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TRUEBLUE, INC. - 10-Q - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS(Edgar Glimpses Via Acquire Media NewsEdge) Note About Forward-Looking Statements Certain statements in this report, other than purely historical information, including estimates, projections, statements relating to our business plans, objectives and expected operating results, and the assumptions upon which those statements are based, are "forward-looking statements" within the meaning of the Private Securities Litigation Reform Act of 1995, Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. Forward-looking statements may appear throughout this report, including the following sections: "Management's Discussion and Analysis," and "Risk Factors." Forward-looking statements involve risks and uncertainties, and future events and circumstances could differ significantly from those anticipated in the forward-looking statements. Actual events or results may differ materially. These forward-looking statements generally are identified by the words "believe," "project," "expect," "anticipate," "estimate," "intend," "strategy," "future," "opportunity," "plan," "may," "should," "will," "would," "will be," "will continue," "will likely result," and similar expressions. Forward-looking statements are based on current expectations and assumptions that are subject to risks and uncertainties which may cause actual results to differ materially from the forward-looking statements. We describe risks and uncertainties that could cause actual results and events to differ materially from such forward-looking statements in "Risk Factors" (Part II, Item 1A of this Form 10-Q), "Quantitative and Qualitative Disclosures about Market Risk" (Part I, Item 3), and "Management's Discussion and Analysis" (Part I, Item 2). We undertake no obligation to update or revise publicly any forward-looking statements, whether because of new information, future events, or otherwise. OVERVIEW The following Management's Discussion and Analysis ("MD&A") is intended to help the reader understand the results of operations and financial condition of TrueBlue. Our MD&A is provided as a supplement to, and should be read in conjunction with, our Annual Report on Form 10-K for the fiscal year ended December 27, 2013, and our subsequently filed Quarterly Reports on Form 10-Q. The MD&A is designed to provide the reader of our financial statements with a narrative from the perspective of management on our financial condition, results of operations, liquidity, and certain other factors that may affect future results. Our MD&A is presented in the following sections: • Results of Operations • Liquidity and Capital Resources • Contractual Obligations and Commitments • Summary of Critical Accounting Estimates • New Accounting Standards Revenue grew to $633.4 million for the thirteen weeks ended September 26, 2014, a 40.4% increase compared to the same period in the prior year. The revenue increase is primarily due to the acquisition of Staffing Solutions Holdings, Inc. ("Seaton"). We completed the acquisition of all of the outstanding equity interests of Seaton effective June 30, 2014, the first business day of our third quarter. Revenue for Seaton was $148.6 million for the thirteen weeks ended September 27, 2014 or 33% of our revenue growth. The Seaton acquisition expanded the scope of our services from temporary blue-collar staffing to include outsourced workforce management solutions: • Staff Management | SMX provides exclusive recruitment and on-premise management of a facility's contingent workforce (Outsourced Workforce Management or "OWM"). The dedicated on-premise teams are supported by centralized services for sourcing and screening candidates, drug testing, verification and compensation together with reporting and other administrative activities. Centralized recruiting and customer support services are based in Chicago with no branch network; • Staff Management | SMX also provides management of multiple third party staffing vendors on behalf of their customers to manage contingent labor spend (Managed Service Provider or "MSP"); and, • PeopleScout and Australia-based hrX provide high-volume outsourced recruitment of permanent employees on behalf of their customers (Recruitment Process Outsourcing or "RPO"). PeopleScout and hrX provide full turnkey solutions for the entire sourcing through on-boarding recruiting process for both hourly and exempt employees. In 2013 they placed over 250,000 individuals into permanent jobs. Centralized recruiting and customer support services are based in Chicago with no branch network. -------------------------------------------------------------------------------- Page - 21 -------------------------------------------------------------------------------- Table of Contents -------------------------------------------------------------------------------- Seaton offers outsourced workforce solutions as an integrated partner with their customers. They have dedicated teams on-site at their customers' facilities while leveraging centralized support services for sourcing and recruiting to the specialized needs of each customer. Seaton does not operate a branch network to service their customers and accordingly operates a more flexible centralized support structure. Seaton is headquartered in Chicago and their operations will continue to be managed and supported from Chicago. See Note 2: Acquisition, to our Consolidated Financial Statements found in Item 1 of Part I of this Quarterly Report on Form 10-Q for additional details of our acquisition of Seaton. We are in the process of integrating Seaton and determining our operating segments and future segment reporting. Approximately 5% of the revenue growth for the thirteen weeks ended September 26, 2014 was generated from the acquisition of The Work Connection, Inc. ("TWC") effective October 1, 2013. We acquired substantially all of the assets and assumed certain liabilities of TWC, a light industrial staffing provider with 37 branches located predominantly in the Midwest, which had minimal overlap with existing TrueBlue branch offices. TWC's operations were primarily integrated with those of our Spartan Staffing service line during the fourth quarter of 2013. Organic revenue growth for the quarter was approximately 2%, or 5% excluding our energy practice. The immediate pipeline for new energy projects has not offset project completions. We expect this trend to continue into the first quarter of 2015, but believe there is opportunity for improvement as we enter warmer weather months in the second quarter of 2015. Gross profit as a percentage of revenue for the thirteen weeks ended September 26, 2014 was 25.2% compared to 27.4% for the same period in 2013. The decline was largely due to the impact of the acquisition of Seaton and TWC, which carried lower gross margins in comparison with our blended company average. This was offset by improved gross margin in our organic business through disciplined pricing and management of our temporary labor wages, payroll taxes, and benefits. Selling, general and administrative ("SG&A") spending increased $29.6 million to $120.3 million for the thirteen weeks ended September 26, 2014 compared to the same period in the prior year. The increase is primarily related to the acquired operations of Seaton of $20.0 million. We completed the acquisition of Seaton on the first business day of our third quarter of 2014. We incurred $2.3 million of costs related to our acquisition and integration of Seaton during the third quarter ended September 26, 2014 and expect to complete our integration by mid-2015. SG&A spending also increased by approximately $2.6 million due to the acquired operations of TWC . We completed the acquisition of TWC in the beginning of our fourth quarter of 2013. We incurred $0.6 million of costs related to our acquisition of TWC during the thirteen weeks ended ended September 27, 2013 and completed the integration in the fourth quarter of 2013. The remaining increase is primarily due to variable SG&A expenses associated with organic revenue growth and continued investments in our strategy to align the dedicated sales, recruiting, and services of our branch-based service lines to better serve our customers and enable further branch consolidation and centralization of services, which we believe will continue to increase our operating efficiency. SG&A as a percentage of revenue decreased to 19.0% for the thirteen weeks ended September 26, 2014 from 20.1% for the same period in 2013, primarily due to Seaton and their lower cost of doing business as a percent of sales. This was partially offset by the continued investments in our strategy to align the dedicated sales, recruiting, and services of our branch-based service lines, enable further branch consolidation and centralization of services, and continue to increase our operating efficiency. We consolidated 14 branches during this quarter and expect to consolidate additional branches in the future. Depreciation and amortization increased $4.9 million primarily due to acquired finite-lived tangible and intangible assets acquired through acquisitions for the thirteen weeks ended September 26, 2014. Income tax expense for the thirteen weeks ended September 26, 2014 included increased Work Opportunity Tax Credit benefits of approximately $2.9 million. The Work Opportunity Tax Credit program has not been renewed for 2014 new hires. However, we continue to generate benefits from prior year programs. The increased credits are primarily due to qualified workers working longer, mix of workers generating higher credits, such as veterans, and states processing a backlog of credit applications with higher than expected certification rates. Net income grew to $20.9 million, or $0.51 per diluted share, for the thirteen weeks ended September 26, 2014, compared to $19.0 million, or $0.47 per diluted share, for the same period in 2013. -------------------------------------------------------------------------------- Page - 22 -------------------------------------------------------------------------------- Table of Contents -------------------------------------------------------------------------------- RESULTS OF OPERATIONS The following table presents selected financial data (in thousands, except percentages and per share amounts): Total company results Thirteen weeks ended Thirty-nine weeks ended September 26, September 27, September 26, September 27, 2014 2013 2014 2013 Revenue from services $ 633,365 $ 451,169 $ 1,482,655 $ 1,219,977 Total revenue growth % 40.4 % 18.9 % 21.5 % 16.8 % Gross profit $ 159,599 $ 123,528 $ 378,741 $ 322,040 Gross profit as a % of revenue 25.2 % 27.4 % 25.5 % 26.4 % Selling, general and administrative expenses $ 120,318 $ 90,767 $ 308,654 $ 268,538 Selling, general and administrative expenses as a % of revenue 19.0 % 20.1 % 20.8 % 22.0 % Depreciation and amortization $ 9,719 $ 4,771 $ 20,126 $ 15,133 Depreciation and amortization as % of revenue 1.5 % 1.1 % 1.4 % 1.2 % Income from operations $ 29,562 $ 27,990 $ 49,961 $ 38,369 Income from operations as a % of revenue 4.7 % 6.2 % 3.4 % 3.1 % Interest and other income (expense), net $ (409 ) $ 416 $ 385 $ 1,167 Net income $ 20,910 $ 18,952 $ 38,650 $ 30,412 Net income per diluted share $ 0.51 $ 0.47 $ 0.94 $ 0.75 Our business experiences seasonal fluctuations. Our quarterly operating results are affected by the seasonality of our customers' businesses as well as timing and duration of project work. Demand for our legacy TrueBlue blue-collar temporary staffing services is typically higher during the second and third quarters of the year with demand peaking in the third quarter and is lower during the first and fourth quarters, in part due to limitations to outside work during the winter months. Demand for Seaton OWM services is significantly higher during the fourth quarter in connection with manufacturing and distributing for the holiday season. Our year over year trends are significantly impacted by acquisitions. Effective February 4, 2013, we acquired substantially all of the assets and assumed certain liabilities of MDT, the third-largest general-labor staffing provider in the United States. MDT supplied blue-collar labor to industries similar to those served by TrueBlue, including construction, event staffing, disaster recovery, hospitality, and manufacturing through its network of 105 branches in 25 states. MDT operations were primarily integrated with our Labor Ready service line. We consolidated 65 branch locations, blended our sales and service teams, and fully integrated all former MDT locations into our enterprise systems. The acquisition of MDT has both deepened our expertise and strengthened our position in the key industries we serve. The customers of MDT have been fully integrated with our existing customer base and are serviced by our blended operations. We completed the integration of all remaining administrative services during the second quarter of 2013. Due to full consolidation of the MDT branches, blending our sales and service teams, and fully integrating all former MDT locations into our enterprise systems, we cannot accurately segregate the acquisition revenue from our organic revenue growth. Effective October 1, 2013, we acquired substantially all of the assets and assumed certain liabilities of TWC, a light industrial staffing provider with 37 branches located predominantly in the Midwest with minimal overlap with existing TrueBlue branch offices. TWC delivered specialized blue-collar staffing solutions for more than 25 years to customers in industries similar to those served by TrueBlue. TWC's operations were primarily integrated with those of our Spartan Staffing service line during the fourth quarter of 2013. We completed the acquisition of all of the outstanding equity interests of Seaton effective June 30, 2014, the first business day of our third quarter. Revenue for Seaton was $148.6 million for the thirteen weeks ended September 27, 2014 or 33% of our revenue growth. The Seaton acquisition expanded the scope of our services from temporary blue-collar staffing to include outsourced workforce management solutions: -------------------------------------------------------------------------------- Page - 23 -------------------------------------------------------------------------------- Table of Contents --------------------------------------------------------------------------------• Staff Management | SMX provides exclusive recruitment and on-premise management of a facility's contingent workforce (Outsourced Workforce Management or "OWM"). The dedicated on-premise teams are supported by centralized services for sourcing and screening candidates, drug testing, verification and compensation together with reporting and other administrative activities. Centralized recruiting and customer support services are based in Chicago with no branch network; • Staff Management | SMX also provides management of multiple third party staffing vendors on behalf of their customers to manage contingent labor spend (Managed Service Provider or "MSP"); and, • PeopleScout and Australia-based hrX provide high-volume outsourced recruitment of permanent employees on behalf of their customers (Recruitment Process Outsourcing or "RPO"). PeopleScout and hrX provide full turnkey solutions for the entire sourcing through on-boarding recruiting process for both hourly and exempt employees. In 2013 they placed over 250,000 individuals into permanent jobs. Centralized recruiting and customer support services are based in Chicago with no branch network. Seaton offers outsourced workforce solutions as an integrated partner with their customers. They have dedicated teams on-site at their customers' facilities while leveraging centralized support services for sourcing and recruiting to the specialized needs of each customer. Seaton does not operate a branch network to service their customers and accordingly operates a more flexible centralized support structure. Seaton is headquartered in Chicago and its operations will continue to be managed and supported from Chicago. See Note 2: Acquisition, to our Consolidated Financial Statements found in Item 1 of Part I of this Quarterly Report on Form 10-Q for additional details of our acquisition of Seaton. We are in the process of integrating Seaton and determining our segments and future segment reporting. We incurred $2.3 million of costs related to our acquisition and integration of Seaton during the third quarter ended September 26, 2014 and expect to complete our integration by mid-2015. The impact of Seaton on our consolidated results is highlighted as follows (in thousands): 13 Weeks Ended September 26, 2014 September 27, 2013 Legacy TrueBlue Seaton (1) Total Company Legacy TrueBlue Revenue from services $ 484,729 $ 148,636 $ 633,365 $ 451,169 Earnings before interest depreciation and amortization $ 32,593 $ 6,688 39,281 32,761 Depreciation and amortization 9,719 4,771 Income from operations 29,562 27,990 Interest income (expense), net (409 ) 416 Income before tax expense 29,153 28,406 Provision for taxes 8,243 9,454 Net income $ 20,910 $ 18,952 (1) Seaton was acquired effective June 30, 2014. Therefore, the comparative prior year amounts are not presented. Revenue from services Revenue from services was as follows (in thousands, except percentages): Thirteen weeks ended Thirty-nine weeks ended September 26, September 27, September 26, September 27, 2014 2013 2014 2013 Revenue from services $ 633,365 $ 451,169 $ 1,482,655 $ 1,219,977 Total revenue growth % 40.4 % 18.9 % 21.5 % 16.8 % -------------------------------------------------------------------------------- Page - 24 -------------------------------------------------------------------------------- Table of Contents -------------------------------------------------------------------------------- Revenue grew to $633.4 million for the thirteen weeks ended September 26, 2014, a 40.4% increase compared to the same period in the prior year. The revenue increase is primarily due to the acquisition of Seaton. Revenue for Seaton was $148.6 million for the thirteen weeks ended September 26, 2014 or 33% of our revenue growth. Approximately 5% of the revenue growth was generated from the acquisition of TWC. Organic revenue for the quarter was approximately 2%, or 5% excluding our energy practice. The immediate pipeline for new green energy projects has not offset project completions. We expect this trend to continue into the first quarter of 2015, but believe there is opportunity for improvement as we enter warmer weather months in the second quarter of 2015. Revenue grew to $1,482.7 million for the thirty-nine weeks ended September 26, 2014, a 21.5% increase compared to the same period in the prior year. The increase was due primarily to revenue generated from the acquisitions of MDT effective February 4, 2013, TWC effective October 1, 2013, and Seaton effective June 30, 2014. The remainder of our growth was generated from organic revenue growth across most geographies and industries we serve. The organic revenue growth was negatively impacted by a slowdown within the green energy sector. We continue to experience customer project delays and slowed investment. In addition, demand for our services slowed during the first quarter of 2014 due to severe weather conditions. Gross profit Gross profit was as follows (in thousands, except percentages): Thirteen weeks ended Thirty-nine weeks ended September 26, September 27, September 26, September 27, 2014 2013 2014 2013 Gross profit $ 159,599 $ 123,528 $ 378,741 $ 322,040 Percentage of revenue 25.2 % 27.4 % 25.5 % 26.4 % Gross profit represents revenues from services less direct costs of services, which consist of payroll, payroll taxes, workers' compensation costs, and reimbursable costs. Gross profit as a percentage of revenue for the thirteen weeks ended September 26, 2014 was 25.2% compared to 27.4% for the same period in 2013. The decline was largely due to the impact of the acquisition of Seaton and TWC, which carried a lower gross margin in comparison with our blended company average. Excluding the impact of acquisitions on our blended company average, gross profit as a percentage of revenue improved through disciplined pricing and management of our temporary labor wages, payroll taxes, and benefits. Gross profit as a percentage of revenue for the thirty-nine weeks ended September 26, 2014 was 25.5% compared to 26.4% for the same period in the prior year. This was due largely to the impact of the acquisitions of Seaton, TWC, and MDT, which carried lower gross margins in comparison with our blended company average, offset by the favorable impact from disciplined management of bill rates. Workers' compensation expense as a percentage of revenue was 3.4% and 3.7% for the thirteen and thirty-nine weeks ended September 26, 2014, respectively, compared to 3.7% and 3.8%, respectively, for the same periods in the prior year. The decline is due in part to the acquisition of Seaton and the lower cost of workers compensation cost as a percentage of revenue due to the nature of their business. In addition, we continue to actively manage workers' compensation expense through the safety of our temporary workers with our safety programs and actively control costs with our network of service providers. These actions have had a positive impact creating favorable adjustments to workers' compensation liabilities recorded in prior periods. Continued favorable adjustments to our workers' compensation liabilities are dependent on our ability to continue to aggressively lower accident rates and costs of our claims. We expect diminishing favorable adjustments to our workers' compensation liabilities as the opportunity for significant reduction to frequency and severity of accident rates diminishes. Selling, general and administrative expenses Selling, general and administrative ("SG&A") expenses were as follows (in thousands, except percentages): Thirteen weeks ended Thirty-nine weeks ended September 26, September 27, September 26, September 27, 2014 2013 2014 2013 Selling, general and administrative expenses $ 120,318 $ 90,767 $ 308,654 $ 268,538 Percentage of revenue 19.0 % 20.1 % 20.8 % 22.0 % -------------------------------------------------------------------------------- Page - 25 -------------------------------------------------------------------------------- Table of Contents -------------------------------------------------------------------------------- SG&A spending increased $29.6 million to $120.3 million for the thirteen weeks ended September 26, 2014 compared to the same period in the prior year. The increase is primarily related to the acquired operations of Seaton of $20.0 million. We completed the acquisition of Seaton on the first business day of our third quarter of 2014. We incurred $2.3 million of costs related to our acquisition and integration of Seaton during the third quarter ended September 26, 2014 and expect to complete our integration by mid-2015. SG&A spending increased due to the acquired operations of TWC by approximately $2.6 million. We completed the acquisition of TWC in the beginning of our fourth quarter of 2013. We incurred $0.6 million of costs related to our acquisition of TWC during the third quarter ended September 27, 2013 and completed the integration in the fourth quarter of 2013. The remaining increase is primarily due to variable SG&A expenses associated with organic revenue growth and continued investments in our strategy to align the dedicated sales, recruiting, and services of our branch-based service lines to better serve our customers and enable further branch consolidation and centralization of services, which we believe will continue to increase our operating efficiency. Seaton offers outsourced workforce solutions as an integrated partner with their customers. They have dedicated teams on-site at their customers' facilities while leveraging centralized support services for sourcing and recruiting staff for the specialized needs of each customer. Seaton does not operate a branch network to service their customers and accordingly operates a more flexible centralized support structure with lower SG&A. The lower SG&A costs as a percent of sales offsets the lower gross margins of the OWM business, to deliver comparable results to those of our legacy TrueBlue blue-collar temporary staffing solutions. SG&A as a percentage of revenue decreased to 19.0% for the thirteen weeks ended September 26, 2014 from 20.1% for the same period in 2013 primarily due to Seaton and their lower cost of doing business as a percent of sales. This was partially offset by the continued investments in our strategy to align the dedicated sales, recruiting, and services of our branch-based service lines, enable further branch consolidation and centralization, and continue to increase our operating efficiency. We consolidated 14 branches during this quarter and expect to consolidate additional branches in the future. SG&A spending increased $40.1 million to $308.7 million for the thirty-nine weeks ended September 26, 2014. The increase is primarily related to acquired operations of Seaton, TWC, and MDT; and the variable costs associated with organic revenue growth and costs related to strategic initiatives. Increased spending was partially offset by a decline in non-recurring costs related to acquisitions. During the thirty-nine weeks ended September 26, 2014 we incurred $4.3 million of costs related to our acquisition of Seaton compared to total non-recurring acquisition and integration costs for MDT and TWC of $6.6 million during the thirty-nine weeks ended September 27, 2013. We consolidated 52 branches during the thirty-nine weeks ended September 26, 2014 and expect to consolidate additional branches over the remainder of the year. We expect further leverage benefit from branch consolidations in the future. We continue to make investments in our strategy to align the dedicated sales, recruiting, and services of our branch-based service lines to better serve our customers and enable further branch consolidation and centralization of services, which will increase our operating efficiency. Depreciation and amortization Depreciation and amortization were as follows (in thousands, except percentages): Thirteen weeks ended Thirty-nine weeks ended September 26, September 27, September 26, September 27, 2014 2013 2014 2013 Depreciation and amortization $ 9,719 $ 4,771 $ 20,126 $ 15,133 Percentage of revenue 1.5 % 1.1 % 1.4 % 1.2 % Depreciation and amortization expense for the thirteen and thirty-nine weeks ended September 26, 2014 increased over the same periods in 2013 by $4.9 million and $5.0 million respectively, primarily from increased amortization related to the finite-lived intangible assets acquired through acquisitions. Interest and other income (expense), net Interest and other income (expense), net is as follows (in thousands): Thirteen weeks ended Thirty-nine weeks ended September 26, September 27, September 26, September 27, 2014 2013 2014 2013Interest and other income (expense), net $ (409 ) $ 416 $ 385 $ 1,167 -------------------------------------------------------------------------------- Page - 26 -------------------------------------------------------------------------------- Table of Contents -------------------------------------------------------------------------------- Net interest expense for the thirteen weeks ended September 26, 2014 was $0.4 million and net interest income for the thirty-nine weeks ended September 26, 2014 was $0.4 million compared to net interest income of $0.4 million and $1.2 million over the same periods in 2013. The increase in interest expense is due to the debt assumed to acquire Seaton at the beginning of the third quarter. Income taxes The income tax expense and the effective income tax rate were as follows (in thousands, except percentages): Thirteen weeks ended Thirty-nine weeks ended September 26, September 27, September 26, September 27, 2014 2013 2014 2013 Income tax expense $ 8,243 $ 9,454 $ 11,696 $ 9,124 Effective income tax rate 28.3 % 33.3 % 23.2 % 23.1 % Our tax provision or benefit from income taxes for interim periods is determined using an estimate of our annual effective tax rate, adjusted for discrete items, if any, that are taken into account in the relevant period. Each quarter we update our estimate of the annual effective tax rate, and if our estimated tax rate changes, we make a cumulative adjustment. Our quarterly tax provision and our quarterly estimate of our annual effective tax rate are subject to variation due to several factors, including variability in accurately predicting our pre-tax and taxable income and loss and the mix of jurisdictions to which they relate, audit developments, changes in law, regulations and administrative practices, and relative changes of expenses or losses for which tax benefits are not recognized. Additionally, our effective tax rate can be more or less volatile based on the amount of pre-tax income. For example, the impact of discrete items, tax credits and non-deductible expenses on our effective tax rate is greater when our pre-tax income is lower. Our effective tax rate on earnings for the thirteen and thirty-nine weeks ended September 26, 2014,was 28.3% and 23.2%, respectively, compared to 33.3% and 23.1%, respectively, for the same periods in 2013. The principal difference between the statutory federal income tax rate of 35.0% and our effective income tax rate results from the Work Opportunity Tax Credit ("WOTC"), state and foreign income taxes, and certain non-deductible expenses. WOTC expired in 2013 and has not yet been renewed by Congress for 2014 new hires. Changes to our tax provision as a result of the WOTC were as follows: Thirteen weeks ended Thirty-nine weeks ended September 26, September 27, September 26, September 27, 2014 2013 2014 2013 Effective income tax rate without WOTC 40.5 % 40.9 % 41.2 % 41.2 % WOTC estimate from current year wages (2.3 )% (7.6 )% (2.3 )% (7.6 )% Effective income tax rate before discrete 38.2 % 33.3 % 38.9 % 33.6 % adjustments Additional WOTC from prior year wages (9.9 )% - % (15.7 )% (10.5 )% Effective income tax rate with WOTC 28.3 % 33.3 % 23.2 % 23.1 % The comparability of net income for the thirteen weeks ended September 26, 2014, to the same period in 2013, was impacted by discrete adjustments to income taxes for WOTC. This tax credit is designed to encourage employers to hire workers from certain targeted groups with higher than average unemployment rates. During the thirteen weeks ended September 26, 2014, we generated substantially more prior year credits because more veterans with higher credits were certified than expected, our qualified workers worked longer generating more credits than expected, and many states processed a backlog of credit applications with higher than expected certification rates. These factors generated additional WOTC benefits of approximately $8 million, which were recognized during the thirty-nine weeks ended September 26, 2014. This tax credit benefit decreased our effective tax rate for the thirty-nine weeks ended September 26, 2014 from our expected 2014 rate of 38.9% to 23.2%. The effective income tax rate in the prior year was due primarily to the retroactive restoration of the WOTC. The American Taxpayer Relief Act of 2012 ("the Act"), which was signed into law on January 2, 2013, retroactively restored the WOTC. Because a change in tax law is accounted for in the period of enactment, the retroactive effect of the Act on our U.S. federal taxes for 2012 was recognized in the thirty-nine weeks ended September 27, 2013. The effective tax rate was also favorably impacted by the estimated increase to our WOTC benefits from the IRS extension of the 2012 WOTC certification request deadline to April 29, 2013, and by receipt of additional WOTC certification approvals related to years prior to 2012. These factors generated additional worker opportunity tax credit benefits of $4.2 million, which were recognized during the thirty-nine weeks ended September 27, 2013. -------------------------------------------------------------------------------- Page - 27 -------------------------------------------------------------------------------- Table of Contents --------------------------------------------------------------------------------This tax credit benefit decreased our effective tax rate for the thirty-nine weeks ended September 27, 2013 from our expected 2013 rate of 33.6% to 23.1%. Results of Operations Future Outlook The following highlights represent our expectations regarding operating trends for the remainder of fiscal year 2014. These expectations are subject to revision as our business changes with the overall economy: • Our top priority is to produce strong organic revenue and gross profit growth and leverage our cost structure to generate increasing operating income as a percentage of revenue. We will continue to invest in our specialized sales, recruiting, and customer service programs, which we believe will enhance our ability to capitalize on further revenue growth and customer retention. As with all of our investments, we will monitor the success of these investments and make adjustments if necessary. Where possible, we plan to expand the presence of our service lines by sharing existing locations to achieve cost synergies. • We experienced organic revenue growth across most of our business lines and geographies during 2014. However, organic revenue growth in the third quarter of 2014 was lower than expected due primarily to lower revenue from the energy sector of our business. The immediate pipeline of new projects has not offset project completions. We expect this trend to continue through the first quarter of 2015 resulting in a negative impact of $5 to $15 million of revenue per quarter, in comparison with comparable prior year periods. Thereafter, the lower revenue from the energy sector will be reflected in our quarterly run rates. We believe the future for the energy market continues to be bright and our opportunity to service that market will see improvement as we enter warmer weather months in the second quarter of 2015. • Acquisitions are a key element of our growth strategy. We have a proven track record of successfully acquiring and integrating companies and believe we have a strong business competence to continue to do so. On June 30, 2014, we completed the acquisition of Seaton and, as a result, we will be able to offer a broader range of outsourcing workforce solutions to all our customers. We can now do more for our customers through sourcing, screening, and on-boarding their on-premise temporary workers and permanent employees. Through the Seaton acquisition we added industry leaders People Scout, Staff Management | SMX, and Australia-based hrX to our service lines. We have been successful in retaining the leadership, customers and operations of Seaton. We will continue to operate Seaton from Chicago. The service offerings of Seaton are complementary to our legacy business. As such, there is little operational integration to be performed. Most integration efforts are focused on financial systems, efficiencies in common programs, and other administrative activities which we expect to be completed by the end of the second quarter of 2015. • Commencing in 2015, we will be required by the Patient Protection and Affordable Care Act and the Health Care and Education Reconciliation Act of 2010 (collectively, the "ACA") to offer health care benefits to our temporary workers. While we currently offer health care benefits to our permanent employees, we do not currently offer health care benefits to the majority of our temporary workers. In order to comply with the ACA, we intend to begin offering health care coverage in 2015 to all temporary employees eligible for coverage under the ACA. We intend to increase our customer bill rates for the cost increases related to offering this healthcare coverage to our temporary workers. Our best estimate of this increased cost is approximately 0.1% to 0.4% of of estimated 2015 revenue. This estimate of increased cost is based upon various assumptions regarding our temporary workers and their participation rates and related factors which may change. As the regulatory implementation requirements continue to be modified and clarified, any such modifications and clarifications may impact the estimated cost to us. We will continue to evaluate the requirements of the ACA and the costs related to implementing the ACA. Although we intend to pass on to our customers any cost increases related to our temporary workers, there is no assurance that we will be fully successful in doing so. • During 2014, we expect to deploy additional technology that will enhance our recruiting and service capabilities. When combined with the mobile dispatch technology deployed during 2013 and electronic pay the year prior, we expect to drive further productivity gains by increasing the size and quality of our applicant pool as well as the number and speed with which jobs are filled and workers paid. Our ability to reach a wide range of applicants is expanding our geographic reach and enabling branch consolidation and centralization which we believe will increase our operating efficiency. We have consolidated 52 branches since the beginning of the year and intend to close additional branches in the future. LIQUIDITY AND CAPITAL RESOURCES As of September 26, 2014, our cash, cash equivalents, and marketable securities totaled $31.0 million compared to $142.7 million as of December 27, 2013, a decrease of $111.7 million. This decrease in cash, cash equivalents, and marketable securities was primarily driven by cash used to purchase Seaton for a cash purchase price of $308.0 million, net of cash acquired. We entered -------------------------------------------------------------------------------- Page - 28 -------------------------------------------------------------------------------- Table of Contents -------------------------------------------------------------------------------- into a Second Amended and Restated Credit Agreement at the end of the second quarter for a secured revolving credit facility of up to a maximum of $300.0 million, $187.0 million of which was used to fund the Seaton acquisition in addition to $121.0 million of existing cash. The following discussion highlights our cash flow activities for the thirty-nine weeks ended September 26, 2014. Cash flows from operating activities Our cash flows from operating activities were as follows (in thousands): Thirty-nine weeks ended September 26, September 27, 2014 2013 Net income $ 38,650 $ 30,412 Adjustments to reconcile net income to net cash from operating activities: Depreciation and amortization 20,126 15,133 Provision for doubtful accounts 9,619 8,785 Stock-based compensation 8,902 6,428 Deferred income taxes 6,077 (1,694 ) Other operating activities (148 ) 1,213 Changes in operating assets and liabilities, net of acquisition: Accounts receivable (26,391 ) (24,776 ) Income taxes (3,179 ) 6,580 Accounts payable and other accrued expenses 9,686 4,691 Workers' compensation claims reserve 532 2,785 Other assets and liabilities (3,971 ) (4,280 ) Net cash provided by operating activities $ 59,903 $ 45,277 Our principal source of liquidity is operating cash flows. Our net income and, consequently, our cash provided from operations are impacted by sales volume, timing of collections, seasonal sales patterns, and profit margins. Net cash provided by operating activities was $59.9 million for the thirty-nine weeks ended September 26, 2014, compared to $45.3 million for the same period in 2013. • The increase in cash from operating activities is primarily due to net income of $38.7 million. • Depreciation and amortization increased over 2013 by $5.0 million primarily due to the amortization of acquired finite-lived intangible assets in connection with the acquisition of Seaton. • Stock based compensation increased for performance shares due to estimated improvements to company performance with the acquisition of Seaton. • Accounts receivable followed normal seasonal patterns through the third quarter of 2014 by increasing from the beginning of the year. The increase over the prior year is due to revenue growth. Our business experiences seasonal fluctuations. Demand for our legacy TrueBlue blue-collar temporary staffing services is higher during the second and third quarters of the year with demand peaking in the third quarter and is lower during the first and fourth quarters, in part due to limitations to outside work during the winter months. • Income taxes receivable increased in the current year primarily due to the utilization of acquired net operating losses from Seaton. In the prior year, the income tax receivable declined due to refunds of prior year amended returns due primarily to additional worker opportunity tax credits realized. • Accounts payable and accrued expenses followed normal seasonal patterns through the third quarter of 2014 by increasing from the beginning of the year. The increase over the prior year is primarily due to business expansion. -------------------------------------------------------------------------------- Page - 29 -------------------------------------------------------------------------------- Table of Contents -------------------------------------------------------------------------------- Cash flows from investing activities Our cash flows from investing activities were as follows (in thousands): Thirty-nine weeks ended September 26, September 27, 2014 2013 Capital expenditures $ (10,213 ) $ (10,350 ) Acquisition of businesses, net of cash acquired (307,972 ) (54,872 ) Purchases of marketable securities (25,057 ) (35,300 ) Sales and maturities of marketable securities 43,917 205 Change in restricted cash and cash equivalents 10,020 (1,338 ) Purchase of restricted investments (18,196 ) (9,175 ) Maturities of restricted investments 10,588 13,337 Net cash used in investing activities $ (296,913 ) $ (97,493 ) • Cash flows used in investing activities increased primarily due to the acquisition of Seaton for $308 million. In the prior year, cash flows used in investing activities increased primarily due to our acquisition of MDT for $53.4 million in cash, effective February 4, 2013. • Our marketable securities consisted of CDs, VRDNs, corporate debt securities, municipal debt securities, and commercial paper, which are classified as available-for-sale. We sold all of our VRDNs, corporate and municipal debt securities, and commercial paper during the thirteen weeks ended June 27, 2014, for our acquisition of Seaton. • Restricted cash and investments consist primarily of collateral that has been provided or pledged to insurance carriers and state workers' compensation programs. When combining the change in restricted cash and cash equivalents with purchases of restricted investments net of maturities of restricted investments, restricted cash and investments increased by $2.4 million for the thirty-nine weeks ended September 26, 2014. This increase is primarily due to an increase in the collateral requirements by our workers' compensation insurance providers related to growth in operations, which was partially offset by claim payments. Cash flows from financing activities Our cash flows from financing activities were as follows (in thousands): Thirty-nine weeks ended September 26, September 27, 2014 2013Net proceeds from stock option exercises and employee stock purchase plans $ 1,673 $ 8,731 Common stock repurchases for taxes upon vesting of restricted stock (3,021 ) (2,653 ) Proceeds from long-term debt 186,994 34,000 Payments on debt and other liabilities (41,700 ) (8,115 ) Other 1,242 720 Net cash provided by (used in) financing activities $ 145,188 $ 32,683 The increase to net cash provided by financing activities is primarily due to financing a portion of the Seaton acquisition. We entered into a Second Amended and Restated Credit Agreement for a secured revolving credit facility of up to a maximum of $300.0 million, of which $187.0 million was used to fund a portion of the acquisition price effective June 30, 2014. See Note 10: Debt, to our Consolidated Financial Statements found in Item 1 of Part I of this Quarterly Report on Form 10-Q, for details of our Second Amended and Restated credit facility. The credit facility was partially repaid during the third quarter of 2014 in the amount of $40.0 million. In the prior year, the change in cash provided by financing activities was mainly due to proceeds from our Term Loan Agreement with Synovus Bank of $34.0 million in connection with our acquisition of MDT in February 2013. -------------------------------------------------------------------------------- Page - 30 -------------------------------------------------------------------------------- Table of Contents -------------------------------------------------------------------------------- Future outlook Our cash-generating capability provides us with financial flexibility in meeting our operating and investing needs. Our current financial position is highlighted as follows: • On June 30, 2014, we entered into a credit facility with Bank of America, N.A., Wells Fargo Bank, National Association, and PNC Capital Markets LLC, for a secured revolving credit facility of up to a maximum of $300.0 million (the "Amended Credit Facility"). The Amended Credit Facility amends and restates our existing Amended and Restated Credit Agreement dated as of September 30, 2011 with Bank of America and Wells Fargo Capital Finance, LLC and expires on June 30, 2019. We borrowed $187.0 million under the Amended Credit Facility on June 30, 2014 to purchase Seaton. The Amended Credit Facility is an asset backed facility which is principally based on accounts receivable. The additional amount available to borrow at September 26, 2014 was $87.3 million. We believe the Amended Credit Facility provides adequate borrowing availability. • We had cash, cash equivalents, and highly liquid marketable securities of $31.0 million at September 26, 2014. We expect to operate with approximately $30 million of cash and apply any excess cash towards the outstanding balance on our credit facility. • The majority of our workers' compensation payments are made from restricted cash rather than cash from operations. At September 26, 2014, we had restricted cash and investments totaling approximately $152.3 million. We believe that cash provided from operations and our capital resources will be adequate to meet our cash requirements for the foreseeable future. Capital resources Revolving Credit Facility See Note 10: Debt, to our Consolidated Financial Statements found in Item 1 of Part I of this Quarterly Report on Form 10-Q for a description of the Credit Facility, which was outstanding as of the quarter ended September 26, 2014. Restricted Cash and Investments Restricted cash and investments consist principally of collateral that has been provided or pledged to insurance carriers for workers' compensation and state workers' compensation programs. Our insurance carriers and certain state workers' compensation programs require us to collateralize a portion of our workers' compensation obligation. We have agreements with certain financial institutions that allow us to restrict cash and cash equivalents and investments for the purpose of providing collateral instruments to our insurance carriers to satisfy workers' compensation claims. At September 26, 2014, we had restricted cash and investments totaling approximately $152.3 million. The majority of our collateral obligations are held in a trust at the Bank of New York Mellon ("Trust"). We established investment policy directives for the Trust, with the first priority to ensure sufficient liquidity to pay workers' compensation claims, second to maintain and ensure a high degree of liquidity, and third to maximize after-tax returns. Trust investments must meet minimum acceptable quality standards. The primary investments include U.S. Treasury securities, U.S. agency debentures, U.S. agency mortgages, corporate securities, and municipal securities. For those investments rated by the Nationally Recognized Statistical Rating Organizations the minimum ratings are: S&P Moody's Fitch Short-term Rating A-1/SP-1 P-1/MIG-1 F-1 Long-term Rating A- A3 A- Workers' compensation insurance, collateral and claims reserves Workers' compensation insurance We provide workers' compensation insurance for our temporary and permanent employees. The majority of our current workers' compensation insurance policies cover claims for a particular event above a $2.0 million deductible limit, on a "per occurrence" basis. This results in our being substantially self-insured. For workers' compensation claims originating in Washington, North Dakota, Ohio, Wyoming, Canada and Puerto Rico (our "monopolistic jurisdictions"), we pay workers' compensation insurance premiums and obtain full coverage under government- -------------------------------------------------------------------------------- Page - 31 -------------------------------------------------------------------------------- Table of Contents -------------------------------------------------------------------------------- administered programs (with the exception of our Labor Ready service line in the state of Ohio where we have a self-insured policy). Accordingly, because we are not the primary obligor, our financial statements do not reflect the liability for workers' compensation claims in these monopolistic jurisdictions. Workers' compensation collateral Our insurance carriers and certain state workers' compensation programs require us to collateralize a portion of our workers' compensation obligation, for which they become responsible should we become insolvent. The collateral typically takes the form of cash and cash-backed instruments, highly rated investment grade securities, letters of credit, and/or surety bonds. On a regular basis, these entities assess the amount of collateral they will require from us relative to our workers' compensation obligation. Such amounts can increase or decrease independent of our assessments and reserves. We generally anticipate that our collateral commitments will continue to grow as we grow our business. We pay our premiums and deposit our collateral in installments. The majority of the restricted cash and investments collateralizing our self-insured workers' compensation policies are held in the Trust. Our total collateral commitments were made up of the following components (in thousands): September 26, 2014 December 27, 2013 Cash collateral held by insurance carriers $ 22,643 $ 23,747 Cash and cash equivalents held in Trust (1) 25,806 31,474 Investments held in Trust 92,699 86,678 Letters of credit (2) 22,573 7,867 Surety bonds (3) 15,742 16,099 Total collateral commitments $ 179,463 $ 165,865 (1) Included in this amount is $0.9 million and $0.8 million of accrued interest at September 26, 2014 and December 27, 2013. (2) We have agreements with certain financial institutions to issue letters of credit as collateral. We had $1.9 million of restricted cash collateralizing our letters of credit as of September 26, 2014 and December 27, 2013. (3) Our surety bonds are issued by independent insurance companies on our behalf and bear annual fees based on a percentage of the bond, which is determined by each independent surety carrier. These fees do not exceed 2.0% of the bond amount, subject to a minimum charge. The terms of these bonds are subject to review and renewal every one to four years and most bonds can be canceled by the sureties with as little as 60 days' notice. Workers' compensation reserve The following table provides a reconciliation of our collateral commitments to our workers' compensation reserve as of the period end dates presented (in thousands): September 26, 2014 December 27, 2013 Total workers' compensation reserve $ 233,943 $ 214,829 Add back discount on workers' compensation reserve (1) 18,073 19,624 Less excess claims reserve (2) (34,613 ) (34,100 ) Reimbursable payments to insurance provider (3) 9,047 9,500 Less portion of workers' compensation not requiring collateral (4) (46,987 ) (43,988 ) Total collateral commitments $ 179,463 $ 165,865 (1) Our workers' compensation reserves are discounted to their estimated net present value while our collateral commitments are based on the gross, undiscounted reserve. (2) Excess claims reserve includes the estimated obligation for claims above our deductible limits. These are the responsibility of the insurance carriers against which there are no collateral requirements. (3) This amount is included in restricted cash and represents a timing difference between claim payments made by our insurance carrier and the reimbursement from cash held in the Trust. When claims are paid by our carrier, the amount is removed from the workers' compensation reserve but not removed from collateral until reimbursed to the carrier. (4) Represents deductible and self-insured reserves where collateral is not required. Our workers' compensation reserve is established using estimates of the future cost of claims and related expenses, which are discounted to their estimated net present value. The discounted workers' compensation claims reserve was $233.9 million at September 26, 2014. -------------------------------------------------------------------------------- Page - 32 -------------------------------------------------------------------------------- Table of Contents -------------------------------------------------------------------------------- Our workers' compensation reserve for deductible and self-insured claims is established using estimates of the future cost of claims and related expenses that have been reported but not settled, as well as those that have been incurred but not reported. Reserves are estimated for claims incurred in the current year, as well as claims incurred during prior years. Management evaluates the adequacy of the workers' compensation reserves in conjunction with an independent quarterly actuarial assessment. Factors considered in establishing and adjusting these reserves include, among other things: • Changes in medical and time loss ("indemnity") costs; • Mix changes between medical only and indemnity claims; • Regulatory and legislative developments impacting benefits and settlement requirements; • Type and location of work performed; • The impact of safety initiatives; and • Positive or adverse development of claims. Our workers' compensation claims reserves are discounted to their estimated net present value using discount rates based on returns of "risk-free" U.S. Treasury instruments with maturities comparable to the weighted average lives of our workers' compensation claims. At September 26, 2014, the weighted average rate was 1.8%. The claim payments are made over an estimated weighted average period of approximately 4.5 years. Our workers' compensation reserves include estimated expenses related to claims above our deductible limits ("excess claims"), and a corresponding receivable for the insurance coverage on excess claims based on the contractual policy agreements we have with insurance carriers. We discount this reserve and corresponding receivable to its estimated net present value using the discount rates based on average returns of "risk-free" U.S. Treasury instruments available during the year in which the liability was incurred. At September 26, 2014, the weighted average rate was 3.8%. The claim payments are made and the corresponding reimbursements from our insurance carriers are received over an estimated weighted average period of approximately 15.5 years. The discounted workers' compensation reserve for excess claims and the corresponding receivable for the insurance on excess claims were $34.6 million and $34.1 million as of September 26, 2014 and December 27, 2013, respectively. Certain workers' compensation insurance companies with which we formerly did business are in liquidation and have failed to pay a number of excess claims to date. We have recorded a valuation allowance against all of the insurance receivables from the insurance companies in liquidation. CONTRACTUAL OBLIGATIONS AND COMMITMENTS There have been no material changes during the period covered by this quarterly report, except for our Second Amended and Restated Credit Agreement entered into in conjunction with our acquisition of Seaton discussed in detail at Note 10: Debt, to our Consolidated Financial Statements found in Item 1 of Part I of this Quarterly Report on Form 10-Q, outside of the ordinary course of our business, to the contractual obligations specified in the table of contractual obligations included in the section "Management's Discussion and Analysis of Financial Condition and Results of Operations" included in our Annual Report on Form 10-K for the fiscal year ended December 27, 2013. SUMMARY OF CRITICAL ACCOUNTING ESTIMATES Our critical accounting estimates are discussed in "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations; Summary of Critical Accounting Estimates" in our Annual Report on Form 10-K for the fiscal year ended December 27, 2013. NEW ACCOUNTING STANDARDS See Note 1: Accounting Principles and Practices, to our Consolidated Financial Statements found in Item 1 of Part I of this Quarterly Report on Form 10-Q. -------------------------------------------------------------------------------- Page - 33 -------------------------------------------------------------------------------- Table of Contents -------------------------------------------------------------------------------- |