State the aggregate market value of the voting stock held by nonaffiliates of the registrant at

 

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.

PART I

ITEM 1.  BUSINESS

Overview

COMFORCE Corporation (“COMFORCE”) is a leading provider of specialty staffing, consulting and outsourcing services primarily to Fortune 500 companies for their information technology, telecommunications, healthcare support and technical and engineering services.  COMFORCE Operating, Inc. (“COI”), a wholly-owned subsidiary of COMFORCE, was formed for the purpose of facilitating certain of the Company’s financing transactions in November 1997.  Unless the context otherwise requires, the term the “Company” refers to COMFORCE, COI and all of their direct and indirect subsidiaries.

Through a national network of 53 offices (42 company‑owned and 11 licensed), the Company recruits and places highly skilled contingent personnel and provides financial and outsourcing services for a broad customer base, including Boeing Company, Bellsouth Telecommunications, Inc., Sun Microsystems and Los Alamos National Laboratories. The Company’s labor force consists primarily of computer programmers, systems consultants, telecommunication engineers, analysts, engineers, technicians, scientists, researchers, healthcare professionals and skilled office support personnel. 

Services

The Company provides a wide range of staffing, consulting, financial and outsourcing services, including web-enabled solutions for the effective procurement, tracking and engagement of contingent or non-employee labor.  The Company’s extensive proprietary database and national presence enable it to draw from a wealth of resources to link highly‑trained computer technicians, healthcare professionals, telecommunication engineers and other professionals, as well as clerical personnel, with businesses that need highly skilled labor. The Company’s services are designed to give its customers maximum flexibility and maximum choice. The Company’s professionals are available on a short-term or long-term basis. The Company’s services permit businesses to increase the volume of their work without increasing fixed overhead and permanent personnel costs.

The Company reports its results through three operating segments -- Staff Augmentation, Human Capital Management Services and Financial Outsourcing Services (formerly known as Financial Services).  The Staff Augmentation segment provides information technology (IT), telecom, healthcare support, technical and other staffing services.  The Human Capital Management Services segment provides contingent workforce management services.  The Financial Outsourcing Services segment provides funding and back office support services to independent consulting and staffing companies.  A description of the types of services provided by each segment follows.  See note 15 to the Company’s consolidated financial statements for a presentation of segment results.

Staff Augmentation Segment
Information Technology 

In the IT field, the Company provides highly skilled programmers, help desk personnel, systems consultants and analysts, software engineers and project managers for a wide range of technical assignments, including client server, mainframe, desktop services, help desk and Internet/Intranet.  These services consist of recruiting, processing payrolls, which includes withholding taxes, and tracking hours, vacation and sick days. The IT consultants also participate in the Company’s benefit programs rather than those of the customer.  In addition to these staffing services, the Company also provides non-recruited payrolling services to certain of its IT customers.

The Company’s IT customers include BellSouth Telecommunications, Inc., Boeing Information Services, Inc. and Microsoft Corporation.

Telecom 

The Company provides skilled telecom personnel to plan, design, engineer, install and maintain wireless and wireline telecommunications systems.  In recent years, through 2000, the Company significantly increased the amount of telecom services it provided, fueled by the race among telecom companies to build capacity.  In 2001, this work declined dramatically as the telecom sector retrenched due to overcapacity and a weak business environment.  The Company has been seeking to rebuild its business in this sector through its Engineering, Furnish and Installation (“EF&I”) division, which became ISO-certified in 2001.  Also in 2001, the Company partnered with another ISO-certified EF&I organization to satisfy customer demands for the broader, full service platforms.

The Company’s telecom customers include Northern Telecom, Inc., ALCATEL Network Systems, Inc. and Verizon.

Healthcare Support Services

The Company has targeted the healthcare support services as a potential source of growth.  In this sector, the Company provides nurses and credentialed coders for medical reimbursements and other personnel to support insurance claims processing, billing, transcription and confidential patient record keeping.

The Company’s customers in this area are medical offices, multi-physician practices, hospitals and other middle market healthcare providers.

Technical and Engineering Services

 The Company provides technical and engineering services through its Technical Services division for national laboratory research in such areas as environmental safety, alternative energy source development and laser technology.  It also provides highly‑skilled labor meeting diverse commercial needs in the avionics and aerospace, architectural, automotive, energy and power, pharmaceutical, marine and petrochemical fields.  

The Company’s technical and engineering staffing customers include Boeing Company, Gulfstream Aerospace, Raytheon Company and the Department of Energy National Research Laboratories, including Los Alamos and Sandia.

Other Staffing 

In addition to providing contract consulting and other staffing services in the areas described above, the Company provides a broad range of staffing services to its customers, including laboratory and scientific support, and professional, clerical, telemarketing and call center staffing.  The Company also offers highly specialized chemists, biologists, engineers, laboratory instrumentation operators, technicians and others to companies involved in pharmaceutical, environmental, biotech and other businesses.  In addition, the Company also recruits and trains skilled billing, data entry and other clerical personnel who provide support services for smaller businesses such as accounting and law offices.  Human

Capital Management Services Segment

The Company provides Human Capital Management services through its PrO Unlimited subsidiary.  PrO Unlimited has become a market leader in providing end-to-end web-enabled solutions for the effective procurement, tracking and engagement of contingent or non-employee labor.  PrO Unlimited utilizes a combination of proprietary web-based software and intellectual capital to manage all aspects of this rapidly growing segment of the workforce.  While the Company focuses on selling its services primarily to Fortune 500 companies, including customers such as Sun Microsystems and Pfizer, PrO Unlimited’s contingent workforce management tools are suitable for a cross-section of large employers throughout the United States and Canada.  The contingent labor force consists of independent contractors, temporary workers, consultants, returning retirees and freelancers.  A growing number of corporations are utilizing contingent labor solutions to enable them to manage their cost structures more effectively and to better position them to weather business strategy transition and maintain streamlined “just-in-time” labor pools.  PrO Unlimited has been a pioneer in assisting companies with government regulatory compliance regarding contingent personnel, particularly the management, tax, benefit and liability issues associated with the contingent workforce. 

PrO Unlimited’s program is designed to replace vendor-on-premise programs that large companies have been using in recent years to manage their contingent workforces.  PrO Unlimited seeks to draw upon its own resources as well as Internet-based information and tools, and to provide a range of services and software that enable large companies to effectively manage their contingent workforces.  Rather than competing with traditional staffing firms, PrO Unlimited acts as a “vendor neutral” facilitator providing customized management reports and proprietary Total Quality Management (“TQM”) programs that are designed to generate cost savings and improve efficiencies for client companies.  PrO Unlimited’s typical client is a large company that relies upon contingent labor to meet important elements of its staffing needs.  PrO Unlimited currently provides the following solutions:

Services

—             Contingent Staffing Management – provides a consolidated vendor-neutral staffing desk solution for procuring contingent employees by utilizing many different service providers to provide clients’ hiring managers with the most qualified candidate in the shortest period of time at the lowest cost. 

—             The 1099 Management Solution – helps customers manage the tax and benefit risks associated with the use of independent contractors to ensure compliance with all governmental regulations. 

—             Consultant Consolidation Services – acts as single-source supplier by consolidating and managing invoicing for, and negotiating and monitoring services provided by, its customers’ multiple service providers, including small consulting firms and true independent contractors.

—             Professional Payrolling Services – provides automated payroll services and worker benefits as a third party processor.

Software

—             PrO’s exclusive Workforce Alliance Network Database (“WAND”) is a web-enabled system that provides an end-to-end solution for the engagement, management and tracking of the contingent workforce.  The software allows hiring managers and staffing vendors to communicate 24 hours a day to place job orders, check the status of job orders, submit resumes, review resumes, schedule interviews, select candidates and create custom reports on staffing activity.  In addition, workers can utilize WAND’s e-timecarding capabilities to submit time and expense reports online.  WAND also provides extensive reporting, consolidated billing, security check and screening services.

 

Financial Outsourcing Services  Segment

The Company provides funding and back office support services to approximately 134 independent consulting and staffing companies. The Company’s back office services include payroll processing, billing and funding, preparation of various management reports and analysis, payment of all payroll-related taxes and preparation and filing of quarterly and annual payroll tax returns for the contingent personnel employed and placed by independently owned and operated staffing and consulting firms.  Personnel placed by such independent staffing and consulting firms remain employees of such firms. In providing payroll funding services, the Company purchases the accounts receivable of independent staffing firms and receives payments directly from the firms’ clients. The Company pursues the collection of all receivables; however, the amount of any accounts receivable that are not collected within a specified period after billing is charged back by the Company to such firm.

Customers

The Company provides staffing, consulting and outsourcing services to a broad range of customers, including, computer software and hardware manufacturers, aerospace and avionics firms, utilities, national laboratories, pharmaceutical companies, cosmetics companies, healthcare facilities, telecommunication equipment manufacturers, telecommunication service providers (wireline and wireless), educational institutions and accounting firms. Services to Fortune 500 companies represent a majority of the Company’s revenues.

In certain cases, the Company’s contracts with its customers provide that the Company will have the first opportunity to supply the personnel required by that customer. Other staffing companies not under contract with the customer are then offered the opportunity to supply personnel only if the Company is unable to meet the customer’s requirements.

The Company generally invoices its customers weekly.  IT, telecom and professional staffing customers generally obtain the Company’s services on a purchase order basis, while technical and engineering services, healthcare support and Human Capital Management Services customers generally enter into long-term contracts with the Company.

During the year ended December 30, 2001, the only customer that accounted for 10% or more of the Company’s revenues was Boeing Company, which accounted for 11.6% of revenues.  The largest four customers of the Company accounted for approximately 32.8% of the Company’s revenues.

Sales and Marketing

The Company services its customers through a network of 42 company‑owned and 11 licensed offices located in 21 states across the United States and its corporate headquarters located in Woodbury, New York. The Company’s sales and marketing strategy is focused on increasing its share of existing customer business, expanding its business with existing customers through cross‑selling and by establishing relationships with new customers. The Company solicits customers through personal sales presentations, telephone marketing, direct mail solicitation, referrals from customers, and advertising in a variety of local and national media including the Yellow Pages, magazines, newspapers, trade publications and through the Company’s website (www.comforce.com).

The Company’s Sales and Resource Managers are responsible for maintaining contact with existing clients, maximizing the number of requisitions that the Company will have the opportunity to fill, and then working with the recruiting staff to offer the client the candidate or candidates that best fit the specification.  New account targets are chosen by assessing: (1) the need for contract labor with skill sets provided by the Company; (2) the appropriateness of the Company’s niche products to the client’s needs; (3) the potential growth and profitability of the account; and (4) the creditworthiness of the client. While the Company’s corporate office assists in the selection of target accounts, the majority of account selection and marketing occurs locally.  Although the Company continues to market to its Fortune 500 client base, it also places a significant marketing focus on faster-growing middle-market companies.

Recruitment of Billable Employees

Within the Staff Augmentation Segment, the Company’s success depends significantly on its ability to effectively and efficiently match skilled personnel with specific customer assignments. The Company has established an extensive national resume database of prospective employees with expertise in the disciplines served by the Company. To identify qualified personnel for inclusion in this database, the Company solicits referrals from its existing personnel and customers, places advertisements in local newspapers, trade magazines, its website and otherwise actively recruits through the Internet.  The Company continuously updates its proprietary database to reflect changes in personnel skill levels and availability. Upon receipt of assignment specifications, the Company searches the database to identify suitable personnel. Once an individual’s skills are matched to the specifications, the Company considers other selection criteria such as interpersonal skills, availability and geographic preferences to ensure there is a proper fit between the employee and the assignment being staffed. The Company can search its resume database by a number of different criteria, including specific skills or qualifications, to match the appropriate employee with the assignment.

Management believes that the Company enhances its ability to attract recruits by making extensive training opportunities available to its employees.  The Company employs Internet‑based educational programs to train employees in the latest developments in IT, telecommunications and other technologies.  In addition, the Company maintains a telephone hot line to assist its clerical employees with software problems or questions.

The Company believes it has a competitive advantage in attracting and retaining specialty staffing and consulting personnel.  It provides assignments with high-profile customers that make use of advanced technology and offers the employees the opportunity to obtain additional experience that can enhance their skills and overall marketability. To attract and retain qualified personnel, the Company also offers flexible schedules and, depending on the contract or assignment, paid holidays, vacation, and certain benefit plan opportunities.

Information Systems

The Company uses PeopleSoft® HRMS and Financials applications software for its back office operations, and is currently upgrading to PeopleSoft® 8.0 Pure Internet Architecture version.  Utilizing the PeopleSoft® system has enabled the Company to consolidate its back office operations, improve business processes and enhance customer relationships.  Through this system, the Company has also been able to substantially integrate the management information systems of its 11 acquired companies by creating a single database repository of shared business information.

The Company has completed the implementation of the EZAccess® recruiting and sales database application, which has allowed it to consolidate the resume databases of its acquired companies. This software has enabled the Company to streamline the processes of identifying, recruiting and hiring on a national basis.  The Company believes that EZAccess® has enhanced both its recruiting efforts and its customer service capabilities.

Competition

The contingent staffing and consulting industry is very competitive and fragmented. There are relatively limited barriers to entry and new competitors frequently enter the market. The Company’s competitors vary depending on geographic region and the nature of the service(s) being provided. The Company faces competition from larger firms possessing substantially greater financial, technical and marketing resources than the Company and smaller, regional firms with a strong presence in their respective local markets.  In the current economic climate, management believes that attracting and retaining clients and selling services to them in the face of heightened competition are the principal competitive challenges.  The Company competes on the basis of price, level of service, quality of candidates and reputation, and may be in competition with many other staffing companies seeking to fill any requisition for job openings.

In addition, particularly in stronger economic climates, the availability and quality of candidates, the effective monitoring of job performance and the scope of geographic service are the principal elements of competition. The availability of quality contingent personnel is an especially important facet of competition in many cases.  The Company believes its ability to compete also depends in part on a number of competitive factors outside its control, including the economic climate generally and in particular industries served by the Company, the ability of its competitors to hire, retain and motivate skilled personnel and the extent of its competitors’ responsiveness to customer needs.

Employees

The Company currently employs approximately 550 full-time staff employees at its headquarters and company-owned offices.  The Company issued approximately 22,000 W-2s to employees of the Company who provided services to its customers during 2001, not including W-2s issued as part of the Financial Outsourcing Services segment backoffice services provided by the Company to its customers.  In addition to employees on assignment, the Company maintains a proprietary database of prospective employees with expertise in the disciplines served by the Company. Billable employees are employed by the Company on an as-needed basis dependent on customer demand and are paid only for time they actually work. Non-billable administrative personnel provide management, sales and marketing and other services in support of the Company’s services in all of its segments.

Licensed Offices

The Company has granted a limited number of licenses to operate COMFORCE offices. The most recent license for a new office was granted in July 1992, and the Company does not presently expect to grant more licenses. Licensees recruit contingent personnel and promote their services to both existing and new clients obtained through the licensees’ marketing efforts.  Performance of the contingent personnel and overall service quality is the direct responsibility of licensees, and the licensees are ultimately responsible for the collection of accounts receivable.  The Company and the licensees share the gross profits from each licensed office.

Regulations

Contingent staffing and consulting services firms are generally subject to one or more of the following types of government regulations: (1) registration of the employer/employees; (2) licensing, record keeping and recording requirements; and (3) substantive limitations on operations.  The Company is governed by laws regulating the employer/employee relationship, such as tax withholding or reporting, social security or retirement, anti-discrimination and workers’ compensation. In particular, in the heathcare support sector, the Company is subject to extensive federal and state regulations as well as those of public and private healthcare organizations and authorities.  In addition, the Company’s licensees are considered to be franchisees, which are subject to regulation, both by the Federal Trade Commission and a number of states.

ITEM 2.  PROPERTIES

The Company leases all of its office space.  Excluding the Company’s headquarters, these leases are for office space ranging in size from approximately 660 square feet to approximately 15,600 square feet and have remaining lease terms of from less than one year to five years.  The Company’s headquarters in Woodbury, New York occupies approximately 38,000 square feet of space in two facilities under separate leases that expire in 2010. Except for an approximately 700 square foot condominium, the Company owns no real estate.

The Company believes that its facilities are adequate for its present and reasonably anticipated future business requirements.  The Company does not anticipate difficulty locating additional facilities, if needed.

ITEM 3.  LEGAL PROCEEDINGS

The Company is a party to routine contract and employment‑related litigation matters arising in the ordinary course of its business. No such pending matters, individually or in the aggregate, if adversely determined, are believed by management to be material to the business or financial condition of the Company. The Company maintains general liability insurance, property insurance, automobile insurance, employee benefit liability insurance, fidelity insurance, errors and omissions insurance, professional medical malpractice insurance, fiduciary insurance and directors’ and officers’ liability insurance. The Company is generally self-insured with respect to workers’ compensation, but maintains umbrella workers’ compensation coverage to limit its maximum exposure to such claims.

ITEM 4.  SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

None.

 

PART II

ITEM 5.   MARKET FOR THE REGISTRANT’S COMMON EQUITY AND RELATED STOCKHOLDER      MATTERS

Market Price and Dividends

The Company’s Common Stock is traded on the American Stock Exchange (AMEX:CFS). The high and low sales prices for the Common Stock, as reported by the American Stock Exchange in the Monthly Market Statistics for the periods indicated, were as follows:

		High	Low
2000	First Quarter	$3.63	$1.75
	Second Quarter	2.19	1.25
	Third Quarter	2.13	1.25
	Fourth Quarter	2.00	1.25
2001	First Quarter	2.00	1.25
	Second Quarter	1.85	1.37
	Third Quarter	1.40	0.81
	Fourth Quarter	1.75	0.85

The last reported sale price of the Common Stock of the Company on the American Stock Exchange on March 27, 2002 was $1.15.  As of such date, there were approximately 4,500 shareholders of record.

No dividends were declared or paid on the Common Stock during 2001. The terms of the Company’s debt obligations effectively prohibit its payment of dividends.  Accordingly, the Company does not anticipate that it will pay cash dividends on its Common Stock for the foreseeable future. 

Recent Sales of Unregistered Securities

The Company made no sales of unregistered securities since January 1, 2001 except for (1) options to purchase an aggregate of 555,628 shares of the Company’s common stock at an exercise price of $0.6625 per share issued as of January 2, 2001 as part of a litigation settlement agreed to as of November 30, 2000, as previously reported under Part II, Item 5 in the Company’s annual report on Form 10-K for the year ended  December 31, 2000, and (2) the Company’s 8% Subordinated Convertible Note due December 2, 2009 in the original principal amount of $8.0 million issued as of September 21, 2001, as previously reported under Part II, Item 2 in the Company’s quarterly report on Form 10-Q for the quarter ended September 30, 2001.

ITEM 6.  SELECTED FINANCIAL DATA

The following table sets forth selected historical financial data of the Company as of and for each of the five years in the period ended December 30, 2001. The Company derived the statement of operations and balance sheet data as of and for each of the five years in the period ended December 30, 2001 from its audited historical consolidated financial statements (in thousands, except per share data).

	1997	1998	1999	2000	2001
Statement Of Operations Data: (1)
Net sales of services	$216,521	$459,022	$436,221	$480,325	$437,699
Operating income	$6,865	$24,924	$21,863	$25,437	$17,030
Income (loss) before extraordinary gain	(3,700)	805	(2,038)	(397)	(3,223)
Income (loss) available to common stockholders before extraordinary gain	(4,437)	784	(2,038)	(397)	(3,223)
Gain on early debt extinguishment, net of taxes (2)	----	---	---	2,784	9,263
Income (loss) available to common stockholders	(4,437)	784	(2,038)	2,387	6,040
Diluted income (loss) per share: Income (loss) available to common stockholders before extraordinary gain	$ (0.33)	$ 0.05	$ (0.12)	$ (0.02)	$ (0.19)
Extraordinary gain	---	---	---	0.17	0.55
Net income (loss) available to common stockholders	$ (0.33)	$ 0.05	$ (0.12)	$ 0.15	$ 0.36
Balance Sheet Data:
Working Capital	$59,762	$65,563	$65,808	$88,942	$57,902
Accounts receivable, net	72,865	81,680	81,834	119,067	80,029
Intangible assets, net	135,516	138,847	139,010	137,655	134,283
Total assets	235,934	246,082	249,710	283,414	240,009
Total debt, including current maturities	171,038	178,579	182,346	197,421	154,720
Preferred stock	1	---	---	---	---
Stockholders' equity	39,402	44,334	43,163	46,374	52,537

 

---

 

(1)     Results for the year ended December 31, 1997 include results of RHO Company, Incorporated from the acquisition date of February 28, 1997 through December 31, 1997 and results of Uniforce Services, Inc. from the acquisition date of November 26, 1997 through December 31, 1997.  Results for the year ended December 31, 1998 include results of Camelot Consulting Group Inc., Camelot Communications Group Inc., Camelot Control Group Inc. and Camelot Group Inc. (collectively,  “Camelot”) from the acquisition date of January 27, 1998 through December 31, 1998.  Results for the year ended December 31, 2000 include results of Gerri G. Inc. from the acquisition date of February 6, 2000 through December 31, 2000.

(2)     During 2000, the Company repurchased $10.0 million face value of its 12% Senior Notes due 2007 for a purchase price of $5.1 million.  The net extraordinary gain that was realized by these repurchases was $2.8 million, which includes the reduction of $200,000 of deferred financing costs associated with the repurchases, net of tax expense of $1.9 million.  During 2001, the Company repurchased (i) $13.0 million principal amount of its 12% Senior Notes due 2007 for a cash purchase price of $8.9 million and (ii) $23.2 million principal amount of its 15% Senior Secured PIK Debentures due 2009 (with accrued and unpaid interest thereon of $1.2 million), of which Debentures in the principal amount of $5.2 million (bearing accrued, unpaid interest of $340,000) were purchased for a purchase price of $2.5 million and Debentures in the principal amount of $18.0 million (bearing accrued, unpaid interest of $860,000) were exchanged for the Company’s 8% Subordinated Convertible Note due December 2, 2009 in the original principal amount of $8.0 million, plus $1.0 million in cash.  The net extraordinary gain that was realized by these repurchases was $9.3 million, which includes the reduction of $1.1 million of deferred financing costs associated with the repurchases, net of tax expense of $6.6 million.  See also “Financial Condition, Liquidity and Capital Resources” in Item 7.

ITEM 7.   MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The discussion set forth below supplements the information found in the consolidated financial statements and related notes.

Overview

From the time it entered the staffing business in October 1995 through January 1998, the Company completed 10 acquisitions.  In February 2000, it completed one additional acquisition.  Each of these acquisitions has been accounted for on a purchase basis and the results of operations of each of the businesses acquired have been included in the Company’s historical consolidated financial statements from the date of acquisition. Certain of these acquisitions provide for contingent payments by the Company as a part of the purchase consideration based upon the operating results of the acquired businesses for specified future periods. The acquisitions were financed by the Company principally through the issuance of debt and equity securities and borrowings under credit facilities.

Staffing personnel placed by the Company are employees of the Company. The Company is responsible for employee related expenses for its employees, including workers' compensation, unemployment compensation insurance, Medicare and Social Security taxes and general payroll expenses. The Company offers health, dental, disability and life insurance to its eligible billable employees. Staffing and consulting companies, including the Company, typically pay their billable employees for their services before receiving payment from their customers, often resulting in significant outstanding receivables. To the extent the Company grows, these receivables will increase and there will be greater requirements for borrowing availability under its credit facility to fund current operations.

The Company reports its results through three operating segments -- Staff Augmentation, Human Capital Management Services and Financial Outsourcing Services (formerly known as Financial Services).  The Staff Augmentation segment provides information technology (IT), telecom, healthcare support, technical and other staffing services.  The Human Capital Management Services segment provides contingent workforce management services.  The Financial Outsourcing Services segment provides payroll, funding and back office support services to independent consulting and staffing companies.   

Recent Developments

The following is a discussion of certain developments that have occurred since the beginning of the Company’s 2001 fiscal year.  This discussion is not intended to be an exhaustive discussion of all material events that have occurred during this period.

Change in Fiscal Year

On March 22, 2001, the Company’s Board of Directors adopted a resolution to change the Company’s fiscal year, which previously was a calendar year.  Beginning in 2001, the fiscal year consists of the 52 or 53 weeks ending on the last Sunday in December.  Accordingly, the Company’s fiscal year for 2001 ended on Sunday, December 30, 2001.

Amendments to Credit Facility

On January 5, 2001, the Company entered into an amendment of its revolving credit facility agented by IBJ Whitehall Business Credit Corporation (the “IBJ Credit Facility”) to increase the Company’s borrowing availability from $100.0 million to $110.0 million when additional lending institutions requested to join the loan syndicate.  On March 5, 2001, the Company entered into a second amendment of the IBJ Credit Facility to permit borrowings thereunder to repurchase the Company’s 15% Senior Secured PIK Debentures due 2009 (the “PIK Debentures”) under certain circumstances.  As amended, the IBJ Credit Facility permits the use of up to $16.5 million in loan proceeds to pay the aggregate repurchase prices of its Senior Notes due 2007 (the “Senior Notes”) and PIK Debentures, including tax liabilities and other costs associated with any repurchase, not more than $9.0 million of which may be used to pay the repurchase price of PIK Debentures and such associated costs.  As of September 21, 2001, the Company entered into a third amendment to the IBJ Credit Facility to authorize the exchange of PIK Debentures for the Company’s 8% Subordinated Convertible Note due December 2, 2009 in the principal amount of $8.0 million, as more fully described under “Recent Developments--Repurchase of Senior Notes and PIK Debentures” in this Item 7.  As of December 7, 2001, the Company entered into a fourth amendment of the IBJ Credit Facility to reduce the maximum amount of borrowing availability under the IBJ Credit Facility from $110.0 million to $95.0 million and to liberalize the borrowing base calculation in certain circumstances.  In addition, also as of December 7, 2001, the Company entered into a fifth amendment of the IBJ Credit Facility to create additional flexibility for borrowings with respect to the Company’s payroll funding business.  However, through the banks’ imposition of limitations on the Company’s payroll fundings, the benefits realized by the Company as a result of these amendments are insignificant.

Repurchase of Senior Notes and PIK Debentures

As part of its continuing strategy to reduce its higher interest rate debt and improve its balance sheet, in the first quarter of 2001, the Company completed the repurchase of $13.0 million principal amount of its Senior Notes for $8.9 million and $5.2 million principal amount of PIK Debentures (with accrued and unpaid interest thereon of $340,000) for $2.5 million, the repurchase prices of which were paid from lower interest rate borrowings under the IBJ Credit Facility.

In the third quarter of 2001, the Company completed the exchange of $18.0 million principal amount of PIK Debentures (with accrued and unpaid interest thereon of $860,000) for the Company’s 8% Subordinated Convertible Note due December 2, 2009 in the principal amount of $8.0 million (the “Convertible Note”), plus $1.0 million in cash.  Interest on the PIK Debentures accrues at the rate of 15% per annum and, through December 1, 2002, may, at the election of the Company, be paid-in-kind through its issuance of additional PIK Debentures.  The Convertible Note bears interest at the rate of 8% per annum, payable semi-annually on June 1 and December 1 in each year.  Through December 1, 2003, interest on the Convertible Note may, at the election of the Company, be paid-in-kind through its issuance of additional Convertible Notes.  The Convertible Note is convertible into the Company’s common stock based on a price of $1.70 per share of common stock, provided that if such conversion would result in a change of control occurring under the terms of the indentures governing the PIK Debentures or the Senior Notes, the Convertible Note will be convertible into shares of non-voting preferred stock having a nominal liquidation preference (but no other preferences), which in turn will be convertible into common stock at the holder’s option at any time so long as the conversion would not result in a change of control.  Notice of conversion must be given at least 61 days in advance. See “—Related Party Transaction,” below.

Related Party Transaction

As described above under  “--Repurchase of Senior Notes and PIK Debentures,” in September 2001, the Company completed the exchange of $18.0 million principal amount of PIK Debentures for the Convertible Note in the principal amount of $8.0 million, plus $1.0 million in cash.  A limited partnership in which John Fanning, the Company’s Chairman and Chief Executive Officer, holds the principal economic interest, was the holder of the $18.0 million PIK Debentures that were exchanged for the Convertible Note and cash.  Rosemary Maniscalco, a director of the Company, is the general partner of this limited partnership.  By virtue of this position, she is deemed to be a beneficial owner of the Convertible Note.  Prior to the exchange, the Company received the consent to eliminate certain of the covenants in the indenture governing the PIK Debentures.

The purpose of this transaction was to improve the Company’s balance sheet through the exchange of higher interest rate debt (15% per annum) for lower interest rate debt (8% per annum) and elimination of $10.0 million of debt.  No other holder of PIK Debentures accepted the Company’s offer of exchange and repurchase on these terms. The Company obtained the opinion of an independent investment banking firm that this transaction was fair to the Company from a financial point of view.  See note 8(c) to the consolidated financial statements for a description of the Convertible Note.

Critical Accounting Policies and Estimates

Management’s discussion in this Item 7 addresses the Company’s consolidated financial statements which have been prepared in accordance with accounting principles generally accepted in the United States of America.  The preparation of these financial statements requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period.  On an on-going basis, management evaluates its estimates and judgments, including those related to bad debts, intangible assets, income taxes, workers’ compensation, and contingencies and litigation.  Management bases its estimates and judgments on historical experience and on various other factors that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources.  Actual results may differ from these estimates under different assumptions or conditions.

        Management believes the following critical accounting policies, among others, affect its more significant judgments and estimates used in the preparation of its consolidated financial statements.  The Company maintains allowances for doubtful accounts for estimated losses resulting from the inability of its customers to make required payments.  If the financial condition of the Company’s customers were to deteriorate, resulting in an impairment of their ability to make payments, additional allowances may be required.  The Company determines a need for a valuation allowance to reduce its deferred tax assets to the amount that it believes is more likely than not to be realized.  While the Company has considered future taxable income and ongoing prudent and feasible tax planning strategies in assessing the need for the valuation allowance, in the event the Company were to determine that it would not be able to realize all or a part of its net deferred tax assets in the future, an adjustment to the deferred tax assets would be charged to income in the period such determination was made. The Company assesses the recoverability of long-lived assets, intangible assets and goodwill whenever events or changes in circumstances indicate that the carrying value of the asset may not be recoverable.  When the Company determines that the carrying value of the long-lived assets, intangible assets and goodwill may not be recoverable, it measures any impairment based on comparing future cash flows (undiscounted and without interest charges) expected to result from the use or sale of the asset and its eventual disposition, to the carrying amount of the asset.

Results of Operations
Year Ended December 30, 2001 Compared to Year Ended December 31, 2000

Net sales of services for the year ended December 30, 2001 were $437.7 million, a decrease of 8.9% from net sales of services for the year ended December 31, 2000 of $480.3 million.  The Company suffered a decrease in net sales of services in each of its three segments.  In the Staff Augmentation segment, the decrease is principally attributable to a sharp decline in the telecom industry resulting in lower sales to telecom customers, partially offset by higher sales to information technology customers.  Also, due to the continuing effects of the economic recession, sales were lower in both the Human Capital Management Services and Financial Outsourcing Services segments.

Cost of services for the year ended December 30, 2001 was 79.4% of net sales of services as compared to cost of services of 79.0% for the year ended December 31, 2000.  The cost of services as a percentage of net sales for 2001 increased from 2000 levels principally as a result of lower sales (and gross margin percentages on sales) to telecom customers and a decrease in permanent placement fees, partially offset by the Company’s continued focus on higher-margin niche products in the Staff Augmentation segment.

Selling, general and administrative expenses as a percentage of net sales of services were 14.9% for the year ended December 30, 2001, compared to 13.9% for the year ended December 31, 2000. This increase is principally a result of a $2.4 million write-off in the fourth quarter of 2001 relating to uncollectible funding and service fees receivable, and higher payroll and recruiting costs with respect to non-billable staff and investments to expand the infrastructure for the Company’s Human Capital Management Services segment during the first half of 2001, offset partially by initiatives made by management during the second half of 2001 to reduce costs.  Excluding the write-off, selling, general and administrative expenses as percentage of net sales were 14.4% for the year ended December 30, 2001.

Operating income for the year ended December 30, 2001 was $17.0 million as compared to operating income of $25.4 million for the year ended December 31, 2000.  This 33.1% decrease in operating income for the year ended December 30, 2001 resulted principally from a decrease in sales in each of the Company’s three segments, particularly in the telecom sector, the $2.4 million write-off referred to above and an increase in depreciation and amortization.  Operating income for 2000 included a one-time $1.1 million charge for the settlement of a longstanding lawsuit (see note 11 to the consolidated financial statements).

The Company's interest expense for the year ended December 30, 2001 is attributable to the IBJ Credit Facility, the Convertible Note (which was issued in September 2001), the Senior Notes and the PIK Debentures. The Company's interest expense for the year ended December 31, 2000 is attributable to its former credit facility with institutional lenders which was terminated in December 2000 (the “Retired Credit Facility”), the IBJ Credit Facility (which was entered into in December 2000), the Senior Notes and the PIK Debentures. The IBJ Credit Facility was entered into to repay the Retired Credit Facility and provide the Company with additional borrowing availability.  The obligations evidenced by the Retired Credit Facility and those evidenced by the Senior Notes and PIK Debentures were incurred in 1997, principally in connection with the funding of business acquisitions.

During the first quarter of 2001, the Company repurchased $13.0 million principal amount of Senior Notes for $8.9 million and $5.2 million principal amount of PIK Debentures for $2.5 million (including accrued and unpaid interest of $340,000), the repurchase prices of which were paid from lower interest rate borrowings under the IBJ Credit Facility.  In September 2001, the Company completed the exchange of $18.0 million principal amount of PIK Debentures (including accrued and unpaid interest of $860,000) for its Convertible Note in the original principal amount of $8.0 million (bearing interest at the per annum rate of 8%), plus $1.0 million in cash.  The extraordinary gain realized by the Company during the year ended December 30, 2001 as a result of the repurchases (including the exchange) was $9.3 million, which includes the reduction of  $1.1 million of deferred financing costs associated with these transactions, net of tax expense of $6.6 million. See “Financial Condition, Liquidity and Capital Resources” in this Item 7. 

The interest expense was lower for the year ended December 30, 2001 as compared to the year ended December 31, 2000 due to lower market interest rates and lower borrowing levels under the IBJ Credit Facility as well as the reduction of Senior Notes and PIK Debentures through the repurchases (including the exchange) described above.

The income tax provision for the year ended December 30, 2001 was $303,000 on a loss of $2.9 million before taxes and the extraordinary gain associated with the retirement of the Senior Notes and PIK Debentures through the repurchases and exchange described above.  The income tax provision for the year ended December 31, 2000 was $3.1 million on income before taxes and extraordinary gain of $2.7 million.  The difference between the federal statutory income tax rate and the Company’s effective tax rate relates primarily to the nondeductibility of amortization expense associated with certain intangible assets, the nondeductibility of a portion of the interest expense associated with the PIK Debentures and state income taxes.

Year Ended December 31, 2000 Compared to Year Ended December 31, 1999

Net sales of services for the year ended December 31, 2000 were $480.3 million, an increase of 10.1% from net sales of services for the year ended December 31, 1999 of $436.2 million.  The increase in 2000 net sales of services is principally attributable to higher sales to customers in the Company’s Human Capital Management Services segment and to telecom customers in the Staff Augmentation segment, the contribution of sales by Gerri G since its acquisition in February 2000 in the Staff Augmentation segment (see note 3 to the consolidated financial statements) and there being more business days in 2000 than in 1999, partially offset by a decrease in sales to Staff Augmentation customers in the technical and engineering services and information technologies sectors.  

Cost of services for the year ended December 31, 2000 was 79.0% of net sales of services as compared to cost of services of 80.7% for the year ended December 31, 1999.  The cost of services decreased as a percentage of net sales for the year ended December 31, 2000 as a result of the continued strategies undertaken by management to increase margins throughout the Company, as well as increases in fees for direct hire placements, which generally have no related costs of services.

Selling, general and administrative expenses as a percentage of net sales of services were 13.9% for the year ended December 31, 2000, compared to 12.7% for the year ended December 31, 1999.  This increase resulted principally from higher payroll and recruiting costs with respect to non-billable staff, the expansion of the Company's corporate headquarters and investments to expand the infrastructure for the Company’s Human Capital Management Services segment.

The Company incurred a charge in the year ended December 31, 2000 of approximately $1.1 million as a result of the settlement of its litigation with Austin Iodice and Anthony Giglio in November 2000  (see note 11 to the consolidated financial statements).

Operating income for the year ended December 31, 2000 was $25.4 million as compared to operating income of $21.9 million for the year ended December 31, 1999.  This 16.3% increase in operating income for the year ended December 31, 2000 resulted principally from an increase in gross margin, partially offset by higher selling, general and administrative expenses and the Iodice and Giglio litigation settlement as well as an increase in depreciation and amortization.

The Company's interest expense for the year ended December 31, 2000 and 1999 is attributable to the interest on the Retired Credit Facility, the IBJ Credit Facility, the Senior Notes and the PIK Debentures.  The IBJ Credit Facility was entered into in December 2000 to repay the Retired Credit Facility and provide the Company additional borrowing availability.  These other obligations were incurred in 1997, principally in connection with the funding of business acquisitions.  The Company incurred a charge of $742,000 for the write-off of deferred financing costs in the fourth quarter of 2000 for the early termination of the Retired Credit Facility.  The interest expense is higher in 2000 due to increased interest rates and borrowings under the credit facilities.

Included in other income is a payment for a restricted covenant release of $1.0 million for the year ended December 31, 2000.  This represents a payment made by certain former officers of the Company to release them from certain restrictive agreements and non-competition covenants.

During the third quarter of 2000, the Company repurchased $10.0 million face value of the Senior Notes for a purchase price of $5.1 million.  The net extraordinary gain that was realized by these repurchases was $2.8 million, which includes the reduction of $200,000 of deferred financing costs associated with the repurchases net of tax expense of $1.9 million.  See “Financial Condition, Liquidity and Capital Resources” in this Item 7. 

The income tax provision for the year ended December 31, 2000 was $3.1 million on income before taxes and extraordinary gain of $2.7 million, compared to an income tax provision for the year ended December 31, 1999 of $2.2 million on a profit before taxes of $131,000.  The difference between the federal statutory income tax rate of 34.0% and the Company’s effective tax rate of 114.8% relates primarily to the nondeductibility of amortization expense associated with certain intangible assets, the nondeductibility of a portion of the interest expense associated with the PIK Debentures and state income taxes.

Financial Condition, Liquidity and Capital Resources

The Company generally pays its billable employees weekly for their services, and remits certain statutory payroll and related taxes as well as other fringe benefits.  Invoices are generated to reflect these costs plus the Company’s markup.  These bills are typically paid within 45 days.  Increases in the Company's net sales of services, resulting from expansion of existing offices or establishment of new offices, will require additional cash resources.

The following table represents certain contractual commitments associated with operating agreements, obligations to financial institutions and other long-term debt obligations and earnout (contingent payment) agreements:

	Payments Due By Period (in thousands)
	2002	2003	2004-5	Thereafter
Operating Leases	$ 3,337	$ 2,846	$ 3,666	$ 4,841
IBJ Credit Facility - principal amounts due (see note 8(d))	---	49,220	---	---
Senior Notes - principal amounts due (see note 8 (a))	---	---	---	87,000
PIK Debentures - principal amounts due (see note 8(b))	---	---	---	10,379
Convertible Notes - principal amounts due (see note 8(c))	---	---	---	8,121
Earnout agreements	325	---	---	---
Total	$ 3,662	$ 52,066	$ 3,666	$ 110,341

 

The Company also had standby letters of credit outstanding at December 30, 2001 in the aggregate amount of $4.0 million.

During the year ended December 30, 2001, the Company's primary sources of funds to meet working capital needs were from borrowings under the IBJ Credit Facility.  Cash and cash equivalents decreased $873,000 during the year ended December 30, 2001.  Cash flows provided by operating activities of $33.9 million were exceeded by cash flows used in financing activities of $30.1 million and cash flows used in investing activities of $4.7 million.

As of December 30, 2001, the Company had outstanding $49.2 million principal amount under the IBJ Credit Facility bearing interest at a weighted average rate of 4.33% per annum.  In addition, as of December 30, 2001, the Company had outstanding $10.4 million principal amount of PIK Debentures bearing interest at a rate of 15% per annum, $87.0 million principal amount of Senior Notes bearing interest at a rate of 12% per annum and $8.1 million principal amount of Convertible Notes bearing interest at the rate of 8% per annum.  As more fully described below, interest on the PIK Debentures and the Convertible Notes may be satisfied through the issuance of new PIK Debentures and Convertible Notes.  To date, the Company has chosen to issue new PIK Debentures and Convertible Notes to pay interest thereon. 

The Company entered into the IBJ Credit Facility in December 2000 to provide greater borrowing availability and flexibility.  As described under  “Recent Developments—Amendments to Credit Facility” in this Item 7, the IBJ Credit Facility was amended five times in 2001. The IBJ Credit Facility, as amended, has permitted the Company to execute its strategy of reducing its higher interest rate debt and improving its balance sheet by retiring Senior Notes and PIK Debentures, as more fully described under “Recent Developments—Repurchase of Senior Notes and PIK Debentures” in this Item 7. 

Except for special accounts, borrowings under the IBJ Credit Facility bear interest, at the Company’s option, at a per annum rate equal to either (1) the base commercial lending rate of IBJ as announced from time to time (but not less than 0.5% in excess of the weighted average of the rates on overnight Federal funds transactions), plus a margin ranging from 0% if the Company’s leverage ratio is 4.00 or less to 1% if the Company’s leverage ratio is greater than 6.00 (which margin was 0.75% at December 30, 2001), or (2) LIBOR plus a margin ranging from 1.75% if the Company’s leverage ratio is 4.00 or less to 2.75% if the Company’s leverage ratio is greater than 6.00 (which margin was 2.25% at December 30, 2001).  Borrowings on certain special accounts bear additional interest of 1% per annum. The IBJ Credit Facility currently provides for borrowing availability of up to $95.0 million based upon a specified percentage of the Company’s eligible accounts receivable.  At December 30, 2001, the Company had outstanding borrowings under the IBJ Credit Facility of $49.2 million and remaining availability based upon then outstanding eligible accounts receivable of $12.2 million.  The obligations evidenced by the IBJ Credit Facility are collateralized by a pledge of the capital stock of the subsidiaries of the Company and by security interests in substantially all of the assets of the Company.  The agreements evidencing the IBJ Credit Facility contain various financial and other covenants and conditions, including, but not limited to, limitations on paying dividends, engaging in affiliate transactions, making acquisitions and incurring additional indebtedness.  The scheduled maturity date of the IBJ Credit Facility is December 14, 2003.  The Company intends to seek to extend the IBJ Credit Facility or to seek to obtain alternative financing.

The IBJ Credit Facility permits the use of up to $16.5 million in loan proceeds to pay the aggregate repurchase prices of Senior Notes and PIK Debentures and tax liabilities and costs associated therewith, not more than $9.0 million of which may be used to pay the repurchase price of PIK Debentures and these associated costs.  During 2001, the Company has reduced its higher interest rate debt and improved its balance sheet by retiring Senior Notes and PIK Debentures through public market and privately negotiated transactions and exchanging PIK Debentures for the new Convertible Note with a substantially lower interest rate. In the case of each repurchase and the exchange, the Company has incurred tax liabilities for the forgiveness of indebtedness as a result of its retirement of Senior Notes and PIK Debentures for consideration that is less than par.  In the first quarter of 2001, the Company repurchased $13.0 million principal amount of Senior Notes for $8.9 million and $5.2 million principal amount of PIK Debentures for $2.5 million, the repurchase prices of which were paid from lower interest rate borrowings under the IBJ Credit Facility.  In the third quarter of 2001, the Company completed the exchange of $18.0 million principal amount of PIK Debentures (bearing interest at the rate of 15% per annum) for its new $8.0 million Convertible Note (bearing interest at the rate of 8% per annum), plus $1.0 million in cash.   The total interest savings from these repurchases is estimated to be $4.5 million annually based upon current market interest rates.

Substantially all of the consolidated net assets of the Company are assets of COI and all of the net income that has been generated by the Company through December 30, 2001 is net income attributable to the operations of COI.   Accordingly, except for permitted distributions, these assets and net income are restricted as to their use by COMFORCE.   The indenture governing the Senior Notes imposes restrictions on COI making specified payments, which are referred to as “restricted payments,” including making distributions or paying dividends (referred to as upstreaming funds) to COMFORCE.  Under the indenture, COI is not permitted to make cash distributions to COMFORCE other than (1) to upstream $2.0 million annually ($1.25 million annually prior to 2000) to pay public company expenses, (2) to upstream up to $10.0 million to pay income tax related to deemed forgiveness of PIK Debentures to facilitate the purchase or exchange by COMFORCE of PIK Debentures at less than par, (3) under certain circumstances in connection with a disposition of assets, to upstream proceeds therefrom to repay the PIK Debentures, and (4) to upstream funds to the extent COI meets the restricted payments test under the indenture as described under note 8 to the Company’s consolidated financial statements.   

In 2001, COI upstreamed $1.8 million for public company expenses of COMFORCE.   Management believes that $2.0 million annually (if COI has funds available for this purpose) will be sufficient to pay COMFORCE’s annual public company expenses for the foreseeable future.  During 2001, in connection with its repurchase of Senior Notes and PIK Debentures (including through their exchange for the Convertible Note), COMFORCE incurred tax liabilities related to the forgiveness of indebtedness of approximately $6.6 million, payable from the $10.0 million permitted to be upstreamed for this purpose.  In 2001, COI also made upstream payments of $3.5 million to COMFORCE to repurchase PIK Debentures.  These payments were permitted restricted payments under the indenture governing the Senior Notes.  As of December 30, 2001, COI had approximately $2.0 million remaining available for distribution to COMFORCE as permitted restricted payments (representing 50% of consolidated net income of COI for the period from January 1, 1998 through December 30, 2001, less the total amount of restricted payments through such date). 

Through December 1, 2002, interest under the PIK Debentures is payable, at the option of COMFORCE, in cash or in kind through the issuance of additional PIK Debentures.  In addition, through December 1, 2003, interest on the Convertible Note is payable, at the option of COMFORCE, in cash or in kind through the issuance of additional Convertible Notes.  To date, COMFORCE has paid all interest under the PIK Debentures and Convertible Note in kind.  In 2001, the Company paid $2.8 million in interest in kind.  Beginning with the interest payment due June 1, 2003, COMFORCE will be required to pay interest on the PIK Debentures in cash, and beginning with the interest payment due June 1, 2004, COMFORCE will be required to pay interest on the Convertible Note in cash.  Its ability to do so will be dependent on the ability of COI to borrow funds for this purpose under the IBJ Credit Facility and to upstream funds under the restricted payments test.  In addition, COMFORCE’s ability to repay the PIK Debentures and the Convertible Note at their respective maturity dates in December 2009, or on any earlier required repayment or repurchase dates, will also be dependent on the ability of COI to upstream funds for these purposes under the restricted payments test, unless COMFORCE separately obtains a loan or sells its capital stock or other securities to provide funds therefor. 

The Convertible Note is convertible into the Company’s common stock based on a price of $1.70 per share of common stock, provided that if such conversion would result in a change of control occurring under the terms of the indentures governing the PIK Debentures or the Senior Notes, the Convertible Note will be convertible into shares of non-voting preferred stock having a nominal liquidation preference (but no other preferences), which in turn will be convertible into common stock at the holder’s option at any time so long as the conversion would not result in a change of control.  Notice of conversion must be given at least 61 days in advance. See “—Related Party Transaction,” above.

As of December 30, 2001, approximately $134.3 million, or 56.0%, of the Company's total assets were intangible assets. These intangible assets substantially represent amounts attributable to goodwill recorded in connection with the Company's acquisitions.  Intangible assets are amortized over a 5 to 40 year period, resulting in an annual non-cash charge of approximately $4.3 million.

Effective December 31, 2001, the Company ceased recording amortization expense relating to goodwill amounting to approximately $4.2 million upon its required adoption of a new accounting standard (SFAS 142), as described below under “Impact of Recently Issued Accounting Standards.”  However, also as described below under “Impact of Recently Issued Accounting Standards,” SFAS 142 changes the standards under which the Company must evaluate the recoverability of goodwill on its books and may cause the Company to write-off goodwill when it completes its evaluation, which could have a material adverse impact on its financial condition and results of operations.

The Company is obligated under various agreements to make earn-out payments to the sellers of companies acquired by the Company and to sellers of franchised businesses repurchased by the Company, subject to the sellers meeting specified contractual requirements.  The maximum amount of the remaining potential earn-out payments is approximately $325,000 in cash payable through December 31, 2002.  The Company cannot currently estimate whether it will be obligated to pay the maximum amount; however, the Company anticipates that the cash generated by the operations of the acquired companies or franchised businesses will provide all or a substantial part of the capital required to fund the cash portion of the earn-out payments.

Management of the Company believes that cash flow from operations and funds anticipated to be available under the IBJ Credit Facility will be sufficient to service the Company’s indebtedness and to meet anticipated working capital requirements for the foreseeable future.

Impact of Recently Issued Accounting Standards

In July 2001, the Financial Accounting Standards Board (“FASB”) issued Statement No. 141, Business Combinations (“SFAS 141”) and Statement No. 142, Goodwill and Other Intangible Assets (“SFAS 142”) and in August 2001 the FASB issued statement No. 144 Accounting for the Impairment or Disposal of Long-Lived Assets ("SFAS 144").  SFAS 141 requires that the purchase method of accounting be used for all business combinations initiated or completed after June 30, 2001.  The Company adopted the provisions of SFAS 141 upon issuance.  SFAS 141 also specifies criteria that intangible assets acquired in a purchase method business combination must meet to be recognized and reported apart from goodwill.  SFAS 142 requires, commencing December 31, 2001, that goodwill and intangible assets with indefinite useful lives no longer be amortized.  Instead, they will be tested for impairment at least annually in accordance with the provisions of SFAS 142.  SFAS 142 will also require that intangible assets with definite useful lives be amortized over their respective estimated useful lives to their estimated residual values, and reviewed for impairment in accordance with SFAS 144.  Goodwill and intangible assets acquired by the Company in its business combinations completed before July 1, 2001 was amortized during the period through December 30, 2001.

SFAS 141 requires that upon adoption of SFAS 142, the Company evaluate its existing intangible assets and goodwill that were acquired in a prior purchase business combination, and make any necessary reclassifications in order to conform with the new criteria in SFAS 141 for recognition apart from goodwill.  The Company also adopted SFAS 142 and, accordingly, will be required to reassess the useful lives and residual values of all intangible assets acquired in purchase business combinations, and to make any necessary amortization period adjustments by the end of the first interim period after adoption.  In addition, to the extent an intangible asset is identified as having an indefinite useful life, the Company will be required to test the intangible asset for impairment within the first interim period in accordance with SFAS 144.  Any impairment loss will be measured as of the date of adoption and recognized as the cumulative effect of a change in accounting principle in the first interim period.

In connection with the transitional goodwill impairment evaluation, SFAS 142 and SFAS 144 require that the Company perform an assessment of whether there is an indication that goodwill is impaired as of the date of adoption.  To the extent a reporting unit’s carrying amount (as defined in SFAS 142) exceeds its fair value, the Company must perform the second step of the transitional impairment test.  In the second step, the Company must compare the implied fair value of the reporting unit’s goodwill, determined by allocating the reporting unit’s fair value to all of its assets (recognized and unrecognized) and liabilities in a manner similar to a purchase price allocation in accordance with SFAS 141, to its carrying amount, both of which would be measured as of the date of adoption.  This second step is required to be completed as soon as possible, but no later than the end of the fiscal year of adoption.  Any transitional impairment loss will be recognized as the cumulative effect of a change in accounting principle in the Company’s consolidated statement of operations.

As of the date of adoption, the Company has unamortized goodwill and identifiable intangible assets in the amount of $134.3 million, which are subject to the transition provision of SFAS 141 and SFAS 142.  Amortization expense related to goodwill was $4.2 million for the year ended December 30, 2001.  The Company has evaluated the remaining useful lives of its intangible assets that will continue to be amortized and has determined that no revision to the useful lives will be required.  The Company expects to complete its initial impairment review of intangible assets with indefinite useful lives by the end of the first quarter of 2002 and of goodwill by the end of the second quarter 2002.  The Company does not expect that its impairment review of its intangible assets with indefinite useful lives will result in a material impact to its consolidated financial statements.  Because of the extensive effort needed to comply with adopting SFAS 142, it is not practicable to reasonably estimate whether any transitional impairment losses associated with the Company’s goodwill will be required to be recognized.

In June 2001, the FASB issued Statement No. 143, Accounting for Asset Retirement Obligations (“SFAS 143”).  SFAS 143 addresses financial accounting and reporting for obligations associated with the retirement of tangible long-lived assets and the associated asset retirement costs.  It applies to legal obligations associated with the retirement of long-lived assets that result from the acquisition, construction, development and (or) the normal operation of a long-lived asset, except for certain obligations of lessees.  This Statement amends FASB Statement No. 19, Financial Accounting and Reporting by Oil and Gas Producing Companies, and it applies to all entities.  The Company is required to adopt SFAS 143, effective for calendar year 2003.  The Company does not expect the adoption of SFAS 143 to have a material impact on its future consolidated operations or financial position, as the Company is now constituted.

SFAS 144 addresses financial accounting and reporting for the impairment or disposal of long-lived assets and supersedes SFAS 121, Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of.  However, SFAS 144 retains the fundamental provisions of SFAS 121 for (a) recognition and measurement of the impairment of long-lived assets to be held and used and (b) measurement of long-lived assets to be disposed of by sale.  SFAS 144 supersedes the accounting and reporting provisions of APB Opinion No. 30, Reporting the Results of Operations-Reporting the Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring Events and Transactions, for the disposal of a segment of a business.  However, SFAS 144 retains the requirement of Opinion 30 to report discontinued operations separately from continuing operations and extends that reporting to a component of an entity that either has been disposed of (by sale, by abandonment, or in distribution to owners) or is classified as held for sale.  SFAS 144 also amends ARB No. 51, Consolidated Financial Statement, to eliminate the exception to consolidation for a temporarily controlled subsidiary.  The Company is required to adopt SFAS 144 effective December 31, 2001.  The Company does not expect the adoption of SFAS 144 for long-lived assets held for use to have a material impact on its consolidated financial statements because the impairment assessment under SFAS 144 is largely unchanged from SFAS 121.  The provisions of this statement for assets held for use or other disposal generally are required to be applied prospectively after the adoption date to newly initiated disposal activities and therefore, will depend on future actions initiated by management.  As a result, the Company cannot determine the potential effects that adoption of SFAS 144 will have on its financial statements with respect to future disposal decisions, if any.

Seasonality

The Company’s quarterly operating results are affected primarily by the number of billing days in the quarter and the seasonality of its customers’ businesses.  Demand for technical and engineering services, IT and telecom staffing services has historically been lower during the second half of the fourth quarter through the following first quarter, and, generally, shows gradual improvement until the second half of the fourth quarter; however, the Company’s revenues have declined since the first quarter of 2001 as a result of the economic climate generally and in certain of the industries served by the Company or other factors. 

Forward Looking Statements

Various statements made in this Report concerning the manner in which the Company intends to conduct its future operations, and potential trends that may impact future results of operations, are forward looking statements.  The Company may be unable to realize its plans and objectives due to various important factors, including, but not limited to the following: a continuation of the current recessionary environment, particularly in the aircraft manufacturing, telecom and other sectors served by the Company (which may reflect cyclical conditions or fundamental changes in these industries), could further reduce demand for contingent personnel and further heighten the competition for customers, resulting in lower revenues and margins and affecting the Company’s ability to continue to meet the financial covenants under the IBJ Credit Facility; the Company’s significant leverage may leave it with a diminished ability to obtain additional financing for working capital or other capital expenditures, for retiring higher interest rate debt or for otherwise improving the Company’s competitiveness and capital structure or expanding its operations; the recent effectiveness of SFAS 142 changes the standards under which the Company must evaluate the recoverability of goodwill on its books and may cause the Company to write-off goodwill, which could have a material adverse impact on its financial condition and results of operations; or, if  COI fails to generate sufficient consolidated net income or have other funds available to upstream to COMFORCE under the restricted payments test of the Senior Notes indenture in order for it to pay cash interest on the PIK Debentures (which is required beginning June 1, 2003) or the Convertible Note (which is required beginning June 1, 2004) or to repay the PIK Debentures or the Convertible Note at their maturity in December 2009, or on any earlier required repayment or repurchase date, then, unless COMFORCE obtains a loan or sells its capital stock or other securities to provide funds for this purpose, the Company will default under the indentures governing the PIK Debentures and the Senior Notes and under the IBJ Credit Facility. 

Additional important factors that could cause the Company to be unable to realize its plans and objectives are described under “Risk Factors” in the Registration Statement on Form S-3 of the Company filed with the Securities and Exchange Commission on December 21, 2000 (Registration No. 333-52356).  The disclosure under “Risk Factors” in the Registration Statement may be accessed through the Web site maintained by the Securities and Exchange Commission at “www.sec.gov.”  In addition, the Company will provide, without charge, a copy of such “Risk Factors” disclosure to each stockholder of the Company who requests such information.  Requests for copies should be directed to the attention of Linda Annicelli, Vice President of Administration at COMFORCE Corporation, 415 Crossways Park Drive, P.O. Box 9006, Woodbury, New York 11797, telephone 516-437-3300.

ITEM 7A.   QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Most of the Company’s borrowings are fixed rate obligations.  During 2001, approximately 21.9% of the Company’s interest expense was attributable to variable rate loans, all of which were under IBJ Credit Facility.  The IBJ Credit Facility currently provides for borrowing availability of up to $95.0 million based upon a specified percentage of the Company’s eligible accounts receivable.  Since the interest rates on borrowings under the IBJ Credit Facility are variable, they will be impacted by changes in interest rates generally prevailing in the United States and internationally.  However, management of the Company does not believe that any adjustments to the rate under the IBJ Credit Facility are likely to have a material impact on the Company’s results of operations in the immediate future.  Assuming an immediate 10% increase in the weighted average interest rate as of December 30, 2001, the impact to the Company in annualized interest payable would be approximately $225,000.  Since management does not believe that any adjustments to the rate under the IBJ Credit Facility are likely to have a material impact on the Company’s results of operations, the Company has not entered into any swap agreements or other hedging transactions as a means of limiting exposure to interest rate fluctuations. 

ITEM 8.    FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

Financial Statements and Schedules as listed on page F-1.

ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE

None.