**SECURITIES AND EXCHANGE COMMISSION**

**WASHINGTON, D.C. 20549**

 

**FORM 10-Q**

 

**QUARTERLYREPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF1934**

 

**For the quarterly period endedMarch 31, 2004**

 

**Commission file number 0-23940**

 

**ALTERNATIVERESOURCES CORPORATION**

(Exact name ofregistrant as specified in its charter)

 

| **Delaware**                                                     |   | **38-2791069**                        |
|------------------------------------------------------------------|--------|---------------------------------------|
| (State or other  jurisdiction of  incorporation or organization) |   | (I.R.S. Employer  Identification No.) |
|                                                             |   |                                  |
| **600 Hart Road, Suite 300,  Barrington, IL**                    |   | **60010**                             |
| (Address of  principal executive offices)                        |   | (Zip code)                            |
|                                                             |   |                                  |
| **(847) 381-6701**                                               |
| (Registrant’s  telephone number, including area code)       |

 

Indicate by check markwhether the registrant (1) has filed all reports required to be filed bySection 13 or 15(d) of the Securities Exchange Act of 1934 during thepreceding 12 months (or for such shorter period that the registrant wasrequired to file such reports), and (2) has been subject to such filingrequirements for the past 90 days.  YES  ý  NO  o.

 

Indicate by check markwhether the registrant (1) is an accelerated filer (as defined in Rule 12b-2 ofthe Act). YES  o NO  ý.

 

Indicate the number ofshares outstanding of each of the issuer’s classes of common stock, as of thelatest practicable date:

 

17,117,304shares of the registrant’s common stock were outstanding as of May 5, 2004.

 

 

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**ALTERNATIVE RESOURCES CORPORATION**

**FORM 10-Q**

**INDEX**

 
| PART  I. FINANCIAL INFORMATION                                                                       |                                                                                                                         |
|------------------------------------------------------------------------------------------------------|------------------------------------------------------------------------------------------------------------------------------|
|                                                                                                 |                                                                                                                         |
| Item  1. Financial Statements                                                                        |                                                                                                                         |
|                                                                                                 |                                                                                                                         |
|                                                                                                 | Consolidated Balance Sheets  at March 31, 2004 (Unaudited) and December 31, 2003                                   |   |
|                                                                                                 |                                                                                                                         |   |
|                                                                                                 | Consolidated  Statements of Operations for the three months ended March 31, 2004 and  2003 (Unaudited)                  |   |
|                                                                                                 |                                                                                                                         |   |
|                                                                                                 | Consolidated Statements of Comprehensive  Income (Loss) for the three months ended March 31, 2004 and 2003  (Unaudited) |   |
|                                                                                                 |                                                                                                                         |   |
|                                                                                                 | Consolidated  Statements of Cash Flows for the three months ended March 31, 2004 and  2003 (Unaudited)                  |   |
|                                                                                                 |                                                                                                                         |   |
|                                                                                                 | Notes to Consolidated  Financial Statements (Unaudited)                                                                      |   |
|                                                                                                 |                                                                                                                         |
| 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  6. Exhibits and Reports on Form 8-K.                                                           |                                                                                                                         |
|                                                                                                 |                                                                                                                         |
| SIGNATURES.                                                                                          |                                                                                                                         |

 

2

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**PART I****- FINANCIAL INFORMATION**

 

**Item 1****. -Financial Statements**

 

**ALTERNATIVE RESOURCES CORPORATION**

**CONSOLIDATED BALANCE SHEETS**

(In thousands,except share data)

 
|                                                                                                                                                                 |   | **December 31,  2003** |   | **March 31,  2004** |   |
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|-----------------------------|--------|--------------------------|--------|
|                                                                                                                                                                 |   |                        |   | **(Unaudited)**          |   |
| **ASSETS**                                                                                                                                                           |   |                        |   |                     |   |
| **Current Assets:**                                                                                                                                                  |   |                        |   |                     |   |
| Cash  and cash equivalents                                                                                                                                           |   | $                           | 19     |                     | $      | 63 |   |
| Trade  accounts receivable, net of allowance for doubtful accounts of $326 at  December 31, 2003 and March 31, 2004                                             |   | 21,423                      |   | 20,469                   |   |
| Prepaid  expenses                                                                                                                                                    |   | 1,217                       |   | 1,088                    |   |
| Income  taxes receivable                                                                                                                                             |   | 76                          |   | 76                       |   |
| Other  assets                                                                                                                                                        |   | 442                         |   | 452                      |   |
| Total  current assets                                                                                                                                                |   | 23,177                      |   | 22,148                   |   |
| **Property  and Equipment:**                                                                                                                                         |   |                        |   |                     |   |
| Office  equipment                                                                                                                                                    |   | 8,413                       |   | 8,413                    |   |
| Furniture  and fixtures                                                                                                                                              |   | 2,389                       |   | 2,389                    |   |
| Software                                                                                                                                                             |   | 19,786                      |   | 19,835                   |   |
| Leasehold  improvements                                                                                                                                              |   | 1,998                       |   | 1,998                    |   |
|                                                                                                                                                                 |   | 32,586                      |   | 32,635                   |   |
| Less  accumulated depreciation and amortization                                                                                                                      |   | (25,053                     | )      | (25,914                  | )      |
| Net  property and equipment                                                                                                                                          |   | 7,533                       |   | 6,721                    |   |
| **Other  Assets:**                                                                                                                                                   |   |                        |   |                     |   |
| Goodwill                                                                                                                                                             |   | 2,723                       |   | 2,723                    |   |
| Deposits                                                                                                                                                             |   | 380                         |   | 343                      |   |
| Total  other assets                                                                                                                                                  |   | 3,103                       |   | 3,066                    |   |
| Total  assets                                                                                                                                                        |   | $                           | 33,813 |                     | $      | 31,935 |   |
|                                                                                                                                                                 |   |                        |   |                     |   |
| **LIABILITIES AND STOCKHOLDERS’  EQUITY (DEFICIT)**                                                                                                             |   |                        |   |                     |   |
| **Current  Liabilities:**                                                                                                                                            |   |                        |   |                     |   |
| Cash  overdraft                                                                                                                                                      |   | $                           | 2,213  |                     | $      | 2,018 |   |
| Short-term  debt                                                                                                                                                     |   | 11,789                      |   | 12,393                   |   |
| Accounts  payable                                                                                                                                                    |   | 11,223                      |   | 9,852                    |   |
| Payroll  and related expenses                                                                                                                                        |   | 4,660                       |   | 4,919                    |   |
| Accrued  expenses                                                                                                                                                    |   | 1,434                       |   | 1,955                    |   |
| Accrued  restructuring and other charges                                                                                                                             |   | 3,019                       |   | 2,559                    |   |
| Income  taxes payable                                                                                                                                                |   | 697                         |   | 697                      |   |
| Total  current liabilities                                                                                                                                           |   | 35,035                      |   | 34,393                   |   |
| Long-term  debt                                                                                                                                                      |   | 14,725                      |   | 15,349                   |   |
| Other  liabilities                                                                                                                                                   |   | 438                         |   | 448                      |   |
| Total  liabilities                                                                                                                                                   |   | 50,198                      |   | 50,190                   |   |
| **Stockholders’  Equity (Deficit):**                                                                                                                            |   |                        |   |                     |   |
| Preferred  stock ($.01 par value, 1,000,000 shares authorized; none issued and  outstanding)                                                                         |   | —                      |   | —                   |   |
| Common  stock ($.01 par value, 50,000,000 shares authorized; 17,703,104 shares issued  and 17,117,304 outstanding at December 31, 2003 and March 31, 2004) |   | 178                         |   | 178                      |   |
| Additional  paid-in capital                                                                                                                                          |   | 30,764                      |   | 30,764                   |   |
| Accumulated  other comprehensive loss                                                                                                                                |   | (56                         | )      | (79                      | )      |
| Accumulated  deficit                                                                                                                                                 |   | (42,474                     | )      | (44,321                  | )      |
|                                                                                                                                                                 |   | (11,588                     | )      | (13,458                  | )      |
| Less:  Treasury stock, at cost (585,800 shares)                                                                                                                      |   | (4,797                      | )      | (4,797                   | )      |
| Total  stockholders’ deficit                                                                                                                                    |   | (16,385                     | )      | (18,255                  | )      |
| Total  liabilities and stockholders’ deficit                                                                                                                    |   | $                           | 33,813 |                     | $      | 31,935 |   |

 

See accompanyingnotes to consolidated financial statements.

 

3

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**ALTERNATIVE RESOURCES CORPORATION**

**CONSOLIDATED STATEMENTS OF OPERATIONS**

(In thousands,except per share data)

 
|                                        |   | **Three  Months  Ended March 31,** |   |
|---------------------------------------------|--------|-----------------------------------------|--------|
|                                        |   | **2003**                                |   | **2004** |   |
|                                        |   | **(Unaudited)**                         |   |
|                                        |   |                                    |   |
| Revenue                                     |   | $                                       | 36,846 |   | $ | 29,130 |   |
| Cost  of services                           |   | 27,668                                  |   | 22,453 |   |
| Gross  profit                               |   | 9,178                                   |   | 6,677 |   |
|                                        |   |                                    |   |   |   |
| Operating  expenses:                        |   |                                    |   |   |   |
| Selling,  general and administrative        |   | 8,921                                   |   | 6,662 |   |
| Depreciation  and amortization              |   | 929                                     |   | 861 |   |
| Other  charges                              |   | —                                  |   | 38 |   |
| Total  operating expenses                   |   | 9,850                                   |   | 7,561 |   |
| Loss  from operations                       |   | (672                                    | )      | (884 | ) |
| Other  expense, principally interest, net   |   | (983                                    | )      | (959 | ) |
| Loss  before income taxes                   |   | (1,655                                  | )      | (1,843 | ) |
| Income  tax expense (benefit)               |   | (1                                      | )      | 4 |   |
|                                        |   |                                    |   |   |   |
| Net  loss                                   |   | $                                       | (1,654 | ) | $ | (1,847 | ) |
|                                        |   |                                    |   |   |   |
| Net  loss per share:                        |   |                                    |   |   |   |
| Basic  and diluted                          |   | $                                       | (0.10  | ) | $ | (0.11 | ) |
|                                        |   |                                    |   |   |   |
| Shares  used to compute net loss per share: |   |                                    |   |   |   |
| Basic  and diluted                          |   | 17,117                                  |   | 17,117 |   |

 

See accompanyingnotes to consolidated financial statements.

 

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**ALTERNATIVE RESOURCES CORPORATION**

**CONSOLIDATED STATEMENTS OF**

**COMPREHENSIVE INCOME (LOSS)**

(In thousands)

 
|                                                 |   | **Three  Months  Ended March 31,** |   |
|------------------------------------------------------|--------|-----------------------------------------|--------|
|                                                 |   | **2003**                                |   | **2004** |   |
|                                                 |   | **(Unaudited)**                         |   |
|                                                 |   |                                    |   |
| Net  loss                                            |   | $                                       | (1,654 | ) | $ | (1,847 | ) |
|                                                 |   |                                    |   |   |   |   |   |
| Other  comprehensive income (loss):                  |   |                                    |   |   |   |
| Foreign  currency translation adjustment, net of tax |   | (35                                     | )      | (23 | ) |
| Other  comprehensive loss                            |   | (35                                     | )      | (23 | ) |
|                                                 |   |                                    |   |   |   |
| Comprehensive  loss                                  |   | $                                       | (1,689 | ) | $ | (1,870 | ) |

 

See accompanyingnotes to consolidated financial statements.

 

5

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**ALTERNATIVE RESOURCES CORPORATION**

**CONSOLIDATED STATEMENTS OF CASH FLOWS**

(In thousands)

 
|                                                                                      |   | **Three  Months Ended  March 31,** |   |
|-------------------------------------------------------------------------------------------|--------|-----------------------------------------|--------|
|                                                                                      |   | **2003**                                |   | **2004** |   |
|                                                                                      |   | **(Unaudited)**                         |   |
|                                                                                      |   |                                    |   |   |   |
| **Cash  flows from operating activities:**                                                |   |                                    |   |   |   |
| Net  loss                                                                                 |   | $                                       | (1,654 | ) | $ | (1,847 | ) |
| Adjustments  to reconcile net loss to net cash provided by (used in)operating activities: |   |                                    |   |   |   |
| Depreciation  and amortization                                                            |   | 929                                     |   | 861 |   |
| Provision  for (recoveries of) doubtful accounts                                          |   | (39                                     | )      | 21 |   |
| Non-cash  interest expense from deferred financing costs                                  |   | 131                                     |   | 100 |   |
| Non-cash  interest expense from accretion of warrants                                     |   | 112                                     |   | — |   |
| Non-cash  interest expense from security purchase agreement                               |   | 425                                     |   | 624 |   |
| Change  in assets and liabilities:                                                        |   |                                    |   |   |   |
| Trade  accounts receivable                                                                |   | 8,782                                   |   | 933 |   |
| Prepaid  expenses                                                                         |   | 155                                     |   | 129 |   |
| Income  taxes receivable                                                                  |   | 63                                      |   | — |   |
| Other  assets                                                                             |   | 64                                      |   | (110 | ) |
| Deposits                                                                                  |   | 6                                       |   | 37 |   |
| Accounts  payable                                                                         |   | (1,333                                  | )      | (1,371 | ) |
| Payroll  and related expenses                                                             |   | (88                                     | )      | 259 |   |
| Accrued  expenses and other liabilities                                                   |   | (714                                    | )      | 71 |   |
| Net  cash provided by (used in) operating activities                                      |   | 6,839                                   |   | (293 | ) |
|                                                                                      |   |                                    |   |   |   |
| **Cash  flows from investing activities:**                                                |   |                                    |   |   |   |
| Purchases  of property and equipment                                                      |   | (120                                    | )      | (49 | ) |
| Net  cash used in investing activities                                                    |   | (120                                    | )      | (49 | ) |
|                                                                                      |   |                                    |   |   |   |
| **Cash  flows from financing activities:**                                                |   |                                    |   |   |   |
| Proceeds  from short-term debt                                                            |   | 55,166                                  |   | 45,723 |   |
| Payments  on short-term debt                                                              |   | (61,484                                 | )      | (45,119 | ) |
| Cash  overdraft                                                                           |   | (377                                    | )      | (195 | ) |
| Net  cash provided by (used in) financing activities                                      |   | (6,695                                  | )      | 409 |   |
| Effect  of exchange rate changes                                                          |   | (35                                     | )      | (23 | ) |
|                                                                                      |   |                                    |   |   |   |
| Net  increase (decrease) in cash and cash equivalents                                     |   | (11                                     | )      | 44 |   |
| Cash  and cash equivalents at beginning of period                                         |   | 54                                      |   | 19 |   |
| Cash  and cash equivalents at end of period                                               |   | $                                       | 43     |   | $ | 63 |   |
|                                                                                      |   |                                    |   |   |   |
| Supplemental  disclosures of cash flow information:                                       |   |                                    |   |   |   |
| Cash  paid for interest                                                                   |   | $                                       | 310    |   | $ | 238 |   |
| Cash  paid for income taxes                                                               |   | 1                                       |   | 4 |   |
| Cash  refunds received for income taxes                                                   |   | 65                                      |   | — |   |

 

See accompanyingnotes to consolidated financial statements.

 

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**ALTERNATIVE RESOURCES CORPORATION**

**NOTES TO CONSOLIDATED FINANCIALSTATEMENTS**

**(UNAUDITED)**

 

**1.****                    Basisof Presentation**

 

The interim consolidatedfinancial statements presented are unaudited, but in the opinion of management,have been prepared in conformity with accounting principles generally acceptedin the United States of America applied on a basis consistent with those of theannual financial statements.  Suchinterim consolidated financial statements reflect all adjustments (consistingprincipally of normal recurring accruals) necessary for a fair presentation ofthe financial position and the results of operations for the interim periodspresented.  The results of operationsfor the interim periods presented are not necessarily indicative of the resultsto be expected for any other interim period or for the year endingDecember 31, 2004.  The interimconsolidated financial statements should be read in connection with the auditedconsolidated financial statements for the year ended December 31, 2003,included in the 2003 Form 10-K of Alternative Resources Corporation (“ARC” orthe “Company”).

 

Certain prior yearbalances have been reclassified in order to conform to the current yearpresentation.

 

##### **2.**                    Stock Options

 

The Company accounts forits stock options in accordance with the provisions of Accounting PrinciplesBoard Opinion No. 25, “Accounting for Stock Issued to Employees” (APB25) and related interpretations. Under APB 25, no compensation cost hasbeen recognized for the Company’s stock-based compensation plans. The Companycontinues to apply the provisions of APB 25 and provides the pro formadisclosures required by Statement of Financial Accounting Standards No. 123,“Accounting for Stock-Based Compensation” (SFAS 123) and SFAS No. 148,“Accounting for Stock-Based Compensation-Transition and Disclosure-an Amendmentof FASB Statement No. 123” (SFAS 148).

 

The following datareflect the pro forma effects of the stock-based compensation cost for theCompany’s stock option transactions in accordance with SFAS No. 123 and SFASNo. 148:

 
|                            |   | **Three  Months Ended  March 31,**    |         |
|---------------------------------|--------|--------------------------------------------|--------------|
|                            |   | **2003**                                   |         | **2004** |   |
|                            |   | **(in thousands, except  per share data)** |         |
|                            |   |                                       |         |
| Net  loss, as reported          |   | $                                          |  (1,654 | ) | $ | (1,847 | ) |
| Pro  forma compensation expense |   | (74                                        | )            | (45 | ) |
|                            |   |                                       |         |   |   |
| Pro  forma net loss             |   | $                                          |  (1,728 | ) | $ | (1,892 | ) |
|                            |   |                                       |         |   |   |
| Diluted  loss per share:        |   |                                       |         |   |   |
| As  reported                    |   | $                                          |  (0.10  | ) | $ | (0.11 | ) |
| Pro  forma                      |   | (0.10                                      | )            | (0.11 | ) |

 

Duringthe first quarter of 2004, there were no options granted. The fair value ofeach option is estimated on the date of grant using the Black-Scholesoption-pricing model.  The followingweighted average assumptions were used for options granted for the three monthsended March 31, 2003: risk-free interest rates of 3.8%; expected lives of 7years; expected volatility of 165%; and no dividends expected to be paid.

 

**3.****                    Computationof Earnings (Loss) per Share**

 

Basic earnings (loss) pershare is based on the weighted average number of common shares outstanding forthe period.  Diluted earnings (loss) pershare is based on the weighted average number of common shares outstanding andincludes the dilutive effect of unexercised stock options and warrants whichare in-the-money using the treasury stock method.   Dilutive securities have not been included in the weightedaverage shares used for the calculation of earnings per share in periods of netloss because the effect of such securities would be anti-dilutive. AtMarch 31, 2003 and 2004, potentially dilutive securities consisted ofoptions to purchase 5 thousand and 354 thousand shares of common stock,respectively.  In addition, the Companyissued 11.0 million warrants to purchase common stock in connection with itsdebt refinancing described in Note 4. These warrants are also potentially dilutive securities as ofMarch 31, 2003 and 2004.

 

7

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##### **4.**                    Borrowings

 

***Short-Term Borrowings:***

 

On January 31, 2002,the Company replaced its existing bank line with a $30.0 million senior securedrevolving credit facility with Fleet Capital Corporation, a subsidiary of theFleetBoston Financial Corporation.

 

The $30.0 millionrevolving credit facility is secured by the assets of the Company, principallyconsisting of accounts receivable.  Thecredit facility has a three-year term and bears interest at LIBOR plus 3.25% orthe bank’s base rate plus 2.00%.

 

Throughout 2002, theCompany and Fleet Capital Corporation executed four amendments to the revolvingcredit agreement.  These amendments wererequired to waive events of default that occurred relative to the fixed chargeand tangible net worth covenants.  Bothcovenants were reset with tangible net worth reestablished at $2.8 million andthe fixed charge covenant reestablished at an allowable shortfall of $0.7million through October 1, 2002 and a ratio of 1:1, thereafter.  In addition, the borrowing limit subject topledged accounts receivable as collateral was reduced to $28.0 million andcertain restrictions were placed on the amount of capital spending inconsideration for the waiver of existing financial loan covenants.

 

In 2003, the Company andFleet Capital Corporation executed additional amendments to the revolvingcredit agreement. The Fifth Amendment addressed the fact that the Company hadentered into litigation with a major customer, Bluecurrent.  This action eliminated that account from theCompany’s borrowing base creating a borrowing overadvance.  The amendment allowed for an overadvance of$2.0 million through December 31, 2003. In addition, the amendment waived the events of default relative to thefixed charge and tangible net worth covenants that occurred atDecember 31, 2002.  The tangiblenet worth covenant was reset at ($1.0) million and the fixed charge shortfall wasset to $1.0 million through March 31, 2003 and $1.4 million up throughJune 30, 2003 and a ratio of 1:1, thereafter.  The Sixth Amendment eliminated the requirement that any amountsreceived as a result of the settlement with Bluecurrent reduce the WynnchurchCapital Partners, L.P. guarantee as discussed below.  The Seventh Amendment waived the events of default as ofJune 30, 2003 relating to the tangible net worth and fixed chargecovenants.   Additionally, the covenantswere reset for the remainder of 2003 as follows; the tangible net worth covenantwas reset to ($5.0) million with the fixed charge covenant reset to anallowable shortfall of $0.7 million for the three months endedSeptember 30, 2003, and $1.0 million for the six months endedDecember 31, 2003. The fixed charge covenant will be 1:1, thereafter. Inaddition, the interest rate was changed effective August 1, 2003 from thebank’s base rate plus 1.00% to the base rate plus 2.00%. As of March 31,2004, the applicable rate is 6.00%, which represents the bank’s base rate plus 2.00%.  The Seventh Amendment also reduced themaximum revolving credit commitment from $28.0 million to $23.0 million.  The Eighth Amendment waived the events ofdefault as of September 30, 2003 relating to the tangible net worth andfixed charge covenants.  Additionally,the covenants were reset for future periods as follows: the tangible net worthcovenant was reset to ($8.5) million for the quarter ending December 31,2003 and each quarter thereafter.  Thefixed charge covenant was reset to an allowable shortfall of $1.0 million forthe three months ending December 31, 2003, $1.8 million for the six monthsended March 31, 2004, and $1.9 million for the nine months endingJune 30, 2004.  The fixed chargecovenant will be 1:1, thereafter. Capital expenditures will also be limited to $50,000 per quartercommencing with the quarter ended December 31, 2003.  The Company was in compliance with itscovenants as of March 31, 2004.

 

8

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***Long-Term Borrowings:***

 

On January 31, 2002,$10.0 million principal amount of Senior Subordinated Convertible Notes wassold to Wynnchurch Capital Partners, L.P., a private equity investor.

 

The Senior SubordinatedConvertible Notes originally bore interest at 15% and are due January 31,2009. These notes were initially convertible into common stock anytime afterJanuary 31, 2002 at a conversion price of $2.50 per share. At theCompany’s election, one-half of the interest could be deferred during the firstfour years, subject to certain conditions. In conjunction with the sale ofthese notes, the Company issued 10.0 million warrants to purchase shares of theCompany’s common stock at $0.55 per share. An additional 1.0 million warrantsto purchase its common stock at $0.73 per share were not exercisable for oneyear contingent upon the Company meeting certain performance measures, however,the warrants would expire if such performance measures were met.  As of December 31, 2002, the Companydid not meet the specific performance measures related to the 1.0 millioncontingent warrants and these warrants did not expire.

 

Throughout 2002, theCompany and Wynnchurch Capital Partners, L.P. executed four amendments to thesecurities purchase agreement. These amendments were required to waive eventsof default that occurred relative to the fixed charge and tangible net worthcovenants.  Both covenants were resetwith tangible net worth reestablished at $2.6 million and the fixed chargecovenant reestablished at an allowable shortfall of $0.7 million through October 1,2002 and a ratio of .95:1, thereafter. In addition, the Company and Wynnchurch Capital, L.P. agreed to deferall quarterly cash interest payments until the Company satisfied the covenantswith the senior lender, Fleet Capital Corporation.

 

In 2003, in connectionwith an amendment to the Company’s credit agreement with Fleet CapitalCorporation, Wynnchurch Capital Partners, L.P. executed a guarantee with FleetCapital Corporation to allow overadvances of up to $2.0 million throughDecember 31, 2003, reduced by any payments received from Bluecurrent.  In consideration, Wynnchurch CapitalPartners, L.P. and the Company amended their agreements. The 15% SeniorSubordinated Convertible Notes conversion price was reduced from $2.50 to $1.50per share of common stock.  The exerciseprice of all outstanding warrants was reduced to $0.26 per share.  Additionally, a provision was made that anydraw on the guarantee by the Company could be satisfied with a purchase byWynnchurch Capital Partners, L.P. of additional 15% Senior SubordinatedConvertible Notes having a principal amount equal to the Company’s draw andhaving terms equal to the outstanding 15% Senior Convertible Notes, andprovided for a $0.3 million fee to Wynnchurch Capital Partners, L.P. in the eventof a draw upon their guarantee.  The$0.3 million fee would be payable through the issuance of additional 15% SeniorSubordinated Convertible Notes.  As ofMarch 31, 2004, the Company has not been required to draw on theguarantee, and no additional Convertible Notes have been issued. InJuly 2003, Wynnchurch Capital Partners, L.P. agreed to waive the agreedrequirement that their guarantee be reduced by any amounts received fromBluecurrent. Consequently, Bluecurrent’s initial payment of $0.9 million didnot reduce the $2.0 million guarantee. However, all subsequent payments fromBluecurrent will continue to reduce the outstanding guarantee. In considerationfor this waiver, Wynnchurch Capital Partners, L.P. received a fee of $0.1million payable as interest and added to the principal amount of thenotes.  Under the Sixth Amendment to thesecurities purchase agreements, Wynnchurch Capital Partners, L.P. waived theevents of default as of June 30, 2003, relating to the tangible net worthand fixed charge covenants. Additionally, the covenants were reset for the remainder of 2003 asfollows;  the tangible net worthcovenant was reset to ($5.2) million with the fixed charge covenant reset to anallowable shortfall of $0.7 million for the three months ended September 30,2003 and $1.0 million for the six months ending December 31, 2003.  The fixed charge covenant will be 0.95:1thereafter.  In addition, the interestrate of the Senior Subordinated Convertible Notes was changed effectiveJuly 1, 2003 from 15% to 16% per annum. In September 2003, Wynnchurch Capital Partners L.P. agreed tomaintain its $2.0 million guarantee and not to reduce such guarantee by anypayments received from Bluecurrent.  Inconsideration for maintaining the guarantee, the Company agreed to payWynnchurch Capital Partners, L.P. $0.3 million payable as additional interestand added to the principal amount of the notes.  The Company also executed a Seventh Amendment to the securitiespurchase agreement that waived the events of default that occurred as ofSeptember 30, 2003 and reset the financial covenants for futurequarters.  The covenants were reset forfuture quarters as follows; the tangible net worth covenant was reset to ($8.9)million for the quarter ended December 31, 2003 and each quarterthereafter.  The fixed charge covenantwas reset to an allowable shortfall of $1.0 million for the three months endedDecember 31, 2003, $1.8 million for the six months ended March 31,2004, and $1.9 million for the nine months ended June 30, 2004.  The fixed charge covenant will be 0.95:1thereafter.  Capital expenditures willalso be limited to $52,500 per quarter commencing with the quarter endedDecember 31, 2003.  Inconsideration for this waiver and for continuing to maintain the $2.0 millionguarantee, Wynnchurch Capital Partners, L.P. will receive a

 

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monthly fee of $30,000for each month such guarantee is in effect. This fee will be payable as additional interest and added to the principalamount of the notes. On March 29, 2004, a letter of agreement was executedto maintain the $2.0 million guarantee until June 30, 2004.  The Company was in compliance with itscovenants as of March 31, 2004. Wynnchurch Capital Partners, L.P. has waived compliance by the Companywith respect to the financial covenants through January 1, 2005.  Additionally, Wynnchurch Capital Partners,L.P. has provided a commitment up to $5.0 million of additional financing,should the need arise, on such terms as the Company, its Board of Directors andWynnchurch Capital Partners, L.P. may agree.

 

Due to the change in theunderlying terms of the Convertible Notes and Warrants, the original valuationof the warrants was reassessed during the second quarter of 2003.  The fair value ascribed to these warrantswas determined to be approximately $2.3 million prior to the price change and$2.4 million subsequent to the price change. This change in value ascribed to the price change of approximately$69,000 was amortized over the seven-month life of the guarantee as a non-cashinterest charge.  The valuation of thewarrants was determined based on advice from a third-party valuation specialistwho utilized a valuation model with the following inputs: measurement date ofApril 14, 2003; fair value of $0.23; exercise price of $0.55 prior to theprice change ($0.73 for contingent warrants) and $0.26 subsequent to the pricechange; contractual term of 10 years from the original issue date; dividendrate of zero; volatility rate of 123.5%; and risk-free interest rate of 3.76%.

 

During the third quarterof 2003, the Company concluded that the change in interest rate combined withthe change in conversion price of the convertible notes in the second quarterof 2003 met the criteria of an extinguishment of debt per EITF 96-19 “DebtorsAccounting for a Modification or Exchange of Debt Instruments,” as the changein the present value of the notes exceeded the present value prior to themodifications by more than 10%.  Thevaluation of the notes was determined based on advice from a third-partyvaluation specialist who utilized a valuation model.  Based on the results, the fair value of the notes was determinedto be $13.2 million versus the carrying value of $9.7 million.  As such, a $3.5 million charge wasrecognized for the modification of debt to recognize the fair value of thenotes in the financial statements. Additionally, origination fees of $0.9 million related to these notesand $0.1 million related to the revolving credit commitment were written offdue to the modifications.

 

As of March 31,2004, the Company has three irrevocable standby letters of credit for $1.8million, which expire as follows:  $0.5million on November 1, 2004, $0.5 million on November 15, 2004, and $0.8million on December 31, 2004.

 

##### **5.**                    Restructuring and Other Charges

 

***Restructuring and Other Charges – 2003***

 

During the third quarterof 2003, the Company incurred a $0.5 million restructuring charge representingseverance costs associated with the restructuring of the Company’s sales,delivery and corporate staff.  A totalof 33 positions were eliminated, comprised of 11 in sales, 9 in delivery and 13in corporate staff positions.  TheCompany recorded an additional restructuring charge of $0.4 million in the fourthquarter of 2003 related to the severance cost of two executive employees and$38.0 thousand in the first quarter of 2004 related to portions of severancerecognized over the employee’s service period.

 

The primary components ofthe restructuring charge can be summarized as follows:

 
|      |   | **Total  Initial  Reserve** |   | **2003  Cash  Payments** |   | **Balance at  December 31,  2003** |   | **2004  Additional  Charges** |   | **2004  Cash  Payments** |   | **Balance at  March 31,  2004** |   |
|-----------|--------|-----------------------------|--------|--------------------------|--------|-----------------------------------------|--------|-------------------------------|--------|--------------------------|--------|--------------------------------------|--------|
|      |   | **(in  thousands)**         |   |
|      |   |                        |   |                     |   |                                    |   |                          |   |                     |   |                                 |   |
| Severance |   | $                           | 952    |                     | $      | (270                                    | )      | $                             | 682    |                     | $      | 38                                   |   | $ | (169 | ) | $ | 551 |   |
|           |        |                             |        |                          |        |                                         |        |                               |        |                          |        |                                      |        |  |  |  |  |  |  |

 

The remaining severancebalance at March 31,2004 represents the severance of three executiveemployees that will be paid out in accordance with their respective employmentagreements through December 2007.

 

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***Restructuring and Other Charges – 2002***

 

The Company recordedrestructuring and other charges in the aggregate amount of $6.1 millionduring 2002. During the second quarter of 2002, the Company recorded a chargeof $1.1 million, classified as other charges, representing the severancepay associated with the departure of the Company’s former Chief ExecutiveOfficer. During the third quarter of 2002, the Company recorded a$4.7 million restructuring charge due to excess office space and therestructuring of the service delivery function. An additional $0.3 millionrestructuring charge was recorded in the fourth quarter, which was also due tothe restructuring of the service delivery function.

 

The primary activity inthe restructuring reserve can be summarized as follows:

 
|                        |   | **Total  Initial  Reserve** |   | **2002  Cash  Payments** |   | **Balance at  December 31,  2002** |   | **2003  Cash  Payments** |   | **Adjustment  to  reserve** |   | **Balance at  December 31,  2003** |   | **2004  Cash  Payments** |   | **Balance at  March 31,  2004** |   |
|-----------------------------|--------|-----------------------------|--------|--------------------------|--------|-----------------------------------------|--------|--------------------------|--------|-----------------------------|--------|-----------------------------------------|--------|--------------------------|--------|--------------------------------------|--------|
|                        |   | **(in thousands)**          |   |
|                        |   |                        |   |                     |   |                                    |   |                     |   |                        |   |                                    |   |                     |   |                                 |   |
| Real estate costs           |   | $                           | 4,328  |                     | $      | (569                                    | )      | $                        | 3,759  |                        | $      | (1,659                                  | )      | $                        | (605   | )                                    | $      | 1,495 |   | $ | (295 | ) | $ | 1,200 |   |
|                        |   |                        |   |                     |   |                                    |   |                     |   |                        |   |                                    |   |                     |   |                                 |   |   |   |   |   |   |   |   |   |
| Severance                   |   | 627                         |   | (362                     | )      | 265                                     |   | (200                     | )      | —                      |   | 65                                      |   | —                   |   | 65                                   |   |
|                        |   |                        |   |                     |   |                                    |   |                     |   |                        |   |                                    |   |                     |   |                                 |   |
| Other charges               |   | 1,100                       |   | (202                     | )      | 898                                     |   | (121                     | )      | —                      |   | 777                                     |   | (34                      | )      | 743                                  |   |
|                        |   |                        |   |                     |   |                                    |   |                     |   |                        |   |                                    |   |                     |   |                                 |   |
| Total restructuring reserve |   | $                           | 6,055  |                     | $      | (1,133                                  | )      | $                        | 4,922  |                        | $      | (1,980                                  | )      | $                        | (605   | )                                    | $      | 2,337 |   | $ | (329 | ) | $ | 2,008 |   |

 

The portion of the chargerelated to real estate costs, which totaled $4.3 million, relates to leasecosts associated with decreased requirements for office space as the Companyrestructured its service delivery organization. The costs associated with thischarge related primarily to the value of ongoing lease obligations for vacatedoffices, net of anticipated sublease income. A portion of the charge alsorelated to broker commissions and estimated leasehold improvement costsnecessary to sublease vacated offices.

 

During the third quarterof 2003, the Company reassessed its 2002 restructuring accrualrequirements.  Based on this review, theCompany determined the remaining reserve was overstated by $0.6 million due tovarious real estate cost assumptions made versus actual activity.  The majority of this adjustment relates tothe successful early termination negotiated on the lease of the Company’sprevious headquarters.

 

The $0.6 millionseverance charge related to headcount reductions associated with centralizingthe service delivery organization as part of a re-engineering exercise. A totalof 60 positions were eliminated with the largest group being the clientstaffing managers. The remainder of positions eliminated was a mix of corporatestaff and recruiting personnel. The remaining severance balance atMarch 31, 2004 relates to an employee with an employment agreement. It isanticipated that this amount will be paid out through July 2004.

 

The $1.1 millionother charges related to the severance pay associated with the departure of theCompany’s former Chief Executive Officer. The remaining balance at March 31, 2004 is anticipated to be paidin full by July 2004.

 

##### **Item 2**. - Management’s Discussion and Analysis of FinancialCondition and Results of Operations

 

## **Resultsof Operations**

 

All of the Company’srevenue is generated from information technology services that offer thebenefits of outsourcing, while allowing information services operationsmanagers to retain strategic control of their operations. Revenues arerecognized as services are performed, utilizing four different billingmethodologies as follows:  (1) time andmaterial billing, whereby the client is billed by the hour on a weekly basisfor past services performed; (2) project-based billing, for which fees arefixed and are based on specific contracts; (3) per-incident billing, wherebythe Company charges a fee for each specific task related to certain services;and (4) fee-based billing, which is

 

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used for candidateplacement/recruiting fees and vendor management fees.  The Company typically provides discounts on staffing services toits largest clients in exchange for the opportunity to sell more volume, aswell as the opportunity to sell its higher-margin, value-added services.  All revenues are recognized net of suchdiscounts and after services have been completed.

 

# **FirstQuarter Fiscal 2004 Compared to First Quarter Fiscal 2003**

 

The following tablepresents quarter-over-quarter changes in revenue and gross profit from 2003 to2004.

 
| **(in thousands)** |   | **Revenues** |   | **Gross  Profit** |   |
|--------------------|--------|--------------|--------|-------------------|--------|
|               |   |         |   |              |   |
| 2003               |   | $            | 36,846 |              | $      | 9,178 |   |
| Staffing           |   | 69           |   | (359              | )      |
| Solutions          |   | (7,785       | )      | (2,142            | )      |
| 2004               |   | $            | 29,130 |              | $      | 6,677 |   |

 

**Revenue.**Revenuesconsist of fees earned from Staffing Services and Solutions Services.  Revenue decreased $7.7 million or 20.9% from$36.8 million in the first quarter of 2003 to $29.1 million in the firstquarter of 2004.  The Company’sSolutions revenue decreased by $7.8 million or 39.9% from $19.5 million in thefirst quarter of 2003 to $11.7 million in the first quarter of 2004.  The decline in Solutions revenue was drivenby declines in the Technology Deployments and Field Service offerings.  The decline in Field Services was due to theCompany’s largest customer of these services changing to a multi-vendorstrategy.  The Company’s traditionalStaffing Services revenue increased by $0.1 million or 0.4% from $17.3 millionin the first quarter of 2003 to $17.4 million in the first quarter of 2004.

 

**Gross profit.** Grossprofit decreased by $2.5 million or 27.3% from $9.2 million in the firstquarter of 2003 to $6.7 million in the first quarter of 2004.  Margins decreased by $0.4 million in theStaffing Service offerings due to overall pricing pressures from customers.  Margins decreased by $2.1 million in theSolutions Service offerings due to decreased revenue as well as overall pricingpressures from customers.  As apercentage of revenue, gross profit decreased by 2.0% from 24.9% in the firstquarter of 2003 to 22.9% in the first quarter of 2004.

 

**Operating expenses. **Operating expenses consistof salaries and benefits, sales costs, recruiting, retention and trainingcosts, management and administrative costs, and depreciation andamortization.  Operating expensesdecreased by $2.3 million or 23.2% from $9.9 million in the first quarter of2003 to $7.6 million in the first quarter of 2004.  The operating expense decrease was attributable to therestructuring actions the Company has taken in the past, which is reflected inreduced office space and lower headcount. As a percentage of revenue, operatingexpenses decreased by 0.7% from 26.7% in the first quarter of 2003 to 26.0% inthe first quarter of 2004.

 

**Other expense, net. **Other expense, net,consists primarily of interest expense on the Company’s outstanding debt. Otherexpense, net, was level during the first quarters of 2003 and 2004.

 

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# **Liquidityand Capital Resources**

 

Current liabilitiesexceed current assets by $12.2 million at March 31, 2004.  Included in current liabilities is $12.4million of outstanding borrowings against the revolving credit agreement thathas a maturity date of January 31, 2005.

 

Net cash used inoperations was $0.3 million in the first three months of 2004.  Net cash used in operations is comprised ofa net loss for the quarter of $0.3 million (net of adjustments for non-cashcharges including depreciation and amortization of $0.9 million and non-cashinterest expense totaling $0.7 million); offset by a decrease in accountsreceivable of approximately $0.9 million; a decrease in accounts payable of$1.4 million and an increase in payroll and related expenses of $0.2 million.

 

Net cash used ininvesting activities was approximately $0.1 million in both of the quartersended March 31, 2004 and 2003. Beginning with the quarter endedDecember 31, 2003, the Company has been restricted by its credit agreementto capital spending of $50,000 per quarter.

 

On January 31, 2002,the Company replaced its existing bank line with a $30.0 million senior securedrevolving credit facility with Fleet Capital Corporation, a subsidiary of theFleetBoston Financial Corporation. Additionally, $10.0 million principal amount of Senior SubordinatedConvertible Notes was sold to Wynnchurch Capital Partners, L.P., a private equityinvestor.

 

The $30.0 millionrevolving credit facility is secured by the assets of the Company, principallyconsisting of accounts receivable.  Thecredit facility has a three-year term and bears interest at LIBOR plus 3.25% orthe bank’s base rate plus 2.00%.

 

Throughout 2002, theCompany and Fleet Capital Corporation executed four amendments to the revolvingcredit agreement.  These amendments wererequired to waive events of default that occurred relative to the fixed chargeand tangible net worth covenants.  Bothcovenants were reset with tangible net worth reestablished at $2.8 million andthe fixed charge covenant reestablished at an allowable shortfall of $0.7million through October 1, 2002 and a ratio of 1:1, thereafter.  In addition, the borrowing limit subject topledged accounts receivable as collateral was reduced to $28.0 million andcertain restrictions were placed on the amount of capital spending inconsideration for the waiver of existing financial loan covenants.

 

In 2003, the Company andFleet Capital Corporation executed additional amendments to the revolvingcredit agreement. The Fifth Amendment addressed the fact that the Company hadentered into litigation with a major customer, Bluecurrent.  This action eliminated that account from theCompany’s borrowing base creating a borrowing overadvance.  The amendment allowed for an overadvance of$2.0 million through December 31, 2003. In addition, the amendment waived the events of default relative to thefixed charge and tangible net worth covenants that occurred atDecember 31, 2002.  The tangiblenet worth covenant was reset at ($1.0) million and the fixed charge shortfallwas set to $1.0 million through March 31, 2003 and $1.4 million up throughJune 30, 2003 and a ratio of 1:1, thereafter.  The Sixth Amendment eliminated the requirement that any amountsreceived as a result of the settlement with Bluecurrent reduce the WynnchurchCapital Partners, L.P. guarantee as discussed below.  The Seventh Amendment waived the events of default as ofJune 30, 2003 relating to the tangible net worth and fixed chargecovenants.   Additionally, the covenantswere reset for the remainder of 2003 as follows; the tangible net worthcovenant was reset to ($5.0) million with the fixed charge covenant reset to anallowable shortfall of $0.7 million for the three months endedSeptember 30, 2003, and $1.0 million for the six months endedDecember 31, 2003. The fixed charge covenant will be 1:1, thereafter. Inaddition, the interest rate was changed effective August 1, 2003 from thebank’s base rate plus 1.00% to the base rate plus 2.00%. As of March 31,2004, the applicable rate is 6.00%, which represents the bank’s base rate plus2.00%.  The Seventh Amendment alsoreduced the maximum revolving credit commitment from $28.0 million to $23.0million.  The Eighth Amendment waivedthe events of default as of September 30, 2003 relating to the tangiblenet worth and fixed charge covenants. Additionally, the covenants were reset for future periods as follows:the tangible net worth covenant was reset to ($8.5) million for the quarterending December 31, 2003 and each quarter thereafter.  The fixed charge covenant was reset to anallowable shortfall of $1.0 million for the three months endingDecember 31, 2003, $1.8 million for the six months ended March 31,2004, and $1.9 million for the nine months ending June 30, 2004.  The fixed charge covenant will be 1:1,thereafter.  Capital expenditures willalso be limited to $50,000 per quarter commencing with the quarter endedDecember 31, 2003.  The Company wasin compliance with its covenants as of March 31, 2004.

 

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The Senior SubordinatedConvertible Notes originally bore interest at 15% and are due January 31,2009. These notes were initially convertible into common stock anytime afterJanuary 31, 2002 at a conversion price of $2.50 per share. At theCompany’s election, one-half of the interest could be deferred during the firstfour years, subject to certain conditions. In conjunction with the sale ofthese notes, the Company issued 10.0 million warrants to purchase shares of theCompany’s common stock at $0.55 per share. An additional 1.0 million warrantsto purchase its common stock at $0.73 per share were not exercisable for oneyear contingent upon the Company meeting certain performance measures, however,the warrants would expire if such performance measures were met.  As of December 31, 2002, the Companydid not meet the specific performance measures related to the 1.0 millioncontingent warrants and these warrants did not expire.

 

Throughout 2002, theCompany and Wynnchurch Capital Partners, L.P. executed four amendments to thesecurities purchase agreement. These amendments were required to waive eventsof default that occurred relative to the fixed charge and tangible net worthcovenants.  Both covenants were resetwith tangible net worth reestablished at $2.6 million and the fixed chargecovenant reestablished at an allowable shortfall of $0.7 million through October 1,2002 and a ratio of .95:1, thereafter. In addition, the Company and Wynnchurch Capital, L.P. agreed to deferall quarterly cash interest payments until the Company satisfied the covenantswith the senior lender, Fleet Capital Corporation.

 

In 2003, in connectionwith an amendment to the Company’s credit agreement with Fleet CapitalCorporation, Wynnchurch Capital Partners, L.P. executed a guarantee with FleetCapital Corporation to allow overadvances of up to $2.0 million throughDecember 31, 2003, reduced by any payments received from Bluecurrent.  In consideration, Wynnchurch CapitalPartners, L.P. and the Company amended their agreements. The 15% SeniorSubordinated Convertible Notes conversion price was reduced from $2.50 to $1.50per share of common stock.  The exerciseprice of all outstanding warrants was reduced to $0.26 per share.  Additionally, a provision was made that anydraw on the guarantee by the Company could be satisfied with a purchase byWynnchurch Capital Partners, L.P. of additional 15% Senior SubordinatedConvertible Notes having a principal amount equal to the Company’s draw andhaving terms equal to the outstanding 15% Senior Convertible Notes, andprovided for a $0.3 million fee to Wynnchurch Capital Partners, L.P. in the eventof a draw upon their guarantee.  The$0.3 million fee would be payable through the issuance of additional 15% SeniorSubordinated Convertible Notes.  As ofMarch 31, 2004, the Company has not been required to draw on theguarantee, and no additional Convertible Notes have been issued. InJuly 2003, Wynnchurch Capital Partners, L.P. agreed to waive the agreedrequirement that their guarantee be reduced by any amounts received fromBluecurrent. Consequently, Bluecurrent’s initial payment of $0.9 million did notreduce the $2.0 million guarantee. However, all subsequent payments fromBluecurrent will continue to reduce the outstanding guarantee. In considerationfor this waiver, Wynnchurch Capital Partners, L.P. received a fee of $0.1million payable as interest and added to the principal amount of thenotes.  Under the Sixth Amendment to thesecurities purchase agreements, Wynnchurch Capital Partners, L.P. waived theevents of default as of June 30, 2003, relating to the tangible net worthand fixed charge covenants. Additionally, the covenants were reset for the remainder of 2003 asfollows;  the tangible net worthcovenant was reset to ($5.2) million with the fixed charge covenant reset to anallowable shortfall of $0.7 million for the three months ended September 30,2003 and $1.0 million for the six months ending December 31, 2003.  The fixed charge covenant will be 0.95:1thereafter.  In addition, the interestrate of the Senior Subordinated Convertible Notes was changed effectiveJuly 1, 2003 from 15% to 16% per annum. In September 2003, Wynnchurch Capital Partners L.P. agreed tomaintain its $2.0 million guarantee and not to reduce such guarantee by anypayments received from Bluecurrent.  Inconsideration for maintaining the guarantee, the Company agreed to payWynnchurch Capital Partners, L.P. $0.3 million payable as additional interestand added to the principal amount of the notes.  The Company also executed a Seventh Amendment to the securitiespurchase agreement that waived the events of default that occurred as ofSeptember 30, 2003 and reset the financial covenants for futurequarters.  The covenants were reset forfuture quarters as follows; the tangible net worth covenant was reset to ($8.9)million for the quarter ended December 31, 2003 and each quarterthereafter.  The fixed charge covenantwas reset to an allowable shortfall of $1.0 million for the three months endedDecember 31, 2003, $1.8 million for the six months ended March 31,2004, and $1.9 million for the nine months ended June 30, 2004.  The fixed charge covenant will be 0.95:1thereafter.  Capital expenditures willalso be limited to $52,500 per quarter commencing with the quarter endedDecember 31, 2003.  Inconsideration for this waiver and for continuing to maintain the $2.0 millionguarantee, Wynnchurch Capital Partners, L.P. will receive a monthly fee of$30,000 for each month such guarantee is in effect.  This fee will be

 

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payable as additionalinterest and added to the principal amount of the notes. On March 29,2004, a letter of agreement was executed to maintain the $2.0 million guaranteeuntil June 30, 2004.  The Companywas in compliance with its covenants as of March 31, 2004.  Wynnchurch Capital Partners, L.P. has waivedcompliance by the Company with respect to the financial covenants throughJanuary 1, 2005.  Additionally,Wynnchurch Capital Partners, L.P. has provided a commitment up to $5.0 millionof additional financing, should the need arise, on such terms as the Company,its Board of Directors and Wynnchurch Capital Partners, L.P. may agree.

 

Due to the change in theunderlying terms of the Convertible Notes and Warrants, the original valuationof the warrants was reassessed during the second quarter of 2003.  The fair value ascribed to these warrantswas determined to be approximately $2.3 million prior to the price change and$2.4 million subsequent to the price change. This change in value ascribed to the price change of approximately$69,000 was amortized over the seven-month life of the guarantee as a non-cashinterest charge.  The valuation of thewarrants was determined based on advice from a third-party valuation specialistwho utilized a valuation model with the following inputs: measurement date ofApril 14, 2003; fair value of $0.23; exercise price of $0.55 prior to theprice change ($0.73 for contingent warrants) and $0.26 subsequent to the pricechange; contractual term of 10 years from the original issue date; dividendrate of zero; volatility rate of 123.5%; and risk-free interest rate of 3.76%.

 

During the third quarterof 2003, the Company concluded that the change in interest rate combined withthe change in conversion price of the convertible notes in the second quarterof 2003 met the criteria of an extinguishment of debt per EITF 96-19 “DebtorsAccounting for a Modification or Exchange of Debt Instruments,” as the changein the present value of the notes exceeded the present value prior to themodifications by more than 10%.  Thevaluation of the notes was determined based on advice from a third-partyvaluation specialist who utilized a valuation model.  Based on the results, the fair value of the notes was determinedto be $13.2 million versus the carrying value of $9.7 million.  As such, a $3.5 million charge wasrecognized for the modification of debt to recognize the fair value of thenotes in the financial statements. Additionally, origination fees of $0.9 million related to these notesand $0.1 million related to the revolving credit commitment were written offdue to the modifications.

 

As of March 31,2004, the Company has three irrevocable standby letters of credit for $1.8million, which expire as follows:  $0.5million on November 1, 2004, $0.5 million on November 15, 2004, and $0.8million on December 31, 2004.

 

The Company currentlyanticipates its cash balances and funds from operations, together with fundsavailable under its credit facility will be sufficient to meet all of itsanticipated cash requirements for at least the next 12 months.  Additionally, Wynnchurch Capital Partners,L.P. has provided a commitment up to $5.0 million of additional financing,should the need arise, on such terms as the Company, its Board of Directors,and Wynnchurch Capital, L.P. may agree. General economic and industry conditions could impact the Company’sability to meet anticipated cash requirements. Since the existing credit facility is secured by the assets of theCompany, principally consisting of accounts receivable, these uncertainties maydirectly impact the availability of this credit facility.  Additionally, the Company’s ability tosuccessfully meet debt covenants in future periods is a significant riskfactor.

 

The following summarizesthe Company’s contractual obligations at March 31, 2004, and the effectsuch obligations are expected to have on our liquidity and cash in the futureperiods.

 
|                                |   |                |   | **Payments  Due by Period** |   |           |   |
|-------------------------------------|--------|---------------------|--------|-----------------------------|--------|----------------|--------|
|                                |   | **Total**           |   | **Less Than  1 Year**       |   | **1-3  Years** |   | **3-5  Years** |   | **After  5 Years** |   |
|                                |   | **(in  thousands)** |   |
|                                |   |                |   |                        |   |           |   |   |   |   |   |
| Contractual  Obligations:           |   |                |   |                        |   |           |   |   |   |   |   |
| Senior  Secured Revolving Credit    |   | $                   | 12,393 |                        | $      | 12,393         |   | $ | — |   | $ | — |   | $ | — |   |
| Securities  Purchase Agreement      |   | 14,375              |   | —                      |   | —         |   | 14,375 |   | — |   |
| Non-cancelable  operating leases    |   | 8,494               |   | 2,676                       |   | 2,769          |   | 2,425 |   | 624 |   |
|                                |   |                |   |                        |   |           |   |   |   |   |   |
| Total  contractual cash obligations |   | $                   | 35,262 |                        | $      | 15,069         |   | $ | 2,769 |   | $ | 16,800 |   | $ | 624 |   |

 

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**CRITICAL ACCOUNTING POLICIES**

 

The Company’sconsolidated financial statements are impacted by the accounting policies used, and the estimates and assumptionsmade by management.  The mostsignificant accounting policies and management estimates that affect thepresentation of the consolidated financial statements include revenue recognition,allowance for doubtful accounts, analysis of goodwill impairment and valuationallowance for deferred tax assets.

 

**Revenue Recognition**

 

The Company recognizesrevenues as services are performed, utilizing four different billingmethodologies, as follows:  (1) time andmaterial billing, whereby the client is billed by the hour on a weekly basisfor past services performed; (2) project-based billing, for which fees arefixed and are based on specific contracts; (3) per-incident billing, wherebythe Company charges a fee for each specific task related to certain services;and (4) fee-based billing, which is used for candidate placement/recruitingfees and vendor management fees.   TheCompany typically provides discounts on staffing services to its largestclients in exchange for the opportunity to sell more volume, as well as theopportunity to sell its higher-margin, value-added services.  All revenues are recognized net of suchdiscounts and after services have been completed.

 

**Allowance for Doubtful Accounts**

 

The Company performs ongoing credit evaluationsof its customers and adjusts credit limits based upon payment history and thecustomers’ current credit worthiness. The Company continuously monitors collections and payments from itscustomer base and maintains a provision for estimated credit losses based uponhistorical experience and any specific customer collection issues that havebeen identified.  The Companyspecifically reviews outstanding account balances that are overdue 90 days ormore in making its assessment of the provision for bad debts in eachperiod.  While the Company hashistorically had sufficient coverage of allowances for credit losses, it cannotguarantee that it will continue to experience the same credit loss rates as inpast periods.

 

**Goodwill Impairment**

 

On January 1, 2002,the Company adopted SFAS No. 142, “Goodwill and Other Intangible Assets” (“SFAS142”).  This Statement dictates thatgoodwill and intangible assets with indefinite useful lives should be testedfor impairment at least annually, instead of being amortized on an ongoingbasis.  The Company has terminated itspolicy of amortizing goodwill on a monthly basis and performs an annualanalysis of goodwill impairment on December 31, or upon the occurrence ofcircumstances which could indicate impairment, using the discounted future cashflows methodology in determining fair value.

 

**Valuation Allowance forDeferred Tax Assets**

 

The Company records avaluation allowance to reduce its deferred tax assets to the amount that itbelieves is more likely than not to be realized.  A valuation allowance was established for the net deferred taxasset given the uncertainty with respect to the future realization of deferredtax assets.  This valuation allowance isrequired given that the net operating losses have no remaining carrybackpotential and the lack of ability to accurately forecast taxable income overthe 20 year net operating loss carryforward period.  When a valuation allowance is deemed necessary, the Companyrecords an adjustment to the deferred tax asset, with a corresponding charge tothe statement of operations.  In theevent that the Company determines that it would be able to realize its deferredtax assets in the future in excess of its net recorded amount, an adjustment tothe deferred tax assets would increase income, or reduce a net loss, in theperiod such determination was made.

 

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##### **Item 3**. - Quantitative and Qualitative Disclosures AboutMarket Risk

 

 The market risk that the Company is exposedto primarily relates to changes in interest rates on its borrowings. AtMarch 31, 2004, the Company had $12.4 million in floating-rate debt. Anadverse change in interest rates during any period that the loan is outstandingwould cause an increase in interest expense. A 100 basis point increase in thebank’s base rate would increase the annual amount of interest paid by $0.1million.

 

The Company issuedwarrants on January 31, 2002, which are classified as derivative financialinstruments pursuant to SFAS 133, “Accounting for Derivative Instruments andCertain Hedging Activities,” which was adopted by the Company onJanuary 1, 2001.  Pursuant to SFASNo. 133 and interpretations by the Emerging Issues Task Force coveringderivative financial instruments, these warrants meet the criteria for equityclassification on the measurement date of January 31, 2002 and the Companyis not required to remeasure the warrants on subsequent dates.  As such, there is no mark-to-market adjustmentwhich will be reflected in the statement of operations as unrealized gains orlosses as a result of changes in fair value of these warrants in periodssubsequent to the measurement date. There is no equity price risk associated with changes in fair value ofthe warrants.  The Company does not haveany derivative financial instruments other than the warrants.

 

**Item 4****. - Controlsand Procedures**

 

(a)                            *Evaluationof disclosure controls and procedures.*  Under the supervision and with the participation of our seniormanagement, including our Chief Executive Officer and Chief Financial Officer,we conducted an evaluation of the effectiveness of the design and operation ofour disclosure controls and procedures, as defined in Rules 13a-15(e) and15d-15(e) under the Securities Exchange Act of 1934, as amended, as of the endof the period covered by this annual report (the “Evaluation Date”).  Based on this evaluation, our ChiefExecutive Officer and Chief Financial Officer concluded as of the EvaluationDate that our disclosure controls and procedures were effective such that theinformation relating to the Company required to be disclosed in our Securitiesand Exchange Commission (“SEC”) reports (i.) is recorded, processed, summarizedand reported within the time periods specified in the SEC rules and forms, and(ii.) is accumulated and communicated to the Company’s management, includingour Chief Executive Officer and Chief Financial Officer, as appropriate toallow timely decisions regarding required disclosure.

 

(b)                           *Changes ininternal control over financial reporting.*  There have been no changes in our internal control over financialreporting that occurred during the quarter ended March 31, 2004 that havematerially affected or are reasonably likely to materially affect our internalcontrol over financial reporting.

 

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**FORWARD-LOOKING STATEMENTS**

 

The Company makesforward-looking statements from time to time and desires to take advantage ofthe “safe harbor,” which is afforded such statements under the PrivateSecurities Litigation Reform Act of 1995, when they are accompanied bymeaningful cautionary statements identifying important factors that could causeactual results to differ materially from those in the forward-lookingstatements. The statements contained in this Form 10-Q, including those under“Management’s Discussion and Analysis of Financial Condition and Results ofOperations,” statements contained in future filings with the Securities andExchange Commission and publicly disseminated press releases, and statementswhich may be made from time-to-time in the future by management of the Companyin presentations to shareholders, prospective investors, and others interestedin the business and financial affairs of the Company, which are not historicalfacts, are forward-looking statements that involve risks and uncertainties thatcould cause actual results to differ materially from those set forth in theforward-looking statements. Any projections of financial performance orstatements concerning expectations as to future developments should not beconstrued in any manner as a guarantee that such results or developments will,in fact, occur. There can be no assurance any forward-looking statement will berealized or that actual results will not be significantly different from thatset forth in such forward-looking statement.

 

In addition to the risksand uncertainties of ordinary business operations, the forward-lookingstatements of the Company referred to above are also subject to the following risksand uncertainties:

 

•                  TheCompany’s ability to attract and retain qualified information technologyprofessionals;

•                  TheCompany’s ability to recruit, train, integrate and retain qualified salesdirectors, account managers, and recruiters;

•                  Competitionin the information technology services marketplace;

•                  TheCompany’s continued ability to initiate and develop client relationships;

•                  TheCompany’s ability to identify and respond to trends in information technology;

•                  Unforeseenbusiness trends in the Company’s national accounts or other large clients;

•                  Pricingpressures and/or wage inflation and the resulting impact on gross profit andnet operating margins;

•                  Theability to successfully enter new geographic markets;

•                  TheCompany’s ability to successfully meet debt covenants; and

•                  Theeffect of changes in general economic conditions.

 

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**PART II****- OTHER INFORMATION**

 

### **Item 6.**- Exhibits and Reports on Form 8-K

 

(a)                      Thefollowing documents are furnished as an exhibit and numbered pursuant to Item601 of Regulation S-K:

 
| **Exhibit Number** |   | **Description**                                                                                                                                                     |
|--------------------|--------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|               |   |                                                                                                                                                                |
| 10.1               |   | Executive Employment  Agreement between Alternative Resources Corporation and Gibbs Vandercook  dated February 1, 2004.                                        |
|               |   |                                                                                                                                                                |
| 31.1               |   | Certification of Chief  Executive Officer pursuant to Rule 13a-15(e) or Rule 15d-15(e), as adopted  pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. |
|               |   |                                                                                                                                                                |
| 31.2               |   | Certification of Chief  Financial Officer pursuant to Rule 13a-15(e) or Rule 15d-15(e), as adopted  pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. |
|               |   |                                                                                                                                                                |
| 32                 |   | Certification Pursuant  to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of  the Sarbanes-Oxley Act of 2002.                                 |

 

(b)                     No reports onForm 8-K were required to be filed during the quarterly period endedMarch 31, 2004.

 

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**SIGNATURES**

 

Pursuant to therequirements of the Securities Exchange Act of 1934, the registrant has dulycaused this report to be signed on its behalf by the undersigned thereunto dulyauthorized.

 

 
|               | ALTERNATIVE RESOURCES  CORPORATION                                        |
|--------------------|---------------------------------------------------------------------------|
|               |                                                                      |
|               |                                                                      |
| Date: May 10, 2004 |      /s/  Steven Purcell                         |   |
|               | Steven Purcell                                                            |
|               | Senior Vice President,  Chief Financial Officer,  Treasurer and Secretary |

 

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