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Audit # 2004-4 Issue Date: February 28, 2005 Executive Office of the Governor Office of The Chief Inspector General Prison Rehabilitative Industries and Diversified Enterprises, Inc., Industries Training Corporation and Affiliates Audit Number 2004-4 Date: February 28, 2005 Audit # 2004-4 Issue Date: February 28, 2005 TABLE OF CONTENTS PRISON REHABILITATIVE INDUSTRIES AND DIVERSIFIED ENTERPRISES, INC., INDUSTRIES TRAINING CORPORATION AND AFFILIATES AUDIT REPORT NUMBER 2004-4 TABLE OF CONTENTS EXECUTIVE SUMMARY ............................................................3 BACKGROUND ........................................................................3 SCOPE, METHODOLOGY AND OBJECTIVES ..............................5 FINDINGS AND RECOMMENDATIONS .....................................6 EXHIBITS ............................................................................. 19 RESPONSES.......................................................................... 29 Response from PRIDE Response from ITC 2 Audit # 2004-4 Issue Date: February 28, 2005 PRISON REHABILITATIVE INDUSTRIES AND DIVERSIFIED ENTERPRISES, INC., INDUSTRIES TRAINING CORPORATION AND AFFILIATES EXECUTIVE SUMMARY The Office of the Chief Inspector General performed an audit of Prison Rehabilitative Industries and Diversified Enterprise, Inc. (PRIDE), Industries Training Corporation (ITC) and its affiliated entities for the period January 1, 1999, through June 30, 2004. The audit objectives were designed to assess the overall effectiveness and efficiency of the financial operations of PRIDE and its affiliates in order to determine whether they were operating in accordance with the purposes for which PRIDE was statutorily created. The findings in this report revealed significant decline in the financial condition of PRIDE, ITC and its affiliates. In addition, the findings revealed a breakdown in accountability, as well an inadequate system of internal controls. • PRIDE did not enter into a formal contract with ITC, although required by the letter agreement dated June 30, 1999. Currently, no formal contract exists. • Payments made to ITC by PRIDE for management services have not been in accordance with the June 30, 1999 agreement or sound business practices. • PRIDE has loaned/advanced funds to ITC and its affiliates interest-free, without any stated terms of repayment. Also, amounts recorded in PRIDE’s financial records as due from ITC and ITC affiliates have been reduced by significant amounts for reasons that were sometimes questionable. • Management had not established a policy setting limits on the amount of funds that can be used to support ITC and its affiliates. The lack of such a policy has resulted in significant advances being made to ITC and its affiliates at the expense of PRIDE’s financial welfare. • The amounts paid to PRIDE and ITC executives were not reasonable considering the companies’ financial condition. PRIDE’s response addressed and generally agreed with our findings and recommendations. Responses from both PRIDE and ITC are included in this report. Synopsis of Findings: • The organizational and operational relationship between PRIDE and ITC continues to be flawed in large measure because PRIDE initially adopted a corporate and governance structure which was inconsistent with the Florida Statutes applicable to managing and leasing correctional work programs. • Management’s system of internal controls was inadequate to ensure effective, efficient, and proper use of resources. • PRIDE experienced a significant financial decline from July 1, 1999 to December 31, 2003, recently resulting in cash flow difficulties. • ITC is a financially troubled entity and its current financial condition raises concerns as to whether it will be able to continue to operate. BACKGROUND In 1981, the Legislature passed legislation to provide for a not-for-profit corporation to lease and manage the correctional work programs of the Department of Corrections (Department). Once such not-for-profit corporation was organized, no other not-for-profit corporation could be organized for this purpose. The corporation’s board would be made up of members appointed by the Governor and confirmed by the Senate. In December 1981, Prison Rehabilitative Industries and Diversified Enterprises, Inc. (PRIDE) was incorporated and, in 1983, the Legislature authorized PRIDE to assume the responsibilities of managing the Department’s correctional work programs. The Department transferred to PRIDE certain assets of the correctional work program. PRIDE recorded these transfers at estimated fair market value. In addition to these transfers, various lease agreements between PRIDE and the Department provided for PRIDE to use 3 Audit # 2004-4 Issue Date: February 28, 2005 Since the mid 1990’s, the PRIDE Board has been considering ways to improve PRIDE’s performance, specifically in the area of job creation and market diversification. At PRIDE’s strategic planning workshop in August 1997, the Board developed a model for how PRIDE could expand its reach, diversify its market, and increase inmate jobs. They anticipated PRIDE would maintain and expand government markets and identify other markets that could be developed for the products produced in the current industries. The Board felt that creating a “strategic leadership” company would assist PRIDE in developing a variety of relationships, either through joint ventures, acquisition, or the creation of other companies. Also, the cost of the administrative support services, i.e.: human resources, information resources, finance and accounting, etc., would be shared by all other companies, thus reducing the overall cost to PRIDE. The Board also concluded that creating a “partnership outsourcing” company could benefit PRIDE by targeting and focusing on the commercial forprofit sectors that were determined to be best suited for the prison environment. RISE, an affiliate of PRIDE, would expand its transitional support services and expand into a temporary employment company providing job placement opportunities for inmates released from prison, in addition to the PRIDE workers. certain land, buildings, and equipment in the operation of its correctional work programs. PRIDE’s mission as stated in Section 946.501(2), Florida Statutes, in administering the correctional work program is, “in order of priority: (a) To provide a joint effort between the department, the correctional work programs, and other vocational training programs to reinforce relevant education, training, and postrelease job placement and help reduce recommitment. (b) To serve the security goals of the state through the reduction of idleness of inmates and the provision of an incentive for good behavior in prison. (c) To reduce the cost of state government by operating enterprises primarily with inmate labor, which enterprises do not seek to unreasonably compete with private enterprise. (d) To serve the rehabilitative goals of the state by duplicating, as nearly as possible, the operating activities of a free-enterprise type of profitmaking enterprise.” To assist PRIDE in its mission, the Legislature granted it certain privileges. PRIDE has sovereign immunity, which shields it from liability in the same manner as the State. In addition, PRIDE is not subject to the authority of any state agency, except the auditing and investigatory powers of the Legislature and the Governor. Legislation also granted purchasing preference for PRIDE, meaning that state agencies must buy its products when they are of similar quality and price to those offered by outside vendors. A business development consultant was hired in 1998 to develop a comprehensive growth strategy for a for-profit company to enhance PRIDE’s effectiveness. The PRIDE Board approved the consultant’s proposal and subsequent business plan to create separate but related companies. The intent of the creation of these new companies was to help PRIDE find ways to increase the number of inmate jobs and to expand its social mission. In addition, PRIDE wanted to establish clear criteria for the separation of markets and the allocation of capital resources between the proposed businesses. Effective July 1, 1999, PRIDE formed Industries Training Corporation (ITC), a tax exempt organization, for the purpose of entering into relationships and managing prison work programs for PRIDE and any other tax exempt, governmental and forprofit sectors located in the state and the United States. In addition, ITC created the following affiliates to assist in its mission: PRIDE operates a variety of industries including furniture manufacturing, agriculture, digital print technologies, textiles, and services. PRIDE receives no funding from the Legislature and is totally supported by the earnings it generates from the sale of its products. The majority of its sales are to state agencies. In fiscal year 2003 (January 1 – December 31), PRIDE provided 1,995 inmate work positions at 21 prisons throughout Florida and generated $60.9 million in sales. Exhibit 1 of this report lists PRIDE’s Board of Directors. 4 Audit # 2004-4 Issue Date: February 28, 2005 FIGURE 1—CORPORATE STRUCTURE OF PRIDE, ITC & AFFILIATES PRIDE •Non-profit •Trains and works inmates to aid rehabilitative goals, enhance security, and reduce inmate idleness and recidivism Industries Training Corporation •Non-profit •Provides administrative and managerial support for PRIDE Florida Citrus Partners •Limited Liability •Partnership between ITC and Labor Line Services private sector associate (50% owned by each) •Produces fresh citrus juice and sectioned fruit •Non-profit •Provides transition support and job training services for former PRIDE inmates Global Outsourcing Labor Line, Inc, •For-profit temp-to-hire staffing agency •Works with underemployed individuals, including former inmates Florida Citrus Producers •For-profit •Established June 2004 •Produces fresh citrus juice and •For-profit •Develops partnerships with private businesses •Acts as private sector partner for PRIDE when necessary •D/b/a Global Digital and Global Reman Diversified Supply Management •For-profit •40% owned by ITC Northern Outfitters •For-profit •Manufacturers extreme weather apparel using inmate labor in Utah sectioned fruit Labor Line, Inc. (LLI); Labor Line Services, Inc. (LLS) and Global Outsourcing, Inc. (Global) and purchased its wholly owned subsidiary, Northern Outfitters. ITC also formed private partnerships to create Florida Citrus Partners (FCP), in which ITC has 50% ownership and Diversified Supply Management Company (DSM) in which ITC has 40% ownership. PRIDE considers ITC and its affiliates related parties for financial reporting purposes. The members of ITC’s Board of Directors are listed in Exhibit 1 of this report. Figure 1 above illustrates the corporate structure of PRIDE, ITC and the affiliates. affiliates. This request was made in response to concerns raised in the Office of Program Policy Analysis and Government Accountability (OPPAGA) Special Report No. 03-68, PRIDE Benefits the State But Needs to Improve Transparency in Operations, issued December 2003. The objectives of the audit were to determine: • Whether management’s system of internal control was adequate to ensure effective, efficient, and proper use of resources; • Whether management established policies regarding investment best practices and whether management followed those policies; SCOPE, METHODOLOGY AND OBJECTIVES • The Chief Inspector General initiated this audit in response to a request by the Governor to conduct a review of PRIDE, ITC and the Whether the organizational relationships between PRIDE, ITC and the related affiliates are appropriate; • Whether the relationships between key In fiscal year 2003 (January 1 - December 31), ITC and its affiliates generated $20,256,522 in sales. 5 Audit # 2004-4 Issue Date: February 28, 2005 FINDINGS AND RECOMMENDATIONS employees of PRIDE, ITC and the related affiliates are appropriate and do not contain any conflicts of interest; • Whether the salaries of PRIDE and ITC senior management are reasonable and in accordance with similar positions in other organizations; and • Whether the organization is fulfilling its statutory purpose to duplicate as nearly as possible the operating activities of a profitmaking enterprise. Audit Finding #1 The organizational and operational relationship between PRIDE and ITC continues to be flawed in large measure because PRIDE initially adopted a corporate and governance structure which was inconsistent with the Florida Statutes applicable to managing and leasing correctional work programs. In early 1999 the PRIDE Board of Directors approved a number of initiatives for the stated purpose of expanding sales outside the historical outlets of the State of Florida and local governments. One of the initiatives was to create additional entities. To meet these objectives, we reviewed transactions and selected activities occurring during the period January 1, 1999 through June 30, 2004 and additional activities through December 2004. Our methodology included the following: • Interviews with members of both Boards of Directors, and selected officers and managers • Analyses of documents • Review of minutes of meetings of the PRIDE and ITC Boards of Directors • Review of statutes, corporate bylaws, policies and procedures • Review of financial reports, including audited and unaudited financial statements • Review of annual reports • Examination of selected financial transactions and supporting documentation • Examination of personnel files financial records A consultant was engaged to develop a comprehensive business plan to determine the feasibility of establishing a for-profit operation under the Prison Industry Enhancement (PIE) program1 within the PRIDE corporate structure. The consultant proposed restructuring PRIDE under a management company format as illustrated in Figure 2. and The structure shows a management company as a holding company with PRIDE, RISE, and a for-profit company as subsidiaries. Industries Management Corporation was established as the management company (the name was later changed to Industries Training Corporation – ITC) and Global Outsourcing, Inc. was created as the for-profit entity. In ITC’s 1999 and 2000 financial statements, PRIDE’s accounts were consolidated with ITC and its affiliates. (PRIDE issued separate, audited financial statements.) The CFO explained that including PRIDE as a subsidiary of ITC was considered appropriate since PRIDE and ITC had the same individuals serving on their respective Boards of Directors. In our interviews with Board members, at least one indicated that PRIDE is subordinate to ITC. charters, Our audit was conducted in accordance with the International Standards for the Professional Practice of Internal Auditing published by the Institute of Internal Auditors. The creation of a management company organizationally superior to PRIDE appears to be contrary to Section 946.502(1), Florida 1 PIE programs are authorized by Federal law for the purpose of allowing goods manufactured in prison industries to be sold in the competitive retail market. To ensure that the prison industries do not have an unfair advantage due to the small salary amounts paid to their inmates, the inmates working in PIE programs must be paid the current prevailing wage 6 Audit # 2004-4 Issue Date: February 28, 2005 FIGURE 2—CONSULTANT-PROPOSED REVISED CORPORATE STRUCTURE Management Company Commercial Sector PRIDE RISE Prision Rehabilitative Industriesand Diversified Enterprises,Inc Retraining Industrial Skills Enterprises,Inc L Government Products & Services Only L L Mix of Government & Private Services L Contracts with Government Agencies & Prisons Only NewCo PIE Commercial Products & Services Only L L Contracts with both Government and Pri vate Enterprise Contracts with Private Enterprise & Prisons Only justified. While the original consultant’s report may have brought to light a reasonable means of expanding PRIDE, it does not appear that other options/proposals/alternatives were considered. Other options may have provided a means by which PRIDE could have expanded its sales market with companies created as PRIDE subsidiaries. Statutes, which provides, “It is the intent of the Legislature that a not-for-profit corporation lease and manage the correctional work programs of the Department of Corrections. Section 946.502(2), Florida Statutes provides, “It is further the intent of the Legislature that once one such not-for-profit corporation is organized, no other not-for-profit corporation be organized for the purpose of carrying out this part . . ..” We made inquiries of senior executives and board members as to the reasons for creating ITC as a separate entity. Generally, the reasons expressed were: (1) to expand PRIDE’s sales base into non-State and private market segments; (2) the reluctance of private firms to do business with PRIDE because of concerns about the perceived ability of government to examine their records once they entered into a business relationship with PRIDE, and (3) to market products without the stigma associated with inmate-produced goods. In Report No. 03-68 dated December 2003, OPPAGA staff reported that PRIDE had failed to adequately maintain the distinction between itself and its related businesses. They go on to state, “The relationship between PRIDE, ITC and the other corporations is intertwined and difficult to separate. For example, PRIDE and ITC have some common managers, common board members, and use the same offices.” (See Exhibits 1 and 2.) We question, at least to some degree, the validity of these bases for establishing the separate entities because: The structure of the organization should promote the mission of the organization and each unit within the organization should function to further that mission. Private corporations in some instances have wholly owned subsidiaries. The purposes of wholly owned subsidiaries may be to spread risk so that a judgment against one subsidiary could not be enforced against other subsidiaries and subsidiaries are sometimes created to compete in different markets. Although these may have been the reasons for which PRIDE created ITC, PRIDE’s decision to create entities outside the control of PRIDE does not appear to be • 7 PRIDE does not control ITC or any of its affiliates, therefore PRIDE has no voice in how any profits would be distributed or used. We saw no evidence of how the activities of the companies increased PRIDE’s sales. Rather, PRIDE’s sales have ranged from $60,930,000 to $65,278,000 over the last 3 years, which is a significant decrease from the sales of $93,677,000 reported in 2000. Audit # 2004-4 Issue Date: February 28, 2005 • • Section 946.517, Florida Statutes, provides that “corporation [PRIDE] records are public records; however, proprietary confidential business information shall be confidential and exempt from the provisions of s. 119.07(1) and s. 24(a), Art. I of the State Constitution. … ‘Proprietary confidential business information’ means information regardless of form or characteristics, that is owned or controlled by the corporation; is intended to be and is treated by the corporation as private and the disclosure of the information would cause harm to the corporation’s business operations.” This information includes “information relating to private contractual data, the disclosure of which would impair the competitive interest of the provider of the information.” Such an exemption from public records disclosure laws appear to cover the records of private companies doing business with PRIDE. outline the provisions for the repayment of amounts ITC and its affiliates owe PRIDE, • An effort has been made to formalize the June 30, 1999 letter agreement, • Loan documents have been drafted which accounts have • ITC’s financial statements no longer include PRIDE account balances. Given ITC’s poor financial performance and current financial state, we recommend that PRIDE discontinue its relationship with ITC. If the Board chooses to continue the relationship, it should be re-structured so PRIDE is superior to ITC and its affiliates in form and substance and PRIDE ultimately benefits from operations of the related entities. Audit Finding #2 Management’s system of internal controls was inadequate to ensure effective, efficient, and proper use of resources. State resources were transferred to PRIDE for the purpose of leasing and managing the correctional work programs of the Florida Department of Corrections (Department). The PRIDE Board of Directors had a fiduciary responsibility to safeguard those assets and manage the correctional work programs in a manner that would provide income to expand the program and make lease payments to the Department. An adequate system of internal control was necessary to satisfy the obligations set forth in the Florida Statutes and the related lease agreements. Although the erroneous financial reporting methodology of 1999 and 2000 was corrected in 2001, vestiges of ITC’s superiority continued (e.g. PRIDE’s CEO was also ITC’s President/CEO and PRIDE’s CFO and internal auditor are organizationally responsible to the ITC President/CEO). Currently, PRIDE is taking steps to clarify the relationship between PRIDE and the related entities. We noted that: Separate bank established, ITC’s President/CEO is no longer PRIDE’s CEO and Recommendation: In our interviews with staff of prison industry programs in other states, several indicated they are fairly successful in dealing with private companies even though their products are produced using inmate labor. We realize that some major companies have a strict policy against establishing a relationship with prison industries, but considering the success of some other states’ programs, there are companies that do not have such a policy and could provide a sales market for PRIDE products. • • Authoritative accounting literature defines internal control as a process affected by an entity board of directors, management and other personnel. The process should be designed to provide reasonable assurance regarding achievement of objectives relating to: (1) reliability of financial reporting, (2) effectiveness and efficiency of operations, and (3) compliance with applicable laws and regulations. The foundation for all other components of internal control, providing discipline and structure, is the control environment, which sets the tone of the organization. There are seven control been 8 Audit # 2004-4 Issue Date: February 28, 2005 environment factors. between the Board of Directors and senior management would be detrimental to operations of the organization but the Board of Directors should be sufficiently independent to provide an appropriate level of oversight. The Board of Directors did not have staff and therefore they depended on senior managers to provide information needed for making important decisions. a. b. c. d. Integrity and ethical values Commitment to competence Board of directors or audit committee Management’s philosophy and operating style e. Organizational structure f. A ss ig n m e n t of a u th o r it y and responsibility g. Human resources policies and procedures The Board’s involvement and scrutiny of activities and the degree with which difficult questions were raised and pursued with management seemed limited. Our review of the Board packets (documents provided to Board members for review before the meetings), and the Board meeting minutes did not always document vigorous scrutiny and questioning on major decisions. For example, our review of the documents provided to the Board relating to the December 9, 2002 Board meeting disclosed a one page document providing a summary of the reasons for the asset write down ($5,279,190 receivable reduction described in Finding No. 7) and estimates of the amounts involved. The meeting minutes indicated: Our review raised questions as to the adequacy of controls related to items (c) - the board of directors, (e) - organizational structure and item (f) – assignment of authority and responsibility. The Board of Directors An entity’s control consciousness is influenced significantly by the entity’s board of directors or audit committee. Attributes include the board or audit committee’s independence from management, the experience and stature of its members, the extent of its involvement and scrutiny of activities, the appropriateness of its actions, the degree with which difficult questions are raised and pursued with management, and its interaction with internal and external auditors. The finance committee had previously met to review the financial results. Mike Smith shared the summary of the results and reviewed the recommendation of the asset writedowns of procurement management, business development and inmate placement. Upon a motion by Ed Peddie, seconded by Marcelo Alvarez, the recommended write-downs were unanimously approved.2 Our review disclosed that the PRIDE Board of Directors is not sufficiently independent from management. PRIDE’s Board asked Deloitte Consulting LLP to conduct a management assessment. The report indicated, “There is a perception among several interviewees [selected board members, employees and outside stakeholders] that the Board member nomination and selection process is not independent from the CEO, impairing the Board’s ability to provide oversight and effective governance.” This is an example of the limited documentation available on key decisions made by the Board. PRIDE has a Finance Committee that is responsible for determining that accurate and adequate accounts of the property and business transactions of the corporation are kept. We could not determine the level of scrutiny provided by this critical committee regarding the receivable reductions because minutes are not recorded at their meetings. Our interviews of PRIDE Board members disclosed that the majority of the Board “trusted” the PRIDE management team and did not always provide vigorous oversight when warranted. An antagonistic relationship 2 Mike Smith is the Chief Financial Officer of PRIDE and ITC; Ed Peddie and Marcelo Alvarez are PRIDE Board members. 9 Audit # 2004-4 Issue Date: February 28, 2005 President. An August 4, 2004 ITC organizational chart showed the internal auditor as an employee of ITC reporting to the President/CEO; however, ITC’s Internal Auditor has access to PRIDE’s information and financial records. During the audit, ITC’s Internal Auditor was designated as our liaison and initial contact for scheduling interviews and obtaining PRIDE records. However, PRIDE’s most recent organizational chart does not show an internal audit section. Without an effective internal audit function, the Board does not have an independent, internal source of information regarding the propriety of actions taken by management. Organizational Structure/Assignment of Authority and Responsibility An entity’s organization structure provides the framework within which its activities for achieving entity-wide objectives are planned, executed, controlled, and monitored. Some of the dual positions held raise concerns. As shown in Exhibit 2, Pamela Davis served as PRIDE’s Chief Executive Officer (CEO) (until July 2004) and serves as the President/CEO of ITC and several affiliates. Robert (Mike) Smith serves as the Chief Financial Officer (CFO) for both PRIDE and ITC (reporting to the President/CEO of ITC) and treasurer for several affiliates. These assignments appear to place the CEO and CFO in positions with competing interests. PRIDE has the line of credit and holds most of the assets, while ITC is the entity that has not had a profitable year and consistently needs to borrow funds to cover operating expenses. We noted several instances in which decisions made by the CEO and CFO would improve the financial condition of one company while impairing the financial condition of the other. For example: • • Recommendation: The PRIDE Board should review the present management structure and implement a system of internal controls adequate to ensure the objectives of the enterprise are fulfilled. Audit Finding #3 PRIDE experienced a significant financial decline from July 1, 1999 to December 31, 2003, recently resulting in cash flow difficulties. The CFO approved the PRIDE payments to ITC for administrative services which were based on PRIDE sales with no subsequent determination by the CFO as to ITC’s actual cost for providing the services, as required by the June 30, 1999 agreement. (See Finding No. 6) PRIDE’s audited financial statements indicated that, as of June 30, 1999, net assets exceeded $42 million. In 1999, the PRIDE Board of Directors approved the creation of ITC and ITC created affiliates and partnerships. However, due to declining sales, discontinued operations, asset transfers to ITC and asset write-downs (fair market value reductions), PRIDE’s net assets had dropped to approximately $26 million as of December 31, 2003, a reduction of $16 million over a four year period. From 1999 to 2003, PRIDE’s annual sales have ranged from a high of $93,677,025 in 2000 to a low of $60,930,006 in 2002, resulting in an average of $65 million for the period. Figure 3 shows the disposition of PRIDE’s funds from July 1, 1999 through December 31, 2003. The CFO recommended that the PRIDE Board approve the significant reduction of the amount due from ITC. The reasons for the deduction are questionable. (See Finding No. 7). Although the managers indicated that they finitely discharge their duties for each entity, the appearance of a conflict of interest cannot be disputed. Also related to efficient operations, internal auditors contribute to the monitoring of activities and the results of their reviews are reported directly to the Audit Committee. PRIDE had established an internal audit position and the Audit Committee met with the Internal Auditor twice a year. However, the PRIDE internal audit manual, dated July 1, 1990, states that the Internal Audit Department is a staff function reporting to the PRIDE has made substantial financial contributions, both in direct contributions and loans, to the startup of ITC and the other entities. Despite their poor financial performance, PRIDE has continued to approve loans to these failing entities, so that as of December 31, 2003, ITC and its affiliate, FCP, 10 Audit # 2004-4 Issue Date: February 28, 2005 FIGURE 3—PRIDE DISPOSITION OF FUNDS Year Disposition of Funds Gain/(Loss) from Asset Decreases Gain/(Loss) Discontinued Related to ITC & From Operations Operations Affiliates 1999 (6 months) 2000 2001 2002 2003 $ (5,673.00) $ (3,468,765.00) $ (1,057,299.00) $ (653,083.00) $ (2,076,931.00) $ (5,575,671.00) $ 2,876,225.00 $ 815,444.00 $ (5,279,190.00) $ (2,183,825.00) management confirmed that PRIDE was experiencing short-term cash flow problems. PRIDE’s solvency status is questionable because if PRIDE needs funds for operations, they have very few assets they can convert to cash. Much of the surplus property once owned by PRIDE and available to convert to cash has been sold, transferred by gift to ITC or cannot be sold because the buildings are located on state-owned land. The efficiency ratios show that PRIDE is efficient in using its assets to generate sales. However, the profitability ratios indicate PRIDE’s assets, sales and net income are not generating a return on the investment and therefore PRIDE is not considered a profitable entity. The details for each ratio, including how it is calculated, what it represents, what is a desirable ratio and PRIDE’s ratio at December 31, 2003 are contained in Exhibit 3 of this report. owed PRIDE a total of $5,351,459, with no stated terms of repayment. Also, PRIDE’s bank line of credit was structured so that PRIDE and ITC were cross-collateralized, meaning that both entities could draw down funds from PRIDE’s line of credit and each was responsible for the outstanding obligation. PRIDE used the funds to finance its operations and repaid its obligation from operating revenues. ITC also drew funds from this account as authorized by its Chief Financial Officer (who is also PRIDE’s Chief Financial Officer). The amounts borrowed by ITC limited PRIDE’s access to cash it may have needed to fund its prison industry units’ operations. PRIDE’s cash balances for the period 1999 through 2003 have decreased by an average of $600,000 each year. On January 1, 1999, PRIDE’s cash balance exceeded $3 million and had decreased to approximately $250,000 as of December 31, 2003. In its current financial state, PRIDE has not been able to meet its financial obligations. Based on information provided to us by ITC’s Internal Auditor, the terms of the crosscollateralized line of credit were revised in November 2004 to make the amount due from PRIDE separate from the amount due from ITC. Under the revised arrangement, if the bank requires payment of the outstanding balances, PRIDE is no longer responsible for ITC’s debt. Recommendation: We recommend that PRIDE take measures to reduce and eventually eliminate the trend toward financial and economic decline. These efforts should include a careful review of how PRIDE’s funds are used and the elimination of financial support for any business ventures, including ITC and its affiliates, which are not generating profits for PRIDE. To obtain a clearer picture of PRIDE’s financial state, we used data from the 2003 audited financial statements and calculated ratios that indicated the solvency, profitability and efficiency of PRIDE’s operations. Our analyses indicated that PRIDE is having difficulty meeting its current obligations. During our fieldwork in September 2004, PRIDE senior Audit Finding #4 ITC is a financially troubled entity and its current financial condition raises concerns as to whether it will be able to continue to operate. 11 Audit # 2004-4 Issue Date: February 28, 2005 FIGURE 4—PRIDE DISPOSITION OF FUNDS Period Ended December 31, 1999 * December 31, 2000 December 31, 2001 December 31, 2002 December 31, 2003 June 30, 2004 ** TOTAL * July - December only ** January - June only Revenues ITC and Subsidiaries $ 5,002,994 14,718,054 17,868,492 16,484,325 20,256,522 9,760,601 $ 84,090,988 ITC provides management services to PRIDE and ITC affiliates. As shown in Figure 4, ITC is heavily dependent upon PRIDE as a funding source. Revenue Attributed to PRIDE 100.00% 67.30% 51.39% 37.90% 32.77% 35.24% 48.06% has no net worth, meaning its liabilities exceed its assets. While ITC appears to be efficient in using its revenues to pay its suppliers, it is not as efficient in collecting its receivables. ITC has not generated any profits therefore there are no returns on assets or sales. The details for each ratio, including how it is calculated, what it represents, what is a desirable ratio and ITC’s ratio at December 31, 2003 are contained in Exhibit 4. Not only is PRIDE one of ITC’s major customers, PRIDE has provided financial support in other ways. In 1999, PRIDE made a significant contribution by transferring by gift to ITC land and buildings. When the properties were sold by ITC, they retained the profits. Also, ITC had access to additional funds through PRIDE’s line of credit. During our audit period, ITC was not considered creditworthy and since they could not obtain their own line of credit, they used PRIDE’s line of credit to obtain working capital. (ITC’s Internal Auditor indicated that as of November 2004, ITC no longer has access to PRIDE’s line of credit.) Despite the infusion of PRIDE’s assets to the start-up and operations of ITC, financial records indicate ITC has not been profitable since its inception. Net losses each year have been as follows: 1999 (July - Dec.) 2000 2001 2002 2003 TOTAL PRIDE Support Payments $ 5,002,994 9,905,388 9,183,504 6,246,744 6,639,053 3,439,506 $ 40,417,189 Our conclusion is that ITC is not a viable business entity that can promote PRIDE’s goals and missions. ITC is an entity struggling to survive. If PRIDE withdrew its support, ITC could not survive in its present form. ITC and its affiliates would have to significantly downsize operations and staff, expand their sales markets, reduce overhead and search for new customers and funding sources. The benefits PRIDE envisioned in the creation of ITC and its affiliates have not been realized and have, to a degree, contributed to the financial decline of PRIDE. $ (130,182.00) (1,399,102.00) (4,882,701.00) (1,869,527.00) (1,265,145.00) $ (9,546,657.00) Recommendation: Given ITC’s financial failures and the effect it is having on PRIDE’s financial condition, we recommend that the PRIDE Board of Directors sever its relationship. However, if PRIDE chooses to continue the relationship, the basis for that decision should be documented. A key element to be considered by the Board is whether further support of ITC and its affiliates is an effective and efficient use of resources. A financial analysis and calculation of financial ratios for solvency, efficiency and profitability present a bleak picture for ITC. ITC is not solvent in that it has few assets which can be used to pay its current liabilities. The company 12 Audit # 2004-4 Issue Date: February 28, 2005 letter agreement was executed by the President/CEO of ITC (who was also the CEO of PRIDE) and the CFO of PRIDE (who also became the CFO of ITC). Audit Finding #5 PRIDE did not enter into a formal contract with ITC, although required by the letter agreement dated June 30, 1999. Currently, no formal contract exists. Our audit disclosed that the comprehensive agreement has not been executed. When asked why a formal agreement had not already been executed, PRIDE senior management indicated, “we just didn’t get around to it”. In June 2004, a proposed agreement was drafted and was to be presented to the Board for approval. At the request of the Chief Inspector General, final approval was deferred until the completion of this audit. Since June 30, 1999, the letter agreement has been the complete agreement of the parties; however, several key issues have arisen over the past five years that are not addressed in the letter agreement, including: ITC provides assistance, management services and support to PRIDE. The terms under which ITC will operate are set forth in a letter agreement dated June 30, 1999. Per the letter agreement, the central goal of PRIDE and ITC is to work toward the implementation of Prison Industries Enhancement (PIE) Programs. To meet the goal, ITC agreed to perform services such as: • Training and recruiting employees to work for PRIDE; • Analyzing data to determine enterprises, people and locations which will complement PRIDE’s mission, particularly with respect to PIE programs; • Providing accounting and payroll support; • • The repayment terms for money borrowed from PRIDE by ITC, • The extent to which ITC could use funds from PRIDE’s line of credit, Providing computer support; • Transfer of land and buildings from PRIDE to ITC and • Providing assistance in accounts receivable and collection; • Details of PRIDE initiatives assumed by ITC and ITC’s responsibilities. • Entering into arrangements; • Providing human resources services; • Arranging for employee health, pension, and other benefits; • Providing assistance representation and • Providing assistance in acquiring, leasing, constructing and mortgaging real and personal property. banking in and financing selecting The provisions relating to such critical issues should have been outlined in a formal document. Without formalization of those provisions, there is no assurance that these matters will be handled in a consistent manner when decisions must be made. Recommendation: legal Given ITC’s current financial condition and its inability to meet the goals of the June 30, 1999 agreement, it does not appear reasonable for PRIDE to enter into a formal contract with ITC. We recommend that the PRIDE Board of Directors sever its relationship with ITC. However, if the Board chooses to continue that relationship, the justification should be documented and a formal contract detailing the responsibilities of each party should be immediately executed. ITC and PRIDE were to develop a more extensive operating agreement to accomplish the goals and purposes of PRIDE with respect to the PIE Programs. The parties contemplated finalizing the operating agreement by December 31, 1999, with a 10-year term. The 13 Audit # 2004-4 Issue Date: February 28, 2005 In formalizing the administrative support services agreement between PRIDE and ITC, the June 2004 proposed contract provided that, in addition to PRIDE paying all costs and expenses paid in connection with the performance of the services, the administrative service fee paid to ITC would be 10% of the gross amount of PRIDE’s total support and revenues realized from all sources and would be paid until PRIDE and ITC could agree on a fixed monthly amount. Audit Finding #6 Payments made to ITC by PRIDE for management services have not been in accordance with the June 30, 1999 agreement or sound business practices. Effective June 30, 1999, a letter agreement was executed between PRIDE and ITC to set forth the terms under which ITC would provide assistance, service and support to PRIDE. With regard to fees to be paid to ITC by PRIDE, the agreement provides: One additional observation is that ITC’s cost of providing administrative services may be high. We found no evidence that this possibility was explored because the PRIDE Board/ management did not obtain quotes or bids from other companies as a means of determining the reasonableness of the amounts being charged by ITC. The failure of the PRIDE Board and management to properly monitor the fees paid to ITC has possibly resulted in PRIDE further subsidizing ITC operations to PRIDE’s detriment. “The initial fees for services rendered by ITC will be estimated based on PRIDE’s estimated budget as reflected in its financial statements for the period ending June 30, 2000. PRIDE and ITC will work together to schedule, in reasonable detail, the fee to be paid by PRIDE for each of the services outlined in the agreement. The fees will be paid quarterly in advance and will be based on estimated costs incurred by ITC in providing the services. The fee will be adjusted annually to reflect actual costs to ITC of providing the services. PRIDE shall have the right to audit any calculation of these fees.” Recommendation: We recommend that PRIDE immediately exercise its right to audit the calculation of fees charged by ITC in prior years. PRIDE should require immediate repayment of any amounts overpaid to ITC. Also, if PRIDE’s relationship with ITC continues, the Board should take steps to ensure that ITC is the best company to provide administrative services and that the fee being charged is reasonable. The fee payment calculation should conform to best business practices. PRIDE’s financial records indicate that PRIDE has made payments totaling $40,417,189 to ITC during the period July 1, 1999 through June 30, 2004 (see chart in Finding No. 4). During 2000 and 2001, ITC’s management services fee was calculated at 10% of PRIDE’s budgeted revenues. For 2002 and 2003, ITC charged PRIDE a flat rate of 10% of PRIDE’s gross sales. Each year, the administrative services fee was included in PRIDE’s budget which was approved by the Board; however we found no evidence that the Board was aware of the methodology being used to determine the amounts to be paid to ITC. The ITC charges were not calculated in accordance with the methodology outlined in the June 30, 1999 agreement. Also, payment for services based on the receiving agency’s budget or sales are not normal business practice. As of June 30, 2004, neither PRIDE nor ITC had determined actual costs and the amounts paid had not been adjusted accordingly. The possibility exists that ITC may have overcharged PRIDE. Inspector General’s Comment: In response to Finding No. 6, the PRIDE Chairman indicates that, although PRIDE believes that there have been overpayments in the past, the actual computation of those overpayments would be very difficult and very time consuming to perform. Further, even if an acceptable management service fee could be computed for prior periods, and even if it was less than the actual fee paid, based upon the information in Finding No. 4, it is unlikely that PRIDE would be able to collect on the overpayments. Given ITC’s current financial status, the ability to collect any overpayment 14 Audit # 2004-4 Issue Date: February 28, 2005 FIGURE 5—PRIDE RELATED PARTY RECEIVABLES As of Dec. 31 1999 2000 2001 2002 2003 Current $ $ 3,867,777.00 $ 807,331.00 $ 1,196,915.00 $ 1,511,000.00 does seem unlikely. However, ITC is continuing to operate. In the event that the company does become profitable in the future, PRIDE may have legal recourse for collecting overpayment of fees. As PRIDE continually monitors the likelihood of collecting its receivables due from ITC, periodically PRIDE should also evaluate the feasibility of calculating ITC’s cost and the possibility of collecting a refund for any amounts overpaid. $ $ $ $ $ Long-Term 8,682,751.00 8,463,973.00 3,840,459.00 Total $ $ $ $ $ 3,867,777.00 9,490,082.00 9,660,888.00 5,351,459.00 of Board-approved reductions of $5,279,190 and $4,106,546, respectively. Our findings on each of these reductions are addressed below. 2002 Reduction of the Amount Due from ITC’s Affiliates In 2002, PRIDE management requested approval from the Board to reduce the amounts due from RISE3 ($1,572,926 reduction), Global ($1,945,042 reduction) and DSM ($1,775,622 reduction) totaling $5,293,590. The Board approved a reduction of $5,279,190. PRIDE’s 2002 Annual Report indicates: In the response from ITC’s Chairman, he indicates ITC does not believe there have been past overpayments. Without a review to determine the actual costs to ITC for the services it provided to PRIDE, that assumption cannot be verified. PRIDE and ITC concluded that ITC would not benefit from certain initiatives as PRIDE had assumed responsibility for administering them. As a result, it was agreed that PRIDE would assume the initial and the majority of the operational costs of these initiatives. Management identified these initiatives, isolated the costs and adjusted the amount due from ITC. Audit Finding #7 PRIDE has loaned/advanced funds to ITC and its affiliates interest-free, without any stated terms of repayment. Also, amounts recorded in PRIDE’s financial records as due from ITC and ITC affiliates have been reduced by significant amounts for reasons that were sometimes questionable. We were unable to verify which PRIDE initiatives were transferred to ITC (see Finding #5) and which initiatives were re-assumed by PRIDE. The validity of the reasons for the reduction of receivables is questionable. We noted: Since the creation of ITC and its affiliates, PRIDE has advanced funds to them for the purpose of funding ITC initiatives. Currently, there are no stated terms of repayment. The related party receivables (amounts due from ITC and its affiliates) that have been reported in PRIDE’s financial statements are listed in Figure 5. • The amounts shown for 2002 and 2003 are net 3 RISE became Labor Line, Inc, (LLI) and Labor Line Service (LLS) which are both currently subsidiaries of ITC. RISE’s mission to assist PRIDE inmates and the mainstream population in finding jobs was assumed by LLI. LLI generates income by RISE (Renewed for Industries, Services and Employment) was a tax exempt organization established to provide job placement and related services for ex-offenders and other underemployed persons. In addition, RISE organized a network of services that enhance the participants’ ability to stay on the job. These services included support during the transition of ex-offenders from prison to the community. The organization was supported by PRIDE through an operations agreement to secure job placement for 400 PRIDE inmates upon their release. 15 Audit # 2004-4 Issue Date: February 28, 2005 providing temporary employment services to hard-to-place individuals, such as low income or under employed persons. ITC staff estimates that approximately 60% of the individuals on LLI’s staff available for temporary employment are ex-offenders. LLS assumed Rise’s second mission, which was to provide transitional (from prison back to the community) support to PRIDE inmates upon their release from prison. PRIDE pays a monthly fee to LLS for providing this service for PRIDE inmates. Currently, LLS provides services only to former PRIDE inmates. It appears that Labor Line, Inc. and Labor Line Services, not PRIDE, have assumed the RISE initiative. • • Neither explanation provides justification for the 2002 reduction. a clear 2003 Reduction of Amount Due from ITC The $4,106,546 reduction in 2003 related to PRIDE’s pension obligations to ITC. PRIDE’s 2003 Annual Report indicates: This obligation relates to the fact that for the years ended December 31, 2002 and 2003, the defined benefit pension plan was underfunded due to market losses and changes in actuarial assumptions. The obligation represents PRIDE’s share of the additional pension expense incurred by ITC. It was actuarially determined based on the participation of PRIDE employees in the plan, PRIDE employees account for approximately 93% of the total obligation. It was recognized by reducing PRIDE’s receivable from ITC. Global’s current mission is to establish private enterprise partners that would increase inmate jobs and provide inmate training. The reduction in the amount owed to PRIDE was related to organization and process development costs for this purpose, which appear to be directly related to the mission of Global. This transaction did not result in a decrease in the amount by which the pension plan was under funded; it simply shifted the obligation from PRIDE to ITC. Given ITC’s current financial condition, concerns are raised as to how they (ITC) will pay the obligation when it becomes due. As of June 30, 2004, sponsorship of the defined benefit pension plan has been transferred back to PRIDE. As a result, the $4.1 million effectively paid by PRIDE to ITC at December 31, 2003 for its share of the unfunded pension liability must be transferred back to PRIDE. PRIDE staff indicated that the appropriate accounting entries have been drafted and will be included in the accounting records and financial statements for the fiscal year ended December 31, 2004. DSM’s mission was to purchase and provide services and products from and to minorityowned vendors and customers. ITC is a 40% shareholder in the company. As an ITC initiative, it is unclear as to why this company’s obligation to PRIDE was written off rather than being assumed by ITC. While PRIDE’s financial statements explained the reduction in receivables as being a result of PRIDE assuming responsibility for certain initiatives, the information presented to the Board for approval of the asset write downs indicated a different reason. The information provided to the Board indicated the reductions were necessary because certain obligations may have been over-valued given the market conditions at the time. In order to reflect a more conservative valuation, a write down was recommended. Board minutes and corresponding documents did not provide an explanation of how these project costs were determined to be over-valued and how the more conservative valuation amounts were calculated. Minutes were not available from meetings of the Finance Committee, which should have been involved in this decision making process. Recommendation: We recommend that the PRIDE Board determine whether either of the explanations for the 2002 accounts receivable reduction– assumption of initiatives or adjustment for overvaluation of assets is valid. Documentation should be obtained from management providing the details of the transactions and the basis for the decision to request the reduction. If it is determined that the transaction, or any portion thereof, was not 16 Audit # 2004-4 Issue Date: February 28, 2005 valid, PRIDE should demand payment of the invalid amount. the criteria for deciding whether to continue or discontinue support of the project. In addition, if PRIDE chooses to continue its relationship with ITC, documents should be prepared to memorialize the bases on which the decision was made to allow the $5,279,190 reduction in receivables. Consider PRIDE’s relationship with Florida Citrus Producers. This entity is a recently created affiliate of ITC that was established to take over the operations of the citrus processing operation in 2004 as Florida Citrus Partners (FCP) was winding down operations due to a legal dispute between ITC and its partner. At the July 22, 2004 PRIDE Board meeting, ITC indicated that it could no longer manage and run the operation. PRIDE’s Board Chairman indicated that since PRIDE owned most of the FCP assets, a determination should be made regarding taking over the operations or allowing ITC to shut it down. Per the minutes, after significant discussion, the PRIDE Board unanimously approved a $390,000 line of credit to ITC for the continuation of Florida Citrus Producers operation through December 2004. This decision was made without the benefit of an investment policy, during a time when PRIDE was experiencing immediate cash flow problems and ITC’s ability to pay its current receivable to PRIDE was doubtful. A clearly defined investment plan outlining the level of support PRIDE would provide to Florida Citrus Producers or any other entity would have provided some assurance that all risks were considered and the decision made was based on a proper consideration of those risks. (Note: At the September 16, 2004 Board meeting, PRIDE management advised the Board that PRIDE did not have the money to fund the line of credit approved for Florida Citrus Producers. The Board unanimously agreed to withdraw the line of credit extended on July 22, 2004.) For the 2003 write-down, the appropriate PRIDE staff should monitor the proposed accounting entry to ensure that it is properly recorded at fiscal year end. Audit Finding #8 Management had not established a policy setting limits on the amount of funds that can be used to support ITC and its affiliates. The lack of such a policy has resulted in significant advances being made to ITC and its affiliates at the expense of PRIDE’s financial welfare. Risk assessment is the entity’s identification and analysis of relevant risks to achieve its objectives, forming a basis for determining how risks should be managed. Such an assessment should have been made by PRIDE’s management prior to recommending advances to support the activities of ITC and its affiliates and should have been reviewed by the PRIDE Board prior to approving the advances especially since PRIDE was concerned about its own decreasing sales volume and revenues. The PRIDE Board of Directors approved the use of PRIDE resources to provide funding to ITC or business ventures established by ITC. Criteria for the basis of decisions relating to the amounts advanced to the affiliates were not provided for our examination. PRIDE did not have an overall plan outlining the criteria whereby PRIDE’s resources would be evaluated and a determination made as to the specific amount of venture capital that was available for the new businesses. Such a plan should include criteria that would be used as a basis for approving or disapproving a specific funding proposal, procedures for evaluating PRIDE’s financial condition to determine the level of funding that could be safely committed, the balance to be achieved between profitability and achievement of the societal mission and Recommendation: PRIDE should establish a financially sound policy for evaluating all investments. Future investment decisions should be firmly grounded in a plan geared to attaining the projected return on the investment. Audit Finding #9 The amounts paid to PRIDE and ITC executives were not reasonable considering the companies’ financial condition. 17 Audit # 2004-4 Issue Date: February 28, 2005 ITC executives’ salaries greatly exceeded (and in some cases were more than double) that paid to the chief executives managing those programs, including California, which generates annual revenues of approximately $160 million. In many ways, PRIDE and ITC function like private sector businesses. Private sector practice would dictate that salary increases for senior managers be based on operational performance of the company. Given the recent state of the economy, the decline in PRIDE and ITC revenues and net assets, and in comparison to the level of compensation provided to managers in similar programs in other states and not-for-profit organizations, it appears that the amount of compensation provided to some PRIDE and ITC executives is excessive. The Chairman of the Board approves the salaries and bonuses for the executive management team. Accountability for the results of decisions made which have adversely affected the financial status of the entities appears to be lacking. Our review also disclosed that a supplemental executive retirement plan was initiated by ITC effective October 1, 2001. The ITC plan provided for supplemental retirement benefits for senior managers. Ten years of service was required to qualify for benefits. Benefits were payable over a 15 year period calculated at 40% for 10 years of service, 45% for 11 years but less than 16 years of service, 50% for 16 years but less than 20 years of service, and 60% for over 20 years of service. These amounts will be reduced by amounts received from the defined benefit plan. Payments into the supplemental retirement plan totaled $357,226 as of June 30, 2004. Currently, ITC’s President/CEO and CFO and Global’s COO qualify for this plan. In performing our analysis of salary increases, we made the assumption that an average annual increase of 10% or less was reasonable. That assumption is conservative and may be too high relative to the declining financial condition of the entities and the current U.S. salary trends. Using this assumption, the salary increases (including bonuses) given to some senior managers appeared to be unreasonable. From 1998 to 2004, the increases given to PRIDE’s President and Vice President of Operations and ITC’s President/CEO and CFO averaged more than 14% annually. (See Exhibit 5.) We obtained the Association Executive Compensation and Benefits Study, Fourteenth Edition, produced by the American Society of Association Executives. We used this document to help assess the reasonableness of the ITC President/CEO’s compensation. The total compensation of the President/CEO falls within the salary range for a CEO within a trade association with a budget of $15 million or more (the industry type of the organizations within this category were not determinable). However, in a separate analysis, we noted that the total compensation paid to the ITC President/CEO exceeded the $245,250 maximum annual salary for CEOs surveyed in the manufacturing category. Based on our review of information obtained from prison industry programs in other states, PRIDE and Recommendation: We recommend that the PRIDE and ITC Boards revisit their policies for calculating salary increases and bonuses. Not only should the attainment of operational goals (e.g., number of products produced; meeting contract deadlines, etc.) be considered but goals related to the financial growth of the company should also be included. The attainment of those goals and the company’s ability to pay should be the basis for determining the amount of salary increases given. Justification for the supplemental executive retirement plan should be documented. This audit was conducted in accordance with the International Standards for the Professional Practice of Internal Auditing, published by the Institute of Internal Auditors. This audit was conducted by Deette Preacher, CPA, P.A., an independent contractor, and supervised by Kim Mills. Please address inquiries regarding this report to Kim Mills, Director of Auditing, at (850) 922-4637. 18 Audit # 2004-4 Issue Date: February 28, 2005 EXHIBIT 1—PRIDE AND ITC BOARD OF DIRECTORS PRIDE Board of Directors (prior to December 31, 2004) Maria Camila Leiva, Chairman Pamela Davis, CEO (until July 22, 2004) Jack Edgemon, Interim CEO (as of September 29, 2004) John F. Bruels, President (until July 22, 2004) Kenneth L. Mellem Lawrence W. Hamilton Marcelo A. Alvarez William G. Dresser Richard L. Hanas Walter B. “Mike” Hill James V. Crosby Edward C. Peddie Carol S. Spalding Gwendolyn W. Stephenson Derrick D. Wallace (until July 22, 2004) ITC Board of Directors (prior to December 31, 2004) Randall L. May, Chairman Pamela Davis, President/CEO Maria Camilla Leiva (until December 16,2004) Kenneth Mellem (until December 22, 2004) Lawrence Hamilton (until December 31, 2004) Marcelo Alvarez (until December 17, 2004) Cecilia Bryant R. Ray Goode James E. Huff Roy Harrell, General Counsel 19 Audit # 2004-4 Issue Date: February 28, 2005 EXHIBIT 2—KEY EMPLOYEES, PRIDE, ITC PRIDE, Inc. Date Filed* 12/14/81 ITC 4/22/99 Labor Line Services, Inc. Labor Line, Inc. Florida Citrus Partners, LLC Florida Citrus Producers, Inc. Diversified Supply Mgt, Inc. Northern Outfitters Global Outsourcing, Inc. Global Reman Services, Inc. 1/18/96 Mike Smith CFO Mike Jouret P/CEO, D CEO, D VP, CFO T IA T 7/8/99 CEO, D Mgr 6/10/04 D 6/6/02 D 9/13/99 Pamela Davis CEO ** AND Mike Harrell AFFILIATES—1999-2004 Jack Edgemon VP – Ops., Interim CEO ** Bea Battistoni Bob Bury Esther Knightly AS**** S S VP S Mgr Mgr D AT AS 11/4/93 P 1/5/99 CEO, D 6/10/04 D T COO S Legend CEO ....................................Chief Executive Officer CFO......................................Chief Financial Officer COO ....................................Chief Operating Officer P .................................................................President VP ..................................................... Vice President IA ....................................................Internal Auditor T ................................................................ Treasurer Mgr............................................................. Manager D.................................................................. Director S ................................................................ Secretary A.................................................................Assistant Note: Excluding Northern Outfitters, the Department of State, Div. Of Corp. database lists all organizations above as Active and the principal and mailing addresses for all organizations are 12425 28th St. North; Suite 103; St. Petersburg, Florida 33716. * ** *** **** Date corporation documents filed with Department of State, Division of Corporations. Ms. Davis served as CEO until July 22, 2004. Mr. Edgemon was appointed as Interim CEO, effective September 29, 2004. Mr. Smith served as CFO until November 30, 2004. Ms. Knightly served as Assistant Secretary until May 2003. 20 Audit # 2004-4 Issue Date: February 28, 2005 EXHIBIT 3—PRIDE RATIO ANALYSES PRIDE’s Ratio Analysis at December 31, 2003 PRIDE’s Ratio Quick Ratio .68:1 Current Ratio 1.7:1 Current Liabilities to Net Worth Ratio Total Liabilities to Net Worth Ratio (Debt to Equity) Fixed Assets to Net Worth 38% AS OF DECEMBER 31, 2003 Standard Ratio Greater than 1:1 is desirable 2:1 or higher Favorable/ Unfavorable Unfavorable Unfavorable 50% or less is desirable Not to exceed 100% Favorable 67% 75% or less Favorable 37 days 40 days or less Favorable Assets to Sales Ratio 59% Favorable Sales to Net Working Capital Ratio Accounts Payable to Sales Ratio Return on Sales 9.11 6.41% Greater than 25%, lower than 75% Less than or equal to 11 8.5% or lower -3.35% Should be positive Favorable for 12/31/03 Unfavorable Return on Assets -5.64% Should be positive Unfavorable -8.41 Should be positive Unfavorable 12.8% 33% manufacturing & 82% for services. Combined weighted average 60% Range from 18% to 43% 61% to 87.5%. Combined weighted average 76.6% Unfavorable Collection Period Ratio Return on Net Worth Gross Margin Percentage Operating Expenses as a Percentage of Sales Total Expenses as a Percentage of Sales Approximately 50% 13% 103.3% Favorable Favorable Favorable Unfavorable PRIDE’s ratio analyses are as follows: Quick Ratio: Unfavorable - A solvency ratio that measures the extent to which a business can cover its current liabilities with those current assets readily convertible to cash, a ratio greater than 1:1 is desirable.4 PRIDE’s ratio of 68% or (.68:1) at December 31, 2003 shows that the company is not in a liquid position and may have difficulties in meeting its current obligations without further leveraging or selling off of property and equipment. PRIDE has not been considered in a liquid position since December 31, 1999. 4 Source—American Express Small Business Resources Understanding Financial Ratios 21 Audit # 2004-4 Issue Date: February 28, 2005 Current Ratio: Unfavorable - A solvency ratio that measures the degree to which current assets cover current liabilities. The higher the ratio, the more likely the company will be able to meet its liabilities. A ratio of 2:1 or higher is standard.5 PRIDE’s current ratio is 1.7:1 and has not been over 2:1 since December 31, 2000. Current Liabilities to Net Worth Ratio: Favorable – A solvency ratio that indicates the amount due creditors within a year as a percentage of the net assets or net worth. A ratio less than or equal to 50% is desirable and according to Dun & Bradstreet,6 a business starts to have trouble when this relationship exceeds 80%. For PRIDE this ratio at December 31, 2003 is 38% and has never exceeded 50%. Total Liabilities to Net Worth Ratio (Debt to Equity): Favorable – A solvency ratio that shows how all of the company’s debt relates to the equity or net assets. The higher this ratio, the less protection there is for creditors. Generally, this ratio should not exceed 100% because at this point creditors would have more at stake than owners. PRIDE’s ratio is approximately 50% at December 31, 2003, total liabilities have never exceeded net worth. Fixed Assets to Net Worth: Favorable – A solvency ratio that shows the percentage of assets centered in fixed assets compared to total equity. According to Dun & Bradstreet,7 the higher this percentage is over 75%, the more vulnerable a concern becomes to unexpected hazards and business climate changes. Capital is frozen in the form of property and equipment and the margin for operating funds becomes too narrow to support day-to-day operations. For PRIDE, this ratio was 67% and has never exceeded 75%. Collection Period Ratio: Favorable – An efficiency ratio that is helpful in analyzing the collectibility of accounts receivable, or how fast a business can increase its cash supply. For PRIDE, the collection period has been approximately 37 days for the last three years. Generally, where most sales are for credit, any collection period more than one-third over normal selling terms (40 for 30-day terms) is indicative of some slow-turning receivables. Because PRIDE operates in multiple industries a general collection period of 37 days indicates no slow turning accounts receivable. Assets to Sales Ratio: Favorable – An efficiency ratio that rates sales to the total investment that is used to generate those sales. This ratio ties in sales and the total investment that is used to generate those sales. Abnormally low percentages (above the upper quartile) can indicate overtrading, which may lead to financial difficulties if not corrected. Extremely high percentages (below the lower quartile) can be the result of overly conservative or poor sales management, indicating a more aggressive sales policy may need to be followed.8 PRIDE’s assets to sales ratio is 59% on December 31, 2003 and indicates no issues. 5 6 7 8 Source—American Express Small Business Resources Understanding Financial Ratios Source—Dun & Bradstreet—Fourteen Key Business Ratios Source—Dun & Bradstreet—Fourteen Key Business Ratios Source—Dun & Bradstreet—Fourteen Key Business Ratios 22 Audit # 2004-4 Issue Date: February 28, 2005 Sales to Net Working Capital Ratio: Favorable – An efficiency ratio that measures the number of times working capital turns over annually in relation to net sales. This relationship indicates whether a company is overtrading or conversely carrying more liquid assets than needed for its volume. PRIDE’s sales to working capital ratio is 9.11 times. An average range of annual sales to net working capital listed as 11.0 and under as measured by insurance industry analysts.9 A high turnover may indicate that the business relies extensively upon credit granted by suppliers or the bank as a substitute for an adequate margin of operating funds. Accounts Payable to Sales Ratio: Favorable – An efficiency ratio that measures how the company pays its suppliers in relation to the sales volume being transacted. For PRIDE this ratio was 6.41% as of December 31, 2003. A low percentage would indicate that the entity generally pays its suppliers when bills are due. Whereas a higher percentage would indicate that the entity may be using suppliers to help finance operations. PRIDE appears to have a ratio indicating that its suppliers are being paid on time or within 23 days (6.41% * 365 days). This may not be indicative of the daily account balances during the fiscal year. Return on Sales: Unfavorable – A profitability ratio that measures profits after taxes on the year’s sales (profits earned per dollar of sales). PRIDE’s return on sales was –3.35% for the year ended December 31, 2003 and since 1999 has averaged –3.43%, therefore no return on sales has been recognized. Return on Assets: Unfavorable – A profitability ratio that is the key indicator of profitability according to Dunn & Bradstreet.10 PRIDE’s return on assets for the year ended December 31, 2003 was –5.64% and since 1999 has averaged –4.85%, again showing no return. Return on Net Worth: Unfavorable – A profitability ratio that measures the ability of a company’s management to realize an adequate return on the capital invested. PRIDE’s return on net worth for the year ended December 31, 2003 was –8.41 and has averaged -7.00 percent since 1999, again showing no return. Gross Margin Percentage: Unfavorable – A profitability ratio that measures gross profit as a percentage of sales. For PRIDE this percentage was 12.8% as of December 31, 2003 and averaged 11.1% for all years since 1999 indicating a very slim gross margin. When compared to a composite of businesses with similar product mixes,11 these businesses had a gross margin percentage of ranging from 33% for manufacturing to 82% for service businesses and a weighted average of 60% based on the same proportion of sales as PRIDE. Operating Expenses as a Percentage of Sales: Favorable – A profitability ratio that measures operating expenses as a percentage of sales. This ratio for PRIDE was 13.0% for the year ended December 31, 2003. The average for all years since 1999 was 13.4% indicating very low operating expenses. A composite of business with similar product mixes,12 shows these businesses had operating expenses ranging between 18% and 43% of sales. 9 Source—Surety Company of the Pacific Ratio Table Source—Dun & Bradstreet—Fourteen Key Business Ratios 11 Source—BizStats.com—Average Profitability and Expense Percentages for U.S. Small Businesses 12 Source—BizStats.com—Average Profitability and Expense Percentages for U.S. Small Businesses 10 23 Audit # 2004-4 Issue Date: February 28, 2005 Total Expenses as a Percentage of Sales: Unfavorable – A profitability ratio that measures total expenses as a percentage of sales. This ratio for PRIDE was 103.3% of sales and averaged 104.2% since 1999, indicating a serious and chronic profitability issue. Compared to a composite of businesses with similar product mixes13 that show the total expenses ranged from 61% to 87.5% and a weighted average of 76.6% for these businesses. 13 Source—BizStats.com—Average Profitability and Expense Percentages for U.S. Small Businesses 24 Audit # 2004-4 Issue Date: February 28, 2005 EXHIBIT 4—ITC RATIO ANALYSES ITC’s Ratio Analysis at December 31, 2003 ITC’s Ratio Quick Ratio 1:1 Current Liabilities to Net Worth Ratio Total Liabilities to Net Worth Ratio (Debt to Equity) Fixed Assets to Net Worth Collection Period Ratio -78% Unfavorable Unfavorable -35% 75% or less Unfavorable Avg 61 days 40 days or less Unfavorable 45% Favorable No working Capital 2.31% Greater than 25%, Less than 75% Less than or equal to 11 8.5% or lower Unfavorable -2.98% Should be positive Unfavorable -1.27 Should be positive Unfavorable No history of any returns on investments Should be positive Unfavorable -256% Return on Assets Return on Net Worth Greater than 1:1 desirable 2:1 or higher Favorable/ Unfavorable Unfavorable 50% or less is desirable Not to exceed 100% Assets to Sales Ratio Sales to Net Working Capital Ratio Accounts Payable to Sales Ratio Return on Sales DECEMBER 31, 2003 Standard Ratio .75:1 Current Ratio AS OF Unfavorable Favorable ITC’s ratio analyses are as follows: Quick Ratio: Unfavorable - A solvency ratio that measures the extent to which a business can cover its current liabilities with those current assets readily convertible to cash, a ratio greater than 1:1 (100%) is desirable.14 ITC’s ratio of 75% (.75:1) at December 31, 2003 shows that the company is not in a liquid position and may not be able to pay its current liabilities. ITC has not been considered liquid since December 31, 2000. Current Ratio: Unfavorable - A solvency ratio that measures the degree to which current assets cover current liabilities. The higher the ratio, the more likely the company will be able to meet its liabilities. A ratio of 2:1 (200%) or higher is desirable.15 ITC’s current ratio is nearly 1:1 and has not been over 2:1 since December 31, 1999. Current Liabilities to Net Worth Ratio: Unfavorable - A solvency ratio that indicates the amount due creditors within a year as a percentage of the net assets. According to Dun & Bradstreet,16 a business starts to have trouble when this relationship exceeds 80%. For ITC this ratio at December 31, 2003 is -78% and has never exceeded 50%. 14 15 16 Source—American Express Small Business Resources Understanding Financial Ratios Source—American Express Small Business Resources Understanding Financial Ratios Source—Dun & Bradstreet—Fourteen Key Business Ratios 25 Audit # 2004-4 Issue Date: February 28, 2005 Total Liabilities to Net Worth Ratio: Unfavorable - A solvency ratio that shows how all of the company’s debt relates to the equity or net assets. The higher this ratio, the less protection there is for creditors. ITC’s ratio is approximately –256% at December 31, 2003, net worth has never exceeded total liabilities. Fixed Assets to Net Worth: Unfavorable - A solvency ratio that shows the percentage of assets centered in fixed assets compared to total equity. According to Dun & Bradstreet,17 the higher this percentage is over 75%, the more vulnerable a concern becomes to unexpected hazards and business climate changes. Capital is frozen in the form of property and equipment and the margin for operating funds becomes too narrow to support day-to-day operations. For ITC, this ratio was -35% and was at 74% at December 31, 2000 but has never exceeded 75%. Collection Period Ratio: Unfavorable - An efficiency ratio that is helpful in analyzing the collectibility of accounts receivable, or how fast a business can increase its cash supply. For ITC, the collection period averages 61 days. Generally, where most sales are for credit, any collection period month than one-third over normal selling terms (40 for 30-day terms) is indicative of some slow-turning receivables. ITC appears to have slow-turning receivables. This may indicate that ITC may have accounts receivable that are uncollectible or that ITC grants terms in excess of 30 days. Assets to Sales Ratio: Favorable - An efficiency ratio that rates sales to the total investment that is used to generate those sales. This ratio ties in sales and the total investment that is used to generate those sales. Abnormally low percentages (above the upper quartile) can indicate overtrading, which may lead to financial difficulties if not corrected. Extremely high percentages (below the lower quartile) can be the result of overly conservative or poor sales management, indicating a more aggressive sales policy may need to be followed.18 ITC’s assets to sales ratio are 45% on December 31, 2003 and indicates no issues. Sales to Net Working Capital Ratio:Unfavorable – An efficiency ratio that measures the number of times working capital turns over annually in relation to net sales. Should be viewed in conjunction with the assets to sales ratio. ITC’s sales to working capital ratio is over extraordinarily high because it has virtually no working capital at December 31, 2003. Accounts Payable to Sales Ratio: Favorable - An efficiency ratio that measures how the company pays its suppliers in relation to the sales volume being transacted. For ITC this ratio was 2.31% as of December 31, 2003. A low percentage would indicate a healthy ratio. A high percentage indicates the firm may be using suppliers to help finance operations. Return on Sales: Unfavorable - A profitability ratio that measures profits after taxes on the year’s sales (profits earned per dollar of sales). ITC’s return on sales for the year ended December 31, 2003 was –2.98% and since 1999 has averaged –8.57%, therefore no return on sales has ever been recognized. 17 18 Source—Dun & Bradstreet—Fourteen Key Business Ratios Source—Dun & Bradstreet—Fourteen Key Business Ratios 26 Audit # 2004-4 Issue Date: February 28, 2005 Return on Assets: Unfavorable - A profitability ratio that is the key indicator of profitability according to Dun & Bradstreet.19 ITC’s return on assets for the year ended December 31, 2003 was –1.27% and the average since 1999 has been –12.87%, again showing no return. Return on Net Worth: Unfavorable - A profitability ratio that measures the ability of a company’s management to realize an adequate return on the capital invested. ITC has never provided a return on investment. 19 Source—Dun & Bradstreet—Fourteen Key Business Ratios 27 Audit # 2004-4 Issue Date: February 28, 2005 EXHIBIT 5—SALARY PROGRESSION FOR KEY PRIDE AND ITC EMPLOYEES—1999-2003 300,000 280,000 $275,573.66 $262,975.78 260,000 240,000 $238,200.71 $231,542.87 220,000 200,000 $195,987.51 180,000 $175,711.02 $170,223.50 $161,538.00 160,000 $164,230.78 $151,342.33 140,000 $141,317.48 $139,916.18 120,000 $114,995.00 $113,122.08 $144,849.43 $110,708.01 100,000 1999 2000 Davis 2001 Smith 2002 Bruels 2003 Edgemon Note 1: The amounts shown are total compensation consisting of salary and bonuses. Note 2: The 2001 salary shown for Bruels (PRIDE’s President) is annualized based on his actual salary for the period August 1, 2001 (employment date) through December 31, 2001. 28