ITEM 1.
BUSINESS
General
We are a national business services company engaged in providing outsourced labor and operational resources and temporary staffing services. We were incorporated in Delaware in March 1997 and began operations in August 1997 with the purchase of certain assets of Royalpar Industries, Inc. and its subsidiaries. This purchase provided us with a foundation to become a national provider of comprehensive staffing services. We believe that as businesses increasingly outsource a wider range of human resource functions in order to focus on their core operations, they will require more sophisticated and diverse services from their staffing providers.
We offer different groups of staffing services comprised of Staffing Services, SMARTSolutions™ and Information Technology Services. Our Staffing Services offering provides temporary workers for short-term needs, extended-term temporary employees, temporary-to-permanent placements, recruiting, permanent placements, payroll processing, on-site supervising and human resource consulting. Our SMARTSolutions™ technology, available through our Staffing Services branch offices, provides a comprehensive, customized staffing program designed to reduce labor and management costs and increase workforce efficiency. Our 50% owned joint venture, Stratus Technology Services (“STS”) provides information technology (“IT”) staffing solutions to Fortune 1000, middle market and emerging companies. STS offers expertise in a wide variety of technology practices and disciplines ranging from networking professionals to internet development specialists and application programmers. All service groups seek to act as business partners to our clients rather than merely a vendor. In doing so, they seek to systematically enhance client productivity and positively impact our and our clients’ financial results. We are headquartered at 500 Craig Road, Suite 201, Manalapan, New Jersey 07726 and our telephone number is (800) 777-1557.
Between September 1997 and December 2004, we completed ten acquisitions of staffing businesses, representing thirty offices in seven states. In March 2002, we sold our Engineering Division and in fiscal 2003 we sold the assets of eight of our offices located in Nevada, New Jersey, Florida and Colorado. As of December 21, 2004 we were providing services from 29 locations in 7 states. We also maintain a presence on the Internet with our website at www.stratusservices.com, an informational site designed to give prospective customers and employees additional information regarding our operations.
Financial Information About Industry Segments
We disclose segment information in accordance with SFAS NO. 131, “Disclosure about Segments of an Enterprise and Related Information.” We operate as one business segment which provides different types of staffing services. In accordance with SFAS 131, in concluding that our operations comprise a single operating segment, we have taken into account that we do not compile discrete financial information, other than revenue information, by service offering. As a result, in assessing our performance and making decisions regarding resources to be allocated within our company, our Chief Executive Officer and other members of management review consolidated financial information as well as discrete financial information compiled for each of our branch offices.
Principal Services & Markets
Our business operations are classified as one segment of different types of staffing services that consists of Staffing Services, SMARTSolutions™ and Information Technology Services service offerings, each service offering having a particular specialty niche within our broad array of targeted markets for all our staffing services.
Staffing Services includes both personnel placement and employer services such as payrolling, outsourcing, on-site management and administrative services. Payrolling typically involves the placement of individuals identified by a customer as short-term seasonal or special use workers on our payroll for a designated period. Outsourcing represents a growing trend among businesses to contract with third parties to provide a particular function or business department for an agreed price over a designated period. On-site services involve the placement of one of our employees at the customer’s place of business to manage all of the customer’s temporary staffing requirements. Administrative services include skills testing, drug testing and risk management services. Skills testing available to our customers include cognitive, personality and psychological evaluation and drug testing that is confirmed through an independent, certified laboratory.
Staffing Services can also be separated into assignment types into supplemental staffing, long-term staffing and project staffing. Supplemental staffing provides workers to meet variability in employee cycles, and assignments typically range from days to months. Long-term staffing provides employees for assignments that typically last three to six months but can sometimes last for years. Project staffing provides companies with workers for a time specific project and may include providing management, training and benefits.
Staffing services are marketed through our on-site sales professionals throughout our nationwide network of offices. Generally, new customers are obtained through customer referrals, telemarketing, advertising and participating in numerous community and trade organizations.
SMARTSolutions™. SMARTSolutions™ is a customized staffing program provided through our staffing services offices designed to reduce labor and management costs and increase workplace efficiency. While we assist the client in attempting to reach certain targets and milestones, our billings do not depend on the success or failure of the client achieving or not achieving such milestones.
While SMARTSolutions™ is designed to be most effective in manufacturing, distribution and telemarketing operations, it is marketed to all companies that have at least 50 people dedicated to specific work functions that involve repetitive tasks measurable through worker output and could benefit from proactive workforce management. Since SMARTSolutions™ is a more sophisticated offering of our traditional staffing services, we have developed a national marketing team dedicated strictly to marketing these programs. However, the team utilizes our Staffing Services branch staff to identify companies within their geographic regions that could potentially benefit from a SMARTSolutions™ program. Once identified, the team assumes full responsibility for the sales process. A significant portion of our SMARTSolutions™ clients have been obtained through this process or from “word of mouth” recommendations from current SMARTSolutions™ customers.
Stratus Technology Services, LLC. We provide IT services throughout our branch network through our affiliate, STS. STS was formed in November 2000 as a 50/50 joint venture between us and Fusion Business Services, LLC, a New Jersey based technology project management firm, to consolidate and manage the company-wide technology services business into a single entity focused on establishing market share in the IT market for staffing services. See “Part III-Item 13 Certain Relationships and Related Party Transactions”. STS markets its services to client companies seeking staff for project staffing, system maintenance, upgrades, conversions, installations, relocations, etc. STS provides broad-based professionals in such disciplines as finance, pharmaceuticals, manufacturing and media which include such job specifications as Desktop Support Administrators, Server Engineers, Programmers, Mainframe IS Programmers, System Analysts, Software Engineers and Programmer Analysts. In addition, STS, through its roster of professionals, can initiate and manage turnkey IT projects and provide outsourced IT support on a twenty-four hour, seven day per week basis.
Business Strategy
Our objective is to become a leading provider of staffing services throughout the United States. Key elements of our business strategy include:
FOCUS ON SALES WITHIN THE CLERICAL, LIGHT INDUSTRIAL AND LIGHT TECHNICAL SECTOR. We focus on placing support personnel in markets for clerical, light industrial and light technical temporary staffing. We believe that these services are the foundation of the temporary staffing industry, will remain so for the foreseeable future and best leverage our assets and expertise. We also believe that employees performing these functions are, and will remain, an integral part of the labor market in local, regional and national economies around the world. We believe that we are well-positioned to capitalize on these business segments because of our ability to attract and retain qualified personnel and our knowledge of the staffing needs of customers.
ENHANCE RECRUITING OF QUALIFIED PERSONNEL. We believe that a key component of our success is our ability to recruit and maintain a pool of qualified personnel and regularly place them into desirable positions. We use comprehensive methods to assess, select and, when appropriate, train our temporary employees in order to maintain a pool of qualified personnel to satisfy ongoing customer demand. We offer our temporary employees comprehensive benefit, retention and recognition packages, including bonuses, vacation pay and holiday pay.
EMPHASIZE BUSINESS CORRIDORS. Our strategy is to capitalize on our presence along the I-95 business corridor from New York to Delaware, to grow our presence in the California West Coast markets, and to build market share by targeting small to mid-sized customers, including divisions of Fortune 500 companies. We believe that in many cases, such markets are less competitive and less costly in which to operate than the more central areas of metropolitan markets, where a large number of staffing services companies frequently compete for business and occupancy costs are relatively high. In addition, we believe that business corridor markets are more likely to provide the opportunity to sell recurring business that is characterized by relatively higher gross margins. We focus on this type of business while also selectively servicing strategic national and regional contracts. While we have, in fiscal 2003, made our growth through acquisitions a secondary focus to our internal growth, we are continuously evaluating other potential acquisition opportunities.
MAINTAIN ENTREPRENEURIAL AND DECENTRALIZED OFFICES WITH STRONG CORPORATE SUPPORT. We seek to foster an entrepreneurial environment by operating each office as a separate profit center, by giving managers and staff considerable operational autonomy and financial incentives. We have designed programs to encourage a “team” approach in all aspects of sales and recruiting, to improve productivity and to maximize profits. We believe that this structure allows us to recruit and retain highly motivated managers who have demonstrated the ability to succeed in a competitive environment. This structure also allows managers and staff to focus on branch operations while relying on corporate headquarters for support in back-office operations, such as risk management programs and unemployment insurance, credit, collections, advice on legal and regulatory matters, quality standards and marketing.
ENHANCE INFORMATION SYSTEMS. We believe our management information systems are instrumental to the success of our operations. Our business depends on our ability to store, retrieve, process and manage significant amounts of data. We continually evaluate the quality, functionality and performance of our systems in an effort to ensure that these systems meet our operation needs. We utilize the Keynote Staffing Business Software System. This AS/400 based system comes complete with a rich automated skill search capability, quality and performance measurement reporting capabilities and user friendly, proactive tools that we believe improves the level of service our branch offices are capable of delivering.
In addition, we have fully upgraded both our hardware and software at our corporate headquarters to accommodate potential future growth. We have implemented a nationwide area network based upon a reliable, secure, inexpensive, and high performance Virtual Private Network, or VPN. Our VPN integrates all of our offices onto one large area network, capable of multiple changes in a LIVE environment. Through our VPN, all of our locations can share common data through various servers and a mid-range system which runs our Keynote application. All VPN access includes, but is not limited to, all back office software systems, internet access and real time e-mail access.
We believe that our investments in information technology have increased our management’s ability to store, retrieve, process and manage information. As a result, we believe we will be able to improve service to our customers and employees by reducing errors and speeding the resolution of inquiries, while more efficiently allocating resources devoted to developing and maintaining the Company’s information technology infrastructure.
CONTROL COSTS THROUGH EMPHASIS ON RISK MANAGEMENT. Workers’ compensation and unemployment insurance premiums are significant expenses in the temporary staffing industry. Workers’ compensation costs are particularly high in the light industrial sector. Furthermore, there can be significant volatility in these costs. We have a dedicated risk management department that has developed risk management programs and loss control strategies that we believe will improve management’s ability to control these employee-related costs through pre-employment safety training, safety assessment and precautions in the workplace, post-accident procedures and return to work programs. We believe that its emphasis on controlling employee-related costs enables branch office managers to price services more competitively and improve profitability.
OUTSOURCE PAYROLL SERVICES IN CERTAIN STATES. We have outsourced payroll services in California, Delaware, Maryland and Texas. This has, to some degree, minimized the impact of increased workers’ compensation costs in those states.
Growth Strategy
Our current strategy for growing our business and improving our financial performance focuses evenly on a combination of internal growth, sales of underperforming offices and strategic acquisitions.
INTERNAL GROWTH. A significant element of our growth strategy has been, and continues to be, our focus on internal growth. Our internal growth strategy consists of the following:
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Increase Sales and Profitability at Existing Offices. We believe that a substantial opportunity exists to increase sales of services and profitability in existing offices. We have incentive compensation plans to encourage branch office managers and staff to increase productivity and profits at the branch level while maintaining accountability for costs and collections of accounts receivable. In addition, we have maintained our corporate-level branch management function to establish and monitor branch office performance targets and develop programs to support branch operations.
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Expand SMARTSolutions™ and Vendor-on-Premise Programs. We have taken advantage of industry trends by continuing to promote our SMARTSolutions™ program and “vendor-on-premises” programs. As of December 22, 2004, we had 4 SMARTSolutions™ sites and 11 vendor-on-premises programs. Under these programs, we assume administrative responsibility for coordinating all essential staffing services throughout a customer’s location, including skills testing and training.
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Pursue Expansion by Establishment of New Offices. Subject to the availability of resources, we seek to open new offices primarily in existing markets to benefit from common area management, cross-marketing opportunities and leveraging of administrative expenses. Our corporate and operating management jointly develop expansion plans for new offices based upon various criteria, including market demand, availability of qualified personnel, the regulatory environment in the relevant market and whether a new office would complement or broaden our current geographic network.
SALES OF UNDER-PERFORMING OFFICES. In order to improve our financial performance and generate cash for operations, we sold the assets of seven of our offices which were not performing up to management’s expectations in fiscal 2003. The offices sold were located in Elizabeth, New Brunswick, Paterson, Perth Amboy and Trenton, New Jersey; Miami Springs, Florida and Colorado Springs, Colorado. The terms of these sales are described in this report under the caption “Management’s Discussion and Analysis of Financial Condition and Results of Operations - Results of Operations - Discontinued Operations/Acquisition or Disposition of Assets.”
PURSUIT OF COMPLEMENTARY AND STRATEGIC ACQUISITIONS. We intend to focus on opportunities for growth through acquisitions in existing as well as new markets. While we have, in recent periods, made our growth through acquisitions a secondary focus to our internal growth, we are continuously evaluating other potential acquisition opportunities.
In evaluating potential acquisition candidates, we focus on independent staffing companies with a history of profitable operations, a strong management team, a recognized presence in secondary markets and compatible corporate philosophies and culture. We have used, and may continue to use, a team approach by making select corporate officers and outside consultants responsible for identifying prospective acquisitions, performing due diligence, negotiating contracts and subsequently integrating the acquired companies. The integration of newly acquired companies generally involves standardizing each company’s accounting and financial procedures with those of ours. Acquired companies typically are brought under our uniform risk management program and key personnel of acquired companies often become part of field management. Marketing, sales, field operations and personnel programs must be reviewed and, where appropriate, conformed to the practices of our existing operations.
Between August 2001 and December 2004, we completed five acquisitions of primarily staffing companies or divisions of staffing companies. We also sold the assets of 8 of our underperforming offices. Pursuant to our acquisition strategy we made the following purchases:
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In August 2001, we acquired certain assets of the light industrial and clerical businesses of Source One Personnel, Inc., a $15 million (in annual revenues) Lawrenceville, New Jersey based, closely-held corporation. This acquisition significantly expanded our I-95 corridor coverage in New Jersey and provided inroads into the lucrative Philadelphia suburb market.
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In January 2002, we acquired the assets of the seven Southern California branches of Provisional Employment Services, Inc. (“PES”), a $23 million (in annual revenues) Orange, California based provider of light industrial and clerical staffing services. This acquisition established a strong base in Southern California for regional expansion.
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In March 2002, we acquired certain assets of Eden Health Employment Services, a temporary staffing firm located in Union City, New Jersey from Wells Fargo Credit, Inc..
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In December 2002, we acquired the assets of six California and Nevada branches of Elite Personnel Services, Inc., a $30 million (in annual revenues), Downey, California based provider of light industrial and clerical staffing services. This acquisition expands the already-existing California region for continued West Coast expansion.
Competitive Business Conditions
Staffing companies provide one or more of four basic services to clients: (i) flexible staffing; (ii) Professional Employer Organization (“PEO”) services; (iii) placement and search; and (iv) outplacement. According to the American Staffing Association, in the second quarter of 2004, domestic staffing companies employed an average of 2.5 million temporary and contract workers per day, nearly 350,000 more than in the same period in 2003. During the second quarter of 2004, temporary and contract staffing services revenues totaled $15.8 billion, an increase of 13.9% over the same period in 2003. Further, according to the American Staffing Association, during the third quarter of 2004, U.S. staffing firms employed an average of 2.6 million temporary and contract workers per day, on par, with the industry’s peak employment in the third quarter of 2000 and 14% more people than in the same period last year. U.S. sales of temporary and contract staffing services totaled a record $16.5 billion in the third quarter of 2004, an increase of 13.8% over the same period of last year. Sales for the quarter narrowly surpassed those of the third quarter of 2000, the industry’s previous peak, when sales totaled $16.4 billion.
According to the American Staffing Association, over 90% of businesses use staffing companies for temporary help. We believe that the U.S. staffing industry is highly fragmented and has been experiencing consolidation in recent years, particularly with respect to temporary staffing companies. We believe that the industry is consolidating in response to:
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The increased demands of companies for a single supplier of a full range of staffing and human resource services;
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Increased competition from larger, better capitalized competitors; and
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Owner’s desires for liquidity.
Although some consolidation activity has already occurred, we believe that consolidation in the U.S. staffing industry will continue and that there will be numerous available acquisition candidates.
Historically, the demand for temporary staffing employees has been driven by a need to temporarily replace regular employees. More recently, competitive pressures have forced businesses to focus on reducing costs, including converting fixed labor costs to variable and flexible costs. Increasingly, the use of temporary staffing employees has become widely accepted as a valuable tool for managing personnel costs and for meeting specialized or fluctuating employment requirements. Organizations also use temporary staffing to reduce administrative overhead by outsourcing operations that are not part of their core business operations, such as recruiting, training and benefits administration. By utilizing staffing services companies, businesses are able to avoid the management and administrative costs that would be incurred if full time employees were employed. An ancillary benefit, particularly for smaller business, is that the use of temporary personnel reduces certain employment costs and risks, such as workers’ compensation and medical and unemployment insurance, that a temporary personnel provider can spread over a much larger pool of employees.
In the past decade, the staffing industry has seen an evolution of services move away from “temp help” or supplemental staffing to more permanent staffing relationships. The industry has developed specialization among various sectors and can be classified into four categories: integrated staffing service providers, professional services providers, information technology providers and commodity providers. Integrated staffing services provide a vendor-on-premise, acting as the general contractor managing the workforce and maintaining the payroll. Through this arrangement, providers are able to establish long-term relationships with their customers, reduce cyclicality of employees, and maintain relationships with customers that are less price-sensitive. The professional services provider supplies employees in the fields of engineering, finance, legal, accounting and other professions. In general, these services are less cyclical than the light industrial and clerical segments and carry higher margins. Information technology companies offer technical employees to maintain and implement all forms of information systems. The commodity segment of the staffing industry is the traditional temporary employer business in which an employee of the service is placed at the customer for a short period. It is characterized by intense competition and low margins. This sector is most exposed to economic cycles and price competition to win market share. Growth in this segment has been constrained over the past three years due to a competitive labor market for low-end workers.
We compete with other companies in the recruitment of qualified personnel, the development of client relationships and the acquisition of other staffing and professional service companies. A large percentage of temporary staffing and consulting companies are local operators with fewer than five offices and have developed strong local customer relationships within local markets. These operators actively compete with us for business and, in most of these markets; no single company has a dominant share of the market. We also compete with larger, full-service and specialized competitors in national, regional and local markets. The principal national competitors include MPS Group, Manpower, Inc., Kelly Services, Inc., Olsten Corporation, Spherion Corp., and Norrell Corporation, all of which may have greater marketing, financial and other resources than Stratus. We believe that the primary competitive factors in obtaining and retaining clients are the number and location of offices, an understanding of clients’ specific job requirements, the ability to provide temporary personnel in a timely manner, the monitoring of the quality of job performance and the price of services. The primary competitive factors in obtaining qualified candidates for temporary employment assignments are wages, responsiveness to work schedules and number of hours of work available. We believe our long-term client relationships and strong emphasis on providing service and value to our clients and temporary staffing employees makes us highly competitive.
Customers
During the year ended September 30, 2004, we provided services to 552 customers in 17 states. Our five largest customers represented 25% of our revenue from continuing operations but no one customer exceeded 10% and only one customer exceeded 5%.
Governmental Regulation
Staffing services firms are generally subject to one or more of the following types of government regulation: (1) regulation of the employer/employee relationship between a firm and its temporary employees; and (2) registration, licensing, record keeping and reporting requirements. Staffing services firms are the legal employers of their temporary workers. Therefore, laws regulating the employer/employee relationship, such as tax withholding and reporting, social security or retirement, anti-discrimination and workers’ compensation, govern these firms. State mandated workers’ compensation and unemployment insurance premiums have increased in recent years and have directly increased our cost of services. In addition, the extent and type of health insurance benefits that employers are required to provide employees have been the subject of intense scrutiny and debate in recent years at both the national and state level. Proposals have been made to mandate that employers provide health insurance benefits to staffing employees, and some states could impose sales tax, or raise sales tax rates on staffing services. Further increases in such premiums or rates, or the introduction of new regulatory provisions, could substantially raise the costs associated with hiring and employing staffing employees.
Certain states have enacted laws that govern the activities of “Professional Employer Organizations,” which generally provide payroll administration, risk management and benefits administration to client companies. These laws vary from state to state and generally impose licensing or registration requirements for Professional Employer Organizations and provide for monitoring of the fiscal responsibility of these organizations. We believe that Stratus is not a Professional Employer Organization and not subject to the laws that govern such organizations; however, the definition of “Professional Employer Organization” varies from state to state and in some states the term is broadly defined. If we are determined to be a Professional Employer Organization, we can give no assurance that we will be able to satisfy licensing requirements or other applicable regulations. In addition, we can give no assurance that the states in which we operate will not adopt licensing or other regulations affecting companies that provide commercial and professional staffing services.
Trademarks
We have not obtained federal registration of any of the trademarks we use in our business, including SMARTSolutions, SMARTReport, and SMARTTraining, our slogan, name or logo. Currently, we are asserting Common Law protection by holding the marks out to the public as the property of Stratus. However, no assurance can be given that this Common Law assertion will be effective to prevent others from using any of our marks concurrently or in other locations. In the event someone asserts ownership to a mark, we may incur legal costs to enforce any unauthorized use of the marks or defend ourselves against any claims.
Employees
As of September 30, 2004, we were employing 7,608 total employees. Of that amount, 116 were classified as staff employees, including 50 outsourced employees, and 6,145 (including outsourced employees) were classified as field or “temp” employees, those employees placed at client facilities.
A key factor contributing to future growth and profitability will be the ability to recruit and retain qualified personnel. To attract personnel, we employ recruiters, called “Staffing Specialists” who regularly visit schools, churches and professional associations and present career development programs to various organizations. In addition, applicants are obtained from referrals by existing staffing employees and from advertising on radio, television, in the Yellow Pages, newspapers and through the Internet. Each applicant for a Staffing Services position is interviewed with emphasis on past work experience, personal characteristics and individual skills. We maintain software-testing and training programs at our offices for applicants and employees who may be trained and tested at no cost to the applicant or customer. Management Personnel are targeted and recruited for specific engagements. We usually advertise for professionals who possess specialized education, training or work experience.
To promote loyalty and improve retention among our employees and to differentiate ourselves from competing staffing firms, we offer a comprehensive benefits package after only ninety days of employment instead of the industry standard of one hundred eighty days. The benefits package includes paid time off, holiday and vacation time, medical coverage, dental, vision, prescription, mental health, life insurance and disability coverage. The average length of assignment for employees ranges from six months to five years depending on the client requirements.
Factors Affecting Future Operating Results
This Form 10-K contains forward-looking statements concerning our future programs, products, expenses, revenue, liquidity and cash needs as well as our plans and strategies. These forward-looking statements are based on current expectations and the Company assumes no obligation to update this information. Numerous factors could cause actual results to differ significantly from the results described in these forward-looking statements, including the following risk factors.
We have limited liquid resources and a history of net losses.
Our auditors have qualified their opinion on our financial statements for the year ended September 30, 2004, with a qualification which raises substantial doubt about our ability to continue as a going concern. Our ability to continue in business depends upon the continued cooperation of our creditors, our ability to generate sufficient cash flow to meet our continuing obligations on a timely basis and our ability to obtain additional financing. At September 30, 2004, we had limited liquid resources and owed $171,000 under promissory notes that are past due or due upon demand. In addition, approximately $5,200,000 of payroll taxes, including interest and penalties, was delinquent. Current liabilities at September 30, 2004 were $31,026,182 and current assets were $20,024,877. The difference of $11,001,305 is a working capital deficit, which is primarily the result of losses incurred during the last three years. We can give no assurance that we will raise sufficient capital to eliminate our working capital deficit or that our creditors will not seek to enforce their remedies against us, which could include the imposition of insolvency proceedings.
Fluctuations in the general economy could have an adverse impact on our business.
Demand for our staffing services is significantly affected by the general level of economic activity and unemployment in the United States. Companies use temporary staffing services to manage personnel costs and staffing needs. When economic activity increases, temporary employees are often added before full-time employees are hired. However, as economic activity slows, many companies reduce their utilization of temporary employees before releasing full-time employees. In addition, we may experience less demand for our services and more competitive pricing pressure during periods of economic downturn. Therefore, any significant economic downturn could have a material adverse effect on our business, results of operations, cash flows or financial condition.
We may be unable to continue and manage our growth.
Our ability to continue growth will depend on a number of factors, including: the strength of demand for temporary employees in our markets; the availability of capital to fund acquisitions; the ability to maintain or increase profit margins despite pricing pressures; and existing and emerging competition. We must also adapt our infrastructure and systems to accommodate growth and recruit and train additional qualified personnel. Should an economic slowdown or a recession continue for an extended period, competition for customers in the staffing industry would increase and may adversely impact management’s allocation of our resources and result in declining revenues.
We rely heavily on executive management and could be adversely affected if our executive management team was not available.
We are highly dependent on our senior executives, including Joseph J. Raymond, our Chairman, CEO and President since September 1, 1997; Michael A. Maltzman, Executive Vice President and Chief Financial Officer who has been serving in that capacity since September 1, 1997; and on the other members of our senior management team. We entered into an employment agreement with Mr. Raymond effective September 1, 1997 for continuing employment until he chooses to retire or until his death and that agreement remains in effect as written. Employment arrangements with Mr. Maltzman and other key members of senior management are at-will. The loss of the services of either Mr. Raymond or Mr. Maltzman and other senior executives or other key executive personnel could have a material adverse effect on our business, results of operations, cash flows or financial condition.
We rely heavily on our management information systems and our business would suffer if our systems fail or cannot be upgraded or replaced on a timely basis.
We believe our management information systems are instrumental to the success of our operations. Our business depends on our ability to store, retrieve, process and manage significant amounts of data. We continually evaluate the quality, functionality and performance of our systems in an effort to ensure that these systems meet our operational needs. We have, in the past, encountered delays in implementing, upgrading or enhancing systems and may, in the future, experience delays or increased costs. There can be no assurance that we will meet anticipated completion dates for system replacements, upgrades or enhancements that such work will be competed in the cost-effective manner, or that such replacements, upgrades and enhancements will support our future growth or provide significant gains in efficiency. The failure of the replacements, upgrades and enhancements to meet these expected goals could result in increased system costs and could have a material adverse effect on our business, results of operations, cash flows or financial condition.
Increases in employee-related costs would have an adverse effect on our business.
Our employee-related costs fluctuate and an increase in these costs could have a significant effect on our ability to achieve profitability. We are responsible for all employee-related expenses for the temporary employees, including workers’ compensation, unemployment insurance, social security taxes, state and local taxes and other general payroll expenses. We maintain workers’ compensation insurance on a fully-insured guaranteed cost basis with various private carriers and state insurance funds. We have outsourced our California, Delaware and Maryland employees to Advantage Services Group, LLC (See “Part III - Item 13, Certain Relationships and Related Party Transactions”), which outsourcing arrangement has, amongst other benefits, resulted in a decrease in our workers’ compensation costs in those states. We accrue for workers’ compensation costs based upon payroll dollars paid to temporary employees. The accrual rates vary based upon the specific risks associated with the work performed by the temporary employee. Unemployment insurance premiums are set by the states in which our employees render their services. A significant increase in these premiums or in workers’ compensation-related costs or our inability to continue to maintain workers’ compensation coverage could have a material adverse effect on our business, results of operations, cash flows or financial condition.
Our financial results will suffer if we lose any of our significant customers.
As is common in the temporary staffing industry, certain of our engagements to provide services to our customers are of a non-exclusive, short-term nature and subject to termination by the customer with little or no notice. During fiscal 2003 and 2004, no single customer of ours accounted for more than 10% of our revenues. Nonetheless, the loss of any of our significant customers could have an adverse effect on our business, results of operations, cash flows or financial condition. We are also subject to credit risks associated with our trade receivables. During fiscal 2003 and fiscal 2004, we incurred costs of $875,000 and $525,000, respectively, for bad debts. Should any of our principal customers default on their large receivables, our business results of operations, cash flows or financial condition could be adversely affected.
We have experienced significant fluctuations in our operating results and anticipate that these fluctuations may continue.
Fluctuations in our operating results could have a material adverse effect on the price of our common stock. Operating results may fluctuate due to a number of factors, including the demand for our services, the level of competition within our markets, our ability to increase the productivity of our existing offices, control costs and expand operations, the timing and integration of acquisitions and the availability of qualified temporary personnel. In addition, our results of operations could be, and have in the past been, adversely affected by severe weather conditions. Moreover, our results of operations have also historically been subject to seasonal fluctuations. Demand for temporary staffing historically has been greatest during our fourth fiscal quarter due largely to the planning cycles of many of our customers. Furthermore, sales for the first fiscal quarter are typically lower due to national holidays as well as plant shutdowns during and after holiday season. These shutdowns and post-holiday season declines negatively impact job orders received by us, particularly in the light industrial sector. Due to the foregoing factors, we have experienced in the past, and may possibly experience in the future, results of operations below the expectations of public market analysts and investors.
If we are not able to attract and retain the services of qualified temporary personnel, our business will suffer.
Our success depends upon our ability to attract and retain qualified personnel who possess the skills and experience necessary to meet the staffing requirements of our customers. We have experienced and may continue to experience significant difficulties in hiring and retaining sufficient numbers of qualified personnel to satisfy the needs of our customers. During periods of increased economic activity and low unemployment, the competition among temporary staffing firms for qualified personnel increases. Many regions in which we operate have in the past, and may continue to experience, historically low rates of unemployment which reduces the supply of qualified personnel. Furthermore, we may face increased competitive pricing pressures during such periods. While the current economic environment is uncertain, competition for individuals with the requisite skills is expected to remain strong for the foreseeable future. There can be no assurance that qualified personnel will continue to be available to us in sufficient numbers and on terms of employment acceptable to us. We must continually evaluate and upgrade our base of available qualified personnel to keep pace with changing customer needs and emerging technologies. Furthermore, a substantial number of our temporary employees during any given year will terminate their employment with us to accept regular staff employment with our customers. The inability to attract and retain qualified personnel could have a material adverse effect on the business, results of operations, cash flows or financial condition.
Our success depends upon the performance of our field management.
We are dependent on the performance and productivity of our local managers, particularly branch and regional managers. This loss of some of our key managers could have an adverse effect on our operations, including our ability to establish and maintain customer relationships. Our ability to attract and retain business is significantly affected by local relationships and the quality of services rendered by branch, area, regional and zone managerial personnel. If we are unable to attract and retain key employees to perform these services, our business, results of operations, cash flows or financial condition could be adversely affected. Furthermore, we may be dependent on the senior management of companies that may be acquired in the future. If any of these individuals do not continue in their management roles, there could be material adverse effects on our business, results of operations, cash flows or financial condition.
We may be subject to claims as a result of actions taken by our temporary staffing personnel.
Actions taken by our temporary staffing employees could subject us to significant liability. Providers of temporary staffing services place people in the workplaces of other businesses. An inherent risk of such activity includes possible claims of errors and omissions, discrimination or harassment, theft of customer property, misappropriation of funds, misuse of customers’ proprietary information, employment of undocumented workers, other criminal activity or torts, claims under health and safety regulations and other claims. There can be no assurance that we will not be subject to these types of claims, which may result in negative publicity and our payment of monetary damages or fines, which, if substantial, could have a material adverse effect on our business, results of operations, cash flows or financial condition.
Future acquisitions could increase the risk of our business.
While we intend to pursue acquisitions in the future, there can be no assurance that we will be able to expand our current market presence or successfully enter other markets through acquisitions. Competition for acquisitions may increase to the extent other temporary services firms, many of which have significantly greater financial resources than us, seek to increase their market share through acquisitions. In addition, we are subject to certain limitations on the incurrence of additional indebtedness under our credit facilities, which may restrict our ability to finance acquisitions. Further, there can be no assurance that we will be able to identify suitable acquisition candidates or, if identified, complete such acquisitions or successfully integrate such acquired businesses into our operations. Acquisitions also involve special risks, including risks associated with unanticipated problems, liabilities and contingencies, diversion of management’s attention and possible adverse effects on earnings resulting from increased interest costs and workers’ compensation costs, as well as difficulties related to the integration of the acquired businesses, such as retention of management. Furthermore, once integrated, acquisitions may not achieve comparable levels of revenue or profitability as our existing locations. In addition, to the extent that we consummate acquisitions in which a portion of the consideration is in the form of common stock, current shareholders may experience dilution. The failure to identify suitable acquisitions, to complete such acquisitions or successfully integrate such acquired businesses into our operations could have a material adverse effect on our business, results of operations, cash flows or financial condition.
Short sales of our common stock could place downward pressure on the price of our common stock.
Selling stockholders and others may engage in short sales of our common stock. Short sales could place downward pressure on the price of our common stock.
Regulatory and legal uncertainties could harm our business.
The implementation of unfavorable governmental regulations or unfavorable interpretations of existing regulations by courts or regulatory bodies could require us to incur significant compliance costs, cause the development of the affected markets to become impractical or otherwise adversely affect our financial performance. If we are determined to be a “Professional Employer Organization,” we cannot assure you that we will be able to satisfy licensing requirements or other applicable regulations. Certain states have enacted laws which govern the activities of Professional Employer Organizations, which generally provide payroll administration, risk management and benefits administration to client companies. These laws vary from state to state and generally impose licensing or registration requirements for Professional Employer Organizations and provide for monitoring of the fiscal responsibility of these organizations. We believe that Stratus is not a Professional Employer Organization and not subject to the laws which govern such organizations; however, the definition of Professional Employer Organization varies from state to state and in some states the term is broadly defined. In addition, we can give no assurance that the states in which we operate will not adopt licensing or other regulations affecting companies which provide commercial and professional staffing services.
We are controlled by our Chairman, who is our principal stockholder, and our management.
As of December 16, 2004, our Chairman of the Board, Joseph J. Raymond, owned or had the right to vote shares representing approximately 12.66% of the outstanding voting power of our capital stock. Our directors and executive officers, as a group, own or have the right to vote shares representing approximately 16.80% of the outstanding voting power of our capital stock. As a result, Mr. Raymond and, if they should determine to act together, our directors and executive officers as a group, will be able to exercise significant influence over the outcome of any matters which might be submitted to our stockholders for approval, including the election of directors and the authorization of other corporate actions requiring stockholder approval.
We are close to the $12 million limit of our Line of Credit.
As of December 17, 2004, we had borrowed $11.1 million of our total available $12 million Line of Credit with our Lender, Capital TempFunds, Inc. If we are unable to increase our Line of Credit, or unable to obtain alternate credit facilities, our ability to continue revenue growth may be limited.
ITEM 2.
ITEM 2.
PROPERTIES
We own no real property. We lease approximately 6,841 square feet in a professional office building in Manalapan, New Jersey as our corporate headquarters. That facility houses all of our centralized corporate functions, including the Executive management team, payroll processing, accounting, human resources and legal departments. Our lease expires on September 30, 2007. As of September 30, 2004, we leased 26 additional facilities, primarily flexible staffing offices, in 7 states. We believe that our facilities are generally adequate for our needs and we do not anticipate any difficulty in replacing such facilities or locating additional facilities, if needed.
ITEM 3.
ITEM 3.
LEGAL PROCEEDINGS
We are involved, from time to time, in routine litigation arising in the ordinary course of business. We do not believe that any currently pending litigation will have a material adverse effect on our financial position or results of operations.
ITEM 4.
ITEM 4.
SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
During the fourth quarter of fiscal 2004, no matter was submitted to a vote of security holders through the solicitation of proxies or otherwise.
PART II
ITEM 5.
ITEM 5.
MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.
On April 11, 2000, our registration statement on Form SB-2 (Commission File No. 333-83255) for our initial public offering of common stock, $.01 par value, became effective and our shares commenced trading on the Nasdaq SmallCap Market under the symbol “SERV” on April 26, 2000. On February 27, 2002, our common stock was delisted from the Nasdaq SmallCap Market and is currently trading on the NASD OTC Bulletin Board under the symbol “SERV.OB”. There were approximately 102 holders of record of common stock as of December 16, 2004. This number does not include the number of shareholders whose shares were held in “nominee” or “street name”. The table below sets forth, for the periods indicated, the high and low sales prices of our common stock as reported by the Nasdaq Stock Market and by the NASD OTC Bulletin Board, as adjusted to give retroactive effect to the one-for-four reverse split of our common stock, which became effective on July 14, 2004.
On December 16, 2004, the closing price of our common stock as reported by the NASD OTC Bulletin Board was $.36 per share. We have never paid cash dividends on our common stock and we intend to retain earnings, if any, to finance future operations and expansion. In addition, our credit agreement restricts the payment of dividends, therefore, we do not anticipate paying cash dividends on our common stock in the foreseeable future. Any future payment of dividends on our common stock will depend upon our financial condition, capital requirements and earnings as well as other factors that the Board of Directors deems relevant.
See “Part III, Item 12, Security Ownership of Certain Beneficial Owners and Management” for information regarding securities authorized for issuance under equity compensation plans.
ITEM 6.
ITEM 6.
SELECTED FINANCIAL DATA.
(In thousands except per share)
The selected financial data that follows should be read in conjunction with our financial statements and the related notes thereto and Management’s Discussion and Analysis of Financial Condition and Results of Operations appearing elsewhere in this report.
ITEM 7.
ITEM 7.
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.
Introduction
We provide a wide range of staffing services and productivity consulting services associated with such staffing services nationally through a network of offices located throughout the United States. Regardless of the type of temporary service offering we provide, we recognize revenues based on hours worked by assigned personnel. Generally, we bill our customers a pre-negotiated, fixed rate per hour for the hours worked by our temporary employees. Therefore we do not separate our various service offerings into separate offering segments. We do not routinely provide discrete financial information about any particular service offering. We also do not conduct any regular reviews of, nor make decisions about, allocating any particular resources to a particular service offering to assess its performance. As set forth below, certain of our service offerings target specific markets, but we do not necessarily conduct separate marketing campaigns for such services. We are responsible for workers’ compensation, unemployment compensation insurance, Medicare and Social Security taxes and other general payroll related expenses for all of the temporary employees we place. These expenses are included in the cost of revenue. Because we pay our temporary employees only for the hours they actually work, wages for our temporary personnel are a variable cost that increases or decreases in proportion to revenues. Gross profit margin varies depending on the type of services offered. In some instances, temporary employees placed by us may decide to accept an offer of permanent employment from the customer and thereby “convert” the temporary position to a permanent position. Fees received from such conversions are included in our revenues. Selling, general and administrative expenses include payroll for management and administrative employees, office occupancy costs, sales and marketing expenses and other general and administrative costs.
Critical Accounting Policies and Estimates
The following accounting policies are considered by us to be “critical” because of the judgments and uncertainties affecting the application of these policies and because of the likelihood that materially different amounts would be reported under different conditions or using different assumptions.
Revenue Recognition
We recognize revenue as the services are performed by our workforce. Our customers are billed weekly. At balance sheet dates, there are accruals for unbilled receivables and related compensation costs.
During fiscal 2003, we changed our method of reporting the revenues for payrolling services from gross billing to a net revenue basis. Unlike traditional staffing services, under a payrolling arrangement, our customer recruits and identifies individuals for us to hire to provide services to the customer. We become the statutory employer although the customer maintains substantially all control over those employees. Accordingly, Emerging Issues Task Force (“EITF”) 99-19, “Reporting Revenue Gross as a Principal versus Net as an Agent” requires that we do not reflect the direct payroll costs paid to such employees in revenues and cost of revenue.
Allowance for Doubtful Accounts Receivable
We provide customary credit terms to our customers and generally do not require collateral. We perform ongoing credit evaluations of the financial condition of our customers and maintain an allowance for doubtful accounts receivable based upon historical collection experience and expected collectibility of accounts. As of September 30, 2004, we had recorded an allowance for doubtful accounts of approximately $2,038,000. The actual bad debts may differ from estimates and the difference could be significant.
Goodwill and Intangible Assets
Effective October 1, 2002, the Company adopted the provisions of Statement of Financial Accounting Standards (“SFAS”) No. 142, “Goodwill and other Intangible Assets”. The provisions of SFAS No. 142 require that intangible assets not subject to amortization and goodwill be tested for impairment annually, or more frequently, if events or changes in circumstances indicate that the carrying value may not be recoverable. Amortization of goodwill and intangible assets with indefinite lives, including such assets recorded in past business combinations, ceased upon adoption. Thus no amortization for such goodwill was recognized in the accompanying statement of operations for the years ended September 30, 2004 and 2003, compared to $289,177 for the year ended September 30, 2002.
In order to assess the fair value of our goodwill as of the adoption date, we engaged an independent valuation firm to assist in determining the fair value. The valuation process appraised our assets and liabilities using a combination of present value and multiple of earnings valuation techniques. Based upon the results of the valuations, it was determined that there was no impairment of goodwill.
Valuation Allowance Against Deferred Income Tax Assets
Deferred tax assets and liabilities are determined based on differences between the financial reporting and tax bases of assets and liabilities, and are measured using the enacted tax rates and laws that are expected to be in effect when the differences reverse. We have recorded a valuation allowance of approximately $9.2 million to offset the entire balance of the deferred tax asset as of September 30, 2004. The valuation allowance was recorded as a result of the losses incurred by us and our belief that it is more likely than not that we will be unable to recover the net deferred tax assets.
Results of Operations
Discontinued Operations/Acquisition or Disposition of Assets
In March 2002, we completed the sale of the assets of our Engineering Services Division (the “Division”) to SEA Consulting Services Corporation (the “Purchaser”). Prior to the sale, the assets of the Division had been transferred to SEP, LLC (“SEP”), a limited liability company in which we held a 70% interest and Sahyoun Holdings LLC, a company wholly owned by Charles Sahyoun, the President of the Division, owned the remaining 30% interest. We received total net proceeds of $1,709,079 from the sale of the Division.
Effective January 1, 2002, we purchased substantially all of the tangible and intangible assets, excluding accounts receivable, of seven offices of PES. The initial purchase price was $1,480,000, represented by a $1,100,000 promissory note and 400,000 shares of our common stock. There was an additional $334,355 of costs incurred in connection with the acquisitions. In addition, PES is entitled to earnout payments of 15% of pretax profit of the acquired business up to a total of $1.25 million or the expiration of ten years, whichever occurs first. The note bears interest at 6% a year and is payable over a ten-year period in equal quarterly payments. See Note 3 to the Financial Statements included with this Report.
Effective December 1, 2002, we purchased substantially all of the tangible and intangible assets, excluding accounts receivable, of six offices of Elite Personnel Services, Inc. Pursuant to a Asset Purchase Agreement dated November 19, 2002 between us and Elite (the “Elite Purchase Agreement”), the purchase price paid at closing (the “Base Purchase Price”) was $1,264,000, all of which was represented by a promissory note (the “Note”) payable over eight years, in equal monthly installments. Imputed interest at the rate of 4% per year is included in the Note amount. Accordingly, the net Base Purchase Price was $1,083,813.
In addition to the Base Purchase Price, Elite may also receive as deferred purchase price an amount equal to 10% of “Gross Profits” as defined in the Elite Purchase Agreement, of the acquired business between $2,500,000 and $3,200,000 per year, plus 15% of Gross Profits of the acquired business in excess of $3,200,000 per year, for a minimum of one year from the effective date of the transaction, and for a period of two years from the effective date if Gross Profits for the first year reach specified levels.
On September 29, 2003, we completed the sale of substantially all of the tangible and intangible assets, excluding accounts receivable, of our Las Vegas, Nevada office. Pursuant to the terms of an Asset Purchase Agreement between us and US Temp Services, Inc. (“US Temps”) dated September 29, 2003, the purchase price for the purchased assets was $105,000, all of which was paid by means of a promissory note, which bears interest at the rate of 6% per year and is payable in monthly installments of $2,029.94, over a 5 year period. The note is secured by a security interest on all of the purchased assets.
On September 10, 2003, we completed the sale, effective as of September 15, 2003 (the “Effective Date”), of substantially all of the tangible and intangible assets, excluding accounts receivable, of five of our New Jersey offices to D/O Staffing LLC (“D/O”). The offices sold are the following: Elizabeth, New Brunswick, Paterson, Perth Amboy and Trenton, New Jersey. Pursuant to the terms of an asset purchase agreement between D/O and us dated September 10, 2003 (the “D/O Purchase Agreement”), the base purchase price for the purchased assets was $1,250,000. Additionally, we may be entitled to receive as a deferred purchase price (the “Bonus”), an amount equal to $125,000 if, for the one year period measured from the Effective Date, the purchased assets generate for D/O at least $18,000,000 in actual billings by client accounts serviced by us as of the closing and transferred by us to D/O pursuant to the D/O Purchase Agreement. The Bonus, if any, is payable by way of a promissory note, payable over a 24 month period and bearing interest at an interest rate of 6% per year. We and D/O are disputing whether or not we are entitled to any Bonus. Accordingly, no contingent gain has been recorded by us at September 30, 2004.
On August 22, 2003, we completed the sale, effective as of August 18, 2003 (the “ALS Effective Date”) of substantially all of the tangible and intangible assets, excluding accounts receivable, of our Miami Springs, Florida office. Pursuant to the terms of the Asset Purchase Agreement between us and ALS, LLC, a Florida limited liability company (“ALS”) dated August 22, 2003 (the “Purchase Agreement”), the purchase price for the purchased assets was $128,000, all of which was paid by means of a promissory note, which bears interest at the rate of 7% per annum, with payments over a 60 month period. The amount of the monthly payments due under the note is the greater of $10 per month or 20% of the monthly net profits generated by the staffing business originating from the purchased assets, commencing October 31, 2003. The note is secured by a security interest in all of the purchased assets.
The purchase price for the assets acquired by ALS was arrived at through negotiations with a related party purchaser. The son of our President and Chief Executive Officer is a 50% member in ALS, LLC.
On March 9, 2003, we completed the sale of substantially all of the tangible and intangible assets, excluding accounts receivable, of our Colorado Springs, Colorado office. Pursuant to the terms of an asset purchase agreement between us and US Temps dated March 9, 2003, the purchase price for the purchased assets was $20,000, all which was paid by means of a promissory note, which bears interest at the rate of 6% per year and is payable in monthly installments of $608, over a three year period. The note is secured by a security interest on all of the purchased assets.
Continuing Operations
Year Ended September 30, 2004 Compared to the Year Ended September 30, 2003
Revenues. Revenues increased 44.3% to $110,499,451 for the year ended September 30, 2004 from $76,592,209 for the year ended September 30, 2003. Approximately $5.0 million of the increase was attributable to the Elite acquisition in December, 2002. Excluding acquisitions, revenues increased 37.7%. This increase was a result of an increase in billable hours.
Gross Profit. Gross profit increased 17.2% to $13,365,426 for the year ended September 30, 2004 from $11,405,778 for the year ended September 30, 2003, primarily as a result of increased revenues. Gross profit as a percentage of revenues decreased to 12.1% for the year ended September 30, 2004 from 14.9% for the year ended September 30, 2003. Effective May 2004, the California State Compensation Insurance Fund increased our effective workers’ compensation rates by approximately 238%. This increase reduced our gross profit by approximately $800,000 or 0.7% of revenues. In August 2004, we entered into an agreement with a related party to outsource all payroll in California, which will eliminate the negative impact of the increased workers’ compensation costs. (see Note 10 to Consolidated Financial Statements) Exclusive of this increased cost, our gross profit would have increased 24.2% as a result of increased revenues. Gross profit as a percentage of revenues, exclusive of the 0.7% decrease, decreased 2.1% as a result of increases in state unemployment taxes and other increases in the cost of workers’ compensation insurance.
Selling, General and Administrative Expenses. Selling, general and administrative expenses increased 5.3% to $14,020,338 for the year ended September 30, 2004, from $13,309,072 for the year ended September 30, 2003. Selling, general and administrative expenses as a percentage of revenues decreased to 12.7% for the year ended September 30, 2004 from 17.4% for the year ended September 30, 2003. The percentage of revenue decrease is attributable to significant cost reductions implemented by us and the increase in revenues with no proportionate increase in selling, general and administrative expenses.
Other Charges. During the period May 1, 2001 through May 20, 2002, we maintained workers’ compensation insurance with an insurance company, with a deductible of $150,000 per incident. We had established reserves based upon our evaluation of the status of claims still open in conjunction with claims reserve information provided to us by the insurance company. We believe that the insurance company has paid and reserved claims in excess of what should have been paid or reserved. Although we believe we can recover some of the amounts already paid, this can only be pursued through litigation against the insurance company. Since there is no assurance we will prevail, we recorded $753,000 of additional payments made and reserves in the year ended September 30, 2003.
Interest Expense. Interest expense increased 33.8% to $2,525,245 for the year ended September 30, 2004 from $1,887,900 for the year ended September 30, 2003. Prior to September 30, 2003, the current value of our Series A Preferred Stock had been included in stockholders’ equity. In accordance with Statement of Financial Accounting Standards No. 150, “Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity”, the current value of our Series A Preferred Stock was reclassified as a liability. Accordingly, $427,349 (0.4% of revenues) of dividends and accretion relating to the Series A Preferred Stock is included in interest expense in the year ended September 30, 2004. As a result of our redemption of all the Series A Preferred Stock effective July 21, 2004, we ceased to incur these costs subsequent to that date. Interest expense as a percentage of revenues decreased to 2.3% for the year ended September 30, 2004 from 2.5% for the year ended September 30, 2003.
Preferred Stock Redemptions and Exchanges. In July 2004, we redeemed the 1,458,933 outstanding shares of our Series A Preferred Stock for $500,000 in cash, 1,750,000 shares of our Common Stock and an obligation to pay an additional $250,000 by January 31, 2005 in cash or at our option, in additional shares of our Common Stock having an aggregate market value of $250,000. We recorded the excess of the carrying amount of the Series A Preferred Stock over the consideration given as a $2,087,101 gain on redemption.
In August 2004, we closed on an exchange offer (the “Exchange Offer”) in which we had offered to exchange each share of our outstanding Series E Preferred Stock for, at the election of the holder, either (i) 125 shares of our Common Stock and 250 Common Stock purchase warrants for each $100 of stated value and accrued dividends represented by the Series E Preferred Stock; or (ii) one share of Series I Preferred Stock having a stated value of $100 per share and 125 Common Stock purchase warrants for each $100 in stated value and accrued dividends represented by the Series E Preferred Stock.
The results of the exchange offer were as follows: 24,833 shares of Series E Preferred Stock, plus accrued dividends thereon, were exchanged for 3,274,750 shares of common stock and 6,549,500 warrants to purchase common stock, 20,585 shares of Series E Preferred Stock, plus accrued dividends thereon, were exchanged for 21,775 shares of Series I Preferred Stock and 2,721,875 warrants to purchase common stock, and 2,310 shares of Series E Preferred Stock, plus accrued dividends thereon, were not exchanged. We recognized a loss of $3,948,285 as a result of the exchange.
Net (Loss) Attributable to Common Stockholders. As a result of the foregoing, we had a net loss and net loss attributable to common stockholders of $(1,085,948) and $(6,399,733), respectively, for the year ended September 30, 2004, compared to a net loss and net loss attributable to common stockholders of $(4,433,132) and $(6,063,006) for the year ended September 30, 2003.
Year Ended September 30, 2003 Compared to the Year Ended September 30, 2002
Revenues. Revenues increased 67.0% to $76,592,209 for the year ended September 30, 2003 from $45,859,801 for the year ended September 30, 2002. Approximately $28.6 million of the increase was attributable to the acquisitions in January and December, 2002. Excluding acquisitions revenues increased 4.6%. This increase was a result of an increase in billable hours.
Gross Profit. Gross profit increased 38.5% to $11,405,778 for the year ended September 30, 2003 from $8,235,085 for the year ended September 30, 2002, primarily as a result of increased revenues. Gross profit as a percentage of revenues decreased to 14.9% for the year ended September 30, 2003, from 18.0% for the year ended September 30, 2002. This decrease was a result of increased pricing competition for staffing services and increases in the cost of workers’ compensation insurance and state unemployment taxes. In addition, we were assessed the penalty rate by the New Jersey Department of Labor for state unemployment taxes because of payment delinquencies (see “Liquidity and Capital Resources”). The estimated additional expense in the year ended September 30, 2003 was $700,000.
Selling, General and Administrative Expenses. Selling, general and administrative expenses, not including depreciation and amortization, increased 19.7% to $12,386,826 for the year ended September 30, 2003 from $10,348,747 for the year ended September 30, 2002. Selling, general and administrative expenses, not including depreciation and amortization, as a percentage of revenues decreased to 16.2% for the year ended September 30, 2003 from 22.6% for the year ended September 30, 2002. The increase in the dollar amount was primarily a result of the acquisitions in January and December 2002, whereas the percentage of revenue decrease was attributable to significant cost reductions implemented by us and the increase in revenues with no proportionate increase in selling, general and administrative expenses.
Loss on Impairment of Goodwill. As a result of the steady decline in revenue and earnings of certain previously acquired business units, we determined that there was a permanent impairment of goodwill and accordingly, recorded an impairment loss of $300,000 in the year ended September 30, 2002.
Depreciation and Amortization. Depreciation and amortization expenses not including amortization of goodwill of $169,849 in the year ended September 30, 2002, increased 20.5% to $922,246 for the year ended September 30, 2003 from $595,744 for the year ended September 30, 2002. Depreciation and amortization as a percentage of revenues decreased to 1.2% for the year ended September 30, 2003 from 1.3% for the year ended September 30, 2002. The increase in the dollar amount was due to capital expenditures and the amortization of intangibles associated with the acquisition in December 2002.
Other Charges. During the period May 1, 2001 through May 20, 2002, we maintained workers’ compensation insurance with an insurance company, with a deductible of $150,000 per incident. We had established reserves based upon our evaluation of the status of claims still open in conjunction with claims reserve information provided to us by the insurance company. We believe that the insurance company has paid and reserved claims in excess of what should have been paid or reserved. Although we believe we can recover some of the amounts already paid, this can only be pursued through litigation against the insurance company. Since there is no assurance we will prevail, we recorded $753,000 of additional payments made and reserves in the year ended September 30, 2003. Other charges for the year ended September 30, 2002 was comprised of costs incurred in connection with financing not obtained ($75,066), penalties associated with the Series B Preferred Stock ($28,160), and the fair value of shares issued in connection with a forbearance agreement ($37,500).
Interest Expense. Interest expense increased to $1,887,900 for the year ended September 30, 2003 from $1,689,635 for the year ended September 30, 2002. Included in the amounts for the year September 30, 2002, was $104,535, which was the portion of the discount on the beneficial conversion feature of convertible debt and $291,755 of costs we incurred in connection with the issuance of the convertible debt. Interest expense, not including these convertible debt costs, as a percentage of revenue decreased to 2.5% for the year ended September 30, 2003, from 2.8% for the year ended September 30, 2002. The increase in the dollar amount was attributable to the increase in borrowings under our line of credit because of increased revenues and additional loans required to provide funding for our operations.
Loss on Sale of Investment. In the year ended September 30, 2002, we sold 63,025,000 shares, representing our entire 26.3% investment in a publicly-traded foreign company for net proceeds of $206,631 and realized a loss of $2,159,415.
Net (Loss) Attributable to Common Stockholders. As a result of the foregoing, we had a net loss and net loss attributable to common stockholders of $(4,433,132) and $(6,063,006), respectively, for the year ended September 30, 2003, compared to a net loss and net loss attributable to common stockholders of $(7,085,633) and $(8,127,443) for the year ended September 30, 2002.
Liquidity and Capital Resources
At September 30, 2004, we had limited liquid resources. Current liabilities were $31,026,182 and current assets were $20,024,877. The difference of $11,001,305 is a working capital deficit, which is primarily the result of losses incurred during the last four years. These conditions raise substantial doubts about our ability to continue as a going concern. The financial statements do not include any adjustments to reflect the possible future effect on the recoverability and classification of assets or the amounts and classification of liabilities that may result from the outcome of this uncertainty.
Our continuation of existence is dependent upon our ability to generate sufficient cash flow to meet our continuing obligations on a timely basis, to fund the operating and capital needs, and to obtain additional financing as may be necessary.
We have taken steps to revise and reduce our operating requirements, which we believe will be sufficient to assure continued operations and implementation of our plans. The steps include closing branches that are not profitable, consolidating branches and reductions in staffing and other selling, general and administrative expenses. We continue to pursue other sources of equity or long-term debt financings. We also continue to negotiate payment plans and other accommodations with our creditors.
In order to raise capital to sustain our operations, we filed a Registration Statement on Form S-1 with respect to an offering of securities (the “Offering”). We were seeking to raise up to a maximum of $10,000,000 through the sale of units consisting of common stock and warrants to purchase common stock. On August 11, 2004, we completed the Offering. A total of 4,961,028 units were sold at $.80 per unit, generating net proceeds of approximately $2,527,000. The proceeds were used towards the redemption of all of the outstanding shares of our Series A Preferred Stock ($500,000), redemption of 1,750 shares of our Series E Preferred Stock ($179,000), reduction of loans and notes payable and put options liability ($475,000) and working capital ($1,373,000).
Net cash used in operating activities was $1,526,842 and $2,432,131 in the years ended September 30, 2004 and 2003, respectively.
Net cash provided by (used in) investing activities was $(62,929) and $819,725 in the years ended September 30, 2004 and 2003, respectively. The sale of certain branches in the year ended September 30, 2003 generated net cash proceeds of $1,120,770, which was used to fund operating activities. Cash used for acquisitions for the year ended September 30, 2003, was $61,644. The balance in both periods was primarily for capital expenditures.
Net cash provided by financing activities was $2,271,744 and $1,503,313 in the years ended September 30, 2004 and 2003, respectively. We had net borrowings of $2,716,795 and $573,158 under our line of credit in the years ended September 30, 2004 and 2003, respectively. During the year ended September 30, 2004, we received net proceeds of $2,527,338 from the Offering. During the year ended September 30, 2003, we received $1,442,650, in proceeds from the issuance of our Series E Preferred Stock. During the year ended September 30, 2004, we redeemed $179,000 of Series E Preferred Stock, and paid $500,000 as partial consideration for redemption of all of our Series A Preferred Stock. Net short-term borrowings (repayments) were $(868,572) and $629,946 in the years ended September 30, 2004 and 2003, respectively. Payments of notes payable-acquisitions was $600,201 and $687,775 in the years ended September 30, 2004 and 2003, respectively. We also paid $150,000 against the put options liability in the year ended September 30, 2004.
Our principal uses of cash are to fund temporary employee payroll expense and employer related payroll taxes; investment in capital equipment; start-up expenses of new offices; expansion of services offered; workers’ compensation, general liability and other insurance coverages; debt service and costs relating to other transactions such as acquisitions. Temporary employees are paid weekly.
We have a loan and security agreement (the “Loan Agreement”) with Capital Temp Funds, Inc. which provides for a line of credit up to 85% of eligible accounts receivable, as defined, not to exceed $12,000,000. Until April 10, 2003, advances under the Loan Agreement bore interest at a rate of prime plus 1-3/4%. The Loan Agreement restricts our ability to incur other indebtedness, pay dividends and repurchase stock. Effective April 10, 2003, we entered into a modification of the Loan Agreement which provides that borrowings under the Loan Agreement bear interest at 3% above the prime rate. Borrowings under the Loan Agreement are collateralized by substantially all of our assets. As of September 30, 2004, $11,029,070 was outstanding under the credit agreement.
At September 30, 2004, we were in violation of the following covenants under the Loan Agreement:
(i)
Failing to meet the tangible net worth requirement;
(ii)
Our common stock being delisted from the Nasdaq SmallCap Market
We have received a waiver from the lender on all of the above violations.
We are obligated to pay quarterly dividends to holders of our Series E Preferred Stock at a rate of 6% per year of the stated value of the stock in preference and priority to any payment of dividends on our common stock. We are obligated to pay monthly dividends on our Series F Preferred Stock at a rate of 7% per year of the stated value of the stock in preference and priority to any payment of dividends on our common stock. The aggregate stated value of the Series E and Series F Preferred Stock was $57,200 and $600,000, respectively, as of September 30, 2004. Dividends on the Series E and Series F Preferred Stock may be paid at the Company’s option in shares of common stock (valued at the conversion price of the applicable class of preferred stock) if such shares have been registered for resale under the Securities Act of 1933.
In July 2003, we entered into an agreement with Artisan (UK) plc, the parent company of Artisan.com Limited, pursuant to which we agreed to redeem the aggregate 1,458,933 shares of our Series A Preferred Stock owned by Artisan.com Limited and Cater Barnard (USA) plc, an affiliate of Artisan. These shares represented all of the outstanding shares of Series A Preferred Stock. The agreement, as amended in March 2004, provided that our obligation to redeem the Series A Preferred Stock was contingent upon our sale of not less than $1,000,000 of units in our proposed best efforts offering of units. This condition was satisfied in July 2004. As a result, we paid $500,000 and issued 1,750,000 shares of common stock to an assignee of Artisan and redeemed all of the Series A Preferred Stock following the initial closing of the best efforts offering of units. We are obligated to pay Artisan an additional $250,000 by January 31, 2005, or, at our option, issue to Artisan shares of our common stock having an aggregate market value of $250,000, based upon the average closing bid prices of the common stock for 30 trading days preceding January 31, 2005. If we fail to make the $250,000 payment in cash or stock, we will be required to pay Artisan $300,000 in cash, plus interest calculated on a daily basis at a rate of 18% per year from the date of the default to the date the default is cured.
We issued shares of Series I Preferred Stock upon the closing of the Exchange Offer in August 2004. We will be required to redeem each share of the Series I Preferred Stock for an amount equal to the stated value of $100 per shares plus all accrued and unpaid dividends (12% per year) on the one year anniversary date of the issuance of the Series I Preferred Stock to the extent permitted by applicable law; provided, however, that we will have the right to extend the required redemption date for an additional one year, in which case we will be required to pay all dividends accrued through the first year of issuance in cash and issue to each holder of Series I Preferred Stock, a number of shares of our common stock which then have a value equal to 10% of the stated value of the Series I Preferred Stock held. In addition, if we extend the redemption date, we will be required to pay dividends quarterly and pay an advisory fee to an advisor designated by the holders of the Series I Preferred Stock in an amount equal to 10% of the aggregate stated value of the outstanding shares of Series I Preferred Stock, 8% of which will be payable in cash and 2% of which will be paid in shares of our common stock, valued at the then current market value. If we do not redeem the Series I Preferred Stock by the extended redemption date, the dividend rate of the Series I Preferred Stock will increase to 24% per year and the Series I Preferred Stock will be convertible, at the option of the holder, into either common stock at a conversion price equal to 80% of the average closing bid price of the common stock during the five trading days preceding the conversion or common stock and warrants at a rate of 125 shares of common stock and 250 warrants for each $100 of stated value and accrued and unpaid dividends represented by the Series I Preferred Stock. We can give no assurance that we will be able to redeem the Series I Preferred Stock as required. We will have the right at any time during the 12 month period following the closing of the Exchange Offer, to cause all of the outstanding shares of the Series I Preferred Stock to be converted into, at the election of the holder, either common stock at a conversion price equal to 80% of the average closing bid price of the common stock during the five trading days preceding the conversion, or common stock and warrants at a rate of 125 shares of common stock and 250 warrants for each $100 of stated value and accrued and unpaid dividends represented by the Series I Preferred Stock. The discount associated with the conversion feature of the Series I Preferred Stock could result in changes to our earnings in future periods. Holders of Series I Preferred Stock will have no voting rights, except as provided by law and with respect to certain limited matters.
Other fixed obligations that we had as of September 30, 2004 include:
•
$650,771 under a promissory note bearing interest at 7% per year which was issued in connection with our acquisition of Source One and which is payable in equal quarterly installments of $130,717 until its maturity date in August 2005.
•
$973,498 under a promissory note bearing interest at 6% per year which was issued in connection with our acquisition of certain assets of PES and which is payable in equal quarterly installments of $36,770 until its maturity date in December 2011.
•
$849,326, including $213,205 of imputed interest, under a promissory note which was issued in connection with our acquisition of Elite and which is payable in equal monthly installments of $13,167 until its maturity in November 2010.
•
$80,000 under a promissory note that was due in April 2002 which bears interest at 18% per year.
•
$41,000 under a demand note bearing interest at 10% per annum issued to a corporation wholly owned by the son of Joseph J. Raymond, our President and Chief Executive Officer.
•
$98,575 due to a trust formed for the benefit of a family member of a former member of our Board of Directors, under a promissory note bearing interest at 12% per year, payable $10,000 a month for principal and interest, with a final payment of $4,309 on August 15, 2005.
•
$100,000 due to a member of our Board of Directors under a promissory note bearing interest at 12% per year, payable $5,500 a month for principal and interest through May 2006.
•
$50,000 under a demand loan which bears interest at 12% per year.
•
$19,091 under promissory notes used to acquire and secured by motor vehicles which require aggregate monthly payments of principal and interest of $1,186 through July 2005.
All of our offices are leased through operating leases that are not included on the balance sheet. As of September 30, 2004, future minimum lease payments under lease agreements having initial terms in excess of one year were: 2005 -$537,000, 2006 - $339,000, 2007 - $273,000, and 2008 - $5,000.
We may be required to make certain “earnout” payments to sellers of businesses that we have acquired in recent years, including Source One, PES and Elite. The amount of these payments, if any, will depend upon the results of the acquired businesses. There is $244,000 included in “Accounts payable and accrued expenses” on the balance sheet as of September 30, 2004 for estimated earnout payments that we recorded as part of the acquisition of Elite. As of September 30, 2004, $154,000 of the Elite contingent purchase price has been earned, but not yet paid.
Source One has the right to require us to repurchase 100,000 shares of our common stock at a price of $8.00 per share at any time after July 27, 2003 and before the later of July 27, 2005 and the full payment of the outstanding note that we issued to it in connection with the acquisition transaction completed with Source One in July 2001. Source One notified us that it was exercising this right on July 29, 2003. We are attempting to negotiate an arrangement which would permit us to pay this amount over an extended period of time or upon receipt of financing. No assurance can be given that Source One will agree to such an arrangement. During the year ended September 30, 2004, we paid $150,000 against this liability. In addition, the holder of the $80,000 note which was due in April 2002 has the right to require us to repurchase 20,000 shares of common stock at a price of $1.00 per share plus interest at a rate of 15% per year until the note is paid in full.
During fiscal 2003, we were notified by both the New Jersey Department of Labor and the California Department of Industrial Relations that, if certain payroll delinquencies were not cured, judgment would be entered against us. As of September 30, 2004, there was still an aggregate of $5.2 million in delinquent payroll taxes outstanding, including interest and penalties, which are included in “Payroll Taxes Payable” in the September 30, 2004 balance sheet set forth herein at Pages and. Judgment has not been entered against us in California. While judgment has been entered against us in New Jersey, no actions have been taken to enforce same.
As of September 30, 2004, there were no off-balance sheet arrangements, unconsolidated subsidiaries, commitments or guarantees of other parties, except as disclosed in the notes to financial statements. Stockholders’ (deficiency) at that date was $(4,507,221).
We engaged in various transactions with related parties during fiscal 2004 including the following:
•
We paid $103,000 to an entity owned by Jeffrey J. Raymond and who is the son of Joseph J. Raymond, our Chairman, President and Chief Executive Officer, for consulting services. We also paid $64,000 to an entity owned by Joseph J. Raymond, Jr., who also is the son of Joseph J. Raymond, for consulting services. These amounts were included in selling, general and administrative expense. The services provided included the identification of acquisition candidates, acquisition advisory services, due diligence, post-acquisition transition services, customer relations, accounts receivable collection and strategic planning advice.
•
Joseph J. Raymond, Jr. is a 50% member in ALS, LLC, which is the holding company for Advantage Services Group, LLC (“Advantage”). During the years ending September 30, 2003 and 2004, the Company entered into various agreements with ALS and Advantage, in which ALS and Advantage are to provide payroll outsourcing services for all of the Company’s in-house staff and customer staffing requirements in California, Delaware, Maryland, Texas and Florida. The Company pays agreed upon pay rates, plus burden (payroll taxes and workers’ compensation insurance) plus a fee ranging between 2% and 3% of pay rates. The total amount charged by ALS and Advantage under this agreement was $31,920,000 in the year ended September 30, 2004.
•
In addition to the foregoing, in November 2003, we agreed to pay Advantage $5,000 per week until $225,000 owed to Advantage in connection with a previous agreement for payrolling services has been paid. The obligation to pay this amount was secured by a warrant to purchase 500,000 shares of our common stock. The warrant, which was exercisable only if we defaulted on our payment obligations to Advantage, had an exercise price equal to the lower of $.60 per share or 75% of the then current market price of the common stock. We repaid the balance due Advantage and accordingly, canceled the warrants.
•
We issued an aggregate of 480 shares of Series E Preferred Stock to a corporation wholly-owned by our Chairman, President and Chief Executive Officer, Joseph J. Raymond, in lieu of cash penalties owed as a result of our failure to timely register for public resale shares of Common Stock issuable upon the conversion of the Series E Preferred Stock owned by the corporation in accordance with the terms of the agreement pursuant to which the Series E Preferred Stock was originally acquired. Mr. Raymond, through this corporation, exchanged a total of 2,080 shares of Series E Preferred Stock for 285,250 shares of Common Stock and 570,500 warrants to purchase Common Stock in our Exchange Offer.
While the terms of these transactions were arrived at through negotiations with a related party, we believe that all transactions with related parties have been on terms no less favorable to us than those that could have been obtained from unaffiliated third parties.
Contractual Obligations
Our aggregate contractual obligations are as follows:
(a)
Includes $218,000 of dividends accruing through required redemption date.
(b)
The Company has the option to extend the redemption date for an additional one year period as set forth above
Seasonality
Our business follows the seasonal trends of our customer’s business. Historically, we have experienced lower revenues in the first calendar quarter with revenues accelerating during the second and third calendar quarters and then starting to slow again during the fourth calendar quarter.
Impact of Inflation
We believe that since our inception, inflation has not had a significant impact on our results of operations.
Impact of Recent Accounting Pronouncements
In January 2003, the Financial Accounting Standards Board (the “FASB”) issued FASB Interpretation No. 46 (“FIN 46”) - Consolidation of Variable Interest Entities, and a revised interpretation of FIN 46 (FIN 46R) was issued in December 2003. FIN 46 requires that if an entity has a controlling financial interest in a variable interest entity, the assets, liabilities and results of activities of the variable interest entity should be included in the consolidated financial statements of the entity. The provisions of FIN 46 are effective immediately for all arrangements entered into after January 31, 2003. We do not have any variable interest entities created after January 31, 2003. For those arrangements entered into prior to January 31, 2003, the FIN 46R provisions are required to be adopted at the beginning of the first interim or annual period ending after March 15, 2004. We adopted the provision of FIN 46R as of March 31, 2004, resulting in the consolidation of a joint venture (STS) previously accounted for under the equity method (see Note 10 to Consolidated Financial Statements).
In May 2003, the FASB issued SFAS No. 150, “Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity”. SFAS No. 150 changes the accounting for certain financial instruments that, under previous guidance, issuers could account for as equity and requires that those instruments be classified as liabilities (or assets in certain circumstances) in statements of financial position. This statement affects the issuer’s accounting for three types of freestanding financial instruments including (1) mandatorily redeemable shares that are required to be redeemed at a specified or determinable date or upon an event certain to occur, (2) put options and forward purchase contracts, which involves financial instruments embodying an obligation that the issuer must or could choose to settle by issuing a variable number of its shares or other equity instruments based solely on something other than the issuer’s own equity shares and (3) certain obligations that can be settled with shares, the monetary value of which is (i) fixed, tied solely or predominantly to a variable such as a market index, or (ii) varies inversely with the value of the issuer’s shares. For public companies, SFAS No. 150 became effective at the beginning of the first interim period beginning after June 15, 2003. As a result of SFAS No. 150, we have classified put options that were previously classified as “Temporary equity” and our Series A redeemable convertible preferred stock as liabilities at September 30, 2003.
On December 16, 2004, the FASB issued SFAS No. 123R, “Share Based Payment”, which replaces SFAS No. 123 and supercedes APB opinon No. 25, "Accounting for Stock Issued to Employees". This new statement will require the expensing of stock options issued by us in the financial statements using a fair-value-based method and will be effective for periods beginning after June 15, 2005. See Note 1 to Consolidated Financial Statements for pro forma disclosures regarding the effect on net income and income per share if we had applied the fair value recognition provisions of the SFAS No. 123R. Depending on the method adopted by us to calculate stock-based compensation expense upon the adoption of Share Based Payment, the pro forma disclosure in Note 1 to the Consolidated Financial Statements may not be indicative of the stock-based compensation expense to be recognized in periods beginning after June 15, 2005.
In September 2004, the FASB’s Emerging Issue Task Force (“EITF”) reached a consensus on EITF Issue No. 04-08, The Effect of Contingently Convertible Instruments on Diluted Earnings per Share. The Task Force reached a conclusion that Contingently Convertible Instruments should be included in diluted earnings per share computations, if dilutive, regardless of whether the market price trigger or other contingent feature has been met. Through September 30, 2004, EITF Issue No. 04-08 had no effect on us.
ITEM 7A.
ITEM 7A.
QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISKS
We are subject to the risk of fluctuating interest rates in the ordinary course of business for borrowings under our Loan and Security Agreement with Capital Tempfunds, Inc. This credit agreement provides for a line of credit up to 85% of eligible accounts receivable, not to exceed $12,000,000. Advances under this credit agreement bear interest at a rate of prime plus 3%.
We believe that our business operations are not exposed to market risk relating to foreign currency exchange risk or commodity price risk.
ITEM 8.
ITEM 8.
FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
The response to this item is submitted in a separate section of this report commencing on Page.
ITEM 9.
ITEM 9.
CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE.
No change in accountants or disagreement requiring disclosure pursuant to applicable regulations took place within the reporting period or in any subsequent interim period.
ITEM 9A.
ITEM 9A.
CONTROLS AND PROCEDURES
Our management, with the participation of our Chief Executive Officer and Chief Financial Officer, has evaluated the effectiveness of our disclosure controls and procedures as of September 30, 2004. Based on this evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures are generally effective for gathering, analyzing and disclosing the information we are required to disclose in the reports we file under the Securities Exchange Act of 1934, within the time periods specified in the SEC’s rules and forms. Such evaluation did not identify any change in the year ended September 30, 2004 that has materially affected, or is reasonably likely to materially affect, out internal control over financial reporting but there are three areas of material weakness of concern.
In connection with its audit of, and in the issuance of its report on our financial statements for the year ended September 30, 2004, Amper Politziner & Mattia, P.C. delivered a letter to the Audit Committee of our Board of Directors and our management that identifies certain items that it considers to be material weaknesses in the effectiveness of our internal controls pursuant to standards established by the Public Company Accounting Oversight Board. A “material weakness” is a reportable condition in which the design or operation of one or more of the specific control components has a defect or defects that could have a material adverse effect on our ability to record, process, summarize and report financial data in the financial statements in a timely manner. These material weaknesses are: (1) limited resources and manpower in the finance department; (2) inadequacy of the financial review process as it pertains to various account analyses; and (3) inadequate documentation of financial procedures as it relates to certain accounting estimates and accruals. While we believe that we have adequate policies, we agree with our independent auditors that our implementation of those policies should be improved. We are re-evaluating these various factors and are implementing additional procedures to alleviate these weaknesses. The impact of the above conditions were relevant to the fiscal year ended September 30, 2004 only and did not affect the results of this period or any prior period.
ITEM 9B.
ITEM 9B.
OTHER INFORMATION
None.
PART III
ITEM 10.
ITEM 10.
DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.
The Board of Directors and Officers
The name and age of each the directors and the executive officers of the Company and their respective positions with the Company are set forth below. Additional biographical information concerning each of the directors and the executive officers follows the table.
Joseph J. Raymond has served as Chairman of the Board and Chief Executive Officer of Stratus since its inception in 1997. Prior thereto, he served as Chairman of the Board, President and Chief Executive Officer of Transworld Home Healthcare, Inc. (NASDAQ:TWHH), a provider of healthcare services and products, from 1992 to 1996. From 1987 through 1997, he served as Chairman of the Board and President of Transworld Nurses, Inc., a provider of nursing and paraprofessional services, which was acquired by Transworld Home Healthcare, Inc. in 1992.
Michael J. Rutkin has served as a Director of Stratus since November 1997 and was Chief Operating Officer and President from March 1997 to October 1998. Since November 1998, Mr. Rutkin has served as General Manager/Chief Executive Officer of Battleground Country Club. From 1996 to 1998, Mr. Rutkin served as Vice President of Transworld Management Services, Inc. From February 1993 to October 1996, he served as Chief Operating Officer of HealthCare Imaging Services, Inc. Prior thereto, Mr. Rutkin was the Executive Vice President of Advanced Diagnostic Imaging from February 1987 to February 1993. From March 1981 to September 1984, he served as Director of New Business Development for the United States Pharmaceutical Division of CIBA-Geigy. Mr. Rutkin is the brother-in-law of Joseph J. Raymond.
Donald W. Feidt has served as a Director of Stratus since November 1997. From 1987 to December 1998, Mr. Feidt was a Managing Partner of Resource Management Associates, an information technology consulting company. From December 1998 through October 2004, Mr. Feidt served as a Vice President to the Chief Executive Officer of Skila, a Sela2 Company, which is a global web-based business intelligence platform company providing services to the medical industry. Mr. Feidt retired from Skila on October 11, 2004, and now serves as a consultant to Skila.
Sanford I. Feld has served as a Director of the Company since November 1997. Mr. Feld is currently president of Leafland Associates, Inc., an advisor to Feld Investment and Realty Management, a real estate development and management company. He also serves as Chairman of Flavor and Food Ingredients, a private savory and flavor company. From 1973 to 1979, he served as Director of the Chelsea National Bank of New York City.
Michael A. Maltzman has served as Treasurer and Chief Financial Officer of Stratus since September 1997 when it acquired the assets of Royalpar Industries, Inc. Mr. Maltzman served as a Chief Financial Officer of Royalpar Industries, Inc., from April 1994 to August 1997. From June 1988 to July 1993, he served as Vice President and Chief Financial Officer of Pomerantz Staffing Services, Inc., a national staffing company. Prior thereto, he was a Partner with Eisner & Lubin, a New York accounting firm. Mr. Maltzman is a Certified Public Accountant.
J. Todd Raymond has served as Secretary of the Company since September 1997 and as General Counsel from September 1997 until March 2002. He currently serves as Secretary, Controller and General Counsel of Telx Group, Inc., a telecommunications company. From December 1994 to January 1996, Mr. Raymond was an associate and managing attorney for Pascarella & Oxley, a New Jersey general practice law firm. Prior thereto, Mr. Raymond acted as in-house counsel for Raymond & Perri, an accounting firm. From September 1993 to September 1994, Mr. Raymond was an American Trade Policy Consultant for Sekhar-Tunku Imran Holdings Sdn Berhad, a Malaysian multi-national firm. He is the nephew of Joseph J. Raymond.
Code of Ethics and Business Conduct
We have adopted a Code of Ethics and Business Conduct that applies to all of our directors, officers and employees, including our Chief Executive Officer, our Chief Financial Officer and other senior financial officers. Our Code of Ethics and Business Conduct is posted on our website, www.stratusservices.com, under the “Employee Information-Legal” caption. We intend to disclose on our website any amendment to, or waiver of, a provision of the Code of Ethics and Business Conduct that applies to our Chief Executive Officer, our Chief Financial Officer or our other senior financial officers.
Audit Committee Financial Expert
Our Board of Directors has determined that Michael Rutkin is the Audit Committee’s financial expert. Mr. Rutkin is the brother-in-law of Joseph J. Raymond, our Chairman, President and Chief Executive Officer, and thus is not considered “independent” under NASD Rule 4200(a)(15).
Compliance with Section 16(a) of the Exchange Act
Section 16(a) of the Exchange Act requires our executive officers and directors, and persons who own more than ten percent of a registered class of our equity securities, to file reports of ownership and changes in ownership on Forms 3, 4 and 5 with the Securities and Exchange Commission (the “SEC”). Officers, directors and greater than ten percent stockholders are required by SEC regulation to furnish the Company with copies of all Forms 3, 4 and 5 they file.
Based solely on our review of the copies of such forms we have received, we believe that all of our executive officers, directors and greater than ten percent stockholders complied with all filing requirements applicable to them with respect to events or transactions during fiscal 2004, except that Joseph J. Raymond was late in filing his Form 4 in connection with his participation, through an entity in which he owns a 100% interest, in the Exchange Offer, and also in connection with his receipt of shares of Series E Preferred Stock in lieu of cash penalties; and each of Michael J. Rutkin, Sanford F. Feld and Donald W. Feidt were late in filing their Forms 4, which were due in connection with the grant of options made to such individuals in September, 2004.
ITEM 11.
ITEM 11.
EXECUTIVE COMPENSATION
The following table provides certain summary information regarding compensation paid by us during the fiscal years ended September 30, 2002, 2003 and 2004 to our Chief Executive Officer and our only other executive officer who earned compensation of $100,000 or more in fiscal 2004 (together with the Chief Executive Officer, the “Named Executive Officers”):
Directors’ Compensation
Directors who are our employees are not compensated for serving on the Board of Directors. Non-employee directors are paid a fee of $1,000 per Board of Directors or committee meeting attended in person and $500 for telephonic attendance.
Employment Agreements
In September 1997, we entered into an employment agreement (the “Raymond Agreement”) with Joseph J. Raymond, Chairman and Chief Executive Officer, which had an initial term that expired in September 2000. The Raymond Agreement has been extended through September 30, 2007. Pursuant to the Raymond Agreement and subsequent amendments, Mr. Raymond is entitled to a minimum annual base salary of $175,000 which is reviewed periodically and subject to such increases as the Board of Directors, in its sole discretion, may determine. During the term of the Raymond Agreement, if we are profitable, Mr. Raymond is entitled to a bonus/profit sharing award equal to .4% of our gross margin, but not in excess of 100% of his base salary. If we are not profitable, he is entitled to a $10,000 bonus. Mr. Raymond is eligible for all benefits made available to senior executive employees, and is entitled to the use of an automobile. In fiscal 2002, 2003 and 2004, Mr. Raymond voluntarily waived a substantial portion of his minimum annual base salary.
In the event we terminate Mr. Raymond without “Good Cause”, Mr. Raymond will be entitled to severance compensation equal to 2.9 times his base salary then in effect plus any accrued and unpaid bonuses and unreimbursed expenses. As defined in the Raymond Agreement “Good Cause” shall exist only if Mr. Raymond:
•
willfully or repeatedly fails in any material respect to perform his obligations under the Raymond Agreement, subject to certain opportunities to cure such failure;
•
is convicted of a crime which constitutes a felony or misdemeanor or has entered a plea of guilty or no contest with respect to a felony or misdemeanor during his term of employment;
•
has committed any act which constitutes fraud or gross negligence;
•
is determined by the Board of Directors to be dependent upon alcohol or drugs; or
•
breaches confidentiality or non-competition provisions of the Raymond Agreement.
Mr. Raymond is also entitled to severance compensation in the event that he terminates the Raymond Agreement for “Good Reason” which includes:
•
the assignment to him of any duties inconsistent in any material respect with his position or any action which results in a significant diminution in his position, authority, duties or responsibilities;
•
a reduction in his base salary unless his base salary is, at the time of the reduction, in excess of $200,000 and the percentage reduction does not exceed the percentage reduction of our gross sales over the prior twelve month period;
•
We require Mr. Raymond to be based at any location other than within 50 miles of our current executive office location; and
•
a Change in Control of our Company, which includes the acquisition by any person or persons acting as a group of beneficial ownership of more than 20% of our outstanding voting stock, mergers or consolidations of our company which result in the holders of Stratus’ voting stock immediately before the transaction holding less than 80% of the voting stock of the surviving or resulting corporation, the sale of all or substantially all of our assets, and certain changes in the our Board of Directors.
In the event that the aggregate amount of compensation payable to Mr. Raymond would constitute an “excess parachute payment” under the Internal Revenue Code of 1986, as amended (the “Code”), then the amount payable to Mr. Raymond will be reduced so as not to constitute an “excess parachute payment.” All severance payments are payable within 60 days after the termination of employment.
Mr. Raymond has agreed that during the term of the Raymond Agreement and for a period of one year following the termination of his employment, he will not engage in or have any financial interest in any business enterprise in competition with us that operates anywhere within a radius of 25 miles of any offices maintained by us as of the date of the termination of employment.
We have entered into an employment agreement with Mr. Maltzman which provides for a base salary of $165,000 per annum. Mr. Maltzman is entitled to profit sharing awards based upon our overall profitability. The agreement with Mr. Maltzman is terminable by either party at any time without cause. However, in the event that this agreement is terminated without cause or by Mr. Maltzman with good reason, Mr. Maltzman will be entitled to a severance payment equal to the greater of one month’s salary for each year worked or three months salary. In addition, we will pay Mr. Maltzman any earned but unused vacation time and any accrued but unpaid profit sharing. We are also required to maintain insurance and benefits for Mr. Maltzman during the severance period.
Option Grants
Shown below is further information with respect to grants of stock options in fiscal 2004 to the Named Officers by the Company which are reflected in the Summary Compensation Table set forth under the caption “Executive Compensation.” As indicated, no options were granted to our Named Officers in fiscal 2004.
Option Exercises and Fiscal Year-End Values
Shown below is information with respect to options exercised by the Named Executive Officers during fiscal 2004 and the value of unexercised options to purchase our Common Stock held by the Named Executive Officers at September 30, 2004.
No options were exercised by the Named Executive Officers during the fiscal year ended September 30, 2004.
(1)
Represents market value of shares covered by in-the-money options on September 30, 2004. The closing price of the Common Stock on such date was $.31. Options are in-the-money if the market value of shares covered thereby is greater than the option exercise price. No options held by the Names Officers as of September 30, 2004 were in-the-money.
ITEM 12.
ITEM 12. SECURITIES OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The following table sets forth information, as of December 16, 2004 with respect to (a) each person who is known by us to be the beneficial owner (as defined in Rule 13d-3 (“Rule 13d-3”) of the Securities and Exchange Act of 1934) of more than five percent (5%) of our Common Stock and Series F Preferred Stock and (b) the beneficial ownership of Common Stock and Series F Preferred Stock by each director and each of our current Executive Officers who earned in excess of $100,000 in fiscal 2004 and by all directors and executive officers as a group. Except as set forth in the footnotes to the table, the stockholders have sole voting and investment power over such shares.
(1)
Includes 1,500,000 shares of common stock issuable as of December 16, 2004, upon conversion of 6,000 shares of Series F Preferred Stock; (ii) 289,250 shares of common stock owned by a corporation of which Mr. Raymond is the sole owner, and (iii) 713,029 shares of common stock subject to options which are currently exercisable or may become exercisable within 60 days of December 16, 2004.
(2)
These shares are owned directly by Mr. Raymond.
(3)
Shares beneficially owned do not exceed 1% of our outstanding Common Stock.
(4)
Includes 171,362 shares subject to currently exercisable stock options.
(5)
Includes 7,500 shares held by the children of Michael Rutkin, living in his household and 2,500 shares held by his wife, 107,025 shares held as personal representative of his mother’s estate, and 150,000 shares subject to currently exercisable options.
(6)
Includes 175,291 shares subject to currently exercisable stock options and warrants.
(7)
Includes 165,000 shares subject to currently exercisable options.
(8)
Includes 118,260 shares of common stock that are beneficially owned by J. Todd Raymond, our Corporate Secretary, including 92,195 shares subject to currently exercisable options.
Securities Authorized for Issuance under Equity Compensation Plans
The number of stock options outstanding under our equity compensation plans, the weighted average exercise price of outstanding options, and the number of securities remaining available for issuance, as of September 30, 2004, was as follows:
(1)
Our equity incentive plans provide for the issuance of incentive awards to officers, directors, employees and consultants in the form of stock options, stock appreciation rights, restricted stock and deferred stock, and in lieu of cash compensation.
(2)
Represents shares subject to options granted to certain officers pursuant to employment agreements and individual stock option agreements, including (a) options with respect to 250,000 shares granted to Joseph J. Raymond which expire in January 2010 and which become exercisable only if we achieve earnings of $4.00 per share in a fiscal year and options with respect to 125,000 shares granted to Joseph J. Raymond which expire in March 2013, and (b) options with respect to 20,833 shares granted to Michael A. Maltzman which expire in March 2013, options with respect to 6,667 shares granted to J. Todd Raymond which expire in March, 2013, options with respect to 12,500 shares granted to Charles Sahyoun which expire in March 2012, options with respect to 150,000 shares granted to Michael J. Rutkin, which expire September 21, 2009, options with respect to 150,000 shares granted to Donald W. Feidt, which expire September 21, 2009, and options with respect to 150,000 shares granted to Sanford I. Feld, which expire September 21, 2009.
ITEM 13.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED PARTY TRANSACTIONS.
Jeffrey J. Raymond, the son of Joseph J. Raymond, our Chairman, President and Chief Executive Officer (the “CEO”), serves as a consultant to us pursuant to an agreement which requires him to supervise the collection of certain accounts receivable, to use his best efforts to maintain relationships with certain clients and to assist in due diligence investigations of acquisitions of other companies. Total consulting fees paid to Jeffrey Raymond were $103,000 in fiscal 2004.
During fiscal year 2004, we paid consulting fees of $64,000 to RVR Consulting, Inc., a corporation of which Joseph J. Raymond, Jr., the son of Joseph J. Raymond, is an officer and 100% stockholder.
During the year ended September 30, 2002, our CEO loaned $75,000 to us which was repaid during the year ended September 30, 2003. During the year ended September 30, 2003, our CEO made various loans to us aggregating $215,000 of which $175,000 was repaid by September 30, 2003 and $40,000 was repaid during the year ended September 30, 2004.
During the year ended September 30, 2002, a son of our CEO loaned $41,000 to us, which is still outstanding at September 30, 2004. During the year ended September 30, 2003, this son of our CEO, another son of our CEO and the brother of our CEO loaned us $100,000, $6,000 and $100,000, respectively. All of these amounts were repaid during the year ended September 30, 2004.
During the year ended September 30, 2003, a member of our Board of Directors (the “Board Member”) and a trust formed for the benefit of the family of another member of the Board of Directors (the “Trust”) loaned $100,000 and $116,337, respectively, to us. Both of these loans were unsecured and due on demand. In August 2004, we executed a promissory note with the Trust, whereby the $116,337 is to be paid at $10,000 a month, with a final payment of $4,309 due on August 15, 2005. Payment is guaranteed by our CEO. Interest of 12% a year is included in the payments. In September 2004, we and the Board Member executed a promissory note whereby the $100,000 is to be paid at $5,500 a month through May 2006. Interest of 12% a year is included in the payments.
During the years ending September 30, 2003 and 2004, we entered into various agreements with ALS, LLC and Advantage Services Group, LLC (“Advantage”) (collectively ALS, Advantage and/or any of their wholly-owned subsidiaries are referred to herein as “Advantage”), a company in which Joseph J. Raymond, Jr., a son of the CEO, holds a 50% interest, pursuant to which ALS and Advantage are to provide payroll outsourcing services for all of our in-house staff and customer staffing requirements in California, Delaware, Maryland, Texas and Florida. We pay agreed upon rates, plus burden (payroll taxes and workers’ compensation insurance) plus a fee ranging between 2% and 3% of pay rates. The total amount charged by ALS and Advantage under this agreement was $31,920,000 and $2,475,000 in the years ended September 30, 2004 and 2003, respectively.
On August 22, 2003, we completed the sale, effective as of August 18, 2003 of substantially all of the tangible and intangible assets, excluding accounts receivable, of our Miami Springs, Florida office to ALS, LLC. Pursuant to the terms of the Asset Purchase Agreement between us and ALS, the purchase price for the purchased assets was $128,000, which was paid by a promissory note which bears interest at the rate of 7% per year, with payments over a 60 month period. The amount of the monthly payments due under the note is the greater of $10 per month or 20% of the monthly net profits generated by the staffing business originating from the purchased assets, commencing October 31, 2003. As of September 30, 2004, $122,849 was outstanding under the note, which is secured by a security interest in all of the purchased assets.
Joseph J. Raymond, Jr., the son of our President and Chief Executive Officer is a 50% member in ALS. ALS is the holding company for Advantage.
In fiscal 2004, we issued an aggregate of 480 shares of Series E Preferred Stock to a corporation wholly owned by our President, Joseph J. Raymond, in lieu of cash penalties owed as a result of our failure to timely register for public resale shares of Common Stock issuable upon the conversion of the Series E Preferred Stock owned by the corporation in accordance with the terms of the agreement pursuant to which the Series E Preferred Stock was originally acquired. Mr. Raymond, through this corporation, exchanged a total of 2,080 shares of Series E Preferred Stock for 285,250 shares of Common Stock and 570,500 warrants to purchase Common Stock in our Exchange Offer.
In November 2000, we formed the STS joint venture with Fusion Business Services, LLC. Jamie Raymond, son of Joseph J. Raymond, our Chairman, President and Chief Executive Officer, is the managing member of STS and Fusion, which owns a 50% interest in Stratus Technology Services, LLC.
On July 30, 2002, our Chairman, President and Chief Executive Officer, Joseph J. Raymond, invested $1,000,000 of his personal funds in us in exchange for 10,000 shares of our newly created Series F Preferred Stock, with a stated value of $100 per share. In each of the years ending September 30, 2003 and 2004, Mr. Raymond converted 2,000 shares of the Series F Preferred Stock into 500,000 shares of our common stock.
All prior and ongoing material transactions with related parties have been reviewed and/or ratified by a majority of our independent, disinterested directors. We anticipate that from time to time we will enter into additional transactions with related parties. However, we anticipate that all future material transactions with related parties will be entered into on terms that are no less favorable than those that can be obtained from unaffiliated third parties. At all times, our directors have access to our counsel to discuss issues related to us.
ITEM 14.
ITEM 14. PRINCIPAL ACCOUNTING FEES AND SERVICES
The following table sets forth the aggregate fees billed to us for the years ended September 30, 2004 and September 30, 2003 by Amper, Politziner & Mattia, P.C., our independent auditors:
Audit fees represent amounts billed for professional services rendered for the audit of our annual financial statements and the reviews of the financial statements included in our Forms 10-Q and Forms 8-K for the fiscal year. Audit Related Fees represent amounts charged for reviewing various registration statements filed by us with the Securities and Exchange Commission during the year and audits of 401K plans. Before Amper, Politziner & Mattia, P.C. was engaged by us to render audit or non-audit services, the engagement was approved by our Audit Committee. Our Board of Directors is of the opinion that the Audit Related Fees charged by Amper, Politziner & Mattia, P.C. are consistent with Amper, Politziner & Mattia, P.C. maintaining its independence from us.
PART IV
ITEM 15.
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a)
Financial statements and financial statement schedules. Reference is made to Index of Financial Statements and Financial Statement Schedules hereinafter contained.
(b)
Reports on Form 8-K
On August 20, 2004, the Company filed a Report on Form 8-K to report that on August 17, 2004, the Company issued a News Release to report on its financials results for the third quarter ended June 30, 2004.
(c)
Exhibits
Number
Description
2.1
Asset Purchase Agreement, dated July 9, 1997, among the Company and Royalpar Industries, Inc., Ewing Technical Design, Inc., LPL Technical Services, Inc. and Mainstream Engineering Company, Inc., as amended by Amendment No. 1 to the Asset Purchase Agreement, dated as of July 29, 1997.(1)
2.2
Asset Purchase Agreement, effective January 1, 1999, by and between the Company and B&R Employment Inc.(1)
2.3
Asset Purchase Agreement, dated June 16, 2000, by and between the Company and Outsource International of America, Inc.(5)
2.4
Asset Purchase Agreement, dated October 13, 2000, by and between the Company and Outsource International of America, Inc.(6)
2.5
Asset Purchase Agreement, dated January 2, 2001, by and between the Company and Cura Staffing Inc. and Professional Services, Inc.(15)
2.6
Asset Purchase Agreement, dated July 27, 2001, by and between the Company and Source One Personnel, Inc.(8)
2.7
Asset Purchase Agreement, dated December 27, 2001, by and between the Company and Provisional Employment Solutions, Inc.(9)
2.8
Asset Purchase Agreement, dated as of January 24, 2002 among the Company, Charles Sahyoun, Sahyoun Holdings, LLC and SEA Consulting Services Corporation. Information has been omitted from the exhibit pursuant to an order granting confidential treatment.(16)
2.9
Asset Purchase Agreement dated as of March 4, 2002, by and among Wells Fargo Credit, Inc. and the Company.(22)
2.10
Asset Purchase Agreement dated November 19, 2002, by and between the Company and Elite Personnel Services, Inc.(23)
2.11
Asset Purchase Agreement dated as of September 10, 2003 between the Company and D/O Staffing, LLC.(28)
2.12
Asset Purchase Agreement dated as of August 18, 2003 between the Company and ALS, LLC.(28)
3.1
Amended and Restated Certificate of Incorporation of the Company.(1)
3.1.1
Certificate of Designation, Preferences and Rights of Series A Preferred Stock.(10)
3.1.2
Certificate of Amendment to Certificate of Designation.(14)
3.1.3
Certificate of Designation, Preferences and Rights of Series B Preferred Stock.(14)
3.1.4
Certificate of Designation, Preferences and Rights of Series E Preferred Stock.(21)
3.1.7
Certificate of Designation, Preferences and Rights of Series H Preferred Stock.(24)
3.1.8.1
Certificate of Amendment to Certificate of Designation, Preferences and Rights of Series E Preferred Stock.(28)
3.1.8.2
Form of Certificate of Designation, Preferences and Rights of Series I Preferred Stock.(31)
3.1.9
Certificate of Amendment to Restated Certificate of Incorporation.(31)
3.2
By-Laws of the Registrant.(2)
3.5
Certificate of Amendment to Certificate of Designation, Preferences and Rights of Series E Preferred Stock.(21)
3.6
Certificate of Designation, Preferences and Rights of Series F Preferred Stock.(21)
4.1.1
Specimen Common Stock Certificate of the Company.(1)
4.1.2
Form of 6% Convertible Debenture.(11)
4.1.8
Specimen Series E Stock Certificate of the Company.(21)
4.1.9
Specimen Series F Stock Certificate of the Company.(21)
4.1.10
Exchange Agreement between Pinnacle Investment Partners, LP and the Company.(21)
4.1.11
Exchange Agreement between Transworld Management Services, Inc. and the Company.(21)
4.1.12
Stock Purchase Agreement between Joseph J. Raymond, Sr., and the Company regarding Series F Preferred Stock. (21)
4.1.13
Specimen Series I Stock Certificate of the Company.(32)
4.2.1
Warrant for the Purchase of 10,000 Shares of Common Stock of Stratus Services Group, Inc., dated November 30, 1998, between Alan Zelinsky and the Company and supplemental letter thereto dated December 2, 1998.(1)
4.2.2
Warrant for the Purchase of 40,000 Shares of Common Stock of Stratus Services Group, Inc., dated November 23, 1998, between David Spearman and the Company.(1)
4.2.3
Warrant for the Purchase of 10,000 Shares of Common Stock of Stratus Services Group, Inc., dated November 30, 1998, between Sanford Feld and the Company, and supplemental letter thereto dated December 2, 1998.(1)
4.2.4
Warrant for the Purchase of 20,000 Shares of Common Stock of Stratus Services Group, Inc., dated November 30, 1998, between Peter DiPasqua, Jr. and the Company.(1)
4.2.5
Warrant for the Purchase of 20,000 Shares of Common Stock of Stratus Services Group, Inc., dated December 2, 1998, between Shlomo Appel and the Company.(1)
4.2.6
Form of Underwriter’s Warrant Agreement between the Company and Hornblower & Weeks, Inc., including form of warrant certificate.(7)
4.2.7
Warrant for the Purchase of Common Stock dated as of December 4, 2000 issued to May Davis Group, Inc.(13)
4.2.8
Warrant for the Purchase of Common Stock dated as of December 4, 2000 issued to Hornblower & Weeks, Inc.(13)
4.2.9
Warrant for the Purchase of Common Stock dated as of December 12, 2001 issued to International Capital Growth. (15)
4.2.10
Warrant for the Purchase of Common Stock dated as of April 9, 2002 issued to CEOCast.(22)
4.2.11
Warrant for the Purchase of Common Stock dated as of October 17, 2001 issued to Stetson Consulting.(22)
4.2.12
Warrant for the Purchase of Common Stock dated as of November 3, 2003 issued to Advantage Services Group, LLC.(28)
4.2.13
Warrant Agreement between the Company and American Stock Transfer & Trust Company, including form of warrant certificate for warrant comprising part of unit.(31)
10.1.1
Employment Agreement dated September 1, 1997, between the Company and Joseph J. Raymond.(1)*
10.1.6
Executive Employment Agreement dated September 1, 1997 between the Company and Michael A. Maltzman.(1)*
10.1.7
Consulting Agreement, dated as of August 11, 1997, between the Company and Jeffrey J. Raymond.(1)
10.1.8
Non-Competition Agreement, dated June 19, 2000 between the Company and Outsource International of America, Inc.(5)
10.1.9
Non-Competition Agreement, dated October 27, 2000 between the Company and Outsource International of America, Inc.(6)
10.1.10
Option to purchase 1,000,000 shares of the Company’s Common Stock issued to Joseph J. Raymond.(11)
10.1.11
Option to purchase 500,000 shares of the Company’s Common Stock issued to Joseph J. Raymond. (19)
10.1.12
Option to purchase 1,750,000 shares of the Company’s Common Stock issued to Joseph J. Raymond.(19)
10.1.13
Non-Competition Agreements dated December 1, 2002 between the Company and each of Elite Personnel Services, Inc. and Bernard Freedman.(23)
10.1.14
Employment Agreement dated December 1, 2002 between the Company and Bernard Freedman.(23)
10.2.1
Lease, effective October 1, 2002, for offices located at 500 Craig Road, Manalapan, New Jersey 07726.(22)
10.3.1
Loan and Security Agreement, dated December 8, 2000, between Capital Tempfunds, Inc. and the Company.(11)
10.3.2
First Amendment to Loan and Security Agreement between Capital Tempfunds, Inc. and the Company.(28)
10.3.3
Second Amendment to Loan and Security Agreement between Capital Tempfunds, Inc. and the Company.(28)
10.3.4
Third Amendment to Loan and Security Agreement between Capital Tempfunds, Inc. and the Company.(28)
10.3.5
Fourth Amendment to Loan and Security Agreement between Capital Tempfunds, Inc. and the Company.(28)
10.4.2
Promissory Note and Security Agreement in the amount of $400,000, dated as of June 19, 2000, issued by the Company to Outsource International of America, Inc.(5)
10.4.3
Promissory Note in the amount of $100,000, dated as of June 19, 2000, issued by the Company to Outsource International of America, Inc.(5)
10.4.4
Promissory Note and Security Agreement in the amount of $75,000, dated as of October 27, 2000, issued by the Company to Outsource International of America, Inc.(6)
10.4.5
Promissory Note and Security Agreement in the amount of $600,000, dated as of July 27, 2001, issued by the Company to Source One Personnel, Inc.(8)
10.4.6
Promissory Note and Security Agreement in the amount of $1.8 million, dated as of July 27, 2001, issued by the Company to Source One Personnel, Inc.(8)
10.4.7
Promissory Note in the amount of $1,264,000 dated as of December 1, 2002, issued by the Company to Elite Personnel Services, Inc.(23)
10.5.1
Registration Rights Agreement, dated August, 1997, by and among the Company and AGR Financial, L.L.C.(1)
10.5.2
Registration Rights Agreement, dated August 1997, by and among the Company and Congress Financial Corporation (Western).(1)
10.5.3
Form of Registration Rights Agreement, dated December 4, 2000, by and among the Company and purchasers of the Company’s 6% Convertible Debenture.(11)
10.5.4
Registration Rights Agreement, dated as of December 4, 2000, between the Company, May Davis Group, Inc., Hornblower & Weeks, Inc. and the other parties named therein.(13)
10.6.1
Stock Purchase and Investor Agreement, dated August 1997, by and between the Company and Congress Financial Corporation (Western).(1)
10.6.2
Stock Purchase and Investor Agreement, dated August 1997, by and among the Company and AGR Financial, L.L.C.(1)
10.6.3
Form of Securities Purchase Agreement, dated December 4, 2000 by and between the Company and purchasers of the Company’s 6% Convertible Debenture.(11)
10.7.1
1999 Equity Incentive Plan.(1)**
10.7.2
2000 Equity Incentive Plan.(11)**
10.7.3
2001 Equity Incentive Plan.(12)**
10.7.4
2002 Equity Incentive Plan.(19)**
10.7.5
Form of Option issued under 1999 Equity Incentive Plan.(19)**
10.7.6
Form of Option issued under 2000 Equity Incentive Plan.(19)**
10.7.7
Form of Option issued under 2001 Equity Incentive Plan.(19)**
10.7.8
Form of Option issued under 2002 Equity Incentive Plan.(19)**
10.8
Debt to Equity Conversion Agreement by and between the Company and B&R Employment, Inc.(3)
10.8.1
Amendment to Debt to Equity Conversion Agreements by and between the Company and B&R Employment, Inc.(2)
10.8.2
Forbearance Agreement dated January 24, 2002 between the Company and Source One Personnel. (20)
10.8.3
Modification of Forbearance Agreement dated June 4, 2002 between the Company and Source One Personnel, together with Exhibits thereto.(21)
10.10
Allocation and Indemnity Agreement dated as of January 24, 2002 among the Company, Charles Sahyoun and Sahyoun Holdings, LLC.(20)
10.11
Letter Agreement dated April 15, 2002 between the Company, Sahyoun Holdings, LLC and Joseph J. Raymond, Sr. amending the Allocation and Indemnity Agreement dated April 18, 2002.(17)
10.12
Exchange Agreement dated March 11, 2002 by and between Transworld Management Services, Inc. and the Company.(22)
10.13
Securities Purchase Agreement dated March 11, 2002, by and between Pinnacle Investment Partners, LP and the Company.(22)
10.14
Operating Agreement of Stratus Technology Services.(28)
10.15
Form of Securities Purchase Agreement between the Company and Series E Shareholders.(27)
10.16
Compromise Agreement between the Company and Series E Shareholders dated July 30, 2003.(27)
10.17
Redemption Agreement dated July 31, 2003 between Artisan (UK) plc and the Company.(29)
10.18
Agreement to Exchange Series H Preferred Shares for Series E Preferred Shares between the Company and Pinnacle Investment Partners, L.P.(27)
10.19
Letter Agreement regarding Employer Service Agreements between the Company and Advantage Services Group, LLC.(28)
10.20
Letter Agreement regarding Receivables between the Company and Advantage Services Group, LLC. (28)
10.21
Waiver Letter Agreement between the Company and Series E Shareholders.(31)
10.22
Letter Agreement between the Company and the Series A Holders extending the time for issuance of shares.(31)
10.23
Employer Service Agreement dated June 21, 2004 between Advantage Services Group, LLC and the Company. Certain information has been omitted from this exhibit and is subject to a request for confidential treatment.(31)
10.24
Employer Service Agreement dated July 2, 2004 together with Letter Addendum dated July 6, 2004 between Advantage Services Group, LLC and the Company. Certain information has been omitted from this exhibit and is subject to a request for confidential treatment.(31)
10.25
Outsourcing Agreement dated August 13, 2004 between Advantage Services Group, LLC and the Company. Certain information has been omitted from this exhibit and is subject to a request for confidential treatment.(31)
Computation of Ratio of Earnings to Fixed Charges.(filed with Amendment No. 2 to the Registration Statement)
Subsidiaries of Registrant.(15)
23.1
Consent of Amper, Politziner & Mattia, P.C. Independent Registered Public Accounting Firm. (filed herewith).,
Power of Attorney (located on signature pages of this filing).
31.1
Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.(filed herewith)
31.2
Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.(filed herewith)
32.1
Certification of Chief Executive Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.(filed herewith)
32.2
Certification of Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.(filed herewith)
*
Constitutes a management contract required to be filed pursuant to Item 14(c) of Form 10-K.
**
Constitutes a compensation plan required to be filed pursuant to Item 14(c) of Form 10-K.
Footnote 1
Incorporated by reference to similarly numbered Exhibits filed with Amendment No. 1 to the Company’s Registration Statement on Form SB-2 (Registration Statement No. 333-83255) as filed with the Securities and Exchange Commission on September 3, 1999.
Footnote 2
Incorporated by reference to similarly numbered Exhibits filed with Amendment No. 6 to the Company’s Registration Statement on Form SB-2 (Registration Statement No. 333-83255) as filed with the Securities and Exchange Commission on February 1, 2000.
Footnote 3
Incorporated by reference to similarly numbered Exhibits filed with Amendment No. 3 to the Company’s Registration Statement on Form SB-2 (Registration Statement No. 333-83255) as filed with the Securities and Exchange Commission on December 17, 1999.
Footnote 4
Incorporated by reference to similarly numbered Exhibits filed with Amendment No. 7 to the Company’s Registration Statement on Form SB-2 (Registration Statement No. 333-83255) as filed with the Securities and Exchange Commission on March 17, 2000.
Footnote 5
Incorporated by reference to the Exhibits to the Company’s Form 8-K, as filed with the Securities and Exchange Commission on June 30, 2000.
Footnote 6
Incorporated by reference to the Exhibits to the Company’s Form 8-K, as filed with the Securities and Exchange Commission on November 3, 2000.
Footnote 7
Incorporated by reference to Exhibit 1.2 filed with Amendment No. 5 to the Company’s Registration Statement on Form SB-2 (Registration Statement No. 333-83255) as filed with the Securities and Exchange Commission on February 11, 2000.
Footnote 8
Incorporated by reference to the Exhibits to the Company’s Form 8-K, as filed with the Securities and Exchange Commission on August 9, 2001.
Footnote 9
Incorporated by reference to the Exhibits to the Company’s Form 8-K, as filed with the Securities and Exchange Commission on January 2, 2002.
Footnote 10
Incorporated by reference to Exhibit 3 filed with Form 10-Q for the Quarter ended June 30, 2001 as filed with the Securities and Exchange Commission on August 14, 2001.
Footnote 11
Incorporated by reference to similarly numbered Exhibits to the Company’s Form 10-KSB, as filed with the Securities and Exchange Commission on December 29, 2000.
Footnote 12
Incorporated by reference to similarly numbered Exhibits filed with the Company’s Registration Statement on Form S-1 (Registration Statement No. 333-55312) as filed with the Securities and Exchange Commission on February 9, 2001.
Footnote 13
Incorporated by reference to the Exhibits to the Company’s Form S-1/A, as filed with the Securities and Exchange Commission on April 11, 2001.
Footnote 14
Incorporated by reference to the Exhibits to the Company’s Form 8-K, as filed with the Securities and Exchange Commission on April 4, 2002.
Footnote 15
Incorporated by reference to similarly numbered Exhibits filed with the Registrant’s Form 10-K for the fiscal year ended September 30, 2001, and filed with the Securities and Exchange Commission on January 25, 2002.
Footnote 16
Incorporated by reference to similarly numbered Exhibits filed with the Registrant’s Form 10-K/A for the fiscal year ended September 30, 2001, as filed with the Securities and Exchange Commission on March 5, 2002.
Footnote 17
Incorporated by reference to the Exhibits to the Company’s Form 10-Q for the quarter ended March 31, 2002, as filed with the Securities and Exchange Commission on May 15, 2002.
Footnote 18
Incorporated by reference to the Exhibits to the Company’s Form 8-K, as filed with the Securities and Exchange Commission on April 4, 2002.
Footnote 19
Incorporated by reference to the Exhibits to the Company’s Form S-8, as filed with the Securities and Exchange Commission on September 17, 2002.
Footnote 20
Incorporated by reference to the Exhibits to the Company’s Form 10-K, as filed with the Securities and Exchange Commission on January 25, 2002, as amended by the Company’s Form 10-K/A, as filed with the Securities and Exchange Commission on March 5, 2002.
Footnote 21
Incorporated by reference to the Company’s 10-Q, for the quarter ended June 30, 2002, as filed with the Securities and Exchange Commission on August 14, 2002.
Footnote 22
Incorporated by reference to the similarly numbered Exhibits filed with the Company’s Registration Statement on Form S-1 (Registration Statement No. 333-100149) as filed with the Securities and Exchange Commission on September 27, 2002.
Footnote 23
Incorporated by reference to Exhibits to the Company’s Form 8-K, as filed with the Securities and Exchange Commission on November 26, 2002.
Footnote 24
Incorporated by reference to the similarly numbered Exhibits to the Company’s Form 10-K, as filed with the Securities and Exchange Commission on December 23, 2002.
Footnote 25
Incorporated by reference to the Exhibits to the Company’s Form S-1, as filed with the Securities and Exchange Commission on February 2, 2003.
Footnote 26
Incorporated by reference to the Exhibits to the Company’s Form S-1, as filed with the Securities and Exchange Commission on March 20, 2003.
Footnote 27
Incorporated by reference to the similarly numbered exhibits to the Company’s Form 10-Q for the quarterly period ended June 30, 2003, as filed with the Securities and Exchange Commission on August 13, 2003.
Footnote 28
Incorporated by reference to similarly numbered exhibits to the Company’s Form 10-K for the fiscal year ended September 30, 2003 as filed with the Securities and Exchange Commission on December 24, 2003.
Footnote 29
Incorporated by reference to similarly numbered exhibits to Amendment No. 2 to the Company’s Registration Statement on Form S-1 filed with the Securities and Exchange Commission on March 30, 2004.
Footnote 30
Incorporated by reference to similarly numbered exhibits to Post-Effective Amendment No. 1 to the Company’s Registration Statement on Form S-1 filed with the Securities and Exchange Commission on June 14, 2004.
Footnote 31
Incorporated by reference to similarly numbered exhibits to the Company’s Form 10-Q for the quarter ended June 30, 2004 as filed with the Securities and Exchange Commission on August 16, 2004.
Footnote 32
Incorporated by reference to similarly numbered exhibits to Amendment No. 1 to the Company’s Registration Statement on Form S-4 filed with the Securities and Exchange Commission on March 30, 2004.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on behalf of the undersigned, thereunto duly authorized.
POWER OF ATTORNEY
KNOW ALL PERSONS BY THESE PRESENTS that each individual whose signature appears below constitutes and appoints Joseph J. Raymond and each of them, as his true lawful attorney-in-fact and agent, with full power of substitution for him or her and in his or her name, place and stead, in any and all capacities, to sign any and all amendments to this Form 10-K, and to file the same, together with all the exhibits thereto and all documents in connection therewith, with the Securities and Exchange Commission, granting unto said attorneys-in-fact and agents, and each of them, full power and authority to do and perform each and every act and being requisite and necessary to be done in and about the premises, as fully to all intents and purposes as he or she might or could do in person, hereby ratifying and confirming all that said attorneys-in-fact and agents or any of them, of his or her or their substitute or substitutes, may lawfully do or cause to be done by virtue hereof.
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.
STRATUS SERVICES GROUP, INC.
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
As of September 30, 2004 and 2003
and for the Years Ended September 30, 2004, 2003 and 2002
Report of Independent Registered Public Accounting Firm
Consolidated Financial Statements
Consolidated Balance Sheets
Consolidated Statements of Operations
Consolidated Statements of Cash Flows
Consolidated Statements of Stockholders’ Equity (Deficiency)
Consolidated Statements of Comprehensive Income (Loss)
Notes to Consolidated Financial Statements
to
Report of Independent Registered Public Accounting Firm
To the Stockholders of
Stratus Services Group, Inc.
We have audited the accompanying consolidated balance sheets of Stratus Services Group, Inc. as of September 30, 2004 and 2003, and the related consolidated statements of operations, stockholders’ equity (deficiency), cash flows and comprehensive income (loss) for each of the three years in the period ended September 30, 2004. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of Stratus Services Group, Inc. as of September 30, 2004 and 2003, and the consolidated results of its operations and its cash flows for each of the three years in the period ended September 30, 2004, in conformity with accounting principles generally accepted in the United States of America.
The accompanying consolidated financial statements have been prepared assuming that the Company will continue as a going concern. As discussed in Note 1 to the financial statements, the Company has suffered recurring losses from operations and has a net capital deficiency, which raises substantial doubt about its ability to continue as a going concern. Management’s plans regarding those matters also are described in Note 1. The consolidated financial statements do not include any adjustments that might result from the outcome of this uncertainty.
In connection with our audits of the consolidated financial statements referred to above, we audited the financial Schedule II. In our opinion, the financial schedule, when considered in relation to the consolidated financial statements taken as a whole, presents fairly, in all material respects, the information stated therein.
/s/ AMPER, POLITZINER & MATTIA, P.C.
Edison, New Jersey
December 21, 2004
STRATUS SERVICES GROUP, INC.
Consolidated Balance Sheets
See accompanying summary of accounting policies and notes to consolidated financial statements.
STRATUS SERVICES GROUP, INC.
Consolidated Statements of Operations
See accompanying summary of accounting policies and notes to consolidated financial statements.
STRATUS SERVICES GROUP, INC.
Consolidated Statements of Cash Flows
See accompanying summary of accounting policies and notes to consolidated financial statements.
STRATUS SERVICES GROUP, INC.
Consolidated Statement of Stockholders’ Equity (Deficiency)
See accompanying summary of accounting policies and notes to consolidated financial statements.
STRATUS SERVICES GROUP, INC.
Consolidated Statement of Stockholders’ Equity (Deficiency)
See accompanying summary of accounting policies and notes to consolidated financial statements.
STRATUS SERVICES GROUP, INC.
Consolidated Statement of Stockholders’ Equity (Deficiency)
See accompanying summary of accounting policies and notes to consolidated financial statements.
STRATUS SERVICES GROUP, INC.
Consolidated Statement of Stockholders’ Equity (Deficiency)
See accompanying summary of accounting policies and notes to consolidated financial statements.
STRATUS SERVICES GROUP, INC.
Consolidated Statement of Stockholders’ Equity (Deficiency)
See accompanying summary of accounting policies and notes to consolidated financial statements.
STRATUS SERVICES GROUP, INC.
Consolidated Statement of Stockholders’ Equity (Deficiency)
See accompanying summary of accounting policies and notes to consolidated financial statements.
STRATUS SERVICES GROUP, INC.
Consolidated Statements of Comprehensive Income (Loss)
See accompanying summary of accounting policies and notes to consolidated financial statements.
STRATUS SERVICES GROUP, INC.
Notes to Consolidated Financial Statements
Note 1 -
Nature of Operations and Summary of Significant Accounting Policies
Operations
Stratus Services Group, Inc. together with its 50%-owned joint venture, (the “Company”) is a national provider of staffing and productivity consulting services. As of September 30, 2004, the Company operated a network of 27 offices in 7 states.
The Company operates as one business segment. The one business segment consists of its traditional staffing services and SMARTSolutions™, a structured program to monitor and enhance the production of a client’s labor resources. The Company’s customers are in various industries and are located throughout the United States. Credit is granted to substantially all customers. No collateral is maintained.
Principles of Consolidation
The consolidated financial statements include the accounts of Stratus Services Group, Inc. and its 50%-owned joint venture (see Note 1 - “New Accounting Pronouncements”).
Basis of Presentation
The accompanying consolidated financial statements have been prepared on a going concern basis, which contemplates the realization of assets and the satisfaction of liabilities in the normal course of business. As shown in the financial statements, the Company incurred significant losses from continuing operations of $1,086,000, $4,433,000 and $7,086,000 during the years ended September 30, 2004, 2003 and 2002, respectively, and has a working capital deficit of $11,001,000 at September 30, 2004. These factors, among others, indicate that the Company may be unable to continue as a going concern. The financial statements do not include any adjustments relating to the recoverability and classification of liabilities that might be necessary should the Company be unable to continue as a going concern.
Management recognizes that the Company’s continuation as a going concern is dependent upon its ability to generate sufficient cash flow to allow it to satisfy its obligations on a timely basis, to fund the operation and capital needs, and to obtain additional financing as may be necessary.
Management of the Company has taken steps to revise and reduce its operating requirements, which it believes will be sufficient to assure continued operations and implementation of the Company’s plans. The steps include closing or selling branches that are not profitable, consolidating branches and reductions in staffing and other selling, general and administrative expense.
The Company continues to pursue other sources of equity or long-term debt financings. The Company also continues to negotiate payment plans and other accommodations with its creditors.
Revenue Recognition
The Company recognizes revenue as the services are performed by its workforce. The Company’s customers are billed weekly. At balance sheet dates, there are accruals for unbilled receivables and related compensation costs.
The following summarizes revenues:
Unlike traditional staffing services, under a payrolling arrangement, the Company’s customer recruits and identifies individuals for the Company to hire to provide services to the customer. The Company becomes the statutory employer although the customer maintains substantially all control over those employees. Accordingly, Emerging Issues Task Force (“EITF”) 99-19, “Reporting Revenue Gross as a Principal versus Net as an Agent” requires that the Company does not reflect the direct payroll costs paid to such employees in revenues and cost of revenue.
Use of Estimates
The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
Concentration of Cash
The Company maintains its cash in bank deposit accounts, which, at times may exceed federally insured limits. The Company has not experienced any losses in such accounts.
Comprehensive Income (Loss)
Comprehensive income (loss) is the total of net income (loss) and other non-owner changes in equity including unrealized gains or losses on available-for-sale marketable securities.
Earnings/Loss Per Share
The Company utilizes Statement of Financial Accounting Standards No. 128 “Earnings Per Share”, (SFAS 128), whereby basic earnings per share (“EPS”) excludes dilution and is computed by dividing earnings available to common stockholders by the weighted-average number of common shares outstanding during the period. Diluted EPS assumes conversion of dilutive options and warrants, and the issuance of common stock for all other potentially dilutive equivalent shares outstanding.
Following is a reconciliation of the numerator and denominator of Basic EPS to the numerator and denominator of Diluted EPS for all years presented.
Investment
The investment represented securities available for sale which were stated at fair value. Unrealized holding gains and losses were reflected as a net amount in accumulated other comprehensive loss until realized. The entire investment, which consisted of an investment in a publicly-traded foreign company, was sold in the year ended September 30, 2002 at a gross realized loss of $2,159,415. There were no gross realized gains and losses on sales of available-for-sale securities for the years ended September 30, 2004 and 2003.
Property and Equipment
Property and equipment is stated at cost, less accumulated depreciation. Depreciation is provided over the estimated useful lives of the assets as follows:
Goodwill
Effective October 1, 2002, the Company adopted the provisions of Statement of Financial Accounting Standards (“SFAS”) No. 142. “Goodwill and other Intangible Assets”. The provisions at SFAS No. 142 require that intangible assets not subject to amortization and goodwill be tested for impairment annually or more frequently if events or changes in circumstances indicate that the carrying value may not be recoverable. Amortization of goodwill and intangible assets with indefinite lives, including such assets recorded in past business combinations, ceased upon adoption. Thus no amortization for such goodwill was recognized in the accompanying consolidated statement of operations for the years ended September 30, 2004 and 2003, compared to $289,177 for the year ended September 30, 2002.
In order to assess the fair value of our goodwill as of the adoption date, we engaged an independent valuation firm to assist in determining the fair value. The valuation process appraised our assets and liabilities using a combination of present value and multiple of earnings valuation techniques. Based upon the results of the valuations it was determined that there was no impairment of goodwill.
Prior to the adoption of SFAS No. 142 on October 1, 2002, the Company amortized goodwill over its estimated useful life of fifteen years and evaluated goodwill for impairment in conjunction with its other long-lived assets. In this connection, the Company recorded charges of $400,000 in the year ended September 30, 2002. $100,000 has been reclassified to discontinued operations in the year ended September 30, 2002. The steady decline in revenue and earnings of certain previously acquired business units and in the case of one business unit, the loss of a major customer, required that the Company adjust the carrying value of the goodwill.
Fair Values of Financial Instruments
Fair values of cash, accounts receivable, accounts payable and short-term borrowings approximate cost due to the short period of time to maturity. Fair values of long-term debt, which have been determined based on borrowing rates currently available to the Company for loans with similar terms or maturity, approximate the carrying amounts in the financial statements.
Stock - Based Compensation
The Company accounts for stock based compensation issued to its employees and directors in accordance with Accounting Principle Board No. 25, “Accounting for Stock Issued to Employees”, and has elected to adopt the “disclosure only” provisions of SFAS No. 123 as amended by provisions of SFAS No. 148, “Accounting for Stock-Based Compensation - Transition and Disclosure.” SFAS No. 148 amends SFAS No. 123, “Accounting for Stock-Based Compensation”, to provide alternative methods of transition for a voluntary change to the fair value based method of accounting for stock-based compensation. In addition, SFAS No. 148 amends the disclosure requirements of SFAS No. 123 to require new permanent 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 in reported results.
For SFAS No. 148 purposes, the fair value of each option granted is estimated as of the date of grant using the Black-Scholes option pricing model with the following weighted average assumptions used:
If the Company had elected to recognize the compensation costs of its stock option plans based on the fair value of the awards under those plans in accordance with SFAS No. 148, net loss and loss per share would have been adjusted to the proforma amounts below:
Income Taxes
The Company recognizes deferred tax assets and liabilities based on differences between the financial reporting and tax bases of assets and liabilities using the enacted tax rates and laws that are expected to be in effect when the differences are expected to be recovered. The Company provides a valuation allowance for deferred tax assets for which it does not consider realization of such assets to be more likely than not.
Advertising Costs
Advertising costs are expensed as incurred. The expenses for the years ended September 30, 2004, 2003 and 2002 were $143,000, $136,000 and $122,000, respectively, and are included in selling, general and administrative expenses.
Impairment of Long-Lived Assets
The Company evaluates the recoverability of its long-lived assets in accordance with Statement of Financial Accounting Standards No. 144 “Accounting for the Impairment or Disposal of Long-Lived Assets” (“SFAS No. 144”). SFAS No. 144 requires recognition of impairment of long-lived assets in the event the net book value of such assets exceeds the future undiscounted cash flows attributable to such assets.
New Accounting Pronouncements
In January 2003, the Financial Accounting Standards Board (the “FASB”) issued FASB Interpretation No. 46 (“FIN 46”) - Consolidation of Variable Interest Entities, and a revised interpretation of FIN 46 (FIN 46R) was issued in December 2003. FIN 46 requires that if an entity has a controlling financial interest in a variable interest entity, the assets, liabilities and results of activities of the variable interest entity should be included in the consolidated financial statements of the entity. The provisions of FIN 46 are effective immediately for all arrangements entered into prior to January 31, 2003, the FIN 46R provisions are required to be adopted at the beginning of the first interim or annual period ending after March 15, 2004. As a result of adopting FIN 46R, the Company has consolidated Stratus Technology Services, LLC (“STS”), a joint venture in which the Company has a 50% interest (See Note 10). The Company was deemed to be the primary beneficiary of STS since a son of the Chief Executive Officer of the Company has a majority interest in the other 50% venturer. STS provides information technology staffing services. After elimination of inter-company balances, there are no assets remaining of STS included in the Company’s consolidated balance sheet.
Prior to the adoption of FIN 46R, the Company accounted for its investment in STS under the equity method and accordingly, included its share of the earnings (loss) of STS in “Other income (expense)”. Beginning with the third quarter of fiscal 2004, STS was no longer accounted for under the equity method, and its revenues and expenses are included in the Company’s consolidated statement of operations. The other venturer’s share of earnings (loss) is reflected as a minority interest.
Creditors of STS have no recourse to the general credit of the Company.
In May 2003, the FASB issued SFAS No. 150, “Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity”. SFAS No. 150 changes the accounting for certain financial instruments that, under previous guidance, issuers could account for as equity and requires that those instruments be classified as liabilities (or assets in certain circumstances) in statements of financial position. This statement affects the issuer’s accounting for three types of freestanding financial instruments including (1) mandatorily redeemable shares that are required to be redeemed at a specified or determinable date or upon an event certain to occur, (2) put options and forward purchase contracts, which involves financial instruments embodying an obligation that the issuer must or could choose to settle by issuing a variable number of its shares or other equity instruments based solely on something other than the issuer’s own equity shares and (3) certain obligations that can be settled with share, the monetary value of which is (i) fixed, tied solely or predominantly to a variable such as a market index, or (ii) varies inversely with the value of the issuers’ shares. For public companies, SFAS No. 150 became effective at the beginning of the first interim period beginning after June 15, 2003. As a result of SFAS No. 150, the Company has classified put options that were previously classified as “Temporary equity” and the Company’s Series A redeemable convertible preferred stock as liabilities at September 30, 2003.
In March 2004, the FASB issued an exposure draft of a new standard entitled “Share Based Payment”, which would amend SFAS No. 123 and Financial Accounting Standards Board Statement No. 95, “Statement of Cash Flows”. The new accounting standard, as proposed, would require the expensing of stock options issued by the Company in the financial statements using a fair-value-based method and would be effective for periods beginning after June 15, 2005. See Note 1 “Stock-Based Compensation” for pro forma disclosures regarding the effect on net income and income per share if the Company had applied the fair value recognition provisions of the SFAS No. 123. Depending on the method adopted by the Company to calculate stock-based compensation expense upon the adoption of Share Based Payment, the pro forma disclosure in Note 1 - “Stock Based Compensation”, may not be indicative of the stock-based compensation expense to be recognized in periods beginning after June 15, 2005.
In September 2004, the FASB’s Emerging Issue Task Force (“EITF”) reached a consensus on EITF Issue No. 04-08, The Effect of Contingently Convertible Instruments on Diluted Earnings per Share. The Task Force reached a conclusion that Contingently Convertible Instruments should be included in diluted earnings per share computations, if dilutive, regardless of whether the market price trigger or other contingent feature has been met. Through September 30, 2004, EITF Issue No. 04-08 had no effect on the Company.
Reclassifications
Certain prior year financial statement amounts have been reclassified to be consistent with the presentation for the current year.
Note 2 -
Reverse Stock Split
On July 14, 2004, the Company effected a one-for-four reverse stock split of the Company’s common stock. All references to per share information and the number of shares issued and outstanding for all years presented have been adjusted to reflect the reverse stock split on a retroactive basis.
Note 3 -
Public Offering
On August 11, 2004, the Company completed a public offering of units consisting of one share of the Company’s common stock and one warrant to purchase common stock. A total of 4,961,028 units were sold at $.80 per unit, generating net proceeds of approximately $2,153,000, after deducting underwriter’s commission’s and other offering costs aggregating approximately $1,815,000.
Each warrant entitles the holder to purchase one share of the Company’s stock for $.76. The warrants are exercisable at any time during the period commencing July 14, 2005 and ending January 17, 2007, unless the Company has redeemed them. The Company may redeem some or all of the warrants at a redemption price of $.08 per warrant, beginning July 14, 2005, once the closing bid price of the Company’s common stock has been at least $1.33 for 20 consecutive trading days.
Note 4 -
Acquisitions
On July 27, 2001, the Company purchased substantially all of the tangible and intangible assets, excluding accounts receivable of the clerical and light industrial staffing division of Source One Personnel, Inc. (“Source One”). As a result of the acquisition, the Company has expanded its presence in the Philadelphia to New York corridor.
The initial purchase price for the assets was $3,400,000, of which $200,000 in cash, and 100,000 shares of the Company’s restricted common stock were paid at the closing and the remaining $2,400,000 was represented by two promissory notes. In addition, Source One is entitled to earnout payments based upon the acquired business achieving certain performance levels during each of the three fiscal years beginning October 1, 2001. There was no earnout payment due for the years ended September 30, 2004, 2003 and 2002. There was an additional $42,163 of costs paid to third parties in connection with the acquisition. The first note, representing $600,000, was payable in one installment of $600,000 plus accrued interest at 7% per year, at 180 days after the closing. The second note, representing $1,800,000 bears interest at 7% per year and is payable over a four-year period in equal quarterly payments beginning 120 days after the closing. Source One had agreed to allow the Company to defer the payment of the first note and the February 2002 installment of the second note until the earlier of the receipt of the proceeds from the sale of the Company’s Engineering Division (see Note 5) on April 30, 2002. In June 2002, Source One agreed to forbear from exercising remedies against the Company until June 30, 2002. On July 31, 2002, the Company cured all payment defaults under the first and second notes. In exchange for the forbearance, the Company issued 250,000 shares of its restricted Common Stock to Source One. Source One has a put option to sell 100,000 shares back to the Company at $8.00 per share between 24 months after the closing and final payment of the second note, but not less than 48 months (see Note 18).
The following table summarizes the fair value of the assets acquired at the date of acquisition based upon a third-party valuation of certain intangible assets:
Of the $636,300 of intangible assets, $127,300 was assigned to a covenant-not-to-compete and $509,000 was assigned to the customer list. The intangible assets are being amortized over their estimated useful life of four years. Goodwill is not being amortized under the provision of SFAS No. 142. All of the goodwill is expected to be deductible for tax purposes.
Effective January 1, 2002, the Company purchased substantially all of the tangible and intangible assets, excluding accounts receivable, of seven offices of Provisional Employment Solutions, Inc. (“PES”). The initial purchase price was $1,480,000, represented by a $1,100,000 promissory note and 400,000 shares of the Company’s common stock. There was an additional $334,355 of costs paid to third parties in connection with the acquisitions. In addition, PES is entitled to earnout payments of 15% of pretax profit of the acquired business up to a total of $1.25 million or the expiration of ten years, whichever occurs first. There was no earnout payment due for the years ended September 30, 2004, 2003 and 2002. The note bears interest at 6% a year and is payable over a ten-year period in equal quarterly payments.
The following table summarizes the fair value of the assets acquired at the date of acquisition based upon a third-party valuation of certain intangible assets:
Of the $468,596 of intangible assets, $85,880 was assigned to a covenant-not-to-compete and $382,716 was assigned to the customer list. The intangible assets are being amortized over their estimated useful life of two to four years. Goodwill is not being amortized under the provision of SFAS No. 142. All of the goodwill is expected to be deductible for tax purposes.
Effective as of December 1, 2002, (the “Effective Date”), the Company purchased substantially all of the tangible and intangible assets, excluding accounts receivable, of six offices of Elite Personnel Services (“Elite”), a California corporation. The Elite branches provide temporary light industrial and clerical staffing in six business locations in California and Nevada. The Company also took over Elite’s Downey, California office, from which Elite serviced no accounts but which it utilized as a corporate office. The Company has utilized the Downey office as a regional corporate facility. The acquisition of Elite furthers the Company’s expansion into the California staffing market. Pursuant to the terms of an Asset Purchase Agreement between the Registrant and Elite dated November 19, 2002 (the “Asset Purchase Agreement”), the purchase price payable at closing (the “Base Purchase Price”) for the assets was $1,264,000, all of which was represented by an unsecured promissory note. In addition to the Base Purchase Price, Elite will also receive as a deferred purchase price, an amount equal to 10% of the annual “Gross Profits” as defined in the Asset Purchase Agreement of the acquired business between $2,500,000 and $3,200,000, and 15% of the annual Gross Profits of the acquired business in excess of $3,200,000 for a period of two years from the Effective Date. The note includes a stated imputed interest at 4% per year and is payable over an eight-year period in equal monthly payments beginning 30 days after the Effective Date. In connection with the transaction, Elite, its President and other key management members entered into non-competition and non-solicitation agreements pursuant to which they agreed not to compete with the Registrant in the territories of the acquired business for periods ranging from twelve months to five years, and to not solicit the employees or customers of the acquired business for periods ranging from twelve months to five years.
For financial accounting purposes, interest on the note has been imputed at a rate of 11% per year. Accordingly, the note and Base Purchase Price has been recorded at $845,875. In accordance with SFAS No. 141, “Business Combinations” the contingent portion of the purchase price has been recognized as a liability to the extent that the net acquired assets exceed the purchase price. Accordingly, $244,000 is included in “Accounts payable and accrued expenses” on the attached consolidated balance sheet as of September 30, 2004 and 2003. As of September 30, 2004, $154,000 of the contingent purchase price has been earned. There was an additional $176,644 of costs paid to third parties in connection with the acquisition.
The following summarizes the fair value of the assets acquired at the date of acquisition based upon a third-party valuation of certain intangible assets:
The covenant-not-to-compete and customer list are being amortized over their estimated useful life of five and seven years, respectively.
The above acquisitions have been accounted for as purchases. The results of operations are included in the Company’s consolidated statements of operations from the effective date of acquisition.
The unaudited pro forma consolidated results of operations presented below assume that the acquisitions had occurred at the beginning of fiscal 2002. This information is presented for informational purposes only and includes certain adjustments such as goodwill amortization resulting from the acquisitions and interest expense related to acquisition debt.
The maturities on notes payable-acquisitions are as follows:
Note 5 -
Discontinued Operations
Sale of Engineering Division
On January 24, 2002, the Company entered into an agreement to sell the assets of its Engineering Services Division (the “Division”) to SEA Consulting Services Corporation (“SEA”).
On March 28, 2002, the Company completed the sale of the assets of the Division to SEA pursuant to the Asset Purchase Agreement dated as of January 24, 2002, among the Company, SEP, LLC (“SEP”), Charles Sahyoun, Sahyoun Holders LLC and SEA. The transaction was approved by a vote of the Company’s stockholders at the Company’s annual meeting of stockholders held on March 28, 2002.
The assets of the Division had been transferred to SEP, a limited liability company in which the Company owned a 70% interest, at the time of the execution of the Asset Purchase Agreement. Sahyoun Holders, LLC, a company wholly-owned by Charles Sahyoun, the President of the Division, owned the remaining 30% interest in SEP.
Under the terms of the Asset Purchase Agreement, the Company received an initial cash payment of $1,560,000, which represented 80% of the initial $2,200,000 installment of the purchase price payable to SEP net of a $200,000 broker’s fee due to a third party. Sahyoun Holdings, LLC received the other 20% of the initial net installment of the purchase price, or $440,000.
The Asset Purchase Agreement required SEA to make the following additional payments to SEP:
(i)
A payment of $1 million, plus or minus the amount by which SEA’s profit for the six months ending June 30, 2002, as determined pursuant to the Asset Purchase Agreement, were less than $600,000 (the “Second Payment”);
(ii)
A payment of $1 million, plus or minus the amount by which SEA’s profit for the six months ending December 31, 2002, as determined pursuant to the Asset Purchase Agreement, were greater or less than $600,000 (the “Third Payment”);
(iii)
Five subsequent annual payments (the “Subsequent Payments”) which will be based upon a multiple of the annual successive increases, if any, in SEA’s profit during the five year period beginning on January 1, 2003 and ending December 31, 2007.
Pursuant to an allocation and indemnity agreement entered into by the Company, Sahyoun Holdings, LLC and Charles Sahyoun (the “Allocation and Indemnity Agreement”), the Company was entitled to $250,000 of the Second Payment and $250,000 of the Third Payment. On April 15, 2002, by letter agreement between the Company, Sahyoun Holdings, LLC and Joseph J. Raymond, Sr., the Chairman and Chief Executive Officer of the Company, the parties agreed to a modification of the Allocation and Indemnity Agreement. Per that letter agreement, Sahyoun Holdings, LLC provided the Company with $200,000 cash in exchange for the Company’s short-term, 90-day demand note, due and payable by August 1, 2002 in the amount of $250,000. Such $250,000 was repaid by the Company from its $250,000 share of the Second Payment which was received in June 2002.
Sahyoun Holdings, LLC and Charles Sahyoun guaranteed the $250,000 payment to be made to the Company from the Third Payment, regardless of the operating results of SEA. In December 2002, the Company and Charles Sahyoun agreed to offset the $250,000 of the Third Payment due to the Company against $250,000 of accrued commissions due Charles Sahyoun. As a result, the Company is not entitled to any additional payments under the Asset Purchase Agreement.
The transaction resulted in a gain, which was calculated as follows:
Revenues from the Division were $2,730,000 for the year ended September 30, 2002.
Sale of Certain Branches
On March 9, 2003, the Company completed the sale of substantially all of the tangible and intangible assets, excluding accounts receivable, of its Colorado Springs, Colorado office. Pursuant to the terms of an asset purchase agreement between the Company and US Temp Services, Inc. (“US Temps”) dated March 9, 2003, the purchase price for the purchased assets was $20,000 which was paid by a promissory note, which bears interest at the rate of 6% per year and is payable in monthly installments of $608 over a three year period. The note is secured by a security interest on all of the purchased assets.
The purchase price for the assets acquired by US Temps was arrived at through arms-length negotiations between the parties and resulted in a gain on sale of $13,958.
On August 22, 2003, the Company completed the sale, effective as of August 18, 2003 (the “ALS Effective Date”) of substantially all of the tangible and intangible assets, excluding accounts receivable, of its Miami Springs, Florida office. Pursuant to the terms of the Asset Purchase Agreement between the Company and ALS, LLC, a Florida limited liability company (“ALS”) dated August 22, 2003 (the “Purchase Agreement”), the purchase price for the purchased assets was $128,000, which was paid by a promissory note, which bears interest at the rate of 7% per year with payments over a 60 month period. The amount of the monthly payments due under the note is equal to the greater of $10 per month or 20% of the monthly net profits generated by the staffing business originating from the purchased assets, commencing October 31, 2003. The note is secured by a security interest in all of the purchased assets.
In connection with the transaction, ALS entered into a non-compete and non-solicitation agreement pursuant to which ALS agreed not to compete with the Company with respect to any of the Company’s other remaining offices for a period of 18 months.
The purchase price for the assets acquired by ALS was arrived at through negotiations with a related party purchaser and resulted in a gain on sale of $10,777. The son of our President and Chief Executive Officer is a 50% member in ALS, LLC.
On September 10, 2003, the Company completed the sale, effective as of September 15, 2003 (the “Effective Date”), of substantially all of the tangible and intangible assets, excluding accounts receivable, of five of its New Jersey offices to D/O Staffing LLC (“D/O”). The offices sold are the following: Elizabeth, New Brunswick, Paterson, Perth Amboy and Trenton, New Jersey. Pursuant to the terms of an asset purchase agreement between D/O and us dated September 10, 2003 (the “D/O Purchase Agreement”), the base purchase price for the purchased assets was $1,250,000 payable as follows:
(i)
$1,150,000 payable in certified funds at the closing; and
(ii)
$100,000 payable in certified funds into escrow at the closing to be held in escrow by attorneys for the Buyer pursuant to the terms of an escrow agreement, to account for certain post-closing adjustments.
Additionally, the Company may be entitled to receive as a deferred purchase price (the “Bonus”), an amount equal to $125,000 if, for the one year period measured from the Effective Date, the purchased assets generate for D/O at least $18,000,000 in actual billings by client accounts serviced by the Company as of the Closing and transferred by the Company to D/O pursuant to the D/O Purchase Agreement. The Bonus, if any, is payable by a promissory note, payable over 24 months and bearing interest at an interest rate of 6% a year. The Company and D/O are disputing whether or not the Company is entitled to any Bonus. Accordingly, no contingent gain has been recorded at September 30, 2004.
The purchase price for the assets was arrived at through arms-length negotiations between the parties and resulted in a (loss) on sale of ($50,354).
On September 29, 2003, the Company completed the sale of substantially all of the tangible and intangible assets, excluding accounts receivable, of its Las Vegas, Nevada office. Pursuant to the terms of an asset purchase agreement between the Company and US Temps dated September 29, 2003, the purchase price for the purchased assets was $105,000, all of which was paid by a promissory note, which bears interest at the rate of 6% per year and is payable in monthly installments of $2,030, over a five year period. The note is secured by a security interest on all of the purchased assets.
The purchase price for the assets acquired by US Temps was arrived at through arms-length negotiations between the parties and resulted in a gain on sale of $4,599.
The net loss on sale for the aforementioned certain branches are calculated as follows:
Revenues from the aforementioned certain branches were $18,089,065 and $19,261,294 for the years ended September 30, 2003 and 2002, respectively.
The consolidated statements of operations for all periods presented have been reclassified to reflect the operating results of the Division and sold branches as discontinued operations.
Note 6 -
Line of Credit
The Company has a loan and security agreement (the “Loan Agreement”) with a lending institution whereby the Company can borrow up to 85% of eligible accounts receivable, as defined, not to exceed the lesser of $12 million or six times the Company’s tangible net worth (as defined). Until April 10, 2003, borrowings under the Loan Agreement bore interest at
1 ¾% above the prime rate. Effective April 10, 2003, the Company entered into another modification of the Loan Agreement which provides that borrowings under the Loan Agreement bear interest at 3% above the prime rate. The prime rate at September 30, 2004 was 4.75%. Borrowings under the Loan Agreement are collateralized by substantially all of the Company’s assets. The Loan Agreement expires on June 12, 2005.
At September 30, 2004, the Company was in violation of the following covenants under the Loan Agreement:
(i)
Failing to meet the tangible net worth requirement, and;
(ii)
The Company’s common Stock being delisted from the Nasdaq SmallCap Market
The Company has received a waiver from the lender on the above.
Note 7 -
Property and Equipment
Property and equipment consist of the following as of September 30:
Note 8 -
Goodwill and other Intangible Assets
The following table provides a reconciliation of net (loss) attributable to common stockholders for exclusion of goodwill amortization:
The changes in the carrying amount of goodwill for the years ended September 30 were as follows:
Intangible assets consist of the following as of September 30:
Estimated amortization expense for each of the next five years is as follows:
Amortization expense of amortizable intangible assets for the years ended September 30, 2004, 2003 and 2002 was $419,643, $393,982 and $276,251, respectively.
Note 9 -
Loans Payable
Loans payable consist of the following as of September 30:
(i)
Payable $1,816 per month, including interest at 9.25% a year.
(ii)
Note was due in April 2002. In addition, the Company issued 5,000 shares of its common stock to the noteholder. The noteholder has the right to demand the repurchase by the Company of the shares issued, until the note is paid in full, at $4.00 per share plus 15% interest. Accordingly, $23,000, representing the put option plus interest, is included in “Put options - Liability” on the attached consolidated balance sheets as of September 30, 2004, 2003 and 2002 (see Note 18).
(iii)
Promissory note issued in January 2001 in connection with the purchase of treasury stock. Note was payable $8,000 per month, including interest at 15% a year.
(iv)
On September 30, 2002, the Company converted $215,000 of accounts payable due to Source One (see Note 4) into a demand note. The non-interest bearing note was due in sixteen monthly installments of $13,437.
(v)
Due to non-related parties on demand, bearing interest at various rates.
(vi)
Short-term loan payable, which was payable $7,500 per month, bearing interest at 8%.
Note 10 - Related Party Transactions
Consulting Fees
The son of the Chief Executive Officer of the Company (the “CEO”) provides consulting services to the Company. Consulting expense was $103,000, $53,000 and $125,000 for the years ended September 30, 2004, 2003 and 2002, respectively.
The Company has paid consulting fees to an entity whose stockholder is another son of the CEO of the Company. Consulting fees amounted to $64,000, $86,000 and $141,000 for the years ended September 30, 2004, 2003 and 2002, respectively.
Sale of Common Stock
During the year ended September 30, 2002, the Company sold 177,722 shares of its common stock in private placements to a relative of the CEO of the Company at prices approximating the then current market of $.87 to $.93 per share, for total gross proceeds of $156,833.
Loans Payable
During the year ended September 30, 2002, the CEO loaned $75,000 to the Company which was repaid during the year ended September 30, 2003. During the year ended September 30, 2003, the CEO made various loans to the Company aggregating $215,000 of which $175,000 was repaid by September 30, 2003 and $40,000 was repaid during the year ended September 30, 2004.
During the year ended September 30, 2002, a son of the CEO loaned $41,000 to the Company, which is still outstanding at September 30, 2004. During the year ended September 30, 2003, this son of the CEO, another son of the CEO and the brother of the CEO loaned the Company $100,000, $6,000 and $100,000, respectively. All of these amounts were repaid during the year ended September 30, 2004.
During the year ended September 30, 2003, a member of the Board of Directors of the Company (the “Board Member”) and a trust formed for the benefit of the family of another member of the Board of Directors (the “Trust”) loaned $100,000 and $116,337, respectively, to the Company. Both of these loans were unsecured and due on demand. In August 2004, the Company and the Trust executed a promissory note whereby the $116,337 is to be paid at $10,000 a month, with a final payment of $4,309 on August 15, 2005. Payment is guaranteed by the CEO. Interest of 12% a year is included in the payments. In September 2004, the Company and the Board Member executed a promissory note whereby the $100,000 is to be paid at $5,500 a month through May 2006. Interest of 12% a year is included in the payments.
Preferred Stock
In March 2002, a $160,000 note payable by the Company to a company owned by the CEO was exchanged for 32,000 shares of Series B Convertible Preferred Stock (see Note 15).
In July 2002, the CEO invested $1,000,000 in the Company in exchange for 10,000 shares of newly created Series F Convertible Preferred Stock (see Note 15).
Joint Venture
The Company provides information technology staffing services through a joint venture, Stratus Technology Services, LLC (“STS”), in which the Company has a 50% interest. A son of the CEO of the Company has a majority interest in the other 50% venturer. The Company’s share of income (loss) from operations of STS of ($19,280), for the six months ended March 31, 2004 and $30,473 and $46,312 for the years ended September 30, 2003 and 2002, respectively, is included in other income (expense) in the consolidated statements of operations.
Effective March 31, 2004, the Company adopted the provisions of FIN 46R as it relates to STS (see Note 1).
Note Receivable
The “Note Receivable - related party” as of September 30, 2004, is the amount due from ALS in connection with the sale of the Company’s Miami Springs, Florida office (see Note 5). ALS is the holding company for Advantage Services Group, LLC (“Advantage”).
Payroll Outsourcing
During the years ending September 30, 2003 and 2004, the Company entered into various agreements with ALS and Advantage, a company in which a son of the CEO holds a 50% interest, in which ALS and Advantage are to provide payroll outsourcing services for all of the Company’s in-house staff and customer staffing requirements in California, Delaware, Maryland, Texas and Florida. The Company pays agreed upon pay rates, plus burden (payroll taxes and workers’ compensation insurance) plus a fee ranging between 2% and 3% of pay rates. The total amount charged by ALS and Advantage under this agreement was $31, 920,000 and $2,475,000 in the years ended September 30, 2004 and 2003, respectively.
Accounts payable and accrued expenses-related parties on the attached consolidated balance sheets at September 30, 2004 and 2003 represents amounts due to ALS and Advantage.
Note 11 -
Accounts Payable and Accrued Expenses
Accounts payable consist of the following as of September 30:
Note 12 -
Payroll Taxes Payable
Payroll taxes payable at September 30, 2004 is comprised of delinquent state unemployment payroll taxes, including interest and penalties thereon, due to New Jersey and California. The Company is in the process of negotiating a payment plan with regards to the approximately $2.2 million due California.
Note 13 -
Income Taxes
Deferred tax attributes resulting from differences between financial accounting amounts and tax bases of assets and liabilities follow:
The change in valuation allowance was an increase of $1,162,000, $2,751,000 and $2,355,000 for the years ended September 30, 2004, 2003, and 2002, respectively.
At September 30, 2004, the Company has available the following federal net operating loss carryforwards for tax purposes:
The utilization of the net operating loss carryforwards may be limited due to certain factors, including changes in control.
The effective tax rate on net earnings (loss) varies from the statutory federal income tax rate for periods ended September 30, 2003, 2002 and 2001.
Note 14 -
Convertible Debt
At various times through the year ended September 30, 2002, the Company issued convertible debentures through private placements. The debentures bore interest at 6% a year, payable quarterly and had a maturity date of five years from issuance. Each debenture was convertible after 120 days from issuance into the number of shares of the Company’s common stock determined by dividing the principal amount of the debenture by the lesser of (a) 120% of the closing bid price of the common stock on the trading day immediately preceding the issuance date or (b) 75% of the average closing bid price of the common stock for the five trading days immediately preceding the date of the conversion. The Company had the right to prepay any of the debentures at any time at a prepayment rate that varied from 115% to 125% of the amount of the debenture depending on when the prepayment was made.
The discount arising from the 75% beneficial conversion feature aggregated $136,000 in the year ended September 30, 2002 and was charged to interest expense during the period from the issuance of the debenture to the earliest time at which the debenture became convertible.
Deferred finance costs incurred in connection with the issuance of the debentures was being amortized over the five year term of the debentures. Included in interest expense for the year ended September 30, 2002 is approximately $290,000 for amortization of deferred finance costs in connection with the debentures.
During the year ended September 30, 2002, the Company redeemed $270,180 of debentures, resulting in a gain of approximately $3,000, which is included in “Other income (expense)” in the consolidated statements of operations. The gain is comprised of the following:
During the year ended September 30, 2002, $970,593 of debentures were converted into 634,370 shares of common stock at prices ranging from $1.20 to $2.40 per share.
In March 2002, the Company entered into an agreement with the holder (the “Debenture Holder”) of all but $40,000 of the remaining outstanding debentures pursuant to which it issued to the Debenture Holder, 231,300 shares of Series B Convertible Preferred Stock (see Note 15) in exchange for (i) $456,499 aggregate principal amount of debentures, (ii) the cancellation of a $400,000 promissory note issued by the Company to the Debenture Holder in January 2002, and (iii) $300,000 in cash. As a result, only $40,000 of Debentures remained outstanding at September 30, 2003 and 2004.
Note 15 -
Preferred Stock
a. Series A
The shares of Series A Preferred Stock had a stated value of $3.00 per share. The difference between the carrying value and redemption value of the Series A Preferred Stock was being accreted through a charge to additional paid-in-capital through September 30, 2003, since prior to September 30, 2003, the current value of the Series A Preferred Stock, including accrued dividends, had been included in stockholders’ equity. Pursuant to SFAS No. 150, “Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity”, the current value of the Series A Preferred Stock, including accrued dividends was classified as a liability at September 30, 2003. Accordingly, subsequent to September 30, 2003, the difference between the carrying value and redemption value of the Series A Preferred Stock was being accreted through a charge to interest expense through the June 30, 2008 redemption date.
The Series A Preferred Stock entitled the holders thereof to cumulative dividends at $.21 per share per year, payable semi-annually, commencing on December 31, 2001, when and if declared by the Board of Directors. The shares of Series A Preferred Stock were convertible at the option of the holder into shares of the Company’s Common Stock on a one-for-one basis. On June 30, 2008, the Company was to be required to redeem any shares of Series A Preferred Stock outstanding at a redemption price of $3.00 per share together with accrued and unpaid dividends, payable at the Company’s option, either in cash or in shares of common stock. For purposes of determining the number of shares which the Company was to be required to issue if it chose to pay the redemption price in shares of Common Stock, the Common Stock was to have a value equal to the average closing price of the Common Stock during the five trading days immediately preceding the date of redemption.
In July 2003, the Company entered into an agreement with Artisan (UK) plc (“Artisan”) pursuant to which the Company agreed to redeem the aggregate 1,458,933 shares of its Series A Preferred Stock owned by Artisan.com and Cater Barnard (USA) plc, an affiliate of Artisan. These shares represented all of the shares of Series A Preferred Stock then outstanding. The agreement, as amended in March 2004, provided that the Company’s obligation to redeem the Series A Preferred Stock was contingent upon the Company’s sale of not less than $1,000,000 of units in a proposed “best-efforts” public offering of the units (the “Offering”). This condition was satisfied in July 2004. As a result, the Company paid $500,000 and issued 1,750,000 shares of common stock to an assignee of Artisan and redeemed all of the Series A Preferred Stock following the initial closing of the Offering. The Company is obligated to pay Artisan an additional $250,000 by January 31, 2005, or at the Company’s option, issue to Artisan shares of the Company’s common stock having an aggregate market value of $250,000, based upon the average closing bid prices of the common stock for 30 days preceding January 31, 2005. If the Company fails to make the $250,000 payment in cash or stock, it will be required to pay Artisan $300,000 in cash, plus accrued interest at the rate of 18% per year from the date of default until the date the default is cured.
As a result of the redemption, the Company recorded the excess of the carrying amount of the Series A Preferred Stock over the consideration given as a gain on redemption of Series A redeemable preferred stock.
b. Series B
In March 2002, the Company issued 32,000 shares of Series B Convertible Preferred Stock (the “Series B Preferred Stock”) in exchange for a $160,000 note due to a company owned by the Chief Executive Officer of the Company (see Note 8). An additional 231,300 shares were issued to the Debenture Holder (see Note 11) in exchange for (i) 456,499 aggregate principal amount of debentures, (ii) cancellation of a $400,000 promissory note due to the Debenture Holder and (iii) $300,000 in cash.
The shares of Series B Convertible Preferred Stock had a stated value of $5 per share. Holders of the Series B Preferred Stock were entitled to cumulative dividends at a rate of 6% of the stated value per year, payable when and as declared by the Board of Directors. Dividends could be paid in cash or, at the option of the Company, in shares of Common Stock, under certain circumstances. Holders of Series B Preferred Stock were entitled to a liquidation preference of $5.00 per share plus accrued dividends. The Series B Preferred Stock was convertible into shares of Common Stock at the option of the holder at any time. The number of shares of Common Stock into which each share of Series B Preferred Stock was convertible was determined by dividing the aggregate liquidation preference of the shares being converted by the lesser of (i) $4.65 or (ii) 75% of the closing bid price of the Common Stock on the trading day preceding the date of conversion. The discount arising from the beneficial conversion feature was treated as a dividend from the date of issuance to the earliest conversion date.
In June 2002, the Company redeemed for cash, 91,000 shares of Series B Preferred Stock at $5.00 per share, totaling $455,000.
In July 2002, the remaining 172,300 shares of Series B Preferred Stock (including the 32,000 shares held by a company owned by the Chief Executive Officer of the Company) were exchanged for 8,615 shares of Series E Convertible Preferred Stock (the “Series E Preferred Stock”).
c. Series E
In July 2002, the Company sold 7,650 shares of newly created Series E Preferred Stock in a private placement for $765,000 in cash and issued an additional 8,615 shares of Series E Preferred Stock in exchange for all of the outstanding shares of Series B Preferred Stock, which had an aggregate stated value of $861,500. In addition, $41,790 of dividends and penalties, which had accrued on the Series B Preferred Stock prior to the exchange were exchanged for 418 shares of Series E Preferred Stock.
In July 2003, the Company sold 14,362 shares of Series E Preferred Stock in private placements for $1,436,250 in cash. Also, in July 2003, the Company entered into an agreement with the holder of the Series H Convertible Preferred Stock (the “Series H Preferred Stock”) pursuant to which the 5,000 shares of Series H Preferred Stock then outstanding plus accrued dividends of $8,750 were exchanged for 5,087 shares of Series E Preferred Stock.
On July 30, 2003, the Company and the Series E holders entered into a letter agreement (the “Compromise Agreement”) to compromise certain disputed penalties arising out the of Company’s alleged failure to timely cause the suspension of the effectiveness of the Company’s Form S-1 Registration Statement, filed with the SEC on behalf of the Series E holders to terminate at the earliest possible date. Pursuant to the terms of the Compromise Agreement, while the Company does not admit that it failed to fulfill its contractual obligations to the Series E shareholders, in the interest of amicably resolving this matter, the Company issued an additional 4,477 shares of Series E Preferred Stock to the Series E shareholders.
During the year ended September 30, 2004, the Company issued an additional 11,196 shares of Series E Preferred Stock to the Series E shareholders in connection with additional penalties that accrued. On July 21, 2004, the Series E shareholders agreed to waive any further penalties with respect to the Company’s failure to register shares issuable upon conversion of the Series E Preferred Stock for public resale, and acknowledged that the penalties that accrued in March 2004 were the last penalties due and owing to the Series E shareholders.
The shares of Series E Preferred Stock have a stated value of $100 per share. The holders of the Series E Preferred stock are entitled to cumulative dividends at a rate of 6% of the stated value per year, payable every 120 days, in preference and priority to any payment of any dividend on the Company’s Common Stock. Dividends may be paid, at the Company’s option, either in cash or in shares of Common Stock, valued at the Series E Conversion Price (as defined below). Holders of Series E Preferred Stock are entitled to a liquidation preference of $100 per share, plus accrued and unpaid dividends.
The Series E Preferred Stock is convertible into Common Stock at a conversion price (the “Series E Conversion Price”) equal to 75% of the average of the closing bid prices, for the five trading days preceding the conversion date, for the Common Stock. The number of shares issuable upon conversion is determined by multiplying the number of shares of Series E Preferred Stock to be converted by $100, and dividing the result by the Series E Conversion Price then in effect.
Holders of Series E Preferred Stock do not have any voting rights, except as required by law.
The Company may redeem the shares of the Series E Preferred Stock at any time prior to conversion, at a redemption price of 115% of the purchase price paid for the Series E Preferred Shares, plus any accrued but unpaid dividends.
The discount arising from the beneficial conversion feature was treated as a dividend from the date of issuance to the earliest conversion date.
In February 2004, the Company commenced an exchange offer pursuant to which the Company offered to exchange each outstanding share of its Series E Preferred Stock for, at the election of the holder, common stock and common stock purchase warrants or Series I Preferred Stock and common stock purchase warrants (the “Exchange Offer”).
Pursuant to the terms of the Exchange Offer, as amended, the Company offered to exchange each share of Series E Preferred Stock, at the holder’s election, for either (i) 125 shares of common stock and 250 common stock purchase warrants for each $100 of stated value and accrued dividends represented by the Series E Preferred Stock; or (ii) one share of Series I Preferred Stock having a stated value of $100 per share and 125 common stock purchase warrants for each $100 of stated value and accrued dividends represented by the Series E Preferred Stock.
Each warrant entitles its owner to purchase one share of the Company’s common stock for $.76. The warrants will be exercisable at any time during the period commencing July 14, 2005 and ending January 17, 2007, unless the Company has redeemed them. The Company may redeem the warrants, at a redemption price of $.08 per warrant, upon thirty days prior written notice beginning one year after the closing of the Exchange Offer, once the closing bid price of its common stock has been at least $1.33 for 20 consecutive trading days.
The Exchange Offer closed on August 5, 2004. The results of the Exchange Offer were as follows: 24,833 shares of Series E Preferred Stock, plus accrued dividends thereon, were exchanged for 3,274,750 shares of common stock and 6,549,500 warrants to purchase common stock, 20,585 shares of Series E Preferred Stock, plus accrued dividends thereon, were exchanged for 21,775 shares of Series I Preferred Stock and 2,721,875 warrants to purchase common stock, and 2,310 shares of Series E Preferred Stock, plus accrued dividends thereon, were not exchanged.
In August 2004, the Company issued 12 shares of Series E Preferred Stock in satisfaction of accrued dividends and in August and September 2004, the Company redeemed 1,750 shares of Series E Preferred Stock, plus accrued dividends, leaving 572 shares outstanding at September 30, 2004.
The Company recognized a loss of $3,948,285 as a result of the Exchange Offer. The warrants were valued at $.44 per warrant using the Black-Scholes pricing model.
During the year ended September 30, 2004, holders of Series E Preferred Stock converted 3,725 shares into 713,385 shares of common stock at conversion prices between $.464 and $.63. During the year ended September 30, 2003, holders of Series E Preferred Stock converted 7,352 shares into 1,480,617 shares of Common Stock at conversion prices between $.30 and $.99.
d. Series F
In July 2002, the Company’s Chief Executive Officer invested $1,000,000 in the Company in exchange for 10,000 shares of newly created Series F Convertible Preferred Stock (the “Series F Preferred Stock”), which has a stated value of $100 per share.
The holder of the Series F Preferred Stock is entitled to receive, from assets legally available therefore, cumulative dividends at a rate of 7% per year, accrued daily, payable monthly, in preference and priority to any payment of any dividend on the Common Stock and on the Series F Preferred Stock. Dividends may be paid, at the Company’s option, either in cash or in shares of Common Stock, valued at the Series F Conversion Price (as defined below). Holders of Series F Preferred Stock are entitled to a liquidation preference of $100 per share, plus accrued and unpaid dividends.
The Series F Preferred Stock is convertible into Common Stock at a conversion price (the “Series F Conversion Price”) equal to $.40 per share. The number of shares issuable upon conversion is determined by multiplying the number of shares of Series F Preferred Stock to be converted by $100, and dividing the result by the Series F Conversion Price.
Except as otherwise required by law, holders of Series F Preferred Stock and holders of Common Stock shall vote together as a single class on each matter submitted to a vote of stockholders. Each outstanding share of Series F Preferred Stock shall be entitled to the number of votes equal to the number of full shares of Common Stock into which each such share of Series F Preferred Stock is then convertible on the date for determination of stockholders entitled to vote at the meeting. Holders of the Series F Preferred Stock are entitled to vote as a separate class on any proposed amendment to the terms of the Series F Preferred Stock which would increase or decrease the number of authorized shares of Series F Preferred Stock or have an adverse impact on the Series F Preferred Stock and on any proposal to create a new class of shares having rights or preferences equal to or having priority to the Series F Preferred Stock.
The Company may redeem the shares of the Series F Preferred Stock at any time prior to conversion at a redemption price of 115% of the purchase price paid for the Series F Preferred Shares plus any accrued but unpaid dividends.
During each of the years ended September 30, 2004 and 2003, the Company’s Chief Executive Officer converted 2,000 shares of the Series F Preferred Stock into 500,000 shares of Common Stock.
e. Series H
In September 2002, the Company sold 5,000 shares of the newly created Series H Preferred Stock in a private placement for $500,000 in cash.
The Series H Preferred Stock was convertible into Common Stock at a conversion price (the “Series H Conversion Price”) equal to the lower of $.20 per share or the average market price of the Common Stock for the five trading days immediately preceding the conversion date. The number of shares issuable upon conversion was determinable by multiplying the number of shares of Series H Preferred Stock to be converted by $100 and dividing the result by the Series H Conversion Price then in effect.
Holders of Series H Preferred Stock did not have any voting rights, except as required by law.
In July 2003, the 5,000 shares of the Series H Preferred Stock, plus accrued dividends of $8,750 were exchanged for 5,087 shares of Series E Preferred Stock.
f. Series I
The Company issued shares of Series I Preferred Stock upon the closing of the Exchange Offer in August 2004. The Company is required to redeem each share of the Series I Preferred Stock for an amount equal to the stated value of $100 per share plus all accrued and unpaid dividends on the one year anniversary date of the issuance of the Series I Preferred Stock to the extent permitted by applicable law; provided, however, that the Company has the right to extend the required redemption date for an additional one year, in which case the Company will be required to pay all dividends accrued through the first year of issuance in cash and issue to each holder of Series I Preferred Stock a number of shares of its common stock which then have a value equal to 10% of the stated value of the Series I Preferred Stock held. In addition, if the Company extends the redemption date, it will be required to pay dividends quarterly and pay an advisory fee to an advisor designated by the holders of the Series I Preferred Stock in an amount equal to 10% of the aggregate stated value of the outstanding shares of Series I Preferred Stock, 8% of which will be payable in cash and 2% of which will be paid in shares of the Company’s common stock, valued at the then current market value. If the Company does not redeem the Series I Preferred Stock by the extended redemption date, the dividend rate of the Series I Preferred Stock will increase to 24% per year and the Series I Preferred Stock will be convertible, at the option of the holder, into either common stock at a conversion price equal to 80% of the average closing bid price of the common stock during the five trading days preceding the conversion or common stock and warrants at a rate of 125 shares of common stock and 250 warrants for each $100 of stated value and accrued and unpaid dividends represented by the Series I Preferred Stock. The Company has the right at any time during the 12 month period following the closing of the Exchange Offer, to cause all of the outstanding shares of the Series I Preferred Stock to be converted into, at the election of the holder, either common stock at a conversion price equal to 80% of the average closing bid price of the common stock during the five trading days preceding the conversion, or common stock and warrants at a rate of 125 shares of common stock and 250 warrants for each $100 of stated value and accrued and unpaid dividends represented by the Series I Preferred Stock. The discount associated with the conversion feature of the Series I Preferred Stock could result in changes to our earnings in future periods. Holders of Series I Preferred Stock have no voting rights, except as provided by law and with respect to certain limited matters.
Note 16 -
Other Charges
Year ended September 30, 2003:
During the period May 1, 2001 through May 20, 2002, the Company maintained workers’ compensation insurance with an insurance company, with a deductible of $150,000 per incident. The Company had established reserves based upon its evaluation of the status of claims still open in conjunction with claims reserve information provided to the Company by the insurance company. The Company believes that the insurance company has paid and reserved claims in excess of what should have been paid or reserved. Although the Company believes it can recover some of the amounts already paid, this can only be pursued through litigation against the insurance company. Since there is no assurance the Company will prevail, the Company recorded $1,186,000 of additional payments made and reserves in the year ended September 30, 2003. $433,000 of such amount is included in discontinued operations.
Year ended September 30, 2002:
Included in “Other Charges” are costs incurred in connection with financing not obtained ($75,066), penalties associated with the Series B Preferred Stock ($28,160), and the fair value of shares issued to Source One in connection with a forbearance agreement ($37,500) (see Note 4).
Note 17 -
Commitments and Contingencies
Office Leases
The Company leases offices and equipment under various leases expiring through 2008. Monthly payments under these leases are $57,000.
The following is a schedule by years of approximate future minimum rental payments required under operating leases that have initial or remaining non-cancelable lease terms in excess of one year, as of September 30, 2004.
Rent expense was $758,000, $910,000 and $801,000 for the years ended September 30, 2004, 2003 and 2002, respectively.
Other
From time to time, the Company is involved in litigation incidental to its business including employment practices claims. There is currently no litigation that management believes will have a material impact on the Company’s financial position.
Note 18 -
Put Options Liability
Put options liability consists of the following as of September 30, 2004 and 2003:
On July 29, 2003, the Company received written notification from Source One that it was exercising its option which requires the Company to buy back 100,000 shares of its Common Stock at $8 per share. The Company had thirty days from the receipt of the notification, unless otherwise agreed to in writing, to pay the $800,000. The Company is attempting to negotiate an arrangement, which would permit the Company to pay this amount over an extended period of time or upon receipt of financing. No assurance can be given that Source One will agree to such an agreement. During the year ended September 30, 2004, the Company paid $150,000 against the liability.
Note 19 -
Stock Options and Warrants
The Company currently has in place four stock option plans, the 1999 Equity Incentive Plan (“1999 Plan”), the 2000 Equity Incentive Plan (“2000 Plan”), the 2001 Equity Incentive Plan (“2001 Plan”), and the 2002 Equity Incentive Plan (“2002 Plan”) (collectively the “Equity Incentive Plans” or the “Plans”). The terms of these Plans are substantially similar. The aggregate number of shares reserved for issuance under each of the Plans and the options issued and vested as September 30, 2004 are, respectively, as follows:
1999 Plan
-
125,000 shares authorized, 41,083 issued, 41,083 vested
2000 Plan
-
125,000 shares authorized, -0- issued, -0- vested
2001 Plan
-
250,000 shares authorized, -0- issued, -0- vested
2002 Plan
-
1,250,000 shares authorized, 922,500 issued, 922,500 vested
In addition, in 2000, the Company issued to the Chief Executive Officer of the Company, options to acquire 250,000 shares at $24.00 per share. These options have a ten-year term and are exercisable at the earlier of five years or when the Company achieves earnings of $4.00 per share in a fiscal year. These options will be forfeited if the Chief Executive Officer leaves the employment of the Company.
The Company has also issued 615,000 options under agreements with officers and directors of the Company, including options with respect to 450,000 shares exercisable at $.39 per share granted to directors of the Company in the year ended September 30, 2004.
A summary of the Company’s stock option activity and related information for the years ended September 30 follows:
The exercise prices range from $.39 to $24.00 per share.
The weighted-average fair value of options granted was $.28, $.76 and $1.48 in the years ended September 30, 2004, 2003 and 2002, respectively.
Following is a summary of the status of stock options outstanding at September 30, 2004:
The Company has issued the following outstanding warrants as of September 30, 2004:
During the year ended September 30, 2004, the Company issued 4,961,028 and 9,271,375 warrants in connection with the Offering (see Note 3) and the Exchange Offer (see Note 14), respectively. In addition, 1,375,000 warrants with the same terms as the Offering and the Exchange Offer warrants, were issued to a consultant in connection with the Offering. The balance of the outstanding warrants were issued in prior years to investors and consultants in connection with private placements and in exchange for services rendered to the Company.
A summary of the Company’s warrant activity and related information for the years ended September 30 follows:
The exercise prices range from $.76 to $30.00 per share.
The weighted-average fair value of warrants granted was $.44, $1.04 and $1.16 in the years ended September 30, 2004, 2003 and 2002, respectively.
Note 20 -
Major Customers
The Company had no customers who accounted for more than 10% of total revenues for the years ended September 30, 2004, 2003 and 2002. Major customers are those who account for more than 10% of total revenues.
Note 21 -
Retirement Plans
The Company maintained two 401(k) savings plans for its employees through July 2004. The terms of the plan defined qualified participants as those with at least three months of service. Employee contributions were discretionary up to a maximum of 15% of compensation. The Company could match up to 20% of the employees’ first 5% contributions. The Company’s 401(k) expense for the years ended September 30, 2004, 2003 and 2002 was $-0-, $-0- and $8,000, respectively.
Note 22 -
Private Placements
In June 2001, the Company entered into an agreement with an investment banker to raise $1,200,000 through the sale of the Company’s stock through private placements at a price per share calculated at a 30% discount to the 20-day average of the mean between the closing bid and asked prices. The agreement provided that the Company would be required to pay a placement fee to the investment banker of 10% of the gross proceeds received from the private placements and also issues five-year warrants equal to 10% of the number of shares sold at an exercise price equal to the price per share of the private placement. In addition, the Company was to pay the investment banker’s expenses in connection with the agreement, not to exceed $50,000. During the year ended September 30, 2002, the Company sold 100,002 shares, at $.75 per share under this agreement. In connection therewith, the Company paid $91,750 to the investment banker and issued warrants to purchase 10,000 shares of the Company’s common stock in the year ended September 30, 2002.
For the year ended September 30, 2002, private placements with a related party resulted in the issuance of 177,722 shares of common stock, (see Note 10).
For the years ended September 30, 2004, 2003 and 2002, private placements and exchanges resulted in the issuance of -0-, -0- and 263,300 shares of Series B Preferred Stock, 11,208, 18,839 and 16,683 shares of Series E Preferred Stock, -0-, -0- and 10,000 shares of Series F Preferred Stock, and -0-, -0- and 5,000 shares of Series H Preferred Stock, respectively (see Note 15).
Note 23 -
Selected Quarterly Financial Data (unaudited)
Stratus Services Group, Inc.
Schedule II - Valuation and Qualifying Accounts
(1)
Includes $100,000 and $244,000 charged to discontinued operations in the year ended September 30, 2003 and 2002, respectively.
(2)
Reflects the increase (decrease) in the valuation allowance associated with net operating losses of the Company.