U.S. SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
FORM 10-Q
(Mark One)
[X] Quarterly report under Section 13 or 15(d) of the Securities
Exchange Act of 1934
For the quarterly period ended June 30, 1996
-----------------------------
[ ] Transition report under Section 13 or 15(d) of the Securities
Exchange Act of 1934
For the transition period from ______________ to _____________
Commission file number 0-22600
---------------------------------------
EMPLOYEE SOLUTIONS, INC.
- --------------------------------------------------------------------------------
(Exact Name of Registrant as Specified in Its Charter)
Arizona 86-0676898
- ------------------------------- ----------------
(State or Other Jurisdiction of (I.R.S. Employer
Incorporation or Organization) identification No.)
2929 E. Camelback Road, Suite 220, Phoenix, Arizona 85016
- --------------------------------------------------------------------------------
(Address of Principal Executive Offices)
602-955-5556
- --------------------------------------------------------------------------------
(Registrant's Telephone Number, Including Area Code)
- --------------------------------------------------------------------------------
(Former Name, Former Address and Former Fiscal Year,
if Changed Since Last Report)
Indicate by check mark whether the registrant: (1) 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
--- ---
APPLICABLE ONLY TO ISSUERS INVOLVED IN
BANKRUPTCY PROCEEDINGS DURING THE
PRECEDING FIVE YEARS
Indicate by check mark whether the registrant has filed all documents
and reports required to be filed by Section 12, 13 or 15(d) of the Securities
Exchange Act of 1934 after the distribution of securities under a plan confirmed
by a court.
Yes No
--- ---
APPLICABLE ONLY TO CORPORATE ISSUERS
State the number of shares outstanding of each of the issuer's classes
of common stock, as of the latest practicable date: 30,505,754 Common Shares, no
par value, were outstanding as of August 12, 1996.
<PAGE>
EMPLOYEE SOLUTIONS, INC.
FORM 10-Q
FOR THE QUARTERLY PERIOD ENDED JUNE 30, 1996
INDEX
<TABLE>
<CAPTION>
Page
Number
------
<S> <C> <C>
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Consolidated Balance Sheets - June 30, 1996 (Unaudited) and
December 31, 1995 (Audited)............................................3
Unaudited Consolidated Statements of Operations for the
Three Months and Six Months Ended June 30, 1996 and 1995...............4
Unaudited Consolidated Statement of Changes in Stockholders'
Equity for the Six Months Ended June 30, 1996..........................5
Unaudited Consolidated Statements of Cash Flows for the
Six Months Ended June 30, 1996 and 1995...............................6
Notes to Unaudited Consolidated Financial Statements...................8
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations.................................................14
PART II. OTHER INFORMATION
Item 1. Legal Proceedings.....................................................26
Item 4. Submission of Matters to a Vote of Security Holders...................27
Item 6. Exhibits and Reports on Form 8-K......................................28
SIGNATURES..............................................................................28
</TABLE>
2
<PAGE>
EMPLOYEE SOLUTIONS, INC.
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
ASSETS
June 30, 1996 December31,1995
------------- ---------------
(Unaudited) (Audited)
<S> <C> <C>
Current Assets:
Cash and cash equivalents....................................................$ 10,717,673 $ 14,028,898
Restricted cash.............................................................. 5,000,000 2,742,380
Accounts receivable, net..................................................... 24,363,339 7,844,854
Notes receivable, including related parties................................. 475,491 107,322
Prepaid expenses and deposits................................................ 1,525,276 379,352
Deferred income taxes........................................................ 185,727 334,255
------------- --------------
Total Current Assets........................................................ 42,267,506 25,437,061
Property and equipment, net..................................................... 885,459 439,579
Other assets, net............................................................... 17,971,739 10,963,012
------------- --------------
Total Assets................................................................$ 61,124,704 $ 36,839,652
============= ==============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities:
Bank overdraft...............................................................$ 1,604,295 $ 3,751,757
Accrued salaries, wages and payroll taxes.................................... 16,064,474 6,680,862
Accrued workers' compensation and health insurance........................... 3,125,489 2,463,012
Accrued pension contributions................................................ 17,954 130,984
Accounts payable............................................................. 1,636,900 982,738
Income taxes payable......................................................... -- 2,206,978
Other accrued expenses....................................................... 2,265,034 631,554
------------- --------------
Total Current Liabilities................................................... 24,714,146 16,847,885
------------- --------------
Deferred income taxes........................................................... 43,000 48,913
------------- --------------
Commitments and Contingencies
Stockholders' Equity:
Class A convertible preferred stock, non-voting, no par value,
10,000,000 shares authorized, 0 shares in 1996 and 0 shares in 1995
issued and outstanding..................................................... -- --
Common stock, no par value, 75,000,000 shares authorized, and
30,505,754 shares issued and outstanding in 1996,
26,747,196 shares issued and 26,652,272 shares
outstanding in 1995........................................................ 26,561,941 15,937,789
Retained earnings............................................................ 9,805,617 4,336,493
Treasury stock, 0 shares of common stock in 1996 and 94,924 shares
in 1995, at cost.......................................................... -- (331,428)
------------- --------------
Total Stockholders' Equity.................................................. 36,367,558 19,942,854
------------- --------------
Total Liabilities and Stockholders' Equity..................................$ 61,124,704 $ 36,839,652
============= ==============
</TABLE>
The accompanying notes are an integral part of these
consolidated balance sheets.
3
<PAGE>
EMPLOYEE SOLUTIONS, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
<TABLE>
<CAPTION>
Three Months Ended June 30, Six Months Ended June 30,
--------------------------- -------------------------
1996 1995 1996 1995
---- ---- ---- ----
<S> <C> <C> <C> <C>
Revenues...................................................... $ 91,007,672 $ 29,158,964 $ 164,941,702 $ 57,958,847
Cost of revenues ............................................. 82,181,484 26,525,568 148,445,598 53,499,343
---------- ---------- ---------- ----------
Gross profit ................................................. 8,826,188 2,633,396 16,496,104 4,459,504
Selling, general and administrative expenses ................. 3,428,623 1,409,834 6,975,184 2,700,066
Depreciation and amortization ............................... 334,060 73,699 653,987 145,211
---------- ---------- ---------- ----------
Income from operations .............................. 5,063,505 1,149,863 8,866,933 1,614,227
---------- ---------- ---------- ----------
Other income (expenses):
Interest income ............................................ 223,054 38,446 410,044 77,557
Interest expense ........................................... (4,371) (3,546) (7,198) (5,649)
Minority interest .......................................... -- 73,100 -- 124,244
---------- ---------- ---------- ----------
218,683 108,000 402,846 196,152
---------- ---------- ---------- ----------
Income before
provision for income taxes ................................. 5,282,188 1,257,863 9,269,779 1,810,379
Income tax provision ......................................... 2,166,153 566,838 3,800,655 809,667
---------- ---------- ---------- ----------
Net income .......................................... $ 3,116,035 $ 691,025 $ 5,469,124 $ 1,000,712
========== ========== ========== ==========
Net income per common
and common equivalent shares
outstanding:
-Primary................................................... $ .10 $ .03 $ .17 $ .05
-Fully diluted............................................. $ .10 $ .03 $ .17 $ .05
========== ========== ========== ==========
Weighted average number of common
and common equivalent shares outstanding
-Primary .................................................. 32,564,993 21,101,948 32,200,621 21,101,948
-Fully diluted ............................................ 32,564,993 21,101,948 32,276,888 21,101,948
========== ========== ========== ==========
</TABLE>
The accompanying notes are an integral part of these consolidated
financial statements.
<PAGE>
EMPLOYEE SOLUTIONS, INC.
CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY
FOR THE SIX MONTHS ENDED JUNE 30, 1996
(UNAUDITED)
<TABLE>
<CAPTION>
Total
Preferred Common Retained Treasury Stockholders'
Stock Stock Earnings Stock Equity
-------- --------- -------- -------- ----------
<S> <C> <C> <C> <C> <C>
BALANCE at December 31, 1995 ...................... $ -- $ 15,937,789 $ 4,336,493 $ (331,428) $ 19,942,854
Issuance of 388,150 shares of common stock
in connection with exercise of
stock options ................................. -- 810,380 -- -- 810,380
Exercise of Warrants to 2,816,000
shares of common stock ....................... -- 6,565,000 -- -- 6,565,000
Issuance of 648,000 shares in connection with
acquisition of Employee Solutions-East, Inc.
(Note 4) ...................................... -- 3,580,200 -- -- 3,580,200
Cancellation of treasury stock .................... -- (331,428) -- 331,428 --
Net Income ........................................ -- -- 5,469,124 -- 5,469,124
-------- ------------ ------------ ------------ ------------
BALANCE at June 30, 1996 .......................... $ -- $ 26,561,941 $ 9,805,617 $ -- $ 36,367,558
======== ============ ============ ============ ============
</TABLE>
The accompanying notes are an integral part of these
consolidated financial statements.
5
<PAGE>
EMPLOYEE SOLUTIONS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
<TABLE>
<CAPTION>
SIX MONTHS ENDED JUNE 30,
1996 1995
---------- -------
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Cash received from customers............................................$ 150,938,252 $ 55,368,805
Cash paid to suppliers and employees.................................... (147,365,041) (53,500,548)
Interest received....................................................... 329,809 72,356
Interest paid........................................................... (6,125) (5,648)
Income taxes paid, net of refunds....................................... (6,065,872) (1,076,553)
------------------- ------------
Net cash used by operating activities............................ (2,168,977) 858,412
------------------- ------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of property and equipment...................................... (416,325) (114,542)
Business acquisitions................................................... (1,627,795) --
Cash invested in restricted accounts.................................... (2,357,620) (763,505)
Disbursements for loans to related parties.............................. (322,370) (49,814)
Received from collection of loans to related parties.................... 41,000 304,767
Decrease (increase) in deferred acquisition and
deferred startup costs................................................ (157,950) 49,252
------------------- ------------
Net cash used in investing activities...................... (4,841,060) (573,842)
------------------- ------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from sale of stock............................................. 7,490,827 --
Cash overdraft.......................................................... (3,751,757) --
Proceeds from paid in capital........................................... -- --
Increase in deferred offering and registration costs.................... (40,258) (21,021)
------------------- ------------
Net cash provided by (used in) financing activities................. 3,698,812 (21,021)
------------------- ------------
Net increase (decrease) in cash and cash equivalents......................... (3,311,225) 263,549
CASH AND CASH EQUIVALENTS, beginning of period............................... 14,028,898 1,947,645
------------------- ------------
CASH AND CASH EQUIVALENTS, end of period.....................................$ 10,717,673 $ 2,211,194
=================== ============
</TABLE>
The accompanying notes are an integral part of these
consolidated financial statements.
6
<PAGE>
EMPLOYEE SOLUTIONS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS--(Continued)
<TABLE>
<CAPTION>
SIX MONTHS ENDED JUNE 30,
1996 1995
---------- --------
<S> <C> <C>
RECONCILIATION OF NET INCOME
TO NET CASH PROVIDED BY OPERATING ACTIVITIES:
Net income.................................................................$ 5,469,124 $ 1,000,712
------------ -----------
ADJUSTMENTS TO RECONCILE NET
INCOME TO NET CASH USED IN OPERATING ACTIVITIES:
Depreciation and mortization .......................................... 653,987 145,211
Minority interest...................................................... -- (124,244)
Write off of deferred acquisition costs ............................... -- 45,496
Increase in accounts receivable, net .................................. (14,033,776) (2,519,199)
Increase in prepaid expenses and deposits ............................. (982,065) (6,268)
Decrease (increase) in deferred income tax assets ..................... 148,528 (231,835)
(Increase) decrease in other assets ................................... (80,388) 256
(Decrease) increase in accounts payable ............................... (687,881) 521,273
Decrease in accrued pension contributions ............................. (113,030) (20,664)
Increase in accrued salaries, wages and
payroll taxes ....................................................... 7,653,190 1,446,411
Decrease in income taxes payable ...................................... (2,375,842) (12,332)
Increase in accrued workers'
compensation and health insurance ................................... 944,405 545,667
Increase in other accrued expenses .................................... 1,246,025 81,281
Decrease in deferred income
tax liabilities ..................................................... (11,254) (13,353)
------------ -----------
(7,638,101) (142,300)
------------ -----------
Net cash (used in) provided by operating activities ..........$ (2,168,977) $ 858,412
============ ===========
</TABLE>
The accompanying notes are an integral part of these
consolidated financial statements.
7
<PAGE>
EMPLOYEE SOLUTIONS, INC.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 1996
NOTE 1: BASIS OF PRESENTATION
---------------------
The accompanying unaudited consolidated financial statements of Employee
Solutions, Inc. (together with its subsidiaries, the "Company") have been
prepared by the Company pursuant to the rules and regulations of the Securities
and Exchange Commission. Certain information and footnote disclosures normally
included in consolidated financial statements prepared in accordance with
generally accepted accounting principles have been omitted pursuant to such
rules and regulations. In the opinion of management the consolidated financial
statements include all adjustments, consisting only of normal recurring
adjustments, necessary in order to make the consolidated financial statements
not misleading. Results of operations for the six month period ended June 30,
1996 are not necessarily indicative of the results that may be expected for the
year ending December 31, 1996. For further information, refer to the
consolidated financial statements and footnotes thereto included in the
Company's Form 10-K for the year ended December 31, 1995.
NOTE 2: NET INCOME PER SHARE
--------------------
The Company used the modified treasury stock method prescribed by Accounting
Principles Board Opinion No. 15 to compute net income per share for the three
month and six month periods ended June 30, 1995 since the number of warrants and
options outstanding was in excess of 20% of common shares issued and
outstanding. The Company used the treasury stock method for the three and six
month periods ended June 30, 1996 since the number of warrants and options
outstanding was less than 20% of common shares issued and outstanding. The
computation of adjusted net income and weighted average common and common
equivalent shares used in the calculation of net income per common and common
equivalent share is as follows:
<TABLE>
<CAPTION>
Three Months Ended June 30, Six Months Ended June 30,
--------------------------- -------------------------
1996 1995 1996 1995
----------------------- ---------------------- ---------------------- ---------------------
Primary Fully Primary Fully Primary Fully Primary Fully
------- ----- ------- ----- ------- ----- ------- -----
Diluted Diluted Diluted Diluted
------- ------- ------- -------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Weighted
average
of common
shares
outstanding 30,413,227 30,413,227 21,101,948 21,101,948 30,175,511 30,175,511 21,101,948 21,101,948
Dilutive
effect of
options and
warrants
outstanding 2,151,766 2,151,766 N/A N/A 2,025,110 2,101,377 N/A N/A
---------- ---------- ---------- ---------- ---------- ---------- ---------- ----------
Weighted
average
of common
and
common
equivalent 32,564,993 32,564,993 21,101,948 21,101,948 32,200,621 32,276,888 21,101,948 21,101,948
shares ========== ========== ========== ========== ========== ========== ========== ==========
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
Three Months Ended June 30, Six Months Ended June 30,
--------------------------- -------------------------
1996 1995 1996 1995
--------------------- --------------------- ---------------------- ----------------------
Primary Fully Primary Fully Primary Fully Primary Fully
------- ----- ------- ----- ------- ----- ------- -----
Diluted Diluted Diluted Diluted
------- ------- ------- -------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Net income
$3,116,035 $3,116,035 $691,025 $691,025 $5,469,124 $5,469,124 $1,000,712 $1,000,712
Adjustment
to net
income (5,943) (5,943) -- -- (11,886) (11,886) -- --
---------- ---------- --------- --------- ---------- ---------- ---------- ----------
Adjusted
net income
for
purposes
of the
common and
common
equivalent
shares
calculation $3,110,092 $3,110,092 $ 691,025 $ 691,025 $5,457,238 $5,457,238 $1,000,712 $1,000,712
========== ========== ========= ========= ========== ========== ========== ==========
Net income
per
common and
common
equivalent
share $ .10 $ .10 $ .03 $ .03 $ .17 $ .17 $ .05 $ .05
========= ======== ========= ========= ========= ========== ========== =========
</TABLE>
As of June 30, 1996, the Company had approximately 120,000 common stock purchase
warrants and 2,858,452 stock options outstanding.
NOTE 3: REVOLVING LINE OF CREDIT
------------------------
During the second quarter of 1996, the Company entered into a three year
unsecured revolving credit facility totaling $4.0 million. The new revolving
credit facility provides for borrowings at the prime rate of interest. The
Company pays a facility fee on the unused portion of the commitment. No funds
have been borrowed under this revolving credit facility as of June 30, 1996, and
such facility was terminated on August 1, 1996. (See note 9-Subsequent Events.)
NOTE 4: ACQUISITION OF EMPLOYER SOURCES, INC.
-------------------------------------
On May 20, 1996, the Company completed the acquisition of the principal assets
of Employer Sources, Inc. (formerly known as LMS), a California based employee
leasing company with approximately 1,350 leased employees as of March 31, 1996,
for $400,000 in cash and assumed liabilities. The Company acquired Employer
Sources through Employee Solutions of California, Inc. a newly formed wholly
owned subsidiary.
Prior to the purchase, the Company provided risk management/workers'
compensation services and other management services to Employer Sources.
NOTE 5: ACQUISITION OF ASHLIN TRANSPORTATION SERVICES, INC.
---------------------------------------------------
On June 1, 1996, the Company completed the acquisition of the principal assets
of Ashlin Transportation Services, Inc. ("Ashlin"), an Indiana based employee
leasing company specializing in the transportation industry. The Company
acquired the assets of Ashlin through ESI-Midwest, Inc. ("ESIM"), a newly formed
wholly owned subsidiary.
For approximately five months prior to the purchase, the Company provided risk
management/workers' compensation coverage to Ashlin. The purchase price has been
paid in cash and assumed liabilities for a total purchase price of approximately
$1.2 million.
NOTE 6: ACQUISITION OF TEAM SERVICES
----------------------------
On June 22, 1996, the Company completed the purchase of all of the outstanding
capital stock of GCK Entertainment Services I, Inc. and Talent, Entertainment
and Media Services, Inc. (collectively, "TEAM Services"). TEAM Services is a
Burbank, California based company specializing in leasing commercial talent,
musicians and recording engineers to the music and advertising segments of the
entertainment industry. In connection with the acquisition, the Company will
assume net liabilities of approximately $750,000 which will be recorded as
goodwill and amortized over a 15 year life. The purchase price will be the sum
of the net liabilities assumed at closing plus four times (4X) total TEAM
Services' pre-tax income for the twelve month period ending June 30, 1999. The
purchase price will be paid in the form of net assumed liabilities and the
Company's unregistered common stock. The unregistered shares are entitled to
certain piggyback and demand registration rights.
Jeffery Colby, a member of the Company's Board of Directors and a principal
shareholder of TEAM Services, has served as Chief Executive Officer of TEAM
Services since 1993. Mr. Colby will remain on the Company's Board and enter into
an employment agreement with the Company pursuant to which he will provide,
among other services, certain marketing services. The purchase price payable
under the TEAM Services acquisition agreement will be increased to the extent of
designated amounts generated by Mr.
Colby under such agreement.
NOTE 7: UNAUDITED PRO FORMA FINANCIAL INFORMATION
-----------------------------------------
As discussed in Form 10-K for the year ended December 31, 1995, the Company
completed the acquisition of the principal assets of Hazar, Inc. and certain of
its subsidiaries through ESI America, Inc. ("ESI America") on October 2, 1995.
The following unaudited pro forma combined financial data give effect to the
combined historical results of operations of the Company and ESI America for the
six months ended June 30, 1995, and assumes that the acquisition had been
effective as of the beginning of the period.
The pro forma information is not indicative of the actual results which would
have occurred had the acquisition been consummated at the beginning of such
period or of future consolidated operations of the Company and accordingly, does
not reflect results that would occur from a change in management and planned
restructuring of the operations of ESI America. The pro forma financial
information is based on the purchase method of accounting and reflects
adjustments to eliminate nonrecurring general, administrative and other
expenses, to amortize the excess purchase price over the underlying value of net
assets acquired and to adjust income taxes for the pro forma adjustments.
June 30, 1995
-------------
Total revenues $120,944,000
Net loss $ (1,288,000)
Net income (loss) per common and common
equivalent share
-Primary $ (0.06)
-Fully diluted $ (0.06)
Weighted average number of common and
common equivalent shares outstanding
-Primary 21,101,948
-Fully diluted 21,101,948
NOTE 8: CONTINGENCIES
-------------
The Company has received a letter from the Arizona Department of Economic
Security indicating that the Company has been assigned a higher state
unemployment tax rate for calendar year 1994 than the Company believes it is
entitled to. In consultation with legal counsel the Company believes that based
on Arizona Revised Statutes it is entitled to the lower rate. If it was
ultimately determined that the higher rate applies, the Company would owe
$500,000 (before interest and the income tax effect) more than is reflected in
the Company's June 30, 1996 and December 31, 1995, financial statements. As of
June 30, 1996, the compounded interest totaled approximately $110,000.
The Company was named as a defendant in a lawsuit filed by M & M Building
Services, Inc. in the Superior Court of Arizona, Maricopa County, in March 1996
challenging the manner in which the Company billed plaintiff for payroll taxes.
The complaint alleges improper billing practices and other causes of action and
seeks unspecified damages. The suit purports to be brought as a class action,
although no class action certification has yet been sought. The Company intends
to defend the matter vigorously.
With the exception of the foregoing action, the Company is not a party to any
material pending legal proceedings other than ordinary routine litigation
incidental to its business that the Company believes would not have a material
adverse effect on its financial condition or results of operations.
During the quarter ended June 30, 1996, the Company received payroll tax penalty
notices from the Internal Revenue Service and various states, relating to the
acquired operations of ESI-America, Inc. (formerly Hazar) alleging certain late
payment of payroll taxes during the quarter ended March 31, 1996. The Company
also became aware that penalty notices were also received by Friday Management,
Inc. (a subsidiary of Hazar) ("FMI") alleging late payment of payroll taxes
during the quarter ended December 31, 1995. The Company acquired the assets of
FMI effective January 1, 1996 and provided limited management services to FMI
pursuant to a management agreement from October 2, 1995 to December 31, 1995.
The penalties assessed against the Company and FMI were approximately $377,000
and $390,000, respectively. The Company believes that circumstances surrounding
the tax issues are unique, and non-recurring in nature. While abatement of the
asserted penalties is being pursued vigorously, it is not possible to predict
whether the Company will be successful in abating these penalties. The Company
would be required to record these amounts as an additional expense and liability
if, at any time in the future, it became apparent that it was probable that the
Company would not prevail in this matter.
NOTE 9: SUBSEQUENT EVENTS
-----------------
Common Stock Split
On June 26, 1996, the Board of Directors authorized a two-for-one common stock
split, effected in the form of a 100% stock dividend, effective on July 26,
1996, to shareholders of record at the close of business on July 12, 1996. In
this report, all per share amounts and numbers of shares, including options and
warrants, have been restated to reflect this stock split.
Acquisition of Leaseway Personnel Corp. and Leaseway Personnel, Inc.
The Company has completed the acquisition of the principal assets of Leaseway
Personnel Corp. and Leaseway Administrative Personnel, Inc. (collectively,
"Leaseway") effective August 1, 1996 for approximately $24 million in cash, plus
deferred acquisition costs of approximately $150,000. The Company acquired the
assets of Leaseway through Logistics Personnel Corp. ("LPC") (formerly, Employee
Solutions of Florida, Inc.) a wholly owned subsidiary. LPC is an employee
leasing company providing permanent and temporary private carriage truck
drivers, as well as non-driver employees, including warehouse workers,
mechanics, dispatchers, and administrative personnel to approximately 180
clients in 41 states.
Long-term Debt
On August 1, 1996, the Company entered into a three year $35 million revolving
credit facility for the purposes of acquisition financing, working capital and
general corporate purposes. The revolving credit facility provides for various
borrowing rate options including borrowing rates based on a fixed spread of .25%
over prime or 250 basis points over the London Interbank Offered Rate (LIBOR).
The Company pays a commitment fee of 3/8% on the unused portion of the line.
Total costs incurred in obtaining this facility were approximately $400,000 and
will be amortized over the life of the facility. The principal loan covenants
are as follows: current ratio of at least 1.4 to 1; total liabilities to net
worth of not more than 2 to 1; total funded debt to earnings before taxes,
depreciation and amortization of 2 to 1. The facility includes certain other
covenants and is secured by substantially all of the Company's assets.
The Company borrowed approximately $23.5 million under the revolving credit
facility on August 1, 1996 to finance its acquisition of Leaseway.
Receivable Reimbursement
Effective January 1, 1995, the Company acquired Employment Services of Michigan,
Inc. (subsequently renamed Employee Solutions-Midwest, Inc. ("ESM")). ESM has
entered into a management agreement with Phoenix Capital Management, Inc.
("PCM"), a corporation owned by the seller of ESM, whereby PCM handles
administrative services, benefits and payroll processing for all ESM employees
for a fee generally equal to a per check charge plus a percentage of ESM's
pre-tax profits (as defined), less certain tax payments. In connection with
providing management services to ESM, PCM is involved in credit decisions with
regard to ESM clients. In this regard, PCM has agreed to reimburse ESM under
certain circumstances should collectability issues arise with regard to
designated ESM receivables. Pursuant to this arrangement, PCM reimbursed ESM in
the amount of approximately $568,330 in connection with a receivable due from a
former ESM client which recently commenced bankruptcy proceedings.
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
-------------------------------------------------
CONDITION AND RESULTS OF OPERATIONS
-----------------------------------
The following discussion should be read in conjunction with, and is
qualified in its entirety by, the Company's Consolidated Financial Statements
and the Notes thereto appearing elsewhere herein and in the Company's Report on
Form 10-K for the year ended December 31, 1995. Historical results are not
necessarily indicative of trends in operating results for any future period.
Except for the historical information contained herein, the discussion in
this Form 10-Q contains or may contain forward-looking statements that involve
risks and uncertainties. The Company's actual results could differ materially
from those discussed here. Factors that could cause or contribute to such
differences include, but are not limited to, those discussed in "Item 1 --
Business" and "Item 7--Management's Discussion and Analysis of Financial
Condition and Results of Operations" of the Company's Form 10-K for the year
ended December 31, 1995 as well as those factors discussed elsewhere herein or
in any document incorporated herein by reference.
Results of Operations--Three Months Ended June 30, 1996 Compared to Three Months
Ended June 30, 1995.
<TABLE>
<CAPTION>
Percent
1996 Change 1995
---- ------ ----
<S> <C> <C> <C>
Revenues $91,007,672 212% $29,158,964
Cost of revenues 82,181,484 210% 26,525,568
Gross profit 8,826,188 235% 2,633,396
Selling, general and administrative 3,428,623 143% 1,409,834
Depreciation and amortization 334,060 353% 73,699
Interest income 223,054 480% 38,446
Net income 3,116,035 351% 691,025
</TABLE>
Net income for the three months ended June 30, 1996 was $3,116,035 or $0.10
per fully diluted share, reflecting significant growth from second quarter 1995
net income of $691,025 or $0.03 per fully diluted share. Revenues of $91,007,672
for the three months ended June 30, 1996 were 212% higher than the same period
in 1995. The growth results from the integration of several acquisitions
including Hazar, Inc. and certain of its subsidiaries ("Hazar"), Pokagon Office
Services, Inc., Employer Sources, Inc., Ashlin Transportation Services, Inc.,
and TEAM Services; the growth in the Company's risk management/workers'
compensation program; the success of direct sales and marketing efforts of
Employee Solutions-East, Inc. ("ESEI"), and the efficient administration of
existing business.
Revenues
Revenues increased from $29,158,964 for the three months ended June 30, 1995
to $91,007,672 for the six months ended June 30, 1996, a 212% increase. The
increase in revenues was partially due to sales from the Company's expanded
sales force through ESEI. Acquisitions occurring after the second quarter ended
June 30, 1995 accounted for revenues of approximately $10.0 million in the
quarter ended June 30, 1996. The number of leased employees increased from
approximately 5,200 at June 30, 1995 to approximately 24,300 at June 30, 1996.
In 1995, the Company commenced placing risk management/workers' compensation
services to clients which are not employee-leasing clients of the Company. As of
June 30, 1996, the Company provided risk management/workers' compensation
services to approximately 15,000 non-leased employees compared to 8,000 at June
30, 1995 (most of which were Hazar employees). The significant components of
revenues are payments received from customers for gross salaries and wages paid
to leased employees and the Company's service fee which includes, but is not
limited to, related payroll charges, risk management/workers' compensation
services, health care benefits, and retirement benefits, as well as payments
received from stand-alone risk management/workers' compensation clients.
Cost of revenues
Cost of revenues, which primarily includes salaries and wages paid to
leased employees, related payroll taxes, health care and workers' compensation
insurance costs and retirement benefit costs, increased 210% from $26,525,568 in
the three months ended June 30, 1995 to $82,181,484 in the three months ended
June 30, 1996. This increase is primarily due to the increase in the Company's
business as explained in the paragraph above. Workers' compensation costs
decreased on a per leased employee basis during the three months ended June 30,
1996 compared to 1995 due to the Company's ability to execute effectively its
risk management programs which include on-site safety programs, active claims
management and efficient execution of claims processing. In addition, the risk
management/workers' compensation program utilized the Company's captive offshore
insurance subsidiary, Camelback Insurance, Ltd. ("Camelback") for a full quarter
in 1996 versus only one month in the quarter ended June 30, 1995, as the captive
was not activated until May 1995.
Gross profit
The Company's gross profit margin increased from 9.0% in the three
months ended June 30, 1995 to 9.7% in the three months ended June 30, 1996. This
increase primarily was attributable to an increase in risk management/workers'
compensation services related to non-leased employees. Gross profit margin on
revenues derived from risk management/workers' compensation services provided to
non-leased employees tends to be significantly higher than gross profit margin
on revenues derived from the Company's employee leasing clients because the
gross profit margin calculation with respect to employee leasing clients
includes significant (and substantially offsetting) revenue and expense items
relating to payroll and payroll-related costs associated with the leased
employees. The margin is affected in significant part by the mix of revenues
derived from employee leasing clients and clients for which the Company provides
only risk management/workers' compensation services. The level of gross profit
margin reported for the three months ended June 30, 1996 may not be sustainable
in future periods.
Selling, general and administrative
Selling, general and administrative expenses increased by $2,018,789 or
143% from $1,409,834 for the three months ended June 30, 1995 to $3,428,623 for
the three months ended June 30, 1996. As a percent of gross profit, selling,
general and administrative expenses decreased from 54% to 39% at June 30, 1995
and 1996, respectively. Factors contributing to the increase in selling, general
and administrative expenses in the second quarter 1996 over 1995 are the
integration of the operations of various acquisitions including, the acquisition
by the Company of the remaining 99% interest in ESEI effective January 1, 1996,
offset by an increase from 55 corporate employees at June 30, 1995 to
approximately 150 at June 30, 1996, resulting in a significant increase in
personnel costs, and the expansion of the Company's office space. These factors
which caused increases in selling, general and administrative expenses were
partially mitigated by improved systems utilization and economies of scale
achieved within the Company's operations including consolidation of acquired
companies' administration. The Company's general liability insurance costs have
increased due in part to the added corporate staff, and increased costs for
directors and officers liability insurance. Commission expenses increased in the
three month period ended June 30, 1996 compared to 1995 given the increase in
revenues discussed above. Selling, general and administrative expenses are
expected to continue to increase to meet the needs of new business. The most
extensive growth in selling, general and administrative expenses has been in the
area of risk management/workers' compensation services. This trend is expected
to continue into the foreseeable future.
Depreciation and amortization
Depreciation and amortization represented depreciation of property and
equipment and amortization of organizational costs, customer lists and goodwill
in the three months ended June 30, 1996 and 1995. The increase was due primarily
to depreciation of new phone and computer systems and goodwill amortization
resulting from acquisitions, with Hazar being the most significant.
Interest income
Interest income increased from $38,446 for the three months ended June
30, 1995 to $233,054 for the three months ended June 30, 1996, primarily due to
interest earned on both the restricted cash held for the future payment of
workers' compensation claims at Camelback and cash held at the corporate level
raised through the exercise of common stock purchase warrants and through
operations. The Company anticipates its interest expense will significantly
increase in future periods due to amounts borrowed under its new revolving
credit facility. See, "Liquidity and Capital Resources."
Effective tax rate
The effective tax rate for the year 1996 is estimated to be 41.0%
compared with 42.6% for 1995. The Company's estimated effective tax rate for
financial reporting purposes for 1996 is based on estimates of the following
items that are not deductible for tax purposes:(a) amortization of certain
goodwill, and (b) one-half of the per diem allowance relating to meals paid to
truck drivers. The tax rate used in each quarter is an estimate of the Company's
effective tax rate for the calendar year. The estimated decrease in the
effective tax rate in 1996 over 1995 results from expected decreases in the
proportion of non-deductible goodwill to income before taxes, and through
efforts by the Company to relieve itself of the tax burden of per diem
allowances.
Results of Operations -- Six Months Ended June 30, 1996 Compared With the Six
Months Ended June 30, 1995
Revenues increased from $57,958,847 in 1995 to $164,941,702 in 1996.
The increase in revenues was primarily due to the increased number of leased
employees, the acquisition of various companies as described above and the
revenue generated from non-leasing clients which the Company provides risk
management/workers' compensation services to their employees.
Cost of revenues increased from $53,499,343 in 1995 to $148,445,598 in
1996. This increase was primarily due to the factors described in the paragraph
above.
The Company's gross profit margin increased from 7.7% in the six months
ended June 30, 1995 to 10.0% in the six months ended June 30, 1996. This
increase was attributable to the growth in the Company's risk
management/workers' compensation program, slightly offset by the Company's
higher Arizona unemployment tax rate. The level of gross profit margin reported
for the six months ended June 30, 1996 may not be sustainable in future periods.
The margin is affected in significant part by the mix of revenues derived from
employee leasing clients and clients for which the Company provides only risk
management/workers' compensation services.
General and administrative expenses increased by $4,275,118 from
$2,700,066 in 1995 to $6,975,184 in 1996. The increase is due to the
acquisitions mentioned above and the reasons enumerated in the sections above
comparing the quarters ended June 30, 1995 and 1996.
Depreciation and amortization represented depreciation of property and
equipment and amortization of organizational costs, customer lists and goodwill
in the six months ended June 30, 1996 and 1995. The increase was due primarily
to depreciation of new phone and new computer systems and goodwill amortization
resulting from acquisitions, with Hazar being the most significant.
Liquidity and Capital Resources
The Company defines liquidity as the ability to mobilize cash. The
Company's primary sources of cash have been from operations and financing
activities. In the six month periods ended June 30, 1996 and 1995, cash provided
by (used in) operating activities was $(2,168,977) and $858,412, respectively.
Operating cash flows are derived from customers for leasing services rendered by
the Company and for risk management/workers' compensation services provided to
non-leased employees. Payments from leasing customers typically are received on
or within a few days of the date on which payroll checks are delivered to
customers, and cover the cost of the payroll, payroll taxes, insurance, other
benefit costs and the Company's administration fee. Risk management/workers'
compensation services are billed in accordance with individual policies. The
revenues of risk management/workers' compensation services are expected to cover
the costs of insured losses and selling, general and administrative expenses
related to these programs, though no assurance of such can be provided. Certain
employee leasing clients, primarily those of Team Services, are extended credit
terms which is customary for their market segment. Also, as the Company enters
into new market segments, as with Team Services and Leaseway, working capital
needs are expected to increase because of customary credit terms extended to
customers.
In the six month periods ended June 30, 1996 and 1995, cash provided by
(used in) financing activities was $3,698,812 and $(21,021), respectively. Cash
flows from financing activities during the six months ended June 30, 1996
resulted primarily from the sale of the Company's Common Stock upon exercise of
warrants and options offset by cash used to fund bank overdrafts of acquired
companies. Cash raised from financing activities will be directed by management
to meet the increasing reserve and capital requirements of Camelback, to finance
future acquisitions subject to identification of suitable candidates, and for
general corporate purposes.
At June 30, 1996 and December 31, 1995, the Company had cash and cash
equivalents of $10,717,673 and $14,028,898, respectively. Cash and cash
equivalents are invested in high investment grade instruments with maturities of
less than 90 days. Certain amounts of restricted cash (see below) may have
maturities beyond 90 days but are highly liquid. The Company also maintains cash
reserves at its captive insurance company, Camelback Insurance, Ltd.
("Camelback"), as required by Reliance (see below for further discussion of
Reliance). At June 30, 1996 and December 31, 1995, in addition to the above
cash, approximately $5.0 million and $2.7 million were on deposit at Camelback
which was held in trust as restricted cash. At June 30, 1996 and December 31,
1995, the Company had working capital of $17,534,360 and $8,589,176,
respectively.
Management expects that 1996 capital expenditures will exceed those
incurred in 1995 to meet the continued technological needs of the Company's
growing base of both leased and non-leased employees.
The Company operates a captive offshore insurance company, Camelback
Insurance, Ltd. ("Camelback"), chartered in Bermuda. Effective June 1, 1995, the
Company began conducting substantially all of its risk management/workers'
compensation services through Camelback. Camelback was established to provide
the Company with the opportunity to enhance profitability of its risk
management/workers' compensation program through greater control of the risk
management process. Under Bermuda law, Camelback must maintain statutory capital
and surplus in an amount equal to at least 20% of the net premiums written
through the Company's fronting arrangements, provided that the percentage
requirement is reduced to 10% at such time as annualized premium volume reaches
$6,000,000. Bermuda law also regulates the circumstances under which Camelback
would be permitted to loan funds to its parent company. In the future, these
factors may limit the ability of the Company to execute its planned growth
strategy and may limit the ability of Camelback to transfer funds to its parent
company (whether via dividend or otherwise).
The Company entered into an arrangement with Reliance National
Indemnity in 1994. Under the Reliance program, policies are issued which provide
first dollar workers' compensation coverage to the Company, its subsidiaries and
the clients for which the Company is responsible to provide workers'
compensation insurance coverage. While the insurance policies provide first
dollar coverage, the Company has entered into agreements with Reliance under
which Camelback is responsible for the first $250,000 of each workers'
compensation occurrence with no aggregate to limit its liability. On September
19, 1995, the Company executed a Guarantee and Indemnification to Reliance
National Risk Specialists, a division of Reliance Insurance Company, which
guarantees substantially all of the obligations of Camelback to Reliance.
Individual workers' compensation claims in excess of $250,000 and up to the
statutory limits of the states where the Company operates are the responsibility
of Reliance. Employers liability coverage is provided under the Reliance program
with a limit of $1,000,000. The Company also carries umbrella coverage with a
limit of $25,000,000 that includes insurance coverage for employers liability.
While the retention of the first $250,000 of individual workers' compensation
claims and the capital requirements resulting from the establishment of a
captive insurance subsidiary are intended to enhance profitability, these
actions increase the Company's exposure to risk from workers' compensation
claims. To reduce the Company's exposure to certain types of claims that would
fall into the $250,000 retention, effective March 29, 1995, the Company secured
Accidental Death & Dismemberment insurance from the Federal Insurance Company
(Chubb) with a limit of $250,000 for certain categories of serious claims.
The Company's arrangements with Reliance require it to make various
payments to Reliance throughout the term of the arrangements. The payments
include funds for taxes, fees and other expenses, plus funds set aside to pay
claims (including expected claims for the life of the policy period). In April,
1996, the Company sent approximately $9.0 million in funds to Reliance of which
approximately $2.5 million has been ceded to Camelback and placed into the trust
account for payment of future claims. Reliance will cede the remaining funds to
Camelback, net of certain administrative fees, which will remain unrestricted
and available to the Company for use in the ordinary course. The increase in
amount of funds due Camelback is a direct result of the Company's expanded
leasing programs and increased risk management/workers' compensation programs to
non-leased employees. Amounts payable to Reliance are subject to adjustment
(potentially in materially adverse amounts) depending upon claims experience,
numbers of employees and individual state taxes and assessments.
Assuming continued growth of the Company's leasing services business
and risk management/workers' compensation services program, the Company
anticipates that it will be required under its arrangements with Reliance to set
aside increasing amounts of funds for payment of claims and related
administrative costs should its arrangements with Reliance be renewed.
In June, 1996, the Company entered into a three year unsecured $4.0
million revolving line of credit for working capital and general corporate
purposes with interest at prime rate. No funds have been borrowed under this
line. Except for the above line of credit, as of June 30, 1996, the Company did
not have any other outstanding loans or lines of credit.
On August 1, 1996, the Company entered into a three year $35 million
revolving credit facility for the purposes of acquisition financing, working
capital and other general corporate purposes. The revolving credit facility
provides for various borrowing rate options including borrowing rates based on a
fixed spread of .25% over prime or 250 basis points over the London Interbank
Offered Rate (LIBOR). The Company pays a commitment fee of 3/8% on the unused
portion of the line. Total costs incurred in obtaining this facility were
approximately $400,000 and will be amortized over the life of the facility. The
principal loan covenants are as follows: current ratio of at least 1.4 to 1;
total liabilities to net worth of not more than 2 to 1, and total funded debt to
earnings before taxes, depreciation and amortization of not more than 2 to 1.
The facility includes certain other covenants and is secured by substantially
all of the Company's assets.
The Company borrowed approximately $23.5 million under the revolving
credit facility on August 1, 1996 for the acquisition of Leaseway.
On October 2, 1995 the Company completed the acquisition of the
principal assets of Hazar for approximately $7.0 million plus acquisition costs
of approximately $480,000, payable in cash and by the assumption of certain
liabilities. The Company acquired Hazar through ESI America, Inc. ("ESI
America") its newly formed wholly owned subsidiary. Until fully paid, the cash
portion of the purchase price is payable on an ongoing basis from the operating
cash flow derived from the acquired assets, with a final payment due 18 months
after closing if the purchase price exceeds the sum of the cash flow payments
and assumed liabilities. Hazar was a staff leasing company which, together with
some of its subsidiaries, has been operating under the protection of the federal
bankruptcy laws. Certain of the acquired assets (located primarily in
Massachusetts) were subject to certain tax liens at the time of closing. The
Company has obtained a discharge of such liens conditioned upon its compliance
with the Hazar purchase agreement.
On June 1, 1996, the Company completed its acquisition of the principal
assets of Ashlin Transportation Services, Inc. ("Ashlin"), an Indiana based
employee leasing company specializing in the transportation industry. The
Company acquired the assets of Ashlin through ESI-Midwest, Inc. ("ESIM"), a
newly formed wholly owned subsidiary.
For approximately five months prior to the purchase, the Company
provided risk management/workers' compensation coverage to Ashlin. The purchase
price has been paid in cash and forgiveness of certain obligations of Ashlin to
the Company for a total purchase price of approximately $1.2 million plus
deferred acquisition costs.
On May 20, 1996, the Company completed the acquisition of the principal
assets of Employer Sources, Inc. (formerly known as LMS), a California based
employee leasing company with approximately 1,350 leased employees as of March
31, 1996, and current expected annualized revenue of approximately $20.0 million
for $400,000 in cash and assumed liabilities.
On June 22, 1996, the Company completed the purchase of all of the
outstanding capital stock of GCK Entertainment Services I, Inc. and Talent,
Entertainment and Media Services, Inc. (collectively, "TEAM Services"). Team
Services is a Burbank, California based company specializing in leasing
commercial talent, musicians and recording engineers to the music and
advertising segments of the entertainment industry. In connection with the
acquisition, the Company will assume net liabilities of approximately $750,000
which will be recorded as goodwill and amortized over a 15 year life. The
purchase price will be the sum of the net liabilities assumed at closing plus
four times (4X) total TEAM Services' pre-tax income for the twelve month period
ending June 30, 1999. The purchase price will be paid in the form of net assumed
liabilities and the Company's unregistered common stock. The unregistered shares
will contain certain piggyback and demand registration rights.
Jeffery Colby, a member of the Company's Board of Directors and a
principal shareholder of TEAM Services, has served as Chief Executive Officer of
TEAM Services since 1993. Mr. Colby will remain on the Company's Board and enter
into an employment agreement with the Company pursuant to which he will provide,
among other services, certain marketing services. The purchase price payable
under the TEAM Services acquisition agreement will be increased to the extent of
designated amounts generated by Mr.
Colby under such agreement.
Management believes that cash generated from ongoing operations, the
funds received from recent warrant exercises, and cash available from the
Company's line of credit described above will satisfy the anticipated cash
requirements of the Company's current operations over the next 12 months, though
there can be no assurance that this will be the case. The Company's ability to
continue funding its planned operations beyond the next 12 months is dependent
upon its ability to generate sufficient cash flow to meet its obligations on a
timely basis, or to obtain additional funds through equity or debt financing, or
from other sources of financing, as may be required.
Outlook: Issues and Risks
The Company believes that future growth opportunities in revenues and
profits remain available. However, the following issues and risks, among others
(including those discussed elsewhere herein), should also be considered in
evaluating its outlook.
Management of Rapid Growth. The Company's success will, in part, be
dependent upon its ability to manage growth effectively. Since its formation,
the Company has experienced rapid growth, which potentially places strains on
the Company's management and personnel resources and systems. As part of its
business strategy, the Company intends to pursue the continuation of this growth
through means such as further development of its sales and marketing
capabilities and acquisitions. The Company is unable to predict whether or when
any prospective acquisition candidate will become available or the likelihood
that any acquisition will be completed. The Company competes for acquisition and
expansion opportunities with many entities which may have substantially greater
resources. There can be no assurance that the Company will be able to identify
suitable acquisition candidates, complete acquisitions, integrate acquired
businesses into its operations, or expand into new markets. Once integrated,
acquisitions may not achieve comparable levels of revenues, profitability or
productivity as the existing businesses of the Company or otherwise perform as
expected.
A substantial portion of the Company's historical and anticipated
growth is attributable to its risk management/workers' compensation insurance
services program. The potential risks associated with rapid growth in this area
include lack of experience relating to new geographic markets and industries
served, lack of experienced and trained personnel, and the need to upgrade
operating systems.
While management believes that significant growth can be achieved in
the future, no assurance can be made that historical growth rates are
sustainable. The Company recently established sales programs including a joint
venture with a national insurance wholesaler targeted at potential clients
through which it would provide risk management/workers' compensation services to
non-leased employees, though there can be no assurance as to the rate at which
such clients will be added. The growth of the program currently is substantially
dependent upon the efforts of the wholesaler, and the prospects for the program
will be materially adversely affected if the wholesaler's participation is
ineffective or withdrawn. Part of the Company's strategy is to convert new risk
management/workers' compensation services clients into employee leasing clients
when appropriate. No assurance can be made as to the potential success of this
strategy.
Dependence on Reliance. The Company believes that its risk
management/workers' compensation services program has been and will continue to
be the key competitive factor in its growth and profitability. The Company's
risk management/workers' compensation services program is being conducted in
coordination with Reliance. The Company and Reliance are continuously
restructuring certain terms of the program, including issues relating to the
Company's cash flow requirements under the program. While the Company does not
anticipate that it will be materially adversely affected by the outcome of the
negotiations with respect to these points, there can be no assurance that this
will be the case. The Company would be materially adversely affected by a
termination of its arrangements with Reliance or by a failure to finalize the
current negotiations successfully, or by a failure to accomplish a renewal of
its relationship with Reliance on satisfactory terms upon expiration of the
current program in May 1996.
Adequacy of Loss Reserves. Under its workers' compensation arrangements
with Reliance, the Company is responsible for the first $250,000 of each
workers' compensation claim and/or occurrence with no aggregate to limit the
Company's liability. Under its health insurance arrangements with Nationwide
Life Insurance Company, and John Alden Life Insurance Company ("Alden") the
Company is responsible for the first $100,000 and $75,000 per covered individual
per year, respectively. The Company's aggregate liability limit is based upon a
formula tied to anticipated claims. The reserves for losses and loss adjustment
expenses established by the Company with respect to its workers' compensation
and health insurance programs are estimates of amounts needed to pay reported
and unreported claims and related loss adjustment expenses based on facts and
circumstances then known, including industry data and historical experience.
However, the establishment of appropriate reserves is an inherently uncertain
process, and there can be no assurance that the Company's ultimate liability
will not materially exceed its loss and loss adjustment expense reserves. This
uncertainty is compounded in the Company's case by its rapid growth and limited
experience. If the Company's reserves should be inadequate, the Company will be
required to increase reserves or corresponding loss payments with a
corresponding reduction in the Company's net income in the period in which the
deficiency is identified. Losses in any particular period may be severe.
Fluctuations in Quarterly Operating Results. The Company's revenues
have generally increased on a quarter to quarter basis, though there can be no
assurance this trend can be maintained. Leasing revenues in the fourth quarter
of each year include the effects of bonus payrolls of leased employees, which
are higher in December of each year. Gross profit margin relating to leasing
revenues generally improves from quarter to quarter within a year, with the
first quarter generally the least favorable and the fourth quarter the most
favorable. Employment related taxes are based on the cumulative earnings of
individual employees up to a specified wage level. Therefore, these expenses
tend to decline over the course of the year. Since the Company's revenues for an
individual client are generally earned and collected at a relatively constant
rate throughout each year, payment of such unemployment tax obligations has a
more significant impact on the Company's working capital and results of
operations during the first three months of each year. Other factors affecting
the primary components of direct cost have enhanced or mitigated this tendency.
Examples of these factors include the effects of trends in medical and workers'
compensation claims, adjustments to benefit plans, and other factors. See
"Adequacy of Loss Reserves," above.
The Company's gross profit margin percentage is also materially
affected by the mix of revenues attributable to employee leasing clients and
clients to which the Company provides risk management/workers' compensation
services, and the mix of such business if subject to variation from quarter to
quarter. Gross profit margin percentage on revenues derived from risk
management/workers' compensation services provided to non-leased employees tends
to be significantly higher than gross profit margin percentage on revenues
derived from the Company's employee-leasing clients because the gross profit
margin percentage calculation with respect to employee leasing clients includes
significant (and substantially offsetting) revenue and expense items relating to
payroll and payroll-related costs associated with the leased employees.
Quarterly results are also subject to fluctuation depending upon such factors as
the timing of acquisitions, new contracts and contract terminations.
Government Regulation. The Company is regulated by numerous federal
laws relating to labor, tax and employment matters. Generally, these laws
prohibit race, age, sex, disability and religious discrimination, mandate safety
regulations in the workplace, set minimum wage rates and regulate employee
benefits. Because many of these laws were enacted prior to the development of
non-traditional employment relationships, such as employee leasing services,
many of these laws do not specifically address the obligations and
responsibilities of non-traditional employers. As a result, interpretive issues
concerning the definition of the term "employer" in various federal laws have
arisen pertaining to the employment relationship. Unfavorable resolution of
these issues could have a material adverse effect on the Company's results of
operations or financial condition. Compliance with these laws and regulations is
time consuming and expensive. The Company's standard form of agreement provides
that the client company is responsible for compliance with employment and
employment-related laws and regulations, and that the parties are obligated to
indemnify each other against breaches of the agreement. However, some legal
uncertainty exists with respect to the potential scope of the Company's
liability in the event of violations by its clients of employment,
discrimination and other laws.
The IRS has formed a Market Segment Study Group to examine whether
professional employment organizations, including employee-leasing firms such as
the Company, are the employers of leased employees under the Code provisions
applicable to employee benefit plans and consequently are able to offer to
leased employees benefit plans that qualify for favorable tax treatment. The
Market Segment Study Group is also examining whether client company owners are
employees of professional employment organizations under Code provisions
applicable to employee benefit plans. The loss of tax-qualified status for
401(k) or various other benefit plans maintained by the Company could materially
adversely affect the Company.
The Company is subject to regulation by local and state agencies
pertaining to a wide variety of labor related laws. As is the case with federal
regulations discussed above, many of these regulations were developed prior to
the emergence of the employee leasing industry and do not specifically address
non-traditional employers. While many states do not explicitly regulate employee
leasing companies, 15 states have passed laws that have licensing or
registration requirements and at least four states are considering such
regulation. Such laws vary from state to state but generally provide for
monitoring the fiscal responsibility of employee-leasing firms. There can be no
assurance that the Company will be able to satisfy licensing requirements or
other applicable regulations of any particular state from time to time.
Government Regulation Relating to Workers' Compensation Program.
Camelback is subject to the insurance laws and regulations of Bermuda, which
generally are designed to protect the interests of policyholders, as opposed to
the interests of shareholders. Such laws and regulations, among other things,
relate to capital and surplus levels, levels of dividends payable by
subsidiaries to their parent companies, financial disclosure, reserve
requirements, investment parameters and premium rates. In general, the
regulatory authorities in Bermuda have broad administrative authority over
Bermuda-domiciled insurers. Among other requirements and limitations, Bermuda
law requires that Camelback must maintain statutory capital and surplus in an
amount equal to at least 20% of the net premiums written through the Company's
fronting arrangements, provided that the percentage requirement is reduced to
10% at such time as premium volume reaches at least $6 million. The Company is
subject to additional requirements pursuant to its arrangements with Reliance.
See "Management's Discussion and Analysis of Financial Condition and Results of
Operations--Liquidity and Capital Resources." Bermuda also places certain
limitations upon the transfer of statutory capital and surplus from Camelback to
its parent company (whether via dividend or otherwise), and regulates the
circumstances under which Camelback is permitted to loan funds to its parent
company.
The Company's risk management/workers' compensation services program is
conducted via "fronting" arrangements with Reliance. The National Association of
Insurance Commissioners ("NAIC") recently adopted a model act concerning
"fronting" arrangements. No determination can be made as to whether, or in what
form, such act may ultimately be adopted by any state. The model act requires
reporting and prior approval of reinsurance transactions relating to these
arrangements, and limits the amount of premiums that can be written under
certain circumstances. At this stage, the Company is unable to predict whether
the model act will affect its relationships with Reliance.
State regulation requires licensing of any individual or entity
soliciting the sale of workers' compensation insurance within that state.
Licenses may be residential or non-residential and for both individuals and
entities. The Company has formed ESI Risk Management Agency, Inc. ("RMA") in
1995, to address state regulation and licensing issues and act as the Company's
sales and marketing arm for stand-alone risk management/workers' compensation
services. Although RMA is not required to be licensed in any state since it is
not directly soliciting the sale of workers' compensation insurance, RMA has
voluntarily undertaken to become licensed in all 50 states and the District of
Columbia. Currently, RMA is applying for and has received some state licenses.
Health Care Reform Proposals. Various proposals for national health
care reform have been under discussion in recent years, including proposals to
extend mandatory health insurance benefits to virtually all classes of
employees. Certain reform proposals have called for the inclusion of workers'
compensation coverage in the reform package. While the Company is unable to
predict whether or in what form health care reform will be enacted, aspects of
such reform, if enacted, may have an adverse effect upon the Company's medical
and workers' compensation insurance programs.
Legal Uncertainties. There are many legal uncertainties about employee
leasing, such as the extent of the leasing company's liability for violations of
employment and discrimination laws. The Company may be subject to liability for
violations of these or other laws even if it does not participate in such
violations. The Company's form of client service agreement establishes the
contractual division of responsibilities between the Company and its clients for
various personnel management matters, including compliance with and liability
under various governmental regulations. However, because the Company acts as a
co-employer, the Company may be subject to liability for violations of these or
other laws despite these contractual provisions and even if it does not
participate in such violations. Although the client generally is required to
indemnify the Company for any liability attributable to the conduct of the
client, the Company may not be able to collect on such a contractual
indemnification claim and thus may be responsible for satisfying such
liabilities. In addition, employees of the client may be deemed to be agents of
the Company, subjecting the Company to liability for the actions of such
employees.
Economic Uncertainties. State unemployment taxes and workers'
compensation expense are, in part, determined by the Company's claims
experience. Inflationary pressures on health care costs have been significant in
the last several years. Claims experience also greatly impacts the Company's
health insurance rates and claims cost from year to year. Should the Company
experience a large increase in claims activity for unemployment, workers'
compensation and/or health care, then costs in these areas would increase.
Increased claims under partially self-insured and large deductible plans would
immediately impact negatively on the Company's earnings, while such increases in
fully-insured plans would raise the cost of such insurance at renewal. The
Company would then have to determine how much of such increases to pass on to
subscribers and leased employees. The Company may then have difficulty competing
with the leasing companies that offer lower rates to clients. The Company has
obtained accidental death and dismemberment insurance in an amount up to
$250,000 per claim to limit its exposure to certain categories of serious
claims.
The Company has received a letter from The Arizona Department of
Economic Security indicating that the Company has been assigned a higher state
unemployment tax rate for the year ended December 31, 1994 than the Company
believes it is entitled to. In consultation with legal counsel the Company
believes that based on Arizona Revised Statutes it is entitled to the lower
rate. The Company recorded expenses in 1994 based on the lower rate. If it were
ultimately determined that the higher rate applies, the Company would owe
approximately $500,000 (before interest) more than is reflected in the Company's
March 31, 1996 financial statements. As of March 31, 1996, the compounded
interest on such amount totaled approximately $95,000. The Company would be
required to record these amounts as an additional expense and liability if, at
any time in the future, it became apparent that it was probable that the Company
would not prevail in this matter.
During the quarter ended June 30, 1996, the Company received payroll
tax penalty notices from the Internal Revenue Service and various states,
relating to the acquired operations of ESI-America, Inc. (formerly Hazar)
alleging certain late payment of payroll taxes during the quarter ended March
31, 1996. The Company also became aware that penalty notices were also received
by Friday Management, Inc. (a subsidiary of Hazar) ("FMI") alleging late payment
of payroll taxes during the quarter ended December 31, 1995. The Company
acquired the assets of FMI effective January 1, 1996 and provided limited
management services to FMI pursuant to a management agreement from October 2,
1995 to December 31, 1995. The penalties assessed against the Company and FMI
were approximately $377,000 and $390,000, respectively. The Company believes
that circumstances surrounding the tax issues are unique, and non-recurring in
nature. While abatement of the asserted penalties is being pursued vigorously,
it is not possible to predict whether the Company will be successful in abating
these penalties. The Company would be required to record these amounts as an
additional expense and liability if, at any time in the future, it became
apparent that it was probable that the Company would not prevail in this matter.
Credit Risks. The Company conducts a limited credit investigation bases
on the facts of each case prior to accepting most new clients and thus may
encounter collection problems which would adversely affect its cash flow. The
nature of the Company's business is such that a small number of client credit
failures could have an adverse effect on its business and financial condition.
Inflation. Fees charged to the Company's clients under the Company's
workers' compensation insurance program and partially self-insured medical
insurance program are established before the amounts of losses and loss
adjustment expenses, or the extent to which inflation may affect such amounts,
are known. While the Company attempts to anticipate the potential impact of
inflation in establishing its fees and reserves, actual inflation may be greater
than anticipated.
OTHER INFORMATION - PART II
Item 1. Legal Proceedings
- -------------------------
Information is incorporated herein by reference from the Company's
report of Form 10-Q for the period ended March 31, 1996.
<PAGE>
Item 4. Submission of Matters to a Vote of Security Holders
- -----------------------------------------------------------
(a) The registrant held its Annual Meeting of Shareholders on June 26,
1996.
(b) At the Annual Meeting of Shareholders, the Shareholders elected
five directors, Marvin D. Brody, Harvey A. Belfer, Edward L. Cain, Jr., Robert
L. Mueller and Jeffery A. Colby. With respect to the election of directors, the
following votes were cast for, withhold authority and against each of the
following directors:
Withhold
For Authority Against
--- --------- -------
Marvin D. Brody 12,734,135 531,941 0
Harvey A. Belfer 12,734,286 531,790 0
Edward L. Cain, Jr. 12,733,940 532,136 0
Robert L. Mueller 12,722,987 543,089 0
Jeffery A. Colby 12,735,445 530,631 0
(c) At the Annual Meeting of Shareholders, the Shareholders also voted
on the following matters, with the following results and the following votes
cast for, against, abstain and not voted.
(i) The shareholders approved a proposal to amend the
Company's 1995 Stock Option Plan to increase the number of shares of Common
Stock available for grant thereunder by 750,000 shares. The number of votes cast
for, against, abstain and not voted were: 9,124,599; 3,463,643; 31,922; and
645,912.
(ii) The shareholders approved a proposal to amend the
Company's 1995 Stock Option Plan to reduce the size and change the timing of
automatic formula grants awarded to nonemployee directors. The number of votes
cast for, against, abstain and not voted were: 12,164,615; 172,807; 33,341; and
895,313.
(iii) The shareholders approved a proposal to amend the
Articles of Incorporation of the Company (the "Articles") to increase the
authorized number of shares of Common Stock from 20,000,000 shares to 75,000,000
shares. The number of votes cast for, against, abstain and not voted were:
10,140,395; 2,304,632; 26,657; and 794,392.
(iv) The shareholders approved a proposal to amend the
Articles to increase the maximum number of members of the Board of Directors
from seven to nine directors, the exact number of directors to be determined
from time to time by resolution adopted by the Board of Directors. The number of
votes cast for, against, abstain and not voted were: 9,766,765; 2,676,562;
28,657; and 794,092.
(v) The shareholders did not approve a proposal to amend the
Articles to provide for the division of the Board of Directors into classes of
directors with staggered terms. The number of votes cast for, against, abstain
and not voted were: 5,501,904; 3,500,076; 95,818; and 4,168,278.
(vi) The shareholders did not approve a proposal to amend the
Articles to provide for removal of directors only for cause. The number of votes
cast for, against, abstain and not voted were: 5,551,000; 3,511,889; 34,909; and
4,168,278.
(vii) The shareholders approved a proposal to amend the
Articles to provide that special meetings of shareholders may be called by the
Chairman of the Board, the Chief Executive Officer, the Board of Directors or
shareholders owning 50% or more of the Company's issued and outstanding capital
stock. The number of votes cast for, against, abstain and not voted were:
9,048,817; 190,387; 99,806; and 3,927,066.
(viii) The shareholders approved a proposal to amend the
Articles in certain other respects described herein, primarily to conform the
Articles to current Arizona law and to delete obsolete or superfluous
provisions. The number of votes cast for, against, abstain and not voted were:
11,796,516; 444,671; 25,603; and 999,286.
Item 6. Exhibits and Reports on Form 8-K
- ----------------------------------------
(a) Exhibits
--------
10.1 Purchase Agreement between the Company, GCK Entertainment
Services I, Inc.; Talent, Entertainment and Media Services,
Inc. (collectively, "TEAM Services"); and the shareholders of
TEAM Services.
27 Financial Data Schedule
(b) Reports on Form 8-K
-------------------
No reports on Form 8-K were filed during the quarter ended
June 30, 1996.
SIGNATURES
In accordance with the requirements of The Exchange Act, the
registrant caused this report to be signed on its behalf by the undersigned,
thereunto duly authorized.
EMPLOYEE SOLUTIONS, INC.
Date: August 14, 1996 /S/ Marvin D. Brody
------------------------ --------------------------
Marvin D. Brody
Chief Executive Officer
/S/ Morris C. Aaron
---------------------------
Morris C. Aaron
Chief Financial Officer
BINDING LETTER OF INTENT
FOR ACQUISITION OF
GCK ENTERTAINMENT SERVICES I, INC. AND
TALENT, ENTERTAINMENT AND MEDIA SERVICES, INC.
I. Acquisition. ESI shall acquire the common stock of GCK Entertainment
Services I, Inc. and Talent, Entertainment and Media Services, Inc.
(collectively D.B.A. Team Services or Seller) for a Purchase Price as
defined below. The Acquisition will be treated as a stock purchase
under Section 368 of the Internal Revenue Code as a B Reorganization.
II. Purchase Price. The Purchase Price shall equal four (4x) pre-tax
earnings for the period from July 1, 1998 through June 30, 1999. The
Purchase Price will be paid in the form of ESI unregistered common
stock and assumed liabilities. In any event, ESI will pay a minimum
Purchase Price equal to the total liabilities of Seller assumed at
Closing. Any purchase price in excess of assumed liabilities will be
paid within 60 days (or as soon as practically possible) of June 30,
1999 in the form of ESI unregistered common stock. No discounts will be
taken for unregistered nature of stock.
III. Calculation of Pre-Tax Earnings. Pre-tax earnings will result from two
primary sources. First, the pre-tax earnings of Team Services as
determined under generally accepted accounting principles. Second,
pre-tax earnings resulting from the sale of ESI leasing products as
generated by Jeff Colby. Under the latter scenario, pre-tax earnings
will be calculated as follows: Gross profit from leasing sales
generated by Jeff Colby less an overhead charge of $10 per check equals
the pre-tax income.
IV. General Manager Position. Sellers and ESI will use its best efforts to
hire a general manager to run and to oversee the day-to-day operations
of Team Services enabling Jeff Colby to focus on generating additional
leasing sales (both traditional Team Services type sales and ESI type
sales) for the benefit of Team Services' P&L. Jeff Colby will have
ultimate P&L responsibility and operational responsibility for the Team
Services operations.
V. Liabilities to be Assumed by Sellers. Any liabilities assumed by
Sellers will not be considered in the calculation of payment of
Purchase Price. The Sellers (both individually, except for Bruce
Konheim, and as a group) will personally indemnify Employee Solutions
and its affiliates, on a joint and several basis should any of these
liabilities ultimately become the responsibility of Employee Solutions
or its affiliates.
VI. Exit Strategy. Prior to June 30, 1999, Employee Solutions shall retain
the right to dispose of the Team Services operation under the following
two circumstances:
1. Should the Team Services business have two sequential quarters
resulting in net losses as determined by generally accepted
accounting principles beginning with the quarter starting
April 1, 1997, ESI has the right to dispose of, or shut down,
the Team Services operations. In such a case, the Sellers
shall retain the right of first refusal to acquire Team
Services back from ESI. Should such right of first refusal not
be exercised, ESI shall calculate the net proceeds received,
should there be any, from disposition and any proceeds in
excess of the net proceeds (after ESI recoups any and all
expenses, payments, losses or other costs associated with the
acquisition of Team Services and its operations of Team
Services) shall be split 50/50 between ESI and the Sellers.
2. Should ESI identify a buyer for Team Services at a price
mutually agreeable to both ESI and Seller, Team Services may
be sold to a third party. Should this sale occur, Team
Services and ESI agree to split the proceeds from such sale
50/50 (after ESI recoups any and all expenses, payments,
losses or other costs associated with the acquisition of Team
Services and its operations of Team Services). In any event,
ESI may at its sole discretion sell the operations of Team
Services (excluding new leasing business processed by ESI
which will remain in tact and subject to the formula described
above in section II above --Purchase Price) so long as ESI
pays Sellers an amount equal to its initial investment of $1.6
million.
VII. Compensation of Jeff Colby. Jeff Colby will receive annual compensation
charged to Team Services in the amount of $75,000 per year for his role
as President. In addition, Colby shall receive a non-recourse advance
against future commissions in the amount of $60,000 to be paid monthly
by ESI of which amounts will be reimbursed to ESI from any future
commissions earned as a Regional Vice President from selling ESI
leasing services. Commissions will be applied against advances at a
rate of 25% of earned commissions during the first twelve months period
from closing and at 50% thereafter.
VIII. Effective Date. This transaction will be effective as of June 22, 1996.
IX. Effective Control. Team Services, and its shareholders, acknowledge
that they have effectively turned over control of Team Services to ESI
at the conclusion of their board meeting held on June 22, 1996, whereby
all material management decisions will require the approval of ESI, ESI
shall assume the risks and rewards of Team Services on the Effective
Date, and the day to day operations now fall under ESI's control. Team
Services will file its final S-Corp tax return with a June 21, 1996
short period year end, and ESI shall begin to include Team Services'
earnings in its taxable income on June 22, 1996.
X. Stock Purchase Agreement. The acquisition will be pursuant to a written
Stock Purchase Agreement. The Stock Purchase Agreement and any other
agreements executed in connection herewith will also contain all
standard representations, warranties, indemnification's, etc., on the
part of all parties, which are customary for these types of
transactions. Further, Team Services represents and warrants that all
written and verbal information of a material nature provided to ESI
prior to the Effective Date, which ESI has relied upon, is true and
accurate. Should this not be the case, Team Services and/or its
principals listed below will make ESI whole or indemnify ESI against
losses which arise due to a misrepresentation.
XI. ESI Unregistered Common Stock. Any shares of ESI common stock issued in
connection with this transaction will be in the form of unregistered
shares. Such unregistered shares will carry piggyback rights for one
year from the date of issue and one demand right during the second
year. The stock price for calculating the number of shares to be issued
in consideration for the purchase price will be based on the average
NASDAQ closing price for ESI's common stock for the calendar month
ending June 30, 1999. Further, ESI will enter into agreements with
individual sellers within five business days of June 30, 1999 (at the
option of the sellers) to provide price protection on fluctuations in
ESI's common stock price from July 1, 1999 through the effective date
of the common share registration. Such agreements will provide that
seller and ESI will pay the other the spread between the share price
(as calculated above for purchase price) and the share price on the
effective date of the registration statement. Payments will occur only
if the stock fluctuates more than 5% in either direction. If the share
price decreased, ESI will pay sellers whom elected such option. If the
share price increases, sellers whom elected such option shall pay ESI.
No discounts will be taken for the unregistered nature of the stock.
TEAM SERVICES Employee Solutions, Inc.
By ____________________________ By _________________________
Jeffery Colby Marvin D. Brody
By ____________________________
Richard K. Gottlieb
By ____________________________
Lawrence Berkowitz
By ____________________________
Michael Konheim
By ____________________________
Bruce Konheim
By ____________________________
Andrew Shaddock
By ____________________________
Thomas Fagan
End of Term Sheet
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
COMPANY'S FORM 10-Q FOR THE SIX MONTHS ENDED JUNE 30, 1996 AND IS
QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FORM 10-Q
</LEGEND>
<MULTIPLIER> 1
<CURRENCY> U.S. DOLLARS
<S> <C>
<PERIOD-TYPE> 6-MOS
<FISCAL-YEAR-END> DEC-31-1996
<PERIOD-START> JAN-01-1996
<PERIOD-END> JUN-30-1996
<EXCHANGE-RATE> 1
<CASH> 10,717,673
<SECURITIES> 0
<RECEIVABLES> 24,363,339
<ALLOWANCES> 0
<INVENTORY> 0
<CURRENT-ASSETS> 42,267,506
<PP&E> 885,459
<DEPRECIATION> 0
<TOTAL-ASSETS> 61,124,704
<CURRENT-LIABILITIES> 24,174,146
<BONDS> 0
0
0
<COMMON> 26,561,941
<OTHER-SE> 9,805,617
<TOTAL-LIABILITY-AND-EQUITY> 61,124,704
<SALES> 0
<TOTAL-REVENUES> 164,941,702
<CGS> 0
<TOTAL-COSTS> 148,445,598
<OTHER-EXPENSES> 6,975,184
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 7,198
<INCOME-PRETAX> 9,269,779
<INCOME-TAX> 3,800,655
<INCOME-CONTINUING> 5,469,124
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 5,469,124
<EPS-PRIMARY> .17
<EPS-DILUTED> .17
</TABLE>
