to revenues determined in accordance with
generally accepted accounting principles as an indicator of operating
performance. The net revenues of franchisees, which are not earned by or
available to the Company, are derived from reports that are unaudited.
System revenues consist of the following:
<TABLE>
<CAPTION>
Years ended December 31,
------------------------
1998 1997 1996 1995 1994
---- ---- ---- ---- ----
(Dollars in thousands)
<S> <C> <C> <C> <C> <C>
Company's net revenues................. $565,394 $447,579 $280,171 $149,825 $ 80,647
Less Company revenues from:
Franchise royalties.................. (7,352) (6,997) (5,671) (4,138) (2,712)
Services to franchisees.............. (25,199) (34,642) (35,079) (7,507) (4,698)
Add Franchisees' net revenues.......... 114,458 149,862 149,893 104,501 78,171
------- -------- ------- ------- --------
System revenues........................ $647,301 $555,802 $389,314 $242,681 $151,408
======== ======== ======== ======== ========
</TABLE>
14
<PAGE>
ITEM 7 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
General
The Company is a national provider of human resource services focusing
on the staffing market through its Tandem division and on the PEO market through
its Synadyne division. While implementing its growth strategies, the Company
completed 36 acquisitions, primarily staffing companies, from January 1, 1995
through March 19, 1999 - the last acquisition closed in October 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
124 and the number of metropolitan markets (measured by Metropolitan Statistical
Areas, or MSAs) served by Company-owned locations increased from one to 50. 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.
The Company's staffing operations generate significantly higher gross
profit margins than its PEO operations. The higher staffing margin reflects
compensation for recruiting, training and other services not required as part of
many PEO relationships, where the employees have already been recruited by the
client and are trained and in place at the beginning of the relationship.
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>
Years Ended December 31,
------------------------
1998 1997 1996
---- ---- ----
(Dollars in thousands)
<S> <C> <C> <C>
Net revenues:
Flexible industrial staffing (1)............................ $296,267 $207,312 $ 97,397
PEO (1)..................................................... 253,271 225,836 172,069
Franchising................................................. 7,352 7,027 5,755
Other....................................................... 8,504 7,404 4,950
-------- -------- ---------
Total net revenues.......................................... $565,394 $447,579 $ 280,171
======== ======== =========
Gross profit................................................ $ 84,820 $ 66,306 $ 38,069
Selling, general and administrative expenses (2)............ 72,852 55,897 32,586
-------- -------- ---------
Operating income............................................ 11,968 10,409 5,483
Net interest and other expense (2).......................... 5,476 9,698 3,623
-------- -------- ---------
Income before provision for
income taxes and extraordinary item..................... 6,492 711 1,860
Pro forma income taxes (2).................................. 1,611 296 757
-------- -------- ---------
Pro forma income before
extraordinary item (2).................................. $ 4,881 $ 415 $ 1,103
======== ======== =========
System Revenues (3)......................................... $647,301 $ 555,802 $ 389,314
======== ======== =========
</TABLE>
15
<TABLE>
<CAPTION>
Years Ended December 31,
------------------------
1998 1997 1996
---- ---- ----
<S> <C> <C> <C>
Net revenues:
Flexible industrial staffing (1)............................ 52.4% 46.3% 34.8%
PEO (1)..................................................... 44.8 50.5 61.4
Franchising................................................. 1.3 1.6 2.0
Other....................................................... 1.5 1.6 1.8
---- ----- -----
Total net revenues.......................................... 100.0% 100.0% 100.0%
===== ===== =====
Gross profit................................................ 15.0% 14.8% 13.6%
Selling, general and administrative expenses (2)............ 12.9 12.5 11.6
---- ----- -----
Operating income............................................ 2.1 2.3 2.0
Net interest and other expense (2).......................... 1.0 2.1 1.3
---- ----- -----
Income before provision for
income taxes and extraordinary item..................... 1.1 0.2 0.7
Pro forma income taxes (2).................................. 0.2 0.1 0.3
---- ----- -----
Pro forma income before extraordinary item (2).............. 0.9% 0.1% 0.4%
==== ===== =====
</TABLE>
- -------------------
(1) SFAS No. 131, "Disclosures about Segments of an Enterprise and Related
Information", establishes standards for reporting information about operating
segments in financial statements. Operating segments are defined as components
of an enterprise about which separate financial information is available that is
evaluated regularly by the chief operating decision maker, or decision making
group, in deciding how to allocate resources and in assessing performance. The
Company's reportable operating segments under SFAS No. 131 include the
Industrial Staffing segment and the PEO segment. PEO revenues, as reported
above, include certain industrial revenues that the Company believes are
operationally consistent with the PEO business and operational model, but are
not includable in the PEO segment due to the way the Company is organized.
Following is a reconciliation of Flexible Industrial Staffing net revenues and
the PEO net revenues, as shown above, to the revenues reported by the Company in
accordance with the requirements of SFAS No. 131 see Note 14 to the Company's
Consolidated Financial Statements.
<TABLE>
<CAPTION>
Years Ended December 31,
------------------------
1998 1997 1996
---- ---- ----
(Dollars in thousands)
<S> <C> <C> <C>
Flexible Industrial Staffing revenues $296,267 $ 207,312 $ 97,397
Add: industrial staffing client payrolling 25,184 14,149 12,841
-------- --------- ---------
Industrial Staffing operating segment revenues $321,451 $ 221,461 $ 110,238
======== ========= =========
PEO revenues $253,271 $ 225,836 $ 172,069
Less: industrial staffing client payrolling (25,184) (14,149) (12,841)
Less: PEO services to industrial staffing franchises (25,199) (34,642) (35,079)
-------- --------- ---------
PEO operating segment revenues $202,888 $ 177,045 $ 124,149
======== ========= =========
</TABLE>
Gross profit amounts and percentages discussed herein are calculated on a
consistent basis with the revenues reported herein.
- -------------------
(2) For the year ended December 31, 1996, and 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 those periods, the Company paid compensation to the
Company's founding shareholders and to the Company's President, Chief Executive
Officer, and Chairman of the Board, who is also a shareholder of the Company
("Shareholder Compensation"). All of the compensation for the founding
shareholders and a portion of the compensation for the Company's President was
discontinued after the Reorganization. The discontinued Shareholder Compensation
was $0 in 1998, $0.3 million in 1997 and $2.0 million in 1996. In 1996, the
Company incurred unusual expenses of approximately $1.4 million in relation to a
registration statement filed by the Company with the Securities and Exchange
Commission that was subsequently withdrawn and an internal investigation into
certain Company transactions (See Note 7 to the Company's Consolidated Financial
Statements). In 1997, the Company recorded non-operating expense of
approximately $1.8 million related to the Put Warrants Valuation Adjustment and
incurred an extraordinary loss (net of income tax benefit) of approximately
$13.4 million (See Note 5 to the Company's Consolidated Financial Statements).
In 1998, as a result of the reduction of the income tax benefit included in the
1997 extraordinary loss and relating to the release of certain put warrants in
1998, the Company recorded an extraordinary loss of approximately $1.4 million
(See Note 4 to the Company's Consolidated Financial Statements). The following
table sets forth the amounts and the percentage of certain items in the
Company's consolidated statements of income, 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, the unusual expenses in 1996, the 1997
Put Warrants Valuation Adjustment and the 1997 and 1998 extraordinary losses and
is calculated assuming the Company had been subject to federal and state income
taxes and taxed as a C corporation during each of these periods. This adjusted
computation of income taxes excludes a $141,000 expense included in the
Company's 1998 income tax provision due to the adjustment for tax return
purposes of the 1997 put warrants valuation adjustment associated with the
Warrants (see Notes 4 and 5 to the Company's Consolidated Financial Statements).
16
<PAGE>
<TABLE>
<CAPTION>
Years Ended December 31,
------------------------
1998 1997 1996
---- ---- ----
(Dollars in thousands, except for percentages)
<S> <C> <C> <C>
Selling, general and administrative expenses,
as adjusted................................... $72,852 $55,635 $30,635
As a percentage of net revenues................. 12.9% 12.4% 10.9%
Operating income, as adjusted................... $11,968 $10,671 $ 7,434
As a percentage of net revenues................. 2.1% 2.4% 2.7%
Net income, as adjusted......................... $ 5,022 $ 2,139 $ 3,220
As a percentage of net revenues................. 0.9% 0.5% 1.1%
</TABLE>
- -------------------
(3) System revenues is the sum of the Company's net revenues (excluding revenues
from franchise royalties and services performed for the franchisees) and the net
revenues of the franchisees. System revenues provide information regarding the
Company's penetration of the market for its services, as well as the scope and
size of the Company's operations, but are not an alternative to revenues
determined in accordance with generally accepted accounting principles as an
indicator of operating performance. The net revenues of franchisees, which are
not earned by or available to the Company, are derived from reports that are
unaudited. System revenues consist of the following:
<TABLE>
<CAPTION>
Years Ended December 31,
------------------------
1998 1997 1996
---- ---- ----
(Dollars in thousands)
<S> <C> <C> <C>
Company's net revenues....................... $565,394 $447,579 $280,171
Less Company revenues from:
Franchise royalties...................... (7,352) (6,997) (5,671)
Services to franchisees................... (25,199) (34,642) (35,079)
Add Franchisees' net revenues................ 114,458 149,862 149,893
-------- -------- --------
System revenues.............................. $647,301 $555,802 $389,314
======== ======== ========
</TABLE>
Year Ended December 31, 1998 Compared To Year Ended December 31, 1997
Net Revenues. Net revenues increased $117.8 million, or 26.3%, to
$565.4 million in 1998 from $447.6 million in 1997. This increase resulted from
growth in staffing revenues in 1998 of $89.0 million, or 42.9%, and PEO revenues
growth of $27.4 million, or 12.1%, compared to 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. The
Company-owned staffing offices increased by 24 locations to 111 locations as of
December 31, 1998. This increase was the result of the 40 additional staffing
locations attributable to 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 $91.5 million, or 16.5%, to $647.3 million
in 1998 from $555.8 million in 1997. The increase in system revenues was
attributable to the $117.8 million increase in the Company's net revenues
discussed above. Franchise revenues of franchisees operating as of December 31,
1998 increased $14.6 million, or 22.3%, in 1998 as compared to 1997, offset by a
$50.0 million decrease in revenues for the same period resulting from other
franchisees no longer operating. The result is a net decrease of franchise
revenues of $35.4 million. The Company acquired and converted 30 franchise
locations to Company-owned locations during 1997 and 1998 and also allowed the
early termination of franchise agreements in 1997 and 1998 attributable to
another 38 locations to enable the Company to develop the related territories.
At the time the Company agrees to terminate a franchise agreement, it receives
an initial buyout payment from the former franchisee. The Company continues to
receive payments from the former franchisees based on a percentage of the gross
revenues of the formerly franchised locations for up to three years after the
termination dates. Although those gross revenues are not included in the
Company's franchisee or system revenues totals, the initial buyout payment, as
well as subsequent payments from the former franchisees, are reflected in total
royalties reported by the Company.
Gross Profit. Gross profit (margin) increased $18.5 million, or 27.9%,
to $84.8 million in 1998, from $66.3 million in 1997. Gross profit as a
percentage of net revenues increased to 15.0% in 1998 from 14.8% in 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
17
<PAGE>
gross profit margins. In 1998, PEO operations generated gross profit margins of
3.6% as compared to gross profit margins of 22.2% generated by staffing
operations.
Gross profit margin percent for the Company's staffing operations
decreased to 22.2% in 1998 from 23.5% in 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 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 gross profit margin percent was unchanged at 3.6% in 1998 and 1997.
Selling, General and Administrative Expenses. Selling, general and
administrative expenses ("SG&A") increased $17.0 million, or 30.3%, to $72.9
million in 1998 from $55.9 million in 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. 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 $9.4 million in 1998. In addition, the Company
incurred indirect infrastructure costs to evaluate, acquire and integrate these
operations, as well as to support the larger customer base.
As a percentage of net revenues, SG&A increased to 12.9% in 1998 from
12.5% in 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 $4.2 million, to $5.5 million in 1998 from $9.7 million in 1997.
This decrease was primarily due to a $2.4 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 1997 of $1.8 million attributable to a Put Warrants
Valuation Adjustment, with no corresponding item in 1998.
Pro Forma Income Before Extraordinary Item. Pro forma income before
extraordinary item increased by $4.5 million, to $4.9 million in 1998 from $0.4
million in 1997. This increase was primarily due to the $4.2 million decrease in
interest and other expense discussed above and an increase of $1.6 million in
operating income as a result of increases in sales and gross profit discussed
above, partially offset by the related income taxes.
Extraordinary Item. As a result of the reduction of the income tax
benefit included in the 1997 extraordinary loss and relating to the release of
certain put warrants in 1998, the Company recorded an extraordinary loss of
approximately $1.4 million in 1998.
Year Ended December 31, 1997 Compared To Year Ended December 31, 1996
Net Revenues. Net revenues increased $167.4 million, or 59.8%, to
$447.6 million in 1997 from $280.2 million in 1996. This increase resulted from
growth in staffing revenues of $109.9 million, or 112.9% and PEO revenues growth
of $53.8 million, or 31.2%. Staffing revenues increased due to (i) the 1996
Acquisitions (ii) the 1997 Acquisitions and (iii) internal growth. The
Company-owned staffing offices increased to 87 locations as of December 31, 1997
from 46 locations as of December 31, 1996, with 29 of the 41 additional
locations attributable to the 1997 Acquisitions. 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 increased $166.5 million, or 42.8%, to $555.8 million
in 1997 from $389.3 million in 1996. The increase in system revenues was
attributable to the $167.4 million increase in the Company's net revenues
discussed above. Franchise revenues of franchisees operating as of December 31,
1997 increased $22.7 million, or 22.0%, in 1997 as compared to 1996, offset by a
18
<PAGE>
$22.7 million decrease in revenues for the same period resulting from other
franchisees no longer operating. The result is no net change in franchise
revenues. The Company acquired and converted 13 franchise locations to
Company-owned locations during 1997 and also allowed the early termination of
franchise agreements in 1997 attributable to another 23 locations to enable the
Company to develop the related territories.
Gross Profit. Gross profit (margin) increased $28.2 million, or 74.2%,
to $66.3 million in 1997 from $38.1 million in 1996. Gross profit as a
percentage of net revenues increased to 14.8% in 1997 from 13.6% in 1996. 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 1997, PEO operations generated gross profit margins of
3.6% as compared to gross profit margins of 23.5% generated from staffing
operations.
Gross profit margin percent for the Company's staffing operations
decreased to 23.5% in 1997 from 24.5% in 1996, 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) two increases in the minimum wage
during the period from October 1, 1996 through December 31, 1997, for which the
Company increased billing rates without a related profit 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 gross profit margin percent decreased slightly to 3.6% in 1997 from
3.7% in 1996, primarily due to (i) a higher average wage and benefit cost per
PEO employee, while the gross profit amount per employee is relatively
consistent (See "-General" for a discussion of the effect of these costs on the
Company's revenue calculation), (ii) lower prices that reflect lower interest
costs incurred by the Company due to a decline in the relative proportion of
total PEO customers receiving credit terms, and (iii) larger contracts obtained
by the Company which have lower gross margin percentages based on
correspondingly lower selling, general and administrative expenses from the
economies of scale in servicing a larger contract. The Company anticipates that
these factors will continue to affect gross margins from PEO operations, which
the Company expects to be generally offset by lower selling, general and
administrative expenses (measured as a percentage of gross profit), as mentioned
above.
Selling, General and Administrative Expenses. SG&A increased $23.3
million, or 71.5%, to $55.9 million in 1997 from $32.6 million in 1996. This
increase was primarily a result of (i) operating costs related to the 1996 and
1997 Acquisitions, (ii) sales costs associated with increased staffing volume at
existing locations and, for part of the year, the 1996 Acquisitions and (iii)
pre-opening and operating expenses associated with new office locations in
existing staffing regions. The number of Company-owned staffing offices opened
for less than one year, excluding acquired offices, increased to 18 locations as
of December 31, 1997 from 12 locations as of December 31, 1996. Also, the
Company increased its corporate financial, legal, human resource, information
systems and other staff (and related expenses) in anticipation of operating as a
public company and in order to properly manage expected future growth. These
increases were partially offset by a decrease of $2.0 million in shareholders'
compensation from 1996 to 1997. As a percentage of net revenues, selling,
general and administrative expenses increased to 12.5% in 1997 from 11.6% in
1996. In addition to the items previously discussed, this percentage increase is
also due to the significant increase in 1997 of staffing revenues in proportion
to total Company revenues. The staffing operations have higher associated
selling, general and administrative expenses (as a percentage of revenues) than
PEO operations.
Net Interest and Other Expense. Net interest and other expense
increased by $6.1 million, to $9.7 million in 1997 from $3.6 million in 1996.
This increase included $1.8 million attributable to the Put Warrants Valuation
Adjustment. The remaining net increase is comprised of (i) a $5.7 million
increase in interest expense, including amortization of debt discount and
issuance costs, of which approximately $2.8 million was associated with the
Senior Notes which were issued in the first quarter of 1997, with the remainder
primarily being associated with net additional borrowings of $23.9 million in
1997 under the Revolving Facility to finance working capital requirements and
the 1997 Acquisitions and (ii) a $1.4 million decrease in other charges,
primarily professional fees, related to a registration statement filed by the
Company with the Securities and Exchange Commission that was subsequently
withdrawn and an internal investigation into certain Company transactions, both
events occurring in 1996.
Pro Forma Income Before Extraordinary Item. Pro forma income before
extraordinary item decreased by $0.7 million, to $0.4 million in 1997 from $1.1
million in 1996. This decrease was primarily due to the $5.7 million increase in
interest expense and a $1.8 million Put Warrants Valuation Adjustment, as
discussed above.
Extraordinary Item. As a result of the repayment in full of the Senior
Notes, the Company recorded an extraordinary loss in the fourth quarter of 1997
of approximately $13.4 million (net of a $6.6 million income tax benefit). This
loss consists of the unamortized debt discount and the unamortized debt issuance
costs related to the Senior Notes.
19
<PAGE>
Additional Operating and Segment Information
SFAS No. 131, "Disclosures about Segments of an Enterprise and Related
Information", establishes standards for reporting information about operating
segments in financial statements. Operating segments are defined as components
of an enterprise about which separate financial information is available that is
evaluated regularly by the chief operating decision maker, or decision making
group, in deciding how to allocate resources and in assessing performance. The
Company's reportable operating segments under SFAS No. 131 differ from the
operating information presented below, as explained in footnote 1 to the table
in "---Results of Operations" above. Gross profit amounts and percentages
discussed below are also calculated on a consistent basis with the revenues
reported below. See Note 14 to the Company's Consolidated Financial Statements.
Flexible Industrial Staffing:
Net revenues from the Company's staffing services increased $198.9
million, to $296.3 million for 1998 from $97.4 million for 1996, or a compound
annual growth rate of 74.4%. Staffing comprised an increasing share of the
Company's total net revenues, to 52.4% for 1998 from 34.8% for 1996, 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 $41.9
million, to $65.8 million for 1998 from $23.9 million for 1996, or a compound
annual growth rate of 66.0%. This represented an increasing share of the
Company's total gross profit, to 77.5% for 1998, from 62.7% for 1996. 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 $81.2 million, to
$253.3 million for 1998 from $172.1 million for 1996, or a compound annual
growth rate of 21.3%. Due to the Company's greater focus on growth of its
staffing operations during this period as well as conditions beginning in 1997
that resulted in changes made in the PEO management structure and marketing
approach, PEO revenues represented a decreasing share of the Company's total net
revenues, to 44.8% for 1998 from 61.4% for 1996. The Company expects that PEO
sales growth will continue at its present rate during 1999. During 1998, the
Company terminated 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 20% of the Company's 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 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 $2.7 million, to
$9.1 million for 1998 from $6.4 million for 1996, or a compound annual growth
rate of 19.7%. Due to 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 10.7% for 1998 from 16.7% for 1996.
Franchising:
Net revenues from the Company's franchising operations increased $1.6
million, to $7.4 million for 1998 from $5.8 million for 1996, or a compound
annual growth rate of 13.0%. Franchising operations represented a decreasing
share of the Company's total net revenues, to 1.3% in 1998 from 2.1% for 1996,
reflecting the Company's greater focus on growth of its Company-owned staffing
operations during this period, including the Company's conversion of 30
20
<PAGE>
franchise locations to Company-owned locations and the termination of franchise
agreements related to another 28 locations. The Company expects to continue to
convert franchise locations to Company-owned locations and to allow terminations
of franchise agreements in key markets that the Company believes it can develop
further. Such acquisitions and terminations will be subject to the Company's
ability to negotiate them on acceptable terms. The Company also expects to
continue to sell new franchises in smaller, less populated geographic areas,
subject to, among other factors, the success of the Company's marketing efforts
in this regard.
Gross profit from the Company's franchising operations increased $1.6
million, to $7.4 million for 1998 from $5.8 million for 1996, or a compound
annual growth rate of 13.0%. Consistent with the revenue trend discussed above,
this area represented a decreasing share of the Company's total gross profit, to
8.7% for 1998 from 15.1% for 1996.
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 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 5.65% as of December 31, 1998.
As of December 31, 1998, a $44.8 million interest in the Company's uncollected
accounts receivable had been sold under this agreement, which amount is excluded
from the accounts receivable balance presented in the Company's consolidated
financial statements.
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. 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. The Company is currently discussing renewal of the Liquidity
Facility with the syndicate and other banks.
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 December 31, 1998, the
Company had outstanding borrowings under the Revolving Facility of $21.0
million, bearing interest at an annualized rate of 7.8%. The Revolving Facility
contains certain affirmative and negative covenants relating to the Company's
operations, certain of which were amended in February 1999 in order to provide
additional flexibility to the Company as well as enabling it to be in compliance
as of December 31, 1998. These covenant modifications also resulted in a 0.5%
increase in the annualized interest rate, to approximately 8.3%.
The Company regularly evaluates its compliance with the financial
covenants included in the Revolving Credit Facility. The Company believes, based
on its current projections, that it will be in compliance with those covenants
throughout 1999, although the Company expects certain covenants to remain close
to the current limitations. There can be no assurance that the Company will be
in compliance with those covenants at March 31, 1999 or that it will not require
waivers from the syndicate of lenders led by BankBoston, N.A., regarding
compliance with those covenants as of that date, or at subsequent dates. In the
event waivers are required, but are not granted, the Company could experience
liquidity problems depending on the ability and willingness of the syndicate of
lenders to continue lending to the Company, and the availability and cost of
financing from other sources.
21
<PAGE>
In February 1998, the Company entered into a five year notional $42.5
million interest rate collar agreement with Bank Boston, 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.
Unrealized losses arising from this agreement are not required to be and have
not been recognized in the Company's results of operations - see Note 6 to the
Company's Consolidated Financial Statements.
As of December 31, 1998, the Company had (i) bank standby letters of
credit outstanding, in the aggregate amount of $10.5 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) $10.6 million of promissory notes
outstanding in connection with certain acquisitions, primarily bearing interest
at rates from 4.0% to 8.5% 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 $2.2
million; and (iv) obligations under mortgages totaling $4.2 million.
The Company's principal uses of cash are for wages and related payments
to temporary and PEO employees, operating costs, acquisitions, capital
expenditures and repayment of debt and interest thereon. For 1998, cash provided
by operations was approximately $50.8 million, compared with $12.9 million used
in 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 1998 was
approximately $31.3 million, principally expenditures of $27.8 million for
acquisitions (primarily intangible assets), compared with $24.7 million in 1997,
primarily expenditures of $21.9 million for acquisitions. Cash used in financing
activities during 1998 was approximately $15.6 million, comprised primarily of
$12.8 million in net repayments of the Revolving Facility and $4.4 million of
repayments of long term debt, offset by an increase in the Company's liability
for outstanding checks (in excess of the funded bank balances) of $2.1 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 1997 was approximately $39.3 million, including
$40.3 million net proceeds from the Offering and $23.9 million from borrowings
under the Revolving Facility, substantially offset by payments of $16.1 million
for shareholders distributions and other amounts in connection with the
Reorganization and $7.8 million of repayments of long-term debt (net of note
repayments from related parties).
Prior to 1999, the Company secured its workers' compensation
obligations by the issuance of bank standby letters of credit to its insurance
carriers, minimizing the required current cash outflow for such items. In 1999,
the Company selected a prefunded deductible program whereby expected claims
expenses are funded in advance in exchange for reductions in administrative
costs. The required advance funding will be provided through either cash flows
from operations or additional borrowings under the Revolving Credit Facility.
This new arrangement could adversely affect the Company's ability to meet
certain financial covenants. Although the Company's workers' compensation
expense for claims is effectively capped at a contractually agreed upon
percentage of payroll and cannot exceed these amounts for the respective fiscal
years, this limit was increased to 2.8% for calendar 1999, from 2.4% in 1998,
reflecting the inclusion of general and automobile liability coverage as well as
an adjustment based on the changing business mix of the Company.
One of the key elements of the Company's growth strategy in 1997 and
1998 has been expansion through acquisitions, which require significant sources
of financing; however the Company does not expect to complete further
acquisitions until its internal growth and the United States manufacturing
environment improves. The financing sources for acquisitions include cash from
operations, seller financing, bank financing and issuances of the Company's
Common Stock. The Company's previous acquisitions have been primarily in the
industrial staffing area, and when it resumes acquisition activity, 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 60 days from the
presentation date of the invoice. Beginning in the fourth quarter of 1998, the
Company experienced an increase in the percentage of its staffing accounts
receivable that are past due. As a result, the Company has taken several
actions, including among other things increasing the number of employees
focusing on accounts receivable issues and establishing employee compensation
plans based on satisfactory collections, which it believes will satisfactorily
address this issue so that there is no adverse long-term impact to the Company.
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 80% (based on revenues) of its existing customers,
with the remainder paying on average 30 to 45 days from the presentation date of
the invoice.
The Company anticipates spending up to $4.0 million during the next
twelve months to open new staffing locations, improve its management information
and operating systems, upgrade existing and acquired locations and other capital
expenditures. This amount does not include expenditures for goodwill or other
intangible assets arising from acquisitions, which the Company does not expect
to be significant in 1999.
22
<PAGE>
In order to remain in compliance with certain covenants in its
Revolving Credit Facility, and to reduce the cash impact of scheduled payments
under its subordinated acquisition debt, the Company has put into place a plan
to renegotiate the payment terms of its subordinated acquisition debt. Pursuant
to such plan, the Company has negotiated extensions of the payment dates of
certain of the subordinated notes and is in the process of negotiating the
remainder of such notes. There can be no assurance, however, that the Company
will be successful in renegotiating all remaining subordinated notes. In the
event it is not successful, and the Company elects not to pay a scheduled
payment, this could result in a default being declared by the noteholder against
the Company, which would subject the Company to lawsuits commenced by the note
holders to recover the indebtedness due.
The Company is currently completing negotiations with certain financial
institutions to borrow approximately $2.4 million, repayable over 3 years at an
interest rate of approximately 10% per annum. The loan would be secured by
property and equipment currently owned by the Company and the proceeds would be
used to reduce outstanding borrowings under the Revolving Credit Facility,
creating additional availability thereunder.
The Company believes that funds provided by operations, including sales
of accounts receivable under the Securitization Facility, plus 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 staffing acquisitions including five
offices and approximately $7.0 million in revenues for the twelve months
preceding each acquisition ("annual historical revenue"). During 1996, the
Company made five staffing acquisitions including 13 offices and approximately
$16.0 million in annual historical revenue. During 1997, the Company made eight
staffing acquisitions including 30 offices and approximately $61.0 million in
annual historical revenue. During 1998, the Company made 17 staffing
acquisitions including 40 offices and approximately $96.0 million in annual
historical revenue. These acquisitions have resulted in a significant increase
in goodwill and other intangible assets and correspondingly have resulted and
will continue to result in increased amortization expense. In addition, the
amount of these intangible assets as a percentage of the Company's total assets
and shareholders' equity has increased significantly and while the net
unamortized balance of intangible assets as of December 31, 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 was lower than that experienced
in prior years, which the Company attributes to slower economic activity in U.S.
manufacturing and distribution. 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 historically 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.
See Note 15 to the Company's Consolidated Financial Statements.
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.
23
<PAGE>
New Accounting Pronouncements
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.
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, the Company believes that it also will
result in software that properly interprets dates beyond the year 1999 ("Year
2000 Compliant").
The Company's State of Readiness:
The Company has implemented a Y2K readiness program with the objective
of having all of the Company's significant Information Systems functioning
properly with respect to Y2K before January 1, 2000. The first component of the
Company's readiness program was to identify the internal Information Systems of
the Company that are susceptible to system failures or processing errors as a
result of the Y2K issue. This effort is substantially complete. All operating
divisions have identified the Information Systems that may require remediation
or replacement and have established priorities for repair or replacement. Those
Information Systems considered most critical to continuing operations have been
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 remediation and replacement of internal
Information Systems is substantially complete, with the final testing and
certification for Y2K readiness anticipated by June 1999. This does not include
the Information Systems utilized in franchise locations, which the Company
anticipates will be Year 2000 Compliant no later than September 30, 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.
24
<PAGE>
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 June 30, 1999.
Y2K Costs:
The Company's management estimates that the total cost to the Company
of its Y2K compliance activities will not exceed $150,000, which is not
considered material to the Company's business, results of operations or
financial condition. The costs and time necessary to complete the Y2K
modification and testing processes are based on management's best estimates,
which were derived utilizing numerous assumptions of future events including the
continued availability of certain resources, third party modification plans and
other factors; however, there can be no assurance that these estimates will be
achieved and actual results could differ from the estimates.
The Company has capitalized and will continue to capitalize the costs
of purchasing and developing new Y2K compliant Information Systems, but will
expense the costs of the modifications to existing software made solely for
purposes of Y2K compliance. Most of the cost of purchasing or modifying software
in this regard had been incurred as of December 31, 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.
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-K 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
25
<PAGE>
forward looking statements. Such forward looking statements involve known and
unknown risks and are also based upon assumptions of future events, which may
not prove to be accurate. Therefore, actual results may differ materially from
any future results expressed or implied in the forward looking statements. These
known and unknown risks and uncertainties, include, but are not limited to
changes in U.S. economic conditions, particularly in the manufacturing sector;
the Company's dependence on regulatory approvals; its future cash flows, sales,
gross margins and operating costs; 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 ability
to maintain existing banking relationships; the Company's ability to raise
capital in the public equity markets; the availability of capital for additional
acquisitions and 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; volatility in the workers' compensation, liability and other
insurance markets; inclement weather; interruption, impairment or loss of data
integrity or malfunction of information processing systems; changes in
government regulations or interpretations thereof, particularly those related to
PEOs, including the possible adoption by the IRS of an unfavorable position as
to the tax-qualified status of employee benefit plans maintained by PEOs, and
other risks detailed from time to time by the Company or in its press releases
or in its filings with the Securities and Exchange Commission.
In addition, the market price of the Company's stock may from time to
time be significantly volatile as a result of, among other things, the Company's
operating results, the operating results of other temporary staffing and PEO
companies, economic conditions, the proportion of the Company's stock available
for active trading 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-K, and in other reports filed by the Company with the Securities and Exchange
Commission, including, but not limited to the Company's Registration Statement
on Form S-3 (File No. 333-69125), including the "Risk Factors" section thereof,
filed with the Securities and Exchange Commission on December 17, 1998, and
declared effective on January 6, 1999.
ITEM 7A - QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company, as a result of borrowing associated with its operating and
investing activities, is exposed to changes in interest rates that may adversely
affect its results of operations and financial position. To fund most of its
working capital needs, the Company utilizes proceeds from the sale of its
accounts receivable to a third party, who in turn uses the receivables to secure
U.S. dollar-denominated short-term commercial paper. The Company's cost for this
funding is based on the interest paid by the third party on the outstanding
commercial paper. Long-term debt is generally used to finance long-term
investments. Of the $38.3 million of long-term borrowings on the Company's
balance sheet as of December 31, 1998, approximately 45% represented fixed rate
instruments. Of the $85.2 million arrived at by adding the outstanding
commercial paper not on the Company's balance sheet as of December 31, 1998 to
the $38.3 million of borrowings on the Company's balance sheet at that date,
approximately 20% represented fixed rate instruments.
There is inherent rollover risk for borrowings as they mature and are
renewed at current market rates. The extent of this risk is not quantifiable or
predictable because of the variability of future interest rates and business
26
<PAGE>
financing requirements. In seeking to minimize the risks and/or costs associated
with its borrowing activities, the Company has entered into a derivative
financial instrument transaction to maintain the desired level of exposure to
the risk of interest rate fluctuations and to minimize interest expense - See
Note 6 to the Company's Consolidated Financial Statements for additional
information. The Company does not utilize financial instruments for trading or
other speculative purposes. The Company's financial instrument counterparty is a
high quality commercial bank with significant experience with such instruments.
The Company manages exposure to counterparty credit risk through specific
minimum credit standards. The maximum credit exposure at December 31, 1998 was
not significant to the Company.
A hypothetical 10% (about 53 basis points) adverse move in interest
rates along the entire interest rate yield curve would increase the Company's
1999 interest expense by approximately $0.5 million and decrease 1999 net income
after taxes by approximately $0.3 million, or $0.03 per diluted share. This
includes the mitigating effects, if any, of the derivative financial instrument
transaction entered into by the Company and assumes that the Company's financing
requirements in 1999 would approximate the actual outstanding debt and
commercial paper balances as of December 31, 1998.
The above discussion and the estimated amounts generated from the
analyses referred to above include forward-looking statements of market risk
which assume for analytical purposes that certain adverse market conditions may
occur. Actual future market conditions may differ materially from such
assumptions because the amounts noted previously are the result of analyses used
for the purpose of assessing possible risks and the mitigation thereof. The SEC
disclosures on market risk require that all financial instruments, as defined by
Statement of Financial Accounting Standards ("SFAS") No. 107, "Disclosures about
Fair Value of Financial Instruments", should be included in the quantitative
disclosure calculation. Operating leases are not required to be disclosed by
SFAS No.107, and have not been included as part of the above analysis. This is a
significant limitation to the analysis presented. As a result, the overall
impact to the Company's operating results from a hypothetical change in interest
rates may be overstated. There are certain other shortcomings inherent to the
analyses presented. The model assumes interest rate changes are instantaneous
parallel shifts in the yield curve. In reality, changes are rarely
instantaneous. Although certain liabilities may have similar maturities or
periods to repricing, they may not react correspondingly to changes in market
interest rates. The effect of the hypothetical change in interest rates ignores
the effect this movement may have on other variables including changes in actual
sales volumes that could be indirectly attributed to changes in interest rates.
The actions that management would take in response to such a change are also
ignored. Accordingly, the forward-looking statements should not be considered
projections by the Company of future events or losses and are subject to the
factors discussed under the caption "Forward -Looking Statements: Certain
Cautionary Statements" of Item 7 "Management's Discussion and Analysis of
Financial Condition and Results of Operations".
27
<PAGE>
ITEM 8 - FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
OUTSOURCE INTERNATIONAL, INC. AND SUBSIDIARIES
INDEX TO FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
Page
----
<S> <C>
Independent Auditors' Report........................................................................ 29
Consolidated Balance Sheets as of December 31, 1998 and 1997........................................ 30
Consolidated Statements of Income for the years ended December 31, 1998, 1997 and 1996.............. 31
Consolidated Statements of Shareholders' Equity for the
years ended December 31, 1998, 1997, and 1996................................................... 32
Consolidated Statements of Cash Flows for the years ended December 31, 1998, 1997 and 1996.......... 33
Notes to Consolidated Financial Statements.......................................................... 34
</TABLE>
28
<PAGE>
INDEPENDENT AUDITORS' REPORT
OutSource International, Inc. And Subsidiaries:
We have audited the consolidated balance sheets of OutSource
International, Inc. and Subsidiaries (the "Company") as of December 31, 1998 and
1997, and the related consolidated statements of income, shareholders' equity,
and cash flows for each of the three years in the period ended December 31,
1998. Our audits also included the financial statement schedule listed in the
index at Item 14 (a)2. These financial statements and financial statement
schedule are the responsibility of the Company's management. Our responsibility
is to express an opinion on these financial statements and financial statement
schedule based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, such consolidated financial statements present fairly,
in all material respects, the financial position of OutSource International,
Inc. and Subsidiaries as of December 31, 1998 and 1997 and the results of their
operations and their cash flows for each of the three years in the period ended
December 31, 1998 in conformity with generally accepted accounting principles.
Also, in our opinion, such financial statement schedule, when considered in
relation to the basic consolidated financial statements taken as a whole,
presents fairly in all material respects the information set forth therein.
/s/ Deloitte & Touche LLP
DELOITTE & TOUCHE LLP
Certified Public Accountants
Fort Lauderdale, Florida
February 22, 1999
29
<PAGE>
OUTSOURCE INTERNATIONAL, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
December 31,
------------------------------------
1998 1997
---- ----
ASSETS (Dollars in thousands)
<S> <C> <C>
CURRENT ASSETS:
Cash.................................................................... $ 5,501 $1,685
Trade accounts receivable, net of allowance for doubtful accounts of
$1,924 and $1,640 ................................................. 12,946 47,298
Funding advances to franchises.......................................... 441 2,186
Deferred income taxes and other current assets.......................... 7,795 5,910
---------- -----------
Total current assets............................................... 26,683 57,079
PROPERTY AND EQUIPMENT, net............................................. 17,628 14,953
GOODWILL AND OTHER INTANGIBLE ASSETS, net............................... 64,262 30,427
OTHER ASSETS............................................................ 3,429 3,284
---------- -----------
Total assets............................................................ $112,002 $ 105,743
========== ===========
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable........................................................ $ 5,217 $ 3,555
Accrued expenses:
Payroll............................................................. 4,322 3,325
Payroll taxes....................................................... 4,067 2,182
Workers' compensation and insurance................................. 10,659 9,086
Other............................................................... 2,482 1,864
Other current liabilities............................................... 1,312 908
Current maturities of long-term debt to related parties................. 541 100
Current maturities of other long-term debt.............................. 6,782 2,408
---------- -----------
Total current liabilities........................................... 35,382 23,428
NON-CURRENT LIABILITIES:
Revolving credit facility............................................... 20,980 33,800
Long-term debt to related parties, less current maturities.............. 745 --
Other long-term debt, less current maturities........................... 9,257 7,737
Other non-current liabilities........................................... 1,050 --
---------- -----------
Total liabilities................................................... 67,414 64,965
---------- -----------
COMMITMENTS AND CONTINGENCIES (NOTES 1, 2, 4, 6, 8, 9, 10 and 11)
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 December 31, 1998 and 1997.. 9 8
Additional paid-in capital ............................................. 53,546 53,201
Retained earnings (deficit)............................................. (8,967) (12,431)
---------- -----------
Total shareholders' equity.......................................... 44,588 40,778
---------- -----------
Total liabilities and shareholders' equity.......................... $ 112,002 $105,743
========== ===========
</TABLE>
See notes to consolidated financial statements.
30
<PAGE>
OUTSOURCE INTERNATIONAL, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
<TABLE>
<CAPTION>
Years Ended December 31,
------------------------------------------------
1998 1997 1996
---- ---- ----
(Dollars in thousands, except per share data)
<S> <C> <C> <C>
Net revenues.................................................... $ 565,394 $ 447,579 $ 280,171
Cost of revenues .............................................. 480,574 381,273 242,102
----------- ------------ ------------
Gross profit ................................................... 84,820 66,306 38,069
----------- ------------ ------------
Selling, general and administrative expenses:
Shareholders' compensation................................. -- 292 2,321
Amortization of intangible assets.......................... 3,684 1,853 424
Other selling, general and administrative.................. 69,168 53,752 29,841
----------- ------------ ------------
Total selling, general and
administrative expenses................................ 72,852 55,897 32,586
----------- ------------ ------------
Operating income .............................................. 11,968 10,409 5,483
----------- ------------ ------------
Other expense:
Interest expense (net)...................................... 5,529 7,877 2,175
Put warrants valuation adjustment........................... -- 1,842 --
Other expense (income)...................................... (53) (21) --
Other charges............................................... -- -- 1,448
----------- ------------ ------------
Total other expense ............................... 5,476 9,698 3,623
----------- ------------ ------------
Income before provision (benefit) for
income taxes and extraordinary item......................... 6,492 711 1,860
Provision (benefit) for income taxes............................ 1,611 (69) --
----------- ------------ ------------
Income before extraordinary item ............................... 4,881 780 1,860
Extraordinary item - 1998 - income tax valuation
adjustment (Note 4); 1997 - loss on early retirement
of debt, net of income tax benefit (Note 5)................. (1,417) (13,384) --
----------- ------------ ------------
Net income (loss) .............................................. $ 3,464 $ (12,604) $ 1,860
=========== ============ ============
Unaudited pro forma data:
Income before provision (benefit) for
income taxes and extraordinary item......................... $ 6,492 $ 711 $ 1,860
Provision for income taxes ..................................... 1,611 296 757
----------- ------------ ------------
Income before extraordinary item ............................... 4,881 415 1,103
Extraordinary item, net of income tax benefit................... (1,417) (13,384) --
----------- ------------ ------------
Net income (loss)............................................... $ 3,464 $ (12,969) $ 1,103
=========== ============ ============
Weighted average common shares outstanding:
Basic....................................................... 8,603,521 6,055,439 5,785,218
=========== ============ ============
Diluted..................................................... 9,919,492 7,320,362 5,843,618
=========== ============ ============
Earnings (loss) per share:
Basic
Income before extraordinary item........................ $ 0.57 $ 0.07 $ 0.19
Extraordinary item, net of
income tax benefit.................................... (0.17) (2.21) --
----------- ------------ ------------
Net income (loss)....................................... $ 0.40 $ (2.14) $ 0.19
=========== ============ ============
Diluted
Income before extraordinary item........................ $ 0.49 $ 0.06 $ 0.19
Extraordinary item, net of
income tax benefit.................................... (0.14) (1.83) --
----------- ------------ ------------
Net income (loss)....................................... $ 0.35 $ (1.77) $ 0.19
=========== ============ ============
</TABLE>
See notes to consolidated financial statements.
31
<PAGE>
OUTSOURCE INTERNATIONAL, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
<TABLE>
<CAPTION>
Additional Retained
Common Paid-In Earnings
Stock Capital (Deficit) Total
----- ------- --------- -----
(Dollars in thousands)
<S> <C> <C> <C> <C>
Balance, December 31, 1995....................... $ 5 $ 95 $ 3,501 $ 3,601
Distributions to shareholders.................... -- -- (967) (967)
Net income....................................... -- -- 1,860 1,860
---------- --------- ---------- ----------
Balance, December 31, 1996....................... 5 95 4,394 4,494
Net loss for the period from January 1, 1997
through February 21, 1997.................... -- -- (172) (172)
Distributions and other payments in
connection with the Reorganization........... -- (11,880) (4,222) (16,102)
Contribution of notes payable by shareholders.... -- 4,300 -- 4,300
Net loss for the period from February 22, 1997
through December 31, 1997.................... -- -- (12,431) (12,431)
Termination of Put Warrants Liability............ -- 20,384 -- 20,384
Sale of common stock............................. 3 40,302 -- 40,305
---------- --------- ---------- ----------
Balance, December 31, 1997 ...................... 8 53,201 (12,431) 40,778
Issuance of common stock......................... -- 775 -- 775
Exercise of warrants............................. 1 2 -- 3
Distributions and other payments in
connection with the Reorganization.......... -- (432) -- (432)
Net income............................................. -- -- 3,464 3,464
---------- --------- ---------- ----------
Balance, December 31, 1998 ...................... $ 9 $ 53,546 $ (8,967) $ 44,588
========== ========= ========== ==========
</TABLE>
See notes to consolidated financial statements.
32
<PAGE>
OUTSOURCE INTERNATIONAL, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
Years Ended December 31,
----------------------------------------------------
1998 1997 1996
---- ---- ----
(Dollars in thousands)
<S> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss).............................................. $ 3,464 $ (12,604) $ 1,860
Adjustments to reconcile net income (loss) to net cash
provided by (used in) operating activities:
Depreciation and amortization............................... 6,756 4,179 1,592
Amortization of debt discount and issuance costs............ -- 938 --
Put warrants valuation adjustment........................... -- 1,842 --
Loss on early retirement of debt............................ -- 20,031 --
Deferred income tax provision (benefit)..................... 1,106 (6,716) --
(Gain) loss on disposal of property
and equipment.......................................... 61 (19) 23
Changes in assets and liabilities (excluding effects of
acquisition):
(Increase) decrease in:
Trade accounts receivable.......................... 36,744 (20,948) (11,353)
Prepaid expenses and other current assets.......... (326) (379) 94
Other assets....................................... (419) (1,405) (112)
Increase (decrease) in:
Accounts payable................................... (443) (519) 315
Accrued expenses:
Payroll........................................ 749 (888) 2,235
Payroll taxes.................................. 1,685 2 (1,225)
Workers' compensation and insurance............ 1,494 3,622 3,608
Other.......................................... 287 463 778
Other current liabilities.......................... (397) (509) 905
---------- ---------- ----------
Net cash provided by (used in) operating
activities................................. 50,761 (12,910) (1,280)
---------- ---------- ----------
CASH FLOWS FROM INVESTING ACTIVITIES:
Funding (advances) repayments (to) from franchises, net........ 1,745 1,046 (805)
Property and equipment expenditures............................ (5,296) (4,105) (2,129)
Expenditures for acquisitions.................................. (27,769) (21,948) (1,950)
Proceeds from disposal of property and equipment............... 4 263 50
---------- ---------- ----------
Net cash used in investing activities................. (31,316) (24,744) (4,834)
---------- ---------- ----------
CASH FLOWS FROM FINANCING ACTIVITIES:
Increase (decrease) in excess of outstanding checks over
bank balance, included in accounts payable................. 2,066 1,398 278
Net proceeds from (repayment of) line of credit and
revolving credit facility.................................. (12,820) 23,912 3,620
Related party borrowings (repayments).......................... (483) (1,988) 577
Proceeds of senior notes and put warrants, net of
issuance costs............................................. -- 22,615 --
Repayment of senior notes...................................... -- (25,000) --
Proceeds of other long-term debt............................... -- -- 1,500
Repayment of other long-term debt.............................. (3,963) (5,845) (1,328)
Proceeds from sale of common stock, net of offering costs...... 3 40,305 --
Distributions and other payments in connection with the
Reorganization............................................. (432) (16,102) --
---------- ---------- ----------
Net cash provided by (used in) financing activities... (15,629) 39,295 4,647
---------- ---------- ----------
Net increase (decrease) in cash................................ 3,816 1,641 (1,467)
Cash, beginning of period...................................... 1,685 44 1,511
---------- ---------- ----------
Cash, end of period............................................ $ 5,501 $ 1,685 $ 44
========== ========== ==========
SUPPLEMENTAL CASH FLOW INFORMATION:
Interest paid.................................................. $ 4,960 $ 7,091 $ 1,842
========== ========== ==========
</TABLE>
See notes to consolidated financial statements.
33
<PAGE>
OUTSOURCE INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1. NATURE OF BUSINESS AND SIGNIFICANT ACCOUNTING POLICIES
Nature of business: OutSource International, Inc. and Subsidiaries (the
"Company") is a national provider of human resource services focusing on the
flexible industrial staffing ("staffing") market through its Tandem division and
on the professional employer organization ("PEO") market through its Synadyne
division. The Company also operates a small office clerical staffing business
through its Office Ours division. The Company provides its industrial staffing
services through locations owned or leased by the Company (collectively
identified as "Company-owned") and franchise locations and its PEO and clerical
staffing services through Company-owned locations.
Industrial staffing services include recruiting, training and workforce
re-deployment, as well as certain PEO services. PEO services include payroll
administration, workers' compensation insurance, health, life and disability
insurance, retirement plans, and human resource compliance, administration and
management.
Public Offering: The Company sold 3 million shares of its common stock
to the public (the "Offering") at $15.00 per share on October 24, 1997, and
received proceeds of $40.3 million, net of offering costs and expenses of $4.7
million.
Reorganization: On February 21, 1997, a Reorganization was consummated
in which nine companies under common ownership and management became wholly
owned subsidiaries of OutSource International, Inc. (the "Reorganization").
OutSource International, Inc. was incorporated in April 1996 for the purpose of
becoming the parent holding company, but was inactive with no assets,
liabilities or operations prior to the Reorganization.
The nine companies which became subsidiaries of OutSource
International, Inc. are OutSource International of America, Inc., OutSource
Franchising, Inc., Synadyne I, Inc., Synadyne II, Inc., Synadyne III, Inc.,
Synadyne IV, Inc., Synadyne V, Inc., Employees Insurance Services, Inc. and
Capital Staffing Fund, Inc. (the "Initial Subsidiaries"). Except for Capital
Staffing Fund, Inc., the outstanding common stock of each of the Initial
Subsidiaries was owned prior to the Reorganization by the same shareholders with
identical ownership percentages. The shareholders and their ownership
percentages were: (a) a control group consisting of two brothers, who were
founders, their immediate families and four family trusts (the "S
Group")--58.2%; (b) a control group consisting of an individual, who was a
founder, his immediate family and two family trusts (the "M Group")--29.1%; (c)
the chief executive officer of the Initial Subsidiaries (the "CEO")--9.7%; and
(d) the executive vice president of the Initial Subsidiaries and a family trust
(the "EVP")--3.0%. The shareholders and their ownership percentages of Capital
Staffing Fund, Inc. prior to the Reorganization were: S Group--48.5%; M
Group--24.25 %; CEO--24.25% and EVP--3.0%.
In 1974, the three founders began the industrial staffing services
business which became the operations of the Initial Subsidiaries, and these
operations expanded to also include franchising of staffing services, PEO
services, and funding services to certain franchises. The operations of the
Initial Subsidiaries historically have been integrated to provide a single
source of human resource services for customers under the direction of a single
executive management group and with a centralized administrative and business
support center.
34
<PAGE>
OUTSOURCE INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1. NATURE OF BUSINESS AND SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
The Reorganization consisted of (a) the distribution by the Initial
Subsidiaries, which were S corporations, of previously undistributed accumulated
taxable earnings to all shareholders, in proportion to their ownership
interests, a portion of which was used to repay $4.3 million in notes receivable
of OutSource Franchising, Inc. from its shareholders, in proportion to their
ownership interests; (b) the contribution to paid-in capital of Synadyne II,
Inc. and Synadyne III, Inc. of $4.3 million in notes payable by such Initial
Subsidiaries to their shareholders, in proportion to their ownership interests;
and (c) the exchange by all of the shareholders of all of their shares of common
stock in the Initial Subsidiaries for shares of common stock in OutSource
International, Inc., except that the founders in the S Group and M Group
received cash and notes for a portion of their common stock, aggregating 5.8% of
the total ownership interests in the Initial Subsidiaries (the equivalent of
336,430 shares of common stock of OutSource International, Inc.). The following
is a summary of the cash paid, notes issued (which were paid in full at the time
of the Offering), cash paid and immediately returned to the Company by the
Shareholders for repayment of OutSource Franchising, Inc. notes receivable,
contribution to additional paid-in capital, and common stock of OutSource
International, Inc. issued in the Reorganization (all dollars in thousands):
<TABLE>
<CAPTION>
Cash Paid Notes (Paid Total Issuance of
(Returned to Repay at time of Shareholder Common Stock
Cash Notes Receivable) the Offering) Distributions Shares Percentage
---- ----------------- ------------- ------------- ------ ----------
<S> <C> <C> <C> <C> <C> <C>
S Group............ $ 5,841 $ 2,502 $ 1,420 $ 9,763 3,131,667 57.5%
M Group............ 3,850 1,251 -- 5,101 1,552,315 28.5%
CEO................ 226 417 325 968 591,249 10.8%
EVP................ 140 130 -- 270 173,557 3.2%
--------- ---------- ---------- --------- --------- -------
$ 10,057 $ 4,300 $ 1,745 16,102 5,448,788 100.0%
========= ========== ========== ========= ========= =======
Less contribution to additional paid-in capital of notes
payable to Synadyne II, Inc. and Synadyne III, Inc................ (4,300)
---------
Net charge to shareholders' equity................................ $ 11,802
=========
</TABLE>
All shareholders of the Initial Subsidiaries owned virtually the same
proportion of the common stock of OutSource International, Inc. after the
Reorganization as they owned of the Initial Subsidiaries prior to the
Reorganization. Additionally, all of the Subsidiaries were historically an
integrated operation under the direction of a single executive management group
and with a centralized administrative and business support center, which
continued after the Reorganization. Accordingly, the Reorganization was
accounted for as a combination of companies at historical cost. The effects of
the Reorganization on common stock have been reflected retroactively in the
financial statements of prior years.
Subsequent to the Reorganization, all compensation for the three
founders (principal shareholders) was discontinued, and the Initial Subsidiaries
terminated their elections to be treated as S corporations. The distribution by
the Initial Subsidiaries to all shareholders at the time of the Reorganization
is 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 $432,000 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.
Restructuring: On December 31, 1998, an internal restructuring was
consummated wherein two new operating subsidiaries were formed (Guardian
Employer East, LLC and Guardian Employer West, LLC) and the ownership of most of
the Subsidiaries (consisting of the Initial Subsidiaries, the two new entities,
and an additional seven subsidiaries incorporated or acquired subsequent to the
Reorganization - Staff All, Inc., Mass Staff, Inc., OutSource of Nevada, Inc.,
Employment Consultants, Inc., X-Tra Help, Inc., Co-Staff, Inc. and OutSource
Funding Corporation) were transferred from OutSource International, Inc. to
various of the Subsidiaries. OutSource International, Inc. retained 100% direct
or indirect ownership of all Subsidiaries after this restructuring, which was
done in order to better align the legal entities on a geographic basis. This
restructuring had no effect on the consolidated financial position or results of
operations of the Company.
35
<PAGE>
OUTSOURCE INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1. NATURE OF BUSINESS AND SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
A summary of the Company's significant accounting policies follows:
Basis of presentation: The accompanying consolidated financial
statements present the financial position, results of operations and cash flows
of OutSource International, Inc. and the Subsidiaries, as well as SMSB
Associates ("SMSB"), a Florida limited partnership comprised of the Company's
three principal shareholders and the CEO. SMSB, a special purpose entity which
leases certain properties to the Company, is consolidated in these financial
statements from January 1, 1995 to September 30, 1997, based on the criteria for
a non-substantive lessor in Emerging Issues Task Force No. 90-15, due to the
control exercised by the Company over the assets of SMSB during that period.
Effective October 1, 1997 the Company discontinued the consolidation of SMSB's
assets and liabilities in these financial statements, based on the Company's
determination that SMSB was no longer a non-substantive lessor as defined by
EITF No. 90-15. All significant intercompany balances and transactions are
eliminated in consolidation.
The Company's reportable operating segments are the Industrial Staffing
segment, the PEO segment and the Franchising segment - see Notes 6 and 14. The
accounting policies of the operating segments are the same as those described in
the summary of significant accounting policies except that the disaggregated
financial results have been prepared using a management approach, which is
consistent with the basis and manner in which the Company internally
disaggregates financial information for the purposes of assisting in making
internal operating decisions.
Pervasiveness of estimates: The preparation of financial statements in
conformity with generally accepted accounting principles requires management to
make estimates and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at the date of
the financial statements and the reported amounts of revenues and expenses
during the reporting period. Actual results could differ from those estimates.
Revenue recognition: All staffing and PEO revenues are based upon the
gross payroll of the Company's staffing and PEO employees plus a corresponding
fee. The Company's fee structure is based upon the estimated costs of employment
related taxes, health benefits, workers' compensation benefits, insurance and
other services offered by the Company plus a negotiated mark-up. All staffing
and PEO customers are invoiced on a periodic basis ranging from weekly to
monthly. The 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.
Initial franchise fees are generally recognized when substantially all
services or conditions relating to the franchise sale have been performed or
satisfied by the Company. Costs relating to such fees are charged to selling,
general and administrative expenses when incurred. When the fees are collected
over an extended period of time and no reasonable basis for estimating
collections exists, the fees are recognized as income when received through the
use of the installment method. Royalties, which are based on gross sales and
gross profit of the related franchisees, are recognized as revenue when earned
and become receivable from the franchisees.
Funding advances: The Company makes advances on behalf of certain of
its franchises to fund the payroll and other related costs for industrial
personnel provided by those franchises to their clients. The advances are
secured by the franchises' accounts receivable from these clients. The Company
invoices the clients and receives payment directly from the clients as part of
this arrangement. These payments are applied to reimburse outstanding advances,
and to pay franchise royalties and the fee charged for these funding and billing
services, with any remaining amounts remitted to the franchise. The funding fee
is charged and recognized as revenue by the Company as the weekly invoices are
produced.
36
<PAGE>
OUTSOURCE INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1. NATURE OF BUSINESS AND SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
Property and equipment: Property and equipment is stated at cost and
depreciated or amortized on straight-line bases over the estimated useful
service lives of the respective assets. Leasehold improvements are stated at
cost and amortized over the shorter of the term of the lease or estimated useful
life of the improvement. Amortization of property under capital leases,
leasehold improvements and computer software is included in depreciation
expense. The estimated useful life of buildings is 39 years, while the estimated
useful lives of other items range from five to seven years.
Long-lived assets: In accordance with Statement of Financial Accounting
Standards ("SFAS") No. 121, "Accounting for the Impairment of Long-Lived Assets
and for Long-Lived Assets to be Disposed Of", impairments, measured using fair
value, are recognized whenever events or changes in circumstances indicate that
the carrying amount of long-lived assets may not be recoverable and the
projected future undiscounted cash flows attributed to the assets are less than
their carrying values.
Intangible assets: Identifiable intangible assets include territory
rights, customer lists, employee lists and covenants not to compete acquired in
connection with acquisitions. Such assets are recorded at fair value on the date
of acquisition as determined by management with assistance by an independent
valuation consultant and are being amortized over the estimated periods to be
benefited, ranging from less than one year to 15 years, except territory rights
which are being amortized over periods ranging from 15 to 40 years.
Goodwill relates to the excess of cost over the fair value of net
assets of the businesses acquired. Amortization is calculated on a straight-line
basis over periods ranging from 15 to 40 years. The overall business strategy of
the Company includes the acquisition and integration of independent and
franchise staffing and PEO operations. The Company believes that this strategy
creates synergies, achieves operating efficiencies and allows the Company to be
more competitive in its pricing, all of which will provide benefits for the
foreseeable future.
Management assesses on an ongoing basis if there has been an impairment
in the carrying value of its intangible assets. If the undiscounted future cash
flows over the remaining amortization period of the respective intangible asset
indicates that the value assigned to the intangible asset may not be
recoverable, the carrying value of the respective intangible asset will be
reduced. The amount of any such impairment would be determined by comparing
anticipated discounted future cash flows from acquired businesses with the
carrying value of the related assets. In performing this analysis, management
considers such factors as current results, trends and future prospects, in
addition to other relevant factors.
Disclosures about fair value of financial instruments: The following
methods and assumptions were used to estimate the fair value of each class of
financial instruments for which it is practicable to estimate that value.
Cash, receivables, funding advances to franchises, accounts payable,
accrued expenses except workers' compensation and insurance, other current
liabilities and other amounts due from and to related parties: The carrying
amounts approximate fair value because of the short maturity of those
instruments. Although the accrued workers' compensation and insurance liability
is anticipated to be paid over a number of years, due to the lack of a defined
payment schedule and the estimates inherent in establishing the recorded
liability amount, management believes that it is not practical to estimate the
fair value of this financial instrument.
Revolving credit facility and long-term debt: The carrying amounts
approximate the fair value at December 31, 1997 and 1998, because the interest
rates on these instruments approximate interest rates currently available for
similar borrowings. The carrying amount of the unrealized hedge loss (included
in Other Non-Current Liabilities) is based on its fair value based primarily on
information from BankBoston - see Note 6.
Income taxes: Effective February 21, 1997, the Initial Subsidiaries
terminated their elections to be treated as S corporations under applicable
provisions of the Internal Revenue Code. Prior to the date such election was
terminated, items of income, loss, credits, and deductions were not taxed within
the Company but were reported on the income tax returns of the Initial
Subsidiaries' shareholders. Accordingly, no provision for income taxes was
recorded.
37
<PAGE>
OUTSOURCE INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1. NATURE OF BUSINESS AND SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
Since the Reorganization on February 21, 1997, the Company provides for
income taxes in accordance with SFAS No. 109, "Accounting for Income Taxes",
which requires an asset and liability approach to financial accounting and
reporting for income taxes. Deferred income tax assets and liabilities are
computed annually for (a) the differences between financial statement and tax
bases of assets and liabilities that will result in taxable or deductible
amounts in the future based on enacted tax laws and rates applicable to the
periods in which the differences are expected to affect taxable income and (b)
net operating loss and tax credit carryforwards. Valuation allowances are
established when necessary to reduce deferred tax assets to the amount expected
to be realized. Income tax expense equals the taxes payable or refundable for
the period plus or minus the change in the period of deferred tax assets and
liabilities.
Workers' compensation: Effective January 1, 1997 through December 31,
1998, the Company's workers' compensation insurance coverage provided for a
$250,000 deductible per accident or industrial illness with an aggregate maximum
dollar limit based on 2.2% and 2.4% of covered payroll for 1997 and 1998,
respectively. The Company's policy is to accrue worker's compensation expense
equal to those maximum dollar limits, using internally generated rates that
reflect the specific risk profile of each Company segment in order to allocate
the maximum dollar limit between segments. For claims related to periods prior
to 1997, there was no aggregate maximum dollar limit on the Company's liability
for deductible payments and therefore the Company employs an independent
third-party administrator to assist it in establishing an appropriate accrual
for the uninsured portion of workers' compensation claims arising in those
years, including claims incurred but not reported, based on prior experience and
other relevant data. From May 1, 1995 through December 31, 1996, in exchange for
a lower excess insurance premium rate, the Company accepted the responsibility
for certain losses exceeding the $250,000 policy deductible per accident or
industrial illness on a dollar-for-dollar basis, but only to the extent such
losses cumulatively exceed 85% of the excess insurance premiums (excluding the
profit and administration component) and subject to a maximum additional premium
(approximately $0.8 million in 1995 and $1.2 million in 1996).
For claims arising through December 31, 1998, the Company is only
required to pay such claims as they actually arise, which may be over a period
extending up to 5 years after the related incident occurred. In 1999, the
Company selected a prefunded deductible program whereby expected 1999 claims
expenses are funded in advance in exchange for reductions in administrative
costs. The required advance funding will be provided through either cash flows
from operations or additional borrowings under the Revolving Credit Facility.
This new arrangement could adversely affect the Company's ability to meet
certain financial covenants. See Note 6.
Amortization of debt discount and issuance costs: The Company records
debt discount as a contra-liability and debt issuance costs as a non-current
asset. Both are amortized to interest expense using the interest method.
Stock based compensation: The Company uses the accounting methods
prescribed by APB Opinion No. 25, "Accounting for Stock Issued to Employees",
and provides the pro forma disclosures required by SFAS No. 123, "Accounting for
Stock-based Compensation". See Note 10.
Advertising: The Company expenses advertising and promotional
expenditures as incurred. Total advertising and promotional expenses were
approximately $1.5 million, $1.8 million, and $0.7 million for the years ended
December 31, 1998, 1997, and 1996, respectively.
New accounting pronouncements: In June 1997, SFAS No. 130, "Reporting
Comprehensive Income", was issued. SFAS No. 130 establishes standards for
reporting and display of comprehensive income and its components (revenues,
expenses, gains, and losses) in a full set of general-purpose financial
statements. SFAS No. 130 requires that all items that are required to be
recognized under accounting standards as components of comprehensive income be
reported in a financial statement that is displayed with the same prominence as
other financial statements. 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 and those changes required by generally
accepted accounting principles to be recognized in paid-in capital or other
similar nonincome equity accounts. SFAS No. 130 does not apply to the Company
since the Company has no items of other comprehensive income in any of the
periods presented.
38
<PAGE>
OUTSOURCE INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1. NATURE OF BUSINESS AND SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
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.
Reclassifications: Certain reclassifications have been made in amounts
for prior periods to conform to current period presentation.
NOTE 2. ACQUISITIONS
Goodwill and other intangible assets consist of the following:
<TABLE>
<CAPTION>
As of December 31, Weighted Average
1998 1997 Amortization Periods
---- ---- --------------------
(Dollars in thousands)
<S> <C> <C> <C>
Goodwill............................. $ 32,806 $ 12,374 29.8 years
Territory rights..................... 24,743 14,296 33.1 years
Customer lists....................... 10,105 4,672 6.7 years
Covenants not to compete............. 2,191 1,205 7.6 years
Employee lists....................... 417 197 .1 year
----------- -----------
Goodwill and other intangible
assets............................ 70,262 32,744 26.8 years
Less accumulated amortization........ 6,000 2,317
----------- -----------
Goodwill and other intangible
assets, net....................... $ 64,262 $ 30,427
=========== ===========
</TABLE>
The costs of each acquisition have been allocated to the assets
acquired and liabilities assumed based on their fair values at 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 the consolidated financial
statements.
In January 1995, the Company purchased the franchise rights for two
staffing locations from All Temps, Inc. and converted these locations to
Company-owned locations. At the time of the transaction, three of the four
shareholders of the franchise were shareholders with a cumulative controlling
interest in the Company. Therefore, the acquisition was accounted for as a
business combination of entities under common control and the purchase of the
remaining minority interest in the franchise. No material tangible assets were
acquired. During 1995 and 1996, $0.3 million and $1.1 million, respectively, of
the purchase price was accrued, with $0.2 million and $1.0 million payable to
shareholders of the Company in 1995 and 1996, respectively, recorded as a
distribution and the remainder as goodwill. The Company agreed that the
remaining
39
<PAGE>
OUTSOURCE INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 2. ACQUISITIONS (CONTINUED)
payments to the minority interest would be no less than $40,000 per year from
1997 through 1999 and no less than $150,000 on a cumulative basis for that three
year period. In December 1997, the Company paid $141,000 to the minority
interest, which is expected to be the final amount due under the renegotiated
terms although the Company is still subject to making further payments based on
gross profits through 1999.
In June 1995, the Company purchased the franchise rights for one
flexible staffing location from WAD, Inc. and converted this location to a
Company-owned location. At the time of the transaction, both shareholders of the
franchise were shareholders and officers of the Company but did not hold a
controlling interest. The total purchase price recorded as of December 31, 1998
was $1.0 million.
During 1995, the Company purchased the franchise rights for two
flexible staffing locations from Komco Inc. and Demark, Inc. and converted them
to Company-owned locations. The total purchase price recorded as of December 31,
1998 was $0.3 million.
In April 1996, the Company purchased the franchise rights for eight
flexible staffing locations from Payray, Inc. and Tri-Temps, Inc. and converted
these locations to Company-owned locations. Some shareholders of the franchises
are shareholders of the Company but do not hold a controlling interest in the
Company. The terms of the purchase, as set forth in an asset purchase agreement,
required the Company to pay $4.9 million with $0.8 million due at closing and a
note for the remainder to be paid in 60 monthly installments plus 10.0% per
annum interest through July 1, 1996 and 14.0% per annum interest thereafter. On
February 21, 1997, these payment terms were renegotiated. The renegotiated terms
called for a payment of $1.3 million against the outstanding balance and a note
for the remainder of $2.6 million to be paid in 48 equal monthly installments
including interest of 14.0% per annum, commencing April 1, 1997, but fully
payable at the time of an initial public offering. The remaining outstanding
balance was accordingly paid at the time of the Offering, except for $0.1
million repaid in March 1998.
In May 1996, the Company purchased certain assets and the business of
CST Services Inc., a flexible staffing operation not previously affiliated with
the Company. The total purchase price recorded as of December 31, 1998 was $1.8
million.
During 1996, the Company purchased the franchise rights for four
flexible staffing locations from Temp Aid, Inc., LL Corps, Inc. and Kesi, Inc.
and converted them to Company-owned locations. The total purchase price recorded
as of December 31, 1998 was $0.3 million.
Primarily during the first three months of 1997, the Company purchased
the franchise rights for 13 flexible staffing locations from LaPorte, Inc.,
Superior Temporaries, Inc. and Labor World of Minneapolis, Inc., and converted
these locations to Company-owned locations. The total purchase price was $11.1
million (of which $9.0 million related to Superior Temporaries, Inc.) in cash
and notes.
During the first three months of 1997, the Company purchased flexible
staffing operations with 17 locations from Apex, Inc., Standby Personnel of
Colorado Springs, Inc., Staff Net, Inc., Staff Management, Inc. and Stand-By,
Inc. (none previously affiliated with the Company). The total initial purchase
price was $14.2 million in cash and notes, plus certain sellers received options
to purchase a total of 8,126 shares of the Company's common stock at their fair
market value at the date of issuance. Such options were issued March 12, 1997
and were still outstanding at December 31, 1998 - See Note 10. During 1997 and
1998, the initial contractual purchase prices of Standby Personnel of Colorado
Springs, Inc. and Stand-By, Inc. was decreased by a total of $0.6 million, based
on the gross profit from the acquired locations for the two years following the
acquisition.
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 $5.5 million in cash and notes. 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
$4.8 million in cash and notes. 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
$0.8 million note, payable over five years plus interest at 8.0% per annum.
40
<PAGE>
OUTSOURCE INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
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 $2.5 million for the excess of net tangible assets over liabilities
assumed) was $11.7 million, paid in cash, notes and $0.8 million in the
Company's common stock (57,809 shares) delivered at closing. 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 December 31, 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 $6.9 million, with $5.0 million paid in cash at
closing plus the issuance of a note for $1.7 million bearing interest at 7.25%
per annum (imputed at 8.75% for financial statement purposes) and payable
quarterly over three years. The remaining $0.2 million of purchase price
represents the Company's assumption of approximately $0.1 million of the
seller's liabilities under certain employment contracts and the Company's
agreement to reduce by approximately $0.1 million the sellers' obligation to
the Company in connection with the termination of their remaining franchise
agreements with the Company (See Note 11). See Note 6 regarding options for
certain franchise territories also granted in connection with this transaction.
Effective February 1, 1999, the note was renegotiated so that the remaining
principal balance of $1.3 million would bear interest at 8.50% per annum and
would be payable in monthly payments totaling $0.3 million in the first year
and $0.6 million in the second year, plus a $0.4 million payment at the end of
the two year term.
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 $1.6 million in cash and
notes.
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 $9.2 million, with
$7.1 million paid in cash at closing (which included $0.9 million placed in
escrow) plus notes issued for $2.1 million. 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
(i) 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 and (ii) an additional payment up to $0.2 million
contingent primarily upon the gross profit of one of the acquired locations for
the twelve months following the acquisition.
During the third and fourth quarters of 1998, the Company (i) purchased
the franchise rights for three flexible staffing locations from ALPAP, Inc. and
Sterling Temporaries, Inc. and converted these locations to Company-owned
locations and (ii) purchased certain PEO operations from Hamilton-Ryker Co.,
Inc., which were immediately transferred to existing Company locations. The
total purchase price was $1.2 million in cash and the Company's assumption of
liabilities. Approximately $0.1 million of this purchase price is contingent
upon the gross profit of certain of the acquired locations for the three years
following the acquisition, and this amount may increase to $0.5 million. The
Company is obligated for additional payments to another of the sellers of up to
$125,000 based on the gross profit of the location acquired from such seller for
the twelve months ended December 31, 1998 and the workers' compensation premium
with relation to that location for the six months ended December 31, 1998.
41
<PAGE>
OUTSOURCE INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 2. ACQUISITIONS (CONTINUED)
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 following unaudited pro forma results of operations have been
prepared assuming the acquisitions described above 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 an
attempt to obtain the most complete and reliable financial information and
believes that the financial information it used is materially accurate, although
the Company has not independently verified such information.
<TABLE>
<CAPTION>
Years Ended December 31,
------------------------
1998 1997
---- ----
(Dollars in thousands)
<S> <C> <C>
Unaudited Pro Forma:
Net revenues.......................................................... $584,991 $551,301
Operating income...................................................... 13,108 15,839
Income before provision for income taxes and extraordinary item....... 6,934 1,700
Income before extraordinary item...................................... 5,124 1,188
</TABLE>
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 13, except that the number of weighted average shares has been increased
by 57,809 basic and 143,701 diluted shares for the year ended December 31, 1997
and 4,923 basic and diluted shares for the year ended December 31, 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 and (ii) the timing of the issuance of common stock and options in
connection with those acquisitions:
<TABLE>
<CAPTION>
Years Ended December 31,
------------------------
1998 1997
---- ----
Unaudited pro forma, as adjusted: (Dollars in thousands)
<S> <C> <C>
Income before provision for income taxes
and extraordinary item.......................................... $ 6,934 $ 1,700
Pro forma provision for income taxes.................................. 1,810 877
----------- -----------
Pro forma income before extraordinary item............................ $ 5,124 $ 823
=========== ===========
Weighted average common shares outstanding:
Basic.............................................................. 8,608,444 6,113,248
=========== ===========
Diluted............................................................ 9,924,415 7,464,063
=========== ===========
Earnings per share, before extraordinary item:
Basic.............................................................. $ .60 $ .13
=========== ===========
Diluted............................................................ $ .52 $ .11
=========== ===========
</TABLE>
42
<PAGE>
OUTSOURCE INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 3. PROPERTY AND EQUIPMENT
Property and equipment consists of the following:
<TABLE>
<CAPTION>
As of December 31,
------------------
1998 1997
---- ----
(Dollars in thousands)
<S> <C> <C>
Buildings and land............................................ $ 6,210 $ 6,210
Furniture, fixtures and equipment............................. 9,158 6,935
Computer software............................................. 6,187 4,061
Leasehold improvements........................................ 2,756 2,034
Vehicles...................................................... 592 500
---------- ----------
Property and equipment........................................ 24,903 19,740
Less accumulated depreciation and amortization................ 7,275 4,787
---------- ----------
Property and equipment, net................................... $ 17,628 $ 14,953
========== ==========
</TABLE>
Depreciation and amortization expense for property and equipment for
the years ended December 31, 1998, 1997 and 1996 was $3.1 million, $2.3 million,
and $1.2 million, respectively. The Company sold or retired assets with a net
book value of $0.1 million (net of accumulated depreciation of $0.6 million)
during the year ended December 31, 1998.
NOTE 4. INCOME TAXES
The net deferred tax asset as of December 31, 1998 and 1997 includes
deferred tax assets and liabilities attributable to the following items,
including amounts recorded as a result of the February 21, 1997 termination of
the elections by the Initial Subsidiaries to be treated as S corporations:
<TABLE>
<CAPTION>
As of December 31,
------------------
1998 1997
---- ----
(Dollars in thousands)
<S> <C> <C>
Current:
--------
Workers' compensation accrual................................. $ 4,048 $ 2,693
Debt discount and valuation adjustment related to warrants.... 678 --
Allowance for doubtful accounts............................... 741 617
Change from cash to accrual tax basis......................... (483) (363)
Net operating loss carryforward............................... -- 1,330
Employment tax credit carryforward............................ 1,476 834
Other......................................................... (91) --
--------- --------
Net current deferred tax asset, included in prepaid
expenses and other current assets ......................... 6,369 5,111
--------- --------
Non-current:
------------
Debt discount and valuation adjustment related to warrants.... -- 2,215
Change from cash to accrual tax basis......................... (540) (786)
Other......................................................... (97) 176
--------- --------
Net non-current deferred tax asset (liability), included in other
non-current liabilities and in other assets, respectively . (637) 1,605
--------- --------
Net deferred tax asset ....................................... $ 5,732 $ 6,716
========= ========
</TABLE>
43
<PAGE>
OUTSOURCE INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 4. INCOME TAXES (CONTINUED)
Management has determined, based on the Company's history of prior
taxable earnings and its expectations for the future, that taxable income will
more likely than not be sufficient to fully realize deferred tax assets and
accordingly, has not reduced deferred tax assets by a valuation allowance. The
employment tax credit carryforward of $1.5 million as of December 31, 1998 will
expire in 2013 and 2014. The employment tax credits recorded by the Company from
February 21, 1997 through December 31, 1998 include Federal Empowerment Zone
("FEZ") credits which represent a net tax benefit of approximately $550
thousand. Although the Company believes that these FEZ credits have been
reasonably determined, the income tax law addressing how FEZ credits are
determined for staffing companies is evolving and as a result the Company's
positions with regards to its calculation of FEZ credits may be challenged by
the Internal Revenue Service.
<TABLE>
<CAPTION>
The components of the income tax provision (benefit) are as follows:
Years Ended December 31,
------------------------
1998 1997
---- ----
(Dollars in thousands)
<S> <C> <C>
Federal - Current................................................ $ 1,682 $ 2,054
State - Current.................................................. 362 494
Federal - Deferred............................................... (357) (2,235)
State - Deferred................................................. (76) (382)
-------- --------
Income tax provision (benefit)................................... $ 1,611 $ (69)
======== ========
</TABLE>
During 1997, the Company also recorded a $6.6 million income tax
benefit as a direct reduction of the extraordinary loss arising from early debt
retirement (see Note 5). This benefit offset any Federal tax payments that would
have otherwise been due as a result of the current portion of the $69,000 tax
benefit shown above.
The 1998 extraordinary expense of $1.4 million recognized by the
Company represents a reduction of the above 1997 tax benefit, arising from the
final valuation for income tax purposes of the deduction allowable to the
Company related to warrants to purchase 392,896 shares of the Company's common
stock. The warrants were issued by the Company into escrow in 1997 but the
ultimate recipient was not determined until February 21, 1999 (see Note 5).
Although the Company recognized a tax benefit in 1997 associated with the debt
discount amortization expense for these warrants, the benefits were initially
recorded as a deferred tax asset since these expenses would be tax deductible by
the Company as interest expense only if and when the warrants were released to
the Senior Note Holders and only to the extent of the fair value of the warrants
upon release. As the public market price of the Company's shares on February 21,
1999 was less than the public market price on the Offering valuation date, the
estimated tax benefit initially recorded was adjusted to the tax benefit as
finally determined. In addition to the $1.4 million extraordinary item, another
$141,000 expense was included in the Company's 1998 income tax provision due to
the adjustment for tax return purposes of the 1997 put warrants valuation
adjustment (see Note 5) associated with these warrants.
44
<PAGE>
OUTSOURCE INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 4. INCOME TAXES (CONTINUED)
The Company's effective tax rate differed from the statutory federal
rate of 35%, as follows:
<TABLE>
<CAPTION>
Years Ended December 31,
------------------------
1998 1997
---- ----
Amount Rate Amount Rate
------ ---- ------ ----
(Dollars in thousands)
<S> <C> <C> <C> <C>
Statutory rate applied to income before income taxes
and extraordinary item............................... $ 2,272 35.0% $ 249 35.0%
Increase (decrease) in income taxes resulting from:
State income taxes, net of federal benefit............ 189 2.9 74 10.4
Effect of termination of S corporation status......... -- -- (424) (59.6)
Loss prior to termination of S corporation status..... -- -- 59 8.2
Put warrants valuation adjustment..................... 141 2.2 445 62.6
Employment tax credits................................ (975) (15.0) (551) (77.4)
Nondeductible expenses................................ 215 3.3 57 8.0
Other................................................. (231) (3.6) 22 3.1
--------- ------- --------- -------
Total................................................. $ 1,611 24.8% $ (69) (9.7%)
========= ======= ========= =======
</TABLE>
The decrease in the 1998 state tax rate from 1997 as shown above was
because additions to financial statement income for the 1997 state tax expense
calculation, primarily the non-deductible portion of the put warrants valuation
adjustment, were larger than financial statement income in 1997 but not in 1998.
The tax benefit of $6.6 million related to the 1997 extraordinary loss
was 33.2% of that loss (26.1% after considering the $1.4 million reduction of
that benefit in 1998), which differed from the statutory federal rate of 35% due
to a portion of the debt discount that was included in the extraordinary loss
being non-deductible for tax purposes.
NOTE 5. DEBT
Securitization: Effective July 27, 1998, the Company entered into a
five year financing arrangement pursuant to which it can sell up to a $50
million secured interest in its eligible accounts receivable to EagleFunding
Capital Corporation ("Eagle"), which uses the receivables to secure A-1 rated
commercial paper (the "Securitization Facility"). Eagle is an affiliate of
BankBoston, N.A, the lead bank in a syndicate of commercial banks that provide
the Company with a $34 million revolving credit facility ("Revolving Credit
Facility").
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 5.65% as of December 31, 1998. As of December
31, 1998, a $44.8 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 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. 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
45
<PAGE>
OUTSOURCE INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 5. DEBT (CONTINUED)
Revolving Credit Facility. The Company is currently discussing renewal of the
Liquidity Facility with the syndicate and other banks.
Bank financing: In connection with the Securitization Facility,
effective July 27, 1998, the Company's Revolving Credit Facility was amended,
primarily to reduce the maximum amount available for borrowing from $85 million
to $34 million and to extend the remaining term of the Revolving Facility to
five years from the date of that amendment. The Revolving Credit Facility was
first entered into on February 21, 1997, following the Reorganization, and
includes a letter of credit facility of $15 million. Including the effects of a
February 1999 amendment to the Revolving Credit Facility, the interest rate is
based on: 1) the bank's prime rate (7.75% at December 31, 1998) plus a margin of
up to 0.75% according to the Company's consolidated debt to earnings ratio (as
defined by the terms of the Revolving Credit Facility) or 2) the Eurodollar base
rate (5.65% at December 31, 1998) plus a margin from 1.25% to 2.75% according to
the Company's consolidated debt to earnings ratio. The effective interest rate
at December 31, 1998 was 7.8% per annum; however, the February 1999 amendment
resulted in a 0.5% increase in that rate effective January 1, 1999, to
approximately 8.3%. Revolving Credit Facility borrowings are collateralized by
all tangible and intangible assets of the Company and are governed by certain
covenants, which include an interest coverage ratio, a cash flow coverage ratio,
leverage ratios determined by indebtedness to EBITDA (earnings before interest,
taxes, depreciation and amortization) and the current ratio. As part of the
pricing increase in February 1999, certain of these covenants were amended,
which provided additional flexibility to the Company and enabled the Company to
be in compliance as of December 31, 1998. The terms of the Revolving Credit
Facility also require prior bank approval of most acquisitions and borrowings
from third parties. In February 1998 the Company entered into an interest rate
collar agreement, as required by the terms of the Revolving Credit Facility at
that time (see Note 6).
The Company secures its liability for the deductible portion of its
workers' compensation coverage by the issuance of letters of credit to its
insurance carriers, which amounted to $10.5 million at December 31, 1998. The
letter of credit fee at December 31, 1998 was 1.50% per annum, increasing to
1.875% as of January 1, 1999, but may reduce to as low as 0.75% per annum
according to the Company's consolidated debt to earnings ratio.
Senior Notes: On February 21, 1997, following the Reorganization, the
Company entered into senior subordinated note agreements ("Senior Notes") with
two investors (the "Senior Note Holders") for borrowings totaling $25 million,
with payments of $10 million in March 2001 and $15 million in February 2002, and
quarterly interest payments at 11% per annum through February 1999 and 12.5%
thereafter. The Senior Notes were repaid in full from the proceeds of the
Offering. The Company also issued to the Senior Note Holders warrants to
purchase 786,517 shares of common stock at $.015 per share to be exercised at
the discretion of the Senior Note Holders and expiring five years from issuance
(the "A warrants"). These warrants had not been exercised as of December 31,
1998.
In connection with the Senior Notes, warrants to purchase 573,787
shares of the Company's common stock at $.015 per share were issued by the
Company into escrow. In April 1997, warrants to purchase 180,891 shares (the "B
warrants") were released from escrow to the Company's shareholders as of
February 21, 1997, as a result of the Company's consummation of the last of
certain acquisitions in accordance with conditions of the agreements related to
the Senior Notes. As of December 31, 1998, 29,575 of the B warrants had not been
exercised and expire in February 2002. The terms for the release of the
remaining warrants to purchase 392,896 shares (the "C warrants") provided for
their release to either (i) 100% to the Senior Note Holders, (ii) 100% to the
then existing Company shareholders or (iii) 50% to each group, depending on
46
<PAGE>
OUTSOURCE INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 5. DEBT (CONTINUED)
certain conditions including the market valuation, over the two year period
ended February 21, 1999, of the A warrants. It has now been determined that the
C warrants will be released 100% to the Senior Note Holders. The warrants in
escrow are exercisable any time after being released from escrow and expire in
February 2002.
The A , B and C warrants all contained a put right, whereby the Company
would be required at the holder's option to purchase the warrants for the
"publicly traded" fair value of those warrants should the Company not consummate
a qualified initial public offering, as defined in the warrant agreement, by
February 2001. This put right was terminated as a result of the Company's
October 1997 Offering.
The proceeds of the Senior Notes were recorded as a liability. The fair
value of the A, B and C warrants was recorded as debt discount, which was a
contra-account to the Senior Notes liability and was periodically amortized
using the interest method, resulting in a level effective rate of 55.7% per
annum applied to the sum of the face amount of the debt less the unamortized
discount. Interest expense (including discount amortization of $0.7 million) of
$2.6 million was recorded related to these Senior Notes for the year ended
December 31, 1997.
The B and C warrants were designed to provide the Senior Note Holders
with additional consideration for their $25 million investment if certain
performance criteria (in the case of the B warrants) are not met or if certain
triggering events (in the case of the C warrants) did not occur. Therefore, the
value of the B and C warrants was, in substance, embedded within the $25 million
subordinated debt proceeds and, as such, was accounted for in the same manner as
the A warrants. Accordingly, the amount allocated from the $25 million
subordinated debt proceeds to the detachable stock purchase warrants included
the fair value of the B and C warrants. The original debt discount was $18.5
million, based on the fair value of the A, B and C warrants as determined by an
independent appraiser as of the date of their issuance.
Due to the put option included in all of the warrants, their fair value
of $18.5 million at the date of issuance was classified as a liability which was
adjusted to fair value at each reporting date until the put option terminated.
This liability was adjusted to a fair value of $20.4 million as of October 24,
1997, with the cumulative adjustment of $1.8 million included in non-operating
expense for the year ended December 31, 1997. The fair value of the warrants
recorded as of October 24, 1997 was equal to the price of the Company's shares
sold to the public at that time (see Note 1), less the warrant exercise price.
As a result of the termination of the put right at the time of the Company's
October 1997 Offering, the final put warrants liability was reclassified from
debt to additional paid-in capital at that time.
The Company incurred $2.4 million of costs related to the issuance of
the Senior Notes, which were recorded in other non-current assets and amortized
to interest expense using the interest method. Amortization of $0.2 million was
recorded for the year ended December 31, 1997.
As a result of the early repayment of the Senior Notes in October 1997,
the Company recorded an extraordinary loss of $13.4 million (net of a $6.6
million income tax benefit). This loss consists of the unamortized debt discount
and the unamortized debt issuance costs related to the Senior Notes. See Note 4
regarding the 1998 extraordinary expense of $1.4 million recognized by the
Company which represents the reduction of the 1997 income tax benefit, arising
from the final valuation for income tax purposes of the deduction allowable to
the Company related to the unamortized debt discount.
47
<PAGE>
OUTSOURCE INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 5. DEBT (CONTINUED)
<TABLE>
<CAPTION>
Long-Term Debt:
As of December 31,
1998 1997
---- ----
(Dollars in thousands)
<S> <C> <C>
Obligations under capital leases. See
discussion below.............................................. $ 2,217 $ 2,818
Acquisition notes payable, subordinated to the
Revolving Credit Facility and payable over three years
at imputed interest rates ranging from 8.75% to
12.0% per annum. See Note 2................................... 9,156 2,877
Mortgage notes payable in monthly installments and
collateralized by buildings and land. The interest
rates range from 8.0% to 9.5% per annum.......................... 4,229 4,333
Notes payable in monthly installments and
collateralized by property and equipment. The
interest rates range from 8.25% to 10.9% per annum............ 119 117
Insurance premium note payable................................. 318 --
--------- ----------
Long-term debt................................................. 16,039 10,145
Less current maturities of long-term debt...................... 6,782 2,408
--------- ----------
Long-term debt, less current maturities........................ $ 9,257 $ 7,737
========= ==========
</TABLE>
The aggregate annual principal payments on long-term debt (including
obligations under capital leases) are as follows as of December 31, 1998:
<TABLE>
<CAPTION>
Year (Dollars in thousands)
<S> <C> <C>
1999.......................................... $ 6,782
2000.......................................... 4,624
2001.......................................... 811
2002.......................................... 525
2003.......................................... 134
Thereafter.................................... 3,163
---------
$ 16,039
=========
</TABLE>
Capital Leases: From December 1996 to December 1997, the Company
occupied an office building for its national office and support center under a
15 year capital lease agreement with an unrelated party, having annual lease
payments of approximately $0.6 million. The Company had an option to buy the
building during the first two years of the lease term and in December 1997 it
exercised that option. Prior to that purchase, the capitalized costs relating to
this lease were equal to the purchase option price.
Furniture, fixtures, equipment and computer software held under capital
leases and included in property and equipment were $2.2 million and $2.8
million, net of accumulated depreciation of $0.9 million and $0.4 million, as of
December 31, 1998 and 1997, respectively.
48
<PAGE>
OUTSOURCE INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 5. DEBT (CONTINUED)
The following is a summary of future minimum lease payments, and their
present value, required under all capital leases for the years ended after
December 31, 1998:
<TABLE>
<CAPTION>
Year (Dollars in thousands)
----
<S> <C> <C>
1999............................................ $ 821
2000............................................ 821
2001............................................ 726
2002............................................ 131
Thereafter...................................... --
-----------
Total future minimum lease payments............. 2,499
Less amount representing interest............... (282)
-----------
Present value of net minimum lease payments..... $ 2,217
===========
</TABLE>
NOTE 6. COMMITMENTS AND CONTINGENCIES
Lease Commitments: The Company conducts its operations in various
leased facilities under leases that are classified as operating leases for
financial reporting purposes. The leases provide for the Company to pay real
estate taxes, common area maintenance and certain other expenses. Lease terms,
excluding renewal option periods exercisable by the Company at escalated rents,
expire between 1999 and 2004. Also, certain equipment used in the Company's
operations is leased under operating leases. The following is a summary of fixed
minimum lease commitments required under all operating leases for the years
ended after December 31, 1998:
<TABLE>
<CAPTION>
Year (Dollars in thousands)
----
<S> <C> <C>
1999............................................. $ 3,065
2000............................................. 2,827
2001............................................. 1,997
2002............................................. 1,145
2003............................................. 353
Thereafter....................................... 41
-----------
Total............................................ $ 9,428
===========
</TABLE>
Rent expense, including equipment rental, was $3.4 million, $2.2
million, and $0.9 million for the years ended December 31, 1998, 1997 and 1996,
respectively.
Franchise Agreements: The Company had granted 24, 55 and 75 Tandem
franchises (some covering multiple locations) still outstanding as of December
31, 1998, 1997 and 1996, respectively. In consideration for royalties paid by
the franchise holders, the agreements provide, among other things, that the
Company will provide the franchise holder with the following for terms ranging
from 10 to 15 years with varying renewal options: exclusive geographical areas
of operations, continuing advisory and support services and access to the
Company's confidential operating manuals.
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.
49
<PAGE>
OUTSOURCE INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 6. COMMITMENTS AND CONTINGENCIES (CONTINUED)
The following tables set forth various revenues from staffing
franchises as well as a schedule showing staffing franchise offices opened and
purchased by the Company, as well as the number of Company owned staffing
locations. The Company's franchising activities in its other divisions is not
significant.
<TABLE>
<CAPTION>
Years Ended December 31,
------------------------
1998 1997 1996
---- ---- ----
(Dollars in thousands)
<S> <C> <C> <C>
PEO services....................................... $ 25,199 $ 34,642 $ 35,079
Royalties.......................................... 7,352 6,997 5,671
Payroll funding services........................... 327 713 1,288
Initial franchise fees............................. -- 15 84
Other.............................................. -- 15 41
---------- ---------- ---------
Total revenues.................................. $ 32,878 $ 42,382 $ 42,163
========== ========== =========
</TABLE>
<TABLE>
<CAPTION>
Years Ended December 31,
------------------------
1998 1997 1996
---- ---- ----
<S> <C> <C> <C>
Number of franchise locations, beginning................. 65 95 83
New franchise locations.................................. 10 6 24
Franchises closed/Buyouts................................ (15) (23) --
Franchises converted to
Company - owned locations.............................. (17) (13) (12)
----- ----- -----
Number of franchise locations, ending.................... 43 65 95
Number of Company owned locations........................ 111 87 46
----- ----- -----
Total locations........................................ 154 152 141
===== ===== =====
</TABLE>
PEO services revenues are based on the payroll and other related costs
for industrial personnel provided by the franchises to their clients, under a
relationship whereby the Company is the employer of those industrial personnel.
The Company's gross profit margin on these services is approximately 1.2% of the
related revenues. See Note 1 for a discussion of initial franchise fees,
royalties, and payroll funding services (funding advances). The Company's gross
profit margin on these services is 100% of the related revenues.
Buyouts are early terminations of franchise agreements allowed by the
Company in order to enable the Company to develop the related territories. At
the time the Company agrees to terminate a franchise agreement, it receives an
initial buyout payment from the former franchisee. The Company continues to
receive payments from the former franchisees based on a percentage of the gross
revenues of the formerly franchised locations for up to three years after the
termination dates. The initial buyout payment, as well as subsequent payments
from the former franchisees, are included in total royalties shown above.
Litigation: On September 24, 1998, an action was commenced against the
Company for breach of contract in connection with a purported services
arrangement, seeking damages of approximately $0.6 million. The Company filed
an answer denying any breach of contract and moved to transfer the action to
Florida. The motion for removal was granted and the case has been transferred
to, and is now pending in, the Southern District of Florida, Fort Lauderdale
division. The action is presently in discovery and no trial date has been set.
The Company believes that the claim is without merit and the resolution of this
lawsuit will not have a material adverse effect on its financial position or
future operating results; however, no assurance can be given as to the ultimate
outcome of this lawsuit.
On November 12, 1997, an action was commenced against the Company,
alleging state law claims of pregnancy/maternity discrimination and violations
of the Family and Medical Leave Act as a result of an alleged demotion following
the plaintiff's return from maternity leave. The complaint also asserts a claim
for unpaid overtime based on both
50
<PAGE>
OUTSOURCE INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 6. COMMITMENTS AND CONTINGENCIES (CONTINUED)
state law and the Fair Labor Standards Act. The case is presently in discovery
and no trial date has been set. The Company believes the claims are without
merit and is vigorously defending this action.
The Company and the other party to litigation with regards to one of
the service marks used in the Company's operations have reached an agreement in
principle to settle this matter, resulting in no substantive change to the
Company's continued use of the "OutSource" service mark and without any effect
to the Company's financial condition or results of operations.
Interest Rate Collar Agreement: 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 $0.4 million liability
as of December 31, 1998 which is included in Other Non-current Liabilities 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 December 31, 1998 was approximately $0.4 million. The
Company reevaluates the portion of the hedge designated to the Revolving Credit
Facility and the Securitization Facility on a monthly basis.
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.
Employment Agreements: As of December 31, 1998, the Company had certain
obligations under employment agreements it entered into in 1998 and 1997 with
its Chief Executive Officer ("CEO") and seven 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. In February 1999, one of those officers resigned his position, which
resulted in the Company incurring a liability approximately equal to one year's
salary, in exchange for the former employee's agreement, among other things, to
not compete with the Company for one year.
Promissory Note Renegotiations: In order to remain in compliance with
certain covenants in its Revolving Credit Facility, and to reduce the cash
impact of scheduled payments under its subordinated acquisition debt, the
Company has put into place a plan to renegotiate the payment terms of its
subordinated acquisition debt. Pursuant to such plan, the Company has negotiated
extensions of the payment dates of certain of the subordinated notes and is in
the process of negotiating the remainder of such notes. There can be no
assurance, however, that the Company will be successful in renegotiating all
51
<PAGE>
OUTSOURCE INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 6. COMMITMENTS AND CONTINGENCIES (CONTINUED)
remaining subordinated notes. In the event it is not successful, and the Company
elects not to pay a scheduled payment when due, this could result in a default
being declared by the noteholder against the Company, which would subject the
Company to lawsuits commenced by the note holders to recover the indebtedness
due.
Revolving Credit Facility Covenants: The Company regularly evaluates
its compliance with the financial covenants included in the Revolving Credit
Facility. The Company believes, based on its current projections, that it will
be in compliance with those covenants throughout 1999, although the Company
expects certain covenants to remain close to the current limitations. There can
be no assurance that the Company will be in compliance with those covenants at
March 31, 1999 or that it will not require waivers from the syndicate of lenders
led by BankBoston, N.A., regarding compliance with those covenants as of that
date, or at subsequent dates. In the event waivers are required, but are not
granted, the Company could experience liquidity problems depending on the
ability and willingness of the syndicate of lenders to continue lending to the
Company, and the availability and cost of financing from other sources.
NOTE 7. OTHER CHARGES
In 1996, the Company incurred $1.4 million of expenses, primarily
professional fees, related to (a) a Form S-1 Registration Statement filed by the
Company with the Securities and Exchange Commission that the Company withdrew
and (b) subsequent due diligence, which included an internal investigation of
allegations regarding payments by the Company to a management employee of a
customer of the Company. Based on the findings of the investigation, the Company
paid restitution to the customer, is continuing to transact business with the
customer and believes that further expenses or liabilities, if any, related to
this matter will not be material to its financial position or results of
operations. These expenses have been separately disclosed as other charges in
the consolidated statement of income due to their unusual nature.
NOTE 8. SIGNIFICANT CUSTOMERS AND CONCENTRATION OF RISK
For the years ended December 31, 1998, 1997 and 1996, approximately 9%,
12%, and 16%, respectively, 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.
For the years ended December 31, 1998, 1997 and 1996, approximately
20%, 19% and 27%, respectively, of the Company's revenues were from the
provision of services to customers in the Chicago, Illinois area. For each of
the years ended December 31, 1998, 1997 and 1996, approximately 27%, 29% and 29%
of the Company's revenues were from the provision of services to customers in
the South Florida area.
The Company's financial instruments that are exposed to concentrations
of credit risk consist primarily of cash, trade accounts receivable and funding
advances to franchises. The Company places its cash with what it believes to be
high credit quality institutions. At times cash deposits may be in excess of the
FDIC insurance limit. The Company grants credit to its customers generally
without collateral and regularly assesses their financial strength. Funding
advances to franchises are collateralized by the franchises' accounts receivable
from their clients. The Company believes that credit risk related to its trade
accounts receivable and funding advances is limited due to diversification of
the accounts based on geography and industry as well as the lack of material
concentration of balances due from any one customer.
NOTE 9. EMPLOYEE BENEFIT PLANS
The Company had a 401(k) single-employer retirement plan and two 413(c)
multiple-employer retirement plans covering all employees except for (a)
employees under the age of 21 for all plans, (b) employees with less than one
year of service for all plans, (c) certain temporary employees for the 413(c)
plans and (d) all highly compensated employees as defined by the Internal
Revenue Code for the 401(k) plan and certain highly compensated employees for
the 413(c) plans.
One of the 413(c) plans was established for use by not-for-profit
employers only, effective January 1, 1996.
On February 28, 1997, the 401(k) plan and the 413(c) plan established
for use by not-for-profit employers were made inactive by the Company. All
participating employees were enrolled in the currently active 413(c) plan for
future contributions and all previously contributed net assets remained in the
inactive plans for eventual distribution to the employees upon retirement or
other qualifying event.
52
<PAGE>
OUTSOURCE INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 9. EMPLOYEE BENEFIT PLANS (CONTINUED)
Eligible employees who participate elect to contribute to the plan an
amount up to 15% of their salary. Each year, the Company's Board of Directors
determines a matching percentage to contribute to each participant's account; if
a determination is not made, the matching percentage is 50% of the participant's
contributions, limited to the first 6% of each participant's salary contributed
by the participants. This matching policy may vary in the case of PEO employees,
although all matching amounts related to PEO employees are recovered by the
Company in its charges to the respective PEO customers. Matching contributions
by the Company for its employees, which includes PEO employees, were $0.5
million, $0.5 million and $0.3 million for the years ended December 31, 1998,
1997 and 1996, respectively.
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 10. SHAREHOLDERS' EQUITY
Voting Trust: The Company's three principal shareholders resigned from
the Company's Board of Directors in November 1996. On February 21, 1997, in
connection with the issuance of the Senior Notes and the closing of the
Revolving Credit Facility, 4,683,982 shares of the common stock of the Company,
owned by those shareholders and their families, were placed in a voting trust,
with a term of ten years. On October 24, 1997, at the time of the Offering,
700,000 shares were released from the voting trust and sold to the public. On
May 12, 1998, as the result of their exercise of certain warrants (see Note 5)
the Company issued 124,671 shares to certain of those shareholders and their
families, which were immediately deposited into the voting trust. During 1998,
these shareholders and their families purchased an additional 81,940 shares from
third parties which were deposited into the voting trust.
Under the terms of the voting trust and agreements among the Company,
the Company's shareholders at the time the trust was established and the Senior
Note Holders, the 4,190,593 shares of common stock in the voting trust, which
represent approximately 48% of the common stock of the Company as of December
31, 1998, will be voted in favor of the election of a Board of Directors having
seven members and comprised of three directors nominated by the CEO of the
Company, two directors nominated by the Senior Note Holders, and two independent
directors nominated by the vote of both directors nominated by the Senior Note
Holders and at least two of the directors nominated by the CEO of the Company.
When the warrants to purchase 392,896 shares, as discussed in Note 5, are
released from escrow to the Senior Note Holders, the number of directors may be
increased by two, with the additional directors nominated by the Senior Note
Holders. Further, the shares in the voting trust will be voted as recommended by
the Board of Directors for any merger, acquisition or sale of the Company, or
any changes to the Articles of Incorporation or Bylaws of the Company. On any
other matter requiring a vote by the shareholders, the shares in the voting
trust will be voted as directed by the Company's current CEO.
Incentive Stock Option Plan: During 1995, a Subsidiary of the Company
established an incentive stock option plan ("Stock Option Plan") for that
Subsidiary only, whereby incentive stock options could be granted to employees
to purchase a specified number of shares of common stock at a price not less
than fair market value on the date of the grant and for a term not to exceed 10
years. Once awarded, these options become vested and exercisable at 25% per
year, unless special terms are established at the time the option is granted. On
January 1, 1996, the Subsidiary granted options to purchase 815,860 shares of
its common stock at an exercise price of $4.77 per share, which an independent
appraiser determined to be the fair market value of that Subsidiary's common
stock on the date of grant. On February 18, 1997, the Company adopted the Stock
Option Plan and, pursuant to the terms of the Stock Option Plan, adjusted (i)
the number of outstanding options to 318,568, corresponding to shares of its
common stock, and (ii) the exercise price of such options to $10.38 per share.
The ratios utilized in such conversion were determined by an independent
appraiser as of the date of the Subsidiary's initial grant.
53
<PAGE>
OUTSOURCE INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 10. SHAREHOLDERS' EQUITY (CONTINUED)
The total number of shares of common stock reserved for issuance under
the stock option plan is 1,040,000. The Company's Board of Directors has agreed
to increase the number of reserved shares to 1,581,675 and the Company's
management intends to request ratification by the Company's shareholders in
their May 1999 annual meeting. As of December 31, 1998, the status of all
outstanding option grants was as follows:
<TABLE>
<CAPTION>
Grant Date Options Granted Options Outstanding Exercisable Options Exercise Price
---------- --------------- ------------------- ------------------- --------------
<S> <C> <C> <C> <C>
January 1996................ 318,568 233,711 116,856 $10.38
March 1997.................. 221,473 140,986 35,247 $11.42
September 1997.............. 116,933 97,552 24,388 $15.00
October 1997................ 1,625 1,625 406 $14.75
December 1997............... 2,238 2,238 560 $11.75
January 1998................ 265,646 233,986 77,221 $13.88
March 1998................. 71,700 49,354 - $18.88
May 1998................... 18,375 13,375 - $19.50 to $20.13
June 1998................... 4,432 4,432 - $16.75
August 1998................. 75,000 75,000 - $10.38 to $13.88
August 1998................. 52,500 51,500 - $6.00 to $7.25
November 1998............... 386,318 383,218 - $6.00
---------- ---------
1,286,977 254,678
========== =========
</TABLE>
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 exercise price of options granted prior to the Offering are
based on the fair market value of the Company's common stock, as determined by
an independent appraiser as of the date of the grant. The above options vest
over a four year period from the date of issuance, except 77,221 options issued
in January 1998, which vested immediately upon grant.
The weighted average remaining contractual life of the above options
was 8.9, 8.7 and 9.0 years as of December 31, 1998, 1997 and 1996, respectively.
The weighted average exercise price was $10.59 and $11.57 per share as of
December 31, 1998 and 1997, respectively. No options had been exercised as of
December 31, 1998.
The Company has elected to follow APB Opinion No. 25, "Accounting for
Stock Issued to Employees" ("APB 25") in accounting for its stock options. Under
APB 25, because the exercise price of the Company's employee stock options
equals the fair value of the underlying stock on the grant date, no compensation
is recognized. However SFAS No. 123, "Accounting for Stock-based Compensation",
requires presentation of pro forma net income as if the Company had accounted
for its employee stock options under the fair value method. The Company has
estimated the fair value of stock options granted to employees prior to the
Offering to be from $2.20 to $3.41 per option as of the respective grant dates,
using the Black-Scholes option pricing model with the following assumptions:
risk free interest rate from 6.12% to 6.65%; no volatility factor because the
Company was not a public entity when the options were granted; no expected
dividends; and expected option life of 4 years. For options granted subsequent
to the Offering through December 31, 1998, the Company has estimated the fair
value of stock options granted to employees to be from $1.66 to $5.56 per option
as of the respective grant dates, using the Black-Scholes option pricing model
with the following assumptions: risk free interest rate from 5.87% to 6.65%; an
anticipated volatility factor of 101%; no expected dividends; and expected
option life of 4 years. For purposes of pro forma disclosure, the estimated fair
value of the options is amortized to expense over the vesting period. Under the
fair value method, the Company's unaudited pro forma income (before
extraordinary item) would have been $4.3 million ($0.50 basic and $0.44 diluted
earnings per share) for the year ended December 31, 1998, $0.2 million ($0.04
basic and $0.03 diluted earnings per share) for the year ended December 31, 1997
and $1.0 million for the year ended December 31, 1996 ($0.17 basic and diluted
earnings per share).
54
<PAGE>
OUTSOURCE INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 10. SHAREHOLDERS' EQUITY (CONTINUED)
The March 1997 and January 1998 grants include 8,126 and 6,000 options,
respectively, issued in connection with acquisitions - see Note 2.
During January 1999, the Company granted options to purchase 72,500
shares of the Company's common stock, vesting over a 4 year period from the
grant date and with an exercise price of $6.00 per share based on the market
price of the shares at the grant date. During March 1999, the Company granted
options to purchase 95,675 shares of the Company's common stock, vesting
immediately upon grant and with an exercise price of $4.125 per share based on
the market price of the shares at the grant date.
Reverse Stock Split: On October 21, 1997, the Company effectuated a
reverse stock split pursuant to which each then issued and outstanding share of
common stock was converted into approximately 0.65 shares of common stock. The
effect of this reverse split has been retroactively applied to all share, option
and warrant amounts, including the related option and warrant exercise prices.
NOTE 11. RELATED PARTY TRANSACTIONS
Revenues: Certain shareholders of the Company owned franchises from
which the Company received the following revenues in the periods indicated:
<TABLE>
<CAPTION>
Years Ended December 31,
------------------------
1998 1997 1996
---- ---- ----
(Dollars in thousands)
<S> <C> <C> <C>
Royalties.......................... $ 1,289 $ 194 $ 684
PEO services....................... - 349 13,505
---------- ----------- ----------
Included in net revenues........... $ 1,289 $ 543 $ 14,189
========== =========== ==========
</TABLE>
These franchises owed the Company $100,000, $92,000 and $151,000 at
December 31, 1998, 1997 and 1996 respectively, primarily related to the above
items.
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. The initial
buyout payment, as well as subsequent payments under the buyout agreement, are
included in total royalties shown above.
Receivables and interest income: During 1996 and 1997 the Company had
notes and advances receivable due on demand from shareholders and affiliates,
although there were no outstanding balances due as of December 31, 1997. The
notes had an interest rate of 10% per annum and the advances were non-interest
bearing. Total interest income from notes receivable and other amounts due from
related parties was $0, $66,000, and $29,000 for the years ended December 31,
1998, 1997 and 1996, respectively.
Long-term debt and interest expense: See Note 2 for the details of
acquisition notes payable to related parties as of December 31, 1998 and 1997,
respectively. Total interest expense for long-term debt to related parties was
$113,000, $547,000 and $667,000 for the years ended December 31, 1998, 1997 and
1996, respectively.
55
<PAGE>
OUTSOURCE INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 11. RELATED PARTY TRANSACTIONS (CONTINUED)
Other transactions: During 1997, the Company purchased certain real
estate from SMSB for $840,000, such assets having a net book value as reflected
on SMSB's financial statements of $608,000 at the time of purchase.
A law firm owned by a shareholder of the Company received legal fees
for services rendered to the Company during 1998, 1997 and 1996 in the
approximate amounts of $38,000, $148,000 and $97,000, respectively.
The Company employed one of its minority shareholders (a member of the
S group) in a non-management position at an annual salary of approximately $40
thousand during 1998, 1997 and 1996. This arrangement was discontinued in March
1998.
Since July 1997, the Company has leased on a month to month basis a
portion of a warehouse controlled by the Company's CEO, for approximately $2,000
per month. Effective February 1999, the Company entered into a three year
staffing office lease with a company controlled by the CEO, with rental payments
of approximately $2,000 per month.
As a result of the Company's 1996 acquisition of franchise rights
from Payray, Inc. and Tri-Temps, Inc. (see Note 2), the Company subsequently
leased from one of the sellers, a minority shareholder of the Company, four
industrial staffing offices, for rental payments of $49,000 and $33,000 in 1997
and 1996, respectively. The Company made an additional payment of $71,000 to
that seller shareholder in 1997 in order to terminate the leases and satisfy the
Company's remaining liability.
NOTE 12. SUPPLEMENTAL INFORMATION ON NONCASH INVESTING AND FINANCING ACTIVITIES
The consolidated statements of cash flows do not include the following
noncash investing and financing activities, except for the net cash paid for
acquisitions:
<TABLE>
<CAPTION>
Years Ended December 31,
------------------------
1998 1997 1996
---- ---- ----
(Dollars in thousands)
<S> <C> <C> <C>
Acquisitions:
Tangible and intangible assets
acquired.......................... $ 41,913 $ 25,651 $ 8,498
Liabilities assumed................. (1,794) (186) (147)
Debt issued......................... (11,575) (3,517) (6,401)
Common stock issued................... (775) -- --
------------ ------------ -----------
Net cash paid for acquisitions.......... $ 27,769 $ 21,948 $1,950
============ ============ ===========
Deferred loss on interest rate
collar agreement...................... $ 413 $ -- $ --
============ ============ ===========
Decrease in goodwill and long-term
debt, due to earnout adjustments...... $ 539 $ -- $ --
============ ============ ===========
Increase in other current assets and notes
payable, due to insurance financing... $ 356 $ -- $ --
============ ============ ===========
Increase in property and equipment
and long-term debt, primarily
capitalized leases................ $ 38 $ 813 $ 7,370
============ ============ ===========
</TABLE>
56
<PAGE>
OUTSOURCE INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 12. SUPPLEMENTAL INFORMATION ON NONCASH INVESTING AND FINANCING ACTIVITIES
(CONTINUED)
<TABLE>
<CAPTION>
Years Ended December 31,
------------------------
1998 1997 1996
---- ---- ----
(Dollars in thousands)
<S> <C> <C> <C>
Refinancing of capitalized leases and
mortgages on buildings and land..... $ -- $ 4,339 $ --
============ ============ =============
Reclassification of Put Warrants
Liability to additional paid-in
capital........................... $ -- $ 20,384 $ --
============ ============ =============
Shareholders' contribution to additional
paid-in capital in connection
with the Reorganization........... $ -- $ 4,300 $ --
============ ============ =============
Discontinuance of consolidation of
SMSB-owned building and related
mortgage debt..................... $ -- $ 1,665 $ --
============ ============ =============
Debt to shareholders for distributions.. $ -- $ -- $ 967
============ ============ =============
</TABLE>
NOTE 13. PRO FORMA DATA
Pro forma net income for 1997 and 1996 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 historical (for 1998) and pro forma (for
1997 and 1996) weighted average shares outstanding used to calculate pro forma
basic and diluted earnings (loss) per share were calculated as follows:
<TABLE>
<CAPTION>
Years Ended December 31,
------------------------
1998 1997 1996
---- ---- ----
(Historical) (Pro forma) (Pro forma)
<S> <C> <C> <C>
Shares issued in connection with the Reorganization.......... 5,448,788 5,448,788 5,448,788
Equivalent shares represented by shares
of common stock of certain Subsidiaries
purchased in the Reorganization........................... - 46,211 336,430
Shares sold by the Company in the October 1997
Offering (see Note 1)................................... 3,000,000 560,440 -
Shares issued in connection with a February 1998
acquisition (see Note 2).................................. 52,886 - -
Warrants exercised in May 1998 (see Notes 5 and 10).......... 101,847 - -
------------ ----------- -----------
Weighted average common shares - basic....................... 8,603,521 6,055,439 5,785,218
Outstanding options and warrants to purchase common
stock- remaining shares after assumed repurchase
using proceeds from exercise.............................. 1,315,971 1,264,923 58,400
------------ ----------- -----------
Weighted average common shares - diluted..................... 9,919,492 7,320,362 5,843,618
============ =========== ===========
</TABLE>
57
<PAGE>
OUTSOURCE INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 13. PRO FORMA DATA (CONTINUED)
Certain of the outstanding options and warrants to purchase common
stock were anti-dilutive for certain of the periods presented above and
accordingly were excluded from the calculation of diluted weighted average
common shares for those periods.
NOTE 14. OPERATING SEGMENT INFORMATION
SFAS No. 131, "Disclosures about Segments of an Enterprise and Related
Information", establishes standards for reporting information about operating
segments in financial statements. Operating segments are defined as components
of an enterprise about which separate financial information is available that is
evaluated regularly by the chief operating decision maker, or decision making
group, in deciding how to allocate resources and in assessing performance. The
Company's chief operating decision maker is its CEO. The operating segments are
managed separately because each operating segment represents a strategic
business unit that offers different products and serves different markets. The
Company evaluates performance based on stand alone operating segment income,
which does not include any allocation of corporate support center costs or
income taxes (other than employment tax credits).
The Company's reportable operating segments are (i) the Industrial
Staffing segment, which derives revenues from recruiting, training and
deployment of temporary industrial personnel and provides payroll
administration, risk management and benefits administration services to its
clients, (ii) the PEO segment, which derives revenues from providing a
comprehensive package of PEO services to its clients including payroll
administration, risk management, benefits administration and human resource
consultation and (iii) the Franchising segment, which derives revenues under
agreements with industrial staffing franchisees that provide those franchises
with, among other things, exclusive geographical areas of operations, continuing
advisory and support services and access to the Company's confidential operating
manuals (see Note 6).
Transactions between segments affecting their reported income are
immaterial. Differences between the reportable segments' operating results and
the Company's consolidated financial statements relate primarily to other
operating divisions of the Company and items excluded from segment operating
measurements, such as corporate support center expenses and interest expense in
excess of interest charged to the segments based on their outstanding
receivables (before deducting amounts sold under the Securitization Facility).
The Company does not regularly provide information regarding the reportable
segments' net assets to the chief operating decision maker.
The Company derives none of its revenue from markets outside of the
United States. See Note 8 for information regarding significant customers and
geographic concentration. Financial information for the Company's operating
segments, reconciled to Company totals, is as follows:
<TABLE>
<CAPTION>
Years Ended December 31,
------------------------
1998 1997 1996
---- ---- ----
(Dollars in thousands)
<S> <C> <C> <C>
REVENUES
Industrial Staffing.................. $ 321,451 $ 221,461 $ 110,238
PEO.................................. 202,888 177,045 124,149
Franchising.......................... 7,352 7,027 5,755
Other Company revenues............... 33,703 42,046 40,029
----------- ------------ -------------
Total Company revenues............... $ 565,394 $ 447,579 $ 280,171
=========== ============ =============
</TABLE>
58
<PAGE>
OUTSOURCE INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 14. OPERATING SEGMENT INFORMATION (CONTINUED)
<TABLE>
<CAPTION>
Years Ended December 31,
------------------------
1998 1997 1996
---- ---- ----
(Dollars in thousands)
<S> <C> <C> <C>
INCOME
Industrial Staffing......................................... $ 13,534 $ 10,245 $ 6,754
PEO......................................................... 1,120 1,058 1,378
Franchising................................................. 5,943 5,764 3,994
Shareholders' compensation.................................. - (292) (2,321)
Put Warrants valuation adjustment........................... - (1,842) -
Other charges............................................... - - (1,448)
Other Company income (expenses)............................. (14,105) (14,222) (6,497)
----------- ------------ ------------
Total Company income before taxes and extraordinary item.... $ 6,492 $ 711 $ 1,860
=========== ============ ============
DEPRECIATION AND AMORTIZATION OF INTANGIBLE ASSETS
Industrial Staffing......................................... $ 5,077 $ 2,711 $ 943
PEO......................................................... 363 163 107
Franchising................................................. 41 23 25
Other Company depreciation and amortization................. 1,275 1,282 517
----------- ------------ ------------
Total Company depreciation and amortization................. $ 6,756 $ 4,179 $ 1,592
=========== ============ ============
INTEREST EXPENSE, NET
Industrial Staffing......................................... $ 3,407 $ 2,402 $ 1,065
PEO......................................................... 321 361 242
Franchising................................................. 43 69 69
Other Company interest expense, net......................... 1,758 5,045 799
----------- ------------ ------------
Total Company interest expense, net......................... $ 5,529 $ 7,877 $ 2,175
=========== ============ ============
</TABLE>
59
<PAGE>
OUTSOURCE INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 15. QUARTERLY FINANCIAL DATA (UNAUDITED)
The following table sets forth the amounts of certain items in the
Company's consolidated statements of income for the four quarters of 1998 and
1997:
<TABLE>
<CAPTION>
1998
------------------------------------------------------------------
Quarters Ended
March 31 June 30 September 30 December 31
------------------------------------------------------------------
(Dollars in thousands, except per share data)
<S> <C> <C> <C> <C>
Net revenues......................... $120,986 $134,796 $153,416 $156,196
Gross profit......................... 18,038 21,276 22,767 22,739
Operating income..................... 1,917 2,911 3,613 3,527
Income before
extraordinary item................. 673 1,095 1,512 1,601
Earnings per share (basic) before
extraordinary item................. .08 .13 .17 .19
Earnings per share (diluted)
before extraordinary item.......... .07 .11 .15 .16
Net income........................... 673 1,095 1,512 184
</TABLE>
<TABLE>
<CAPTION>
1997
------------------------------------------------------------------
Quarters Ended
March 31 June 30 September 30 December 31
------------------------------------------------------------------
(Dollars in thousands, except per share data)
<S> <C> <C> <C> <C>
Net revenues......................... $85,374 $107,823 $121,976 $132,406
Gross profit......................... 11,135 16,224 19,052 19,895
Operating income..................... 575 2,223 3,311 4,078
Pro forma income (loss) before
extraordinary item................. 1,233 (2,700) 93 1,789
Earnings (loss) per share (basic) before
extraordinary item................. .22 (.50) .02 .23
Earnings (loss) per share (diluted)
before extraordinary item.......... .20 (.50) .01 .20
Pro forma net income (loss).......... 1,233 (2,700) 93 (11,595)
</TABLE>
See Notes 4 and 5, respectively, for an explanation of the
extraordinary losses of $1.4 million and $13.3 million recorded by the Company
in the fourth quarters of 1998 and 1997, respectively. See Note 13 for an
explanation of the adjustments made to arrive at pro forma net income.
60
<PAGE>
ITEM 9 - CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON
ACCOUNTING AND FINANCIAL DISCLOSURE
This item is not applicable.
PART III
The information required by Items 10, 11, 12 and 13 of this Part III is
hereby incorporated by reference to the Definitive Proxy Statement that the
Company will file with the Securities and Exchange Commission not later than 120
days after December 31, 1998.
61
<PAGE>
PART IV
ITEM 14 - EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(a)1. The following Financial Statements (with accompanying notes)
have been included in Part II, Item 8 of this 10-K:
Consolidated Balance Sheets as of December 31, 1998 and 1997
Consolidated Statements of Income for the years ended December 31,
1998, 1997, and 1996 Consolidated Statements of Shareholders'
Equity for the years ended December 31, 1998, 1997 and 1996
Consolidated Statements of Cash Flows for the years ended December
31, 1998, 1997, and 1996 Notes to Consolidated Financial
Statements
2. The following schedules are filed herewith:
Schedule
Number Schedule Description
II Valuation and Qualifying Accounts - Years ended
December 31, 1998, 1997 and 1996.
(b) No reports were filed on Form 8-K during the quarter ended
December 31, 1998.
(c) The following exhibits are filed herewith:
EXHIBIT
NUMBER EXHIBIT DESCRIPTION
2.1 Amended and Restated Agreement Among Shareholders dated February 21,
1997(1)
2.2 Articles of Share Exchange among OutSource International, Inc., Capital
Staffing Fund, Inc., OutSource Franchising, Inc., Synadyne I, Inc.,
Synadyne II, Inc., Synadyne III, Inc., Synadyne IV, Inc., Synadyne V,
Inc., Employees Insurance Services, Inc. and OutSource International of
America, Inc. dated February 21, 1997(1)
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)
9 Voting Trust Agreement among OutSource International, Inc., Richard
J. Williams and Paul M. Burrell, as Trustees, and certain shareholders
of Outsource International, Inc. dated as of February 21, 1997(1)
10.1 Securities Purchase Agreement among Triumph-Connecticut Limited
Partnership, Bachow Investment Partners III, L.P., OutSource
International, Inc., Capital Staffing Fund, Inc., OutSource Franchising,
Inc., Synadyne I, Inc., Synadyne II, Inc., Synadyne III, Inc., Synadyne
IV, Inc., Synadyne V, Inc., Employees Insurance Services, Inc. and
OutSource International of America, Inc. dated as of February 21,
1997(1)
10.2 Escrow Agreement Among State Street Bank and Trust Company of
Connecticut, N.A., certain shareholders of OutSource International,
Inc., and OutSource International, Inc. dated as of February 21, 1997(1)
62
<PAGE>
EXHIBIT
NUMBER EXHIBIT DESCRIPTION
10.3 Registration Rights Agreement among OutSource International, Inc.,
Triumph-Connecticut Limited Partnership, Bachow Investment Partners III,
L.P., and shareholders of OutSource International, Inc. dated as of
February 21, 1997(1)
10.4 Agreement among Shareholders and Investors in OutSource International,
Inc. dated as of February 21, 1997(1)
10.7 Asset Purchase Agreement among Standby Personnel of Colorado Springs,
Inc., Adrian Walker and OutSource International, Inc. dated as of
February 24, 1997(1)
10.8 Asset Purchase Agreement between Staff Management Services, Inc. and
OutSource International, Inc. dated as of March 3, 1997(1)
10.9 Asset Purchase Agreement between Superior Temporaries, Inc. and
OutSource International, Inc. dated as of March 3, 1997(1)
10.10 Asset Purchase Agreement among Stand-By, Inc., Carlene Walker and
OutSource International of America, Inc. dated as of March 31, 1997(1)
10.11 Employment Agreement between Paul M. Burrell and the Company dated as of
February 21, 1997(1)*
10.12 Employment Agreement between Robert A. Lefcort and the Company dated as
of March 3, 1997(1)*
10.13 Employment Agreement between Robert E. Tomlinson and the Company dated
as of March 3, 1997(1)*
10.14 Employment Agreement between Robert J. Mitchell and the Company dated as
of March 3, 1997(1)*
10.15 Employment Agreement between Brian Nugent and the Company dated as of
March 11, 1997*
10.17 Employment Agreement between Scott R. Francis and the Company dated as
of April 1, 1998(6)*
10.18 Stock Option Plan, As Amended Effective May 8, 1998(6)*
10.19 Third Amended and Restated Credit Agreement among OutSource
International, Inc., the banks from time to time parties hereto and
BankBoston, N.A., successor by merger to Bank of Boston, Connecticut, as
agent - Revolving Credit Facility dated as of July 27, 1998. (6)
10.20 OI Pledge Agreement made by OutSource International, Inc. in favor of
Bank of Boston Connecticut, as Agent, dated as of February 21, 1997(1)
10.21 OI Security Agreement made by OutSource International, Inc. in favor of
Bank of Boston Connecticut, as Agent, dated as of February 21, 1997(1)
10.22 Subsidiary Security Agreement made by Capital Staffing Fund, Inc.,
OutSource Franchising, Inc., Synadyne I, Inc., Synadyne II, Inc.,
Synadyne III, Inc., Synadyne IV, Inc., Synadyne V, Inc., Employees
Insurance Services, Inc. and OutSource International of America, Inc. in
favor of Bank of Boston Connecticut, As Agent, dated as of February 21,
1997(1)
10.23 Subsidiary Guarantee by Capital Staffing Fund, Inc., OutSource
Franchising, Inc., Synadyne I, Inc., Synadyne II, Inc., Synadyne III,
Inc., Synadyne IV, Inc., Synadyne V, Inc., Employees Insurance Services,
Inc. and OutSource International of America, Inc. in favor of Bank of
Boston Connecticut, As Agent, dated as of February 21, 1997(1)
10.24 Trademark Security Agreement made by OutSource International, Inc. and
OutSource Franchising, Inc. in favor of Bank of Boston Connecticut dated
as of February 21, 1997(1)
10.25 Interest Rate Collar Transaction between BankBoston, N.A. and OutSource
International, Inc. dated as of February 20, 1998(5)
10.33 Form of Accumulated Adjustments Account Promissory Note dated February
20, 1997 issued by Capital Staffing Fund, Inc., OutSource Franchising,
Inc. and OutSource International of America, Inc. to the following
shareholders of the Company and Schedule of Allocation of AAA
Distribution to such shareholders: Lawrence H. Schubert Revocable Trust;
Robert A. Lefcort Irrevocable Trust; Nadya I. Schubert Revocable Trust;
Louis J. Morelli S Stock Trust; Margaret Ann Janisch S Stock Trust;
Matthew Schubert OutSource Trust; Jason Schubert OutSource Trust; Alan
E. Schubert; Louis A. Morelli; Louis J. Morelli; Raymond S. Morelli;
Matthew B. Schubert; Mindi Wagner; Margaret Morelli Janisch; Robert A.
Lefcort; and Paul M. Burrell(1)
63
<PAGE>
EXHIBIT
NUMBER EXHIBIT DESCRIPTION
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.(6)
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.(6)
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.(6)
10.50 First Amendment to Third Amended and Restated Credit Agreement among
OutSource International, Inc., each of the banks party to the Credit
Agreement and BankBoston, N.A., as agent for the banks, dated as of
February 22, 1999.
21 Subsidiaries of the Company
23 Consent of Deloitte & Touche LLP
27 Financial Data Schedule
- ------------------------
* Compensatory plan or arrangement.
(1) Incorporated by reference to the Exhibits to the Company's Registration
Statement on Form S-1 (Registration Statement No. 333-33443) as filed
with the Securities and Exchange Commission on August 12, 1997
(2) Incorporated by reference to the Exhibits to Amendment No. 3 to the
Company's Registration Statement on Form S-1 (Registration Statement No.
333-33443) as filed with the Securities and Exchange Commission on
October 21, 1997
(3) Incorporated by reference to the Exhibits to Amendment No. 1 to the
Company's Registration Statement on Form S-1 (Registration Statement No.
333-33443) as filed with the Securities and Exchange Commission on
September 23, 1997
(4) Incorporated by reference to the Exhibits to the Company's Form 10-K as
filed with the Securities and Exchange Commission on March 31, 1998.
(5) Incorporated by reference to the Exhibits to the Company's Form 10-Q for
the quarterly period ended March 31, 1998, as filed with the Securities
and Exchange Commission on May 15, 1998.
(6) 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.
64
<PAGE>
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this report to be signed on
behalf of the undersigned, thereunto duly authorized.
OUTSOURCE INTERNATIONAL, INC.
By: /s/ PAUL M. BURRELL
----------------------------------------
Paul M. Burrell
Chairman of the Board of Directors,
President and Chief Executive Officer
Date: March 30, 1999
Pursuant to the requirements of the Securities Exchange Act of 1934,
this report has been signed below by the following persons on behalf of the
registrant and in the capacities and on the dates indicated.
<TABLE>
<CAPTION>
Signature Title Date
--------- ----- ----
<S> <C> <C>
/s/ PAUL M. BURRELL President, Chief Executive March 30, 1999
- ------------------------------------ Officer and Chairman of the Board
Paul M. Burrell of Directors
(Principal Executive Officer)
/s/ SCOTT R. FRANCIS Chief Financial Officer, March 30, 1999
- ------------------------------------ Treasurer and Director
Scott R. Francis (Principal Financial
Officer)
/s/ ROBERT A. LEFCORT Assistant Secretary and Director March 30, 1999
- ------------------------------------
Robert A. Lefcort
/s/ RICHARD J. WILLIAMS Director March 30, 1999
- ------------------------------------
Richard J. Williams
/s/ DAVID S. HERSHBERG Director March 30, 1999
- ------------------------------------
David S. Hershberg
/s/ LAWRENCE CHIMERINE Director March 30, 1999
- ------------------------------------
Lawrence Chimerine
/s/ JAY SEID Director March 30, 1999
- ------------------------------------
Jay Seid
/s/ ROBERT E. TOMLINSON Chief Accounting Officer March 30, 1999
- ------------------------------------ (Principal Accounting Officer)
Robert E. Tomlinson
</TABLE>
65
<PAGE>
SCHEDULE II
OUTSOURCE INTERNATIONAL, INC. AND AFFILIATES
VALUATION AND QUALIFYING ACCOUNTS
Years Ended December 31, 1996, 1997 and 1998
<TABLE>
<CAPTION>
Charged to Credits
Balance, Costs and Issued and Balance
Description January 1, 1998 Expenses Other Charge Offs December 31, 1998
----------- ---------------- --------- ------ ------------ ------------------
<S> <C> <C> <C> <C> <C>
Allowance for doubtful
accounts and credit memos..... $1,639,767 $3,355,571 $ - $(3,071,192) $ 1,924,146
Charged to Credits
Balance, Costs and Issued and Balance
Description January 1, 1997 Expenses Other Charge Offs December 31, 1997
----------- ---------------- --------- ------ ------------ ------------------
Allowance for doubtful
accounts and credit memos..... $978,250 $3,123,861 $ - $(2,462,344) $ 1,639,767
Charged to Credits
Balance, Costs and Issued and Balance
Description January 1, 1996 Expenses Other Charge Offs December 31, 1996
----------- ---------------- --------- ------ ------------ ------------------
Allowance for doubtful
accounts and credit memos..... $375,243 $1,442,370 $ - $ (839,363) $ 978,250
</TABLE>
The amounts shown above include credits issued and charge offs for
uncollectible amounts as well as customer credits issued for early payment
discounts, pricing adjustments, customer service concessions, billing
corrections, and other matters.
S-1
<PAGE>
INDEX TO EXHIBITS
EXHIBIT
NUMBER EXHIBIT DESCRIPTION
10.15 Employment Agreement between Brian Nugent and the Company dated as of
March 11, 1997
10.50 First Amendment to Third Amended and Restated Credit Agreement among
OutSource International, Inc., each of the banks party to the Credit
Agreement and BankBoston, N.A., as agent for the banks, dated as of
February 22, 1999.
21 Subsidiaries of the Company
23 Consent of Deloitte & Touche LLP
27 Financial Data Schedule
EMPLOYMENT AGREEMENT
THIS EMPLOYMENT AGREEMENT (the "Agreement") is made and entered into as of
March 11, 1997, by and between OutSource International, Inc., a Florida
corporation (the "Company"), and Brian Nugent ("Employee").
WHEREAS, the Company, through its Board of Directors, desires to retain the
services of Employee, and Employee desires to be retained by the Company, on the
terms and conditions set forth in this Agreement;
NOW, THEREFORE, in consideration of the premises and the mutual covenants
and agreements contained herein, and for other good and valuable consideration,
the receipt and adequacy of which are hereby acknowledged, the parties hereto,
intending to be legally bound, hereby agree as follows:
1. Employment. The Company hereby employs Employee, and Employee hereby
accepts employment, as Vice President and General Counsel of Outsource
International, Inc. upon the terms subject to this Agreement.
2. Term. The term ("Term") of this Agreement shall commence on March 11,
1997, and shall continue until terminated in accordance with the terms hereof.
3. Duties. During his employment hereunder, Employee will serve as the
General Counsel of the Company and its affiliates and subsidiaries. Employee
shall report directly to the President of the Company and shall serve at his
direction. Employee shall perform services as assigned by the President of the
Company consistent with the title of General Counsel. Employee shall diligently
perform such duties and shall devote his entire business skill, time and effort
to his employment and his duties hereunder and shall not during the Term,
directly or indirectly, alone or as a member of a partnership, or as an officer,
director, employee or agent of any other person, firm or business organization
engage in any other business activities or pursuits requiring his personal
service that materially conflict with his duties hereunder or the diligent
performance of such duties. This shall not, however, preclude Employee from
serving on boards of directors of other corporations; provided that such service
does not conflict with the duties of Employee hereunder or result in a conflict
of interest.
4. Compensation.
a. Salary. During his employment hereunder, Employee shall be paid an
initial salary of $140,000.00 per year, payable in equal installments not
less than monthly ("Base Salary"). The Employee's Base Salary shall be
reviewed at least annually by the Board of Directors or any Committee of
the Board delegated the authority to review executive compensation.
<PAGE>
b. Bonus. In addition to Base Salary, Employee shall be entitled to
participate in the Company's Stock Option Plan, as amended and restated
(the "Stock Option Plan") and, in addition, to participate in a Management
Bonus Program, beginning in calendar year 1997, to be established by the
Company with an initial targeted bonus for calendar year 1997 of $31,500
for Employee, based upon the achievement of mutually agreed upon goals and
objectives (hereafter the "Management Bonus Program").
c. Insurance. During his employment hereunder, Employee shall be
entitled to participate in such health, life, disability and other
insurance programs, if any, that the Company may offer to other key
executive employees of the Company from time to time.
d. Other Benefits. During his employment hereunder, Employee shall be
entitled to such other benefits, if any, that the Company may offer to
other key executive employees of the Company from time to time.
e. Vacation. Employee shall be entitled to four weeks of vacation leave
(in addition to holidays) in each calendar year during the Term, or such
additional amount as may be set forth in the vacation policy that the
Company shall establish from time to time. Except with respect to vacation
time unused as the result of a written request by the Company to postpone a
vacation, any unused vacation from one calendar year shall not carry-over
to any subsequent calendar year.
f. Expense Reimbursement. Employee shall, upon submission of appropriate
supporting documentation, be entitled to reimbursement of reasonable
out-of-pocket expenses incurred in the performance of his duties hereunder
in accordance with policies established by the Company. Such expenses shall
include, without limitation, reasonable travel and entertainment expenses,
gasoline and toll expenses and cellular phone use charges, if such charges
are directly related to the business of the Company.
5. Grounds for Termination.
The Board of Directors of the Company may terminate this Agreement for any
reason at any time including, without limitation, for "Cause." As used herein,
"Cause" shall mean any of the following: (i) an act of willful misconduct or
gross negligence by Employee in the performance of his material duties or
obligations to the Company; if such act is capable of cure, Employee shall be
given notice and such act shall not be deemed a basis for Cause if cured within
60 days after written notice is received by Employee specifying the alleged
failure in reasonable detail; (ii) indictment of Employee for a felony involving
moral turpitude, whether relating to his employment or otherwise; and (iii) an
act of dishonesty or breach of trust on the part of Employee resulting or
intended to result directly or indirectly in personal gain or enrichment at the
expense of the Company.
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<PAGE>
6. Termination by Employee.
Employee may terminate this Agreement with Good Reason. "Good Reason"
means:
a. Without Employee's express written consent, the assignment to
Employee of duties inconsistent with Employee's position with the
Company as set forth in this Agreement (including status, offices,
titles, and reporting requirements), authority, duties, or
responsibilities contemplated by paragraph 3.
b. The Company causes a material change in the nature or scope of the
authorities, powers, functions, duties or responsibilities attached
to the Employee's position as described in paragraph 3.
c. At any time the Employee is required, without his written consent, to
relocate his office more than seventy-five miles from the location of
the Company's current corporate headquarters;
d. The Company decreases the Employee's compensation below the levels
provided for by the terms of Section 4(a) (taking into account
increases made from time to time in accordance with Section 4);
e. A material breach of the provisions of this Agreement by the Company
(except those set forth in Paragraph 4(a)) and Employee provides at
least 15 days prior written notice to at least two members of the
Company's Board of Directors (other than Employee) of the existence
of such breach and his intention to terminate this Agreement (no such
termination shall be effective if such breach is cured during such
period or if the Company is in good faith attempting to cure such
breach);
f. The failure of the Company to comply with the provisions of Paragraph
4(a)for an uninterrupted 10 day period; or
g. The Company materially reduces the Employee's benefits under any
employee benefit plan, program or arrangement of the Company (other
than a change that affects all employees similarly situated) from the
level in effect upon the Employee's commencement or participation.
h. Notwithstanding anything to the contrary herein, in the event
Employee notifies Employer of an intent to terminate his employment
pursuant to paragraph 6(a) or (b), Employee shall be entitled to,
upon such termination to receive the benefits provided in paragraph
7(b) herein; provided however, that if: (i) Employee continues his
employment for a period of one year from the date on which he
provided notice under paragraph 6(a) or (b) herein to the Company, or
(ii) the Company terminates Employee during such one year period
other than for Cause, as defined herein, or other than for
unsatisfactory performance, as described in paragraph 7(c) herein,
upon such termination, employee shall then be entitled to receive the
benefits provided under paragraphs 7(b) and 7(c)(i) herein. If during
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<PAGE>
such one year period, there is a "Change of Control", as defined
herein, and (x) Employee is terminated other than for Cause, as
defined herein, or (y) if there is Good Reason (as defined in
paragraph 6(a)-(g) hereof for Employee to terminate employment
hereunder, Employee shall be entitled to receive the benefits
provided in paragraph 8 herein. The provisions of this paragraph 6(h)
shall not affect Employee's rights under paragraph 6(c)-(g) or 8
hereof, and shall be independent of these provisions. The parties
agree that the intent of this paragraph 6(h) is to encourage Employee
to remain as an Employee notwithstanding an intent to terminate his
employment hereunder pursuant to paragraph 6(a) or (b).
7. Payment and Other Provisions Upon Termination.
a. In the event that: Employee's employment with the Company (including
its subsidiaries) is terminated by the Company for Cause as provided in
Paragraph 5; or Employee terminates his employment without Good Reason as
described in Paragraph 6; then, on or before Employee's last day of
employment with the Company:
i. Salary and Bonus Payments: The Company shall pay in a lump sum to
Employee such amount of compensation due to Employee hereunder for
services rendered to the Company, as well as compensation for unused
vacation time, as has accrued but remains unpaid. Any and all other
rights granted to Employee under this Agreement shall terminate as of
the date of termination.
ii. Noncompetition/Nonsolicitation Period. The provisions of
Paragraph 14 shall continue to apply with respect to Employee for a
period of one year following the date of termination.
b. In the event that: Employee's employment with the Company (including
its subsidiaries) is terminated by the Company for any reason other than
for Cause as provided in Paragraph 5, and other than as a consequence of
Employee's death, disability, or normal retirement under the Company's
retirement plans and practices; or Employee terminates his employment with
Good Reason as described in Paragraph 6; then:
i. Salary and Bonus Payments:
(A) On or before Employee's last day of employment with the Company,
the Company shall pay to Employee, as compensation for services
rendered to the Company, a cash amount equal to the sum of (x)
one-half (1/2) of the amount of Employee's Base Salary and (y)
ninety percent of one-half (1/2) of the amount of the estimated
target bonus under the Management Bonus Program as in effect
immediately prior to his date of termination (the "Cash Amount").
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<PAGE>
(B) The final calculation of Employee's target bonus shall be made,
and any remaining bonus amount due to Employee paid, in the
manner set forth in Section 7.a.i. At the election of the
Company, the Cash Amount may be paid to Employee in periodic
installments in accordance with the regular salary payment
practices of the Company, with the first such installment to be
paid on or before Employee's last day of employment with the
Company. Notwithstanding the foregoing sentence, the entire Cash
Amount shall be paid to Employee during the period not to exceed
one year following Employee's last day of employment with the
Company. No interest shall be paid with respect to any of the
Cash Amount not paid on the Employee's date of termination.
(C) For purposes of paragraph 7.b.i., the "Cash Amount" shall mean:
(1) if the date of termination is on or before October 1, 1997,
the sum of Employee's annual base salary reduced by the amount of
salary paid through the date of termination and a pro rated
amount of the estimated target bonus under the Management Bonus
Program; or (2) if the date of termination is after October 1,
1997, the product of one-half times the base salary in effect as
of the effective date of the termination plus the Employee's then
current estimated target bonus under the Management Bonus
Program.
ii. Benefit Plan Coverage: The Company shall maintain in full force
and effect for Employee and his dependents for one year after the date
of termination, all life, health, accident, and disability benefit plans
and other similar employee benefit plans, programs and arrangements in
which Employee or his dependents were entitled to participate
immediately prior to the date of termination, in such amounts as were in
effect immediately prior to the date of termination, provided that such
continued participation is possible under the general terms and
provisions of such benefit plans, programs and arrangements. In the
event that participation in any benefit plan, program or arrangement
described above is barred, or any such benefit plan, program or
arrangement is discontinued or the benefits thereunder materially
reduced, the Company shall arrange to provide Employee and his
dependents for one year after the date of termination with benefits
substantially similar to those that they were entitled to receive under
such benefit plans, programs and arrangements immediately prior to the
date of termination, or, at the Company's option, a lump sum payment to
Employee equal to the Company's cost immediately prior to termination to
provide such benefits. If immediately prior to the date of termination
the Company provided Employee with any club memberships, Employee will
be entitled to continue such memberships at his sole expense.
Notwithstanding any time period for continued benefits stated in this
Paragraph 7.b.ii, all benefits in this Paragraph 7.b.ii will terminate
on the date that Employee becomes an employee of another employer and
eligible to participate in the employee benefit plans of such other
employer. To the extent that Employee was required to contribute amounts
for the benefits described in this Paragraph 7.b.ii prior to his
termination, he shall continue to contribute such amounts for such time
as these benefits continue in effect after termination.
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<PAGE>
iii.[INTENTIONALLY OMITTED]
iv. Savings and Other Plans: Except as otherwise more specifically
provided herein or under the terms of the respective plans relating to
termination of employment, Employee's active participation in any
applicable savings, retirement, profit sharing or supplemental employee
retirement plans or any deferred compensation or similar plan of the
Company or any of its subsidiaries shall continue only through the last
day of his employment. All other provisions, including any distribution
and/or vested rights under such plans, shall be governed by the terms of
those respective plans.
v. Noncompetition/Nonsolicitation Period. The provisions of Paragraph
14 shall continue, beyond the time periods set forth in such paragraph,
to apply with respect to Employee for the shorter of (x) twelve months
following the date of termination or (y) until such time as the Company
has failed to comply with the provisions of Paragraph 7.b.i for a an
uninterrupted 10-day period and such failure is not cured within 5 days
after written notice of such failure is delivered to at least two
directors of the Company (other than Employee).
c. In the event Employee's employment with the Company (including its
subsidiaries) is terminated by the Company other than for Cause as provided
in Paragraph 5 and other than as a consequence of Employee's death,
disability, or normal retirement under the Company's retirement plans and
practices, and the reason for such termination is not based upon
unsatisfactory performance by Employee of his duties hereunder as stated in
written performance evaluations or other written documents prepared by the
Company, then the following provision shall apply. This same provision
shall also apply if Employee terminates his employment with Good Reason as
described in Paragraph 6.
i. Exercisability of Stock Options. Notwithstanding the vesting
period provided for in the Stock Option Plan and any related stock
option agreements between the Company and Employee for stock options
("options") and stock appreciation rights ("rights") granted Employee by
the Company, all options and stock appreciation rights shall be
immediately exercisable upon termination of employment. In addition,
Employee will have the right to exercise all options and rights for the
shorter of (x) one year following his termination of employment or (y)
with respect to each option, the remainder of the period of
exercisability under the terms of the appropriate documents that grant
such options.
d. The provisions of this Paragraph 7 shall apply if Employee's
employment is terminated prior to or more than three years after the
occurrence of a Change of Control (as defined in Paragraph 8.c). From the
occurrence of any Change of Control until the second anniversary of such
Change of Control, the provisions of Paragraph 8 shall apply in place of
this Paragraph 7, except that in the event that after a Change of Control
Employee's employment is terminated by Employee without Good Reason or
Company terminates Employee for Cause, then the provisions of Paragraph 8
shall not apply and the provisions of Paragraph 7.a shall apply.
Termination upon death, disability and retirement are covered by Paragraphs
9, 10, and 11, respectively.
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<PAGE>
8. Payment and Other Provisions after Change of Control.
a. Salary, Performance Award, and Bonus Payments: In the event
Employee's employment with the Company is terminated within three years
following the occurrence of a Change of Control (other than as a
consequence of his death or disability, or of his normal retirement under
the Company's retirement plans and practices) either (x) by the Company for
any reason other than for Cause or (z) by Employee with Good Reason as
provided in Paragraph 6, then Employee shall be entitled to receive from
the Company, the following:
i. Base Salary. Employee's Base Salary as in effect at the date of
termination shall be paid on the date of termination;
ii. Target Bonus. Ninety percent of the amount of the Employee's
estimated target bonus under the Management Bonus Program for the fiscal
year in which the date of termination occurs shall be paid on the date
of termination; the final calculation of Employee's target bonus shall
be made, and any remaining bonus amount due to Employee paid, in the
manner set forth in Section 7.a.i.; and
iii.[OMITTED INTENTIONALLY]
iv. Other Benefits. All benefits under Paragraphs 7.b.ii, 7.b.iv and
7.c.i shall be extended to Employee as described in such paragraphs.
b. Noncompetition/Nonsolicitation Period. In the event of a termination
under Paragraph 8.a within one year after a Change of Control the
provisions of Paragraph 14 shall continue to apply as stated in paragraph
7.b.v.
c. For purposes of this Agreement, the term "Change of Control" shall
mean:
i. The acquisition, other than from the Company, by any individual,
entity or group (within the meaning of ??13(d)(3) or ??14(d)(2) of the
Securities Exchange Act of 1934, as amended (the "Exchange Act")) of
beneficial ownership (within the meaning of Rule 13d-3 promulgated under
the Exchange Act) (any of the foregoing described in this Paragraph
8.c.i hereafter a "Person") of 33% or more of either (a) the then
outstanding shares of Capital Stock of the Company (the "Outstanding
Capital Stock") or (b) the combined voting power of the then outstanding
voting securities of the Company entitled to vote generally in the
election of directors (the "Voting Securities"), provided, however, that
any acquisition by (x) the Company or any of its subsidiaries, or any
employee benefit plan (or related trust) sponsored or maintained by the
Company or any of its subsidiaries or (y) any Person that is eligible,
pursuant to Rule 13d-1(b) under the Exchange Act, to file a statement on
Schedule 13G with respect to its beneficial ownership of Voting
Securities, whether or not such Person shall have filed a statement on
Schedule 13G, unless such Person shall have filed a statement on
Schedule 13D with respect to beneficial ownership of 33% or more of the
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<PAGE>
Voting Securities or (z) any corporation with respect to which,
following such acquisition, more than 60% of, respectively, the then
outstanding shares of common stock of such corporation and the combined
voting power of the then outstanding voting securities of such
corporation entitled to vote generally in the election of directors is
then beneficially owned, directly or indirectly, by all or substantially
all of the individuals and entities who were the beneficial owners,
respectively, of the Outstanding Capital Stock and Voting Securities
immediately prior to such acquisition in substantially the same
proportion as their ownership, immediately prior to such acquisition, of
the Outstanding Capital Stock and Voting Securities, as the case may be,
shall not constitute a Change of Control; or
ii. Individuals who, as of the date hereof, constitute the Board (the
"Incumbent Board") cease for any reason to constitute at least a
majority of the Board, provided that any individual becoming a director
subsequent to the date hereof whose election or nomination for election
by the Company's shareholders, was approved by a vote of at least a
majority of the directors then comprising the Incumbent Board shall be
considered as though such individual were a member of the Incumbent
Board, but excluding, for this purpose, any such individual whose
initial assumption of office is in connection with an actual or
threatened election contest relating to the election of the Directors of
the Company (as such terms are used in Rule 14a-11 of Regulation 14A, or
any successor section, promulgated under the Exchange Act); or
iii. Approval by the shareholders of the Company of a reorganization,
merger or consolidation (a "Business Combination"), in each case, with
respect to which all or substantially all holders of the Outstanding
Capital Stock and Voting Securities immediately prior to such Business
Combination do not, following such Business Combination, beneficially
own, directly or indirectly, more than 60% of, respectively, the then
outstanding shares of common stock and the combined voting power of the
then outstanding voting securities entitled to vote generally in the
election of directors, as the case may be, of the corporation resulting
from Business Combination; or
iv. (a) a complete liquidation or dissolution of the Company or (b) a
sale or other disposition of all or substantially all of the assets of
the Company other than to a corporation with respect to which, following
such sale or disposition, more than 60% of, respectively, the then
outstanding shares of common stock and the combined voting power of the
then outstanding voting securities entitled to vote generally in the
election of directors is then owned beneficially, directly or
indirectly, by all or substantially all of the individuals and entities
who were the beneficial owners, respectively, of the Outstanding Capital
Stock and Voting Securities immediately prior to such sale or
disposition in substantially the same proportion as their ownership of
the Outstanding Capital Stock and Voting Securities, as the case may be,
immediately prior to such sale or disposition.
9. Termination by Reason of Death. If Employee shall die while employed by
the Company both prior to termination of employment and during the effective
term of this Agreement, all Employee's rights under this Agreement shall
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<PAGE>
terminate with the payment of that portion of Base Salary as has accrued but
remains unpaid and a prorated amount of targeted bonus under the Company's
Management Bonus Program through the month in which his death occurs, plus three
additional months of the fixed salary and targeted bonus. The calculation of
Employee's target bonus shall be made, and any bonus amount due to Employee
paid, in the manner set forth in Section 7.a.i. All benefits under Paragraphs
7.b.ii, 7.b.iv and 7.c.i shall be extended to Employee's estate as described in
such paragraphs. In addition, Employee's eligible dependents shall receive
continued benefit plan coverage under Paragraph 7.b.ii for three months from the
date of Employee's death.
10. Termination by Disability. Employee's employment hereunder may be
terminated by the Company for disability. In such event, all Employee's rights
under this Agreement shall terminate with the payment of that portion of Base
Salary as has accrued but remains unpaid as of the thirtieth (30th) day after
such notice is given except that all benefits under Paragraphs 7.b.ii, 7.b.iv
and 7.c.i shall be extended to Employee as described in such paragraphs,
provided, however, that, with respect to Paragraph 7.b.ii, the period for
continued benefit plan coverage shall be limited to six months from the date of
termination. In addition, the noncompetition and nonsolicitation provisions of
Paragraph 14 shall continue to apply to Employee for a period of six months from
the date of termination. For purposes of this Agreement, "disability" is defined
to mean that, as a result of Employee's incapacity due to physical or mental
illness:
a. Employee shall have been absent from his duties as an officer of the
Company on a substantially full-time basis for six (6) consecutive months;
and
b. Within thirty (30) days after the Company notifies Employee in
writing that it intends to replace him, Employee shall not have returned to
the performance of his duties as an officer of the Company on a full-time
basis.
11. Retirement. It is expected that the Compensation Committee of the
Company's Board of Directors will develop a benefit plan for retirement. It is
expected that Employee's rights upon retirement will be specifically described
in such retirement benefit plan. If retirement benefits for Employee are not
specifically described in such plan, the Company shall provide Employee upon
retirement benefits no lesser than the highest level of benefits accorded any
other retiring executive officer during the five year period immediately
preceding Employee's retirement.
12. Indemnification. If litigation shall be brought to enforce or interpret
any provision contained herein, the non-prevailing party shall indemnify the
prevailing party for reasonable attorney's fees (including those for
negotiations, trial and appeals) and disbursements incurred by the prevailing
party in such litigation, and hereby agrees to pay prejudgment interest on any
money judgment obtained by the prevailing party calculated at the generally
prevailing NationsBank of Florida, N.A. base rate of interest charged to its
commercial customers in effect from time to time from the date that payment(s)
to him should have been made under this Agreement.
13. [Intentionally Omitted]
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14. Noncompetition and Nonsolicitation.
a. The nature of the system and methods employed in the Company's
business is such that Employee will be placed in a close business and
personal relationship with the customers of the Company and be privy to
confidential customer usage and rate information. Accordingly, at all times
during the term of this Agreement and for a period of one (1) year
immediately following the termination of Employee's employment hereunder
(the "Noncompetition and Nonsolicitation Period") for any reason
whatsoever, and for such additional periods as may otherwise be set forth
in this Agreement in reference to this Paragraph 14, so long as the Company
continues to carry on the same business, Employee shall not, for any reason
whatsoever, directly or indirectly, for himself or on behalf of, or in
conjunction with, any other person, persons, company, partnership,
corporation or business entity:
i. Call upon, divert, influence or solicit or attempt to call upon,
divert, influence or solicit any customer or customers of the Company
nationwide;
ii. Divulge the names and addresses or any information concerning any
customer of the Company;
iii. Disclose any information or knowledge relating to the Company,
including but not limited to, the Company's system or method of
conducting business to any person, persons, firms, corporations or other
entities unaffiliated with the Company, for any reason or purpose
whatsoever;
iv. Own, manage, operate, control, be employed by, participate in or
be connected in any manner with the ownership, management, operation or
control of the same, similar or related line of business as that carried
on by the Company ("Competition") within a radius of fifty (50) miles
from Employee's principal office.
b. The time period covered by the covenants contained in this Paragraph
14 shall not include any period(s) of violation of any covenant or any
period(s) of time required for litigation to enforce any covenant.
c. The covenants set forth in this Paragraph 14 shall be construed as an
agreement independent of any other provision in this Agreement and
existence of any potential or alleged claim or cause of action of Employee
against the Company, whether predicted on this Agreement or otherwise,
shall not constitute a defense to the enforcement by the Company of the
covenants contained herein. An alleged or actual breach of the Agreement by
the Company shall not be a defense to enforcement of the provisions of this
Paragraph 14.
d. Employee acknowledges that he has read the foregoing and agrees that
the nature of the geographical restrictions are reasonable given the
international nature of the Company's business. In the event that these
geographical or temporal restrictions are judicially determined to be
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<PAGE>
unreasonable, the parties agree that these restrictions shall be judicially
reformed to the maximum restrictions which are reasonable.
e. Notwithstanding anything to the contrary contained herein, in the
event that Employee engages in Competition, or any conduct expressly
prohibited by this Paragraph 14 at any time during the Noncompetition and
Nonsolicitation Period for any reason whatsoever, Employee shall not
receive any of the termination benefits he otherwise would be entitled to
receive pursuant to Paragraphs 7.b., 7.c., 8.a. and 10 hereof.
15. Confidentiality.
a. Nondisclosure. Employee acknowledges and agrees that the Confidential
Information (as defined below) is a valuable, special and unique asset of
the Company's business. Accordingly, except in connection with the
performance of his duties hereunder, Employee shall not at any time during
or subsequent to the term of his employment hereunder disclose, directly or
indirectly, to any person, firm, corporation, partnership, association or
other entity any proprietary or confidential information relating to the
Company or any information concerning the Company's financial condition or
prospects, the Company's customers, the design, development, manufacture,
marketing or sale of the Company's products or the Company's methods of
operating its business (collectively "Confidential Information").
Confidential Information shall not include information which, at the time
of disclosure, is known or available to the general public by publication
or otherwise through no act or failure to act on the part of Employee.
b. Return of Confidential Information. Upon termination of Employee's
employment, for whatever reason and whether voluntary or involuntary, or at
any time at the request of the Company, Employee shall promptly return all
Confidential Information in the possession or under the control of Employee
to the Company and shall not retain any copies or other reproductions or
extracts thereof. Employee shall at any time at the request of the Company
destroy or have destroyed all memoranda, notes, reports, and documents,
whether in "hard copy" form or as stored on magnetic or other media, and
all copies and other reproductions and extracts thereof, prepared by
Employee and shall provide the Company with a certificate that the
foregoing materials have in fact been returned or destroyed.
c. Books and Records. All books, records and accounts whether prepared
by Employee or otherwise coming into Employee's possession, shall be the
exclusive property of the Company and shall be returned immediately to the
Company upon termination of Employee's employment hereunder or upon the
Company's request at any time.
16. Injunction/Specific Performance Setoff. Employee acknowledges that a
breach of any of the provisions of Paragraphs 14 or 15 hereof would result in
immediate and irreparable injury to the Company which cannot be adequately or
reasonably compensated at law. Therefore, Employee agrees that the Company shall
be entitled, if any such breach shall occur or be threatened or attempted, to a
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decree of specific performance and to a temporary and permanent injunction,
without the posting of a bond, enjoining and restraining such breach by Employee
or his agents, either directly or indirectly, and that such right to injunction
shall be cumulative to whatever other remedies for actual damages to which the
Company is entitled. Employee further agrees that, except as otherwise provided
in Paragraph 13 hereof, the Company may set off against or recoup from any
amounts due under this Agreement to the extent of any losses incurred by the
Company as a result of any breach by Employee of the provisions of Paragraphs 14
or 15 hereof.
17. Severability: Any provision in this Agreement that is prohibited or
unenforceable in any jurisdiction shall, as to such jurisdiction, be ineffective
only to the extent of such prohibition or unenforceability without invalidating
or affecting the remaining provisions hereof, and any such prohibition or
unenforceability in any jurisdiction shall not invalidate or render
unenforceable such provision in any other jurisdiction.
18. Successors: This Agreement shall be binding upon Employee and inure to
his and his estate's benefit, and shall be binding upon and inure to the benefit
of the Company and any permitted successor of the Company. Neither this
Agreement nor any rights arising hereunder may be assigned or pledged by:
Employee or anyone claiming through Employee; or by the Company, except to any
corporation which is the successor in interest to the Company by reason of a
merger, consolidation or sale of substantially all of the assets of the Company.
The foregoing sentence shall not be deemed to have any effect upon the rights of
Employee upon a Change of Control.
19. Controlling Law: This Agreement shall in all respects be governed by,
and construed in accordance with, the laws of the State of Florida.
20. Notices. Any notice required or permitted to be given hereunder shall
be written and sent by registered or certified mail, telecommunicated or hand
delivered at the address set forth herein or to any other address of which
notice is given:
To the Company: OutSource International, Inc.
1144 East Newport Center Drive
Deerfield Beach, Florida 33442
Attention: General Counsel
To Employee: Brian Nugent
21. Entire Agreement. This Agreement constitutes the entire agreement
between the parties hereto on the subject matter hereof and may not be modified
without the written agreement of both parties hereto.
22. Waiver. A waiver by any party of any of the terms and conditions hereof
shall not be construed as a general waiver by such party.
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23. Counterparts. This Agreement may be executed in counterparts, each of
which shall be deemed an original and both of which together shall constitute a
single agreement.
24. Interpretation. In the event of a conflict between the provisions of
this Agreement and any other agreement or document defining rights and duties of
Employee or the Company upon Employee's termination, the rights and duties set
forth in this Agreement shall control.
25. Certain Limitations on Remedies. Paragraph 7.b provides that certain
payments and other benefits shall be received by Employee upon the termination
of Employee by the Company other than for Cause and states that these same
provisions shall apply if Employee terminates his employment for Good Reason. It
is the intention of this Agreement that if the Company terminates Employee other
than for Cause (and other than as a consequence of Employee's death, disability
or normal retirement) or if Employee terminates his employment with Good Reason,
then the payments and other benefits set forth in Paragraph 7.b shall constitute
the sole and exclusive remedies of Employee. This Paragraph 25 shall have no
effect upon the provisions of Paragraph 8 of this Agreement.
IN WITNESS WHEREOF, this Employment Agreement has been executed by the
parties as of the date first above written.
COMPANY:
OUTSOURCE INTERNATIONAL, INC.
By: /s/ Paul Burrell
----------------
Its: President
EMPLOYEE:
/s/ Brian Nugent
-----------------
Name: Brian Nugent
13
FIRST AMENDMENT TO
THIRD AMENDED AND RESTATED
CREDIT AGREEMENT
Dated as of February 22, 1999
This FIRST AMENDMENT dated as of February 22, 1999 (this "First
Amendment") is among OUTSOURCE INTERNATIONAL, INC. (the "Borrower"), each of the
Banks party to the Credit Agreement hereinafter referred to (individually a
"Bank" and collectively with any successors or permitted assigns, the "Banks")
and BANKBOSTON, N.A., as agent for the Banks (in its capacity as such, the
"Agent").
The Borrower, BankBoston, N.A., Comerica Bank, LaSalle National Bank
and the Agent entered into a Credit Agreement dated as of February 21, 1997,
which Credit Agreement was (i) amended and restated as of March 18, 1997, (ii)
further amended as of September 4, 1997, (iii) amended and restated as of
November 26, 1997 to provide for, among other things, the addition of State
Street Bank and Trust Company, SunTrust Bank, South Florida, National
Association, and The Sumitomo Bank, Limited as Banks, (iv) further amended as of
December 30, 1997, (v) further amended as of January 30, 1998, (vi) further
amended as of March 18, 1998, and (vii) amended and restated as of July 27, 1998
to provide for, among other things, the addition of Fleet National Bank as a
Bank to replace State Street Bank and Trust Company and The Sumitomo Bank,
Limited (as so amended and restated, the "Credit Agreement"). The parties now
wish to amend further the Credit Agreement to provide for certain changes to the
Financial Condition Covenants set forth in Section 7.1 thereof and to make
certain changes in the Applicable Margin, the Commitment Fee and the Letter of
Credit Rate.
NOW, THEREFORE, the Borrower, the Banks and the Agent agree as follows:
Section 1. Amendments to the Credit Agreement. Effective as of the
effective date hereof and subject to the satisfaction of the conditions
precedent set forth in Section 2 hereof, the Credit Agreement is hereby amended
as follows:
(a) The definition of "Pricing Grid" set forth in Section 1.1
of the Credit Agreement shall be, and hereby is, amended by deleting such
definition in its entirety and substituting in lieu thereof the following:
"Pricing Grid": the Applicable Margin, the Commitment Fee
and the Letter of Credit Rate will be determined quarterly for the period of
four (4) consecutive fiscal quarters ending on each FQED and will be as set
forth in the following Pricing Grid:
<PAGE>
<TABLE>
<CAPTION>
Consolidated Applicable
Indebtedness to Margin for Applicable
Consolidated Alternate Base Margin for Commitment Fee Letter of Credit
EBITDA Ratio Rate Loans Eurodollar Loans Fee Rate
--------------- -------------- ---------------- -------------- ----------------
<S> <C> <C> <C> <C> <C>
Level (more than) 3.75 0.750% 2.750% 0.50% 1.875%
------
1 to 1
---------------- ------------------- -------------- ----------------- -------------- ----------------
Level 3.01-3.75 to 1 0.25% 2.250% 0.375% 1.500%
------
2
---------------- ------------------- -------------- ----------------- -------------- ----------------
Level 2.25-3.00 to 1 0.00% 1.875% 0.375% 1.125%
------
3
---------------- ------------------- -------------- ----------------- -------------- ----------------
Level 1.50-2.24 to 1 0.00% 1.500% 0.250% 1.000%
-----
4
---------------- ------------------- -------------- ------------------ -------------- ----------------
Level (less than) 1.50 to 1 0.00% 1.250% 0.250% 0.750%
------
5
---------------- ------------------- -------------- ------------------ -------------- ----------------
</TABLE>
Except as described in the next paragraph, pricing will be adjusted based on the
Borrower's performance relative to the above grid, effective on the first day of
the immediately following fiscal quarter. The Borrower's Consolidated
Indebtedness to Consolidated EBITDA Ratio must have changed from a given Level
for at least two (2) consecutive quarters before pricing will be adjusted up or
down (other than an adjustment arising from the issuance by the Borrower of
publicly traded common stock). In the event that the Borrower's Consolidated
Indebtedness to Consolidated EBITDA Ratio changes Levels twice in two
consecutive quarters (e.g., from Level 2 to Level 3 in one quarter, and from
Level 3 to Level 4 in the next quarter), pricing shall adjust to the less
beneficial (from the Borrower's point of view) of the two Levels attained during
such two consecutive quarters.
The Applicable Margin, the Commitment Fee and the Letter of Credit Rate shall
remain at Level 1 for the period beginning January 1, 1999 and ending upon the
Agent's receipt of the Borrower's financial statements for the fiscal quarter
ended June 30, 1999 pursuant to Section 6.1(b), at which time pricing shall
adjust, effective on the first day of the immediately following fiscal quarter,
based on the Borrower's performance relative to the above grid.
(b) The following definitions of "Senior Consolidated
Indebtedness" and "Senior Consolidated Indebtedness to Consolidated EBITDA
Ratio" shall be, and hereby are, added to Section 1.1 of the Credit Agreement
between the definitions of "Security Documents" and "Senior Subordinated Notes":
"Senior Consolidated Indebtedness": at any particular
date, with respect to the Borrower and its Subsidiaries, Consolidated
Indebtedness less the face amount of all Subordinated Indebtedness.
"Senior Consolidated Indebtedness to Consolidated EBITDA
Ratio": at the end of any month, the ratio of (a) Senior Consolidated
Indebtedness on such date to (b) Consolidated EBITDA for the immediately
preceding twelve (12) months (ending on such date). Note: For purposes of
Section 7.1(e) only (i.e. not for pricing under the Pricing Grid), the Borrower
may add for such twelve (12) months (i) Consolidated EBITDA of any entity
acquired in a Permitted Acquisition or identified in Note 1 to the Unaudited Pro
Forma Consolidated Financial Information contained in the Prospectus, plus any
compensation paid by such entity to any shareholder of such entity during such
period to the extent such shareholder is not continuing
<PAGE>
to receive compensation or consulting or similar fees from the Borrower or any
of its Subsidiaries subsequent to the acquisition and (ii) any verifiable
non-recurring expenses approved by the Required Banks.
(c) Subsection 7.1(a) ("Maximum Consolidated Indebtedness to
Consolidated EBITDA Ratio") of the Credit Agreement shall be, and hereby is,
amended by deleting such subsection in its entirety and substituting in lieu
thereof the following:
(a) Maximum Consolidated Indebtedness to Consolidated EBITDA
Ratio. Permit, as of the end of any month during each of the periods set forth
below, the Consolidated Indebtedness to Consolidated EBITDA Ratio to be greater
than the amount set forth below opposite such period:
<TABLE>
<CAPTION>
----------------------------------------------- --------------------------------------------
Consolidated Indebtedness to Consolidated
Period EBITDA Ratio
----------------------------------------------- --------------------------------------------
<S> <C>
During the period beginning on April 1, 1998 3.75 to 1
and ending on September 30, 1998
----------------------------------------------- --------------------------------------------
During the period beginning on October 1,
1998 and ending on September 30, 1999 4.0 to 1
----------------------------------------------- --------------------------------------------
During the period beginning on October 1, 3.75 to 1
1999 and thereafter
----------------------------------------------- --------------------------------------------
</TABLE>
<PAGE>
(d) Subsection 7.1(b) ("Minimum Consolidated EBITDA to
Consolidated Interest Expense Ratio") of the Credit Agreement shall be, and
hereby is, amended by deleting such subsection in its entirety and substituting
in lieu thereof the following:
(b) Minimum Consolidated EBITDA to Consolidated Interest
Expense Ratio. Permit, as of the end of any month during each of the periods set
forth below, the Consolidated EBITDA to Consolidated Interest Expense Ratio to
be less than the amount set forth below opposite such period:
<PAGE>
<TABLE>
<CAPTION>
----------------------------------------------- --------------------------------------------
Consolidated EBITDA to Consolidated
Period Interest Expense Ratio
----------------------------------------------- --------------------------------------------
<S> <C>
During the period beginning on April 1, 1998 2.5 to 1
and ending on June 30, 1998
----------------------------------------------- --------------------------------------------
During the period beginning on July 1, 1998
and ending on September 30, 1998 3.5 to 1
----------------------------------------------- --------------------------------------------
During the period beginning on October 1,
1998 and ending on September 30, 1999 2.75 to 1
----------------------------------------------- --------------------------------------------
During the period beginning on October 1, 3.0 to 1
1999 and thereafter
----------------------------------------------- --------------------------------------------
</TABLE>
(e) The Credit Agreement shall be, and hereby is, amended by
adding the following Subsection 7.1(e) ("Maximum Senior Consolidated
Indebtedness to Consolidated EBITDA Ratio"):
(e) Maximum Senior Consolidated Indebtedness to Consolidated
EBITDA Ratio. Permit, as of the end of any month, the Maximum Senior
Consolidated Indebtedness to Consolidated EBITDA Ratio to be greater than 3.50
to 1.
(f) Schedule A ("Commitments; Addresses") to the Credit
Agreement shall be, and hereby is, amended by deleting the contact information
for SunTrust Bank, South Florida, National Association and substituting in lieu
thereof the following:
Attention: Thomas Conroy
Phone: 954-765-7151
Telecopy No.: 954-765-7240
Section 2. Conditions of Effectiveness. This First Amendment shall
become effective when, and only when, the Agent shall have received a
counterpart of this First Amendment executed by the Borrower and the Required
Banks and an amendment fee in the amount of $212,500.
Section 3. Representations and Warranties of the Borrower. The
Borrower represents as follows:
(a) The execution, delivery and performance by the Borrower of this
First Amendment have been duly authorized by all necessary corporate action and
do not and will not (i) require any consent or approval of the Borrower's
shareholders; (ii) violate any provisions of the charter or by-laws of the
Borrower or any of its Subsidiaries; (iii) violate any provision of, or require
any filing, registration, consent or approval under, any law, rule, regulation,
order, writ, judgment, injunction, decree, determination or award presently in
effect having applicability to and binding upon the Borrower or any if its
Subsidiaries, except where such violation or failure to file could not
reasonably be expected to have a material adverse effect on the condition
(financial or otherwise) of the Borrower or such Subsidiaries or the ability of
the Borrower to perform its obligations with respect to this First Amendment or
the Credit Agreement, as amended; or (iv) result in a breach of, cause a lien to
arise under, or constitute a default or require any consent under, any indenture
or loan or credit agreement or any other agreement of the Borrower or its
Subsidiaries, except where such breach, default or failure to obtain consent or
approval would not reasonably be expected to have a material adverse effect on
the condition (financial or otherwise) of the Borrower or its Subsidiaries or
the ability of the Borrower to perform its obligations with respect to this
First Amendment or the Credit Agreement, as amended.
(b) This First Amendment and the Credit Agreement, as amended,
constitute the legal, valid and binding obligations of the Borrower enforceable
against the Borrower in accordance with their respective terms, except to the
extent that such enforcement may be limited by applicable bankruptcy, insolvency
and other similar laws affecting creditors' rights generally and by general
principles of equity.
(c) The representations and warranties contained in Section 4 of the
Credit Agreement are true, correct and complete in all material respects on and
as of the date of such certificate as though made on and as of such date except
those that by their terms specifically relate only to another date.
(d) No Event of Default or Default has occurred and is continuing or
would result from the execution and delivery of this First Amendment or the
transactions contemplated hereby.
(e) There has been no material adverse change in the condition
(financial or otherwise) of the Borrower or the ability of the Borrower to
perform its obligations with respect to the Credit Agreement as amended by this
First Amendment since the date of the last financial statements furnished to the
Bank.
Section 4. Reference to and Effect on the Credit Agreement.
(a) Upon the effectiveness of this First Amendment, on and after the
date hereof, each reference in the Credit Agreement to "this Credit Agreement",
"hereunder", "hereof", "herein" or words of like import shall mean and be a
reference to the Credit Agreement as amended hereby.
(b) Except as specifically amended above, the Credit Agreement shall
remain in full force and effect and is hereby ratified and confirmed.
(c) The execution, delivery and effectiveness of this First Amendment
shall not, except as expressly provided herein, operate as a waiver of any
right, power or remedy of the Banks under the Credit Agreement, nor constitute a
waiver of any provision of the Credit Agreement.
Section 5. Costs, Expenses and Taxes. The Borrower agrees to pay on
demand all reasonable costs and expenses of the Agent and Banks in connection
with the preparation, execution and delivery of this First Amendment and any
other instruments and documents to be delivered hereunder, including, without
limitation, the reasonable fees and out-of-pocket expenses of counsel for the
Agent and Banks with respect thereto and with respect to advising the Agent and
the Banks as to their rights and responsibilities hereunder and thereunder,
together with any unpaid fees and out-of-pocket expenses of such counsel
relating to prior amendments to the Credit Agreement. In addition, the Borrower
shall pay any and all stamp and other taxes payable or determined to be payable
in connection with the execution and delivery of this First Amendment and the
other instruments and documents to be delivered hereunder, and agrees to save
the Agent and the Banks harmless from and against any and all liabilities with
respect to or resulting from any delay in paying or omission to pay such taxes.
Section 6. Execution in Counterparts. This First Amendment may be
executed in any number of counterparts, each of which when so executed and
delivered shall be deemed to be an original and all of which taken together
shall constitute but one and the same instrument.
Section 7. Governing Law. This First Amendment shall be governed by,
and construed in accordance with, the laws of the State of Connecticut.
Section 8. Defined Terms. Capitalized terms used herein which are not
expressly defined herein shall have the meanings ascribed to them in the Credit
Agreement.
Remainder of Page Intentionally Left Blank
<PAGE>
IN WITNESS WHEREOF, the parties hereto have caused this First Amendment
to be executed by their respective officers thereunto duly authorized, as of the
date first above written.
OUTSOURCE INTERNATIONAL, INC.
By: /s/ Scott R. Francis
--------------------
Name: Scott R. Francis
Title: Chief Financial Officer
BANKBOSTON, N.A.
As a Bank and as the Agent
By: /s/ Scott S. Barnett
--------------------
Name: Scott S. Barnett
Title: Director
COMERICA BANK
By: /s/ Martin G. Ellis
-------------------
Name: Martin G. Ellis
Title: Vice President
LASALLE NATIONAL BANK
By: /s/ John J. McGuire
-------------------
Name: John J. McGuire
Title: Vice President
<PAGE>
SUNTRUST BANK, SOUTH FLORIDA,
NATIONAL ASSOCIATION
By: /s/ Thomas A. Conroy
--------------------
Name: Thomas A. Conroy
Title: Assistant Vice President
FLEET NATIONAL BANK
By: -------------------
Name:
Title:
EXHIBIT 21
SUBSIDIARIES OF THE COMPANY
OutSource International of America, Inc., a Florida corporation
OutSource Franchising Inc., a Florida corporation
Capital Staffing Fund, Inc., a Florida corporation
Employees Insurance Services, Inc., a Florida corporation
Synadyne I, Inc., a Florida corporation
Synadyne II, Inc., a Florida corporation
Synadyne III, Inc., a Florida corporation
Synadyne IV, Inc., a Florida corporation
Synadyne V, Inc., a Florida corporation
OutSource of Nevada, Inc., a Nevada corporation
Staff All, Inc., a Florida corporation
Mass Staff, Inc., a Florida corporation
Employment Consultants, Inc., a Wisconsin corporation
X-tra Help, Inc., a California corporation
Co-Staff, Inc., a California corporation
OutSource Funding Corporation, a Florida corporation
Guardian Employer East, LLC, a Delaware limited liability company
Guardian Employer West, LLC, a Delaware limited liability company
On December 31, 1998, an internal restructuring was consummated
wherein two new operating subsidiaries were formed (Guardian Employer East, LLC
and Guardian Employer West, LLC) and the ownership of most of the other
subsidiaries were transferred from OutSource International, Inc. to various of
the subsidiaries. OutSource International, Inc. retained 100% direct or indirect
ownership of all Subsidiaries after this restructuring, which was done in order
to better align the legal entities on a geographic basis.
INDEPENDENT AUDITORS' CONSENT
We consent to the incorporation by reference in Registration Statement
No. 333-57085 on Form S-8 and in Registration Statement No. 333-69125 on Form
S-3 of OutSource International, Inc. of our report dated February 22, 1999,
appearing in this Annual Report on Form 10-K of OutSource International, Inc.
for the year ended December 31, 1998.
/s/ DELOITTE & TOUCHE LLP
Certified Public Accountants
Fort Lauderdale, Florida
March 31, 1999
<TABLE> <S> <C>
<ARTICLE> 5
<S> <C> <C> <C>
<PERIOD-TYPE> 12-MOS 12-MOS 2-MOS
<FISCAL-YEAR-END> DEC-31-1998 DEC-31-1997 DEC-31-1996
<PERIOD-START> JAN-01-1998 JAN-01-1997 JAN-01-1996
<PERIOD-END> DEC-31-1998 DEC-31-1997 DEC-31-1996
<CASH> 5,501,000 1,685,000 0
<SECURITIES> 0 0 0
<RECEIVABLES> 14,870,000 48,938,000 0
<ALLOWANCES> (1,924,000) (1,640,000) 0
<INVENTORY> 0 0 0
<CURRENT-ASSETS> 26,683,000 57,079,000 0
<PP&E> 24,903,000 19,740,000 0
<DEPRECIATION> (7,275,000) (4,787,000) 0
<TOTAL-ASSETS> 112,002,000 105,743,000 0
<CURRENT-LIABILITIES> 35,382,000 23,428,000 0
<BONDS> 38,305,000 44,045,000 0
0 0 0
0 0 0
<COMMON> 9,000 8,000 0
<OTHER-SE> 44,579,000 40,770,000 0
<TOTAL-LIABILITY-AND-EQUITY> 112,002,000 105,743,000 0
<SALES> 0 0 0
<TOTAL-REVENUES> 565,394,000 447,579,000 280,171,000
<CGS> 0 0 0
<TOTAL-COSTS> 480,574,000 381,273,000 242,102,000
<OTHER-EXPENSES> 0 0 0
<LOSS-PROVISION> 0 0 0
<INTEREST-EXPENSE> 5,529,000 7,877,000 2,175,000
<INCOME-PRETAX> 6,492,000 711,000 1,860,000
<INCOME-TAX> 1,611,000 (69,000) 0
<INCOME-CONTINUING> 4,881,000 780,000 1,860,000
<DISCONTINUED> 0 0 0
<EXTRAORDINARY> (1,417,000) (13,384,000) 0
<CHANGES> 0 0 0
<NET-INCOME> 3,464,000 (12,604,000) 1,860,000
<EPS-PRIMARY> 0.40 (2.14) 0.19
<EPS-DILUTED> 0.35 (1.77) 0.19
</TABLE>
