UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

FORM 10-Q

 

 

ý QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE

SECURITIES EXCHANGE ACT OF 1934

 

For the quarterly period ended: July 1, 2005

 

or

 

o TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE

SECURITIES EXCHANGE ACT OF 1934

 

Commission File Number: 001-14543

 

 

LABOR READY, INC.

(Exact name of Registrant as specified in its charter)

 

	Washington		91-1287341
	(State or other jurisdiction of		(IRS Employer
	incorporation or organization)		Identification No.)
	1015 A Street, Tacoma, Washington		98402
	(Address of principal executive offices)		(Zip Code)

 

Registrant’s telephone number, including area code:          (253) 383-9101

 

Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the last ninety days.  Yes ý No o

 

Indicate by check mark whether the Registrant is an accelerated filer (as defined in Rule 12b-2 of the Act). Yes ý No o

 

As of July 29, 2005, there were 53,240,486 shares of the Registrant’s common stock outstanding.

 

Documents incorporated by reference:  None.

 

 

LABOR READY, INC.

 

INDEX

 

Part I.	Financial Information
	Item 1.		Consolidated Balance Sheets
			July 1, 2005 and December 31, 2004
			Consolidated Statements of Income
			Thirteen and Twenty-Six Weeks Ended July 1, 2005 and July 2, 2004
			Consolidated Statements of Comprehensive Income
			Thirteen and Twenty-Six Weeks Ended July 1, 2005 and July 2, 2004
			Consolidated Statements of Cash Flows
			Twenty-Six Weeks Ended July 1, 2005 and July 2, 2004
			Notes to Consolidated Financial Statements
	Item 2.		Management’s Discussion and Analysis of
			Financial Condition and Results of Operations
	Item 3.		Quantitative and Qualitative Disclosures
			About Market Risk
	Item 4.		Controls and Procedures
Part II.	Other Information
	Item 1.	Legal Proceedings
	Item 2.	Changes in Securities; Use of Proceeds and Issuer Purchases of Equity Securities
	Item 3.	Defaults Upon Senior Securities
	Item 4.	Submission of Matters to a Vote of Security Holders
	Item 5.	Other Information
	Item 6.	Exhibits
	Signatures

 

2

 

PART I.  Financial Information

 

Item 1.    Financial Statements

 

LABOR READY, INC.

 

CONSOLIDATED BALANCE SHEETS

 

In Thousands

 

ASSETS

 

		July 1,			December 31,
		2005			2004
		(Unaudited)
CURRENT ASSETS:
Cash and cash equivalents		$	104,048		$	128,817
Marketable securities		14,922			11,947
Accounts receivable		31,162			17,082
Accounts receivable pledged under securitization agreement		95,260			81,428
Allowance for doubtful accounts		(4,620		)	(4,197		)
Prepaid expenses, deposits and other		11,163			10,342
Income tax receivable		9,800			15,639
Deferred income taxes		9,932			—
Total current assets		271,667			261,058
PROPERTY AND EQUIPMENT:
Buildings and land		17,650			16,721
Computers and software		33,239			31,201
Cash dispensing machines		15,235			15,140
Furniture and equipment		3,880			2,877
		70,004			65,939
Less accumulated depreciation and amortization		43,736			40,765
Property and equipment, net		26,268			25,174
OTHER ASSETS:
Restricted cash and other assets		139,312			128,607
Deferred income taxes		1,404			6,890
Other assets		70,508			22,378
Total other assets		211,224			157,875
Total assets		$	509,159		$	444,107

 

See accompanying notes to consolidated financial statements.

 

3

 

LABOR READY, INC.

 

CONSOLIDATED BALANCE SHEETS

 

In Thousands (Except Par Values)

 

LIABILITIES AND SHAREHOLDERS’ EQUITY

 

		July 1,			December 31,
		2005			2004
		(Unaudited)
CURRENT LIABILITIES:
Accounts payable		$	19,036		$	14,743
Accrued wages and benefits		25,240			18,182
Current portion of workers’ compensation claims reserve		45,074			41,683
Other current liabilities		851			1,554
Deferred income taxes		—			346
Total current liabilities		90,201			76,508
LONG-TERM LIABILITIES:
Long term debt		—			70,000
Workers’ compensation claims reserve, less current portion		111,686			93,929
Other non-current liabilities		1,650			1,276
Total long-term liabilities		113,336			165,205
Total liabilities		203,537			241,713
COMMITMENTS AND CONTINGENCIES
SHAREHOLDERS’ EQUITY:
Preferred stock, $0.131 par value, 20,000 shares authorized; No shares issued and outstanding		—			—
Common stock, no par value, 100,000 shares authorized; 53,194 and 42,338 shares issued and outstanding		143,199			63,914
Cumulative foreign currency translation adjustment		2,709			3,577
Cumulative unrealized loss on marketable securities		(11		)	(22		)
Retained earnings		159,725			134,925
Total shareholders’ equity		305,622			202,394
Total liabilities and shareholders’ equity		$	509,159		$	444,107

 

See accompanying notes to consolidated financial statements.

 

4

 

LABOR READY, INC.

 

CONSOLIDATED STATEMENTS OF INCOME

 

In Thousands (Except Per Share Data)

 

(Unaudited)

 

		Thirteen Weeks Ended						Twenty-Six Weeks Ended
		July 1,			July 2,			July 1,			July 2,
		2005			2004			2005			2004
Revenue from services		$	295,208		$	267,056		$	538,424		$	475,968
Cost of services		202,535			187,297			369,613			335,482
Gross profit		92,673			79,759			168,811			140,486
Selling, general and administrative expenses		66,253			60,310			125,667			116,756
Depreciation and amortization		2,189			2,280			4,395			4,339
Income from operations		24,231			17,169			38,749			19,391
Interest expense		(1,503		)	(1,620		)	(2,878		)	(3,311		)
Interest and other income		2,214			1,360			4,064			2,046
Interest and other income (expense), net		711			(260		)	1,186			(1,265		)
Income before tax expense
		24,942			16,909			39,935			18,126
Income tax		9,498			6,781			15,135			7,268
Net income		$	15,444		$	10,128		$	24,800		$	10,858
Net income per common share:
Basic		$	0.35		$	0.24		$	0.57		$	0.26
Diluted		$	0.30		$	0.21		$	0.49		$	0.24
Weighted average shares outstanding:
Basic		44,611			41,503			43,557			41,356
Diluted		53,535			52,187			53,254			52,023

 

See accompanying notes to consolidated financial statements.

 

5

 

LABOR READY, INC.

 

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

 

In Thousands

 

(Unaudited)

 

		Thirteen Weeks Ended						Twenty-Six Weeks Ended
		July 1,			July 2,			July 1,			July 2,
		2005			2004			2005			2004
Net income		$	15,444		$	10,128		$	24,800		$	10,858
Other comprehensive income (loss):
Foreign currency translation adjustment		(576		)	(104		)	(868		)	161
Unrealized gain (loss) on marketable securities		14			(34		)	11			(52		)
Other comprehensive income (loss)		(562		)	(138		)	(857		)	109
Comprehensive income		$	14,882		$	9,990		$	23,943		$	10,967

 

See accompanying notes to consolidated financial statements.

 

6

 

LABOR READY, INC.

 

CONSOLIDATED STATEMENTS OF CASH FLOWS

 

In Thousands

 

(Unaudited)

 

		Twenty-Six Weeks Ended
		July 1,			July 2,
		2005			2004
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income		$	24,800		$	10,858
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization		4,749			4,725
Provision for doubtful accounts		3,180			3,508
Deferred income taxes		(5,604		)	(4,259		)
Other operating activities		3,290			1,639
Changes in operating assets and liabilities, exclusive of business acquired:
Accounts receivable		(17,627		)	(23,175		)
Workers’ compensation claims reserve		7,154			14,800
Income tax		5,839			8,735
Other assets		173			(4,012		)
Other current liabilities		6,844			5,392
Net cash provided by operating activities		32,798			18,211
CASH FLOWS FROM INVESTING ACTIVITIES:
Capital expenditures		(2,744		)	(2,876		)
Purchases of marketable securities		(29,154		)	(13,660		)
Maturities of marketable securities		26,190			17,303
Purchase of CLP Holdings Corp., net of cash acquired		(45,892		)	—
Purchase of Spartan Staffing, Inc.		—			(9,890		)
Increase in restricted cash and other assets		(10,705		)	(1,441		)
Other		36			(20		)
Net cash used in investing activities		(62,269		)	(10,584		)
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from sale of stock through options and employee benefit plans		6,608			4,722
Payments on debt		(1,141		)	(1,304		)
Checks issued against future deposits		—			(4,197		)
Net cash provided by (used in) financing activities		5,467			(779		)
Effect of exchange rates on cash		(765		)	156
Net change in cash and cash equivalents		(24,769		)	7,004
CASH AND CASH EQUIVALENTS, beginning of period		128,817			83,112
CASH AND CASH EQUIVALENTS, end of period		$	104,048		$	90,116

 

See accompanying notes to consolidated financial statements.

 

7

 

Notes to Consolidated Financial Statements

 

NOTE 1: ACCOUNTING PRINCIPLES AND PRACTICES

 

The accompanying unaudited consolidated financial statements have been prepared in accordance with generally accepted accounting principles for interim financial information and rules and regulations of the Securities and Exchange Commission.  Accordingly, certain information and footnote disclosures usually found in financial statements prepared in accordance with generally accepted accounting principles have been condensed or omitted.  The unaudited consolidated financial statements reflect all adjustments, including normal recurring adjustments, which in the opinion of management are necessary to fairly state the financial position, results of operations and cash flows for the interim periods presented.  These financial statements should be read in conjunction with the consolidated financial statements and related notes included in our annual report on Form 10-K for the year ended December 31, 2004. Operating results for the twenty-six week period ended July 1, 2005 are not necessarily indicative of the results that may be expected for the year ending December 30, 2005.

 

The consolidated financial statements are presented on a 52/53-week fiscal year end basis, with the last day of the fiscal year ending on the Friday closest to December 31. Fiscal years 2004 and 2005 are 52-week years.

 

Revenue recognition

Revenue from services is generally recognized at the time the service is performed.  A portion of our revenue is derived from cash dispensing machine (“CDM”) fees, which are immaterial for all periods presented.  Sales coupons or other incentives are recognized as a reduction of revenues in the period the related revenue is earned.

 

Cost of services

Cost of services includes the wages of temporary employees, related payroll taxes, workers’ compensation expenses and transportation.

 

Stock-based compensation

We follow Accounting Principles Board (“APB”) Opinion No. 25, Accounting for Stock Issued to Employees, and related interpretations to account for stock options and employee stock purchase plans.  Since the exercise price of our employee stock options is not less than the market price of the underlying stock at the date of grant, under APB Opinion No. 25, no compensation cost is recognized.  Statement of Financial Accounting Standards (“SFAS”) No. 123, Accounting for Stock-Based Compensation, as amended by SFAS 148, Accounting for Stock-Based Compensation – Transition and Disclosure, issued in December 2002, requires us to provide pro forma information regarding net income and net income per share as if compensation cost for our stock option plans had been determined in accordance with the fair value based method prescribed in SFAS No. 123, as amended by SFAS 148.

 

Under the provisions of SFAS No. 123, as amended by SFAS 148, our net income and net income per share would have been reduced to the pro forma amounts indicated below (in thousands, except per share amount):

 

				Thirteen Weeks Ended July 1, 2005			Thirteen Weeks Ended July 2, 2004
Net Income As Reported				$	15,444		$	10,128
Add: Stock based compensation as reported, net of tax				196			50
				15,640			10,178
Deduct:	Total stock-based compensation expense determined under fair value method of all awards, net of tax			(460		)	(447		)
Pro Forma				$	15,180		$	9,731
Diluted Net Income Per Share
		As Reported		$	0.30		$	0.21
		Pro Forma		$	0.30		$	0.20
Basic Net Income Per Share
		As Reported		$	0.35		$	0.24
		Pro Forma		$	0.34		$	0.23

 

8

 

				Twenty-Six Weeks Ended July 1, 2005			Twenty-Six Weeks Ended July 2, 2004
Net Income As Reported				$	24,800		$	10,858
Add: Stock based compensation as reported, net of tax				335			50
				25,135			10,908
Deduct:	Total stock-based compensation expense determined under fair value method of all awards, net of tax			(997		)	(755		)
Pro Forma				$	24,138		$	10,153
Diluted Net Income Per Share
		As Reported		$	0.49		$	0.24
		Pro Forma		$	0.48		$	0.23
Basic Net Income Per Share
		As Reported		$	0.57		$	0.26
		Pro Forma		$	0.55		$	0.25

 

New accounting pronouncements

In December 2004, the Financial Accounting Standards Board issued SFAS 123 (Revised), Share-Based Payment, which amended SFAS No. 123 and SFAS No. 95, Statement of Cash Flows. The new accounting standard requires the expensing of new stock options, as well as outstanding unvested stock options, issued by us using a fair-value-based method and is effective for fiscal years beginning after June 15, 2005 and will become effective for us beginning in the first quarter of fiscal year 2006. In March 2005 the Securities and Exchange Commission (“SEC”) issued Staff Accounting Bulletin No. 107, which provides guidance regarding the application of SFAS No. 123 (Revised). See Stock-based compensation section above for pro forma disclosures regarding the effect on net income and net income per share had we applied the fair value recognition provisions of SFAS No. 123. We are currently evaluating the transition methods prescribed by SFAS No. 123 (Revised). Depending on the method we adopt to calculate stock-based compensation expense, the pro forma disclosure above may or may not be indicative of the stock-based compensation expense to be recognized.

 

In October 2004, President Bush signed the American Jobs Creation Act of 2004 (“Act”). The Act provides for a special one-time deduction of 85 percent of certain foreign earnings that are repatriated in either an enterprise’s last tax year that began before the enactment date, or the first tax year that begins during the one-year period beginning on the date of enactment. In December 2004, the FASB issued FASB Staff Position No. 109-2, “Accounting and Disclosure Guidance for the Foreign Repatriation Provision within the American Jobs Creation Act of 2004,” in response to the Act, which provides guidance for the implementation of the provisions of the Act.  Under the Act, we may choose to repatriate earnings from any or all of our foreign investments and may apply the special one-time deduction to any repatriated amounts, provided certain criteria are met. We are currently evaluating the effects of the repatriation provision for each of our several foreign investments and expect to complete the evaluation prior to the end of the fourth quarter of 2005.

 

NOTE 2: BUSINESS COMBINATION

 

The purchase of substantially all of the assets of Spartan Staffing Inc. on April 5, 2004 is fully disclosed in the related notes included in our annual report on Form 10-K for the year ended December 31, 2004.

 

On May 27, 2005, pursuant to an Agreement and Plan of Merger (the “Merger Agreement”), we completed our acquisition of 100% of the common stock of CLP Holdings Corp. (“CLP”), a privately held Nevada corporation for $46.3 million, including acquisition costs of $0.7 million. Seven million dollars of the purchase price is being held in an indemnity escrow for two years from the closing date (except to the extent any amounts are withdrawn earlier to pay claims) to indemnify us for certain matters that are specified in the Merger Agreement.  There are no other contingent payments.

 

9

 

Given that CLP provides skilled and semi-skilled temporary employees to licensed contractors and large facilities on an as needed basis, we believe our acquisition of CLP supports our long-term strategic direction and strengthens our competitive position in the temporary labor industry.

 

Assets acquired and liabilities assumed in the CLP acquisition were recorded at their estimated fair values as of May 27, 2005. We obtained independent valuations of the trade names, trademarks, non-compete agreements and customer relationships purchased and the workers’ compensation liability assumed and internally determined the fair value of the other assets and liabilities. The purchase price allocation is preliminary.

 

The preliminary allocation of the purchase price is summarized as follows (in thousands):

 

 

Identifiable intangible assets purchased in the CLP acquisition, consist of the following (in thousands):

 

		Fair Value			Useful Life
Amortizable intangible assets:
Customer relationships		10,300			6.5 years
Non-compete agreements		700			1.0 to 2.0 years
Total amortizable intangible assets		$	11,000
Indefinite-lived intangible assets:
Trade name/trademarks		6,000
Total indefinite-lived intangible assets		$	6,000

 

The results of operations of CLP are included in the accompanying consolidated financial statements since the date of purchase. The unaudited financial information in the table below summarizes the combined historical results of operations of Labor Ready, Inc., and CLP, on a pro forma basis, as though the companies had been combined as of the beginning of each period presented. This pro forma financial information is presented for informational purposes only and is not necessarily indicative of the results of operations that would have been achieved had the acquisition taken place at the beginning of each period presented. The pro forma amounts are as follows (in thousands, except per share amounts):

 

		Thirteen Weeks Ended						Twenty-Six Weeks Ended
		July 1,			July 2,			July 1,			July 2,
		2005			2004			2005			2004
Revenue from services		$	313,974		$	292,922		$	582,625		$	523,055
Net income		13,617			10,548			22,467			10,826
Net income per common share:
Basic		$	0.31		$	0.25		$	0.52		$	0.26
Diluted		$	0.27		$	0.22		$	0.45		$	0.24

 

10

 

NOTE 3: MARKETABLE SECURITIES

 

Management determines the appropriate classification, pursuant to SFAS No. 115, Accounting for Certain Investments in Debt and Equity Securities, of our investments in debt and equity securities (“Marketable Securities”) at the time of purchase and re-evaluates such determination at each balance sheet date.  Marketable Securities consist of revenue bonds and other municipal obligations, which usually have maturities of one year or less. The aggregate carrying value of our Marketable Securities was $14.9 million at July 1, 2005 and $11.9 million at December 31, 2004. At July 1, 2005 and December 31, 2004, those securities were classified as available-for-sale and stated at fair value as reported by our investment brokers, with the unrealized holding gains and losses reported as a separate component of shareholders’ equity. There were no material unrealized holding gains or losses at July 1, 2005 or December 31, 2004. The specific identification method is used for computing realized gains and losses on the sale of available-for-sale securities.  For the thirteen and twenty-six weeks ended July 1, 2005 and July 2, 2004, there were no sales of available-for-sale securities.  These marketable securities are available to fund current operations, if necessary.

 

NOTE 4: RESTRICTED CASH AND OTHER ASSETS

 

We have cash deposits and other restricted assets with independent financial institutions predominantly for the purpose of securing our workers’ compensation obligations. These assets may be released as workers’ compensation claims are paid or when letters of credit are released or can be supported by eligible accounts receivable.

 

The following is a summary of restricted cash and other assets as of July 1, 2005 and December 31, 2004 (in millions):

 

		July 1, 2005			December 31, 2004
Workers’ Assurance Program – committed cash*		$	128.9		$	117.2
Cash-backed instruments		9.5			9.5
Workers’ Assurance Program – uncommitted cash*		0.8			1.9
Other		0.1			—
Total Restricted Cash and Other Assets		$	139.3		$	128.6

 

* We have agreements with certain financial institutions through our wholly-owned and consolidated subsidiary, Workers’ Assurance of Hawaii, Inc. (our “Workers’ Assurance Program”), that allow us to restrict cash for the purpose of providing cash-backed instruments for our workers’ compensation collateral.  These instruments include cash-backed letters of credit, cash held in trusts that we control as well as cash deposits held by our insurance carriers. Committed cash represents instruments that have been provided or pledged to an insurance company to cover the cost of claims in the event we are unable to make payment.  Uncommitted cash represents cash available for funding future commitments.

 

Our restricted cash and other assets increased $10.7 million since December 31, 2004. The increase is primarily attributable to the growth in our workers’ compensation reserve for the current policy year as we continue to collateralize most of our obligations with restricted cash through our Workers’ Assurance Program.

 

As a result of our recent workers’ compensation insurance policy renewal, we expect to restrict $33.7 million of cash into our Workers’ Assurance Program for use as collateral during the 2005/2006 policy year which expires on July 1, 2006. Of that total, $6.7 million was restricted and then deposited with our insurance carrier subsequent to the quarter ended July 1, 2005. An additional $13.5 million will be restricted and deposited with our insurance carrier by the end of the year and the balance of $13.5 million will be restricted and deposited with our insurance carrier during 2006 as required by our insurance agreement.

 

NOTE 5: RECEIVABLES FROM INSURANCE COMPANIES

 

For workers’ compensation claims originating in the majority of states (which we refer to as self-insured states), we have purchased insurance policies from independent, third-party carriers, which cover any claims for a particular event above a deductible amount, on a “per occurrence” basis.  Our current deductible is $2.0 million for the majority of our workers’ compensation claims.

 

Our workers’ compensation reserves include not only estimated expenses for claims within our deductible layer but also estimated expenses related to claims above our deductible limits (“excess claims”).  We record a receivable for the insurance coverage on excess claims based on the contractual policy agreements we have with insurance companies.  We discount this receivable to its estimated net

 

11

 

present value using a discount rate based on the methodology used to discount the related loss liability as described in Note 8.  When appropriate, based on our best estimate, we record a valuation allowance against the insurance receivable to reflect amounts that may not be realized. Included in other assets in the accompanying Consolidated Balance Sheets at July 1, 2005 and December 31, 2004 are discounted receivables from insurance companies, net of related valuation allowance, of  $13.5 million and $11.0 million, respectively.

 

Two of the workers’ compensation insurance companies with which we formerly did business are currently in liquidation or financial distress and have failed to pay a number of excess claims. We have presented these excess claims to the guarantee funds of the states in which the claims originated.  Certain of these excess claims have been rejected by the state guarantee funds due to statutory eligibility limitations. Although we believe it is probable that we will receive payments on the majority of our excess claims, we have concluded that recovery is unlikely on a portion of these claims. As a result, we have recorded a valuation allowance against the insurance receivables from these two insurance companies at both July 1, 2005 and December 31, 2004 in the amount of $1.2 million.

 

We also record a receivable for other matters where we expect reimbursement from an insurance company.  Included in prepaid expenses, deposits and other in the accompanying Consolidated Balance Sheets at July 1, 2005 is an undiscounted receivable from our insurance company of $1.8 million in connection with certain employment related litigation. The receivable is not discounted due to the short-term nature of the expected reimbursement.

 

NOTE 6: INTANGIBLE ASSETS

 

The following table presents our purchased intangible assets, which are included in other assets in the Consolidated Balance Sheets (in thousands):

 

		July 1, 2005			December 31, 2004
Amortizable intangible assets:
Trade name/trademarks		$	400		$	400
Customer relationships		11,600			1,300
Non-compete agreements		1,600			900
		13,600			2,600
Less accumulated amortization		1,586			847
Total amortized intangible assets, net		$	12,014		$	1,753
Indefinite-lived intangible assets:
Trade name/trademarks		6,500			500
Goodwill		37,357			6,358
Total indefinite-lived intangible assets		$	43,857		$	6,858

 

We obtained all of our intangible assets as a result of acquisitions. Intangible assets are amortized using the straight line method over the assigned amortization periods, which range from 2.5 to 6.5 years for customer relationships, 1 to 2 years for non-compete agreements and 2.5 years for amortizable trade name/trademarks.  A majority of our trade name/trademarks do not have a definite life and, accordingly, are not amortized. Amortization expense of our amortizable intangible assets was $0.5 million for the thirteen weeks and $0.7 million for the twenty-six weeks ended July 1, 2005 and $0.3 million for the thirteen weeks and twenty-six weeks ended July 2, 2004.

 

NOTE 7: LONG-TERM DEBT

 

Convertible Subordinated Notes - During 2002, we issued 6.25% Convertible Subordinated Notes due June 2007 (the “Notes”) in the aggregate principal amount of $70.0 million.  Interest was payable on the Notes on June 15 and December 15 of each year.  Holders could convert the Notes into shares of our common stock at any time prior to the maturity date at a conversion price of $7.26 per share (equivalent to an initial conversion rate of approximately 137.741 shares per $1,000 principal amount of Notes), subject to certain adjustments.  The Notes were unsecured subordinated obligations and ranked junior in right of payment to all existing and future debt that would constitute senior debt under the indenture, including letters of credit and surety bonds.  Pursuant to the terms of the Notes, on or after June 20, 2005, we could redeem some or all of the Notes for cash at 100% of their principal amount plus accrued interest if the market value of our common stock equaled or exceeded 125% of the conversion price ($9.08) for at least 20 trading days in any consecutive 30 trading day period ending on the trading day prior to the date we mail notice of our intent to redeem the Notes.

 

12

 

On April 20, 2005, we announced that we would be calling the Notes for redemption on June 20, 2005 for cash at 100 percent of the principal amount plus accrued interest. Holders of all of the outstanding Notes converted their Notes into shares of our common stock prior to the June 20, 2005 redemption date and none of the outstanding principal amount of the Notes was redeemed for cash.  As a result of these conversions, approximately 9.6 million additional shares of common stock were issued to the holders of the Notes and we reduced our long-term debt by $70.0 million.  The Notes had been accounted for on an “as if converted” basis since their issuance in 2002. Consequently, issuance of the shares was not further dilutive to our diluted net income per share (See Note 9).

 

NOTE 8: WORKERS’ COMPENSATION INSURANCE AND RESERVES

 

We provide workers’ compensation insurance to our temporary and regular employees.  Our workers’ compensation insurance policies must be renewed annually. We recently renewed our coverage with American International Group, Inc. (“AIG”), which is the insurance company for the majority of our workers’ compensation policies, for occurences in the period from July 2005 through June 2006. While we have primary responsibility for all claims, our insurance coverage provides reimbursement for certain losses and expenses beyond the deductible limits (“excess claims”). For workers’ compensation claims originating in the majority of states (which we refer to as self-insured states), our current workers’ compensation insurance policy covers any claims for a particular event above a $2.0 million deductible, on a “per occurrence” basis.  This results in our being substantially self-insured. Furthermore, we now have full liability for all further payments on claims which originated between January 2001 and June 2003, without recourse to any third party insurer as the result of a Novation agreement we entered into with Kemper Insurance Company in December 2004.

 

Our workers’ compensation reserve is discounted to its estimated net present value using a discount rate based on average returns on “risk-free” Treasury instruments, which is evaluated on a quarterly basis.  At July 1, 2005, our reserves are discounted at rates ranging from 3.85% to 5.27%.  Included in the accompanying Consolidated Balance Sheets as of July 1, 2005 and December 31, 2004 are discounted workers’ compensation claims reserves in the amounts of $156.8 million and $135.6 million, respectively.

 

For workers’ compensation claims originating in Washington, Ohio, West Virginia, North Dakota, Wyoming, Canada and Puerto Rico (the “monopolistic jurisdictions”) we pay workers’ compensation insurance premiums and obtain full coverage under government-administered programs. Accordingly, because we are not the primary obligor, our financial statements do not reflect the liability for workers’ compensation claims in these monopolistic jurisdictions. For work-related claims originating in the United Kingdom which exceed amounts covered by governmental medical insurance programs, we have purchased an employers’ liability insurance policy that carries a 25 million British Pound limit in total.

 

Workers’ compensation expense is recorded as part of our cost of services and consists of the following components: self-insurance reserves net of changes in discount, monopolistic jurisdictions premium, insurance premium and any changes in the valuation allowance related to receivables from insurance companies as described in Note 5. Workers’ compensation expense totaling $19.2 million and $20.4 million was recorded for the thirteen weeks ended July 1, 2005 and July 2, 2004, respectively.  Workers’ compensation expense totaling $34.7 million and $37.0 million was recorded for the twenty-six weeks ended July 1, 2005 and July 2, 2004, respectively.

 

NOTE 9: NET INCOME PER SHARE

 

Basic net income per share is calculated by dividing net income by the weighted average number of common shares outstanding during the year.  Diluted net income per share is calculated by dividing adjusted net income by the weighted average number of common shares and potential common shares outstanding during the year.  Potential common shares include the dilutive effects of outstanding options and the conversion features of the Notes, except where their inclusion would be anti-dilutive.  The anti-dilutive shares not considered as part of our calculation are as follows:

 

		(Amounts in Thousands)
		Thirteen Weeks Ended				Twenty-Six Weeks Ended
		July 1,		July 2,		July 1,		July 2,
		2005		2004		2005		2004
Stock Options		130		222		130		316

 

Anti-dilutive shares associated with our stock options relate to those stock options with a grant price higher than the average market value of our stock during the periods presented.

 

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Adjusted net income and diluted common shares were calculated as follows:

 

		Thirteen Weeks Ended
		July 1, 2005			July 2, 2004
Net income		$	15,444		$	10,128
Adjustments:
Interest on Notes		881			1,106
Amortization of costs for Notes issuance		124			149
Tax effect		(383		)	(503		)
Total adjustments		622			752
Adjusted net income		$	16,066		$	10,880

 

		Common Shares and Potential Common Shares (In Thousands)
Weighted average number of common shares used in basic net income per common share		44,611		41,503
Effect of dilutive securities:
Stock options		889		1,042
Convertible Notes		8,035		9,642
Weighted average number of common shares and potential common shares used in diluted net income per common share		53,535		52,187

 

		Twenty-Six Weeks Ended
		July 1, 2005			July 2, 2004
Net income		$	24,800		$	10,858
Adjustments:
Interest on Notes		1,859			2,212
Amortization of costs for Notes issuance		274			298
Tax impact		(808		)	(1,006		)
Total adjustments		1,325			1,504
Adjusted net income		$	26,125		$	12,362

 

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		Common Shares and Potential Common Shares (In Thousands)
Weighted average number of common shares used in basic net income per common share		43,557		41,356
Effect of dilutive securities:
Stock options		859		1,025
Convertible Notes		8,838		9,642
Weighted average number of common shares and potential common shares used in diluted net income per common share		53,254		52,023

 

NOTE 10: COMMITMENTS AND CONTINGENCIES

 

Accounts Receivable Facility

In March 2001, we entered into a letter of credit facility and accounts receivable securitization facility (collectively the “Accounts Receivable Facility”) with certain unaffiliated financial institutions that expires in February 2006.  The Accounts Receivable Facility provides loan advances and letters of credit through the sale of substantially all of our eligible domestic accounts receivable to a wholly-owned and consolidated subsidiary, Labor Ready Funding Corporation.  The Accounts Receivable Facility includes a corporate guarantee by us and requires that we comply with certain financial covenants.  Among other things, these covenants require us to maintain certain liquidity, net income and net worth levels and a certain ratio of net income to fixed expenses.  Subject to certain availability requirements, the Accounts Receivable Facility allows us to borrow a maximum of $80 million, all of which may be used to obtain letters of credit.  The amounts we may borrow (our borrowing capacity) under this agreement are largely a function of the levels of our accounts receivable from time to time, supplemented by pledged and restricted cash. We currently use this facility to issue letters of credit but if we were to take a loan against this borrowing capacity, interest would be charged at 2.5% above the Prime Rate. We are currently in compliance with the covenants related to the Accounts Receivable Facility.

 

At July 1, 2005, we had a total available borrowing capacity of $70.8 million under the Accounts Receivable Facility comprised entirely of the eligible portion of our $95.3 million of securitized accounts receivable. Of that borrowing capacity available at July 1, 2005, we had $51.1 million of letters of credit issued against it leaving us with $19.7 million available for future borrowings.

 

We are required by our insurance carriers and certain state workers’ compensation programs to collateralize a portion of our workers’ compensation obligation with cash and cash-backed instruments, irrevocable letters of credit, or surety bonds. The letters of credit bear fluctuating annual fees, which were approximately 1.0% of the principal amount of the letters of credit outstanding as of July 1, 2005.  The surety bonds bear annual fees based on a percentage of the bond, which is determined by each independent surety carrier but does not exceed 2% of the bond amount.

 

At July 1, 2005 and December 31, 2004 we had provided our insurance carriers and certain states with commitments in the form and amounts outlined below (in millions):

 

		Workers’ Compensation Commitments as of:
		July 1,			December 31,
		2005			2004
Workers’ Assurance Program - committed cash		$	128.4		$	116.7
Accounts Receivable Facility letters of credit		51.0			40.1
Cash-backed instruments		9.5			9.5
Unsecured surety bonds		5.8			5.8
Total Collateral Commitments		$	194.7		$	172.1

 

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Our workers’ compensation commitments increased $22.6 million since December 31, 2004.  The increase is primarily attributable to $10.5 million of additional letters of credit as a result of our acquisition of CLP and the remaining portion of the increase is related to the growth in our workers’ compensation reserve for the current policy year as we continue to collateralize most of our obligations with restricted cash through our Workers’ Assurance Program.

 

Revolving Credit Facility

In January 2002, we entered into a revolving credit facility with Wells Fargo Bank (the “Revolving Credit Facility”).  As of July 1, 2005 the available borrowing amount was $8.4 million with interest at the fluctuating rate per annum of 0.75% below the Prime Rate or 1.85% above the London Inter-Bank Rate, at our option.  The available borrowing amount under this facility will be reduced by $125,000 each quarter through February 2006 at which time the facility expires.  The Revolving Credit Facility bears fees of 0.35% of the unused amount, and is secured by a first deed of trust on our corporate headquarters building. The Revolving Credit Facility contains a cross-default provision with respect to our Accounts Receivable Facility, which obligates us, among other things, to maintain certain liquidity, net income and net worth levels and a certain ratio of net income to fixed expenses.  We currently do not have any borrowings on the Revolving Credit Facility and are in compliance with the related covenants.

 

Capital Leases – The following is a summary of property and equipment held under non-cancelable capital leases:

 

		(Amounts in Thousands)
		July 1, 2005			December 31, 2004
Cash dispensing machines		$	3,667		$	8,119
Computers and software		1,844			1,616
Furniture and equipment		201			292
		5,712			10,027
Less accumulated depreciation and amortization		2,996			6,404
		$	2,716		$	3,623

 

Financing terms for many of our cash dispensing machines were completed during the second quarter of 2005, resulting in a reduction in the total capital lease balance.

 

Future minimum lease payments under these non-cancelable capital leases as of July 1, 2005 are as follows for each of the next five years (in thousands):

 

 

Our capital lease obligations are reported in other liabilities in the Consolidated Balance Sheets. The weighted average interest rate on capitalized leases is approximately 5.0% and the lease terms range from 11 to 84 months.

 

Operating Leases – We have contractual commitments in the form of operating leases related to branch office leases, vehicles and equipment. While most of our branch office leases have longer contractual terms and a small minority have stepped rents to approximate inflation, we have the right to cancel the majority of our leases with 90 days notice. Accordingly, we have not included the leases with 90 day provisions in our disclosure of future minimum lease payments.

 

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