BGSF, INC. 10-Q

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations This Management’s Discussion and Analysis of Financial Condition and Results of Operations should be read in conjunction with our accompanying Unaudited Consolidated Financial Statements and related notes thereto and our Annual Report on Form 10-K for the fiscal year ended January 1, 2023. Comparative segment revenues and related financial information are discussed herein and are presented in Note 15 to our Unaudited Consolidated Financial Statements. See “Forward Looking Statements” on page 3 of this report and “Risk Factors” included in our filings with the SEC, including our Quarterly Reports on Form 10-Q and our Annual Report on Form 10-K for the fiscal year ended January 1, 2023, for a description of important factors that could cause actual results to differ from expected results. Please also refer to Note 4- Discontinued Operations, to our Unaudited Consolidated Financial Statements. Our historical financial information may not be indicative of our future performance. Overview We provide consulting, managed services, and professional workforce solutions to our client partners in a variety of industries through our various divisions in IT, Cyber, Finance & Accounting, Managed Services, and Real Estate (apartment communities and commercial buildings). We have continuing operations in two industry segments: Real Estate and Professional. We currently operate primarily within the United States of America, across 46 states and D.C., and within Colombia and India. On March 21, 2022, we sold substantially all of the assets and certain liabilities of InStaff to Sentech Engineering Services, Inc. (“Sentech”) for a sale price of approximately $30.3 million cash at closing and an additional $2 million one year following the date of the acquisition. See “Note 4 — Discontinued Operations” of our unaudited consolidated financial statements. On December 12, 2022, we acquired substantially all of the assets, and assumed certain of the liabilities of Horn Solutions, Inc. and Horn Solutions Dallas, LLC (collectively “Horn Solutions”). See “Note 3 — Acquisitions” of our our unaudited consolidated financial statements. In connection with the Horn Solutions acquisition on December 12, 2022, we borrowed $40 million in a second amendment to the Credit Agreement with BMO Harris Bank, N.A. (“BMO”), that bears interest either at the Base Rate plus the Applicable Margin or Adjusted Term Secured Overnight Financing Rate ("SOFR") plus the Applicable Margin. See “Note 9 — Debt” of our our unaudited consolidated financial statements. On April 24, 2023, we acquired substantially all of the assets and assumed certain of the liabilities of Arroyo Consulting, LLC ("Arroyo Consulting"), which is a nearshore/offshore workforce solutions firm that specializes in IT and software development with operations in the United States, Columbia, and India. See “Note 16 — Subsequent Events” of our our unaudited consolidated financial statements. At closing, $6.8 million of the closing price was paid from available funds under our credit agreement with BMO. Our Real Estate segment provides office and maintenance field talent to various apartment communities and commercial buildings in 37 states and D.C., via property management companies responsible for the apartment communities' and commercial buildings' day-to-day operations. Our Professional segment provides specialized talent and business consultants on a nationwide basis for IT, finance, accounting, legal, and human resources. The Professional segment operates through three divisions, Information Technology, Managed Services, and Finance and Accounting. 25 Our business normally experiences seasonal fluctuations. Our quarterly operating results are affected by the number of billing days in a quarter, as well as the seasonality of our client partners’ business. Demand for our Real Estate workforce solutions typically increase in the second quarter and is highest during the third quarter of the year due to the increased turns in multifamily units during the summer months when schools are not in session. Overall first quarter demand can be affected by adverse weather conditions in the winter months. In addition, our cost of services typically increases in the first quarter primarily due to the reset of payroll taxes. Results of Operations The following tables summarize key components of our results for the periods indicated, both in dollars and as a percentage of revenues, and have been derived from our unaudited consolidated financial statements. Thirteen Weeks Ended April 2, 2023 March 27, 2022 (dollars in thousands) Revenues $ 75,316 $ 68,542 Cost of services 48,532 45,111 Gross profit 26,784 23,431 Selling, general and administrative expenses 23,212 19,717 Impairment losses 22,545 — Depreciation and amortization 1,757 899 Operating (loss) income (20,730) 2,815 Interest expense, net (1,200) (273) (Loss) income from continuing operations before income taxes (21,930) 2,542 Income tax benefit (expense) from continuing operations 5,464 (534) (Loss) income from continuing operations (16,466) 2,008 Income from discontinued operations: Income — 1,235 Gain on sale — 17,273 Income tax expense — (4,716) Net (loss) income $ (16,466) $ 15,800 Thirteen Weeks Ended April 2, 2023 March 27, 2022 Revenues 100.0 % 100.0 % Cost of services 64.4 % 65.8 % Gross profit 35.6 % 34.2 % Selling, general and administrative expenses 30.8 % 28.8 % Impairment losses 29.9 % — % Depreciation and amortization 2.3 % 1.3 % Operating (loss) income (27.5) % 4.1 % Interest expense, net (1.6) % (0.4) % (Loss) income from continuing operations before income taxes (29.1) % 3.7 % Income tax benefit (expense) from continuing operations 7.3 % (0.8) % (Loss) income from continuing operations (21.9) % 2.9 % 26 Thirteen Week Fiscal Period Ended April 2, 2023 (“Fiscal 2023”) Compared with Thirteen Week Fiscal Period Ended March 27, 2022 (“Fiscal 2022”) Revenues: Thirteen Weeks Ended April 2, 2023 March 27, 2022 (dollars in thousands) Revenues by segment: Real Estate $ 28,405 37.7 % $ 25,916 37.8 % Professional 46,911 62.3 % 42,626 62.2 % Total Revenues $ 75,316 100.0 % $ 68,542 100.0 % Real Estate Revenues : Real Estate revenues increased approximately $2.5 million (9.6%). The increase was driven by a 13.0% increase in average bill rate, offset by 3.0% decrease in billed hours. Professional Revenues : Professional revenues were up $4.3 million (10.1%). Horn Solutions contributed $6.8 million in revenue while the remaining Professional business declined $2.5 million (5.9%) versus the prior year. Gross Profit: Gross profit represents revenues from workforce solutions less cost of services expenses, which consist of payroll, payroll taxes, payroll-related insurance, field talent costs, and reimbursable costs. Thirteen Weeks Ended April 2, 2023 March 27, 2022 (dollars in thousands) Gross Profit by segment: Real Estate $ 11,347 42.4 % $ 9,971 42.6 % Professional 15,437 57.6 % 13,460 57.4 % Total Gross Profit $ 26,784 100.0 % $ 23,431 100.0 % Thirteen Weeks Ended April 2, 2023 March 27, 2022 Gross Profit Percentage by segment: Real Estate 39.9 % 38.5 % Professional 32.9 % 31.6 % Company Gross Profit 35.6 % 34.2 % Total company gross profit increased approximately $3.4 million (14.3%). As a percentage of revenue, gross profit increased to 35.6% from 34.2%, with both segments contributing to the increase. We determine spread as the difference between bill rate and pay rate. Real Estate Gross Profit: Real Estate gross profit increased approximately $1.4 million (13.8%) in line with the increase in revenue, and a 17.3% increase in average spread. Professional Gross Profit: Professional gross profit increased approximately $2.0 million (14.7%). Horn Solutions contributed $3.0 million in gross profit while the remaining Professional business declined $1.0 million (7.3%). 27 Selling, General and Administrative Expenses: Selling, general and administrative expenses ("SGA") increased $3.5 million versus the prior year. While selling expenses are not separated from general and administrative expenses in the expense categories below, total selling expenses increased $2.7 million (approximately 78% of the $3.5 million increase) versus the prior year. Total selling expenses included $2.2 million related to Horn Solutions. Acquisition transaction fees increased $0.3 million versus the prior year. Thirteen Weeks Ended April 2, 2023 March 27, 2022 Amount % of Revenue Amount % of Revenue $ Change % Change (dollars in thousands) Compensation and related $ 17,951 24 % $ 15,236 22 % $ 2,715 18 % Advertising and recruitment 594 1 % 483 1 % 111 1 % Occupancy and office operations 792 1 % 797 1 % (5) (1) % Travel, meals and entertainment 331 — % 189 — % 142 75 % Software 1,485 2 % 1,115 2 % 370 33 % Liability insurance 265 — % 240 — % 25 10 % Professional fees 458 1 % 421 1 % 37 9 % Public company related costs 185 — % 173 — % 12 7 % Bad debt 79 — % 51 — % 28 55 % Share-based compensation 361 — % 211 — % 150 71 % Transaction fees 319 — % — — % 319 — % Other 392 1 % 801 1 % (409) (51) % Total $ 23,212 31 % $ 19,717 29 % $ 3,495 18 % Depreciation and Amortization: Depreciation and amortization charges increased $0.9 million primarily due to amortization of intangible assets created by the Horn Solutions acquisition. Impairment losses: At the February 2023 Board of Directors meeting, managements's plan to rebrand as BGSF was approved, which will eliminate the use of various trade names. The decision to rebrand created an impairment of $22.5 million in trade names, which was written-off during Fiscal 2023. Interest Expense, net: Interest expense, net increased $0.9 million primarily due to debt related to the Horn Solutions acquisition, higher interest rates, and a higher average balance on the Revolving Facility (as defined below). Income Tax: We recorded a tax benefit of approximately $5.5 million, primarily due to impairment losses on trade names versus a tax expense of approximately 0.5% million in 2022. Use of Non-GAAP Financial Measures We present Adjusted EBITDA (defined below), a measure that is not in accordance with accounting principles generally accepted in the United States of America (“non-GAAP”), in this Quarterly Report to provide investors with a supplemental measure of our operating performance. We believe that Adjusted EBITDA is a useful performance measure and is used by us to facilitate a comparison of our operating performance on a consistent basis from period-to-period and to provide for a more complete understanding of factors and trends affecting our business than measures under accounting principles generally accepted in the United States of America (“GAAP”) can provide alone. Our board and management also use Adjusted EBITDA as one of the primary methods for planning and forecasting overall expected performance and for evaluating on a quarterly and annual basis actual results against such expectations, and as a performance evaluation metric in determining achievement of certain compensation programs and plans for our management. In addition, the financial covenants in our credit agreement are based on EBITDA, as defined in the credit agreement. We define “Adjusted EBITDA” as earnings before interest expense, income taxes, depreciation and amortization expense, impairment losses, transaction fees, and certain non-cash expenses such as share-based compensation expense. Omitting interest, taxes, and the other items provides a financial measure that facilitates comparisons of our results of operations with those of companies having different capital structures. Since the levels of indebtedness and tax structures that other companies 28 have are different from ours, we omit these amounts to facilitate investors’ ability to make these comparisons. Similarly, we omit depreciation and amortization because other companies may employ a greater or lesser amount of property and intangible assets. We also believe that investors, analysts and other interested parties view our ability to generate Adjusted EBITDA as an important measure of our operating performance and that of other companies in our industry. Adjusted EBITDA should not be considered as an alternative to net (loss) income from continuing operations for the periods indicated as a measure of our performance. Other companies in our industry may calculate Adjusted EBITDA differently than we do, limiting its usefulness as a comparative measure. The use of Adjusted EBITDA has limitations as an analytical tool, and you should not consider this performance measure in isolation from, or as an alternative to, GAAP measures such as net (loss) income. Adjusted EBITDA is not a measure of liquidity under GAAP or otherwise, and is not an alternative to cash flow from continuing operating activities. Our presentation of Adjusted EBITDA should not be construed as an inference that our future results will be unaffected by the expenses that are excluded from that term or by unusual or non-recurring items. The limitations of Adjusted EBITDA include: (i) it does not reflect our cash expenditures or future requirements for capital expenditures or contractual commitments; (ii) it does not reflect changes in, or cash requirements for, our working capital needs; (iii) it does not reflect income tax payments we may be required to make; and (iv) it does not reflect the cash requirements necessary to service interest or principal payments associated with indebtedness. To properly and prudently evaluate our business, we encourage you to review our unaudited consolidated financial statements included elsewhere in this report and the reconciliation to Adjusted EBITDA from net (loss) income from continuing operations the most directly comparable financial measure presented in accordance with GAAP, set forth in the following table. All of the items included in the reconciliation from net (loss) income from continuing operations to Adjusted EBITDA are either (i) non-cash items or (ii) items that management does not consider in assessing our on-going operating performance. In the case of the non-cash items, management believes that investors may find it useful to assess our comparative operating performance because the measures without such items are less susceptible to variances in actual performance resulting from depreciation, amortization and other non-cash charges and more reflective of other factors that affect operating performance. In the case of the other items that management does not consider in assessing our on-going operating performance, management believes that investors may find it useful to assess our operating performance if the measures are presented without these items because their financial impact may not reflect ongoing operating performance. Thirteen Weeks Ended Trailing Twelve Months Ended April 2, 2023 March 27, 2022 April 2, 2023 (dollars in thousands) (Loss) Income from continuing operations $ (16,466) $ 2,008 $ (7,002) Income tax (benefit) expense from continuing operations (5,464) 534 (2,553) Interest expense, net 1,200 273 2,289 Operating (loss) income (20,730) 2,815 (7,266) Depreciation and amortization 1,757 899 4,911 Impairment losses 22,545 — 22,545 Share-based compensation 361 211 1,234 Transaction fees 319 — 600 Adjusted EBITDA from continuing operations $ 4,252 $ 3,925 $ 22,024 Adjusted EBITDA % of revenue 5.6 % 5.7 % 7.3 % Liquidity and Capital Resources Our working capital requirements are primarily driven by field talent payments, tax payments and client partner accounts receivable receipts. Since receipts from client partners lag payments to field talent, working capital requirements increase substantially in periods of growth. Our primary sources of liquidity are cash generated from operations and borrowings under our amended credit agreement with BMO, that provides for a revolving credit facility maturing July 16, 2024 (the “Revolving Facility”). Our primary uses of cash are payments to field talent, team members, related payroll liabilities, operating expenses, capital expenditures, cash interest, cash taxes, dividends, and contingent consideration and debt payments. We believe that the cash generated from 29 operations, together with the borrowing availability under our Revolving Facility, will be sufficient to meet our normal working capital needs for at least the next twelve months, including investments made, and expenses incurred, in connection with opening new markets throughout the next year. Our ability to continue to fund these items may be affected by general economic, competitive and other factors, many of which are outside of our control. If our future cash flow from operations and other capital resources are insufficient to fund our liquidity needs, we may be forced to obtain additional debt or equity capital or refinance all or a portion of our debt. While we believe we have sufficient liquidity and capital resources to meet our current operating requirements and expansion plans, we may elect to pursue additional growth opportunities within the next year that could require additional debt or equity financing. If we are unable to secure additional financing at favorable terms in order to pursue such additional growth opportunities, our ability to pursue such opportunities could be materially adversely affected. A summary of our working capital, operating, investing and financing activities are shown in the following table: April 2, 2023 January 1, 2023 (dollars in thousands) Working capital $ 47,395 $ 47,955 Thirteen Weeks Ended April 2, 2023 March 27, 2022 (dollars in thousands) Net cash provided by (used in) continuing operations: Operating activities $ 3,939 $ (1,060) Investing activities (745) 28,262 Financing activities (3,124) (27,963) Net change in cash and cash equivalents discontinued operations — 649 Net change in cash and cash equivalents $ 70 $ (112) Operating Activities Cash provided by operating activities consists of net (loss) income adjusted for non-cash items, including depreciation and amortization, share-based compensation expense, interest expense, impairment losses, and the effect of working capital changes. The primary drivers of cash inflows and outflows are accounts receivable, accrued payroll and expenses, and income taxes payable. During Fiscal 2023, net cash provided by continuing operating activities was $3.9 million an increase of $5.0 million compared with net cash used in continuing operating activities of $1.1 million for Fiscal 2022. This increase is primarily attributable to payments received on account receivable, and prior year payments of deferred employer FICA for the CARES Act in other current liabilities, partially offset by a decrease in income taxes payable. Investing Activities Cash used in investing activities consists primarily of cash paid for businesses acquired, cash received for businesses sold, and capital expenditures. In Fiscal 2023, we made capital expenditures of $0.7 primarily related to continued information technology improvements. In Fiscal 2022, we received $30.3 million in connection to the sale of InStaff and made capital expenditures of $2.1 related to the information technology improvement project. 30 Financing Activities Cash flows from financing activities consisted principally of borrowings and payments under our credit agreement and payment of dividends. For Fiscal 2023, we disbursed $1.6 million in cash dividends on our common stock, we paid down $1.0 million on the Term Loan, and reduced our Revolving Facility $0.6 million. For Fiscal 2022, we paid down $26.9 million on the Term Loan, disbursed $1.6 million in cash dividends on our common stock, and made payments of $1.1 million of contingent consideration related to the Momentum acquisition. We borrowed $1.4 million on our Revolving Facility for increased working capital needs. Credit Agreements On July 16, 2019, we entered into a Credit Agreement (the “Credit Agreement”), maturing July 16, 2024, led by BMO, as lead administrative agent, lender, letters of credit issuer, and swing line lender. The Credit Agreement provides for the Revolving Facility permitting us to borrow funds from time to time in an aggregate amount up to $35 million. The Credit Agreement also provided for a term loan commitment (the “Term Loan”) permitting us to borrow funds from time to time in an aggregate amount not to exceed $30 million with principal payable quarterly, based on an annual percentage of the original principal amount as defined in the Credit Agreement, all of which has been funded and repaid. We also had the option to request an increase in in the aggregate Term Loan by $40 million, which was done in connection with the Horn Solutions acquisition. The Credit Agreement bore interest either at the Base Rate plus the Applicable Margin or LIBOR plus the Applicable Margin through August 17, 2022 (as such terms are defined in the Credit Agreement). We pay an unused commitment fee on the daily average unused amount of Revolving Facility. On August 18, 2022, we entered into an amendment to the Credit Agreement (as amended, the “Amended Credit Agreement”) which changed the interest rate component from LIBOR to the SOFR, plus the Applicable Margin. In connection with the Horn Solutions acquisition on December 12, 2022 (See “Note 3 - Acquisitions” of our unaudited consolidated financial statements), we borrowed $40 million, as noted above, pursuant to a second amendment to the credit agreement (“Second Credit Amendment”). Our obligations under the Second Credit Amendment are secured by a first priority security interest in substantially all tangible and intangible property of the Company and its subsidiaries. The Second Credit Amendment bears interest either at the Base Rate plus the Applicable Margin or Adjusted Term SOFR plus the Applicable Margin (as such terms are defined in the Second Credit Amendment), with 2.5% of the original principal balance of the New Term Loan payable on the last business day of each quarter, beginning on March 31, 2023. At closing of the Arroyo Consulting acquisition, $6.8 million of the closing price was paid from available funds under our credit agreement with BMO. The Second Credit Amendment contains customary affirmative and negative covenants. We are subject to a maximum Leverage Ratio and a minimum Fixed Charge Coverage Ratio as defined in the Second Credit Amendment. We were in compliance with these covenants as of April 2, 2023. Off-Balance Sheet Arrangements Letter of Credit In March 2020, in conjunction with the EdgeRock acquisition, we entered into a standby letter of credit arrangement, which expires December 31, 2024, for purposes of protecting a lessor against default on lease payments. As of April 2, 2023, we had a maximum financial exposure from this standby letter of credit totaling $0.1 million, all of which is considered usage against our Revolving Facility. Critical Accounting Policies and Estimates Our consolidated financial statements are prepared in accordance with GAAP. In connection with the preparation of our consolidated financial statements, we are required to make assumptions and estimates about future events, and apply judgments that affect the reported amount of assets, liabilities, revenue, expenses and the related disclosures. We base our assumptions, estimates and judgments on historical experience, current trends, and other factors that management believes to be relevant at the time our consolidated financial statements are prepared. On a regular basis, management reviews the accounting policies, estimates, assumptions and judgments to ensure that our consolidated financial statements are presented fairly and in accordance with GAAP. However, because future events and their effects cannot be determined with certainty, actual results could differ from our assumptions and estimates, and such differences could be material. 31 Our significant accounting policies are discussed in Note 2, Summary of Significant Accounting Policies, of the Notes to Unaudited Consolidated Financial Statements included in “Item 1. Financial Statements.” Please also refer to our Annual Report on Form 10-K for the fiscal year ended January 1, 2023 for a more detailed discussion of our critical accounting policies. As a result of the economic uncertainty, we may need to make necessary changes to accounting policy judgments and estimates over time, which could result in meaningful impacts to our financial statements in future periods. Actual results and outcomes may differ from our estimates and assumptions. The current inflationary environment and related interest rate impacts continue to have significant adverse impact on the economy and market conditions. These factors may impact labor markets by reducing demand for our workforce solutions, increase early terminations, or diminish projects. As a result, our business, financial condition and results of operations may be negatively affected, and could increase our cost of borrowing. Revenue Recognition We derive our revenues from continuing operations in Real Estate and Professional segments. We provide workforce solutions, placement services, and managed services. Revenues are recognized when promised workforce solutions are delivered to client partners, in an amount that reflects the consideration we expect to be entitled to in exchange for those services. We recognize revenue through the following types of services: workforce solutions, contingent placements, retained search placements, and managed services. Intangible Assets We hold intangible assets with indefinite and finite lives. Intangible assets with indefinite useful lives are not amortized. Intangible assets with finite useful lives are amortized over their respective estimated useful lives, ranging from three to ten years, based on a pattern in which the economic benefit of the respective intangible asset is realized. We capitalize purchased software and internal payroll costs directly incurred in the modification of software for internal use. Software maintenance and training costs are expensed in the period incurred. Goodwill Goodwill represents the difference between the enterprise value/cash paid less the fair value of all recognized net asset fair values including identifiable intangible asset values in a business combination. We review goodwill for impairment annually during the fourth quarter or whenever events or changes in circumstances indicate the carrying value of goodwill may not be recoverable. Income Taxes The current provision for income taxes represents estimated amounts payable or refundable on tax returns filed or to be filed for the year. We recognizes any penalties when necessary as part of selling, general and administrative expenses. Deferred tax assets and liabilities are recorded for the estimated future tax effects of temporary differences between the tax basis of assets and liabilities and amounts are classified net as noncurrent in the consolidated balance sheets. Deferred tax assets are also recognized for net operating loss and tax credit carryovers. When appropriate, we will record a valuation allowance against net deferred tax assets to offset future tax benefits that may not be realized. We follow the guidance of Accounting Standards Codification (“ASC”) Topic 740, Accounting for Uncertainty in Income Taxes. Recent Accounting Pronouncements For a discussion of recent accounting pronouncements and their potential effect on our results of operations and financial condition, refer to Note 2 in the Notes to the Unaudited Consolidated Financial Statements in this Quarterly Report on Form 10-Q and Note 2 in the Notes to the Consolidated Financial Statements in our Annual Report on Form 10-K for the fiscal year ended January 1, 2023. 32