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TEAMSTAFF INC - 10-K - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS(Edgar Glimpses Via Acquire Media NewsEdge) Forward Looking and Cautionary Statements This Annual Report on Form 10-K contains "forward-looking statements" within the meaning of the 1995 Reform Act, Section 27A of the Securities Act and Section 21E of the Exchange Act. TeamStaff desires to avail itself of certain "safe harbor" provisions of the 1995 Reform Act and is therefore including this special note to enable TeamStaff to do so. Forward-looking statements are identified by words such as "believe," "anticipate," "expect," "intend," "plan," "will," "may" and other similar expressions. In addition, any statements that refer to expectations, projections or other characterizations of future events or circumstances are forward-looking statements. Forward-looking statements included in this report involve known and unknown risks, uncertainties and other factors which could cause TeamStaff's actual results, performance (financial or operating) or achievements to differ from the future results, performance (financial or operating) or achievements expressed or implied by such forward-looking statements. We based these forward-looking statements on our current expectations and best estimates and projections about future events. Our actual results could differ materially from those discussed in, or implied by, these forward-looking statements. The following factors (among others) could cause our actual results to differ materially from those implied by the forward-looking statements in this Annual Report on Form 10-K: our ability to secure contract awards, including the ability to secure renewals of contracts under which we currently provide services; our ability to enter into contracts with United States Government facilities and agencies on terms attractive to us and to secure orders related to those contracts; changes in the timing of orders for and our placement of professionals and administrative staff; the overall level of demand for the services we provide; the variation in pricing of the contracts under which we place professionals; our ability to manage growth effectively; the performance of our management information and communication systems; the effect of existing or future government legislation and regulation; changes in government 29 -------------------------------------------------------------------------------- Table of Contents and customer priorities and requirements (including changes to respond to the priorities of Congress and the Administration, budgetary constraints, and cost-cutting initiatives); economic, business and political conditions domestically; the impact of medical malpractice and other claims asserted against us; the disruption or adverse impact to our business as a result of a terrorist attack; the loss of key officers, and management personnel; the competitive environment for our services; the effect of recognition by us of an impairment to goodwill; other tax and regulatory issues and developments; the effect of adjustments by us to accruals for self-insured retentions; our ability to obtain any needed financing; our ability to attract and retain sales and operational personnel; and the effect of other events and important factors disclosed previously and from time-to-time in TeamStaff's filings with the U.S. Securities Exchange Commission. For a discussion of such risks and uncertainties which could cause actual results to differ from those contained in the forward-looking statements, see "Risk Factors" in the company's periodic reports filed with the SEC. In light of the significant risks and uncertainties inherent in the forward-looking statements included herein, the inclusion of such statements should not be regarded as a representation by the company or any other person that the objectives and plans of the Company will be achieved. The forward-looking statements contained in this report in Form 10-K are made as of the date hereof and may become outdated over time. The Company does not assume any responsibility for updating any forward-looking statements. Critical Accounting Policies and Estimates TeamStaff believes the accounting policies below represent its critical accounting policies due to the significance or estimation process involved in each. See Note 2 of TeamStaff's 2011 Consolidated Financial Statements contained in this Annual Report on Form 10-K as well as "Critical Accounting Policies" contained therein for a detailed discussion on the application of these and other accounting policies. Our discussion and analysis of our financial condition and results of operations is based upon our Consolidated Financial Statements, which have been prepared in accordance with accounting principles generally accepted in the United States and the rules of the SEC. The preparation of our Consolidated Financial Statements and related notes in accordance with generally accepted accounting principles requires us to make estimates, which include judgments and assumptions that affect the reported amounts of assets, liabilities, revenue, and expenses, and related disclosure of contingent assets and liabilities. We have based our estimates on historical experience and on various assumptions that we believe to be reasonable under the circumstances. We evaluate our estimates on a regular basis and make changes accordingly. Actual results may differ from these estimates under different assumptions or conditions. To the extent that there are material differences between these estimates and actual results, our financial condition, results of operations and cash flow will be affected. A critical accounting estimate is based on judgments and assumptions about matters that are uncertain at the time the estimate is made. Different estimates that reasonably could have been used or changes in accounting estimates could materially impact our financial statements. We believe that the policies described below represent our critical accounting policies, as they have the greatest potential impact on our Consolidated Financial Statements. However, you should also review our Summary of Significant Accounting Policies beginning on page F-9 of the notes to our Consolidated Financial Statements contained elsewhere in this Annual Report on Form 10-K. Revenue Recognition TeamStaff's revenue is derived from professional, technical and other specialized service offerings to US Government agencies through a variety of contracts, some of which are fixed-price in nature and/or may be sourced through Federal Supply Schedules administered by the General Services Administration ("GSA") and the DVA at fixed unit rates or hourly arrangements. We generally operate as a prime contractor, but have also entered into fixed price or fixed unit price contracts as a 30 -------------------------------------------------------------------------------- Table of Contents subcontractor. The recognition of revenue from fixed rates is based upon objective criteria that generally do not require significant estimates that may change over time. Other types of US Government contracts may include fixed price or flexibly priced contracts requiring estimates based on percentage-of-completion methods of recognizing revenue and profit. These contracting vehicles do not, at this time, represent a significant portion of our revenue nor require estimating techniques that would materially impact our revenue reported herein. TeamStaff recognizes and records revenue on DVA contracts when it is realized, or realizable, and earned. TeamStaff considers these requirements met when: (a) persuasive evidence of an arrangement exists; (b) services have been delivered to the customer; (c) the sales price is fixed or determinable and free of contingencies or significant uncertainties; and (d) collectability is reasonably assured. Revenues related to retroactive billings in 2008 (see Note 9 to the Consolidated Financial Statements) from an agency of the Federal government were recognized when: (1) the Company developed and calculated an amount for such prior period services and has a contractual right to bill for such amounts under its arrangements, (2) there were no remaining unfulfilled conditions for approval of such billings and (3) collectability is reasonably assured based on historical practices with the DVA. The related direct costs, principally comprised of salaries and benefits, are recognized to match the recognized reimbursements from the Federal agency; upon approval, wages will be processed for payment to the employees. During the year ended September 30, 2008, TeamStaff recognized revenues of $10.8 million and direct costs of $10.1 million related to these non-recurring arrangements. At September 30, 2011 and 2010, the amount of the remaining accounts receivable with the DVA approximates $9.3 million and accrued liabilities for salaries to employees and related benefits totaled $8.7 million. The $9.3 million in accounts receivable was unbilled to the DVA at September 30, 2011. The Company has been and continues to be in discussions with representatives of the DVA regarding the matter and anticipates resolution during fiscal 2012. At present, the Company expects to collect such amounts during the first half of fiscal 2012. Goodwill In accordance with applicable accounting standards, TeamStaff does not amortize goodwill. TeamStaff continues to review its goodwill for possible impairment or loss of value at least annually or more frequently upon the occurrence of an event or when circumstances indicate that a reporting unit's carrying amount is greater than its implied fair value. At September 30, 2011, we performed a goodwill impairment analysis. For the purposes of this analysis, our estimates of fair value are based on the income approach, which estimates the fair value of the DLH Solutions unit based on the future discounted cash flows. Based on the results of the work performed by an outside independent firm, the Company has concluded that no impairment loss on goodwill was warranted at September 30, 2011. Major assumptions in the valuation study were the estimates of probability weighted future cash flows, the estimated terminal value of the company and the discount factor applied to the estimated future cash flows and terminal value. Estimates of future cash flows were developed by management having regard to current expectations and potential future opportunities. A terminal value for the forecast period was estimated based upon data of public companies that management believes to be similar with respect to the Company's economics and markets. The discount factor used was a cost of capital estimate obtained from a leading third party data provider. The resulting estimated fair value of goodwill exceeded the carrying value at September 30, 2011 by more than 100%, resulting in no impairment charge being taken against goodwill. However, a non-renewal of a major contract (see Note 2-Liquidity and Note 13) or other substantial changes in the assumptions used in the valuation study could have a material adverse effect on the valuation of goodwill in future periods and the resulting charge could be material to future periods' results of operations. 31 -------------------------------------------------------------------------------- Table of Contents If an impairment write off of all the goodwill became necessary, a charge of up to $8.6 million would be expensed in the Consolidated Statement of Operations. All remaining goodwill is attributable to the DLH Solutions reporting unit. TeamStaff has concluded, at present, that there is not any required impairment write off of goodwill. Intangible Assets As required by applicable accounting standards, TeamStaff did not amortize its tradenames, an indefinite life intangible asset. TeamStaff continued to review its indefinite life intangible assets for possible impairment or loss of value at least annually or more frequently upon the occurrence of an event or when circumstances indicate that an asset's carrying amount is greater than its fair value. On September 15, 2011, the Board of Directors of TeamStaff approved the change of the corporate name of TeamStaff GS to DLH Solutions and also approved a plan to change the corporate name of the Company to DLH Holdings Corp. In connection with these actions, the Company will cease further use of the TeamStaff trademark and implement new marketing and branding initiatives associated with the new corporate identity being adopted by the Company. As a result of the corporate name change and associated rebranding efforts being implemented by the Company and its principal operating subsidiary, the Company concluded that it is required to record a non-cash impairment charge with respect to the value of the "TeamStaff" trademark of $2.6 million as a result of abandoning the use of the TeamStaff name to fully write-off the value of this trademark. Prepaid Workers Compensation As part of the Company's discontinued PEO operations, TeamStaff had a workers' compensation program with Zurich American Insurance Company ("Zurich") which covered the period from March 22, 2002 through November 16, 2003, inclusive. Payments for the policy were made to a trust monthly based on projected claims for the policy period. Interest on all assets held in the trust is credited to TeamStaff. Payments for claims and claims expenses are made from the trust. From time-to-time, trust assets have been refunded to the Company based on Zurich's and managers' overall assessment of claims experience and historical and projected settlements. The final amount of trust funds that could be refunded to the Company is subject to a number of uncertainties (e.g. claim settlements and experience, health care costs, the extended statutory filing periods for such claims); however, based on a third party's study of claims experience, TeamStaff estimates that at September 30, 2011, the remaining prepaid asset of $0.3 million will be received within the next twelve to thirty six months. The amount is reflected on TeamStaff's balance sheet as of September 30, 2011 as a current asset, in addition to approximately $0.2 million related to other policy deposits. Workers' Compensation Insurance From November 17, 2003 through April 14, 2009, inclusive, TeamStaff's workers' compensation insurance program was provided by Zurich. This program covered TeamStaff's temporary, contract and corporate employees. This program was a fully insured, guaranteed cost program that contained no deductible or retention feature. The premium for the program was paid monthly based upon actual payroll and was subject to a policy year-end audit. Effective April 15, 2009, TeamStaff entered into a partially self-funded workers' compensation insurance program with a national insurance carrier for the premium year April 15, 2009 through April 14, 2010 which has been renewed through April 14, 2012. The Company pays a base premium plus actual losses incurred, not to exceed certain stop-loss limits. The Company is insured for losses above these limits, both per occurrence and in the aggregate. As of September 30, 2011 and 2010 the adequacy of the workers' compensation reserves (including those periods' amounts that are offset against the trust fund balances in prepaid assets) was determined, in management's opinion, to be reasonable. In determining our reserves we rely in part upon information regarding loss data received from our workers' compensation insurance carriers that 32 -------------------------------------------------------------------------------- Table of Contents may include loss data for claims incurred during prior policy periods. In addition, these reserves are for claims that have not been sufficiently developed and such variables as timing of payments and investment returns thereon are uncertain or unknown, therefore actual results may vary from current estimates. TeamStaff will continue to monitor the development of these reserves, the actual payments made against the claims incurred, the timing of these payments, the interest accumulated in TeamStaff's prepayments and adjust the related reserves as deemed appropriate. Fair Value TeamStaff has financial instruments, principally accounts receivable, accounts payable, loan payable, notes payable and accrued expenses. TeamStaff estimates that the fair value of these financial instruments at September 30, 2011 and 2010 does not differ materially from the aggregate carrying values of these financial instruments recorded in the accompanying consolidated balance sheets. However, because the Company presents certain common stock warrants and embedded conversion features (associated with Convertible Debentures) and accounts for such derivative financial instruments at fair value, such derivatives are materially impacted by the market value of the Company's stock and therefore subject to a high degree of volatility. The Company's future results may be materially impacted by changes in the Company's closing stock price as of the date it prepares future periodic financial statements. Income Taxes TeamStaff accounts for income taxes in accordance with the "liability" method. Under this method, deferred tax assets and liabilities are determined based on the difference between the financial statement and tax bases of assets and liabilities, using enacted tax rates in effect for the year in which the differences are expected to reverse. Deferred tax assets are reflected on the balance sheet when it is determined that it is more likely than not that the asset will be realized. This guidance also requires that deferred tax assets be reduced by a valuation allowance if it is more likely than not that some or all of the deferred tax asset will not be realized. After an assessment of all available evidence (including historical and forecasted operating results), management has concluded that realization of the Company's net operating loss carryforwards (which included those amounts acquired in previous years' business combinations, collectively "NOLs"), tax credits and other deferred tax assets, could not be considered more likely than not. Accordingly, for the fiscal years ended September 30, 2011 and 2010, the Company did not record a tax benefit for NOLs and other deferred tax assets. Based on similar assessments, the Company increased the valuation allowance established on deferred tax assets by approximately $1.0 million and $1.2 million in 2011 and 2010, respectively. The increase in the valuation allowance is primarily due to Federal and state NOLs and stock based compensation for the fiscal year ended September 30, 2011. The increase in the valuation allowance for the fiscal ended September 30, 2010 was principally due to Federal and state NOLs. In prospective periods, there may be reductions to the valuation allowance to the extent that the Company concludes that it is more likely than not that all or a portion of the deferred tax assets can be utilized (subject to annual limitations and prior to the expiration of such NOLs), to offset future periods' taxable income. In the fiscal years ended September 30, 2011 and 2010, the Company recorded no tax expense or benefit. At September 30, 2011 the Company had net operating losses of approximately $38.2 million and $26.2 million for U.S. and state tax return purposes, respectively, and unutilized tax credits of approximately $1.1 million. As a result of previous business combinations and changes in its ownership, there is a substantial amount of. NOLs that are subject to annual limitations on utilization. The U.S. NOLs begin to expire in 2021 and continue to expire through 2031. 33 -------------------------------------------------------------------------------- Table of Contents The Company's tax returns for the years ended September 30, 2008, 2009 and 2010 are open, by statute, for audit by the Federal government and various states. However, there are no examinations currently in progress and the Company is not aware of any pending audits. Allowance for Doubtful Accounts The Company does not, at present, maintain an allowance for doubtful accounts for estimated losses resulting from the inability of its customers to pay. However, if the financial condition of TeamStaff's customers were to deteriorate rapidly, resulting in nonpayment, TeamStaff's accounts receivable balances could grow and TeamStaff could be required to provide for additional allowances, which would decrease operating results in the period that such determination was made. For example, TeamStaff currently maintains no allowance on billed accounts receivable due to the fact that a significant portion of accounts receivable are from the Federal Government which historically have had little, if any, write-offs for non-payment. Overview Business Description TeamStaff Inc., incorporated in New Jersey, is a full-service provider of healthcare delivery solutions, logistics & technical services, and contingency/staff augmentation services to government agencies including the Department of Veteran Affairs, the Department of Defense, and other clients. The Company principally operates through its wholly-owned subsidiary DLH Solutions, Inc. ("DLH Solutions"). Business Lines of Service As a product of the strategic planning process of 2010, the Company realigned into three principle lines of service to leverage its core competencies toward profitable growth within its revised strategically targeted markets. We anticipate that from time-to-time that we may grow faster in particular lines of business, acquire or dispose of business areas or contracts among and within future subsidiaries or entities. Internal realignments will intend to more fully leverage existing competencies and enhance our delivery of quality products and services. Healthcare Delivery Solutions Through our Healthcare Delivery Solutions line of service, the Company provides a broad continuum of care for our nation's servicemen/women and veterans in various settings and facilities. These include Combat Trauma Centers (CTCs), Military Treatment Facilities (MTFs), Medical Centers, Community-based Outpatient Clinics (CBOCs), Pharmacy Distribution Centers (including VA Consolidated Mail-order Outpatient Pharmacy), and an Armed Forces Retirement Facility. We leverage our network of over 400 active clinicians and other healthcare workers throughout selected regions in the US along with differentiating tools, databases and technology (including e-PRAT and SPOT-m) to deliver these services. For over a decade, DLH Solutions has been serving the DVA and DoD by providing qualified medical and other professionals in a variety of positions. Healthcare services continues to be a strategic focus area and a major component of DLH Solutions' business. As more and more Federal and DoD programs call for performance-based requirements, in addition to the mere provision of people, DLH Solutions' workforce profile of medical talent and credentials (as described above) will help it to compete and differentiate itself in the market place. Our rich new business pipeline of healthcare and medical service opportunities add important credentials strategically linked to diversifying and profitably growing our Healthcare Delivery Solutions business base. Professional services have included case management, health and injury assessment, critical care, medical/surgical, emergency room/trauma center, counseling, behavioral health and trauma brain injury, medical systems 34 -------------------------------------------------------------------------------- Table of Contents analysis, and medical logistics. Allied support includes a wide range including MRI technology, diagnostic sonography, phlebotomy, dosimetry, physical therapy, pharmaceuticals and others. In fiscal 2011, approximately 45% of our revenue was derived from the Healthcare Delivery Solutions line of service. Logistics & Technical Services The Logistics & Technical Services line of service draws heavily upon DLH Solutions' proven logistics expertise and processes in areas involving supply chain management, performance-based logistics, distribution center and inventory management, statistical process control, packaging/handling/storage & transportation, and supply support operations. In addition, it embodies program and project management, systems engineering and applicable information technology services, integrated logistics support (including operational systems), readiness assessments, training, equipment and non-tactical vehicle operations and maintenance, hazardous material management, facilities and shipyard support services and more. DLH Solutions also provides logistics and administrative professionals to the federal government specializing in logistics, office administration, IT, and facilities/warehouse management. DLH Solutions' project managers range from career government support employees to retired military veterans with extensive experience. The experience of DLH Solutions' project managers is diverse from operational unit level to systems command/headquarters program office experience. Logistics and technical services remain a core competency and a strategic focus area for DLH Solutions. Through competitively awarded contracts and task orders (including its LOGWORLD contract) DLH Solutions has developed a strong portfolio of logistics processes, personnel and tools to help its clients achieve nationally recognized awards for customer satisfaction. While the DVA is its largest customer in this area, the Company has taken steps to expand in adjacent logistics markets within DoD and other federal agencies. In fiscal 2011, over 50% of our revenue was derived from the Logistics & Technical Services line of service. Contingency/Staff Augmentation The Contingency/Staff Augmentation line of service combines the ability to provide disaster and emergency response services with our legacy staffing and civilian workforce augmentation services. For example, the Company's outstanding track record of response during hurricanes Rita and Katrina demonstrated its ability to support major federal and DoD opportunities in this area. General staffing and selective recruitment process outsourcing are key components of this service area. Less than 5% of fiscal 2011 revenue was derived from the Contingency/Staff Augmentation line of service. Management believes that streamlining the Company's strategic focus around these three lines of services better aligns its resourcing and investments decisions around a cohesive set of business objectives. Equally important in this evolution is the decision to exit previous market focus areas with high barriers to entry and traditionally low margins for the Company. Recent Business Trends TeamStaff developed and started implementation of a long range strategic plan during its 2010 fiscal year. The plan builds upon the core competencies of DLH Solutions in the areas of: (1) Healthcare Delivery Solutions, (2) Logistics and Technical Services, and (3) Contingency & Staff Augmentation Services. The Company has a long history of providing these services to federal clients such as the Department of Veteran Affairs ("DVA"), Department of Defense ("DoD") as well as agencies such as the United States Department of Agriculture ("USDA") and Department of Interior ("DOI"). In the first quarter of fiscal 2011 the Company completed transition of its executive management team, with the addition of John Armstrong, Executive Vice President of Corporate Development, to better align with its government services focus. 35 -------------------------------------------------------------------------------- Table of Contents The DVA continues to be our largest customer followed by the DoD. Prior to the second quarter of fiscal 2011, over 90% of the Company's marketing, sales and discretionary resources were directed toward the commercial nursing and temporary staffing business while DLH Solutions did not bid on large government services contracts to complement its work with DVA and increase its backlog. As such its business base over the recent 5 years remained relatively flat when adjusted for DVA business anomalies (such as overtime policy changes, preparation for anticipated epidemic, government in-sourcing, etc.). The strategic plan first addressed creating the financial stability and runway to support implementation of new infrastructure and business development requirements. As such, significant cost reduction and containment initiatives were put into action in the first two quarters of fiscal 2011. Subsequently, a capital raise initiative was put into place leveraging relationships with our largest shareholder, our new banking partner, and directors and management. Concurrently, management addressed the lack of new and sustainable business by focusing resources on core competencies, existing and adjacent markets, larger and longer-term contracts, and development of differentiators to enhance competitiveness. Major changes in both resources and new business pipeline were implemented to align with the strategy of establishing sustainable, profitable growth while diversifying its portfolio and creating substantial backlog. Management believes that its new strategy has seen early success. As the Company enters fiscal 2012, contract backlog has increased from approximately $11 million at September 30, 2010 to approximately $160 million at September 30, 2011. During fiscal 2011, the Company competed and won 100% of its major healthcare re-compete programs. In addition, new business contracts with an estimated value of $10 million annually were obtained. Due to government delays, the new business revenue will not be recognized until fiscal 2012. Supporting the strategic portfolio diversification, the Company was awarded two large IDIQ contracts covering a range of logistics and technical services during the year; one with the US Army and the other with the US Navy. In keeping with its transformation, the Company has established several new teaming and partnership arrangements with strategic companies complementing our core competencies. Though our nation's economy continues to create headwinds for all markets, management has found that many government services industry analysts project a favorable market outlook particularly in select segments. The Company's strategic decision to build upon its healthcare delivery solutions competencies and business aligns its growth prospects with some of the stronger budget areas on both Capitol Hill and within the Pentagon. Based on current research and market analysis, management believes that the federal government's healthcare budget including the Military Healthcare Systems and veterans' healthcare remain a top priority. For example the DVA discretionary budget for fiscal 2012 is projected to increase 10.6% over that awarded in fiscal 2010 and the drawdown of American service personnel in the gulf theater will lead to a growing veteran population. Further, there has been an increase in mergers and acquisition activity within the government services space due to an interest on the part of acquirers to reposition capability and customer portfolios in areas such as military and veteran healthcare where future growth in anticipated. Management also believes that the most significant of the federal government's in-sourcing efforts occurred in 2009-2010, this is further solidified by then Secretary of Defense Gates stating that governmental in-sourcing did not produce the anticipated savings. Additionally Secretary of the Army John McHugh officially called for an end to in-sourcing in early 2011. Further, management has found that many analysts continue to view the federal services market as an attractive growth area and that strategically-focused and niche firms that can offer a differentiated product or service much like TeamStaff has demonstrated will be considered higher value companies. Although we cannot provide any assurances of our growth or profitability, based on these factors, management believes that TeamStaff's new strategic direction to leverage and invest in its government services strengths within its market sector offers the potential for significantly enhanced shareholder value in the foreseeable future. 36 -------------------------------------------------------------------------------- Table of Contents Results of Operations Fiscal Year 2011 as Compared to Fiscal Year 2010 The following table summarizes, for the periods indicated, selected consolidated statements of operations data expressed as a percentage of revenue: Fiscal Year Ended September 2011 September 2010 Condensed Consolidated Statement of Operations: Revenues 100.0 % 100.0 % Direct Expenses 85.9 % 88.2 % Gross Profit 14.1 % 11.8 % Selling, general and administrative 17.7 % 18.8 % Impairment charge-intangible assets 6.2 % 3.3 % Depreciation and amortization expense 0.3 % 0.3 % Loss from operations (10.1 )% (10.6 )% Other income (expense) (0.9 )% (0.6 )% Loss from continuing operations before tax (11.0 )% (11.2 )% Income tax expense 0.0 % 0.0 % Loss from continuing operations (11.0 )% (11.2 )% Gain (loss) from discontinued operation 0.6 % (3.0 )% Net loss (10.4 )% (14.2 )% Revenues Revenues from TeamStaff's continuing operations for the fiscal years ended September 30, 2011 and 2010 were $41.9 million and $40.9 million, respectively, which represents an increase of $1 million or 2.6% over the prior fiscal year despite extended government delays in major awards. The increase in operating revenues is due primarily to new business awards and increased business on existing contracts. DLH Solutions is currently seeking approval from the Federal government for gross profit on retroactive billing rate increases associated with certain government contracts covered by the Service Contract Act. These adjustments are due to changes in the contracted wage determination rates for employees. A wage determination is the listing of wage rates and fringe benefit rates for each classification of laborers whom the Administrator of the Wage and Hour Division of the U.S. Department of Labor ("DOL") has determined to be prevailing in a given locality. Contractors performing services for the Federal government under certain contracts are required to pay service employees in various classes no less than the wage rates and fringe benefits found prevailing in these localities. An audit by the DOL in 2008 at one of the facilities revealed that notification, as required by contract, was not provided to DLH Solutions in order to effectuate the wage increases in a timely manner. Wages for contract employees on assignment at the time have been adjusted prospectively to the prevailing rate and hourly billing rates to the DVA have been increased accordingly. During the fiscal year ended September 30, 2008, TeamStaff recognized nonrecurring revenues of $10.8 million and direct costs of $10.1 million, based on amounts that are contractually due under its arrangements with the Federal agencies. At September 30, 2011 and 2010, the amount of the remaining accounts receivable with the DVA approximates $9.3 million. The Company has been and continues to be in discussions with representatives of the DVA and the DOL regarding the matter and currently anticipates resolution during the first half of fiscal 2012. The Company is currently in the process of negotiating a final amount related to indirect costs and fees applied to these amounts. As such, there may be additional revenues recognized in future periods once the approval for such additional amounts is obtained. The ranges of additional indirect costs and fees are estimated to be between $0.4 million 37 -------------------------------------------------------------------------------- Table of Contents and $0.6 million. At present, the Company expects to collect such amounts during the first half of fiscal 2012 based on current discussions and collection efforts. Because these amounts are subject to government review, no assurances can be given that we will receive any additional amounts from our government contracts or that if additional amounts are received, that the amount will be within the range specified above. Direct Expenses Direct expenses are generally comprised of direct labor (including benefits), direct material, subcontracts, other direct costs, and overhead. Direct expenses from continuing operations for the fiscal years ended September 30, 2011 and 2010 were $36.0 million and $36.1 million, respectively, which represent a decrease for fiscal 2011 of $0.1 million or 0.1% over the prior fiscal year. This decrease is primarily a result of improved workplace safety measures resulting in lower expenses for workers' compensation insurance offset by increased direct labor expenses. As a percentage of revenue from continuing operations, direct expenses were 85.9% and 88.2%, respectively, for the years ended September 30, 2011 and 2010 driven primarily by lower workers' compensation expenses. Gross Profit Gross profit for the fiscal years ended September 30, 2011 and 2010 was $5.9 million and $4.8 million, respectively, which represents an increase of $1.1 million or 22.7% over the prior fiscal year despite the modest revenue increase. Gross profit from continuing operations, as a percentage of revenue, was 14.1% and 11.8%, for the fiscal years ended September 30, 2011 and 2010, respectively. The key driver for the period over period increase in gross profit (as a percentage of revenue) was improved project management on major contracts. Selling, General and Administrative Expenses Selling, general and administrative ("SG&A") primarily relates to functions such as corporate management, legal, finance, accounting, contracts, administration, human resources, management information systems, and business development. Also contributing may be severance charges. SG&A expenses for the fiscal years ended September 30, 2011 and 2010 were $7.4 million and $7.7 million, respectively, which represent a decrease of $0.3 million, or 3.4%. Major cost reduction initiatives driven by the Long Range Strategic Plan and management policies were responsible for the decrease including elimination of duplicate and non-strategic positions, termination of non-strategic administrative subscriptions and licenses, indirect travel restrictions, temporary work furlough, and more. These savings were partially offset by increases in strategic business development expenditures and approximately $0.6 million in strategic legal fees mostly in support of our DVA client with respect to confirmation of our new CMOP contract award. This reflects the Company having continued to successfully seek elimination of overhead costs deemed to be non-essential to growth or infrastructure in order to permit reinvestment in areas considered important to support the strategic direction of the company. The Company has also continued its cost savings and reallocation initiatives, which have resulted in refocused headcount in non-revenue generating departments and within SG&A costs, with significantly increased emphasis on building a strong and sustainable pipeline of new business opportunities. Impairment Charge-Intangible Assets Impairment charges-intangible assets was $2.6 million for the fiscal year ended September 30, 2011 and $1.3 million for the prior year. As a result of its rebranding initiative, the Company wrote off the carrying value of the tradename related to TeamStaff of $2.6 million. Fiscal year 2010 included an intangible asset write down of $1.3 million related to the carrying value of the trademark names "RS Staffing" and "TeamStaff," based on an intangible asset impairment analysis. 38 -------------------------------------------------------------------------------- Table of Contents Depreciation and Amortization Depreciation and amortization expense on tangible assets was approximately $0.1 million for both of the fiscal years ended September 30, 2011 and 2010. Loss from Operations Loss from operations for the fiscal year ended September 30, 2011 was $4.2 million as compared to loss from operations for the fiscal year ended September 30, 2010 of $4.3 million. This represents an improvement of $0.1 million in results from operations from fiscal 2011 to 2010. The improvement is due primarily to increased operating gross profit and reduction of SG&A expenses in fiscal 2011 offset by the aforementioned impairment charge. Other Expense Other expense was $0.4 million and $0.3 million, for the fiscal years ended September 30, 2011 and 2010, respectively. Interest expense for the fiscal years ended September 30, 2011 and 2010 was approximately $0.3 million and $0.2 million respectively. Interest expense increased by approximately $0.1 million on increased utilization of the credit facility, offset by a net favorable decrease in fair value ascribed to the derivative financial instruments associated with our warrants and convertible debentures.The Company provided a 100% deferred tax valuation allowance because it believes that it cannot be considered more likely than not that it will be able to realize the full benefit of the deferred tax asset. The Company determined that negative evidence, including historic and current taxable losses, as well as uncertainties related to the ability to utilize certain Federal and state net loss carry forwards, outweighed any objectively verifiable positive factors, and as such, concluded that a valuation allowance was necessary. In assessing the need for a valuation allowance, the Company historically has considered all positive and negative evidence, including scheduled reversals of deferred tax liabilities, prudent and feasible tax planning strategies and recent financial performance. In the fiscal years ended September 30, 2011 and 2010, the Company recognized no tax expense. Loss from Continuing Operations Loss from continuing operations for the fiscal year ended September 30, 2011 was $4.6 million, or $0.84 per basic and per diluted share, as compared to loss from continuing operations of $4.6 million, or $0.91 per basic and diluted share, for the fiscal year ended September 30, 2010. Discontinued Operation A non-recurring gain from discontinued operation for the year ended September 30, 2011 was recognized of $270,000 or $0.05 per basic and diluted share. During the year ended September 30, 2011 the State of Florida determined that approximately $270,000 of escheated funds it was holding was the property of the Company and ordered that such funds be paid to the Company. The Company's right to the funds arose in connection with the Company's former PEO operations that were accounted for as a discontinued operation in fiscal 2003 and, accordingly, the Company has recognized the amounts as income from discontinued operations in the current period after concluding that the amount involved was not material to the results of operations in the year of discontinuance. A non-recurring loss of 1.2 million or ($0.24) per basic and diluted share arose in the year ended September 30, 2010 related to the operations and disposal of the TeamStaff Rx business. Net Loss Net loss for the fiscal year ended September 30, 2011 was $4.3 million, or ($0.79) per basic and diluted share, as compared to net loss of $5.8 million, or ($1.15) per basic and diluted share, for the fiscal year ended September 30, 2010. This represents a 26% ($1.5 million) net loss improvement despite taking over $3.0 million in strategic write-downs and expenses. 39 -------------------------------------------------------------------------------- Table of Contents Other Data Earnings Before Interest Tax Depreciation and Amortization ("EBITDA"(1)) for the year ended September 30, 2011 was $(1.5) million as compared to $(2.9) million for the twelve months ended September 30, 2010, representing an improvement of $1.4 million or 48% even after incurring strategic legal fees of $0.6 million in the year ended September 30, 2011, when none were incurred in the year ended September 30, 2010. Liquidity and Capital Resources; Commitments At September 30, 2011, the Company had a net working capital deficit of approximately $3.6 million and an accumulated deficit of approximately $65.4 million. For the year ended September 30, 2011, the Company incurred an operating loss and net loss of approximately $4.2 million and $4.3 million, respectively. The Company has a limited amount of cash and cash equivalents at September 30, 2011 and will be required to rely on operating cash flow and periodic funding, to the extent available, from its line of credit to sustain the operations of the Company unless it elects to pursue and is successful in obtaining additional debt or equity funding, as discussed below, or otherwise. -------------------------------------------------------------------------------- º (1) º We present EBITDA as a supplemental non-GAAP measure of our performance. We define EBITDA as net loss from continuing operations plus (i) interest and other expenses, net, (ii) provision for or benefit from income taxes, if any, (iii) depreciation and amortization, and (iv) impairment charges. This non-GAAP measure of our performance was used by management to conduct and evaluate its business during its regular review of operating results for the periods presented. Management and the Company's Board utilized this non-GAAP measure to make decisions about the use of the Company's resources, analyze performance between periods, develop internal projections and measure management performance. In addition, the compensation committee of the Company's Board of Directors used this non-GAAP measure when setting and assessing achievement of incentive compensation goals. We believe that this non-GAAP measure is useful to investors in evaluating the Company's ongoing operating and financial results and understanding how such results compare with the Company's historical performance. By providing this non-GAAP measure, as a supplement to GAAP information, we believe we are enhancing investors' understanding of our business and our results of operations. This non-GAAP financial measure is limited in its usefulness and should be considered in addition to, and not in lieu of, US GAAP financial measures. Further, this non-GAAP measure may be unique to the Company, as it may be different from the definition of non-GAAP measures used by other companies. A reconciliation of EBITDA with net loss from continuing operations is as follows: For the year ended 30 September 2011 2010 Net loss from continuing operations $ (4,590 ) $ (4,598 ) (i) Interest and other expenses (net) 367 261 (ii) provision for taxes - - (iii) amortization and depreciation, 113 118 (iv) impairment charges 2,583 1,341 EBITDA $ (1,527 ) $ (2,878 ) 40 -------------------------------------------------------------------------------- Table of Contents In an effort to improve the Company's cash flows and financial position, in fiscal 2011 the Company completed measures to enhance its liquidity by approximately $1,000,000 as a result of increasing the maximum availability of its credit facility and receiving funding of and/or commitments for additional equity and/or debt financing. In that regard, our largest shareholder, Wynnefield Capital, Inc., and certain of our directors and executive officers collectively provided $500,000 of additional capital to the Company. As described in Note 6, $150,000 of such capital was provided on March 31, 2011 and $350,000 of such capital was provided in July 2011 by Wynnefield Capital through the sale of convertible debentures which mature 27 months from issuance and bear interest at the rate of the greater of prime plus 5% or 10% per annum. The debentures are convertible into shares of our common stock at an initial rate of $1.30, subject to adjustment for certain customary events and in accordance with a weighted-average anti-dilution formula, subject to certain exclusions. In addition, as described in Note 6, on February 9, 2011, the Company entered into an amendment of its Loan and Security Agreement with Presidential Financial Corporation, pursuant to which they agreed to increase the maximum availability under the Loan and Security Agreement by an additional $500,000 and provide an unbilled receivable facility within the limits of the Loan and Security Agreement. Following this increase, the maximum availability under this loan facility is $3,000,000; subject to eligible accounts receivable. At September 30, 2011, the amount available was $316,000. In addition, as described in greater detail below, the parties agreed to amend certain other provisions of the Loan Agreement, including an extension of the term of the Loan Agreement for an additional year and the Lender agreed not to seek to terminate the Loan Agreement without cause until after February 29, 2012, which date has subsequently been amended to December 31, 2012. In addition, pursuant to its current credit facility, the financial institution also has the ability to terminate the Company's line of credit immediately upon the occurrence of a defined event of default, including among others, a material adverse change in the Company's circumstances or if the financial institution deems itself to be insecure in the ability of the Company to repay its obligations or, as to the sufficiency of the collateral. At present, the Company has not experienced and the financial institution has not declared an event of default. Management believes, at present, that: (a) cash and cash equivalents of approximately $0.8 million as of September 30, 2011; (b) the amounts available under its line of credit (which, in turn, is limited by a portion of the amount of eligible assets); (c) forecasted operating cash flow including timely collection of the retrospective billings; (d) the ultimate non-payment of certain liabilities and recorded guarantees currently contested by the Company or not expected to be settled in cash (see Note 6 to the accompanying consolidated financial statements) (classified as current at September 30, 2011) in fiscal 2012, or the applicable portion of 2013 and (e) effects of cost reduction programs and initiatives should be sufficient to support the Company's operations for twelve months from the date of these financial statements. However, should any of these factors not occur substantially as currently expected, there could be a material adverse effect on the Company's ability to access the level of liquidity necessary for it to sustain operations at current levels for the next twelve months. In such an event, management may be forced to make further reductions in spending or to further extend payment terms with suppliers, liquidate assets where possible, and/or to suspend or curtail planned programs. Any of these actions could materially harm the Company's business, financial position, results of operations and future prospects. Due to the foregoing there could be a future need for additional capital and the Company may pursue equity, equity-based and/or debt financing alternatives or other financing in order to raise any needed funds. If the Company raises additional funds by selling shares of common stock or convertible securities, the ownership of its existing shareholders would be diluted. 41 -------------------------------------------------------------------------------- Table of Contents Presently, the Company derives all of its revenue from agencies of the Federal government and the Company has derived a substantial portion of its revenues through various contracts awarded by the DVA. On May 5, 2011, the Company was awarded a single source Blanket Purchase Agreement with the DVA for the procurement of integrated medical support for the DVA's Consolidated Mail Outpatient Pharmacy ("CMOP") program. This award represents both retention of existing work and expansion of new business at additional DVA locations. The tasks to be performed include project management and a range of pharmaceutical services in support of performance-based pharmaceutical production management at several DVA locations. The maximum total value under this award is presently expected to be approximately $145,000,000 pursuant to site-specific task orders to be rendered by the DVA. The term of the award is for up to five years, initially expiring April 30, 2016, but which was subsequently been extended to October 31, 2016. Work under this contract began November 1, 2011. The agreement is subject to the Federal Acquisition Regulations, and there can be no assurance as to the actual amount of services that the Company will ultimately provide under the agreement. This agreement effectively provides for renewal and expansion of contracts that generated, in aggregate, approximately 45% of its revenue in the year ended September 30, 2011, in respect of which the Company previously held order cover through December 31, 2011 under existing contracts. In addition, the Company also holds contractual order cover through December 31, 2011 in respect of DVA contracts that generated close to a further 50% of its revenue in the year ended September 30, 2011, which are not currently the subject of requests for proposals and may in due course be further extended by the DVA on a sole source basis, although no assurances can be given that this will occur. Cash from operating activities Net cash used in operating activities for the year ended September 30, 2011 was $1.0 million as compared to $2.2 million for fiscal year ended September 30, 2010. The favorable decrease in the cash used from 2010 to 2011 is principally due to a reduced net loss (adjusted for non cash charges) and decreases in accounts receivable and other assets. Cash from investing activities Net cash used in investing activities in 2011 of $37,000 was principally due to capital expenditures. The cash provided by investing activities in 2010 includes proceeds from the sale of TeamStaff RX of $375,000, offset by capital expenditures of $194,000. Cash from financing activities Net cash provided by financing activities for the year ended September 30, 2011 was $0.6 million as a result of receipt of funds from debit and equity capital raising efforts and increased use of the Company's borrowing facilities with Presidential Financial Corporation, reduced by the $0.2 million settlement payment on the long-standing RS Staffing note. As a result of the settlement related to the RS Staffing note discussed under "Settlement Agreement" below, this note was reduced from $1.7 million to approximately $0.7 million due to the aforementioned cash payment and a non-cash issuance of common stock at fair value on the date of the agreement. Loan Facility In April 2010, TeamStaff terminated its prior $2,000,000 revolving credit facility with Sovereign Business Capital. On July 29, 2010, DLH Solutions entered into a Loan and Security Agreement dated as of July 29, 2010 (the "Loan Agreement") with Presidential Financial Corporation (the "Lender"). Under the Loan Agreement, the Lender agreed to provide a two (2) year loan and security facility to DLH Solutions in an aggregate amount of up to $1.5 million, upon the further terms and subject to the conditions of the Loan Agreement. In November, 2010, the Lender agreed by means of an 42 -------------------------------------------------------------------------------- Table of Contents amendment to the Loan Agreement to increase the maximum amount available under the facility from $1.5 million to $2.5 million and on February 9, 2011, we entered into a further amendment to the Loan Agreement pursuant to which the Lender agreed to further increase our maximum availability under the Loan Agreement from $2.5 million to $3.0 million and to provide an unbilled receivable facility within the limits of the Loan Agreement. An interest rate premium of 2% is payable in respect of any advances secured by unbilled accounts receivable, which are subject to a sub-facility limit of $500,000 and an advance rate of 75%. The loan is secured by a security interest and lien on all of DLH Solutions' cash accounts, account deposits, letters of credit and investment property, chattel paper, furniture, fixtures and equipment, instruments, investment property, general intangibles, deposit accounts, inventory, other property, all proceeds and products of the foregoing (including proceeds of any insurance policies and claims against third parties for loss of any of the foregoing) and all books and records related thereto. DLH Solutions' ability to request loan advances under the Loan Agreement is subject to (i) computation of DLH Solutions' advance availability limit based on "eligible accounts receivables" (as defined in the Loan Agreement) multiplied by the "Accounts Advance Rate" established by the Lender which initially shall be 85% and may be increased or decreased by the Lender in exercise of its discretion; and (ii) compliance with the covenants and conditions of the loan. The loan was originally for a term of 24 months and after giving effect to the February 2011 amendment, which also extended the term of the Loan Agreement by 12 months, will mature on July 29, 2013. Interest on the loan initially accrued on the daily unpaid balance of the loan advances secured by billed receivables at the greater of one point ninety-five percent (1.95%) above the Prime Rate (as published in effect in The Wall Street Journal from time to time) or at the rate of three point two-five percent (3.25%) per annum. However, pursuant to the February 2011 amendment, the Company agreed with the Lender to adjust the rate of interest chargeable under the Loan and Security Agreement to be the greater of (a) 3.25% or (b) (i) 1.95% above the Wall Street Journal Prime rate on the accounts receivable portion of the credit line and (ii) 3.95% above the Wall Street Journal Prime rate on the unbilled accounts portion. The interest rate at September 30, 2011 was 5.2%. In addition, DLH Solutions will pay certain other related fees and expense reimbursements including a monthly service charge of 0.65% based on the average daily loan balance which shall accrue daily and be due and payable on the last day of each month so long as the Loan Agreement is outstanding. The interest rate in effect at September 30, 2011 and 2010 was 5.2% and 5.5%, respectively. At September 30, 2011, the amount of the unused availability under the line was $316,000. The respective amounts outstanding at those dates were $740,000 and $362,000, respectively. The Loan Agreement requires compliance with customary covenants and contains restrictions on the Company's ability to engage in certain transactions. Among other matters, under the loan agreement we may not, without consent of the Lender, (i) merge or consolidate with another entity, form any new subsidiary or acquire any interest in a third party; (ii) acquire any assets except in the ordinary course of business; (iii) enter into any transaction outside the ordinary course of business; (iv) sell or transfer collateral; (v) make any loans to, or investments in, any affiliate or enter into any transaction with an affiliate other than on an arms-length basis; (vi) incur any debt outside the ordinary course of business; (vii) pay or declare any dividends or other distributions; or (viii) redeem, retire or purchase any of our equity interests exceeding $50,000. In addition, the Loan Agreement requires DLH Solutions to maintain a minimum tangible net worth of at least $1,000,000 on a trailing 12-month basis. Further, without the consent of the Lender, the Company is also restricted from making any payments in respect of other outstanding indebtedness. The Lender may terminate the Loan Agreement at any time upon 60 days written notice after February 29, 2012, which date has subsequently been amended to December 31, 2012 and the Loan Agreement provides for customary events of default following which the Lender may, at its option, terminate the loan agreement and accelerate the repayment of any amount outstanding. The defined events of default include, among other things, a material adverse 43 -------------------------------------------------------------------------------- Table of Contents change in the Company's circumstances, or if the Lender deems itself insecure in the ability of the Company to repay its obligations, or as to the sufficiency of the collateral. As part of the recent amendment, the Lender also agreed to waive the Company's non-compliance with the covenant under the Loan Agreement to furnish them with a copy of DLH Solutions' financial statements within 90 days after the end of its fiscal year. In addition to granting this waiver, the Lender also agreed to modify this covenant to require that the Company provide them, within 90 days after the end of each fiscal year, audited consolidated financial statements of the Company and its subsidiaries as of the end of such fiscal year and, in addition, at the same time, furnish consolidating income statement and balance sheet schedules, including a reconciliation with DLH Solutions' financial information. The Company has concurrently executed a Corporate Guaranty Agreement with Lender pursuant to which it has guaranteed all of the obligations of DLH Solutions under the Loan Agreement. Payroll Taxes TeamStaff has received notices from the Internal Revenue Service ("IRS") claiming taxes, interest and penalties due related to payroll taxes predominantly from its former PEO operations which were sold in fiscal 2003. TeamStaff has also received notices from the IRS reporting overpayments of taxes. Management believes that these notices are predominantly the result of misapplication of payroll tax payments between its legal entities. If not resolved favorably, the Company may incur interest and penalties. Until the sale of certain assets related to the former PEO operations, TeamStaff operated through 17 subsidiaries, and management believes that the IRS has not correctly identified payments made through certain of the different entities, therefore leading to the notices. To date, TeamStaff has been working with the IRS to resolve these discrepancies and has had certain interest and penalty claims abated. TeamStaff has also received notices from the Social Security Administration claiming variances in wage reporting compared to IRS transcripts. TeamStaff believes the notices from the Social Security Administration are directly related to the IRS notices received. TeamStaff had retained the services of Ernst & Young LLP as a consultant to assist in resolving certain of these matters with the IRS and Social Security Administration. TeamStaff believes that after the IRS applies all the funds correctly, any significant interest and penalties will be abated; however, there can be no assurance that each of these matters will be resolved favorably. In settling various years for specific subsidiaries with the IRS, the Company has received refunds for those specific periods; however, as the process of settling and concluding on other periods and subsidiaries is not yet completed, the potential exists for related penalties and interest and the remaining liability ($1.3 million at September 30, 2011) has been recorded in accounts payable and includes estimated penalties and interest currently sought by the IRS totaling approximately $500,000. The Company believes it has accrued for the entire estimated remaining liability, inclusive of interest and penalties through the date of the financial statements. The Company will incur additional interest and may incur possible additional penalties through the future date that this obligation is settled, however, it is not currently possible to estimate what, if any, additional amount(s) may be claimed in future, given the uncertain timing and nature of any future settlement negotiations. No payments were made in fiscal 2010 or fiscal 2011. Management believes that the ultimate resolution of these remaining payroll tax matters will not have a significant adverse effect on its financial position or future results of operations. The Company's intention is that it will in due course seek to negotiate a mutually satisfactory payment plan with the IRS, but there is no assurance that it would be successful in doing so and the Company's future cash flows and liquidity could therefore be materially affected by this matter. 44 -------------------------------------------------------------------------------- Table of Contents Contractual Obligations Payments Due By Period Obligations Less than 1 - 3 4 - 5 (Amounts in thousands) Total 1 Year Years Years Loan Payable(1) $ 1,459 $ 1,459 $ - $ - Operating Leases(2) 803 176 475 152 Convertible Debentures 350 - 350 - Total Obligations $ 2,612 $ 1,635 $ 825 $ 152 -------------------------------------------------------------------------------- º (1) º Represents the amounts recorded in respect of remaining notes payable related to the acquisition of DLH Solutions, the loan payable due to Presidential in accordance with the loan agreement and capital lease obligations. º (2) º Represents lease payments net of sublease income. Settlement Agreement TeamStaff, Inc. and DLH Solutions entered into a settlement agreement dated as of July 22, 2011 (the "Agreement") with Roger Staggs and E. Barry Durham, the former principals of RS Staffing Services, Inc. (together, the "Sellers"). The Sellers are the holders of certain promissory notes issued by TeamStaff, Inc. in the aggregate principal amount of $1,500,000 (the "Notes"). The claims resolved by the Settlement Agreement concern TeamStaff's claim of indemnification of approximately $1,800,000 arising out of the acquisition by TeamStaff, Inc. of RS Staffing Services, Inc. in June 2005 and certain counterclaims by the Sellers against TeamStaff, including payment under the Notes. Pursuant to the Agreement, the Company paid $200,000 in cash to the Sellers, issued them an aggregate of 300,000 shares of common stock of TeamStaff, Inc., valued at $795,000, the fair value of the stock at July 22, 2011. The Company also agreed to permit the Sellers to resell an aggregate of 201,724 other shares of common stock of TeamStaff, Inc. presently held by them, against which the Company had previously placed a stop order to prevent their resale. The Sellers agreed to orderly sale limitations with respect to their ability to resell all their shares of common stock of TeamStaff, Inc. In accordance with these limits, during the 90 day period commencing on the effective date of the Agreement, neither Seller will resell in excess of 33,000 shares of TeamStaff common stock previously held by them during any 30 day period without the consent of TeamStaff. With respect to the new shares of TeamStaff common stock to be issued pursuant to the Agreement, commencing on the six month anniversary of the effective date of the Agreement, neither will resell in excess of 25,000 shares during any 30 day period without the consent of TeamStaff. In addition, TeamStaff provided guarantees to the Sellers that the net proceeds to be received by them from the resale of all of the shares of common stock of TeamStaff, Inc. sold by them pursuant to the Agreement would not be less than certain minimum guarantees. With respect to the shares of common stock of TeamStaff, Inc. owned by them prior to the effective date of the Agreement (the "Old TeamStaff Shares"), TeamStaff guaranteed to each Seller net proceeds of $100,000 and with respect to the shares of common stock of TeamStaff, Inc. to be issued under the Agreement (the "New TeamStaff Shares"), TeamStaff guaranteed net proceeds of $375,000 to each. The guarantees in respect of the Old TeamStaff Shares were satisfied in full as of September 30, 2011. The payments of all amounts under the Agreement are secured by the Notes. Upon receipt by the Sellers of (i) the payment of $200,000 made by TeamStaff and (ii) the proceeds realized from the sale of the Old TeamStaff Shares and New TeamStaff Shares, or the guarantees, the Notes shall be deemed satisfied in full. In addition, the parties agreed to release each other from any further claims that either may have against the other, except to enforce the Agreement. At September 30, 2011 the maximum remaining contingent liability under the agreement could potentially reach $750,000. 45 -------------------------------------------------------------------------------- Table of Contents The remaining liability under the Agreement does not accrue interest. The Company has evaluated the status of the Agreement, including the amount of consideration that are contingently owed to the Sellers, as well as the uncertainties inherent in predicting future market conditions and whether the Sellers are able to realize sufficient proceeds on sales of New TeamStaff Shares to satisfy the Company's guarantee. Based on such analysis, the Company has concluded at September 30, 2011 that the $711,000 recorded obligation (which approximated to the maximum amount of the guarantee) remaining after issuance of the 300,000 New TeamStaff Shares at a total fair value of $795,000 and the cash payment of $200,000 is reasonable. Although no assurances can be given, should the Sellers be able to individually realize proceeds through future sales of New TeamStaff Shares, the Company may reduce the recorded liability in future periods and recognize a gain. There was no gain recognized in fiscal 2011. The Company recognized expenses related to legal representation and costs incurred in connection with the investigation and settlement in the amount of $96,000 and $113,000 during fiscal 2011 and 2010, respectively, as a component of other income (expense). Off-Balance Sheet Arrangements We have not created, and are not party to, any special-purpose or off-balance sheet entities for the purpose of raising capital, incurring debt or operating parts of our business that are not consolidated into our financial statements. We do not have any arrangements or relationships with entities that are not consolidated into our financial statements that are reasonably likely to materially affect our liquidity or the availability of our capital resources. We have entered into various agreements by which we may be obligated to indemnify the other party with respect to certain matters. Generally, these indemnification provisions are included in contracts arising in the normal course of business under which we customarily agree to hold the indemnified party harmless against losses arising from a breach of representations related to such matters as intellectual property rights. Payments by us under such indemnification clauses are generally conditioned on the other party making a claim. Such claims are generally subject to challenge by us and to dispute resolution procedures specified in the particular contract. Further, our obligations under these arrangements may be limited in terms of time and/or amount and, in some instances, we may have recourse against third parties for certain payments made by us. It is not possible to predict the maximum potential amount of future payments under these indemnification agreements due to the conditional nature of our obligations and the unique facts of each particular agreement. Historically, we have not made any payments under these agreements that have been material individually or in the aggregate. As of our most recent fiscal year end we were not aware of any obligations under such indemnification agreements that would require material payments. Effects of Inflation Inflation and changing prices have not had a material effect on TeamStaff's net revenues and results of operations, as TeamStaff has been able to modify its prices and cost structure to respond to inflation and changing prices. Recently Issued Accounting Pronouncements Affecting the Company In October 2009, the Financial Accounting Standards Board ("FASB") issued a standard addressing the recognition of revenue in multiple-deliverable revenue arrangements. This standard establishes a new selling price hierarchy to use when allocating the revenue of a multiple element arrangement between delivered and undelivered elements. This standard generally results in revenue recognition for more delivered elements than under previous rules. The Company was required to adopt this guidance prospectively for new or materially modified agreements entered into on or after October 1, 2010. The Company's adoption of this standard did not have a material effect on our financial position or results of operations. 46 -------------------------------------------------------------------------------- Table of Contents In January 2010, the FASB issued a standard addressing fair value measurements and disclosures, which amends previously released guidance on fair value measurements and disclosures. The amendment requires additional disclosures about fair value measurements including transfers in and out of Levels 1 and 2 and more disaggregation for the different types of financial instruments. This standard is effective for annual and interim reporting periods beginning after December 15, 2009 for most of the new disclosures and for periods beginning after December 15, 2010 for the new Level 3 disclosures. Comparative disclosures are not required in the first year the disclosures are required. The adoption of this standard had no effect on the Company's financial statements. The Company has evaluated the nonrecurring fair value tabular disclosure requirements related to the impairment valuation of the tradenames, which are considered to be Level 3. Such valuation was based on probability weighted cash flow models, as discussed earlier in Note 2-Long-Lived Assets. Such disclosures were not considered significant to the Company's consolidated financial statements. In May 2011, the FASB amended existing guidance on fair value measurements to clarify certain disclosure requirements and improve consistency with international reporting standards. This amendment is to be applied prospectively and is effective for the Company's fiscal quarter ending March 31, 2012. The Company, at present, does not expect its adoption to have a material effect on prospective financial statements. The FASB amended existing guidance on reporting comprehensive income in June 2011 to require entities to present the total of comprehensive income, the components of net income, and the components of other comprehensive income either in a single continuous statement of comprehensive income or in two separate but consecutive statements. The amendment does not change the items that must be reported in other comprehensive income or when an item of other comprehensive income must be reclassified to net income under current accounting principles generally accepted in the United States of America. This guidance is effective for the Company's fiscal quarter ending March 31, 2012. The Company, at present, does not expect its adoption to have a material effect on prospective financial statements. In August 2011, the FASB approved a revised accounting standard to simplify the testing of goodwill for impairment. The guidance permits an entity to first assess defined qualitative factors in determining whether it is necessary to perform the goodwill impairment test. The guidance is effective for annual and interim goodwill impairment tests for the Company's fiscal year ending September 30, 2013. The Company is currently evaluating the prospective effects, if any, of adopting this guidance. |