UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, DC 20549

FORM 10-Q

OR

Commission File Number 1-05707

GEE GROUP INC.

(Exact name of registrant as specified in its charter)

7751 Belfort Parkway, Suite 150, Jacksonville, FL 32256

(Address of principal executive offices)

(630) 954-0400

(Registrant’s telephone number, including area code)

_____________________________________________________________

(Former name, former address and former fiscal year, if changed since last report)

Securities registered pursuant to Section 12(b) of the Act:

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No o

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (Section 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes x No o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. o

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No x

The number of shares outstanding of the registrant’s common stock as of August 8, 2019 was 12,538,411.

GEE GROUP INC.

Form 10-Q

For the Quarter Ended June 30, 2019

INDEX

PART I. FINANCIAL INFORMATION

PART II. OTHER INFORMATION

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CAUTIONARY STATEMENT REGARDING FORWARD LOOKING STATEMENTS

As a matter of policy, the Company does not provide forecasts of future financial performance. The statements made in this quarterly report on Form 10-Q which are not historical facts are forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. Such forward-looking statements often contain or are prefaced by words such as "believe", "will" and "expect." These statements are based on current expectations, estimates and projections about our business based, in part, on assumptions made by management. These statements are not guarantees of future performance and involve risks, uncertainties and assumptions that are difficult to predict. As a result of a number of factors, our actual results could differ materially from those set forth in the forward-looking statements. Certain factors that might cause the Company's actual results to differ materially from those in the forward-looking statements include, without limitation, general business conditions, the demand for the Company's services, competitive market pressures, the ability of the Company to attract and retain qualified personnel for regular full-time placement and contract assignments, the possibility of incurring liability for the Company's business activities, including the activities of its contract employees and events affecting its contract employees on client premises, and the ability to attract and retain qualified corporate and branch management, as well as those risks discussed in the Company's Annual Report on Form 10-K for the year ended September 30, 2018, and in other documents which we file with the Securities and Exchange Commission. Any forward-looking statements speak only as of the date on which they are made, and the Company is under no obligation to (and expressly disclaims any such obligation to) and does not intend to update or alter its forward-looking statements whether as a result of new information, future events or otherwise.

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Part I -FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS (unaudited)

GEE GROUP INC.

CONDENSED CONSOLIDATED BALANCE SHEETS (unaudited)

(In Thousands)

		June 30, 2019				September 30, 2018
ASSETS
CURRENT ASSETS:
Cash		$	4,163			$	3,213
Accounts receivable, less allowances ($302 and $302, respectively)			20,437				20,755
Prepaid expenses and other current assets			2,756				2,266
Total current assets			27,356				26,234
Property and equipment, net			832				891
Goodwill			72,293				76,593
Intangible assets, net			25,277				29,467
Other long-term assets			588				416
TOTAL ASSETS		$	126,346			$	133,601
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable and accrued compensation		$	9,100			$	7,735
Acquisition deposit for working capital guarantee			883				883
Short-term portion of subordinated debt			1,000				106
Short-term portion of term loan, net of discount			2,931				2,331
Other current liabilities			2,027				2,064
Total current liabilities			15,941				13,119
Deferred taxes			542				146
Revolving credit facility			13,865				11,925
Term loan, net of discount			38,064				40,253
Subordinated convertible debt (includes $1,195, net of discount, due to related parties)			17,880				17,685
Other long-term liabilities			613				583
Total long-term liabilities			70,964				70,592
Commitments and contingencies
MEZZANINE EQUITY
Preferred stock; no par value; authorized - 20,000 shares -
Preferred series A stock; authorized -160 shares; issued and outstanding - none			-				-
Preferred series B stock; authorized - 5,950 shares; issued and outstanding - 5,566 and 5,816 at June 30, 2019 and September 30, 2018, respectively; liquidation value of the preferred series B stock is approximately $27,050 and $28,255 at June 30, 2019 and September 30, 2018, respectively			27,551				28,788
Preferred series C stock; authorized - 3,000 shares; issued and outstanding - 20 and 0 at June 30, 2019 and September 30, 2018, respectively; liquidation value of the preferred series C stock is approximately $20 and $0 at June 30, 2019 and September 30, 2018, respectively			20				-
Total mezzanine equity			27,571				28,788
SHAREHOLDERS' EQUITY
Common stock, no-par value; authorized - 200,000 shares; issued and outstanding - 12,054 shares at June 30, 2019 and 10,783 shares at September 30, 2018, respectively			-				-
Additional paid in capital			49,064				44,120
Accumulated deficit			(37,194	)			(23,018	)
Total shareholders' equity			11,870				21,102
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY		$	126,346			$	133,601

The accompanying notes are an integral part of the unaudited condensed consolidated financial statements.

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GEE GROUP INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (unaudited)

(In Thousands)  

		Three Months Ended								Nine Months Ended
		June 30,								June 30,
		2019				2018				2019				2018
NET REVENUES:
Contract staffing services		$	33,217			$	33,879			$	99,057			$	107,860
Direct hire placement services			4,884				6,388				13,764				17,496
NET REVENUES			38,101				40,267				112,821				125,356
Cost of contract services			24,521				25,546				74,093				81,235
GROSS PROFIT			13,580				14,721				38,728				44,121
Selling, general and administrative expenses (including noncash stock-based compensation expense of $531 and $399, and $1,661 and $1,028 respectively)			10,995				12,111				31,547				35,839
Acquisition, integration and restructuring expenses			564				514				2,990				1,712
Depreciation expense			89				92				269				287
Amortization of intangible assets			1,396				1,409				4,189				4,199
Goodwill impairment charge			4,300				-				4,300				-
INCOME (LOSS) FROM OPERATIONS			(3,764	)			595				(4,567	)			2,084
Interest expense			(3,176	)			(2,889	)			(9,209	)			(8,381	)
LOSS BEFORE INCOME TAX PROVISION			(6,940	)			(2,294	)			(13,776	)			(6,297	)
Provision for income tax			106				407				(400	)			(259	)
NET LOSS		$	(6,834	)		$	(1,887	)		$	(14,176	)		$	(6,556	)
NET LOSS ATTRIBUTABLE TO COMMON
STOCKHOLDERS		$	(6,834	)		$	(1,887	)		$	(14,176	)		$	(6,556	)
BASIC AND DILUTED LOSS PER SHARE		$	(0.57	)		$	(0.18	)		$	(1.22	)		$	(0.64	)
WEIGHTED AVERAGE NUMBER OF SHARES - BASIC AND DILUTED			12,041				10,526				11,609				10,177

The accompanying notes are an integral part of the unaudited condensed consolidated financial statements.

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GEE GROUP INC.

CONDENSED CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY (unaudited)

(In Thousands)

		Common				Additional								Total
		Stock				Paid				Accumulated				Shareholders'
		Shares				In Capital				Deficit				Equity
Balance, September 30, 2018			10,783			$	44,120			$	(23,018	)		$	21,102
Share-based compensation			-				581				-				581
Issuance of stock for interest			171				401				-				401
Conversion of preferred Series B to common stock			250				1,238				-				1,238
Net loss			-				-				(3,452	)			(3,452	)
Balance, December 31, 2018			11,204			$	46,340			$	(26,470	)		$	19,870
Share-based compensation			-				549				-				549
Issuance of stock for interest			517				402				-				402
Net loss			-				-				(3,890	)			(3,890	)
Balance, March 31, 2019			11,721			$	47,291			$	(30,360	)		$	16,931
Share-based compensation			-				531				-				531
Issuance of stock for interest			333				401				-				401
Beneficial conversion features on subordinated debt			-				841				-				841
Net loss			-				-				(6,834	)			(6,834	)
Balance, June 30, 2019			12,054			$	49,064			$	(37,194	)		$	11,870

		Common				Additional								Total
		Stock				Paid				Accumulated				Shareholders'
		Shares				In Capital				Deficit				Equity
Balance, September 30, 2017			9,879			$	39,517			$	(15,454	)		$	24,063
Share-based compensation			-				293				-				293
Issuance of stock for interest			136				595				-				595
Net loss			-				-				(1,791	)			(1,791	)
Balance, December 31, 2017			10,015			$	40,405			$	(17,245	)		$	23,160
Share-based compensation			-				336				-				336
Issuance of stock for interest			321				999				-				999
Conversion of preferred Series B to common stock			110				545				-				545
Net loss			-				-				(2,878	)			(2,878	)
Balance, March 31, 2018			10,446			$	42,285			$	(20,123	)		$	22,162
Share-based compensation			-				399				-				399
Issuance of stock for interest			163				401				-				401
Net loss			-				-				(1,887	)			(1,887	)
Balance, June 30, 2018			10,609			$	43,085			$	(22,010	)		$	21,075

The accompanying notes are an integral part of the unaudited condensed consolidated financial statements. 

 

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GEE GROUP INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (unaudited)

(In Thousands)

		Nine Months Ended
		June 30,
		2019				2018
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss		$	(14,176	)		$	(6,556	)
Adjustments to reconcile net loss to cash (used in) provided by operating activities:
Depreciation and amortization			4,458				4,486
Goodwill impairment charge			4,300				-
Stock Compensation expense			1,661				1,028
Provision for doubtful accounts			-				(815	)
Deferred income taxes			396				290
Amortization of debt discount			634				576
Interest expense paid with common and preferred stock			1,224				1,610
Changes in operating assets and liabilities:
Accounts receivable			318				2,827
Accrued interest			-				1,332
Accounts payable			1,390				(1,213	)
Accrued compensation			(25	)			(2,206	)
Other current items, net			(531	)			(594	)
Long-term items, net			(200	)			(67	)
Net cash (used in) provided by operating activities			(551	)			698
CASH FLOWS FROM INVESTING ACTIVITIES:
Acquisition of property and equipment			(108	)			(224	)
Net cash used in investing activities			(108	)			(224	)
CASH FLOWS FROM FINANCING ACTIVITIES:
Payment on term loan			(2,187	)			(2,112	)
Payments on subordinated debt			(107	)			(806	)
Payments on capital lease			(37	)			-
Net proceeds from revolving credit			1,940				2,296
Net proceeds from subordinate note			2,000				-
Net cash provided by (used in) financing activities			1,609				(622	)
Net change in cash			950				(148	)
Cash at beginning of period			3,213				2,785
Cash at end of period		$	4,163			$	2,637
SUPPLEMENTAL CASH FLOW INFORMATION:
Cash paid for interest		$	7,373			$	6,435
Cash paid for taxes		$	75			$	-
Non-cash financing activities
Conversion of Series B Convertible Preferred Stock to common stock		$	1,238			$	545
Beneficial conversion features on subordinated debt		$	841			$	-
Issuance of stock for extinguishment of debt		$	-			$	385
Acquisition of equipment with capital lease		$	102			$	-

The accompanying notes are an integral part of the unaudited condensed consolidated financial statements.

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1. Description of Business

GEE Group Inc. (the “Company”, “us”, “our” or “we”) was incorporated in the State of Illinois in 1962 and is the successor to employment offices doing business since 1893. We are a provider of permanent and temporary professional and industrial staffing and placement services in and near several major U.S cities. We specialize in the placement of information technology, accounting, finance, office, engineering, and medical professionals for direct hire and contract staffing for our clients and provide temporary staffing services for our commercial clients.

2. Significant Accounting Policies and Estimates

The accompanying unaudited condensed consolidated financial statements of the Company have been prepared in accordance with accounting principles generally accepted in the United States of America for interim financial information and with the instructions to Article 8 of Regulation S-X. Accordingly, they do not include all of the information and notes required by accounting principles generally accepted in the United States of America for complete consolidated financial statements. In the opinion of management, all adjustments considered necessary for a fair presentation have been included. Operating results for the three and nine-month period ended June 30, 2019 are not necessarily indicative of the results that may be expected for the year ending September 30, 2019. The unaudited condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and notes thereto included in the Company's Annual Report on Form 10-K for the year ended September 30, 2018 as filed on December 27, 2018.

Liquidity

The Company experienced significant net losses for its most recent fiscal year ended September 30, 2018, and for the nine-month period ended June 30, 2019.

As of June 30, 2019, the Company had cash of approximately $4.2 million, which was an increase of approximately $1.0 million from approximately $3.2 million at September 30, 2018. Working capital at June 30, 2019 was approximately $11.4 million, as compared to working capital of approximately $13.1 million for September 30, 2018.

Management has taken definitive actions to improve operations, reduce costs and improve profitability, and position the Company for future growth. In addition, the Company’s senior lenders have worked with management in providing amendments and waivers to the Company’s senior credit facilities as management works towards improving the Company’s operations and restructuring its current debt and equity capitalization.

Based on its current projections, management expects that the Company can meet its future debt service requirements and comply with its financial covenants and other commitments, as amended, and will continue to seek reasonable assistance from the Company’s senior lenders, as necessary. However, the Company’s projections are based on assumptions and estimates about future performance and events, which are subject to change or other unforeseen conditions or uncertainties. As such, there can be no assurance that the Company will not fall into non-compliance with its loan covenants or that its Lenders will continue to provide waivers or amendments to the Company in the event of future non-compliance with debt covenants or other possible events of default that could happen in the future.

Principles of Consolidation

The unaudited condensed consolidated financial statements include the accounts and transactions of the Company and its wholly-owned subsidiaries. All significant inter-company accounts and transactions are eliminated in consolidation.

Estimates and Assumptions

Management makes estimates and assumptions that can affect the amounts of assets and liabilities reported as of the date of the unaudited condensed consolidated financial statements, as well as the amounts of reported revenues and expenses during the periods presented. Those estimates and assumptions typically involve expectations about events to occur subsequent to the balance sheet date, and it is possible that actual results could ultimately differ from the estimates.

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Revenue Recognition

Revenues from contracts with customers are generated through the following services: direct hire placement services, temporary professional services staffing, and temporary light industrial staffing. Revenues are recognized when promised services are performed for customers, and in an amount that reflects the consideration the Company expects to be entitled to in exchange for those services. Our revenues are recorded net of variable consideration such as sales adjustments or allowances.

Direct hire placement service revenues from contracts with customers are recognized when employment candidates accept offers of employment, less a provision for estimated credits or refunds to customers as the result of applicants not remaining employed for the entirety of the Company's guarantee period (referred to as “falloffs”). The Company’s guarantee periods for permanently placed employees generally range from 60 to 90 days from the date of hire. Fees associated with candidate placement are generally calculated as a percentage of the new employee’s annual compensation. No fees for permanent placement services are charged to employment candidates.

Temporary staffing service revenues from contracts with customers are recognized in amounts for which the Company has a right to invoice, as the services are rendered by the Company’s temporary employees. The Company records temporary staffing revenue on a gross basis as a principal versus on a net basis as an agent in the presentation of revenues and expenses. The Company has concluded that gross reporting is appropriate because the Company controls the specified service before that service is performed for a customer. The Company has the risk of identifying and hiring qualified employees, has the discretion to select the employees and establish their price, and bears the risk for services that are not fully paid for by customers.

Falloffs and refunds during the period are reflected in the unaudited condensed consolidated statements of operations as a reduction of placement service revenues and were approximately $0.5 million and $0.6 million, and $1.9 million and $1.6 million for the three and nine-month periods ended June 30, 2019 and 2018, respectively. Expected future falloffs and refunds are reflected in the unaudited condensed consolidated balance sheet as a reduction of accounts receivable as described under Accounts Receivable, below.

See Note 13 for disaggregated revenues by segment.

Payment terms in our contracts vary by the type and location of our customer and the services offered. The terms between invoicing and when payments are due are not significant.

Cost of Contract Staffing Services

The cost of contract services includes the wages and the related payroll taxes, employee benefits and certain other employee-related costs of the Company’s contract service employees, while they work on contract assignments.

Cash and Cash Equivalents

Highly liquid investments with a maturity of three months or less when purchased are considered to be cash equivalents. As of June 30, 2019 and September 30, 2018, there were no cash equivalents. The Company maintains deposits in financial institutions and, at times, balances may exceed federally insured limits. We have never experienced any losses related to these balances.

Accounts Receivable

The Company extends credit to its various customers based on evaluation of the customer’s financial condition and ability to pay the Company in accordance with the payment terms. An allowance for placement fall-offs is recorded, as a reduction of revenues, for estimated losses due to applicants not remaining employed for the Company’s guarantee period. An allowance for doubtful accounts is recorded, as a charge to bad debt expense, where collection is considered to be doubtful due to credit issues. These allowances together reflect management’s estimate of the potential losses inherent in the accounts receivable balances, based on historical loss statistics and known factors impacting its customers. The nature of the contract service business, where companies are dependent on employees for the production cycle allows for a relatively small accounts receivable allowance. As of each of June 30, 2019, and September 30, 2018, the allowance for doubtful accounts was $0.3 million. The Company charges off uncollectible accounts once the invoices are deemed unlikely to be collectible. The allowance also includes permanent placement falloffs of $0.2 million as of June 30, 2019 and September 30, 2018.

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Property and Equipment

Property and equipment are recorded at cost. Depreciation expense is calculated on a straight-line basis over estimated useful lives of five years for computer equipment and two to ten years for office equipment, furniture and fixtures. The Company capitalizes computer software purchased or developed for internal use and amortizes it over an estimated useful life of five years. The carrying value of property and equipment is reviewed for impairment whenever events or changes in circumstances indicate that it may not be recoverable. If the carrying amount of an asset group is greater than its estimated future undiscounted cash flows, the carrying value is written down to the estimated fair value. There was no impairment of property and equipment for the nine-month period ended June 30, 2019 and 2018.

Goodwill

In 2019, the Company early adopted ASU 2017-04, Intangibles — Goodwill and Other (Topic 350), Simplifying the Test for Goodwill Impairment, which simplifies the subsequent measurement of goodwill by eliminating the second step from the quantitative goodwill impairment test. Under this guidance, annual or interim goodwill impairment testing is performed by comparing the fair value of a reporting unit with its carrying amount. An impairment charge is recognized for the amount by which the carrying amount exceeds the reporting unit’s fair value, not to exceed the carrying value of goodwill.

Due to a sustained decline in the market capitalization of our common stock during the third quarter of 2019, we performed an interim goodwill impairment test in accordance with the provisions of ASU 2017-04. The outcome of this goodwill impairment test resulted in a non-cash charge for the impairment of goodwill of $4.3 million, which was recorded in the consolidated financial statements for the three and nine-month periods ended June 30, 2019. For purposes of performing this interim goodwill impairment assessment, management mainly considered recent trends in the Company’s stock price, estimated control or acquisition premium, and related matters, including other possible factors affecting the recent declines in the Company’s stock price and their effects on estimated fair value of the Company’s reporting units.

Fair Value Measurement

The Company follows the provisions of Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) 820, “Fair Value Measurement”, which defines fair value, establishes a framework for measuring fair value and enhances fair value measurement disclosure. Under these provisions, fair value is defined as the price that would be received to sell an asset or paid to transfer a liability (i.e., the “exit price”) in an orderly transaction between market participants at the measurement date.

The standard establishes a hierarchy for inputs used in measuring fair value that maximizes the use of observable inputs and minimizes the use of unobservable inputs by requiring that the most observable inputs be used when available. Observable inputs are inputs that market participants would use in pricing the asset or liability developed based on market data obtained from sources independent of the Company. Unobservable inputs are inputs that reflect the Company’s assumptions about the assumptions market participants would use in pricing the asset or liability developed based on the best information available in the circumstances. The hierarchy is described below:

Level 1: Quoted prices (unadjusted) in active markets that are accessible at the measurement date for assets or liabilities. The fair value hierarchy gives the highest priority to Level 1 inputs.

Level 2: Observable prices that are based on inputs not quoted on active markets, but corroborated by market data.

Level 3: Unobservable inputs are used when little or no market data is available. The fair value hierarchy gives the lowest priority to Level 3 inputs.

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The fair value of the Company’s current assets and current liabilities approximate their carrying values due to their short-term nature. The fair value disclosures of the Company’s long-term liabilities approximates the fair value based on current yield for debt instruments with similar terms. The Company’s goodwill and other intangible assets are measured at fair value on a non-recurring basis using Level 3 inputs, as discussed in Note 5.

Earnings and Loss per Share

Basic loss per share is computed by dividing net loss attributable to common stockholders by the weighted average common shares outstanding for the period. Diluted loss per share is computed giving effect to all potentially dilutive common shares. Potentially dilutive common shares may consist of incremental shares issuable upon the exercise of stock options and warrants and the conversion of notes payable and preferred stock to common stock. In periods in which a net loss has been incurred, all potentially dilutive common shares are considered anti-dilutive and thus are excluded from the calculation.

Common stock equivalents, which are excluded because their effect is anti-dilutive, were 13.7 million and 12.4 million for the three and nine-month period ended June 30, 2019 and 10.5 million and 10.9 million for the three and nine-month period ended June 30, 2018, respectively.

Advertising Expenses

The Company expenses the costs of print and internet media advertising and promotions as incurred and reports these costs in selling, general and administrative expenses. For the three and nine-month periods ended June 30, 2019 and 2018, advertising expense totaled $0.6 and $1.7 million each, respectively.

Intangible Assets

Separately identifiable intangible assets held in the form of customer lists, non-compete agreements, customer relationships, management agreements and trade names were recorded at their estimated fair value at the date of acquisition and are amortized over their estimated useful lives ranging from two to ten years using both accelerated and straight-line methods.

Impairment of Long-lived Assets

The Company recognizes an impairment of long-lived assets used in operations, other than goodwill, when events or circumstances indicate that the asset might be impaired and the estimated undiscounted cash flows to be generated by those assets over their remaining lives are less than the carrying amount of those items. The net carrying value of assets not recoverable is reduced to fair value, which is typically calculated using the discounted cash flow method. The Company did not recognize and record any impairments of long-lived assets used in operations, other than goodwill during the nine-month period ended June 30, 2019 and 2018.

Beneficial Conversion Feature

The Company evaluates embedded conversion features within a convertible instrument under ASC 815 Derivatives and Hedging to determine whether the embedded conversion feature(s) should be bifurcated from the host instrument and accounted for as a derivative at fair value with changes in fair value recorded in earnings. If the conversion feature does not require treatment under ASC 815, the instrument is evaluated under ASC 470-20 Debt with Conversion and Other Options for consideration of any beneficial feature.

The Company records a beneficial conversion feature (“BCF”) when the convertible instrument is issued with conversion features at fixed or adjustable rates that are below market value when issued. The BCF for convertible instruments is recognized and measured by allocating a portion of the proceeds equal to the intrinsic value of that feature to additional paid-in capital. The intrinsic value is generally calculated at the commitment date as the difference between the conversion price and the fair value of the common stock or other securities into which the security is convertible, multiplied by the number of shares into which the security is convertible. If certain other securities are issued with the convertible security, the proceeds are allocated among the different components. The portion of the proceeds allocated to the convertible security is divided by the contractual number of the conversion shares to determine the effective conversion price, which is used to measure the BCF. The effective conversion price is used to compute the intrinsic value. The value of the BCF is limited to the basis that is initially allocated to the convertible security.

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The BCF for the convertible instrument is recorded as a reduction, or discount, to the carrying amount of the convertible instrument equal to the fair value of the conversion feature. The discount is then amortized as interest or deemed dividends over the period from the date of the convertible instrument’s issuance to the earliest redemption date, provided that the convertible instrument is not currently redeemable but probable of becoming redeemable in the future.

Stock-Based Compensation

The Company accounts for stock-based awards to employees in accordance with FASB ASC 718, “Compensation-Stock Compensation”, which requires compensation expense related to share-based transactions, including employee stock options, to be measured and recognized in the financial statements based on a determination of the fair value of the stock options. The grant date fair value is determined using the Black-Scholes-Merton ("Black-Scholes") pricing model. For all employee stock options, we recognize expense on an accelerated basis over the employee's requisite service period (generally the vesting period of the equity grant). The Company's option pricing model requires the input of highly subjective assumptions, including the expected stock price volatility, expected term, and forfeiture rate. Any changes in these highly subjective assumptions significantly impact stock-based compensation expense.

Options awarded to purchase shares of common stock issued to non-employees in exchange for services are accounted for as variable awards in accordance with FASB ASC 718, “Compensation-Stock Compensation”. Such options are valued using the Black-Scholes option pricing model.

See Note 9 for the assumptions used to calculate the fair value of stock-based employee and non-employee compensation. Upon the exercise of options, it is the Company's policy to issue new shares rather than utilizing treasury shares.

Income Taxes

We account for income taxes under the asset and liability method, which requires the recognition of deferred tax assets and liabilities for the expected future tax consequences of events that have been included in the financial statements. Under this method, we determine deferred tax assets and liabilities on the basis of the differences between the financial statement and tax bases of assets and liabilities by using enacted tax rates in effect for the year in which the differences are expected to reverse. The effect of a change in tax rates on deferred tax assets and liabilities is recognized in income in the period that includes the enactment date.

We recognize deferred tax assets to the extent that we believe that these assets are more likely than not to be realized. In making such a determination, we consider all available positive and negative evidence, including future reversals of existing taxable temporary differences, projected future taxable income, tax-planning strategies, and results of recent operations. If we determine that we would be able to realize our deferred tax assets in the future in excess of their net recorded amount, we would make an adjustment to the deferred tax asset valuation allowance, which would reduce the provision for income taxes.

We record uncertain tax positions in accordance with ASC 740 on the basis of a two-step process in which (1) we determine whether it is more likely than not that the tax positions will be sustained on the basis of the technical merits of the position and (2) for those tax positions that meet the more-likely-than-not recognition threshold, we recognize the largest amount of tax benefit that is more than 50 percent likely to be realized upon ultimate settlement with the related tax authority.

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We recognize and group interest and penalties, if any, with income tax expense in the accompanying consolidated statement of operations. As of June 30, 2019 and September 30, 2018, no material accrued interest or penalties are included on the related tax liability line in the consolidated balance sheet.

Segment Data

The Company provides the following distinctive services: (a) direct hire placement services, and (b) temporary professional contract services staffing in the fields of information technology, engineering, medical, and accounting, and (c) temporary contract light industrial staffing. The Company’s services can be divided into two reportable segments, Industrial Staffing Services and Professional Staffing Services. Selling, general and administrative expenses are not entirely allocated among Industrial and Professional Staffing Services. Operating results are regularly reviewed by the chief operating decision maker to make decisions about resources to be allocated to the segment and to assess its performance. Other factors, including type of business, type of employee, length of employment and revenue recognition are considered in determining the Company’s operating segments.

3. Recent Accounting Pronouncements

On May 28, 2014, the FASB issued Accounting Standards Update (“ASU”) No. 2014-09, Revenue from Contracts with Customers, which requires an entity to recognize the amount of revenue to which it expects to be entitled for the transfer of promised goods or services to customers. The ASU superseded the existing revenue recognition guidance under U.S. GAAP. In August 2015, the FASB issued ASU No. 2015-14, Revenue from Contracts with Customers (Topic 606): Deferral of the Effective Date, which delayed the effective date of the new standard from January 1, 2017 to January 1, 2018. The FASB also agreed to allow entities to choose to adopt the standard as of the original effective date. This ASU permits the use of either the retrospective or cumulative effect transition method. The new standard was adopted by the Company under the modified retrospective approach effective October 1, 2018. The adoption of this standard did not have a material impact on the Company’s financial statements.

In February 2016 FASB issued ASU No. 2016-02, Leases (Topic 842), which supersedes the existing guidance for lease accounting, Leases (Topic 840). ASU 2016-02 requires lessees to recognize leases on their balance sheets, and leaves lessor accounting largely unchanged. The amendment in the ASU are effective for fiscal years beginning after December 15, 2018 and interim periods within those fiscal years. Early application is permitted for all entities. ASU 2016-02 requires a modified retrospective approach for all eases existing at, or entered into after, the date of initial application, with an option to elect to use certain transition relief. In July 2018, the FASB issued ASU No. 2018-10, “Codification of Improvement to Topic 842 Leases.” The amendments in ASU 2018-10 clarify, correct or remove inconsistencies in the guidance provided under ASU 2016-02 related to sixteen specific issues identified. Also, in July 2018, the FASB issued ASU No. 2018-11 “Leases (Topic 842): Targeted Improvement” which now allows entities the option of recognizing the cumulative effect of applying the new standard as an adjustment to the opening balance of retained earnings in the year of adoption while continuing to present all prior period under previous lease accounting guidance. The effective date and transition requirement for these two ASUs are the same as the effective date and transition requirement as ASU 2016-02. While the Company continues to assess all potential impacts of the standard, the Company currently believes the most significant impact relates to recording right-to-use assets and related operating lease liabilities on the condensed consolidated balance sheets.

In June 2018, the FASB issued ASU 2018-07, which simplifies the accounting for nonemployee share-based payment transactions. The amendments specify that Topic 718 applies to all share-based payment transactions in which a grantor acquires goods or services to be used or consumed in a grantor’s own operations by issuing share-based payment awards. The standard will be effective in the first quarter of fiscal year 2020, although early adoption is permitted (but no sooner than the adoption of Topic 606). The Company is currently evaluating the effect the adoption of this ASU will have on its consolidated financial statements.

No other recent accounting pronouncements were issued by FASB and the SEC that are believed by management to have a material impact on the Company’s present or future financial statements.

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4. Property and Equipment

Property and equipment, net consisted of the following:

		June 30, 2019				September 30, 2018
(in thousands)
Computer software		$	1,447			$	1,447
Office equipment, furniture and fixtures and leasehold improvements			3,549				3,356
Total property and equipment, at cost			4,996				4,803
Accumulated depreciation and amortization			(4,164	)			(3,912	)
Property and equipment, net		$	832			$	891

Depreciation expense for three and nine-month periods ended June 30, 2019 and 2018 was approximately $0.1 million and $0.3 million each.

5. Intangible Assets

The following tables set forth the costs, accumulated amortization and net book value of the Company’s separately identifiable intangible assets as of June 30, 2019 and September 30, 2018, and estimated future amortization expense.

		June 30, 2019												September 30, 2018
(in thousands)		Cost				Accumulated Amortization				Net Book Value				Cost				Accumulated Amortization				Net Book Value
Customer relationships		$	29,070			$	9,605			$	19,465			$	29,070			$	7,459			$	21,611
Trade name			8,329				3,604				4,725				8,329				2,537				5,792
Non-Compete agreements			4,331				3,244				1,087				4,331				2,267				2,064
Total		$	41,730			$	16,453			$	25,277			$	41,730			$	12,263			$	29,467

Estimated Amortization Expense
Remainder of Fiscal 2019		$	1,397
Fiscal 2020			5,038
Fiscal 2021			4,088
Fiscal 2022			3,469
Fiscal 2023			2,879
Thereafter			8,406
		$	25,277

The trade names are amortized on a straight – line basis over the estimated useful life of between five and ten years. Intangible assets that represent customer relationships are amortized on the basis of estimated future undiscounted cash flows or using the straight – line basis over estimated remaining useful lives of five to ten years. Non-compete agreements are amortized based on a straight-line basis over the term of the respective noncompete agreements, which are typically five years in duration.

The intangible assets amortization expense was $1.4 million and $4.2 million for each three and nine-month periods ended June 30, 2019 and 2018, respectively.

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6. Revolving Credit Facility and Term Loan

Revolving Credit, Term Loan and Security Agreement

After the close of business on March 31, 2017, the Company and its subsidiaries, as borrowers, entered into a Revolving Credit, Term Loan and Security Agreement (the “Credit Agreement”) with PNC Bank National Association ("PNC"), and certain investment funds managed by MGG Investment Group LP ("MGG"). Initial funds were distributed on April 3, 2017 (the “Closing Date”) to repay existing indebtedness, pay fees and expenses relating to the Credit Agreement, and to pay a portion of the purchase price for the acquisition of the SNI Companies.

Under the terms of the Credit Agreement, the Company may borrow up to $73.8 million consisting of a four-year term loan in the principal amount of $48.8 million and revolving loans in a maximum amount up to the lesser of (i) $25.0 million or (ii) an amount determined pursuant to a borrowing base that is calculated based on the outstanding amount of the Company’s eligible accounts receivable, as described in the Credit Agreement. The loans under the Credit Agreement mature on March 31, 2021.

The Credit Agreement, as amended, contains certain financial covenants, which are required to be maintained as of the last day of each fiscal quarter, including the following:

Fixed Charge Coverage Ratio (“FCCR”). This is the ratio of consolidated earnings before interest, taxes, depreciation and amortization (“EBITDA”) to Fixed Charges, each of which is as defined in the Credit Agreement, as amended. The minimum FCCR requirements are: 1.00 to 1.00 for the trailing two fiscal quarters ending March 31, 2019; 0.60 to 1.00 for the trailing three fiscal quarters ending June 30, 2019; 0.70 to 1.00 for the trailing four fiscal quarters ending September 30, 2019; 0.75 to 1.00 for the trailing four fiscal quarters ending December 31, 2019; 0.85 to 1.00 for the trailing four fiscal quarters ending March 31, 2020; and 1.00 to 1.00 for each of the trailing four fiscal quarterly periods ending thereafter.

Minimum EBITDA. Minimum EBITDA, which is determined on a consolidated basis and measured on a trailing four (4) quarter basis, as defined in the Credit Agreement, as amended, are: $13 million for the fiscal quarter ending March 31, 2019; $10 million for the fiscal quarter ending June 30, 2019; $10.0 million for the fiscal quarter ending September 30, 2019; $10.0 million for the fiscal quarter ending December 31, 2019; and $11.0 million for the fiscal quarter ending March 31, 2020, and each fiscal quarter thereafter.

Senior Leverage Ratio. This is the ratio of maximum Indebtedness, which is substantially comprised of consolidated senior indebtedness, to consolidated EBITDA, each of which is as defined under the Credit Agreement, as amended. The Senior Leverage Ratios are: 4.25 to 1.00 for the fiscal quarter ending March 31, 2019; 5.50 to 1.00 for the fiscal quarter ending June 30, 2019; 5.50 to 1.00 for the fiscal quarter ending September 30, 2019; 5.60 to 1.00 for the fiscal quarter ending December 31, 2019; and 5.00 to 1.00 for the fiscal quarter ended March 31, 2020, and for each fiscal quarter thereafter.

In addition to these financial covenants, the Credit Agreement includes other restrictive covenants. The Credit Agreement permits capital expenditures up to a certain level and contains customary default and acceleration provisions. The Credit Agreement also restricts, above certain levels, acquisitions, incurrence of additional indebtedness, and payment of dividends.

On August 31, 2017, the Company entered into a Consent to Extension of Waiver to the Credit Agreement (the “Waiver”). Under the terms of the Waiver, the Lenders and the Agents agreed to extend to October 3, 2017 the deadline by which the Company must deliver updated financial information satisfactory to the lenders in order to amend the financial covenant levels, execute a fully executed amendment to the Credit Agreement, and any other terms and conditions required by the lenders in their sole discretion. Additionally, the Company paid a $0.07 million consent fee to the Agents for the pro rata benefit of the lenders, in connection with the Waiver. On August 31, 2017, an additional waiver to the Credit Agreement (“Additional Waiver”), pursuant to which the due date for the Company to deliver the subordination agreement and an amended subordinated note, executed by one of the Company’s subordinated lenders was extended from August 31, 2017 to October 3, 2017, also was obtained.

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On October 2, 2017, the Company, the other borrower entities and guarantor entities named therein (collectively, the “Loan Parties”), PNC, and certain investment funds managed by MGG (collectively the (“Lenders”) entered into a First Amendment and Waiver (the “First Amendment”) to the Revolving Credit, Term Loan and Security Agreement dated as of March 31, 2017 (the “Credit Agreement”) by and among the Loan Parties, and the Lenders. The First Amendment, which was effective as of October 2, 2017, modified the required principal repayment schedule with respect to the Term Loans. The Amendment also modified the ability of the Loan Parties to repay or make other payments with respect to certain other loans that are subordinated in right of payment to the indebtedness under the Credit Agreement.

Pursuant to the First Amendment the Lenders also waived any Event of Default arising out of the Loan Parties’ failure to deliver, on or before October 3, 2017, the materials satisfying the requirements of clauses (i) and (ii) of Section 5 of the Waiver to Revolving Credit, Term Loan and Security Agreement, dated as of August 14, 2017, as amended.

On November 14, 2017, the Company and its subsidiaries, as Borrowers, entered into a second amendment (the “Second Amendment”) to the Revolving Credit, Term Loan and Security Agreement, dated as of March 31, 2017 (the “Credit Agreement”). Pursuant to the Second Amendment the Borrowers agreed, among other things, to use commercially reasonable efforts to prepay, or cause to be prepaid, $10.0 million in principal amount of Advances (as defined in the Credit Agreement) outstanding, which amount shall be applied to prepay the Term Loans in accordance with the applicable terms of the Credit Agreement. Any prepayment to the term loan is contingent upon a future financing, non-operational cash flow or excess cash flow as defined in the agreement. The Company also agreed to certain amendments to the loan covenants required to be maintained.

The Company did not meet its financial loan covenants at September 30, 2018 or at June 30, 2018 or March 31, 2018, previously. On May 15, 2018, the Company obtained a temporary waiver from its lenders for the missed financial covenants at March 31, 2018. On August 10, 2018, the Company and its subsidiaries, as Borrowers, entered into a third amendment and waiver (the “Third Amendment and Waiver”) to the Credit Agreement. Pursuant to the Third Amendment and Waiver, the Lenders agreed to modify the definition of EBITDA in the Credit Agreement to allow for the recognition and exclusion of certain additional acquisition, integration and restructuring expenses not previously specified and to provide a temporary waiver for any Defaults and Events of Default under the Credit Agreement that have solely arisen by reason of the Company failing to comply with the financial covenants of the Credit Agreement for the period ending June 30, 2018.

On December 27, 2018, the Company and its subsidiaries, as Borrowers, entered into a fourth amendment and waiver (the “Fourth Amendment and Waiver”) to the Revolving Credit, Term Loan and Security Agreement, dated as of March 31, 2017 (the “Credit Agreement”). Under the Fourth Amendment and Waiver, the Company and its Lenders have negotiated and agreed to a waiver for non-compliance with the financial covenants under the Credit Agreement as of September 30, 2018, and amendments to the financial covenants and to the remaining scheduled principal payments.

On May 15, 2019, the Company and its subsidiaries, as Borrowers, entered into a fifth amendment and waiver (the “Fifth Amendment”) to the Revolving Credit, Term Loan and Security Agreement, dated as of March 31, 2017 (the “Credit Agreement”). Under the Fifth Amendment, the Company and its Lenders have negotiated and agreed to a waiver for non-compliance with the financial covenants under the Credit Agreement as of March 31, 2019, and amendments to the financial covenants and to the remaining scheduled principal payments.

Management has taken definitive actions to improve operations, reduce costs and improve profitability, and position the Company for future growth. In addition, the Company’s senior lenders have worked with management in providing amendments and waivers to the Company’s senior credit facilities as management works towards improving the Company’s operations and restructuring its current debt and equity capitalization.

Based on its current projections, management expects that the Company can meet its future debt service requirements and comply with its financial covenants and other commitments, as amended, and will continue to seek reasonable assistance from the Company’s senior lenders, as necessary. However, the Company’s projections are based on assumptions and estimates about future performance and events, which are subject to change or other unforeseen conditions or uncertainties. As such, there can be no assurance that the Company will not fall into non-compliance with its loan covenants or that its Lenders will continue to provide waivers or amendments to the Company in the event of future non-compliance with debt covenants or other possible events of default that could happen in the future.

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Revolving Credit Facility

As of June 30, 2019, the Company had $13.9 million in outstanding borrowings under the Revolving Credit Facility, of which approximately $12.7 million was at an interest rate of approximately 17.41%, approximately $0.8 million was at an interest rate of approximately 17.43%, and the remainder was at an interest rate of approximately 19.50%.

As of June 30, 2019, the Company had $1.0 million available on the Revolving Credit facility.

The Revolving Credit Facility is secured by all the Company’s property and assets, whether real or personal, tangible or intangible, and whether now owned or hereafter acquired, or in which it now has or at any time in the future may acquire any right, title or interests.

 Term Loan

The Company had outstanding balances under its Term Loan, as follows:

		June 30, 2019				September 30, 2018
(in thousands)
Term loan		$	42,405			$	44,505
Unamortized debt discount			(1,410	)			(1,921	)
Term loan, net of discount			40,995				42,584
Short term portion of term loan, net of discount			2,931				2,331
Long term portion of term loan, net of discount		$	38,064			$	40,253

The Term Loan is payable as follows, subject to acceleration upon the occurrence of an Event of Default under the Credit Agreement or termination of the Credit Agreement and provided that all unpaid principal, accrued and unpaid interest and all unpaid fees and expenses shall be due and payable in full on March 31, 2021. Principal payments are required as follows: Remainder of Fiscal 2019 – $0.5 million, Fiscal 2020 – $5.5 million and Fiscal 2021 - $36.4 million.

The Company also is required to prepay the outstanding amount of the Term Loan in an amount equal to the Specified Excess Cash Flow Amount (as defined in the agreement) for the immediately preceding fiscal year, commencing with the fiscal year ending September 30, 2018. The Company does not owe any amount as of June 30, 2019.

Interest

The loans under the Credit Agreement for the period commencing on the Second Amendment Effective Date up to and including May 31, 2018, (i) so long as the Senior Leverage Ratio is equal to or greater than 3.75 to 1.00, an amount equal to prime plus 9.75% for Advances consisting of Domestic Rate Loans and LIBOR plus 10.75% for Advances consisting of LIBOR Rate Loans and (ii) so long as the Senior Leverage Ratio is less than 3.75 to 1.00, an amount equal to prime plus 9.00% for Advances consisting of Domestic Rate Loans and LIBOR plus 10.00% for Advances consisting of LIBOR Rate Loans.

Commencing on June 1, 2018 up to and including August 31, 2018, (i) so long as the Senior Leverage Ratio is equal to or greater than 4.00 to 1.00, interest on the loans is payable in an amount equal to prime plus 14.00% for Advances consisting of Domestic Rate Loans and LIBOR plus 15.00% for Advances consisting of LIBOR Rate Loans and (ii) so long as the Senior Leverage Ratio is less than 4.00 to 1.00, interest is payable in an amount equal to prime plus 9.75% for Advances consisting of Domestic Rate Loans and LIBOR plus 10.75% for Advances consisting of LIBOR Rate Loans.

Commencing on September 1, 2018 through the remainder of the Term, (i) so long as the Senior Leverage Ratio is equal to or greater than 3.50 to 1.00, interest on the loans is payable in an amount equal to prime plus 14.00% for Advances consisting of Domestic Rate Loans and LIBOR plus 15.00% for Advances consisting of LIBOR Rate Loans and (ii) so long as the Senior Leverage Ratio is less than 3.50 to 1.00, interest is payable in an amount equal to prime plus 9.00% for Advances consisting of Domestic Rate Loans and LIBOR plus 10.00% for Advances consisting of LIBOR Rate Loans.

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As of June 30, 2019, the Company had $42.4 million in outstanding borrowings under the Term Loan Facility, of which approximately $36.1 million was at an interest of approximately 17.41%, and approximately $6.3 million was at an interest of approximately 17.40%.

Loan Fees and Amortization

In connection with the Credit Agreement, the Company agreed to pay an original discount fee of approximately $0.9 million, a closing fee for the term loan of approximately $0.1 million, a finder’s fee of approximately $1.6 million and a closing fee for the revolving credit facility of approximately $0.5 million. The total of the loan fees paid is approximately $3.1 million. The Company has reported these direct loan-related costs in the form of a discount and reduction of the term loan in the accompanying consolidated balance sheets and is amortizing them as interest expense over the term of the loans. For the nine months ended June 30, 2019 and June 30, 2018, the Company amortized approximately $0.6 million of debt discount each.

7. Accrued Compensation

Accrued Compensation, which is included in Accounts Payable and Accrued Compensation, is comprised of accrued wages, the related payroll taxes, employee benefits of the Company's employees, including those working on contract assignments, commissions earned and not yet paid and estimated commissions and bonuses payable. 

8. Subordinated Debt – Convertible and Non-Convertible

The Company had outstanding balances under its Convertible and Non-Convertible Subordinated Debt agreements, as follows:

		June 30,				September 30,
		2019				2018
(in thousands)
10% Convertible Subordinated Note		$	4,185			$	4,185
Amended and Restated Non-negotiable promissory note			-				106
Subordinated Promissory Note			1,000				1,000
9.5% Convertible Subordinated Note			12,500				12,500
8% Convertible Subordinated Notes, due to related parties net			1,195				-
Total subordinated debt, convertible and non-convertible			18,880				17,791
Short term portion of subordinated debt, convertible and non-convertible			(1,000	)			(106	)
Long term portion of subordinated debt, convertible and non-convertible		$	17,880			$	17,685

10% Convertible Subordinated Note

The Company had a Subordinated Note payable to JAX Legacy – Investment 1, LLC (“JAX Legacy”), pursuant to a Subscription Agreement dated October 2, 2015, in the amount of $4.2 million, and which was scheduled to become due on October 2, 2018.

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On April 3, 2017, the Company and JAX Legacy amended and restated the Subordinated Note in its entirety in the form of a 10% Convertible Subordinated Note (the “10% Note”) in the aggregate principal amount of $4.2 million. The 10% Note matures on October 3, 2021 (the “Maturity Date”). The 10% Note is convertible into shares of the Company’s Common Stock at a conversion price equal to $5.83 per share. All or any portion of the 10% Note may be redeemed by the Company for cash at any time on or after April 3, 2018 that the average daily VWAP of the Company’s Common Stock reported on the principal trading market for the Common Stock exceeds the then applicable Conversion Price for a period of 20 trading days. The redemption price shall be an amount equal to 100% of the then outstanding principal amount of the 10% Note being redeemed, plus accrued and unpaid interest thereon. The Company agreed to issue to the investors in JAX Legacy approximately 77,775 shares of common stock, at a value of approximately $0.4 million which was expensed as loss on the extinguishment of debt during the year ended September 30, 2017.

Total discount recorded at issuance of the original JAX Legacy subordinated note payable was approximately $0.6 million. Total amortization of debt discount for the year ended September 30, 2017 was approximately $0.1 million, and the remaining $0.3 million was written off to loss on extinguishment of debt upon amendment and restatement resulting in the 10% Note.

The Company issued shares of common stock to JAX Legacy related to the conversion of the subordinated note and the interest approximately 87,172 and 276,232 for the three and nine-month period ended June 30, 2019 and 42,500 and 219,155 for the three and nine-month period ended June 30, 2018, respectively. The stock was valued at approximately $0.1 million and $0.3 million for the three and nine-month period ended June 30, 2019 and $0.1 million and $0.3 million for the three and nine-month period ended June 30, 2018, respectively.

On July 3, 2019 the Company issued 132,659 shares of common stock to Jax Legacy related to interest of $0.1 million on the 10% Note.

Amended and Restated Non-Negotiable Promissory Note

On October 4, 2017, the Company executed an Amended and Restated Non-Negotiable Promissory Note in favor of William Daniel Dampier and Carol Lee Dampier (sellers of Access Data Consulting Corporation) in the amount of approximately $1.2 million (the “Note”). This Note amends and, as so amended, restates in its entirety and replaces that certain Subordinated Nonnegotiable Promissory Note dated October 4, 2015, issued by the Company to William Daniel Dampier and Carol Lee Dampier in the original principal amount of $3.0 million. The Company agreed to pay William Daniel Dampier and Carol Lee Dampier 12 equal installments of approximately $107,675, commencing on November 4, 2017 and ending on October 4, 2018. The note was paid off during the three months ended December 31, 2018.

Subordinated Promissory Note

On January 20, 2017, the Company entered into Addendum No. 1 (the “Addendum”) to the Stock Purchase Agreement dated as of January 1, 2016 (the “Paladin Agreement”) by and among the Company and Enoch S. Timothy and Dorothy Timothy (collectively, the “Sellers”). Pursuant to the terms of the Addendum, the Company and the Sellers agreed (a) that the conditions to the “Earnouts” (as defined in the Paladin Agreement) had been satisfied or waived and (b) that the amounts payable to the Sellers in connection with the Earnouts shall be amended and restructured as follows: (i) the Company paid $250,000 in cash to the Sellers prior to January 31, 2017 (the “Earnout Cash Payment”) and (ii) the Company issued to the Sellers a subordinated promissory note in the principal amount of $1.0 million (the “Subordinated Note”), The Subordinated Note bears interest at the rate of 5.5% per annum. Interest on the Subordinated Note is payable monthly and principal can only be paid in stock until the term loan and Revolving Credit Facility are repaid. The Subordinated Note is due January 20, 2020 and may be prepaid without penalty. The principal of and interest on the Subordinated Note may be paid, at the option of the Company, either in cash or in shares of common stock of the Company or in any combination of cash and common stock. The Sellers have agreed that all payments and obligations under the Subordinated Note shall be subordinate and junior in right of payment to any “Senior Indebtedness” (as defined in the Paladin Agreement) now or hereafter existing to “Senior Lenders” (current or future) (as defined in the Paladin Agreement).

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9.5% Convertible Subordinated Notes

On April 3, 2017, the Company issued and paid to certain SNIH Stockholders as part of the acquisition of SNIH an aggregate of $12.5 million in the form of 9.5% Convertible Subordinated Notes (the “9.5% Notes”). The 9.5% Notes mature on October 3, 2021 (the “Maturity Date”). The 9.5% Notes are convertible into shares of the Company’s Common Stock at a conversion price equal to $5.83 per share. Interest on the 9.5% Notes accrues at the rate of 9.5% per annum and is payable quarterly in arrears on June 30, September 30, December 31 and March 31, beginning on June 30, 2017, on each conversion date with respect to the 9.5% Notes (as to that principal amount then being converted), and on the Maturity Date (each such date, an “Interest Payment Date”). At the option of the Company, interest may be paid on an Interest Payment Date either in cash or in shares of Common Stock of the Company, which Common Stock shall be valued based on the terms of the agreement, subject to certain limitations defined in the loan agreement. Each of the 9.5% Notes is subordinated in payment to the obligations of the Company under its Credit Agreement (see Note 6) pursuant to Subordination and Inter-creditor Agreements dated as of March 31, 2017 by and among the Company, the Credit Agreement lenders, and each of the holders of the 9.5% Notes.

Future minimum payments of all subordinated debt will total approximately as follows: fiscal 2019 - $0.0 million, fiscal 2020 - $1.0 million, fiscal 2021- $0.0 and fiscal 2022 - $18.7 million.

The Company issued shares of common stock to the SNI Sellers related to interest of $0.3 million on the 9.5% Notes approximately 246,156 and 744,606 for the three and nine-month period ended June 30, 2019 and 120,654 and 401,256 for the three and nine-month period ended June 30, 2018, respectively. The stock was valued at approximately $0.3 million and $0.9 million for the three and nine-month period ended June 30, 2019 and $0.3 million and $1.2 million for the three and nine-month period ended June 30, 2018, respectively.

On July 3, 2019 the Company issued approximately 351,181 shares of common stock to the SNI Sellers related to interest of $0.3 million on the 9.5% Notes.

8% Convertible Subordinated Notes to Related Parties

On May 15, 2019, the Company issued and sold to members of its executive management and Board of Directors (the “Investors”) $2.0 million in aggregate principal amount of its 8% Notes. The 8% Notes mature on October 3, 2021 (the “Maturity Date”). The 8% Notes are convertible into shares of the Company’s Series C 8% Cumulative Convertible Preferred Stock (“Series C Preferred Stock”) at a conversion price equal to $1.00 per share (subject to adjustment as provided in the 8% Notes upon any stock dividend, stock combination or stock split or upon the consummation of certain fundamental transactions) (the “Conversion Price”). Interest on the 8% Notes accrues at the rate of 8% per annum and shall be paid quarterly in non-cash payments-in-kind (“PIK”) in arrears on June 30, September 30, December 31 and March 31, beginning on June 30, 2019, on each conversion date with respect to the 8% Notes (as to that principal amount then being converted), and on the Maturity Date (each such date, an “Interest Payment Date”). Interest shall be paid on an Interest Payment Date in shares of Series C Preferred Stock of the Company, which Series C Preferred Stock shall be valued at its liquidation value. All or any portion of the 8% Notes may be redeemed by the Company for cash at any time. The redemption price shall be an amount equal to 100% of the then outstanding principal amount of the 8% Notes being redeemed, plus accrued and unpaid PIK interest thereon. The Company may, at its option, prepay any portion of the principal amount of the 8% Notes without the prior consent of the holders thereof; provided, however, that any prepayments of the 8% Notes shall be made on a pro rata basis to all holders of 8% Notes based on the aggregate principal amount of 8% Notes held by such holders. The Company shall be required to prepay the 8% Notes together with accrued and unpaid PIK interest thereon upon the consummation by the Company of any Change of Control. For purposes of the 8% Notes, a Change of Control of the Company shall mean any of the following: (A) the Company effects any sale of all or substantially all of its assets in one transaction or a series of related transactions or (B) the consummation of any transaction (including, without limitation, any merger or consolidation), the result of which is that any person or entity together with their affiliates, becomes the beneficial owner, directly or indirectly, of more than 50% of the Common Stock of the Company. Each of the 8% Notes is subordinated in payment to the obligations of the Company to the lenders parties to that certain Revolving Credit, Term Loan and Security Agreement, dated as of March 31, 2017, as amended, by and among the Company, the Company’s subsidiaries named as borrowers therein (collectively with the Company, the “Borrowers”), the senior lenders named therein and MGG Investment Group LP, as administrative agent and collateral agent (the “Agent”) for the senior lenders (the “Senior Credit Agreement”), pursuant to those certain Subordination and Intercreditor Agreements, each dated as of May 15, 2019 by and among the Company, the Borrowers, the Agent and each of the holders of the 8% Notes.

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On June 30, 2019 the Company issued approximately 20,000 shares of Series C Preferred Stock to Investors related to interest of $20,000 on the 8% Notes.

The BCF for the 8% Notes is recorded as a discount to their carrying value and is equal to the fair value of the conversion feature. The discount will be amortized as interest over the period from the date of issuance to maturity. The total BCF recorded was approximately $0.8 million. For the nine months ended June 30, 2019 and June 30, 2018, the Company amortized approximately $0.04 million and $0 of debt discount, respectively.

9. Equity

On January 25, 2018, the Company issued approximately 110,083 shares of common stock to a SNI Sellers for the conversion of approximately 110,083 shares of series B preferred shares.

On November 9, 2018 the Company issued 250,000 shares of common stock for the conversion of approximately 250,000 shares of Series B Convertible Preferred Stock, see Note 10.

Restricted Stock

During the nine months ended June 30, 2019 no restricted stock was granted or exercised. The restricted shares are to be earned over a three-year period and cliff vest at the end of the third year from the date of grant. Stock-based compensation expense attributable to restricted stock was $0.2 and $0.6 million, and $0.0 and $0.0 million for the three and nine months ended June 30, 2019 and 2018, respectively. As of June 30, 2019, there was approximately $1.6 million of unrecognized compensation expense related to restricted stock outstanding.

A summary of restricted stock activity is presented as follows:

		Number of Shares
(in thousands)
Restricted stock outstanding as of September 30, 2018			1,100
Granted			-
Exercised			-
Restricted stock outstanding as of June 30, 2019			1,100

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Warrants

No warrants were granted or exercised during the nine months ended June 30, 2019.

(in thousands)		Number of Shares				Weighted Average Exercise Price Per Share ($)				Weighted Average Remaining Contractual Life				Total Intrinsic Value of Warrants ($)
Warrants outstanding as of September 30, 2018			497				3.84				2.87				67
Granted			-				-
Exercised			-				-
Forfeited			(58	)			2.00
Warrants outstanding as of December 31, 2018			439				4.09				2.48				-
Granted			-				-
Exercised			-				-
Forfeited							-
Warrants outstanding as of March 31, 2019			439				4.09				2.27				-
Granted			-				-
Exercised			-				-
Forfeited							-
Warrants outstanding as of June 30, 2019			439				4.09				2.05				-
Warrants exercisable as of September 30, 2018			497				3.84				2.87				67
Warrants exercisable as of June 30, 2019			439				4.09				2.05				-

Stock Options

As of June 30, 2019, there were stock options outstanding under the Company’s Second Amended and Restated 1997 Stock Option Plan and the Company’s Amended and Restated 2013 Incentive Stock Plan. Both plans were approved by the shareholders. The plans granted specified numbers of options to non-employee directors, and they authorized the Compensation Committee of the Board of Directors to grant either incentive or non-statutory stock options to employees. Vesting periods are established by the Compensation Committee at the time of grant. All stock options outstanding as of June 30, 2019 and September 30, 2018 were non-statutory stock options, had exercise prices equal to the market price on the date of grant, and had expiration dates ten years from the date of grant.

Stock-based compensation expense attributable to stock options and warrants was $0.3 million and $1.0 million, and 0.4 million and $1.0 million for the three and nine months ended June 30, 2019 and 2018, respectively. As of June 30, 2019 and June 30, 2018, there was approximately $1.9 million of unrecognized compensation expense related to unvested stock options outstanding each, and the weighted average vesting period for those options was 3.9 years. 

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A summary of stock option activity is as follows:

		Number of Shares				Weighted Average Exercise Price per share ($)				Weighted Average Remaining Contractual Life (Years)				Total Intrinsic Value of Options ($)
(in thousands)
Options outstanding as of September 30, 2018			1,578				3.76				7.53				142
Granted			394				1.91
Forfeited/Expired			(178	)			3.89
Options outstanding as of December 31, 2018			1,794				3.34				8.58				-
Granted			-				-
Exercised			-				-
Forfeited/Expired			(48	)			5.03
Options outstanding as of March 31, 2019			1,746				3.29				8.34				-
Granted			-				-
Exercised			-				-
Forfeited/Expired			(37	)			4.23
Options outstanding as of June 30, 2019			1,709				3.27				8.06				-
Exercisable as of September 30, 2018			512				5.08				7.30				1
Exercisable as of June 30, 2019			686				4.25				6.76				-

The fair value of stock options granted was made using the Black-Scholes option pricing model and the following assumptions:

		Nine Months Ended
		June 30, 2019
Weighted average fair value of options		$	1.75
Weighted average risk-free interest rate			3.03	%
Weighted average dividend yield		$	-
Weighted average volatility factor			104	%
Weighted average expected life (years)			10

10. Mezzanine Equity

Series A Convertible Preferred Stock

On April 3, 2017, the Company filed a Statement of Resolution Establishing its Series A Preferred Stock with the State of Illinois. (the Resolution Establishing Series”). Pursuant to the Resolution Establishing Series, the Company designated 160,000 of its authorized preferred stock as Series A Preferred Stock. There are no shares issued and outstanding under this designation.

Series B Convertible Preferred Stock

On April 3, 2017, the Company issued an aggregate of approximately 5.9 million shares of no par value, Series B Convertible Preferred Stock to certain of the SNIH Stockholders as part of the SNIH acquisition. The no par value, Series B Convertible Preferred Stock has a liquidation preference equal to $4.86 per share and ranks senior to all "Junior Securities" (including the Company's Common Stock) with respect to any distribution of assets upon liquidation, dissolution or winding up of the Company, whether voluntary or involuntary.

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In the event that the Company declares or pays a dividend or distribution on its Common Stock, whether such dividend or distribution is payable in cash, securities or other property, including the purchase or redemption by the Company or any of its subsidiaries of shares of Common Stock for cash, securities or property, the Company is required to simultaneously declare and pay a dividend on the no par value, Series B Convertible Preferred Stock on a pro rata basis with the Common Stock determined on an as-converted basis assuming all shares had been converted as of immediately prior to the record date of the applicable dividend or distribution.

Except as set forth in the Resolution Establishing Series or as may be required by Illinois law, the holders of the no par value, Series B Convertible Preferred Stock have no voting rights. Pursuant to the Resolution Establishing Series, without the prior written consent of holders of not less than a majority of the then total outstanding Shares of no par value, Series B Convertible Preferred Stock, voting separately as a single class, the Company shall not create, or authorize the creation of, any additional class or series of capital stock of the Company (or any security convertible into or exercisable for any class or series of capital stock of the Company) that ranks pari passu with or superior to the no par value, Series B Convertible Preferred Stock in relative rights, preferences or privileges (including with respect to dividends, liquidation or voting).

Each share of Series B Convertible Preferred Stock is convertible at the option of the holder thereof into one share of Common Stock at an initial conversion price equal to $4.86 per share, which is subject to adjustment in the event of stock splits, stock combinations, capital reorganizations, reclassifications, consolidations, mergers or sales, as set forth in the Resolution Establishing Series.

None of the shares of no par value, Series B Preferred Stock issued to the SNIH Stockholders are registered under the Securities Act. Each of the SNIH Stockholders who received shares of Series B Preferred Stock is an accredited investor. The issuance of the shares of no par value, Series B Preferred Stock to such SNIH Stockholders is exempt from the registration requirements of the Act in reliance on an exemption from registration provided by Section 4(2) of the Act.

Based on the terms of the Series B Convertible Preferred Stock, if certain fundamental transactions were to occur, the Series B Convertible Preferred Stock would require redemption, which precludes permanent equity classification on the accompanying consolidated Balance Sheet.

During the nine months ended June 30, 2019 the Company issued 250,000 shares of common stock for the conversion of approximately 250,000 shares of Series B Convertible Preferred Stock.

Series C Convertible Preferred Stock

On May 17, 2019, the Company filed a Statement of Resolution Establishing its Series C Preferred Stock with the State of Illinois. (the Resolution Establishing Series”). Pursuant to the Resolution Establishing Series, the Company designated 3,000,000 of its authorized preferred stock as “Series C 8% Cumulative Convertible Preferred Stock”, without par value. The Series C Preferred Stock has a Liquidation Value equal to $1.00 per share and ranks pari passu with the Company’s Series B Convertible Preferred Stock (“Series B Preferred Stock”) and senior to all “Junior Securities” (including the Company’s Common Stock) with respect to any distribution of assets upon liquidation, dissolution or winding up of the Company, whether voluntary or involuntary. Holders of shares of Series C Preferred Stock are entitled to receive an annual non-cash (“PIK”) dividend of 8% of the Liquidation Value per share. Such dividend shall be payable quarterly on June 30, September 30, December 31 and March 31 of each year commencing on June 30, 2019, in preference to any dividend paid on or declared and set aside for the Series B Preferred Stock or any Junior Securities and shall be paid-in-kind in additional shares of Series C Preferred Stock. Except as set forth in the Resolution Establishing Series or as may be required by Illinois law, the holders of the Series C Preferred Stock have no voting rights. Pursuant to the Resolution Establishing Series, without the prior written consent of holders of not less than a majority of the then total outstanding Shares of Series C Preferred Stock, voting separately as a single class, the Company shall not create, or authorize the creation of, any additional class or series of capital stock of the Company (or any security convertible into or exercisable for any class or series of capital stock of the Company) that ranks superior to the Series C Preferred Stock in relative rights, preferences or privileges (including with respect to dividends, liquidation or voting). Each share of Series C Preferred Stock shall be convertible at the option of the holder thereof into one share of Common Stock at an initial conversion price equal to $1.00 per share, each as subject to adjustment in the event of stock splits, stock combinations, capital reorganizations, reclassifications, consolidations, mergers or sales, as set forth in the Resolution Establishing Series.

On June 30, 2019 the Company issued approximately 20,000 shares of Series C Preferred Stock to Investors related to interest of $20,000 on the 8% Notes.

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11. Income Tax

The following table presents the provision for income taxes and our effective tax rate for the three and nine months ended June 30, 2019 and 2018:

		Three Months Ended, June 30,								Nine Months Ended, June 30,
(in thousands)		2019				2018				2019				2018
Provision for Income Taxes			(106	)			(407	)			400				259
Effective Tax Rate			2	%			18	%			-3%				-4%

The effective income tax rate on operations is based upon the estimated income for the year, and adjustments, if any, in the applicable quarterly periods for the potential tax consequences, benefits, resolutions of tax audits or other tax contingencies.

Our effective tax rate for the three and nine months ended June 30, 2019 is lower than the statutory tax rate primarily due to an increase in the deferred tax liability related to indefinite lived assets. Other than the deferred tax liability relating to indefinite lived assets, the Company is maintaining a full valuation allowance against the remaining net DTA position.

The effective tax rate for the three months ended June 30, 2018 is lower than the statutory tax rate primarily due to an increase in the deferred tax liability related to indefinite lived assets.

The effective tax rate for the nine months ended June 30, 2018 is lower than the statutory tax rate primarily due to an increase in the deferred tax liability related to indefinite lived assets being offset by a discrete tax benefit recorded for the impact from the US Tax Reform. The tax provision for the nine months ended June 30, 2018 includes discrete tax benefit totaling $0.4 million relating to the US Tax Reform that was recorded in the period ending December 31, 2017.

12. Commitments and Contingencies

Leases

The Company leases space for all its branch offices, which are generally located either in downtown or suburban business centers, and for its corporate headquarters. Branch offices are generally leased over periods ranging from three to five years. The corporate office lease expires in 2020. The leases generally provide for payment of basic rent plus a share of building real estate taxes, maintenance costs and utilities.

Rent expense was $0.7 million and $2.2 million, and $0.9 million and $2.4 million for the three and nine-month periods ended June 30, 2019 and 2018, respectively.

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As of June 30, 2019 future minimum lease payments due under non-cancelable lease agreements having initial terms in excess of one year, including certain closed offices are as follows:

(in thousands)
Remainder of Fiscal 2019		$	490
Fiscal 2020			1,569
Fiscal 2021			1,038
Fiscal 2022			977
Fiscal 2023			769
Thereafter			872
Total		$	5,715

Litigation and Claims

The Company and its subsidiaries are involved in various litigation that arises in the ordinary course of business. There are no pending significant legal proceedings to which the Company is a party for which management believes the ultimate outcome would have a material adverse effect on the Company’s financial position.

13. Segment Data

The Company provides the following distinctive services: (a) direct hire placement services, (b) temporary professional services staffing in the fields of information technology, accounting, finance, office, engineering, and medical, and (c) temporary light industrial staffing. These Company’s services can be divided into two reportable segments, Industrial Staffing Services and Professional Staffing Services. Some selling, general and administrative expenses are not fully allocated among light industrial services and professional staffing services.

Unallocated corporate expenses primarily include, certain executive compensation expenses and salaries, certain administrative salaries, corporate legal expenses, stock compensation expenses, consulting expenses, audit fees, corporate rent and facility costs, board fees, acquisition, integration and restructuring expenses, and interest expense.

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		Three Months Ended								Nine Months Ended
		June 30,								June 30,
(in thousands)		2019				2018				2019				2018
Industrial Staffing Services
Industrial services revenue		$	5,442			$	5,166			$	16,157			$	16,165
Industrial services gross margin			26.8	%			16.4	%			22.5	%			17.6	%
Operating income		$	1,572			$	31			$	1,908			$	315
Depreciation & amortization			65				65				195				197
Accounts receivable – net			3,359				3,386				3,359				3,386
Intangible assets			302				526				302				526
Goodwill			1,084				1,084				1,084				1,084
Total assets		$	4,745			$	5,555			$	4,745			$	5,555
Professional Staffing Services
Permanent placement revenue		$	4,884			$	6,388			$	13,764			$	17,496
Placement services gross margin			100	%			100	%			100	%			100	%
Professional services revenue		$	27,775			$	28,713			$	82,900			$	91,695
Professional services gross margin			26.1	%			26.1	%			25.7	%			25.9	%
Operating income		$	(3,333	)		$	2,301			$	975			$	5,861
Depreciation and amortization			1,420				1,436				4,263				4,289
Accounts receivable – net			17,078				17,780				17,078				17,780
Intangible assets			24,975				30,336				24,975				30,336
Goodwill			71,209				75,509				71,209				75,509
Total assets		$	121,601			$	128,806			$	121,601			$	128,806
Unallocated Expenses
Corporate administrative expenses		$	829			$	686			$	2,542			$	1,065
Corporate facility expenses			79				139				257				287
Stock Compensation expense			531				399				1,661				1,028
Acquisition, integration and restructuring expenses			564				514				2,990				1,712
Total unallocated expenses		$	2,003			$	1,738			$	7,450			$	4,092
Consolidated
Total revenue		$	38,101			$	40,267			$	112,821			$	125,356
Operating income (loss)			(3,764	)			595				(4,567	)			2,084
Depreciation and amortization			1,485				1,501				4,458				4,486
Total accounts receivables – net			20,437				21,166				20,437				21,166
Intangible assets			25,277				30,862				25,277				30,862
Goodwill			72,293				76,593				72,293				76,593
Total assets		$	126,346			$	134,361			$	126,346			$	134,361