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| WSTF > SEC Filings for WSTF > Form 10-K on 13-Feb-2009 | All Recent SEC Filings |
13-Feb-2009
Annual Report
The following discussion is intended to assist in the understanding and assessment of significant changes and trends related to the results of operations and financial condition of Westaff, Inc., together with its consolidated subsidiaries. This discussion and analysis should be read in conjunction with our consolidated financial statements and notes thereto included elsewhere in this Annual Report on Form 10-K for the fiscal year ended November 1, 2008. Our fiscal year ends on the Saturday nearest the end of October and consists of either 52 or 53 weeks. The fiscal year ended November 1, 2008 consisted of 52 weeks while the fiscal year ended November 3, 2007 consisted of 53 weeks.
References in this Annual Report on Form 10-K to the "Company," "Westaff," "we," "our," and "us" refer to Westaff, Inc., its predecessor and their respective subsidiaries, unless the context otherwise requires.
Cautionary Statement Regarding Forward-Looking Statements
This Annual Report on Form 10-K contains forward-looking statements within the "safe harbor" provisions of the Private Securities Litigation Reform Act of 1995. Except for statements that are purely historical, all statements included in this Annual Report on Form 10-K are forward-looking statements, and readers are cautioned not to place undue reliance on those statements. You can also identify these statements by the fact that they do not relate strictly to current facts and use words such as "will," "anticipate," "estimate," "expect," "project," "intend," "plan," "believe," "target," "forecast," and other words and terms of similar meaning in connection with any discussion of future operating or financial performance. The forward-looking statements include, without limitation our ability to achieve better people and process efficiencies as a result of changes to our operational structure, our ability to enhance the profitability of our accounts through hiring industry-proven placement consultants, and our ability to reduce selling and administrative costs. These statements are only predictions, and actual events or results may differ materially. The forward-looking statements provide our current expectations or forecasts of future events. These forward-looking statements are made based on information available as of the date of this report and are subject to a number of risks and uncertainties that could cause the Company's actual results and financial position to differ materially from those expressed or implied in forward-looking statements and to be below the expectations of public market analysts and investors. Investors should bear this in mind as they consider forward-looking statements. These risks and uncertainties include, but are not limited to, those discussed in Part I, Item 1A, "Risk Factors" and elsewhere in this Annual Report on Form 10-K. You should understand that it is not possible to predict or identify all such factors. Consequently, you should not consider any such list to be a complete set of all potential risks or uncertainties faced by us.
The Company undertakes no obligation to publicly release the results of any revisions to these forward-looking statements to reflect events or circumstances after the date hereof or to reflect the occurrence of unanticipated events, except as required by applicable laws and regulations.
Company Overview
We provide staffing services primarily in suburban and rural markets ("secondary markets"), as well as in the downtown areas of certain major urban centers ("primary markets") in the United States ("US") through our network of Company-owned and franchise agent offices. On March 31, 2008, the Company sold its former United Kingdom operations and related subsidiary. On November 10, 2008, the Company sold its Australia and New Zealand subsidiaries pursuant to a definitive agreement that was previously entered into on September 27, 2008. The sale was completed in the first quarter of fiscal year 2009 and is described in Note 5 to the consolidated financial statements included elsewhere in this Annual Report on Form 10-K.
We offer a wide range of staffing solutions, including permanent placement, replacement, supplemental and on-site temporary programs to businesses and government agencies. Our primary focus is on recruiting and placing clerical/administrative and light industrial personnel. We have 60 years of experience in the staffing industry and currently we operate through a network of 157 offices operated domestically in 42 states. 62% of these offices were Company-owned and operated and 38% were operated by franchise agents. Our corporate headquarters provides support services to the field offices, in areas such as marketing, human resources, risk management, legal, strategic sales, accounting, and information technology.
To complement our service offerings, which include temporary staffing, permanent placement, temp-to-hire services, payroll services and on-location programs, we utilize a number of tools focused on increasing our pool of qualified candidates. Additionally, we employ a robust, targeted marketing program as well as a consultative sales process, and both of these tools assist in our sales efforts to new and existing customers. Management believes all of these tools enhance our competitive edge and position us to effectively pursue high growth market niches.
The staffing industry is highly competitive with generally few barriers to entry, which contributes to significant price competition as competitors attempt to maintain or gain market share. On a prospective basis, we believe our focus on increasing clerical and administrative sales, improving results from underperforming field offices and prudently managing costs will permit us to improve our operating margins.
Our business tends to be seasonal, with sales for the first fiscal quarter typically lower than other fiscal quarters. This decrease results from the traditional holidays that are included within the first fiscal quarter, as well as other customer closures for the holiday season. These closures and post-holiday season declines in business activity negatively impact orders received from customers, particularly in the light industrial sector. Demand for staffing services historically tends to grow during the second and third fiscal quarters and has historically been greatest during the fourth fiscal quarter due largely to customers' planning and business cycles. The recent economic downturn in fiscal 2008 has negatively impacted this expected historical growth, reducing demand for temporary employees and adversely affecting our sales. We anticipate that we may continue to experience weaker demand for temporary employees throughout fiscal 2009.
Domestically, payroll taxes and related benefits fluctuate with the level of payroll costs, but tend to represent a smaller percentage of revenue and payroll costs later in our fiscal year as federal and state statutory wage limits for unemployment are exceeded on a per employee basis. Workers' compensation expense, which is incurred domestically, generally varies with both the frequency and severity of workplace injury claims reported during a quarter. Adverse and positive loss development of prior period claims during subsequent quarters may also contribute to the volatility in our estimated workers' compensation expense.
Critical Accounting Policies
The preparation of our consolidated financial statements and notes thereto in conformity with generally accepted accounting principles in the United States of America requires management to make certain estimates and assumptions affecting the amounts and disclosures reported within those financial statements. These estimates are evaluated on an ongoing basis by management and generally affect revenue recognition, workers' compensation costs, collectibility of accounts receivable, impairment of goodwill and intangible assets, contingencies, litigation and income taxes. Management's estimates and assumptions are based on historical experiences and other factors believed to be reasonable under the circumstances. Actual results under circumstances and conditions different than those assumed could result in differences from the estimated amounts in the financial statements.
Management believes the following critical accounting policies reflect the more significant judgments and estimates used in the preparation of our consolidated financial statements. There have been no material changes to these policies during fiscal 2008.
Revenue Recognition. We record revenue from the sale of temporary staffing, permanent placement fees, and temp-to-hire fees by our Company-owned and franchised operations. Temporary staffing revenue and the related labor costs and payroll taxes are recorded in the period in which the services are performed. Temp-to-hire fees are generally recorded when the temporary employee is hired directly by the customer. We reserve for billing adjustments, principally related to overbillings and client disputes, made after year end that relate to services performed during the fiscal year. The reserve is estimated based on historical adjustment data as a percent of sales. Permanent placement fees are recorded when the candidate commences full-time employment and, if necessary, sales allowances are established to estimate losses due to placed candidates not remaining employed for the permanent placement guarantee period, which is typically 30 - 60 days.
We account for our revenue and the related direct costs of our franchise arrangements in accordance with Emerging Issues Task Force ("EITF") 99-19, "Recording Revenue Gross as a Principal versus Net as an Agent." We first assess whether we act as a principal in our transactions or as an agent acting on the behalf of others. When we are the principal in a transaction and have the risks and rewards of ownership, we record the transaction gross in our statements of operations. Where we act merely as an agent, only the net fees earned are recorded in our statements of operations. Under our traditional franchise agreement, we have the direct contractual arrangements with our customers and the contracts are binding on us. We are also the employer of all temporary employees in the franchise agents' operations and, as such, are obligated for the temporary employee payroll, related payroll taxes and the risk of loss for accounts receivable collection. As we retain the risks and rewards of ownership, the revenue and costs of services of our franchise agents are included in our results of operations. Each accounting period, we remit to each franchisee either a portion of the gross profit or a portion of the sales generated by its office(s), based on what the relevant franchise agreement dictates. Franchise agents' sales represented 40.1%, 35.8% and 35.1% of the Company's total revenue for the fiscal years 2008, 2007 and 2006, respectively. Franchise agents' share of gross profit represents the net distribution paid to the franchise agents for their services in marketing to customers, recruiting temporary employees and servicing customer accounts.
We also had a licensing program with a single licensee who converted their business to a franchise operation in fiscal 2007. Under the licensing program, the licensee had the direct contractual relationships with the customers, held title to the related customer receivables and was the legal employer of the temporary employees. Accordingly, revenue and costs of services generated by licensee operations are not included in our consolidated financial statements. We advanced funds for payroll, payroll taxes, insurance and other related items. Fees are paid to us based either on a percentage of revenue or of gross profit generated by the licensee and such license fees are recorded by us as license fees and included in revenue. We have not entered into any new licensee arrangements for the periods reported and have no current plans to enter into such arrangements in the future.
Workers' Compensation Reserves. We self-insure the deductible amount related to domestic workers' compensation claims, which was $750,000 per claim for policy year 2008 and $500,000 per claim for policy years 2007 and 2006. We maintain reserves for workers' compensation costs based upon actuarial methods utilized to estimate the remaining undiscounted liability for the deductible portion of all claims, including those incurred but not reported. This process includes establishing loss development factors based on our historical claims experience and that of the staffing industry and applying those factors to current claims information to derive an estimate of our ultimate claims liability. The calculated ultimate liability is computed for each policy year and is then reduced by the cumulative claims payments to determine the required reserves. We evaluate the reserve and the underlying assumptions regularly throughout the year and make adjustments accordingly. The key
assumptions include but are not limited to classification of the work performed and estimates of total loss based on the severity of the injury. This data is based on past history and includes an estimate of future claims. At least annually, we obtain an independent actuarially determined calculation of the estimated costs of claims actually made to date, as well as claims incurred but not yet reported. If the actual costs of such claims and related expenses exceed the amounts estimated, additional reserves may be required. These reserves amounted to $23.3 million and $25.9 million at November 1, 2008 and November 3, 2007, respectively. While we believe that the recorded reserves are adequate, there can be no assurances that future, unfavorable changes to estimates relied upon in the determination of these reserves will not occur.
Collectibility of Accounts Receivable. We provide an allowance for uncollectible accounts receivable based on an estimation of credit losses and billing adjustments at a level deemed appropriate to adequately provide for known and inherent risks related to such amounts. The allowances are based on reviews of its history of losses, adjustments, current economic conditions and other factors that warrant consideration in estimating potential losses including known information specific to each customer. We evaluate this allowance on a regular basis throughout the year and make adjustments as the evaluation warrants. If the financial condition of our customers were to deteriorate resulting in an impairment of their ability to make payments, additional allowances may be required. These allowances were $1.0 million at November 1, 2008, and $1.3 million at November 3, 2007. Our estimates are influenced by numerous factors including our large, diverse customer base, which is disbursed across a wide geographical area. No single customer accounted for more than 10% of accounts receivable for fiscal year 2008.
Goodwill and Other Intangible Assets. Statement of Financial Accounting Standards ("SFAS") No. 142, "Goodwill and Other Intangible Assets" ("SFAS 142") requires that goodwill and certain intangible assets with indefinite useful lives no longer be amortized but instead be subject to an impairment test performed on an annual basis or whenever events or circumstances indicate that impairment may have occurred. Intangible assets with finite useful lives continue to be amortized over their useful lives. The valuation methodologies considered include analyses of estimated future discounted cash flows at the reporting unit level, publicly traded companies multiples within the temporary staffing industry and historical control premiums paid by acquirers purchasing companies similar to ours. As part of the assessment, management relies on a number of factors to discount anticipated future cash flows including operating results, business plans and present value techniques. Rates used to discount cash flows are dependent upon market interest rates and the cost of capital at the valuation date. There are inherent uncertainties related to these factors and management's judgment in applying them to the analysis of goodwill impairment.
Due to the presence of impairment indicators, such as a decrease in revenue, market capitalization and operating income in the third quarter of fiscal year 2008, management performed an impairment evaluation and determined that the indefinite life franchise right intangible was impaired by $0.2 million. Such an impairment charge was measured in accordance with SFAS 142 as the excess of the carrying value over the value of the asset.
After completing the intangible asset impairments in the third quarter of fiscal year 2008, the Company compared the fair value of the Domestic Business Services reporting unit to its carrying value and determined that the reporting unit was impaired. Upon completion of the impairment test, the Company recorded a goodwill impairment of $11.4 million in relation to its Domestic Business Services reporting unit. The fair value of the Australia and New Zealand reporting units were greater than the net book value and accordingly, no further impairment testing was performed.
Given the continued decline in revenues, the Company in the fourth quarter of fiscal 2008 again performed an impairment test under SFAS 142 for its indefinite life franchise right intangibles and Australia goodwill. As a result, goodwill of the Australia subsidiary was written down by $186,000.
There was no material impairment on the indefinite life franchise right intangibles as of November 1, 2008.
Income Taxes. We account for income taxes by utilizing an asset and liability approach that requires recording deferred tax assets and liabilities for the future year consequences of events that have been recognized in our financial statements or tax returns. As required under SFAS No. 109, "Accounting for Income Taxes", we measure these expected future tax consequences based upon provisions of tax law as currently enacted. The effects of future changes in tax laws are not anticipated. Variations in the actual outcome of these future tax consequences could materially impact our financial position or our results of operations. We also provide a reserve for tax contingencies when we believe a probable and estimable exposure exists. The Company has deferred tax assets on its books from tax benefits from future deductions of workers compensation claims, tax credit carry forwards and net operating losses ("NOL"). The income tax provision from continuing operations at fiscal year ended November 1, 2008 was $19.8 million.
At November 1, 2008 all of the Company's net deferred tax assets were offset with a valuation allowance as the Company believes it is more likely than not that all of the net deferred tax assets will not be realizable in the foreseeable future.
Reserves for Legal and Regulatory Liabilities. There are various claims, lawsuits and pending actions against us incident to our operations for which we have recorded liabilities that we believe are appropriate. We evaluate this reserve regularly throughout the year and make adjustments as needed. If the actual outcome of these matters is different than expected, an adjustment is charged or credited to expense in the period the outcome occurs or the period in which the estimate changes. Whereas management believes the recorded liabilities are adequate, there are inherent limitations in the estimation process whereby future actual losses may exceed projected losses, which could materially adversely affect our financial condition.
Recent Accounting Pronouncements
In July 2006, the Financial Accounting Standards Board (FASB) issued Financial Interpretation Number (FIN) 48, "Accounting for Income Tax Uncertainties." FIN 48 defines the threshold for recognizing the benefits of tax return positions in the financial statements as "more-likely-than-not" to be sustained by the taxing authority. FIN 48 provides guidance on the recognition, measurement and classification of income tax uncertainties, along with any related interest and penalties. FIN 48 includes guidance concerning accounting for income tax uncertainties in interim periods and increases the level of disclosures associated with any recorded income tax uncertainties. Any differences between the amounts recognized in the statements of financial position prior to the adoption of FIN 48 and the amounts reported after adoption are accounted for as a cumulative-effect adjustment recorded to the beginning balance of retained earnings. We adopted FIN 48 during the first quarter of fiscal 2008. See Note 2.
In September 2006, the FASB issued SFAS No. 157, "Fair Value Measurements." SFAS No. 157 defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles and expands disclosures about fair value measurements. SFAS No. 157 applies under other accounting pronouncements that require or permit fair value measurements, the FASB having previously concluded in those accounting pronouncements that fair value is the relevant measurement attribute. Accordingly, SFAS No. 157 does not require any new fair value measurements. SFAS No. 157 is effective for fiscal years beginning after November 15, 2007. In February 2008, the FASB agreed to a one-year deferral for the implementation of SFAS No. 157 for non-financial assets and liabilities to fiscal years beginning after November 15, 2008. We are currently evaluating the impact, if any that the adoption of SFAS No. 157 will have on the Company's operating results and financial condition.
In February 2007, the FASB issued SFAS No. 159, "The Fair Value Option for Financial Assets and Financial Liabilities." SFAS No. 159 permits companies to choose to measure many financial instruments and certain other items at fair value that are not currently required to be measured at fair value. The objective is to improve financial reporting by providing companies with the opportunity to mitigate volatility in reported earnings caused by measuring related assets and liabilities differently without having to apply complex hedge accounting provisions. SFAS No. 159 is effective for fiscal years beginning after November 15, 2007. Companies are not allowed to adopt SFAS No. 159 on a retrospective basis unless they choose early adoption. We are evaluating the impact, if any that the adoption of SFAS No. 159 will have on the Company's operating results and financial condition.
In December 2007, the FASB issued SFAS No. 160, "Non-controlling Interests in Consolidated Financial Statements" (an Amendment of ARB 51). SFAS 160 amends ARB 51 to establish accounting and reporting standards for the non-controlling interest in a subsidiary and for the deconsolidation of a subsidiary. The statement requires consolidated net income to be reported at amounts that include the amounts attributable to both the parent and the non-controlling interest. It also requires disclosure on the face of the consolidated statement of income, of the amounts of consolidated net income attributable to the parent and to the non-controlling interest. In addition this statement establishes a single method of accounting for changes in a parent's ownership interest in a subsidiary that do not result in deconsolidation and requires that a parent recognize a gain or loss in net income when a subsidiary is deconsolidated. SFAS 160 becomes effective for fiscal periods beginning after December 15, 2008. We are currently evaluating the impact of SFAS 160.
Executive Overview
Our gross revenues from continuing operations for the fiscal year 2008 were $324.5 million, which represents a decline of $115.3 million, or 26.2% from fiscal year 2007. The decline in revenues was primarily due to the economic downturn that began in early fiscal 2008, the loss of two customers which together made up 6.9% of revenues for the fiscal year ended November 1, 2008, and the closing of a number of branch offices in fiscal year 2007. In addition, the decrease in revenue was a result of the termination of a number of unprofitable customer accounts in 2007 and the disruption in billing caused by our implementation of a new Pay/Bill system during the first quarter of fiscal year 2008.
Our loss from continuing operations for the fiscal year 2008 was $47.0 million which was an increase of $42.7 million compared to the fiscal year 2007. The loss from continuing operations for the fiscal year 2008 includes non-cash, one time charges of $29.9 million of income tax expense resulting from the set up of a valuation allowance against 100% of our deferred tax assets, a goodwill and intangible asset impairment charge of $11.5 million, and an out of period adjustment for depreciation expense of $0.9 million. See Note 3.
We have made changes in our domestic operational structure in an effort to achieve better people and process efficiencies. We are committed to improving the profitability of our organization and increasing our market share. We have had success in reducing our domestic selling and administrative costs in total and we are evaluating and implementing additional opportunities for savings. Further, we are divesting our international subsidiaries in order to concentrate on our core domestic business.
Recent Developments
On November 10, 2008, the Company sold its former Australia and New Zealand subsidiaries for A$19 million (Australian dollars). A$13 million of the purchase price was paid at closing, A$3 million of the purchase price was funded by the seller and the remaining A$3 million of the purchase price will be payable in the form of a deferred payment due one year after closing. See Note 19.
On January 28, 2009, the Company entered into an Agreement and Plan of Merger (the "Merger Agreement") with Koosharem Corporation, a California corporation doing business as Select Staffing
("Koosharem") and Select Merger Sub Inc., a Delaware corporation and wholly-owned subsidiary of Koosharem ("Merger Sub"), pursuant to which Merger Sub will be merged with and into the Company, with the Company continuing after the merger as the surviving corporation and a wholly-owned subsidiary of Koosharem (the "Merger"), in accordance with and subject to the terms and conditions set forth in the Merger Agreement.
Concurrently with the execution of the Merger Agreement, our principal stockholder, DelStaff, LLC ("DelStaff"), entered into a Stock & Note Purchase Agreement with Koosharem (the "Purchase Agreement"), pursuant to which Koosharem will purchase, immediately prior to the effective time of the Merger: (1) all of the Company common stock that DelStaff then owns in exchange for first lien term loan debt to be issued by Koosharem under Koosharem's first lien credit facility bearing a face amount of $40,000,000 and (2) all of the then outstanding subordinated notes (the "DelStaff Subordinated Notes") issued by the Company to DelStaff under the Subordinated Loan Agreement, dated as of August 25, 2008, by and among the Company, Westaff (USA), Inc., Westaff Support, Inc., MediaWorld International (as borrowers) and DelStaff in exchange for first lien term loan debt to be issued by Koosharem under Koosharem's first lien credit facility bearing a face amount equal to the actual principal amount of the DelStaff . . .
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