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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549

FORM 10-Q

For the transition period from __________to____________

Commission File Number 001-13956

PERSONNEL GROUP OF AMERICA, INC.
(Exact name of registrant as specified in its charter)

(704) 442-5100
(Registrant’s telephone number including area code)

None
(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.

[X]   Yes              [   ]   No

As of July 29, 2002, there were 26,741,857 shares of outstanding common stock, par value $.01 per share.

PERSONNEL GROUP OF AMERICA, INC.
TABLE OF CONTENTS

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PERSONNEL GROUP OF AMERICA, INC.

The accompanying notes are an integral part of these balance sheets.

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PERSONNEL GROUP OF AMERICA, INC.

The accompanying notes are an integral part of these balance sheets.

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PERSONNEL GROUP OF AMERICA, INC.

The accompanying notes are an integral part of these balance sheets.

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PERSONNEL GROUP OF AMERICA, INC.

(1)

General

     The unaudited consolidated financial statements included herein have been prepared in accordance with the instructions to Form 10-Q and do not include all the information and footnotes required by generally accepted accounting principles; however, they do include all adjustments of a normal recurring nature that, in the opinion of management, are necessary to present fairly the results of operations of the Company for the interim periods presented. These interim financial statements should be read in conjunction with the Company’s audited consolidated financial statements and related notes included in the Company’s Annual Report on Form 10-K for the year ended December 30, 2001. The results of operations for the interim periods presented are not necessarily indicative of the results to be expected for the entire year.

     The Company has adopted Statement of Financial Accounting Standards No. 142 (SFAS 142), Goodwill and Other Intangible Assets, as of the beginning of 2002. As permitted by SFAS 142, the Company completed its impairment analysis during the second quarter and has restated the first quarter results to record the intangibles impairment as a cumulative effect of the change in accounting principle as of the beginning of the year, see Note 2, “Intangible Assets and Change in Accounting Principle.” Additionally, the Company has restated its first quarter results to increase the loss before cumulative effect of change in accounting principle due to an adjustment to the provision for income taxes of $5,222, or $0.20 per share. This adjustment, which was also required as a result of adopting SFAS 142, reduced deferred tax assets due to the establishment of a valuation allowance against certain deferred tax assets, but had no effect on the Company’s cash flows. The impact of these restatements on the Company’s first quarter operating results is shown below:

Debt Compliance

     The Company experienced declines in operating results for the year ended December 30, 2001 and the first half of 2002 as compared in each case to prior year due to the weak economic environment. In response to the deterioration in operating performance, the Company undertook several initiatives beginning in 2001, including the following:

	•		A number of restructuring actions, including a permanent workforce reduction of approximately 36% and office space rationalization efforts. Management expects further headcount and infrastructure rationalization over the balance of 2002;
	•		The divesture of an under-performing business on December 31, 2001;
	•		An amendment to its revolving credit facility extending the facility’s maturity to January 2003, with additional extensions to January 2004 assuming certain conditions are met; and
	•		A concerted effort to reduce accounts receivable, which resulted in substantial cash flow that was used to reduce debt.

     The Company’s ability to continue operating is largely dependent upon its ability to maintain compliance with the financial covenants in the Company’s amended revolving credit facility (the “Credit Facility”). The Company was able to maintain compliance with its Credit Facility as of December 30, 2001 after obtaining a waiver in December 2001 of an anticipated default under certain financial ratios for the fourth quarter of 2001. The Credit Facility was then amended in February and March 2002, with modification of the financial covenants to reflect the weak economic environment beginning with the fourth quarter of 2001 and extending through the new maturity date of the Credit Facility, January 2003 (with extensions to January 2004 assuming certain conditions are met). As a result of these amendments, the Credit Facility, which had an outstanding balance of $104,700 at June 30, 2002, is classified as long-term in the consolidated balance sheet. For further discussion of the Company’s Credit Facility and debt compliance matters, see “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Liquidity and Capital Resources.”

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(2)

Intangible Assets and Change in Accounting Principle

     Intangible assets are principally comprised of goodwill. The Company’s businesses have been acquired from unrelated third parties for cash and other consideration and have been accounted for using the purchase method of accounting. The assets and liabilities of the entities acquired were recorded at their estimated fair values at the dates of the acquisitions. Excess of cost over fair value of net assets acquired resulting from such acquisitions has been recorded at historical cost. Other intangible assets consist mainly of covenants not to compete.

     Effective at the beginning of 2002, the Company adopted SFAS 142. The provisions of SFAS 142 prohibit the amortization of goodwill for indefinite-lived intangible assets and require that goodwill and indefinite-lived intangibles assets be tested annually for impairment. In order to assess the fair value of its goodwill as of the adoption date, the Company engaged an independent valuation firm to assist in determining the fair value. The fair value of each of the Company’s two reporting units was calculated as of December 31, 2001, on an enterprise value basis using the following approaches: (i) market multiple approach and (ii) discounted cash flow approach. Under the market multiple approach, market ratios and performance fundamentals relating to similar public companies’ stock prices or enterprise values were applied to the reporting units to determine their enterprise value. Under the discounted cash flow (“DCF”) approach, the indicated enterprise value was determined using the present value of the projected future cash flows to be generated considering appropriate discount rates. The discount rates used in the calculation reflected all associated risks of realizing the projected future cash flows. Certain of the valuation assumptions are based on management’s expectations for future performance of the IT Services and Commercial Staffing reporting units. These assumptions include expected time frame of technology spending and broader economic recoveries as well as future growth rates in the IT Services and Commercial Staffing businesses. A relatively high discount rate of 17% was utilized in the discounted cash flow valuation approach due principally to the inherent uncertainties associated with these assumptions. While current year to date performance and outlook is generally consistent with the assumptions used in the valuation, any significant adverse changes would likely result in further impairment of the Company’s intangible assets. Based upon the results of the valuation, which was completed in the second quarter, the Company recorded an intangibles impairment charge of $284,695 ($242,497 net of an income tax benefit of $42,198) as a cumulative effect of the change in accounting principle. A reconciliation of intangible assets from December 30, 2001 to June 30, 2002 is as follows:

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     The following table sets forth a reconciliation of net loss and earnings per share information for the periods ended June 30, 2002 and July 1, 2001, adjusted for the non-amortization provisions of SFAS 142:

(3)

Long-term Debt

     Long-term debt consisted of the following at June 30, 2002 and December 30, 2001:

     The Company’s 5-3/4% Convertible Subordinated Notes (the “Notes”) are due July 2004. Interest on the Notes is payable semi-annually. The Notes are convertible into Common Stock of the Company at any time before maturity at an initial conversion price of $17.81 per share. Beginning in July 2000, the Company was permitted to redeem the Notes initially at 103.29% and at decreasing prices thereafter to 100% at maturity, in each case together with accrued interest. The Notes are subordinated to all present and future senior indebtedness of the Company (as defined), including indebtedness under the Company’s Credit Facility.

     The Credit Facility was amended in February and March 2002 to provide for a $136,000 revolving line of credit due January 2003. Assuming the Company is in compliance with the financial covenants set forth in the agreement and the payment of an extension fee, the Company at its option may further extend the maturity of the facility in six-month increments up through January 2004. As a result of these amendments, the outstanding balance under the Credit Facility,

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which was $104,700 at June 30, 2002, is classified as long-term in the consolidated balance sheet. The amended Credit Facility contains customary covenants that require quarterly maintenance of certain financial ratios, minimum tangible net worth and a restriction on the payment of cash dividends on the Common Stock. It also places additional limitations on share repurchases, acquisitions and capital expenditures and includes an Equity Appreciation Rights agreement (the “EAR”) whereby the Company must pay a fee (the “Rights Fee”) to the lenders in the event of default under the Credit Facility or if the Credit Facility has not been paid in full by January 1, 2004. The Rights Fee is the greater of 10% of the fair market value of the Company (as defined in the EAR) as of the exercise date of the EAR or $3,000. Interest rates payable under the amended Credit Facility are currently set at prime plus 250 basis points through December 2002, with increases during each six-month period thereafter through January 2004.

     The principal financial covenants in the Credit Facility are highly dependent upon the Company’s EBITDA levels, as measured at each quarter end on a rolling four-quarter basis, and include an interest coverage ratio and a leverage ratio. The amended Credit Facility provides for certain adjustments that increase EBITDA, including certain restructuring and rationalization charges and certain other charges. The adjusted EBITDA for the trailing four quarters ended June 30, 2002 were $8,817, $6,800, $3,709 and $4,198, respectively. In addition to the quarterly covenants, the amended agreement includes EBITDA and liquidity requirements to be measured based on the six-month periods ending November 2002 and May 2003. The Company believes its margin for compliance throughout 2002 is at its lowest level for the November 2002 EBITDA covenant. In order to stay in compliance with this covenant, the Company will need to generate adjusted EBITDA of at least $7,207 for the six-month period ending November 2002.

     Based on the Company’s fiscal 2002 projections, which reflect the declining demand for the Company’s services, offset by reductions in costs principally resulting from reduced revenues and the Company’s restructuring and rationalization activities, management believes the Company will be able to maintain compliance with the modified financial covenants for the remaining term of the Credit Facility. The Company also believes that the operating results in the first half of 2002 support the key assumptions in its 2002 operating plan. However, there can be no assurance that the economy or the Company will perform as expected or that further economic declines will not adversely impact the Company’s ability to comply with its covenants. If actual results of operations do not meet current forecasts, covenant violations could occur. If the Company does violate covenants in the future, it would seek further waivers and amendments from its lenders, but can give no assurance that any such necessary waivers and amendments would be available at all or otherwise on acceptable terms. If the Company were unable to obtain a waiver of future covenant violations, the lenders would be entitled to require immediate repayment of all amounts outstanding under the Credit Facility and, as described above, payment of the Rights Fee. An acceleration of outstanding amounts under the Credit Facility could also cause a default under, and permit acceleration of, the Notes. In the event of one or more such defaults, the Company’s ongoing viability would be seriously threatened, and it would be forced to evaluate a number of strategic alternatives, including a debt restructuring or other reorganization, the closure of certain locations or the sale of certain or all of its assets in order to continue to fund its operations. In the current economic environment, management believes that asset sales, if any, would be at depressed prices that could be significantly lower than the net book value of assets sold and may not be sufficient to satisfy the Company’s liabilities.

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(4)

Earnings Per Share

     The following table reconciles net income (loss) and weighted average common shares outstanding to the amounts used to calculate basic and diluted earnings per share for each of the periods ended June 30, 2002 and July 1, 2001:

     Stock options to purchase 4,195,296 and 4,532,183 shares of Common Stock were outstanding during the quarters ended June 30, 2002 and July 1, 2001, respectively, but were excluded from the computation of earnings per diluted share because their effect was antidilutive. The conversion of the Notes into 6,456,140 common shares was also excluded from the computation of earnings per diluted share because their effect was antidilutive.

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(5)

Segment Information

     The Company is organized in two segments: Information Technology Services (“IT Services”) and Commercial Staffing Services (“Commercial Staffing”). IT Services provides technical staffing, training and information technology consulting services and technology tools for human capital management. Commercial Staffing provides temporary staffing services, placement of full-time employees and on-site management of temporary employees. The Company evaluates segment performance based on income from operations before corporate expenses, restructuring, rationalization and intangibles impairment charges, amortization of intangible assets, interest and income taxes. Because of the Company’s substantial intangible assets, management does not consider total assets by segment an important management tool and, accordingly, the Company does not report this information separately.

     The table below presents segment information for the quarters ended June 30, 2002 and July 1, 2001:

     The following table sets forth selected identifiable assets by segment at June 30, 2002 and December 30, 2001:

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ITEM 2.    MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

INTRODUCTION

     The following discussion and analysis should be read in conjunction with the Company’s unaudited consolidated financial statements and related notes appearing elsewhere in this report. The Company’s fiscal year ends on the Sunday nearest to December 31.

FORWARD-LOOKING INFORMATION

     In addition to historical information, this report, including “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” contains certain information that may be deemed forward-looking statements, within the meaning of Section 21E of the Securities Exchange Act of 1934, regarding events and financial trends, that may affect the Company’s future operating results or financial position and that are based on management’s belief and assumptions, as well as information currently available to management. These statements may be identified by words such as “estimate,” “forecast,” “plan,” “intend,” “believe,” “should,” “expect,” “anticipate,” or variations or negatives thereof, or by similar or comparable words or phrases. Forward-looking statements are subject to risks and uncertainties that could cause actual results to differ materially from those expressed in such statements. These risks and uncertainties include, but are not limited to, the following: the risk of further violations of New York Stock Exchange continued listing standards or of New York Stock Exchange delisting based on existing or future violations; changes in levels of unemployment and other economic conditions in the United States, or in particular regions or industries; adverse changes in credit and capital markets conditions that may affect the Company’s ability to obtain financing or refinancing on favorable terms; economic declines that affect the Company’s liquidity or ability to comply with its loan covenants; reductions in corporate information technology spending levels; adverse changes to management’s periodic estimates of future cash flows that may affect management’s assessment of its ability to fully recover its intangible assets; reductions in the supply of qualified candidates for temporary employment or the Company’s ability to attract qualified candidates; the entry of new competitors into the marketplace or expansion by existing competitors; the ability of the Company to maintain existing client relationships and attract new clients in the context of changing economic or competitive conditions; the impact of competitive pressures, including any change in the demand for its services, or the Company’s ability to maintain its profit margins; the possibility of the Company incurring liability for the activities of its temporary employees or for events impacting its temporary employees on clients’ premises; the Company’s success in attracting, training and retaining qualified management personnel and other staff employees; whether governments will impose additional regulations or licensing requirements on personnel services businesses in particular or on employer/employee relationships in general, and other matters discussed in this report and the Company’s other filings with the Securities and Exchange Commission. Because long-term contracts are not a significant part of the Company’s business, future results cannot be reliably predicted by considering past trends or extrapolating past results. The Company undertakes no obligation to update information contained in this report.

OVERVIEW

     The Company is organized into two Divisions: the Information Technology Services Division (“IT Services”), which provides information technology staffing and consulting services in a range of computer-related disciplines and technology tools for human capital management, and the Commercial Staffing Services Division (“Commercial Staffing”), which provides a variety of temporary office, clerical, accounting and finance, light technical and light industrial staffing services.

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Approximately 55% of the Company’s second quarter 2002 revenues came from IT Services and 45% came from Commercial Staffing.

     The Information Technology Services business is affected by the timing of holidays and seasonal vacation patterns, generally resulting in lower IT revenues and gross margins in the fourth quarter of each year. The Commercial Staffing business is subject to the seasonal impact of summer and holiday employment trends. Typically, the Commercial Staffing business is stronger in the second half of each calendar year than in the first half, subject to general economic conditions.

RESULTS OF OPERATIONS

     Quarter Ended June 30, 2002 Versus Quarter Ended July 1, 2001

     Revenues. Total revenues decreased 27.1% to $141.7 million in the second quarter of 2002 from $194.4 million in the second quarter of 2001. IT Services revenues decreased 35.8% primarily as the result of the continuing industry-wide slowdown in customer demand for IT staffing services. IT Services billable consultants on assignment declined from approximately 2,300 at the end of the first quarter of 2002 to approximately 2,200 at the end of the second quarter. Commercial Staffing revenues declined 12.8% to $64.1 million in the second quarter of 2002 primarily due to the weak economic climate, which resulted in declines in permanent placement revenues and the retail component of the Company’s temporary staffing business. Permanent placement revenues were 4.0% of Commercial Staffing revenues in the second quarter of 2002, down from 7.1% in 2001, and the retail component of temporary staffing declined to 68.2% of Commercial Staffing temporary revenues in the second quarter of 2002, down from 79.1% in 2001. The Company does not expect improvements in demand for its services until later in 2002 due to expected ongoing uncertain economic conditions, particularly in the technology sectors. In addition, there can be no assurance that IT Services revenues will increase as the broader economy increases.

     Direct Costs of Services and Gross Profit. Direct costs, consisting of payroll and related expenses of consultants and temporary workers, decreased 23.9% to $108.4 million in the second quarter of 2002 on the lower revenues. Gross profit decreased 35.8% to $33.3 million on the lower revenues. Gross profit as a percentage of revenue decreased 320 basis points to 23.5% in the second quarter of 2002 from 26.7% in the second quarter of 2001. This decrease primarily was the result of the continued softening in the higher margin sectors of the staffing and consulting businesses, the significant decline in the retail component of temporary staffing and permanent placement services in Commercial Staffing and downward bill rate pressure imposed by many of the Company’s larger customers, which are expected to negatively impact gross profit for the foreseeable future.

     Operating Expenses. Operating expenses, consisting of selling, general and administrative expenses, before restructuring and rationalization charges and depreciation and amortization expense, decreased 33.3% to $30.9 million in the second quarter of 2002 from $46.3 million in 2001. The decrease was primarily due to the Company’s aggressive cost containment program, including its workforce reduction and office consolidation initiatives. Approximately 36% of the Company’s permanent workforce has been eliminated since the beginning of 2001. Also, variable or incentive compensation declined due to lower revenues and operating margins. As a percentage of revenues, selling, general and administrative expenses decreased to 20.6% in the second quarter of 2002 from 20.7% in 2001. In addition, depreciation and amortization expense decreased to 1.2% of revenues in the second quarter of 2002 from 3.1% in 2001 primarily due to the change in accounting principle eliminating goodwill amortization in 2002. Goodwill amortization expense was $3.9 million in the second quarter of 2001.

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     Restructuring and Rationalization Charges. Beginning in 2001, the Company implemented a plan to restructure and rationalize certain operations. Pursuant to this plan, the Company recorded charges totaling $1.5 million in the second quarter of 2002. These charges were comprised of the following components: employee severance of $0.7 million and other charges of $0.8 million.

     Following is a summary of the accrued liability for cash restructuring and rationalization charges for the quarter ended June 30, 2002:

     Employee severance-related costs include the elimination of both administrative and income-producing employees. Under the workforce reduction plan, the Company terminated 78 employees in the second quarter of 2002, increasing the total workforce reduction to approximately 36%, or 538 employees, since the beginning of 2001. Lease termination costs relate primarily to office closures, branch consolidations and lease space reductions. Other rationalization expenses of $0.8 million were recorded in the second quarter of 2002 associated with professional services expenses and branding costs.

     Of the remaining accrued liability at June 30, 2002, the Company expects to pay approximately $1.3 million over the next 12 months and the balance, primarily lease termination payments, over the next eight years.

     The Company expects to continue consolidating certain administrative functions and operations in other geographic markets in which the Company currently operates multiple branches and to downsize in selected other existing locations, which will result in additional restructuring and rationalization charges throughout 2002; however, the amount of such additional charges is not currently determinable.

     Interest Expense. Interest expense decreased 13.2% to $4.4 million in the second quarter of 2002 from $5.1 million in 2001 due to lower borrowing levels under the Company’s bank revolving credit facility (the “Credit Facility”) and decreases in interest rates. The average interest rate on borrowings was 7.3% in the second quarter of 2002, down 110 basis points from 2001. See “ — Liquidity and Capital Resources.”

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     Provision (Benefit) for Income Taxes. The effective tax benefit rate of 20% in the second quarter of 2002 was lower than the U.S. federal statutory rate of 35% primarily due to the impact of non-deductible expenses and the provision of valuation allowances against deferred income tax assets. The Company currently expects the effective tax benefit rate to continue at approximately 20% for the balance of 2002. Because the Company is providing a valuation allowance against certain deferred tax assets, the effective tax benefit rate could change if actual 2002 temporary differences vary from current estimates. The income tax benefit recorded in the second quarter of 2001 was comprised of the tax benefit related to the operating loss for the period and the $1.4 million tax benefit related to the diminution in value in the Company’s investment in CareerShop.com, which was sold during the second quarter of 2001.

RESULTS OF OPERATIONS

     Six Months Ended June 30, 2002 Versus Six Months Ended July 1, 2001

     Revenues. Total revenues decreased 29.8% to $283.8 million in the first six months of 2002 from $404.0 million in the first six months of 2001. IT Services revenues decreased 36.8% to $159.9 million in the first six months of 2002 primarily as the result of the continuing industry-wide slowdown in customer demand for IT staffing services. IT Services billable consultants on assignment declined from approximately 2,500 at the end of 2001 to approximately 2,200 at the end of the second quarter of 2002. Commercial Staffing revenues declined 18.0% to $123.8 million in the first six months of 2002 primarily due to the weak economic climate, which resulted in declines in permanent placement revenues and the retail component of the Company’s temporary staffing business. Permanent placement revenues were 3.7% of Commercial Staffing revenues in the first six months of 2002, down from 7.8% in 2001, and the retail component of temporary staffing declined to 68.5% of Commercial Staffing temporary revenues in the first six months of 2002, down from 81.0% in 2001. The Company does not expect improvements in demand for its services until later in 2002 due to expected ongoing uncertain economic conditions, particularly in the technology sectors. In addition, there can be no assurance that IT Services revenues will increase as the broader economy increases.

     Direct Costs of Services and Gross Profit. Direct costs, consisting of payroll and related expenses of consultants and temporary workers, decreased 26.6% to $216.7 million in the first six months of 2002 on the lower revenues. Gross profit decreased 38.3% to $67.1 million on the lower revenues. Gross profit as a percentage of revenue decreased 320 basis points to 23.7% in the first six months of 2002 from 26.9% in the first six months of 2001. This decrease primarily was the result of the continued softening in the higher margin sectors of the staffing and consulting businesses, the significant decline in the retail component of temporary staffing and permanent placement services in Commercial Staffing and downward bill rate pressure imposed by many of the Company’s larger customers, which are expected to negatively impact gross profit for the foreseeable future.

     Operating Expenses. Operating expenses, consisting of selling, general and administrative expenses, before restructuring and rationalization charges and depreciation and amortization expense, decreased 34.6% to $62.8 million in the first six months of 2002 from $95.9 million in 2001. The decrease was primarily due to the Company’s aggressive cost containment program, including its workforce reduction and office consolidation initiatives. Approximately 36% of the Company’s permanent workforce has been eliminated since the beginning of 2001. Also, variable or incentive compensation declined due to lower revenues and operating margins. As a percentage of revenues, selling, general and administrative expenses increased to 20.9% in the first six months of 2002 from 20.7% in 2001. In addition, depreciation and amortization expense decreased to 1.3% of revenues in the first six months of 2002 from 3.0% in 2001 primarily due to the change in accounting principles eliminating goodwill amortization in 2002. Goodwill amortization expense was $7.7 million in the first six months of 2001.

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     Restructuring and Rationalization Charges. Beginning in 2001 the Company implemented a plan to restructure and rationalize certain operations. Pursuant to this plan, the Company recorded charges totaling $1.8 million in the first six months of 2002. These charges were comprised of the following components: employee severance of $0.8 million, lease termination charges of $0.2 million and other charges of $0.8 million.

     Following is a summary of the accrued liability for cash restructuring and rationalization charges for the six months ended June 30, 2002: