SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 28, 2003
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from _____ to _____
Commission file number: 1-6081
COMFORCE Corporation
(Exact name of registrant as specified in its charter)
Delaware 36-2262248
------------------------------- ---------------------------------
(State or other jurisdiction of (IRS Employer Identification No.)
incorporation or organization)
415 Crossways Park Drive, P.O. Box 9006, Woodbury, New York 11797
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(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (516) 437-3300
-----------------------------
Not Applicable
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Former name, former address and former fiscal year, if changed since last report
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 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes X No
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date.
Class Outstanding at November 11, 2003
---------------------------- --------------------------------
Common stock, $.01 par value 16,659,394 shares
COMFORCE Corporation
INDEX
Page
Number
PART I FINANCIAL INFORMATION.................................................3
Item 1. Financial Statements..................................................3
Consolidated Balance Sheets at September 28, 2003 (unaudited)
and December 29, 2002.............................................3
Consolidated Statements of Operations for the three and nine
months ended September 28, 2003 and
September 29, 2002 (unaudited)....................................4
Consolidated Statements of Cash Flows for the nine months
ended September 28, 2003 and September 29, 2002 (unaudited).......5
Notes to Unaudited Consolidated Financial Statements..................6
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations....................13
Item 3. Quantitative and Qualitative Disclosure about Market Risk............20
Item 4. Controls and Procedures..............................................21
PART II OTHER INFORMATION....................................................21
Item 1. Legal Proceedings ...................................................21
Item 2. Changes in Securities and Use of Proceeds (not applicable)...........21
Item 3. Defaults Upon Senior Securities (not applicable).....................21
Item 4. Submission of Matters to a Vote of Security Holders
(not applicable)................................................21
Item 5. Other Information ...................................................22
Item 6. Exhibits and Reports on Form 8-K ..................................22
SIGNATURES....................................................................23
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
COMFORCE CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(in thousands, except share and per share amounts)
September 28, 2003 December 29, 2002
----------------------- ----------------------
Assets (unaudited)
Current assets:
Cash and cash equivalents $ 4,915 $ 6,378
Accounts receivable, net 51,891 45,244
Funding and service fees receivable, net 22,175 28,365
Prepaid expenses and other current assets 5,598 6,391
Deferred income taxes, net 2,741 1,858
----------------------- ----------------------
Total current assets 87,320 88,236
Property and equipment, net 9,196 11,612
Intangible assets, net 148 198
Goodwill, net 32,242 60,242
Deferred financing costs, net 2,432 2,576
----------------------- ----------------------
Total assets $ 131,338 $ 162,864
======================= ======================
Liabilities and Stockholders' Deficit
Current liabilities:
Accounts payable $ 1,614 $ 2,957
Accrued expenses 44,101 37,893
----------------------- ----------------------
Total current liabilities 45,715 40,850
Long-term debt 124,135 142,779
Deferred income taxes, net 161 161
Other liabilities 144 315
----------------------- ----------------------
Total liabilities 170,155 184,105
----------------------- ----------------------
Commitments and contingencies
Stockholders' deficit:
Common stock, $.01 par value; 100,000,000 shares authorized;
16,659,379 shares and 16,659,360 shares issued and outstanding
at September 28, 2003 and
December 29, 2002, respectively 167 167
Convertible preferred stock 4,817 --
Additional paid-in capital 50,501 49,588
Accumulated other comprehensive income (loss) 49 (47)
Accumulated deficit (94,351) (70,949)
----------------------- ----------------------
Total stockholders' deficit (38,817) (21,241)
----------------------- ----------------------
Total liabilities and stockholders' deficit $ 131,338 $ 162,864
======================= ======================
The accompanying notes are an integral part of the unaudited consolidated
financial statements.
COMFORCE CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands except per share amounts)
(unaudited)
Three Months Ended Nine Months Ended
Sept. 28, Sept. 29, Sept. 28, Sept. 29,
2003 2002 2003 2002
------------- -------------- ------------- --------------
Revenue:
Net sales of service $ 96,343 $ 97,906 $ 276,027 $ 290,486
Costs and expenses:
Cost of services 80,437 80,361 229,218 237,758
Selling, general and administrative expenses 13,334 13,599 37,209 41,279
Goodwill impairment 28,000 -- 28,000 --
Depreciation and amortization 1,090 1,004 3,207 2,985
------------- -------------- ------------- --------------
Total costs and expenses 122,861 94,964 297,634 282,022
------------- -------------- ------------- --------------
Operating (loss) income (26,518) 2,942 (21,607) 8,464
------------- -------------- ------------- --------------
Other income (expense):
Interest expense (3,267) (4,131) (10,678) (12,171)
Write-off of deferred financing costs -- -- (431) --
Gain on debt extinguishment -- -- 8,774 --
Other income, net (26) 55 619 218
------------- -------------- ------------- --------------
(3,293) (4,076) (1,716) (11,953)
------------- -------------- ------------- --------------
Loss before tax and a cumulative effect of a change in
accounting principle (29,811) (1,134) (23,323) (3,489)
Provision (benefit) for income taxes (3,721) (340) 79 (769)
------------- -------------- ------------- --------------
Loss before a cumulative effect of a change in
accounting principle (26,090) (794) (23,402) (2,720)
Cumulative effect of a change in accounting principle --
goodwill impairment, net of tax benefit -- -- -- (52,800)
------------- -------------- ------------- --------------
Net loss $ (26,090) $ (794) $ (23,402) $ (55,520)
============= ============== ============= ==============
Dividends on preferred stock 381 -- 546 --
------------- -------------- ------------- --------------
Loss attributable to common stockholders $ (26,471) $ (794) $ (23,948) $ (55,520)
============= ============== ============= ==============
Basic and diluted loss per common share:
Loss before a cumulative effect of a change in
accounting principle $ (1.59) $ $ (1.44) $ (0.16)
(0.05)
Cumulative effect of a change in accounting principle
-goodwill impairment -- -- -- (3.17)
------------- -------------- ------------- --------------
Net loss $ (1.59) $ (0.05) $ (1.44) $ (3.33)
============= ============== ============= ==============
Weighted average common shares outstanding,
basic and diluted 16,659 16,659 16,659 16,659
============= ============== ============= ==============
The accompanying notes are an integral part of the unaudited consolidated
financial statements.
COMFORCE CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
(unaudited)
Nine Months Ended
---------------------------------------
September 28, September 29,
2003 2002
------------------ -----------------
Cash flows from operating activities:
Net loss $ (23,402) $ (55,520)
Adjustments to reconcile net loss
to net cash provided by operating activities:
Depreciation and amortization 3,207 2,985
Amortization of deferred financing fees 527 682
Issuance of notes in lieu of interest 351 1,104
Gain on repurchase of Senior Notes (983) --
Gain on repurchase of PIK Debentures (7,791) --
Write-off of deferred financing fees 431 --
Write-off of goodwill, net of tax -- 52,800
Goodwill impairment 28,000 --
Gain on sale of fixed assets -- (156)
Deferred income tax expense (883) --
Changes in assets and liabilities, net of effects of acquisitions
of businesses:
Accounts receivable and funding service fees receivable (361) 4,652
Prepaid expenses and other current assets (328) 932
Accounts payable and accrued expenses 4,675 4,783
Decrease in income tax expense 1,121 810
------------------ -----------------
Net cash provided by operating activities 4,564 13,072
------------------ -----------------
Cash flows from investing activities:
Purchases of property and equipment (673) (2,504)
Cash proceeds from sale of fixed assets -- 434
Payments of contingent consideration -- (323)
------------------ -----------------
Net cash used in investing activities (673) (2,393)
------------------ -----------------
Cash flows from financing activities:
Net repayments under capital lease obligations (204) (135)
Net repayments under line of credit agreements (3,000) (9,917)
Repurchase of Senior Notes and PIK Debentures (1,042) --
Debt financing costs (1,108) (221)
------------------ -----------------
Net cash used in financing activities (5,354) (10,273)
------------------ -----------------
Net (decrease) increase in cash and cash equivalents (1,463) 406
Cash and cash equivalents at beginning of period 6,378 4,067
------------------ -----------------
Cash and cash equivalents at end of period $ 4,915 $ 4,473
================== =================
Supplemental disclosures:
Cash paid for:
Interest $ 6,419 $ 7,001
Income taxes 329 362
Supplemental schedule of significant non-cash financing activities:
Issuance of 2003A Convertible Preferred Stock in exchange for PIK
Debentures $ 4,304 --
Issuance of 2003B Convertible Preferred Stock in exchange for
Subordinated Convertible Notes 513 --
Exchange of PIK Debentures for the Issuance of 2003A Convertible
Preferred Stock 12,335 --
Exchange of 8% Subordinated Convertible Notes for the issuance of
2003B Convertible Preferred Stock 2,052 --
Contribution of capital as a result of the exchange of 8%
Subordinated Convertible Notes 913 --
The accompanying notes are an integral part of the unaudited consolidated
financial statements.
COMFORCE CORPORATION AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
1. GENERAL
The accompanying unaudited interim consolidated financial statements of
COMFORCE Corporation ("COMFORCE") and its subsidiaries, including COMFORCE
Operating, Inc. ("COI") (collectively, the "Company") have been prepared
pursuant to the rules and regulations of the Securities and Exchange Commission.
Certain information and note disclosures normally included in annual financial
statements have been condensed or omitted pursuant to those rules and
regulations. In the opinion of management, all adjustments, consisting of normal
recurring adjustments considered necessary for a fair presentation, have been
included. Although management believes that the disclosures made are adequate to
ensure that the information presented is not misleading, these financial
statements should be read in conjunction with the financial statements and notes
thereto included in the Company's Annual Report on Form 10-K for the fiscal year
ended December 29, 2002. The results for the three and nine months ended
September 28, 2003 are not necessarily indicative of the results of operations
for the entire year.
2. STOCK COMPENSATION PLANS
During December 2002, the FASB issued SFAS 148 which provides for
alternative methods of transition for a voluntary change to the fair value based
method of accounting for stock-based employee compensation. In addition, SFAS
148 amends the disclosure requirements of SFAS 123 to require more prominent
disclosure in both annual and interim financial statements about the method of
accounting for stock-based employee compensation and the effect of the method
used on reported results.
The Company applies APB Opinion 25 and related interpretations in
accounting for stock options; accordingly, no compensation cost has been
recognized for any employees, officers or directors. Had compensation cost been
determined based upon the fair value of the stock options at grant date
consistent with the method in SFAS 123, the Company's net loss and loss per
share would have been increased to the pro forma amounts indicated below:
Three months ended Nine months ended
--------------- --- -------------- -------------- -- ---------------
Sept. 28, 2003 Sept. 29, Sept. 28, Sept. 29, 2002
2002 2003
(in thousands, except per share amounts)
Net loss as reported $ (26,090) $ (794) $ (23,402) $ (55,520)
Deduct: Total stock-based employee
compensation expense
determined under fair value
based method for all awards,
net of related tax effects 7 35 23 103
--------------- -------------- -------------- ---------------
Pro forma loss $ (26,097) $ (829) $ (23,425) $ (55,623)
=============== ============== ============== ===============
Loss per share:
Basic and diluted - as
reported $ (1.59) $ (0.05) $ (1.44) $ (3.33)
Basic and diluted-pro forma
(1.59) (0.05) (1.44) (3.34)
3. DEBT
Notes payable and long-term debt at September 28, 2003 and December 29,
2002 consisted of (in thousands):
September 28, December 29,
2003 2002
------------------- ------------
12% Senior Notes, due 2007 $ 85,000 $ 87,000
15% Senior Secured PIK Debentures, due 2009 -- 11,995
8% Subordinated Convertible Notes due 2009 7,135 8,784
Revolving line of credit, due August 31, 2004, with interest
payable monthly at LIBOR plus 3.00% with a weighted average
rate of 4.64% at December 29, 2002 -- 35,000
Revolving line of credit, due June 24, 2007, with interest payable
monthly at LIBOR plus 2.75% with a weighted average rate of
3.87% at September 28, 2003 32,000 --
------------------- ------------
Total long-term debt $ 124,135 $ 142,779
=================== ============
In June 2003, COMFORCE, COI and various of their operating subsidiaries
entered into a Revolving Credit and Security Agreement (the "PNC Credit
Facility") with PNC Bank, National Association, as a lender and administrative
agent ("PNC") and other financial institutions participating as lenders to
provide for a $75.0 million revolving credit facility with available borrowings
to be based upon a specified percentage of the Company's eligible accounts
receivable. At closing, the Company borrowed $32.7 million and repaid the
Company's then existing revolving credit facility agented by Whitehall Business
Credit Corporation (the "Whitehall Credit Facility"), which was thereupon
terminated. The Whitehall Credit Facility, which the Company entered into in
December 2000, as subsequently amended, provided for borrowings of up to $85.0
million. The Company wrote-off approximately $431,000 of deferred financing
costs in the second quarter of 2003 for the early retirement of the Whitehall
Credit Facility.
Borrowings under the PNC Credit Facility bear interest, at the Company's
option, at a per annum rate equal to either (1) the greater of the base
commercial lending rate of PNC as announced from time to time or the federal
funds rate plus 0.5%, or (2) LIBOR plus a margin ranging from 2.5% if the
Company's fixed charged coverage ratio is greater than 1.30:1 to 3.0% if this
ratio is 1.05:1 or less (with the initial margin fixed at 2.75% until September
1, 2003). The obligations evidenced by the PNC Credit Facility are
collateralized by a pledge of the capital stock of certain key operating
subsidiaries of the Company and by security interests in substantially all of
the assets of the Company. The agreements evidencing the PNC Credit Facility
contain various financial and other covenants and conditions, including, but not
limited to, limitations on paying dividends, engaging in affiliate transactions,
making acquisitions and incurring additional indebtedness. The scheduled
maturity date of the PNC Credit Facility is June 24, 2007. The PNC Credit
Facility affords the Company greater borrowing flexibility and has a maturity
date close to three years beyond the maturity date of the Whitehall Credit
Facility. As of September 28, 2003, the Company had remaining availability based
upon then outstanding eligible accounts receivable of $24.7 million based upon
the borrowing base formula.
In February 2003, the Company issued $6.1 million face amount of its new
Series 2003A Convertible Preferred Stock ("Series 2003A Preferred Stock") having
a fair market value of $4.3 million in exchange for $12.3 million of its
outstanding 15% Senior Secured PIK Debentures, due 2009 ("PIK Debentures"),
including accrued interest, in a transaction with a related party, and
repurchased additional PIK Debentures ($59,000 including interest) from
unrelated parties for a cash payment of $21,000. The remaining PIK Debentures
were subsequently redeemed in May 2003.
In June 2003, the Company repurchased from unrelated parties $2.0 million
principal amount of its 12% Senior Notes due 2007 ("Senior Notes") for $980,000,
resulting in a gain on debt extinguishment of $983,000, which includes the
reduction of approximately $37,000 of deferred financing costs.
Effective as of September 26, 2003, the Company issued 513 shares of its
Series 2003B Convertible Preferred Stock ("Series 2003B Preferred Stock") having
an aggregate face amount and fair market value of $513,000 in exchange for $2.0
million principal amount of the Company's 8.0% Subordinated Convertible Notes
due 2009 (the "Convertible Notes"), plus accrued interest, in a transaction with
a related party, which is a partnership in which John Fanning, the Company's
chairman and chief executive officer, holds the principal economic interest. As
a result of this transaction, the Company recorded a contribution to capital of
$913,000, net of taxes, in lieu of recognizing a gain on the extinguishment of
debt. See note 7.
The debt service costs associated with the Convertible Notes may be
satisfied through issuance of new Convertible Notes through December 1, 2003.
Beginning with the interest payment due June 1, 2004, COMFORCE will be required
to pay interest on the Convertible Notes in cash. Its ability to do so is
expected to be dependent on its availability of funds for this purpose, whether
through borrowings by COI under its new revolving credit facility agented by PNC
Bank, National Association, funds from COI's operations or otherwise, and on
COI's ability to upstream funds in accordance with the restricted payments test
under the indenture for the Senior Notes. COMFORCE's ability to repay
Convertible Notes at their maturity on December 2, 2009, or on any earlier
required repayment or repurchase dates, will also be dependent on any
restrictions under its loan agreements as then in effect and availability of
funds.
Under the indenture governing the Senior Notes, COI is subject to
restrictions in upstreaming funds to its parent COMFORCE. The Company does not
currently have sufficient availability under the indenture to make a cash
payment of semi-annual interest under the Convertible Notes. Management believes
that $2.0 million annually (if COI has funds available for this purpose) will be
sufficient to pay COMFORCE's annual public company expenses for the foreseeable
future. Principally as a result of losses incurred by COI in fiscal 2002 and
nine months ended September 28, 2003 and prior distributions made by COI to
COMFORCE, COI can make no distributions to COMFORCE based upon the cumulative
net income provisions of the indenture. It is anticipated that COI must generate
net income of approximately $5.5 million before it will be able to upstream
funds to COMFORCE under the restrictive payments test of the indenture. In
calculating net income for this purpose, under the terms of the indenture, the
Company must apply generally accepted accounting principles as in effect at the
time the indenture was entered into in 1997. The holder of the Convertible
Notes, which, as described above and in note 7, is a partnership in which the
Company's chairman and chief executive officer holds the principal economic
interest, has advised that it will agree to extend the payment-in-kind terms or
make other mutually acceptable arrangements if the Company does not have
adequate availability under the indenture to upstream funds to make cash
payments of interest on the Convertible Notes commencing June 1, 2004. The
Company expects to pay appropriate consideration to the holder for agreeing to
this accommodation as may be negotiated by the parties in consultation with an
independent financial advisor.
4. FISCAL YEAR
In March 2001, the Company's Board of Directors adopted a resolution to
change the Company's fiscal year, which was previously a calendar year.
Beginning in 2001, the fiscal year consists of the 52 or 53 weeks ending on the
last Sunday in December. Accordingly, the Company's current fiscal year will end
on Sunday, December 28, 2003.
5. LOSS PER SHARE
Basic loss per common share is computed by dividing net loss attributable
to common stockholders by the weighted average number of shares of common stock
outstanding during each period. Diluted loss attributable to common stockholders
per share is computed assuming the conversion of stock options and warrants with
a market value greater than the exercise price, as well the conversion of the
Convertible Note and Preferred Stock into shares of common stock to the extent
such conversion assumption is dilutive. The following represents a
reconciliation of the numerators and denominators for basic and diluted loss per
share computation (in thousands):
Three Months Ended Nine Months Ended
---------------------------------- ---------------------------------
Sept. 28, 2003 Sept. 29, Sept. 28, Sept. 29, 2002
2002 2003
Numerator:
Loss before a cumulative effect of
a change in accounting
principle $ (26,090) $ (794) $ (23,402) $ (2,720)
Cumulative effect of a change in
accounting principle-goodwill
impairment, net of tax benefit -- -- -- (52,800)
--------------- -------------- -------------- ---------------
Net Loss $ (26,090) $ (794) $ (23,402) $ (55,520)
Dividends on preferred stock 381 -- 546 --
--------------- -------------- -------------- ---------------
Loss available to common
stockholders $ (26,471) $ (794) $ (23,948) $ (55,520)
=============== ============== ============== ===============
Denominator:
Weighted average common shares
outstanding, basic and diluted 16,659 16,659 16,659 16,659
Outstanding options and warrants to purchase shares of common stock,
representing approximately 4.0 million shares of common stock, were not included
in the computations of diluted net loss per share for the three and nine months
ended September 28, 2003 because their effect would be anti-dilutive. In
addition, 4.2 million shares issuable upon conversion of the Convertible Notes
and 7.1 million shares issuable upon conversion of preferred stock were excluded
from the September 28, 2003 calculation as their effect would have been
anti-dilutive.
6. INDUSTRY SEGMENT INFORMATION
COMFORCE has determined that its reportable segments can be distinguished
principally by the types of services offered to the Company's clients.
The Company reports its results through three operating segments -- Staff
Augmentation, Human Capital Management Services and Financial Outsourcing
Services. The Staff Augmentation segment provides information technology (IT),
technical, telecom, healthcare support and other staffing services. The Human
Capital Management Services segment provides contingent workforce management
services. The Financial Outsourcing Services segment provides funding and back
office support services to independent consulting and staffing companies.
The accounting policies of the segments are the same as those described in
note 2 to the consolidated financial statements of the Company included in the
Company's Annual Report on Form 10-K for the year ended December 29, 2002.
COMFORCE evaluates the performance of its segments and allocates resources to
them based on operating contribution, which represents segment revenues less
direct costs of operations, excluding the allocation of corporate general and
administrative expenses. Assets of the operating segments reflect primarily net
accounts receivable and goodwill associated with segment activities; all other
assets are included as corporate assets. The Company does not account for
expenditures for long-lived assets on a segment basis.
The table below presents information on the revenues and operating
contribution for each segment for the three and nine months ended September 28,
2003 and September 29, 2002, and items which reconcile segment operating
contribution to COMFORCE's reported pre-tax loss before a cumulative effect of a
change in accounting principle (in thousands):
Three Months Ended Nine Months Ended
----------------------------------------------- ----------------------------------------------
September 28, September 29, September 28, September 29,
2003 2002 2003 2002
Net sales of services:
Staff Augmentation $ 47,948 $ 52,902 $ 136,544 $ 160,716
Human Capital
Management Services 46,667 42,898 134,659 123,006
Financial Outsourcing
Services 1,728 2,106 4,824 6,764
---------- ---------- ---------- ----------
$ 96,343 $ 97,906 $ 276,027 $ 290,486
========== ========== ========== ==========
Operating contribution:
Staff Augmentation(1) $ (23,965) $ 4,897 $ (17,224) $ 14,249
Human Capital
Management Services 1,277 1,089 5,309 3,996
Financial Outsourcing
Services (2) 1,178 1,510 4,808 4,290
---------- ---------- ---------- ----------
(21,510) 7,496 (7,107) 22,535
---------- ---------- ---------- ----------
Consolidated expenses
(income):
Corporate general and
administrative
expenses 3,918 3,550 11,293 11,086
Depreciation and
amortization 1,090 1,004 3,207 2,985
Interest and other, net 3,293 4,076 10,059 11,953
Write-off of deferred
financing costs -- -- 431 --
Gain on debt
extinguishment -- -- (8,774) --
---------- ---------- ---------- ----------
8,301 8,630 16,216 26,024
---------- ---------- ---------- ----------
Loss before tax and a
cumulative effect of a
change in accounting
principle $ (29,811) $ (1,134) $ (23,323) $ (3,489)
========== ========== ========== ==========
At September 28, 2003 December 29, 2002
----------------------- --------------------
Total assets:
Staff Augmentation $ 50,234 $ 73,382
Human Capital
Management Services 33,899 32,104
Financial Outsourcing
Services 22,175 28,365
Corporate 25,030 29,013
---------- ----------
$ 131,338 $ 162,864
========== ==========
(1) The Company recorded a goodwill impairment charge of $28.0 million
during the third quarter of 2003 as a charge against operating income in
accordance with the provisions of SFAS 142. See note 11.
(2) Included in the nine months ended September 28, 2003 is a $1.6 million
insurance recovery recorded in the first quarter of 2003 that related to funding
and services fees receivable of $2.4 million which were written off in the
fourth quarter of 2001.
7. PREFERRED STOCK
In February 2003, the Company issued $6.1 million face amount (6,100
shares) of its new Series 2003A Preferred Stock having a fair market value of
$4.3 million in exchange for $12.3 million of its outstanding PIK Debentures
(including accrued interest) from the Fanning CPD Assets, LP, a limited
partnership in which John C. Fanning, the Company's chairman and chief executive
officer, holds the principal economic interest (the "Fanning Partnership").
Rosemary Maniscalco, a director of the Company, is the general partner of the
Fanning Partnership, but has no pecuniary interest therein. The Company obtained
the opinion of an independent investment banking firm that the terms of the
exchange transaction with the Fanning Partnership were fair to the Company from
a financial point of view, and the Company's independent directors approved the
terms of the transaction. The consideration paid to the Fanning Partnership in
February 2003 for the principal amount of the PIK Debentures exchanged in this
transaction approximated in value the consideration that the Fanning Partnership
had previously been paid to the unrelated third party sellers of the PIK
Debentures. The Company's offer to exchange PIK Debentures for Series 2003A
Preferred Stock was extended to all holders of the PIK Debentures that remained
outstanding.
In September 2003, the Company issued shares of its Series 2003B Preferred Stock
having a face amount and fair market value of $513,000 (513 shares) in exchange
for $2.0 million aggregate amount of the Company's 8.0% Subordinated Convertible
Notes due 2009 (the "Convertible Notes"), plus accrued interest, in a
transaction with the Fanning Partnership. The Company obtained the opinion of an
independent investment banking firm that the terms of the exchange transaction
with the Fanning Partnership were fair to the Company from a financial point of
view, and the Company's directors approved the terms of the transaction. The
consideration paid to the Fanning Partnership in September 2003 for the
principal amount of the Convertible Notes exchanged in this transaction was
substantially less than the consideration paid by the Fanning Partnership for
the securities it had previously exchanged for the Convertible Notes. As a
result, the Company has treated this transaction as a contribution to capital
and has recorded an additional $913,000 to additional paid-in capital. In
addition, the conversion price of $0.54 per share for the Series 2003B Preferred
Stock, as discussed below, represents the average closing price of the common
stock for the 15 trading days immediately preceding the date of the effective
date of the transaction (September 26, 2003), it was lower than the $0.82 per
share closing price as of the effective date. As a result of this beneficial
conversion feature, the Company recorded a preferred stock dividend of $266,000
in the third quarter of fiscal 2003.
The rights and preferences of the Series 2003A and Series 2003B Preferred
Stock are substantially identical except that conversion price is $1.05 for the
Series 2003A Preferred Stock and $0.54 for the Series 2003B Preferred Stock. The
conversion price is the price at which a holder of shares of Series 2003A or
200B Preferred Stock may convert such shares into common stock (or, in certain
circumstances, into a participating preferred stock which in turn will be
convertible into common stock at the same effective rate).
Each share of Series 2003A and 2003B Preferred Stock has a face amount of
$1,000, and bears annual cumulative dividends of $75 per share (7.5% per annum).
As of September 28, 2003, there were cumulative unpaid dividends of $280,000.
Upon liquidation, the holders of the Series 2003A and 2003B Preferred Stock will
be entitled to a liquidation preference of $1,000 per share plus the amount of
accumulated, unpaid dividends before any distributions shall be made to the
holders of common stock or any other junior series or class of stock of the
Company. Unless the holders of two-thirds of the shares of Series 2003A and
2003B Preferred Stock outstanding shall have otherwise consented, no series or
class of preferred stock having rights or preferences that are not junior to the
Series 2003A and 2003B Preferred Stock shall be issued by the Company.
The Company can only pay dividends on the Series 2003A and 2003B Preferred
Stock if (i) dividends can legally be paid in accordance with Delaware law, (ii)
the Company's board of directors, in its discretion upon the exercise of its
fiduciary duties, declares that a dividend be paid, (iii) payment of the
dividend is permitted under the terms of the PNC Credit Facility, and (iv) the
Company has sufficient funds to upstream in accordance with the restricted
payments tests under the indenture governing the Senior Notes.
In the event that the conversion of Series 2003A and 2003B Preferred Stock
into common stock of COMFORCE would result in either (i) the occurrence of a
"change of control" as defined in the indenture governing COI's Senior Notes, or
(ii) require stockholder approval in accordance with the rules and regulations
of the Securities and Exchange Commission or the American Stock Exchange (or any
other exchange or quotation system on which the Company's shares are then
listed), then the Series 2003A and 2003B Preferred Stock held by such holder
shall not be convertible into common stock, but rather shall be convertible into
shares of non-voting participating preferred stock having a liquidation
preference of $0.01 per share (but no other preferences) to be created by the
Company. The participating preferred stock will in turn be convertible into the
Company's common stock (on the same basis as if the conversion to common stock
from Series 2003A and 2003B Preferred Stock had occurred directly) if the
conversion will not result in a "change of control" as defined in the indenture
governing the Senior Notes or require stockholder approval in accordance with
the rules and regulations of the Securities and Exchange Commission or the
American Stock Exchange (or any other exchange or quotation system on which the
Company's shares are then listed). At the request of the holders of a majority
of the outstanding participating preferred stock, the Company will seek
stockholder approval for its conversion into common stock.
8. NEW ACCOUNTING STANDARDS
In December 2002, the Financial Accounting Standards Board ("FASB") issued
Statement No. 148, Accounting for Stock-Based Compensation--Transition and
Disclosure ("SFAS 148"). SFAS 148 provides alternative methods of transition for
a voluntary change to the fair value method of accounting for stock-based
employee compensation as originally provided by Statement No. 123, Accounting
for Stock-Based Compensation ("SFAS 123"). Additionally, SFAS 148 amends the
disclosure requirements of SFAS 123 to require prominent disclosure in both the
annual and interim financial statements about the method of accounting for
stock-based compensation and the effect of the method used on reported results.
The transitional requirements of SFAS 148 are effective for all financial
statements for fiscal years ending after December 15, 2002. The Company adopted
the disclosure portion of this statement beginning for the fiscal quarter ended
March 30, 2003. The application of the disclosure portion of this standard did
not have any impact on the Company's consolidated financial position or results
of operations. The FASB has indicated that it will require stock-based employee
compensation to be recorded as a charge to earnings in the future. The Company
will continue to monitor the FASB's progress on the issuance of this standard as
well as to evaluate its position with respect to current guidance.
In May 2003, the FASB issued Statement of Financial Accounting Standards
No. 150, Accounting for Certain Financial Instruments with Characteristics of
both Liabilities and Equity ("SFAS 150"). This accounting standard establishes
standards for classifying and measuring certain financial instruments with
characteristics of both liabilities and equity. It requires that certain
financial instruments that were previously classified as equity now be
classified as a liability. This accounting standard is effective for financial
instruments entered into or modified after May 31, 2003, and otherwise at the
beginning of the first interim period beginning after June 15, 2003. The
adoption of this statement did not have a material impact on the consolidated
financial statements.
9. RECLASSIFICATIONS
Certain reclassifications have been made to conform prior period amounts to
the current period presentation.
10. COMPREHENSIVE INCOME
The components of comprehensive income are as follows (in thousands):
Three months ended Nine months ended
------------------------------------ -------------------------------
Sept. 28, Sept. 29, Sept.28, Sept. 29,
2003 2002 2003 2002
Net loss, as reported $ (26,090) $ (794) $ (23,402) $(55,520)
Foreign currency translation
adjustment -- (184) 96 31
---------------- ---------------- ------------- --------------
Total comprehensive loss
$ (26,090) $ (978) $ (23,306) $(55,489)
================ ================ ============= ==============
11. GOODWILL IMPAIRMENT
The Company tested goodwill for impairment in accordance with the
provisions of SFAS 142 as of the end of the third quarter of fiscal year 2003.
In connection with this goodwill test, the Company engaged an independent firm
to assist management in the determination of the fair values of its reporting
units (as defined by SFAS 142). In its determination of the fair values, the
firm engaged by the Company primarily utilized a discounted cash flow analysis
as well as various other valuation approaches, including (a) recent values paid
by investors and purchasers of companies in businesses similar to that of the
Company, (b) capitalization multiples of companies with investment
characteristics resembling those of the reporting units, (c) the enterprise
value of the Company, and (d) asset and liability structure.
Significant assumptions used in this analysis include (i) expected future
revenue growth rates, operating unit profit margins, and working capital levels,
(ii) a discount rate, and (iii) a terminal value multiple. The revenue growth
rates, working capital levels and operating unit profit margins are based on
management's expectation of future results. As previously discussed, the
Company's operating results, including those of its more specialized operations,
have been negatively impacted by general economic conditions. Based on
management's assessment of the circumstances and considering the firm's
findings, the Company recognized an impairment loss of $28.0 million due to the
Company's inability to meet previous growth expectations. These impairment
losses relate primarily to the goodwill attributable to staffing companies
acquired by the Company in 1996 through 1998, during which time staffing
companies were customarily valued using higher multiples, and these companies
had significantly higher earnings.
If management's expectations of future operating results change, or if
there are changes to other assumptions, the estimate of the fair value of the
Company's reporting units could change significantly. Such a change could result
in additional goodwill impairment charges in future periods, which could have a
significant impact on the Company's consolidated financial statements.
The changes in the carrying amount of goodwill for the nine months ended
September 28, 2003 is as follows (in thousands):
Human
Staff Capital Financial
Augmentation Management Outsourcing Total
---------------- --------------- --------------- ----------------
Balance as of December 29, 2002 $ 51,042 $ 9,200 -- $ 60,242
Impairment losses (28,000)
---------------- --------------- --------------- ----------------
Balance as of September 28, 2003
$ 23,042 $ 9,200 -- $ 32,242
================ =============== =============== ================
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The discussion set forth below supplements the information found in the
unaudited consolidated financial statements and related notes of COMFORCE
Corporation ("COMFORCE") and its wholly-owned subsidiaries, including COMFORCE
Operating, Inc. ("COI") (collectively, the "Company").
Overview
Staffing personnel placed by the Company are employees of the Company. The
Company is responsible for employee related expenses for its employees,
including workers compensation, unemployment compensation insurance, Medicare
and Social Security taxes and general payroll expenses. The Company offers
health, dental, 401(k), disability and life insurance to its eligible billable
employees. Staffing and consulting companies, including the Company, typically
pay their billable employees for their services before receiving payment from
their customers, often resulting in significant outstanding receivables. To the
extent the Company grows, these receivables will increase and there will be
greater requirements for borrowing availability under its credit facility to
fund current operations.
The Company reports its results through three operating segments -- Staff
Augmentation, Human Capital Management Services and Financial Outsourcing
Services. The Staff Augmentation segment provides healthcare support,
information technology (IT), telecom, technical and other staffing services. The
Human Capital Management Services segment provides consulting services for
managing the contingent workforce. The Financial Outsourcing Services segment
provides payroll, funding and back office support services to independent
consulting and staffing companies.
Replacement of Credit Facility
On June 25, 2003, COMFORCE, COI and various of their operating subsidiaries
entered into the PNC Credit Facility with PNC, as a lender and administrative
agent, and other financial institutions participating as lenders to provide for
a $75.0 million revolving credit facility with available borrowings to be based
upon a specified percentage of the Company's eligible accounts receivable. At
closing, the Company borrowed $32.7 million and repaid the Whitehall Credit
Facility, which was thereupon terminated. The Whitehall Credit Facility, which
the Company entered into in December 2000, as subsequently amended, provided for
borrowings of up to $85.0 million. The Company incurred a write-off of deferred
financing costs of $431,000 in the second quarter of 2003 related to the early
retirement of the Whitehall Credit Facility.
Borrowings under the PNC Credit Facility bear interest, at the Company's
option, at a per annum rate equal to either (1) the greater of the base
commercial lending rate of PNC as announced from time to time or the federal
funds rate plus 0.5%, or (2) LIBOR plus a margin ranging from 2.5% if the
Company's fixed charged coverage ratio is greater than 1.30:1 to 3.0% if this
ratio is 1.05:1 or less (with the initial margin fixed at 2.75% until September
1, 2003). The obligations evidenced by the PNC Credit Facility are
collateralized by a pledge of the capital stock of certain key operating
subsidiaries of the Company and by security interests in substantially all of
the assets of the Company. The agreements evidencing the PNC Credit Facility
contain various financial and other covenants and conditions, including, but not
limited to, limitations on paying dividends, engaging in affiliate transactions,
making acquisitions and incurring additional indebtedness. The scheduled
maturity date of the PNC Credit Facility is June 24, 2007. The PNC Credit
Facility affords the Company greater borrowing flexibility and has a maturity
date close to three years beyond the maturity date of the Whitehall Credit
Facility.
Goodwill Impairment
The Company tested goodwill for impairment in accordance with the
provisions of SFAS 142 as of the end of the third quarter of fiscal year 2003.
In connection with this goodwill test, the Company engaged an independent firm
to assist management in the determination of the fair values of its reporting
units (as defined by SFAS 142). In its determination of the fair values, the
firm engaged by the Company primarily utilized a discounted cash flow analysis
as well as various other valuation approaches, including (a) recent values paid
by investors and purchasers of companies in businesses similar to that of the
Company, (b) capitalization multiples of companies with investment
characteristics resembling those of the reporting units, (c) the enterprise
value of the Company, and (d) asset and liability structure.
Significant assumptions used in this analysis include (i) expected future
revenue growth rates, operating unit profit margins, and working capital levels,
(ii) a discount rate, and (iii) a terminal value multiple. The revenue growth
rates, working capital levels and operating unit profit margins are based on
management's expectation of future results. As previously discussed, the
Company's operating results, including those of its more specialized operations,
have been negatively impacted by general economic conditions. Based on
management's assessment of the circumstances and considering the firm's
findings, the Company recognized an impairment loss of $28.0 million due to the
Company's inability to meet previous growth expectations. These impairment
losses relate primarily to the goodwill attributable to staffing companies
acquired by the Company in 1996 through 1998, during which time staffing
companies were customarily valued using higher multiples, and these companies
had significantly higher earnings.
If management's expectations of future operating results change, or if
there are changes to other assumptions, the estimate of the fair value of the
Company's reporting units could change significantly. Such a change could result
in additional goodwill impairment charges in future periods, which could have a
significant impact on the Company's consolidated financial statements.
Critical Accounting Policies
As disclosed in the annual report on Form 10-K for the fiscal year ended
December 29, 2002, the discussion and analysis of our financial condition and
results of operations are based upon our consolidated financial statements,
which have been prepared in conformity with accounting principles generally
accepted in the United States. The preparation of these financial statements
requires us to make estimates and assumptions that affect the reported amounts
of assets, liabilities, revenues and expenses reported in those financial
statements. These judgments can be subjective and complex, and consequently
actual results could differ from those estimates. Our most critical accounting
policies relate to allowance for doubtful accounts; reserves for workers'
compensation; goodwill impairment; and income taxes. Since December 29, 2002,
there have been no changes in our critical accounting policies and no other
significant changes to the methods used in the assumptions and estimates related
to them.
Results of Operations
Three Months Ended September 28, 2003 Compared to Three Months Ended September
29, 2002
Net sales of services for the three month period ended September 28, 2003
were $96.3 million, a decrease of 1.6 % from net sales of services for the three
month period ended September 29, 2002 of $97.9 million. The Company experienced
a decrease in net sales of services in Staff Augmentation and Financial
Outsourcing Services segments, partially offset by an increase in the Human
Capital Management Services segment. Net sales of services in the Human Capital
Management Services segment increased by $3.8 million or 8.8%, principally due
to an increase in its client base. In the Staff Augmentation segment, the
decrease of $5.0 million (9.4%) is principally attributable to reduced sales to
IT and telecom customers, as a result of the continuing effects of the soft
economy, partially offset by increased sales to technical services customers.
Also, principally as a result of the current economic conditions and a reduced
client base, net sales of services were lower by $378,000 (17.9%) in the
Financial Outsourcing Services segment.
Cost of services for the three month period ended September 28, 2003 was
83.5% of net sales of services as compared to cost of services of 82.1% for the
three month period ended September 29, 2002. The cost of services as a
percentage of net sales for the three month period ended September 28, 2003
increased from the comparable period in 2002 principally as a result of a
decrease in permanent placement fees, a decrease in Financial Outsourcing
Services revenues, increased competitive pressures impacting fees and higher
growth in Human Capital Management Services (which have a higher cost of
services as a percentage of net sales of services).
Selling, general and administrative expenses as a percentage of net sales
of services were 13.8% for the three month period ended September 28, 2003,
compared to 13.9% for the three month period ended September 29, 2002.
Management continued to undertake initiatives to reduce selling, general and
administrative costs by renegotiating existing vendor contracts, reducing the
size of or closing marginal offices, reducing back office support staff and
re-evaluating incentive compensation plans, and has reduced costs as sales
decreased. These costs were further reduced by lower commissions as a result of
the decrease of sales discussed above.
Operating loss for the three month period ended September 28, 2003 was
$26.5 million as compared to operating income of $2.9 million for the three
month period ended September 29, 2002. The decrease in operating income for the
three month period ended September 28, 2003 is principally attributable to the
Company's third quarter $28.0 million write-off related to the impairment of
goodwill discussed above and a decrease in sales and gross margins in Staff
Augmentation and Financial Outsourcing Services segments, offset by a decrease
in selling, general and administrative expenses discussed above.
The Company's interest expense for the three month periods ended September
28, 2003 and September 29, 2002 were principally attributable to interest
recorded on the Company's bank credit facilities, the Convertible Notes and the
Senior Notes. The interest expense was lower for the three month period ended
September 28, 2003 as compared to the three month period ended September 29,
2002 principally due to lower market interest rates and lower borrowing levels
under the PNC Credit Facility (as compared to under the Whitehall Credit
Facility, which was in place in 2002) as well as the retirement of PIK
Debentures in the first quarter of 2003. See "Replacement of Credit Facility"
and "Financial Condition, Liquidity and Capital Resources" in this Item 2.
The income tax benefit for the three month period ended September 28, 2003
was $3.7 million on a loss before tax of $29.8 million. The income tax benefit
for the three month period ended September 29, 2002 was $340,000 on a loss
before tax of $1.1 million. The difference between the federal statutory income
tax rate and the Company's effective tax rate relates primarily to the
nondeductibility of a portion of the $28.0 million goodwill impairment discussed
above, interest expense associated with the PIK Debentures which were retired in
the first quarter of 2003, state income taxes, and a disallowance for travel and
entertainment expenses.
Nine Months Ended September 28, 2003 Compared to Nine Months Ended September 29,
2002
Net sales of services for the nine month period ended September 28, 2003
were $276.0 million, a decrease of 5.0 % from net sales of services for the nine
month period ended September 29, 2002 of $290.5 million. The Company experienced
a decrease in net sales of services in Staff Augmentation and Financial
Outsourcing Services segments, partially offset by an increase in the Human
Capital Management Services segment. Net sales of services in the Human Capital
Management Services segment increased by $11.6 million or 9.5%, principally due
to an increase in its client base. In the Staff Augmentation segment, the
decrease of $24.2 million (15.0%) is principally attributable to reduced sales
to IT and telecom customers, as a result of the continuing effects of the soft
economy, partially offset by increased sales to healthcare support and technical
services customers. Also, principally as a result of the current economic
conditions and a reduced client base, net sales of services were lower by $1.9
million (28.7%) in the Financial Outsourcing Services segment.
Cost of services for the nine month period ended September 28, 2003 was
83.0% of net sales of services as compared to cost of services of 81.8% for the
nine month period ended September 29, 2002. The cost of services as a percentage
of net sales for the nine month period ended September 28, 2003 increased from
the comparable period in 2002 principally as a result of a decrease in permanent
placement fees, a decrease in Financial Outsourcing Services revenues, increased
competitive pressures impacting fees and higher growth in Human Capital
Management Services (which have a higher cost of services as a percentage of net
sales of services).
Selling, general and administrative expenses as a percentage of net sales
of services were 13.5% for the nine month period ended September 28, 2003,
compared to 14.2% for the nine month period ended September 29, 2002. Excluding
the $1.6 million insurance recovery in the first quarter of 2003 related to
uncollectible funding and service fees receivable that were written-off in the
fourth quarter of 2001, selling, general and administrative expenses as a
percentage of net sales of services were 14.1% for the nine month period ended
September 28, 2003. Management continued to undertake initiatives to reduce
selling, general and administrative costs by renegotiating existing vendor
contracts, reducing the size of or closing marginal offices, reducing back
office support staff and re-evaluating incentive compensation plans, and has
reduced costs as sales decreased. These costs were further reduced by lower
commissions as a result of the decrease of sales discussed above.
Operating loss for the nine month period ended September 28, 2003 was $21.6
million as compared to operating income of $8.5 million for the nine month
period ended September 29, 2002. The decrease in operating income for the nine
month period ended September 28, 2003 is principally attributable to the
Company's third quarter $28.0 million write-off related to the impairment of
goodwill discussed above and a decrease in sales and gross margins in Staff
Augmentation and Financial Outsourcing Services segments, partially offset by
the $1.6 million insurance claim recovery discussed above.
The Company's interest expense for the nine month period ended September
28, 2003 was principally attributable to interest recorded on its bank credit
facility (the Whitehall Credit Facility until June 25, 2003 and the PNC Credit
Facility thereafter), the Convertible Notes and the Senior Notes and an
assessment made in the second quarter of 2003 of $170,000 of interest as part of
a settlement with the IRS in connection with its audit of tax years 1999 through
2001. The interest expense was lower for the nine month period ended September
28, 2003 as compared to the nine month period ended September 29, 2002
principally due to lower market interest rates and lower borrowing levels under
the bank credit facilities as well as the retirement of PIK Debentures in the
first two quarters of 2003, partially offset by the assessment of interest in
connection with the IRS settlement. See "Replacement of Credit Facility" and
"Financial Condition, Liquidity and Capital Resources" in this Item 2.
The Company incurred a write-off of deferred financing costs of $431,000 in
the second quarter of 2003 related to the early retirement of the Whitehall
Credit Facility.
The gain on debt extinguishment realized by the Company during the nine
months ended September 28, 2003 was the result of the Company's repurchase of
Senior Notes in the second quarter of 2003, and the Company's exchange and
repurchase of PIK Debentures in the first quarter of 2003. As a result of these
transactions, the Company recognized a gain on debt extinguishment of $8.8
million, which includes the reduction of approximately $277,000 of deferred
financing costs, in the first nine months of 2003.
The income tax provision for the nine month period ended September 28, 2003
was $79,000 on loss before tax of $23.3 million. The income tax benefit for the
nine month period ended September 29, 2002 was $769,000 on a loss before tax and
cumulative effect of a change in accounting principle of $3.5 million. The
difference between the federal statutory income tax rate and the Company's
effective tax rate relates primarily to the nondeductibility of a portion of the
$28.0 million goodwill impairment discussed above, interest expense associated
with the PIK Debentures, state income taxes, and a disallowance for travel and
entertainment expenses. Included in income tax for the nine months ended
September 28, 2003 is an assessment of $975,000 based on an income tax audit by
the IRS for tax years 1999 through 2001.
Financial Condition, Liquidity and Capital Resources
The Company generally pays its billable employees weekly for their
services, and remits certain statutory payroll and related taxes as well as
other fringe benefits. Invoices are generated to reflect these costs plus the
Company's markup. These bills are typically paid within 40 days. Increases in
the Company's net sales of services, resulting from expansion of existing
offices or establishment of new offices, will require additional cash resources.
During the three and nine months ended September 28, 2003, the Company had
no off-balance sheet arrangements other than operating leases entered into in
the normal course of business, as indicated in the table below. The following
table represents contractual commitments associated with operating agreements
(excluding interest on debt obligations):
Payments due by period (in thousands)
-----------------------------------------------------------------------------------
2003 2004 2005-6 2007 Thereafter
------------ ------------ ------------ -------------- -------------
Operating Leases $ 3,184 $ 2,418 $ 3,157 $ 1,177 $ 2,645
PNC Credit Facility-- principal
repayments -- -- -- 32,000 --
Senior Notes -
principal -- -- -- 85,000 --
repayments
Convertible Notes -
principal -- -- -- -- 7,135
repayments
------------ ------------ ------------ -------------- -------------
Total $ 3,184 $ 2, 418 $ 3,157 $118,177 $ 9,780
============ ============ ============ ============== =============
The Company also had standby letters of credit outstanding at September 28,
2003 in the aggregate amount of $4.4 million.
During the nine month period ended September 28, 2003, the Company's
primary sources of funds to meet working capital needs were from borrowings
under the PNC Credit Facility and the Whitehall Credit Facility. Effective June
25, 2003, the Company retired the Whitehall Credit Facility upon entering into
the PNC Credit Facility. See "Replacement of Credit Facility" above in this Item
2. Cash and cash equivalents decreased $1.5 million during the nine-month period
ended September 28, 2003. Cash flows provided by operating activities of $4.6
million were exceeded by cash flows used in financing activities of $5.4 million
and cash flows used in investing activities of $673,000.
At September 28, 2003, the Company had outstanding $32.0 million principal
amount under the PNC Credit Facility bearing interest at a weighted average rate
of 3.87% per annum. At such date, the Company had remaining availability based
upon then outstanding eligible accounts receivable of $24.7 million.
At September 28, 2003, the Company also had outstanding (i) $85.0 million
principal amount of Senior Notes bearing interest at a rate of 12% per annum,
(ii) $7.1 million principal amount of Convertible Notes bearing interest at the
rate of 8% per annum, and (iii) had no PIK Debentures outstanding. The Company
has sought to improve its balance sheet. In 2003, it has done so principally
though the issuance of equity securities in exchange for debt obligations,
including the following transactions:
o In February 2003, the Company issued $6.1 million face amount of its
new Series 2003A Preferred Stock having a fair market value of $4.3
million in exchange for $12.3 million of its outstanding PIK
Debentures (including accrued interest) from a related party and
repurchased additional PIK Debentures ($59,000 including interest)
from unrelated parties for a cash payment of $21,000. As a result of
this transaction, the Company recognized a gain on debt extinguishment
of $7.8 million, which includes the reduction of approximately
$240,000 of deferred financing costs, in the third quarter of 2003.
Following this transaction, only $42,000 principal amount of PIK
Debentures remained outstanding. Accordingly, principally in order to
eliminate the costs associated with the administration of the PIK
Debentures, in May 2003, the Company redeemed the remaining PIK
Debentures in accordance with the procedures set forth in the
indenture. See Note 3 and 7 to the consolidated financial statements.
o In June 2003, the Company repurchased $2.0 million principal amount of
Senior Notes for $980,000, resulting in a gain on debt extinguishment
of $983,000, which includes the reduction of approximately $37,000 of
deferred financing costs.
o In September 2003, the Company issued 513 shares of its Series 2003B
Preferred Stock having an aggregate face amount and fair market value
of $513,000 in exchange for $2.0 million principal amount of
Convertible Notes, plus accrued interest, in a transaction with a
related party. See note 3 and 7 to the consolidated financial
statements.
Substantially all of the consolidated net assets of the Company are assets
of COI and all of the net income that had been generated by the Company was
attributable to the operations of COI. Except for permitted distributions, these
assets and any cumulated net income are restricted as to their use by COMFORCE.
The indenture governing the Senior Notes imposes restrictions on COI making
specified payments, which are referred to as "restricted payments," including
making distributions or paying dividends (referred to as upstreaming funds) to
COMFORCE. Under the indenture, COI is not permitted to make cash distributions
to COMFORCE other than (1) to upstream $2.0 million annually to pay public
company expenses, (2) to upstream up to $10.0 million to pay income tax related
to deemed forgiveness of PIK Debentures to facilitate the purchase or exchange
by COMFORCE of PIK Debentures at less than par, (3) under certain circumstances
in connection with a disposition of assets, to upstream proceeds therefrom to
repay the PIK Debentures, and (4) to upstream funds to the extent COI meets the
restricted payments test under the indenture, the most significant component of
which is based upon a percentage of net income generated by COI since January 1,
1998 on a cumulative basis, less prior distributions made in reliance on this
provision.
Management believes that $2.0 million annually (if COI has funds available
for this purpose) will be sufficient to pay COMFORCE's annual public company
expenses for the foreseeable future. Principally as a result of losses incurred
by COI in fiscal 2002 and the nine months ended September 28, 2003 and prior
distributions made by COI to COMFORCE, COI can make no distributions to COMFORCE
based upon the cumulative net income provisions of the indenture. It is
anticipated that COI must generate net income of approximately $5.5 million
before it will be able to upstream funds to COMFORCE under the restrictive
payments test of the indenture. In calculating net income for this purpose,
under the terms of the indenture, the Company must apply generally accepted
accounting principles as in effect at the time the indenture was entered into in
1997.
Through December 1, 2003, interest on the Convertible Notes is payable, at
the option of COMFORCE, in cash or in kind through the issuance of additional
Convertible Notes. To date, COMFORCE has paid all interest under the Convertible
Notes in kind. Beginning with the interest payment due June 1, 2004, COMFORCE
will be required to pay interest on the Convertible Notes in cash. Its ability
to do so is expected to be dependent on its availability of funds for this
purpose, whether through borrowings by COI under the PNC Credit Facility, funds
from COI's operations or otherwise, and on COI's ability to upstream funds in
accordance with the restricted payments test under the indenture for the Senior
Notes. COMFORCE's ability to repay Convertible Notes at their maturity on
December 2, 2009, or on any earlier required repayment or repurchase dates, will
also be dependent on any restrictions under its loan agreements as then in
effect and availability of funds.
The holder of the Convertible Notes, which is a partnership in which John
Fanning, the Company's chairman and chief executive officer, holds the principal
economic interest, has advised that it will agree to extend the payment-in-kind
terms or make other mutually acceptable arrangements if the Company does not
have adequate availability under the indenture to upstream funds to make cash
payments of interest on the Convertible Notes commencing June 1, 2004. The
Company expects to pay appropriate consideration to the holder for agreeing to
this accommodation as may be negotiated by the parties upon the recommendation
of an independent financial advisor.
As of September 28, 2003, approximately $32.2 million, or 24.5%, of the
Company's total assets were goodwill recorded in connection with the Company's
acquisitions. The Company evaluated the recoverability of goodwill on its books
under the new standards under SFAS 142 at its adoption in the first quarter of
2002, resulting in its write-off of $55.0 million of goodwill in that quarter,
again in the fourth quarter of 2002, resulting in an additional write-off of
$19.0 million of goodwill in that quarter, and most recently in the third
quarter of 2003 (as described above in this Item 2 under "Goodwill Impairment"),
resulting in an additional write-off of $28.0 million. The Company must test
goodwill for impairment in accordance with the provisions of SFAS 142 at least
annually. If management's expectations of future operating results change, or if
there are changes to other assumptions, the estimate of the fair value of the
Company's reporting units could change significantly. Such a change could result
in additional goodwill impairment charges in future periods, which could have a
significant impact on the Company's consolidated financial statements.
Management of the Company believes that cash flow from operations and
funds anticipated to be available under the PNC Credit Facility will be
sufficient to service the Company's indebtedness and to meet currently
anticipated working capital requirements throughout 2003. The Company has made
significant progress in improving its capital structure, most recently through
the elimination of debt in connection with its repurchase of PIK Debentures and
Senior Notes and Convertible Notes during the first nine months of 2003, as
described above, but no assurance can be given that opportunities to further
eliminate high interest rate debt will be available on favorable terms. The
Company currently meets all financial covenants under the PNC Credit Facility
and expects to continue to do so at least through the end of fiscal 2003.
However, management is uncertain as to whether it will meet such covenants
thereafter. In the event that the Company is unable to meet any of such
covenants, it anticipates it would receive a waiver or modification, however,
there can be no assurances that the Company will be successful in any such
request.
Impact of Recently Issued Accounting Standards
In December 2002, the Financial Accounting Standards Board ("FASB") issued
Statement No. 148, Accounting for Stock-Based Compensation--Transition and
Disclosure ("SFAS 148"). SFAS 148 provides alternative methods of transition for
a voluntary change to the fair value method of accounting for stock-based
employee compensation as originally provided by Statement No. 123, Accounting
for Stock-Based Compensation ("SFAS 123"). Additionally, SFAS 148 amends the
disclosure requirements of SFAS 123 to require prominent disclosure in both the
annual and interim financial statements about the method of accounting for
stock-based compensation and the effect of the method used on reported results.
The transitional requirements of SFAS 148 are effective for all financial
statements for fiscal years ending after December 15, 2002. The Company adopted
the disclosure portion of this statement for the current fiscal quarter ended
September 28, 2003. The application of the disclosure portion of this standard
did not have any impact on the Company's consolidated financial position or
results of operations. The FASB has indicated that it will require stock-based
employee compensation to be recorded as a charge to earnings in the future. The
Company will continue to monitor the FASB's progress on the issuance of this
standard as well as to evaluate its position with respect to current guidance.
In May 2003, the FASB issued Statement of Financial Accounting Standards
No. 150, Accounting for Certain Financial Instruments with Characteristics of
both Liabilities and Equity ("SFAS 150"). This accounting standard establishes
standards for classifying and measuring certain financial instruments with
characteristics of both liabilities and equity. It requires that certain
financial instruments that were previously classified as equity now be
classified as a liability. This accounting standard is effective for financial
instruments entered into or modified after May 31, 2003, and otherwise at the
beginning of the first interim period beginning after June 15, 2003. The
adoption of this statement did not have a material impact on the consolidated
financial statements.
Seasonality
The Company's quarterly operating results are affected primarily by the
number of billing days in the quarter and the seasonality of its customers'
businesses. Demand for technical and engineering services, IT and telecom
staffing services has historically been lower during the second half of the
fourth quarter through the following first quarter, and, generally, shows
gradual improvement until the second half of the fourth quarter.
Forward Looking Statements
Various statements made in this Report concerning the manner in which the
Company intends to conduct its future operations, and potential trends that may
impact future results of operations, are forward looking statements. The Company
may be unable to realize its plans and objectives due to various important
factors, including, but not limited to the following: a continuation of the
current recessionary environment, particularly in the aircraft manufacturing,
telecom, information technology and other sectors served by the Company (which
may reflect cyclical conditions or, particularly in the case of telecom,
fundamental changes in these industries), could further reduce demand for
contingent personnel and further heighten the competition for customers,
resulting in lower revenues and margins and affecting the Company's ability to
continue to meet the financial covenants under the PNC Credit Facility; the
Company's significant leverage may leave it with a diminished ability to obtain
additional financing for working capital or other capital expenditures, for
retiring higher interest rate debt or for otherwise improving the Company's
competitiveness and capital structure or expanding its operations; SFAS 142,
which requires the Company to evaluate at least annually the recoverability of
goodwill on its books, could cause the Company to write-off goodwill in future
periods (in addition to the write-offs of $74.0 million in 2002 and $28.0
million in 2003), which could have a material adverse impact on the Company's
financial condition and results of operations; or, if COI fails to generate
sufficient consolidated net income (after covering its cumulative deficit at
September 28, 2003 of $5.5 million) or to have other funds available to upstream
to COMFORCE under the restricted payments test of the Senior Notes indenture in
order for it to pay cash interest on the Convertible Notes (which is required
beginning on June 1, 2004) or to repay the Convertible Notes at their maturity
on December 2, 2009, or on any earlier required repayment or repurchase date,
then, unless COMFORCE obtains a loan or sells its capital stock or other
securities to provide funds for this purpose, the Company will default under the
indenture governing the Senior Notes and under the PNC Credit Facility.
Additional important factors that could cause the Company to be unable to
realize its plans and objectives are described under "Risk Factors" in the
Registration Statement on Form S-8 of the Company filed with the Securities and
Exchange Commission on April 24, 2003 (Registration No. 333-104730). The
disclosure under "Risk Factors" in the Registration Statement may be accessed
through the Web site maintained by the Securities and Exchange Commission at
"www.sec.gov." In addition, the Company will provide, without charge, a copy of
such "Risk Factors" disclosure to each stockholder of the Company who requests
such information. Requests for copies should be directed to the attention of
Linda Annicelli, Vice President, Administration at COMFORCE Corporation, 415
Crossways Park Drive, P.O. Box 9006, Woodbury, New York 11797, telephone
516-437-3300.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The information required by Item 3 has been disclosed in Item 7A of the
Company's Annual Report on Form 10-K for the year ended December 29, 2002. There
has been no material change in the disclosure regarding market risk.
ITEM 4. CONTROLS AND PROCEDURES
The company's management evaluated, with the participation of the chief
executive officer and chief financial officer, the effectiveness of the
Company's disclosure controls and procedures as of the end of the period covered
by this report. Based on that evaluation, the chief executive officer and chief
financial officer have concluded that the Company's disclosure controls and
procedures were effective as of the end of the period covered by this report.
There has been no change in the Company's internal control over financial
reporting that occurred during the quarter covered by this report that has
materially affected, or is reasonably likely to materially affect, the Company's
internal control over financial reporting.
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS.
Since the date of the filing of the Company's Annual Report on Form 10-K
for the year ended December 29, 2002, there have been no material new legal
proceedings involving the Company or any material developments to the
proceedings described in such 10-K.
ITEM 2. Changes in Securities and Use of Proceeds.
In September 2003, the Company issued shares of its Series 2003B Preferred
Stock having a face amount and fair market value of $513,000 (513 shares) in
exchange for $2.0 million aggregate amount of the Company's Convertible Notes,
plus accrued interest, in a transaction the Fanning Partnership. The Company
obtained the opinion of an independent investment banking firm that the terms of
the exchange transaction with the Fanning Partnership were fair to the Company
from a financial point of view, and the Company's directors approved the terms
of the transaction. The consideration paid to the Fanning Partnership in
September 2003 for the principal amount of the Convertible Notes exchanged in
this transaction was substantially less than the consideration paid by the
Fanning Partnership for the securities it had previously exchanged for the
Convertible Notes.
As described in note 7 to the consolidated financial statements (which
description is incorporated herein by reference), the rights and preferences of
the Series 2003A and Series 2003B Preferred Stock are substantially identical
except that conversion price is $1.05 for the Series 2003A Preferred Stock and
$0.54 for the Series 2003B Preferred Stock to convert such shares into common
stock (or, in certain circumstances, into a participating preferred stock which
in turn will be convertible into common stock at the same effective rate).
These shares of Series 2003B Preferred Stock were issued to the Fanning
Partnership in reliance upon the exemptions from registration afforded by
section 3(a)(9) or section 4(2) of the Securities Act of 1933 and the
regulations thereunder. Unless the Company registers the shares of common stock
issuable upon conversion of the Series 2003A Preferred Stock for resale under
the Securities Act of 1933, any resale of those shares by the Fanning
Partnership, as an affiliate of the Company, will be conducted in compliance
with the volume limitations and other conditions of Rule 144 of the Securities
Act of 1933 (other than the holding period requirement).
ITEM 3. Defaults Upon Senior Securities.
Not applicable.
ITEM 4. Submission of Matters to a Vote of Security Holders.
On August 13, 2003, the annual meeting of the stockholders of the Company
was held. At this meeting, the stockholders holders voted on (1) the election of
directors, with each to serve for a term of one year, and (2) the approval of
the Company's issuance of 13,650,000 additional shares of common stock, and (3)
ratification of the appointment of KPMG LLP as the Company's auditors for the
year ending December 28, 2003.
The following individuals were elected to the Board of Directors upon the
vote shown:
Nominee For Withheld
------- --- --------
John C. Fanning 15,418,868 172,075
Harry V. Maccarrone 15,518,868 171,975
Rosemary Maniscalco 15,449,175 141,768
Kenneth J. Daley 15,449,181 141,762
Daniel Raynor 15,552,690 38,253
Gordon Robinett 15,449,183 141,760
The stockholders approved the Company's issuance of 13,650,000 additional
shares of common stock:
Broker
For Against Abstained Non-Votes
--- ------- --------- ---------
8,455,334 1,537,645 4,072 5,593,892
The stockholders approved the Company's the appointment of KPMG LLP as
the Company's independent certified public accountants:
Broker
For Against Abstained Non-Votes
--- ------- --------- ---------
15,574,595 12,613 3,735 --
ITEM 5. Other Information.
Not applicable.
ITEM 6. Exhibits and Reports on Form 8-K.
(a) Exhibits.
3.1 Amended and Restated Certificate of Designation and Determination
of Rights and Preferences of Series 2003A and 2003B Convertible
Preferred Stock of COMFORCE Corporation filed with the Secretary
of State of Delaware on October 6, 2003.
31.1 Certification of chief executive officer pursuant to section 302
of the Sarbanes-Oxley Act of 2002.
31.2 Certification of chief financial officer pursuant to section 302
of the Sarbanes-Oxley Act of 2002.
32.1 Certification of chief executive officer pursuant to section 906
of the Sarbanes-Oxley Act of 2002.
32.2 Certification of chief financial officer pursuant to section 906
of the Sarbanes-Oxley Act of 2002.
(b) Reports on Form 8-K.
The Company filed a current report on Form 8-K on August 8, 2003
to furnish its press release reporting results for the quarter ended
June 29, 2003.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, each
Registrant has duly caused this Report to be signed on its behalf by the
undersigned thereunder duly authorized.
COMFORCE Corporation
By: /s/ Harry V. Maccarrone
-----------------------------------------------
Harry V. Maccarrone,
Executive Vice President and Chief Financial Officer
Date: November 12, 2003