Advertise with us
[March 03, 2014]
ON ASSIGNMENT INC - 10-K - Management's Discussion and Analysis of Financial Condition and Results of Operations
(Edgar Glimpses Via Acquire Media NewsEdge) The following discussion should be read in conjunction with the other sections of this Annual Report on Form 10-K, including Special Note on Forward-looking Statements and Part I, "Item 1A - Risk Factors".
OVERVIEW On Assignment, Inc. is a leading global provider of in-demand, skilled professionals in the growing technology, healthcare, and life sciences sectors.
We provide clients with short- and long-term placement of contract, contract-to-hire, and direct hire professionals.
Our Technology service offering consists of two complementary segments uniquely positioned in the marketplace to offer our clients a broad spectrum of information technology, or IT, staffing solutions: Apex and Oxford. Our Apex segment provides mission-critical daily IT operation professionals for contract and contract-to-hire positions to Fortune 1000 and mid-market clients across the United States. Our Oxford segment proactively recruits and delivers high-end information technology, engineering, regulatory, and compliance professionals for consulting assignments and permanent placements across the United States, Canada, and Europe.
Our Life Sciences service offering segment provides locally-based contract life science professionals to clients in the biotechnology, pharmaceutical, food and beverage, medical device, personal care, chemical, automotive, educational and environmental industries. Our contract professionals include chemists, clinical research associates, clinical lab assistants, engineers, biologists, biochemists, microbiologists, molecular biologists, food scientists, regulatory affairs specialists, lab assistants, biostatisticians, drug safety specialists, SAS programmers, medical writers, and other skilled scientific professionals.
Our Physician segment is a leading provider of physician staffing, known as locum tenens. This division also provides permanent physician search services and temporary staffing for nurse practitioners, nurse anesthetists and physicians assistants. Our Physician segment provides short- and long-term locum tenens services and full-service physician search and consulting services, primarily in the United States, with some locum tenens placements in Australia and New Zealand. We work with physicians in a wide range of specialties, placing them in hospitals, community-based practices and federal, state and local facilities.
Results of Operations RESULTS OF OPERATIONS FOR THE YEAR ENDED DECEMBER 31, 2013 COMPARED WITH THE YEAR ENDED DECEMBER 31, 2012 Year Ended December 31, Change 2013 2012 $ % Revenues by segment (in thousands): Apex $ 942,463 $ 508,743 $ 433,720 85.3 % Oxford 412,189 363,765 48,424 13.3 % Life Sciences 171,518 162,799 8,719 5.4 % Physician 105,827 102,679 3,148 3.1 % $ 1,631,997 $ 1,137,986 $ 494,011 43.4 % Revenues increased $494.0 million, or 43.4 percent, mainly due to the acquisition of Apex in May of 2012, and 9.6 percent year-over-year growth of our other business segments. On a pro forma basis, which assumes the acquisition of Apex, Whitaker and CyberCoders occurred at the beginning of 2012, consolidated revenues were up 14.9 percent year-over-year.
Apex revenues for the year ended December 31, 2013 were $942.5 million or 57.7 percent of total revenues. Apex was acquired on May 15, 2012. On a pro forma basis (assuming Apex was acquired at the beginning of 2012), Apex revenues for 2012 were $791.0 million and revenue growth in 2013 was 19.1 percent.
Oxford revenues increased $48.4 million, or 13.3 percent, comprised of a 9.3 percent increase in the average number of contract professionals on assignment, a 1.9 percent increase in average bill rate and a $2.8 million or 59.0 percent increase in conversion and permanent placement revenue. Oxford includes the results of CyberCoders, which was acquired on December 5, 2013 and our Healthcare Information Management practice that was formerly included in the Healthcare segment. Results of CyberCoders are included from the date of acquisition through the end of the year and CyberCoders accounted for $3.6 million of revenues in 2013.
Life Sciences revenues increased $8.7 million, or 5.4 percent, due to a 6.9 percent increase in the average number of contract professionals, slightly offset by a 2.7 percent decrease in bill rate.
23 -------------------------------------------------------------------------------- Physician revenues increased $3.1 million, or 3.1 percent, due to a 6.9 percent increase in the average number of physicians placed and working and a 3.1 percent increase in average bill rate, slightly offset by a $0.4 million decrease in direct hire and conversation fee revenues. The Physician segment includes the results of Whitaker from December 2, 2013, the date of acquisition, through the end of the year, which accounted for $2.3 million of revenues in 2013.
Gross Profit and Gross Margins Year Ended December 31, 2013 2012 Gross Profit Gross Margin Gross Profit Gross Margin Gross Profit by segment (in thousands): Apex $ 258,150 27.4 % $ 140,669 27.7 % Oxford 143,334 34.8 % 127,895 35.2 % Life Sciences 56,308 32.8 % 55,874 34.3 % Physician 30,614 28.9 % 31,455 30.6 % $ 488,406 29.9 % $ 355,893 31.3 % The year-over-year gross profit increase was primarily due to the inclusion Apex for the full year in 2013 (compared with only 7.5 months in 2012) and higher revenues from our other segments. Gross margin compressed 135 basis points mainly due to the inclusion of Apex for the full 12 months in 2013, as it has a lower gross margin and a lower mix of direct hire and conversion fee revenues than our other segments.
Oxford gross profit increased $15.4 million, or 12.1 percent, primarily due to a $48.4 million, or 13.3 percent increase in revenues, which was partially offset by an 38 basis point contraction in gross margin. The compression in gross margin mainly related to higher growth of lower-margin services and a higher mix of reimbursable expenses, which are billed to customers with no mark-up, partially offset by a $2.8 million increase in direct hire and conversion fee revenue.
Life Sciences gross profit was flat year-over-year, despite revenue growth of $8.7 million. Gross margin was 32.8 percent, down 149 basis points from prior year. The compression in gross margin was primarily due to a decrease in European retained search fees of $0.3 million and a 4.3 percent decrease in bill/pay spread due to competitive pricing pressures.
Physician gross profit decreased $0.8 million, or 2.7 percent, despite revenue growth of $3.1 million. Gross margin was 28.9 percent, down 171 basis points from prior year. The compression in gross margin was primarily due to (i) a higher mix of revenues from lower-margin specialties, (ii) the decline in call and overtime billing, (iii) a lower mix of permanent placement and conversion fees (3.2 percent of Physician revenue in 2013, down from 3.8 percent in 2012), and (iv) an increase in our medical malpractice expense of $0.7 million.
Selling, General and Administrative Expenses. Selling, general and administrative (SG&A) expenses include field operating expenses, such as costs associated with our network of staffing consultants and branch offices, including staffing consultant compensation, rent, other office expenses, marketing and recruiting expenses for our contract professionals. SG&A expenses also include our corporate and branch office support expenses, such as the salaries of corporate operations and support personnel, recruiting and training expenses for field staff, marketing staff expenses, expenses related to being a publicly-traded company and other general and administrative expenses.
For the year ended December 31, 2013, SG&A expenses were $342.7 million, an increase of $86.0 million year-over-year. SG&A expenses as a percentage of revenues was 21.0 percent for 2013, down from 22.6 percent in 2012. The year-over-year increase in SG&A expenses was due to the inclusion of Apex for the full year, and an increase in incentive compensation related to the growth in gross profit and infrastructure investments to support the growth of the business. SG&A expenses included acquisition and strategic planning costs of $4.4 million in 2013, ($10.2 million in 2012), a benefit from reduction in earn-out obligations of $3.6 million in 2013 ($1.2 million in 2012), and charges totaling $2.6 million for certain infrequent adjustments.
Amortization of Intangible Assets. Amortization of intangible assets was $21.8 million compared with $18.0 million in 2012. The $3.8 million increase was due to amortization for a full year of the $104.8 million in identifiable intangible assets acquired related to the Apex acquisition in May 2012.
Interest Expense. Interest expense was $15.9 million compared with $15.8 million in the same period in 2012. The average debt balance during 2013 was higher than in 2012, partially offset by lower interest rates in 2013.
Write-Off of Loan Costs. Write-off of loan costs of $15.0 million related to the refinancing of our credit facility in May 2013, compared with $0.8 million write-off of loan costs in 2012. The refinancing in May 2013 was treated as an early extinguishment of debt resulting in a full write-off of the loan costs associated with the old facility.
24 -------------------------------------------------------------------------------- Provision for Income Taxes. The provision for income taxes was $38.8 million compared with $28.1 million for the same period in the prior year. The annual effective tax rate was 41.6 percent for 2013 and 43.6 percent for 2012. The decrease in the 2013 rate was primarily related to a higher relative increase in income before income taxes than the increase in non-deductible expenses and the benefit from the reduction of certain earn-out obligations that were not taxable for income tax purposes.
Discontinued Operations. During 2013, we sold our Nurse Travel and Allied Healthcare units. These units formerly comprised our Healthcare segment. As a result of these sales, operating results and the gain on sale of these units, net of income tax, are presented as discontinued operations in our Consolidated Statements of Operations and Comprehensive Income for all periods presented.
Income (loss) from discontinued operations, net of income taxes, was $(0.7) million in 2013 and $6.2 million in 2012. The decrease is primarily due to timing of the divestitures - Nurse Travel was sold in February 2013, and Allied Healthcare was sold in December 2013. The gain on sale reflects the transfer of net assets and expenses to sell.
RESULTS OF OPERATIONS FOR THE YEAR ENDED DECEMBER 31, 2012 COMPARED WITH THE YEAR ENDED DECEMBER 31, 2011 Year Ended December 31, Change 2012 2011 $ % Revenues by segment (in thousands): Apex $ 508,743 $ - $ 508,743 - % Oxford 363,765 279,643 84,122 30.1 % Life Sciences 162,799 155,324 7,475 4.8 % Physician 102,679 80,617 22,062 27.4 % $ 1,137,986 $ 515,584 $ 622,402 120.7 % Revenues increased $622.4 million, or 120.7 percent, mainly due to the acquisition of Apex and 22.0 percent year-over-year growth of our other business segments. Apex revenues for the year ended December 31, 2012 were $508.7 million, or 44.7 percent of total revenues. Apex was acquired on May 15, 2012 and is reported in the Apex segment.
Oxford segment revenues increased $84.1 million, or 30.1 percent, comprised of a 23.5 percent increase in the average number of contract professionals on assignment, a 4.7 percent increase in average bill rate and a $1.2 million increase in conversion and permanent placement revenue. Revenues for Oxford's Healthcare IT line of business increased by approximately 119 percent, the Engineering - Regulatory and Compliance line of business increased by approximately 39 percent, and the remaining lines of business grew by approximately 19 percent. Due to the limited availability of senior IT and engineering consultants, the demand for our services have increased. We have continued to focus on diversifying this segment across clients and industries and have selectively added staffing consultants necessary for current and future growth.
Life Sciences segment revenues increased $7.5 million, or 4.8 percent, comprised of a 5.0 percent increase in the average number of contract professionals on assignment and a 0.5 percent increase in the average bill rate, which was slightly offset by a $0.8 million decrease in conversion and permanent placement revenue. The increase was achieved despite the termination in early 2012 of a low-margin account that generated approximately $3.1 million in revenue in 2011.
The year-over-year increase in revenues was attributable to inclusion of a full year's operating results from Valesta, which was acquired on February 28, 2011 and increased demand from our other service offerings as our clients end markets improved. In 2012, Valesta accounted for $24.5 million in revenues up from $20.4 million in 2011.
Physician segment revenues increased $22.1 million, or 27.4 percent. The increase in Physician segment revenues was attributable to inclusion of a full year's operating results from HCP, which was acquired on July 31, 2011 and a $7.8 million increase in our legacy physician business. HCP accounted for $25.5 million in revenues in 2012 up from $11.2 million in 2011. The increase in legacy physician revenues was due to a 4.3 percent increase in the average number of physicians placed and working, a 4.8 percent increase in average bill rate and a $0.6 million increase in direct hire and conversation fee revenues.
Gross Profit and Gross Margins 25 -------------------------------------------------------------------------------- Year Ended December 31, 2012 2011 Gross Profit Gross Margin Gross Profit Gross Margin Gross Profit by segment (in thousands): Apex $ 140,669 27.7 % $ - - % Oxford 127,895 35.2 % 99,187 35.5 % Life Sciences 55,874 34.3 % 52,643 33.9 % Physician 31,455 30.6 % 25,858 32.1 % $ 355,893 31.3 % $ 177,688 34.5 % The year-over-year gross profit increase was primarily due to higher revenues, which was partially offset by a 319 basis point contraction in consolidated gross margin. The decrease in gross margin was primarily attributable to the inclusion of Apex, which has a lower gross margin than our other segments.
Oxford segment gross profit increased $28.7 million, or 28.9 percent, primarily due to a $84.1 million, or 30.1 percent increase in revenues, which was partially offset by a 31 basis point contraction in gross margin. The contraction in gross margin was primarily due to increases in consultant payroll taxes and benefits offset by a $1.2 million increase in direct hire and conversion fee revenue.
Life Sciences segment gross profit increased $3.2 million, or 6.1 percent. The increase in gross profit was primarily due to a 4.8 percent increase in revenues and a 43 basis point expansion in gross margin. The expansion in gross margin was due to a 1.9 percent increase in bill/pay spread, which was partially offset by an increase in travel-related expense, an increase in payroll taxes related to higher European payroll tax rates for Valesta employees, and a $0.8 million decrease in direct hire and conversion fee revenue.
Physician segment gross profit increased $5.6 million, or 21.6 percent. The increase in gross profit was due to a $22.1 million, or 27.4 percent increase in revenues, partially offset by a 145 basis point contraction in gross margin. The contraction in gross margin was primarily due to a 7.7 percent decrease in bill/pay spread in part related to a greater concentration of government work at HCP, which has a lower gross margin than the legacy Physician business. The Physician segment also experienced an increase in non-billable expenses, which was partially offset by a $0.5 million favorable actuarial adjustment to our medical malpractice insurance expense.
Selling, General and Administrative Expenses. For the year ended December 31, 2012, SG&A expenses increased $120.0 million, or 87.8 percent, to $256.7 million from $136.7 million in 2011. The increase in SG&A expenses was primarily due to (i) $88.6 million of SG&A expenses from Apex, which was acquired on May 15, 2012, (ii) $10.2 million in acquisition costs primarily related to the acquisition of Apex, and (iii) $19.7 million, or a 18.9 percent increase, in compensation and benefits excluding Apex. The increase in compensation and benefits was due to an $8.7 million increase in compensation expenses primarily as a result of headcount additions to support anticipated higher growth in certain segments and increased headcount related to the Valesta and HCP acquisitions, and an $11.0 million increase in bonuses and commissions as a result of increased revenue and the attainment of incentive compensation targets. Total SG&A expenses as a percentage of revenues decreased to 22.6 percent for 2012 compared with 26.5 percent in 2011. Excluding acquisition-related costs of $10.2 million, total SG&A expenses as a percentage of revenues was 21.7 percent for 2012.
Amortization of Intangible Assets. Amortization of intangible assets was $18.0 million compared with $2.3 million in 2011. The $15.7 million increase was due to amortization related to $104.8 million of identifiable intangible assets acquired related to the Apex acquisition in May 2012. Apex's customer relationships were valued at $92.1 million and are being amortized using an accelerated method.
Interest Expense. Interest expense was $15.8 million compared with $2.9 million in the same period in 2011. This increase was primarily due to higher debt outstanding for the new senior secured credit agreement closed in May 2012 to fund the cash portion of the acquisition of Apex.
Provision for Income Taxes. The provision for income taxes was $28.1 million compared with $14.8 million for the same period in the prior year. The annual effective tax rate was 43.6 percent for 2012 and 41.6 percent for 2011. The increase in the annual effective tax rate in 2012 relates to the addition of Apex and their higher non-deductible expenses as well as valuation allowances on deferred tax assets of certain of our foreign subsidiaries.
Discontinued Operations. Our former Nurse Travel and Allied Healthcare divisions, previously included in the Healthcare segment, have been presented as discontinued operations in our Consolidated Statements of Operations and Comprehensive Income for all periods presented. Income from discontinued operations, net of income taxes, was $6.2 million in 2012, compared with $3.4 million in 2011. The increase was primarily due to higher revenues from staffing services supporting customers experiencing labor disruptions and higher average number of nurses on assignment.
Liquidity and Capital Resources Our working capital at December 31, 2013 was $180.9 million and our cash and cash equivalents were $37.4 million, of which $7.5 million was held in foreign countries. Cash held in foreign countries is not available to fund domestic operations unless repatriated, which 26 -------------------------------------------------------------------------------- would require the accrual and payment of taxes. We do not intend to repatriate cash held in foreign countries. Our operating cash flows and borrowings under our credit facilities have been our primary source of liquidity and have been sufficient to fund our working capital and capital expenditure needs. Our working capital requirements consist primarily of the financing of accounts receivable, payroll expenses and debt service payments on our credit facilities.
Net cash provided by operating activities was $110.5 million in 2013 and $40.7 million in 2012, respectively. Net cash provided by operating activities in 2013 was comprised of net income of $84.5 million, non-cash items of $33.1 million, and an increase of $7.1 million due to the year-over-year change in net operating assets related to the growth of the business. Net cash provided by operating activities in 2012 was comprised of net income of $42.7 million, non-cash items of $39.8 million, and an increase of $41.7 million due to the year-over-year change in net operating assets due to the growth of the business.
Net cash used in investing activities was $68.4 million in 2013 and $363.0 million in 2012, respectively. Net cash used in investing activities in 2013 was comprised of cash paid for acquisitions of $110.7 million, capital expenditures for information technology projects, leasehold improvements and various property and equipment purchases of $16.5 million, partially offset by $59.9 million of cash proceeds from the sales of Allied Healthcare and Nurse Travel. We estimate that capital expenditures for 2014 will be approximately $19.7 million. Net cash used in investing activities in 2012 was comprised of cash paid for acquisitions of $347.7 million, and capital expenditures for information technology projects, leasehold improvements and various property and equipment purchases of $14.4 million.
Net cash used in financing activities was $32.4 million in 2013 compared with $331.9 million provided by financing activities in 2012. Net cash used in financing activities in 2013 consisted primarily of $456.3 million in principal payments of long-term debt, and proceeds of $429.5 million from new borrowings on the new credit facility. Net cash provided by financing activities in 2012 consisted primarily of proceeds of $513.0 million from new borrowings on the term loan and line of credit, and $173.2 million in principal payments of long-term debt.
Under terms of the credit facility, the Company will be required to make quarterly amortization payments of $2.5 million on the term A loan facility and $0.7 million on the term B loan facility. We are also required to make mandatory prepayments from excess cash flow and with the proceeds of asset sales, debt issuances and specified other events. Our leverage ratio (consolidated funded debt to consolidated EBITDA) was initially limited to no more than 4.25 to 1.00 and steps down to 3.25 to 1.00 as of June 30, 2015. As of December 31, 2013, the leverage ratio was approximately 2.20 to 1.00 and we were in compliance with all such covenants. Additionally, the agreement, which is secured by substantially all of our assets, provides for certain limitations on our ability to, among other things, incur additional debt, offer loans, and declare dividends. As of December 31, 2013, we had $77.8 million of borrowing available under our credit facility.
We continue to make progress on enhancements to our front-office and back-office information systems. These enhancements include the consolidation of back-office systems across all corporate functions, as well as enhancements to and broader application of our front-office software across all lines of business.
We believe that our working capital as of December 31, 2013, our credit facility and expected operating cash flows will be sufficient to fund future requirements of our debt repayment obligations, accounts payable and related payroll expenses, as well as capital expenditure initiatives for the next twelve months.
Commitments and Contingencies We lease space for our corporate and branch offices. Rent expense was $16.6 million in 2013, $12.8 million in 2012 and $7.2 million in 2011.
The following table sets forth, on an aggregate basis including discontinued operations, at December 31, 2013, the amounts of specified contractual cash obligations required to be paid in the periods shown (in thousands): Contractual Obligations 2014 2015 2016 2017 2018 Thereafter Total Long-term debt obligations 1 $ 22,034 $ 21,818 $ 21,601 $ 22,249 $ 109,626 $ 271,556 $ 468,884 Operating lease obligations 15,685 13,863 11,236 7,523 5,351 8,699 62,357 Related party leases 1,299 1,168 694 175 - - 3,336 Total $ 39,018 $ 36,849 $ 33,531 $ 29,947 $ 114,977 $ 280,255 $ 534,577 ____________(1) Long term debt obligations include interest calculated based on the rates in effect at December 31, 2013.
For additional information about these contractual cash obligations, see Note 5 - Long-Term Debt and Note 8 - Commitments and Contingencies to our Consolidated Financial Statements appearing in Part II, Item 8 of this report.
We have large retention policies for our workers' compensation and medical malpractice exposures. In connection with this program, we pay a base premium plus actual losses incurred up to certain levels and are insured for losses greater than certain levels per occurrence and in the aggregate up to the limits of the policies. The workers' compensation and medical malpractice loss reserves liability is determined 27 -------------------------------------------------------------------------------- based on claims filed and claims incurred but not yet reported. We account for claims incurred but not yet reported based on estimates derived from historical claims experience and current trends of industry data. Changes in estimates, differences in estimates and actual payments for claims are recognized in the period that the estimates changed or payments were made. The workers' compensation and medical malpractice loss reserves liability was $32.8 million and $26.8 million at December 31, 2013 and 2012, respectively. Additionally, we have unused stand-by letters of credit outstanding to secure obligations for workers' compensation claims with various insurance carriers. The unused stand-by letters of credit at December 31, 2013 and 2012 were $2.7 million and $2.8 million, respectively.
As of December 31, 2013 and 2012, we have an income tax reserve in other long-term liabilities related to our uncertain tax positions of $1.6 million and $0.4 million, respectively. Income tax reserves are not set forth in the table above. The Company is unable to make reasonably reliable estimates of the period of cash settlement since the statute of limitations might expire without examination by the respective tax authority.
We are involved in various other legal proceedings, claims and litigation arising in the ordinary course of business. We accrued approximately $2.1 million for a settlement, inclusive of all plaintiffs' costs and legal expenses, to resolve an alleged class action dispute regarding the payment of certain of our nurses when we owned a Nurse Travel division from 2008 to 2013. Based on the facts currently available, we do not believe that the disposition of matters that are pending or asserted will have a material effect on our consolidated financial statements, other than described above.
We are subject to earn-out obligations entered into in connection with acquisitions. If the acquired businesses meet predetermined targets, we are obligated to make additional cash payments in accordance with the terms of such earn-out obligations. At December 31, 2013, the Company has potential future earn-out obligations of approximately $16.0 million through 2015.
Off-Balance Sheet Arrangements As of December 31, 2013, the Company had no significant off-balance sheet arrangements other than operating leases and unused stand-by letters of credit outstanding.
Accounting Standards Updates There are no significant accounting standard updates.
Critical Accounting Policies Our accounting policies are described in Note 1 of the Notes to Consolidated Financial Statements in Part II, Item 8 of this report. We prepare our financial statements in conformity with accounting principles generally accepted in the United States, which require us to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the year. Actual results could differ from those estimates. We consider the following policies to be most critical in understanding the judgments that are involved in preparing our financial statements and the uncertainties that could impact our results of operations, financial condition and cash flows.
Allowance for Doubtful Accounts and Billing Adjustments. We estimate an allowance for doubtful accounts, as well as an allowance for billing adjustments related to trade receivables, based on our analysis of historical collection and adjustment experience. We apply bad debt percentages based on experience to the outstanding accounts receivable balances at the end of the period, as well as analyze specific reserves as needed. Impaired receivables, or portions thereof, are charged off when deemed uncollectible. If we experience a significant change in collections or billing adjustment experience, our estimates of the recoverability of accounts receivable could change by a material amount.
Workers' Compensation and Medical Malpractice Loss Reserves. We carry retention policies for our workers' compensation and medical malpractice exposures. In connection with these programs, we pay a base premium plus actual losses incurred, not to exceed certain stop-loss limits. We are insured for losses above these limits, both per occurrence and in the aggregate. The workers' compensation and medical malpractice loss reserves are based upon an actuarial report obtained from a third party and determined based on claims filed and claims incurred but not reported. We account for claims incurred but not yet reported based on estimates derived from historical claims experience and current trends of industry data. Changes in estimates and differences in estimates and actual payments for claims are recognized in the period that the estimates changed or the payments were made.
Contingencies. We record an estimated loss from a loss contingency when information available prior to issuance of our financial statements indicates it is probable that an asset has been impaired or a liability has been incurred at the date of the financial statements, and the amount of the loss can be reasonably estimated. Accounting for contingencies, such as legal settlements, workers' compensation matters and medical malpractice insurance matters, requires us to use our judgment. While we believe that our accruals for these matters are adequate, if the actual loss from a loss contingency is significantly different than the estimated loss, results of operations may be over or understated.
Income taxes. We account for income taxes using the liability method. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years 28 -------------------------------------------------------------------------------- in which those temporary differences are expected to be recovered or settled.
The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. Deferred tax assets are reduced by a valuation allowance if it is more likely than not that a portion of the deferred tax asset will not be realized.
We make a comprehensive review of our uncertain tax positions regularly. In this regard, an uncertain tax position represents our expected treatment of a tax position taken in a filed return, or planned to be taken in a future tax return or claim that has not been reflected in measuring income tax expense for financial reporting purposes. In general, until these positions are sustained by the taxing authorities or statutes expire for the year that the position was taken, we do not recognize the tax benefits resulting from such positions and report the tax effects as a liability for uncertain tax positions in our consolidated balance sheets.
Goodwill and Identifiable Intangible Assets. Goodwill and intangible assets with indefinite lives are tested for impairment on an annual basis as of October 31, and for goodwill whenever an event occurs or circumstances change that would more likely than not reduce the fair value of a reporting unit below its carrying amount and for indefinite lived intangibles, if events or changes in circumstances indicate that it is more likely than not that the asset is impaired.
Intangible assets with indefinite lives consist of trademarks. We test trademarks for impairment on an annual basis, on October 31. In order to test the trademarks for impairment, we determine the fair value of the trademarks and compare such amount to their carrying value. We determine the fair value of the trademarks using a projected discounted cash flow analysis based on the relief-from-royalty approach. The principal factors used in the discounted cash flow analysis requiring judgment are projected net sales, discount rate, royalty rate and terminal value assumption. The royalty rate used in the analysis is based on transactions that have occurred in our industry. Intangible assets having finite lives are amortized over their useful lives and are tested for recoverability whenever events or changes in circumstances indicate that the carrying amount may not be recoverable. Customer relations are amortized using an accelerated method. Contractor relations and non-compete agreements are amortized using the straight-line method. We did not have any impairment of indefinite lived or finite lived intangibles in 2013, 2012, or 2011.
Goodwill is tested for impairment using a two-step process in which the first step compares the fair value of a reporting unit, which is generally an operating segment or one level below the operating segment level which is a business and for which discrete financial information is available and reviewed by segment management, to the reporting unit's carrying value. We determine the fair value of each reporting unit based upon a weighted average calculation using the fair value derived from a discounted cash flow analysis and a market approach analysis. Discounted cash flows are developed for each reporting unit based on assumptions including revenue growth expectations, gross margins, operating expense projections, working capital, capital expense requirements and tax rates. The multi-year financial forecasts for each reporting unit used in the cash flow models considered several key business drivers such as new product lines, historical performance and industry and economic trends, among other considerations. The market approach considers multiples of financial metrics, primarily EBITDA, based on trading multiples of a group of guideline public companies in the staffing industry, which multiples are then applied to the corresponding financial metrics of our reporting units to derive an indication of fair value. The similar transaction method considers multiples of financial metrics, primarily EBITDA, based on trading multiples of actual transactions that have occurred, which multiples are then applied to the corresponding financial metrics of our reporting units to derive an indication of fair value.
If after performing the first step of the goodwill impairment test, the fair value of the reporting unit does not exceed its carrying value, we perform a second step of the goodwill impairment test for that reporting unit. The second step measures the amount of goodwill impairment by comparing the implied fair value of the respective reporting unit goodwill with the carrying value of that goodwill. The implied fair value of goodwill is determined under the same approach utilized to estimate the amount of goodwill recognized in a business combination. This approach requires we allocate the fair value of the respective reporting unit as calculated in the first step of the goodwill impairment test to the reporting unit assets, including identifiable intangible assets, which typically includes tradenames, staffing databases and customer relationships, and reporting unit liabilities, based on the estimated fair values of such assets and liabilities, with any excess reporting unit fair value representing the implied fair value of goodwill for that reporting unit. The reporting unit goodwill impairment loss, if any, is measured as the amount by which the carrying value of goodwill exceeds the implied fair value of goodwill calculated in the second step of the goodwill impairment test.
The principal factors used in the discounted cash flow analysis requiring judgment are the projected results of operations, discount rate, and terminal value assumptions. The discount rate is determined using the weighted average cost of capital ("WACC"). The WACC takes into account the relative weights of each component of an average market participant's capital structure (equity and debt). It also considers our risk-free rate of return, equity market risk premium, beta and size premium adjustment. A range of discount rates are utilized across the reporting units based on the entity size of each reporting unit. The terminal value assumptions are applied subsequent to the tenth year of the discounted cash flow model.
We performed step one goodwill impairment tests for each reporting unit as of October 31, 2013 as this is our new annual impairment test date. No impairment charge was recorded for any of the reporting units as of October 31, 2013. The fair value of all reporting units exceeded their respective carrying values by 27 percent or more. The discount rate used in the cash flow analysis ranged between approximately 13 to 15 percent.
Based upon the annual goodwill impairment tests in 2013, 2012 and 2011, there was no goodwill impairment charge.
The discounted cash flows and the resulting fair value estimates of our reporting units are sensitive to changes in assumptions. An increase of less than seven percent in the discount rate of a reporting unit could cause the fair value of certain significant reporting units to be 29-------------------------------------------------------------------------------- below their carrying value. Changes in the timing of growth and the impact on our operations and costs may also affect the sensitivity of the projections including achieving future cost savings resulting from initiatives which contemplate further synergies from system and operational improvements in infrastructure and field support which were included in our forecasts.
Ultimately, future changes in these assumptions may impact the estimated fair value of a reporting unit and cause the fair value of the reporting unit to be below its carrying value, which would require a step two analysis and may result in impairment of goodwill.
Due to the many variables inherent in the estimation of a reporting unit's fair value and the relative size of recorded goodwill, changes in assumptions may have a material effect on the results of our impairment analysis. Downward revisions of our forecasts or a decline of our stock price resulting in market capitalization significantly below book value could lead to an impairment of goodwill or intangible assets with indefinite lives in future periods.
Impairment or Disposal of Long-Lived Assets. We evaluate long-lived assets, other than goodwill and identifiable intangible assets with indefinite lives, for impairment whenever events or changes in circumstances indicate that the carrying value of an asset may not be recoverable. An impairment loss is recognized when the sum of the undiscounted future cash flows is less than the carrying amount of the asset, in which case a write-down is recorded to reduce the related asset to its estimated fair value. There was no impairment of long-lived assets as of December 31, 2013, 2012 or 2011.
Business Combinations. The purchase price of an acquisition is allocated to the underlying assets acquired and liabilities assumed based upon their estimated fair values at the date of acquisition. To the extent the purchase price exceeds the fair value of the net identifiable tangible and intangible assets acquired and liabilities assumed, such excess is allocated to goodwill. We determine the estimated fair values after review and consideration of relevant information including discounted cash flows, quoted market prices and estimates made by management. Accordingly, these can be affected by contract performance and other factors over time, which may cause final amounts to differ materially from original estimates. We adjust the preliminary purchase price allocation, as necessary, up to one year after the acquisition closing date if we obtain more information regarding asset valuations and liabilities assumed.
Goodwill acquired in business combinations is assigned to the reporting unit(s) expected to benefit from the combination as of the acquisition date. Acquisition related costs are recognized separately from the acquisition and are expensed as incurred.
Stock-Based Compensation. We record compensation expense for restricted stock awards and stock units based on the fair market value of the awards on the date of grant. Compensation expense for performance-based awards is measured based on the amount of shares ultimately expected to vest, estimated at each reporting date based on management's expectations regarding the relevant performance criteria. We account for stock options granted and employee stock purchase plan shares based on an estimated fair market value using a Black-Scholes option valuation model. This methodology requires the use of subjective assumptions, including expected stock price volatility and the estimated life of each award. The fair value of equity-based compensation awards less the estimated forfeitures is amortized over the service period of the award.
Back To NFVZone's Homepage