U.S. SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 1997
[ ] 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.)
6225 North 24th Street, Phoenix, Arizona 85016
(Address of principal executive offices)
Issuer's telephone number: (602) 955-5556
Securities registered pursuant to Section 12(b) of the Act:
Title of each class: Name of each exchange on which registered:
None N/A
---- ---
Securities registered pursuant to Section 12(g)
of the Act:
No Par Value Common Stock
(Title of Class)
Indicate by check mark whether the Registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the Registrant was
required to file such report(s)), and (2) has been subject to such filing
requirements for the past 90 days.
Yes x 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:
30,895,534 Common shares, no par value were outstanding as of August 12, 1997.
<PAGE>
EMPLOYEE SOLUTIONS, INC.
FORM 10-Q
Quarterly Report for the Period Ended June 30, 1997
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INDEX
<TABLE>
<CAPTION>
Page
PART I. Financial Information Number
------
<S> <C> <C>
Item 1. Financial Statements
Consolidated Balance Sheets - June 30, 1997 and
December 31, 1996 2
Consolidated Statements of Operations for the
Quarter and Six Months Ended June 30, 1997 and 1996 3
Consolidated Statement of Changes in Stockholders'
Equity for the Six Months Ended June 30, 1997 4
Consolidated Statements of Cash Flows for the
Six Months Ended June 30, 1997 and 1996 5
Notes to Consolidated Financial Statements 7
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations 12
Item 3. Quantitative and Qualitative Disclosure About Market Risk 27
PART II. Other Information
Item 1. Legal Proceedings 28
Item 4. Submission of Matters to a Vote of Security Holders- 28
Item 6. Exhibits and Reports on Form 8-K 29
Signatures 30
</TABLE>
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<PAGE>
Item 1. Financial Statements
EMPLOYEE SOLUTIONS, INC.
CONSOLIDATED BALANCE SHEETS
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<TABLE>
<CAPTION>
June 30, December 31,
(Dollars in thousands, except share data) 1997 1996
- -------------------------------------------------------------------------------------------------------------
<S> <C> <C>
ASSETS
CURRENT ASSETS:
Cash and cash equivalents $ 10,609 $ 10,980
Restricted cash and investments 14,000 11,500
Accounts receivable, net 50,407 34,839
Receivable from insurance companies 6,965 5,918
Prepaid expenses and deposits 2,770 1,258
Deferred income taxes 3,757 1,156
-------- --------
Total current assets 88,508 65,651
Property and equipment, net 2,105 1,084
Deferred income taxes -- 539
Goodwill and other assets, net 61,144 58,695
-------- --------
Total assets $151,757 $125,969
======== ========
LIABILITIES
CURRENT LIABILITIES:
Bank overdraft $ 2,516 $ 2,477
Accrued salaries, wages and payroll taxes 31,420 17,586
Accounts payable 3,282 4,078
Accrued workers' compensation
and benefits 11,080 6,927
Income taxes payable -- 720
Other accrued expenses 5,191 3,414
-------- --------
Total current liabilities 53,489 35,202
-------- --------
Deferred income taxes -- 111
-------- --------
Long-term debt 47,300 42,800
-------- --------
Other long-term liabilities 1,349 1,349
-------- --------
Commitments and contingencies
STOCKHOLDERS' EQUITY
Class A convertible preferred stock, nonvoting, no par value, 10,000,000 shares
authorized, no shares in 1997 and 1996
issued and outstanding -- --
Common stock, no par value,
75,000,000 shares authorized, 30,895,534 shares
issued and outstanding June 30, 1997, 30,729,433
shares issued and outstanding December 31, 1996 31,747 30,145
Retained earnings 17,872 16,362
-------- --------
Total stockholders' equity 49,619 46,507
-------- --------
Total liabilities and stockholders' equity $151,757 $125,969
======== ========
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</TABLE>
The accompanying notes are an integral part of these
consolidated balance sheets.
2
<PAGE>
EMPLOYEE SOLUTIONS, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
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<TABLE>
<CAPTION>
Quarter ended June 30, Six months ended June 30,
------------------------------- --------------------------------
(Dollars in thousands, except share data) 1997 1996 1997 1996
- ------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Revenues $ 226,058 $ 91,007 $ 422,024 $ 164,942
------------ ------------ ------------ ------------
Cost of revenues:
Salaries and wages of worksite employees 182,439 71,059 338,348 128,777
Healthcare and workers' compensation 16,038 4,932 31,109 7,508
Payroll and employment taxes 15,696 6,190 30,414 12,161
------------ ------------ ------------ ------------
Cost of revenues 214,173 82,181 399,871 148,446
------------ ------------ ------------ ------------
Gross profit 11,885 8,826 22,153 16,496
Selling, general and administrative expenses 8,499 3,429 15,912 6,975
Depreciation and amortization 1,083 334 2,048 654
------------ ------------ ------------ ------------
Income from operations 2,303 5,063 4,193 8,867
Other income (expense):
Interest income 252 223 447 410
Interest expense and other (1,181) (4) (2,123) (7)
------------ ------------ ------------ ------------
Income before provision for income taxes 1,374 5,282 2,517 9,270
Income tax provision 550 2,166 1,007 3,801
------------ ------------ ------------ ------------
Net income $ 824 $ 3,116 $ 1,510 $ 5,469
============ ============ ============ ============
Net income per common and common equivalent share:
Primary $ .03 $ .10 $ .05 $ .17
============ ============ ============ ============
Fully diluted $ .03 $ .10 $ .05 $ .17
============ ============ ============ ============
Weighted average number of common and common
equivalent shares outstanding:
Primary 32,003,224 32,564,993 32,549,438 32,200,621
============ ============ ============ ============
Fully diluted 32,004,592 32,564,993 32,549,438 32,276,888
============ ============ ============ ============
- ------------------------------------------------------------------------------------------------------------------------------
</TABLE>
The accompanying notes are an integral part of these consolidated
financial statements.
3
<PAGE>
EMPLOYEE SOLUTIONS, INC.
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
For the six months ended June 30, 1997
--------------------------------------------------
Total
Preferred Common Retained Stockholders'
(Dollars in thousands, except share data) Stock Stock Earnings Equity
- -----------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
BALANCE, December 31, 1996 $ -- $30,145 $16,362 $46,507
Issuance of 166,101 shares of common stock in
connection with exercise of stock options 414 414
Tax benefit related to the exercise of stock options 1,188 1,188
Net income -- 1,510 1,510
------- ------- ------- -------
BALANCE, June 30, 1997 $ -- $31,747 $17,872 $49,619
======= ======= ======= =======
- -----------------------------------------------------------------------------------------------------------
</TABLE>
The accompanying notes are an integral part of these consolidated
financial statements.
4
<PAGE>
EMPLOYEE SOLUTIONS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
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<TABLE>
<CAPTION>
Six months ended June 30,
--------------------------
(Dollars in thousands) 1997 1996
- --------------------------------------------------------------------------------------------
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Cash received from customers $ 405,409 $ 150,938
Cash paid to suppliers and employees (397,140) (147,365)
Interest received 447 330
Interest paid (2,065) (6)
Income taxes paid, net of refunds (3,900) (6,066)
--------- ---------
Net cash provided by (used in) operating activities 2,751 (2,169)
--------- ---------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of property and equipment (1,143) (416)
Business acquisitions (4,307) (1,628)
Cash invested in restricted cash and investments (2,500) (2,358)
Issuance of notes receivable, and other net -- (439)
--------- ---------
Net cash used in investing activities (7,950) (4,841)
--------- ---------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from issuance of long-term debt 4,500 --
Proceeds from issuance of common stock 414 7,491
Decrease in bank overdraft and other (86) (3,792)
--------- ---------
Net cash provided by financing activities 4,828 3,699
--------- ---------
Net decrease in cash and cash equivalents (371) (3,311)
CASH AND CASH EQUIVALENTS, beginning of period 10,980 14,029
--------- ---------
CASH AND CASH EQUIVALENTS, end of period $ 10,609 $ 10,718
========= =========
- --------------------------------------------------------------------------------------------
</TABLE>
The accompanying notes are an integral part of these consolidated
financial statements.
5
<PAGE>
EMPLOYEE SOLUTIONS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(CONTINUED)
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<TABLE>
<CAPTION>
Six months ended June 30,
-------------------------
(Dollars in thousands) 1997 1996
- --------------------------------------------------------------------------------------------------------------
<S> <C> <C>
RECONCILIATION OF NET INCOME TO NET CASH (USED IN)
PROVIDED BY OPERATING ACTIVITIES:
Net income $ 1,510 $ 5,469
-------- --------
ADJUSTMENTS TO RECONCILE NET INCOME TO NET CASH (USED IN) PROVIDED BY OPERATING
ACTIVITIES:
Depreciation and amortization 2,048 654
Loss on sale of fixed assets 58 --
Increase in accounts receivable, net (15,568) (14,034)
Increase in insurance company receivable (1,047) --
Increase in prepaid expenses and deposits (1,512) (982)
(Increase) decrease in deferred income tax (2,173) 138
Decrease (increase) in other assets 1,187 (80)
Increase in accrued salaries,
wages and payroll taxes 13,834 7,653
Increase in accrued workers' compensation
and health insurance 4,153 944
Decrease in other long term liabilities -- (113)
Decrease in accounts payable (796) (688)
Decrease in income taxes payable (720) (2,376)
Increase in other accrued expenses 1,777 1,246
-------- --------
1,241 (7,638)
-------- --------
Net cash provided by (used in) operating activities $ 2,751 $ (2,169)
======== ========
- --------------------------------------------------------------------------------------------------------------
</TABLE>
SUPPLEMENTAL DISCLOSURE OF NON-CASH INVESTING AND FINANCING ACTIVITIES:
During the six months ended June 30, 1997, $1.2 million was derived as a tax
benefit for the exercise of stock options during the period.
The accompanying notes are an integral part of these consolidated
financial statements.
6
<PAGE>
EMPLOYEE SOLUTIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 1997
(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:
Nature of Corporation
Employee Solutions, Inc. (together with its subsidiaries, ESI or the Company) is
a leading professional employer organization (PEO) providing employers
throughout the United States with comprehensive employee payroll, human
resources and benefits outsourcing services. The Company's integrated
outsourcing services include payroll processing and reporting, human resources
administration, employment regulatory compliance management, risk
management/workers' compensation services, retirement and health care programs,
and other products and services provided directly to worksite employees.
Basis of Presentation
The accompanying unaudited consolidated financial statements of 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 three and six month periods ended
June 30, 1997 are not necessarily indicative of the results that may be expected
for the year ending December 31, 1997. For further information, refer to the
consolidated financial statements and footnotes thereto included in the
Company's Annual Report on Form 10-K for the year ended December 31, 1996.
Principles of Consolidation
The consolidated financial statements include the activities of Employee
Solutions, Inc. and its wholly owned subsidiaries from their respective
acquisition date. All acquisitions were accounted for as purchases. All
significant intercompany accounts and transactions have been eliminated. Certain
amounts have been reclassified from prior years to conform with current year
presentation.
Use of Estimates
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities and disclosure of
contingent assets and liabilities at the date of the financial statements, and
the reported amounts of revenues and expenses during the reporting period. The
nature of the Company's business requires significant estimates to be made in
the areas of workers' compensation reserves and revenue recognized for
stand-alone risk management/workers' compensation services, particularly for
retrospectively rated policies. The actual results of these estimates may be
unknown for a period of years. Actual results could differ from those estimates.
7
<PAGE>
Net Income Per Common and Common Equivalent Share
The Company used the treasury stock method to compute net income per share. The
computation of adjusted net income and weighted average common and common
equivalent shares used in the calculation of income per common share is as
follows:
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
1997 1996
------------------------------ -------------------------------
Fully Fully
(Dollars in thousands, except share data) Primary Diluted Primary Diluted
- ------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Three months ended June 30,
-------------------------------------------------------------------
Weighted average of
common shares outstanding 30,888,061 30,888,061 30,413,227 30,413,227
Dilutive effect of options
and warrants outstanding 1,115,163 1,116,531 2,151,766 2,151,766
------------ ------------ ------------ ------------
Weighted average of common
and common equivalent
shares 32,003,224 32,004,592 32,564,993 32,564,993
============ ============ ============ ============
Net income $ 824 $ 824 $ 3,116 $ 3,116
Adjustments to net income (20) (20) (6) (6)
------------ ------------ ------------ ------------
Adjusted net income for
purposes of the income per
common share calculation $ 804 $ 804 $ 3,110 $ 3,110
============ ============ ============ ============
Net income per common and
common equivalent share $ 0.03 $ 0.03 $ 0.10 $ 0.10
============ ============ ============ ============
Six months ended June 30,
-------------------------------------------------------------------
Weighted average of
common shares outstanding 30,840,094 30,840,094 30,175,511 30,175,511
Dilutive effect of options
and warrants outstanding 1,709,344 1,709,344 2,025,110 2,101,377
------------ ------------ ------------ ------------
Weighted average of common
and common equivalent
shares 32,549,438 32,549,438 32,200,621 32,276,888
============ ============ ============ ============
Net income $ 1,510 $ 1,510 $ 5,469 $ 5,469
Adjustments to net income (32) (32) (12) (12)
------------ ------------ ------------ ------------
Adjusted net income for
purposes of the income per
common share calculation $ 1,478 $ 1,478 $ 5,457 $ 5,457
============ ============ ============ ============
Net income per common and
common equivalent share $ 0.05 $ 0.05 $ 0.17 $ 0.17
============ ============ ============ ============
- ------------------------------------------------------------------------------------------------------------------
</TABLE>
8
<PAGE>
(2) COMMON STOCK SPLITS:
On December 18, 1995, and June 26, 1996 the Board of Directors authorized
two-for-one common stock splits, effected in the form of 100% stock dividends,
effective on January 16, 1996 and July 26, 1996 respectively, to shareholders of
record at the close of business on January 2, 1996 and July 12, 1996. In this
report, all per share amounts and numbers of shares, including options and
warrants, have been restated to reflect these stock splits.
(3) ACQUISITIONS:
Acquisition of ETIC Corporation
On February 1, 1997, the Company completed the acquisition of the principal
assets of ETIC Corporation, d/b/a Employers Trust (ETIC). The purchase price was
$30,000 plus five times ETIC's total pre-tax income for the 12-month period
ending January 31, 1998. At closing, $855,000 was paid in cash. The excess
purchase price over net assets acquired was approximately $994,000 which has
been recorded as goodwill. The final payment of purchase price is due on or
before April 30, 1998, and will be paid in cash. ETIC is a Cincinnati, Ohio
based PEO with a client base consisting primarily of light industrial,
transportation and construction companies, with approximately 150 clients and
2,000 worksite employees.
Acquisition of CMGR Companies
On February 17, 1997, the Company completed the acquisition of the principal
assets of CMGR, Inc., and Humasys (collectively, CMGR) for $3.85 million. At
closing, $2.35 million was paid in cash. The excess purchase price over net
assets acquired was approximately $2.6 million which has been recorded as
goodwill. An interim payment of $500,000 toward the purchase price is due six
months after the closing. Final payment is due on or before April 18, 1998 and
is subject to certain client retention factors. CMGR is a New Jersey based PEO
with a client base consisting primarily of professional, service and light
industrial companies, with approximately 75 clients and 1,700 worksite
employees.
(4) UNAUDITED PRO FORMA FINANCIAL INFORMATION
The following unaudited pro forma combined financial data gives effect to the
combined historical results of operations of the Company and TEAM Services and
Leaseway Personnel Corp. (Leaseway), which were acquired in 1996, for the six
months ended June 30, 1996, and assumes that the acquisitions had been effective
as of the beginning of such period and compares the pro forma results in 1996 to
actual results in 1997.
The pro forma information is not indicative of the actual results which would
have occurred had the acquisitions been consummated at the beginning of such
periods or of future consolidated operations of the Company. 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.
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
For the six months ended June 30,
---------------------------------
(Dollars in thousands, except share data) 1997 Actual 1996 Pro Forma
- --------------------------------------------------------------------------------------------
<S> <C> <C>
Total revenues $ 422,024 $ 245,592
Net income 1,510 6,106
Net income per common and common equivalent share
Primary .05 .19
Fully diluted .05 .19
Weighted average number of common and common
equivalent shares outstanding
Primary 32,549,438 32,200,621
Fully diluted 32,549,438 32,276,888
- --------------------------------------------------------------------------------------------
</TABLE>
9
<PAGE>
(5) ACCOUNTING PRONOUNCEMENTS NOT YET ADOPTED:
In February 1997, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 128 (SFAS No. 128), Earnings per Share. The
statement establishes standards for computing and presenting earnings per share
and requires dual presentation of basic and diluted earnings per share on the
face of the income statement. SFAS No. 128 is effective for financial statement
periods ending after December 15, 1997. Adoption of SFAS No. 128 would have the
following effect on the June 30, 1997 and 1996 financial statements:
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
1997 1996
--------------------------------- -----------------------------------
(Dollars in thousands, except share data) Income Shares Per Share Income Shares Per Share
<S> <C> <C> <C> <C> <C> <C>
Quarter ended June 30,
----------------------------------------------------------------------
Earnings per common share $ .03 $ .10
========= =========
Earnings per common share - assuming dilution $ .03 $ .10
========= ========
Basic earnings per share
Income available to
common stockholders $ 804 30,888,061 $ .03 $ 3,110 30,413,227 $ .10
Effect of Dilutive Securities
Common Stock Options 1,115,163 2,151,766
--------- ----------- --------- ----------- -----------
Diluted earnings per share $ 804 32,003,224 $ .03 $ 3,110 32,564,993 $ .10
========= =========== ========= =========== =========== =========
Six months ended June 30,
----------------------------------------------------------------------
Earnings per common share $ .05 $ .17
========= =========
Earnings per common share - assuming dilution $ .05 $ .17
========= =========
Basic earnings per share
Income available to
common stockholders $ 1,478 30,840,094 $ .05 $ 5,457 30,175,511 $ .18
Effect of Dilutive Securities
Common Stock Options 1,709,344 2,025,110
--------- ----------- --------- ----------- -----------
Diluted earnings per share $ 1,478 32,549,438 $ .05 $ 5,457 32,200,621 $ .17
========= =========== ========= =========== =========== =========
- -------------------------------------------------------------------------------------------------------------------------
</TABLE>
(6) 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 financial statements. As of June 30, 1997, the compounded interest
totaled approximately $170,000.
The Company received payroll tax penalty notices from the Internal Revenue
Service (IRS) and various states, relating to the acquired operations of Hazar
alleging certain late payment of payroll taxes. The penalties proposed to be
assessed against the Company totaled approximately $470,000 and have been abated
in totality by the IRS during the quarter ended June 30, 1997. The penalties to
be assessed against Hazar have been revised down by the IRS to a
10
<PAGE>
maximum of approximately $130,000 from approximately $390,000 for the period
during which the Company performed designated management services on behalf of
the predecessor. The Company has been informed that the IRS is also considering
abatement of these penalties.
The Company, and certain of its present and former executive officers and
directors, have been named as defendants in several actions filed in 1997. While
the exact claims and allegations vary, they all allege violations by the Company
of Section 10(b) of the Securities Exchange Act, and Rule 10b-5 promulgated
thereunder, with respect to the accuracy of statements regarding Company
reserves and other disclosures made by the Company and certain directors and
officers. These suits were filed shortly after a significant drop in the trading
price of the Company's common stock in March 1997. Each of the actions seeks
certification of a class consisting of purchasers of securities of the
Registrant over specified periods of time. Each of the complaints seeks the
award of compensatory damages in amounts to be determined at trial, including
interest thereon, and costs of the action, including attorney's fees. The suits
have been consolidated before a single judge of the U.S. District Court in
Phoenix, Arizona. The Court has before it motions by the plaintiffs for the
appointment of representative plaintiffs and approval of selection of lead
counsel. Once these motions are ruled upon, it is anticipated that a
consolidated, amended complaint will be filed. The Company believes the actions
are without merit and intends to defend the cases vigorously.
From time to time, the Company is named as a defendant in lawsuits in the
ordinary course of business. These lawsuits are not considered to have a
material impact on the Company.
The Company believes that it has meritorious defenses to the lawsuits facing it,
including those mentioned above, and intends to assert such defenses vigorously.
However, it is not possible to predict whether such defenses will be
successfully asserted in all cases. The Company would be required to record an
expense and liability as to any matter if, at any time in the future, it became
probable that the Company would not prevail in such matter.
11
<PAGE>
ITEM 2. 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, 1996. 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 (which include
statements in the future tense and statements using the terms "believe,"
"anticipate," "expect," "intend" or similar terms) 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 this Management's Discussion
and Analysis (particularly in "Outlook: Issues and Risks" in "Item 1 - Business"
and "Item 7 Management's Discussion and Analysis of Financial Condition and
Results of Operations" of the Company's Report on Form 10-K for the year ended
December 31, 1996, as well as those factors discussed elsewhere herein or in any
document incorporated herein by reference.
Results of Operations -- Overview
The following is a summary of certain factors which affect results of operations
and which have generally applied to the Company in all periods presented.
Revenues
The most significant components of the Company's revenues are payments received
from customers for gross salaries and wages paid to PEO worksite employees and
the Company's service fee. The Company negotiates service fees on a
client-by-client basis based on factors such as market conditions, client needs
and services requested, the clients' workers' compensation and benefit plan
experience, Company administrative resources required, the expected profit, and
other factors. These fees are generally expressed as a fixed percentage of the
client's gross salaries and wages except for certain costs, primarily employer's
health care contributions, which are billed to clients on an add-on basis.
Because the service fees are negotiated separately with each client and vary
according to circumstances, the Company's service fees, and therefore its gross
margin, will fluctuate based on the Company's client mix.
Revenues from stand-alone risk management/workers' compensation services consist
primarily of gross premiums charged to clients for such services. The Company
also receives fee income for certain other types of services, such as those in
connection with its driver leasing program.
Costs of Revenues
The Company's primary direct costs of revenues include salaries and wages paid
to worksite employees, employment related taxes, costs of health and welfare
benefit plans, and workers' compensation insurance costs.
The largest component of direct costs is salaries and wages to worksite
employees. Although this cost is generally directly passed through to clients,
the Company is responsible for payment of these costs even if not reimbursed by
its clients. The Company has begun extending credit terms to clients in certain
industries. See "Outlook: Issues and Risks - Credit Risks" herein.
Employment related taxes consist of the employer's portion of payroll taxes
required under the Federal Income Contribution Act (FICA), which includes Social
Security and Medicare, and federal and state unemployment taxes. The federal tax
rates are defined by the appropriate federal regulations. State unemployment
rates are subject to change each year based on claims histories and size of
payments, and vary from state to state.
Workers' compensation costs, whether relating to PEO worksite employees or the
Company's stand-alone risk management/workers' compensation program, include the
costs of claims up to the retention limits relating to the
12
<PAGE>
Company's workers' compensation program, administrative costs, premium taxes and
excess reinsurance premiums, and accidental death and dismemberment insurance
which the Company maintains to limit certain of its losses. In its arrangements
with the Reliance Group of Insurance Companies (Reliance) through the Company's
wholly-owned insurance subsidiary, the Company retains workers' compensation
liabilities up to certain specified amounts. The Company maintained a similar
program with Legion Insurance Company (Legion) which it terminated effective
August 1, 1997 due to cost and capital considerations. Accrued workers'
compensation claims liability is based upon estimates of reported and unreported
claims and the related claims and claims settlement expenses in an amount equal
to the retained portion of the expected total incurred claim. The Company's
accrued workers' compensation reserves are primarily based on industry-wide
data, and to a lesser extent, the Company's past claims experience up to the
retained limits. The liability recorded may be more or less than the actual
amount of the claims when they are submitted and paid. While the Company
believes that its reserves are adequate for future claims expense, there can be
no assurance that this will be the case. See "Outlook: Issues and Risks."
Changes in the liability are charged or credited to operations as the estimates
are revised. Administrative costs include fees paid to Reliance and Legion and
costs of claims management by third party administrators. Premium taxes include
taxes and related fees paid to various states based on premiums written. Premium
for excess reinsurance relates to premium payments to the Company's insurers for
the retention of risks above specified limits.
Health care and other employee benefits costs consist of medical and dental
insurance premiums, payments of and reserves for claims subject to deductibles
and the costs of vision care, disability, life insurance and other similar
benefit plans. The Company's health care benefit plans consist of a mixture of
fully-insured programs and partially self-insured programs with specific and, in
one program, aggregate stop-loss insurance. The Company recognizes a liability
for partially self-insured health insurance claims at the time a claim is
reported to the Company by the third party claims administrator, and also
provides for claims incurred, but not reported based on industry-wide data and
the Company's past claims experience. The liability recorded may be more or less
than the actual amount of ultimate claims. While the Company believes that its
reserves are adequate for future claims expense, there can be no assurance that
this will be the case. See "Outlook: Issues and Risks" herein.
Selling, General and Administrative Expenses
The Company's primary operating expenses are administrative personnel expenses,
other general and administrative expenses, and sales and marketing expenses.
Administrative personnel expenses include compensation, fringe benefits and
other personnel expenses related to the Company's internal administrative
employees. Other general and administrative expenses include rent, office
supplies and expenses, legal and accounting fees, insurance and other operating
expenses. Sales and marketing expenses include commissions to sales executives
and related expenses.
Depreciation and Amortization
Depreciation and amortization consists primarily of the amortization of goodwill
and acquisition costs from the Company's prior acquisitions. The Company
amortizes goodwill and acquisition costs over periods of three to thirty years,
depending on the assets acquired, using the straight-line method. Acquisitions
generally result in considerable goodwill because PEOs generally require few
fixed assets to conduct their operations.
Acquisitions
Period-to-period comparisons are substantially affected by the Company's recent
substantial growth through acquisition of other companies providing PEO
services. The Company has accounted for its acquisitions using the "purchase"
method of accounting, and prior period financial statements therefore have not
been restated to reflect these acquired operations. In addition to increasing
revenues, acquisition activity can affect gross profits and margins because the
industry mix of the acquired companies may differ from that of the Company and
because of the transition period after an acquisition in which the Company acts
to implement pricing changes where appropriate and to eliminate client
relationships which do not meet the Company's risk or profitability profiles.
13
<PAGE>
Operating Results
Margin comparisons are affected by the relative mix of stand-alone risk
management/workers' compensation services and full PEO services in any
particular period. Significant numbers of conversions from stand-alone risk
management/workers' compensation to full-service PEO arrangements (such as those
which have occurred in connection with certain Company acquisitions) would tend
to increase gross profit amounts while decreasing gross margins because of the
addition of pass-through salaries and wages to both revenues and costs.
Certain 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 a 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
decreasing impact on the Company's working capital and results of operations as
the year progresses.
Three and Six Months Results of Operations - June 30, 1997 Compared to June 30,
1996.
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Three months ended June 30, Six months ended June 30,
----------------------------------- ---------------------------------------
Percent Percent
(Dollars in thousands) 1997 Change 1996 1997 Change 1996
- -------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Revenues $ 226,058 148% $ 91,007 $ 422,024 156% $ 164,942
Cost of revenues 214,173 161 82,182 399,871 169 148,446
Gross profit 11,885 35 8,826 22,153 34 16,496
Selling, general and administrative 8,499 148 3,429 15,912 128 6,975
Depreciation and amortization 1,083 224 334 2,048 213 654
Interest income 252 13 223 447 9 410
Interest expense 1,123 -- 4 2,065 -- 7
Net income 824 (75) 3,116 1,510 (72) 5,469
- -------------------------------------------------------------------------------------------------------------------
</TABLE>
Revenues
Revenues increased to $226.1 million for the quarter ended June 30, 1997 from
$91.0 million for the quarter ended June 30, 1996, a 148% increase. For the six
months ended June 30, 1997, revenue was $422.0 million compared to $164.9
million for the six months ended June 30, 1996, an increase of 156%.
Acquisitions, and the addition of US Xpress, Inc. and affiliates (US Xpress) as
a PEO client, primarily accounted for the increase in revenues between the
periods. Growth was in part offset by factors such as attrition of clients and
competitive pressures in the PEO and workers' compensation industry. Excluding
the effects of US Xpress and the full quarter benefit of companies acquired in
February 1997, internal growth, net of attrition, was not significant for the
quarter ended June 30, 1997. The number of worksite employees increased to
approximately 42,900 covering 1,444 client companies at June 30, 1997 from
approximately 24,300 covering 963 client companies at June 30, 1996. In
addition, at June 30, 1997 the Company provides risk management/workers'
compensation services to approximately 13,900 employees covering 64 employers as
compared to approximately 15,000 employees covering 65 employers at the same
period last year. The decrease in the number of employees covered under the
Company's risk management/workers' compensation services was in part due to the
conversion of certain stand-alone clients to PEO clients via acquisition.
Revenues related to stand-alone risk management/workers' compensation services
were $3.6 million for the second quarter of 1997 and $7.1 million for the six
months ended June 30, 1997 (which included first quarter nonrecurring revenue of
approximately $1.0 million related to stand-alone workers'
14
<PAGE>
compensation premiums that were under-billed for policies written in the
previous year) compared with revenues of $5.1 million and $8.5 for the second
quarter and six months ended June 30, 1996. In addition, revenues for risk
management/workers' compensation services include approximately $600,000 and
$900,000 for the three and six month periods ended June 30, 1997, respectively,
related to a single customer as to which disputes have arisen. The Company has
provided reserves for such amounts and is considering what further action,
including litigation, may be necessary to collect these amounts. See "Liquidity
and Capital Resources".
The Company began in late 1996 to experience the effects of competition and a
general weakening in the workers' compensation and employee benefits markets,
which slowed revenue growth. This trend has continued into 1997 and is
continuing to be experienced by the Company. Stand-alone policies, subject to
renewal, in place at June 30, 1997 represent annualized premiums of
approximately $11.3 million.
Cost of revenues
Cost of revenues increased 161%, to $214.2 million in the three months ended
June 30, 1997 from $82.2 million for the three months ended June 30, 1996. For
the six month period ended June 30, 1997 the cost of revenues were $399.9
million compared to $148.4 million for the same period in 1996, representing a
169% increase. This increase is primarily due to the increase in the Company's
business as previously described and as described below.
Included in the results for the three months ended June 30, 1997 are reductions
of $374,000 of workers' compensation expense and $100,000 of payroll tax and
related fees related to certain driver per diem/expense reimbursement programs
and approximately $1.1 million related to retrospective rate adjustments on
workers' compensation programs. The realization of the amount of expense savings
related to the per diem/expense reimbursement program is subject to successful
implementation of the program by the Company. Of the above amounts,
approximately $900,000 relates to prior periods.
Workers' compensation losses for the second quarter and six months ended June
30, 1997 were $5.2 and $9.2 million, respectively. The Company believes that the
overall results of the Company's risk management/workers' compensation program
as measured against industry data can be attributed to the Company's selectivity
in new client acceptance, the effective use of safety inspections and safety
programs and its ability to manage and close open claims coupled with stop
losses of $250,000 and $350,000 per occurrence, the maintenance of accidental
death and dismemberment insurance through the Chubb Group of Insurance Companies
(Chubb) and a 30-day cancellation capability on PEO business. Although the
Company believes its internal method of establishing reserves continues to be
appropriate, the Company commissioned an independent third party actuarial
review of the Company's workers' compensation reserves at year end 1996, as it
had for year end 1995. In the 1996 review, the actuary primarily relied on
industry-wide data, while taking into account to a lesser extent than in past
reviews ESI's specific risk structure and philosophy in determining its
findings. Although the Company believes that determining reserves based more
heavily upon its actual historical experience is appropriate and adequately
addressed its exposure, it determined to adopt the reserve levels determined by
the review for the year ended December 31, 1996, and to use similar
methodologies going forward which may have an impact on future periods. The
Company has also increased its internal risk per occurrence to $500,000 in Ohio
and Washington, as a result of the Company becoming a self-insurer under those
states' monopolistic workers' compensation structures. See "Adequacy of Loss
Reserves" and "Loss and Claims Experience" below in "Outlook: Issues and Risks"
for a further explanation of risks and uncertainties relating to the Company's
establishment of reserves.
15
<PAGE>
The following table provides an analysis of the Company's workers' compensation
reserves from its partially self-insured programs for the following periods:
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Quarter ended Year ended
----------------------- -----------
June 30, March 31, December 31,
(Dollars in thousands) 1997 1997 1996
- --------------------------------------------------------------------------------
<S> <C> <C> <C>
Reserve - Beginning of period $ 6,764 $ 5,154 $ 1,052
Provision for losses 5,236 3,964 10,034
Payments (3,591) (2,354) (5,932)
-------- -------- --------
Reserve - End of period $ 8,409 $ 6,764 $ 5,154
======== ======== ========
- --------------------------------------------------------------------------------
</TABLE>
The following table summarizes certain indicators of performance regarding the
Company's risk services department's ability to close out workers' compensation
claims in each of the following periods:
- --------------------------------------------------------------------------------
Approximate Approximate
Total Open Claims
Incurred Claims by Number of June 30,
Calendar Period Claims 1997
- --------------------------------------------------------------------------------
Six months ended
- ------------------
June 30, 1997 2,280 1,407
Year ended
- ------------------
December 31, 1996 3,408 659
December 31, 1995 1,036 57
December 31, 1994 100 0
----- -----
6,824 2,123
===== =====
- --------------------------------------------------------------------------------
Gross profit
The Company's gross profit margin was 5.3% for the second quarter ended June 30,
1997, compared to 9.7% for the same period in 1996. The gross profit margin for
the six month period ended June 30, 1997 of 5.2% was down from 10.0% for the six
month period ended June 30, 1996. This decrease primarily was attributable to
the change in mix of the Company's stand-alone risk management/workers'
compensation program revenues relative to the revenues derived from the
Company's PEO business. In addition, while a significant portion of the
Company's total 1997 revenue was derived from US Xpress, as discussed
previously, the gross profit was negligible for the six month period ended June
30, 1997. Increased competition in all areas of the Company's business along
with higher workers' compensation claims costs, as discussed previously, all
negatively affected the gross profit margin in 1997. The Company generally earns
a higher gross profit margin on revenues derived from its stand-alone risk
management/workers' compensation services than on revenues derived from the
Company's full-service PEO business, as PEO revenues generally include
significant (and substantially offsetting) revenue and expense items for payroll
and payroll-related costs for the worksite employees. Accordingly, the Company's
overall margin is affected in significant part by the mix of revenues derived
from full-service PEO clients and clients for which the Company provides only
risk management/workers' compensation services. Stand-alone risk
management/workers' compensation services revenue decreased from 3.6% of total
revenues for the second quarter of 1996 to 1.6% in the second quarter of 1997.
16
<PAGE>
Selling, general and administration
Selling, general and administrative expenses for the quarter ended June 30, 1997
increased by approximately $5.1 million to $8.5 million, or 148%, from $3.4
million for the quarter ended June 30, 1996. For the six month period ended June
30, 1997 and 1996, respectively, selling, general and administrative expenses
totaled $16.0 million compared to $7 million, or a 128% increase. Factors
contributing to the increase in selling, general and administrative expenses in
1997 over 1996 are the inclusion of the operations of various acquisitions, an
increase from 139 corporate employees at June 30, 1996 to 271 at June 30, 1997,
and the relocation of the Company's office space. Included in the increase in
costs from acquisitions were expenses for TEAM Services and Leaseway, acquired
in the second and third quarter of 1996, respectively, and which historically
have maintained a higher ratio of selling, general and administrative expense to
gross profit than the Company. These factors which caused increases in selling,
general and administrative expense were partially mitigated by improved systems
utilization and economies of scale achieved within the Company's operations. The
Company's insurance costs have increased due primarily to the Company's growth.
The Company is reviewing the cost effectiveness of all corporate insurance
programs. Commission expenses increased in the three and six months ended June
30, 1997 compared to the same periods in 1996 due to the increase in revenues
discussed. Selling, general and administrative expenses are expected to continue
to increase to meet the needs of new business, though the Company has initiated
efforts to improve efficiencies. The most extensive growth in selling, general
and administrative expenses has been in the finance and risk services
departments. In addition, the Company signed a seven year lease on new office
space in Phoenix, Arizona containing significantly more space at higher rates
than its previous facilities. The annual rental increase of approximately $1
million, began in April 1997. The Company also expects that costs for
professional services will increase in 1997 as a result of litigation recently
brought against the Company; see "Outlook: Issues and Risks - Litigation" below.
Depreciation and amortization
Depreciation and amortization represented depreciation of property and equipment
and amortization of organizational costs, customer lists and goodwill. Total
depreciation and amortization expense for the three months ended June 30, 1997
was $1.1 million compared to $334,000 for the period ended June 30, 1996. For
the six month period ended June 30, 1997, depreciation and amortization expense
totaled $2.0 million compared to $654,000 for the six month period ended June
30, 1996. The increase was due primarily to depreciation of new phone and
computer systems and goodwill amortization resulting from acquisitions, with
Leaseway and McClary-Trapp being the most significant. In addition, the Company
acquired ETIC and CMGR in February of 1997. Goodwill amortization of these
acquisitions was recognized from the date of acquisition. Because the Company
intends to focus in the short term on further integrating prior acquisitions,
the Company does not currently expect 1997 acquisition activity to be as
extensive as in 1996.
Interest
Interest income increased to $252,000 for the three months ended June 30, 1997
from $223,000 for the same period in 1996. For the six month period ended June
30, 1997 interest income totaled $447,000 compared to $410,000 for the six
months ended June 30, 1996. The increase in interest income is primarily due to
interest earned on both the restricted cash and investments held for the future
payment of workers' compensation claims at Camelback Insurance Ltd. (Camelback)
and cash held at the corporate level. Interest expense increased to $1.1 million
for the three months ended June 30, 1997, from $4,000 for the three months ended
June 30, 1996. Interest expense for the six month period ended June 30, 1997
totaled $2.1 million compared to $7,000 for the six month period ended June 30,
1996. The increase in interest expense is primarily due to interest accrued on
the Company's revolving line of credit. The line was first utilized in August
1996 and had average outstanding balances of $49.6 million and $46.6 million for
the three months and six months ended June 30, 1997, respectively. Interest
expense will continue in future periods depending upon amounts borrowed under
the revolving credit facility. See "Liquidity and Capital Resources" below.
17
<PAGE>
Effective tax rate
The Company's effective tax rate provides for federal, state and local income
taxes. The effective tax rate for the six months ended June 30, 1997 was 40% as
compared to 41% for the six months ended June 30, 1996. The tax rate used in
each quarterly reporting period generally is an estimate of the Company's
effective tax rate for the calendar year. The 1997 rate reflects the increased
operations of the Company's wholly-owned subsidiary, Camelback, which pays state
premium tax rather than state income tax. Although the Company believes that it
has structured its Camelback arrangements to qualify for such tax treatment, any
disallowance of this tax treatment could materially affect the Company's results
of operations for the current fiscal year and future fiscal years. The Company's
effective tax rate will vary from time to time depending primarily on the mix of
profits derived from Camelback and the Company's various other profit centers,
the magnitude of nondeductible items relative to overall profitability and other
factors. The Company's estimated effective tax rate for financial reporting
purposes for 1997 is also 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 under
a Company sponsored program.
1997 Outlook
Many factors may affect the Company's 1997 operations and results for the
remainder of 1997 as compared to 1996. As discussed in more detail above, some
of the more significant factors include: a narrowing of profit margins in the
Company's business which began to be felt in late 1996 and continues into 1997;
an increase in competition and an overall weakening in pricing for the Company's
services in the workers' compensation and employee benefit markets; increased
reliance on industry-wide data relative to ESI's specific risk structure and
philosophy in estimating workers' compensation reserves; certain tax benefits
the Company received in 1996 relating to prior years; and increased interest
expense, lease payments, amortization and litigation expense.
Additional factors which may impact the Company's future operations and results
are discussed below under "Outlook: Issues and Risks."
Liquidity and Capital Resources
The Company defines liquidity as the ability to mobilize cash to meet operating,
capital and acquisition financing needs. The Company's primary sources of cash
in the quarter ended June 30, 1997 were from financing activities and
operations.
Cash provided by operating activities was $2.8 million during the six months
ended June 30, 1997 compared to cash used in operating activities of $2.2
million during the same period of 1996. Operating cash flows are derived from
customers for full PEO services rendered by the Company and for stand-alone risk
management/workers' compensation services. Payments from PEO 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. The
acquisitions of TEAM Services, Leaseway and certain companies in the
McClary-Trapp Group and the Company's stand-alone program adversely affected the
Company's operating cash flows as these operations extend credit terms generally
from 15 to 45 days as is customary in their respective markets segments.
Stand-alone risk management/workers' compensation services are billed in
accordance with individual policies. The Company also extends credit terms for
certain of its stand-alone risk management/workers' compensation clients by
billing less than the expected premium over the policy term, with the difference
paid on a deferred basis after the end of a policy year. In addition, accounts
receivable were increased because of the results of audits of stand-alone
workers' compensation policies which began in the first quarter of 1997. These
audits have indicated additional amounts due to the Company based upon changes
during the policy year, which are being billed to customers. The amounts due as
a result of the audits include $1.0 million recognized in the first quarter of
1997 which relate to prior periods. If the Company expands in these market
segments or enters into new market segments, or extends credit terms to
additional clients, its working capital requirements may increase. Included in
other assets is a net receivable of $2.9 million from a single customer as to
which disputes have risen. Although the Company believes the amount is
collectible, the Company is considering its alternatives, including litigation,
for collection of the receivable.
18
<PAGE>
Cash used in investing activities was $8.0 million and $4.8 million in the six
months ended June 30, 1997 and 1996, respectively. For 1997 and 1996, capital
expenditures were $1.1 million and $.4 million, respectively. Capital
expenditures in 1997 consisted primarily of personal computers and other
computer equipment to enhance the Company's ability to support the Company's
increasing client and employee base. In April 1997, the Company relocated its
Phoenix operations to a new facility. The leaseholds and improvements will be
financed by the landlord as a buildout allowance, and subsequently reflected in
rental payments. Moving costs and office furniture represented cash outlays in
the first and second quarters of 1997 of approximately $1.0 million. During the
remainder of 1997, the Company expects to continue to invest in additional
computer and technological equipment. Although the Company continuously reviews
its capital expenditure needs, management expects that 1997 capital expenditures
will exceed those incurred in prior periods to meet the needs of the Company's
growing base of worksite employees.
Cash provided by financing activities was $4.8 million for the six months ended
June 30, 1997 compared to cash provided by financing activities of $3.7 million
for the same period in 1996. Cash flows from financing activities during 1997
resulted primarily from the Company's borrowing for acquisition financing (see
below) and the sale of the Company's Common Stock upon exercise of options.
At June 30, 1997 and 1996, the Company had cash and cash equivalents of $10.6
million and $10.7 million, respectively. Cash and cash equivalents are generally
invested in high investment grade instruments with maturities of less than 90
days. Certain amounts of restricted cash and investments (see below) may have
maturities beyond 90 days but are highly liquid. The Company generally maintains
large cash balances to meet its daily payroll and payroll tax obligations. The
Company is implementing a nationwide cash management program to minimize the
requirement for cash on hand, though as the business continues to grow, cash
requirements to meet daily obligations will increase. The Company is required
through its fronting arrangements with Reliance to maintain restricted cash and
investments to secure the future payment of workers' compensation losses. Such
restricted cash and investments have been calculated based on estimates of the
future growth in the Company's business and ultimate losses on such business.
For this purpose, ultimate losses are actuarially determined by the fronting
carriers utilizing industry-wide data and regulatory requirements which may not
reflect the Company's historical or expected ultimate losses. Restricted cash
and investments is classified as a current asset as the Company settles and pays
most workers' compensation claims within one year from occurrence. The Company
cannot access restricted cash and investments without the agreement of Reliance.
At June 30, 1997, $14.0 million was on deposit at Camelback as restricted cash
and investments.
At June 30, 1997 and December 31, 1996, the Company had working capital of $35.0
million and $30.5 million, respectively.
Assuming continued growth of the Company's full-service PEO business and
stand-alone risk management/workers' compensation services program, the Company
anticipates that it will be required under its arrangements with its insurers to
set aside increasing amounts of funds for payment of claims and related
administrative costs.
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 million. In 1996, the
Company began the process of forming Camelhead Insurance Ltd. (Camelhead) as a
second captive insurance company, in the state of Hawaii. Due to cost and
capital requirement considerations, the Company has determined not to proceed
with the formation of Camelhead at this time and will continue to utilize
Camelback as its captive insurance company for all programs. Accordingly, it is
anticipated that the 1996-1997 Legion program will be placed with Camelback.
Bermuda law also regulates the circumstances under which Camelback may loan
funds to its parent company. In the six months ended June 30, 1997, the Company
paid to Reliance approximately $10.7 million of which $6.6 million was ceded to
the trust account at Camelback for payment of claims and $2.1 million was ceded
directly to Camelback as unrestricted. For the same period the Company also paid
to Legion approximately $2.6 million of which $1.7 million in loss funds will be
ceded to Camelback upon the establishment of a separate trust account for the
program. In the future, these factors may limit the ability of the Company to
execute its planned growth
19
<PAGE>
strategy and may limit the ability of Camelback to transfer funds to its parent
company (whether via dividend or otherwise).
On August 1, 1996, the Company entered into a three year $35 million revolving
credit facility for acquisition financing, working capital and other general
corporate purposes. The line was expanded to $45 million on October 15, 1996 and
to $60 million on February 19, 1997. Currently, the revolving credit facility
provides for various borrowing rate options including borrowing rates based on a
fixed spread of 25 basis points over the prime rate or 250 basis points over the
London Interbank Offered Rate (LIBOR), as adjusted upward to reflect applicable
reserve requirements. The Company pays a commitment fee of 3/8% on the unused
portion of the line. Total costs incurred in obtaining this facility and the
expansion were approximately $650,000 and will be amortized over the life of the
facility. The line matures on August 1, 1999, and the maximum borrowing will
decrease by $3.0 million in each quarter beginning February 1, 1998. Effective
June 30, 1997, the facility was modified to permit the Company to more fully
utilize the line of credit and allow for additional liquidity. The principal
loan covenants have been modified as follows: current ratio of at least 1.3 to
1; minimum net worth of at least $45 million as of June 30, 1997, adjusted by
75% of net income and other factors each and every fiscal quarter thereafter;
total funded debt to earnings before taxes, depreciation and amortization for
the preceding four quarters of not more than 2.5 to 1 as of the end of each
calendar quarter through December 31, 1997, 2.25 to 1 as of March 31, 1998 and
2.0 to 1 as of June 30, 1998 and thereafter. Effective January 1, 1998, with
respect to the variable rate option, if the total funded debt to earnings before
taxes, depreciation and amortization is greater than 1.5 to 1 the borrowing rate
will be 125 basis points greater than the local published Phoenix based prime
rate, the fixed rate shall be based on a fixed spread of 350 basis points over
LIBOR, as adjusted to reflect applicable reserve requirements. Total costs
incurred in obtaining the modification agreement were approximately $75,000 and
will be amortized over the life of the facility. The facility includes certain
other covenants and is secured by substantially all of the Company's assets.
Since the Company obtained its line of credit in August 1996, the $47.3 million
drawn under the line has been used primarily for acquisition financing
including: $24.0 million for the acquisition of Leaseway; $9.4 million for the
acquisition of the McClary-Trapp Group, $3.0 million for CMGR, $.9 million for
ETIC and approximately $10.0 million to finance accounts receivable on such
acquisitions. At June 30, 1997, the Company had borrowed approximately $47.3
million, and had outstanding $2.0 million in letters of credit, under the credit
facility; at that date, the Company's borrowing limit was approximately $56.5
million as a consequence of the combination of the overall line of credit and
borrowing covenants. At August 12, 1997, the Company had borrowed approximately
$48.0 million, and had outstanding $2.0 million in letters of credit, under the
credit facility. On an ongoing basis to provide for future needs, the Company
believes that it will require a credit facility in a larger amount, with more
flexible financial covenants. Because its current lenders have indicated that
such an arrangement would not be available through them, the Company intends to
seek to make alternative credit arrangements. However, there can be no
assurances the Company will be able to accomplish that goal on terms and
conditions which are reasonably acceptable to it.
The Company has financed its acquisitions through combinations of issuance of
Common Stock, borrowing under its credit facility, working capital and
assumption of acquired company obligations. The Company's revolving credit
facility restricts its ability to consummate any acquisition prior to creditor
approval. The Company received a waiver under the revolving credit facility to
enter into its agreements to acquire ETIC and CMGR.
Since the Company's borrowing arrangements limit borrowings based on earnings
before income tax, depreciation and amortization as discussed above, the
Company's borrowing capacity would be affected if earnings in future quarters
are below the preceding quarters, as they were in the first and second quarters
of 1997. Limitations on borrowings (particularly if limits were to go below the
Company's current borrowing level) could negatively affect the Company's
liquidity and operations, depending upon cash needs at the time. Therefore, the
Company is exploring additional sources of capital and liquidity.
Subject to the foregoing and recognizing that the Company is nearing the
borrowing cap and will need to carefully manage its liquidity situation,
management believes that existing cash and cash equivalents, cash generated from
ongoing operations, and cash available through its existing line of credit will
satisfy the anticipated current short-term cash requirements of the Company's
operations; however, unanticipated cash needs may exceed the Company's available
sources of liquidity and in the long-term the Company believes it will need to
arrange a new credit facility. The Company's ability to continue funding its
acquisition strategy is dependent upon its ability to obtain additional funds
through equity or debt financing. In the event of a reduction in the borrowing
capacity under the current credit arrangements, the Company would need to pursue
alternative borrowing strategies or seek equity financing.
20
<PAGE>
Outlook: Issues and Risks
The following issues and risks, among others (including those discussed
elsewhere herein), should also be considered in evaluating the Company's
outlook.
Management of Rapid Growth
The Company's success depends, in part, upon its ability to achieve growth and
manage this growth effectively. Since its formation, the Company has experienced
rapid growth which has challenged the Company's management, personnel, resources
and systems. As part of its business strategy, the Company intends to pursue
continued growth through its sales and marketing capabilities, acquisitions and
marketing alliances. Although the Company intends to expand its management,
personnel resources and systems to manage future growth and to assimilate
acquired operations, there can be no assurance that the Company will be able to
maintain or accelerate its growth in the future or manage this growth
effectively. Failure to do so could materially adversely affect the Company's
business and financial performance. Because the Company intends to focus in the
short term on further integrating prior acquisitions into the Company's
operations, the Company does not currently expect 1997 acquisition activity to
be as extensive as in 1996. To accommodate growth, the Company relocated its
Phoenix operations to new offices in April 1997 and is considering centralizing
certain other operations, which moves may result in certain disruptions.
A substantial portion of the Company's recent and anticipated growth is
attributable to its risk management/workers' compensation services program. The
risks associated with rapid growth in this area include the potential for poor
underwriting due to a lack of experience with new geographic markets and
industries served, a shortage of experienced and trained personnel, and the need
for sophisticated operating systems to help manage these risks. The Company
recently converted its risk management information system to a new operating
system to support this growth; there can be no assurances that this conversion
will ultimately prove to be successful, or that other future changes in systems
or procedures will be successfully completed. Any failure to successfully manage
growth in the risk management/workers' compensation program could adversely
affect the Company's ability to underwrite profitable risks and efficiently
resolve claims, which in turn could have a material adverse effect on the
Company's business and financial performance.
Adequacy of Loss Reserves
Under its present workers' compensation arrangements, the Company is responsible
for the first $250,000 ($350,000 for certain transportation programs and
$500,000 in certain states with "monopolistic" workers' compensation insurance
structures) of each loss with no aggregate limit to the number of losses for
which the Company may be liable. Under its partially self-insured and
self-insured health insurance arrangements, the Company is responsible for the
first $100,000 or $75,000 per covered individual per year, depending upon the
program. The Company's reserves for losses and loss adjustment expenses under
its workers' compensation and health insurance programs are estimates of amounts
needed to pay reported and unreported claims and related loss adjustment
expenses. Reserves are estimates based on industry data and historical
experience, and include judgments of the effects that future economic and social
forces are likely to have on the Company's experience with the type of risk
involved, circumstances surrounding individual claims and trends that may affect
the probable number and nature of claims arising from losses not yet reported.
Consequently, loss reserves are inherently uncertain and are subject to a number
of highly variable and difficult to predict circumstances. This uncertainty is
compounded in the Company's case by its rapid growth and limited experience. For
these reasons, there can be no assurance that the Company's ultimate liability
will not materially exceed its loss and loss adjustment expense reserves. If the
Company's reserves prove to be inadequate, the Company will be required to
increase reserves or corresponding loss payments with a corresponding reduction,
which may be material, in the Company's net income in the period in which the
deficiency is identified.
Loss and Claims Experience
During the limited period of time the Company has operated its risk
management/workers' compensation programs, it believes that it has achieved a
below average loss experience ratio primarily due to its selective evaluation
process, safety programs, active claims management and maintenance of its
accidental death and dismemberment policy. However, the Company may experience
adverse development on prior losses, and in any event not be able to
21
<PAGE>
maintain such a loss experience over a longer period of time. Future loss
experience could increase due to weakened underwriting standards as a result of
internal growth, the loss experience of acquired operations, increased
competition in the Company's risk management/workers' compensation business or
other factors which may affect the Company's standards, procedures or claims
experience in the future. An increase in the Company's loss experience would
decrease the Company's net income and could materially adversely affect the
Company's business and financial performance.
The Company provides stand-alone risk management/workers' compensation coverage
on either a guaranteed cost basis or a "retrospective" basis in which premiums
are adjusted after the end of the policy term to reflect loss experience. In a
guaranteed cost arrangement, the Company bears the risk of losses, which may be
higher than anticipated. While premiums are adjusted to reflect actual losses in
a retrospective policy, which may reduce risk to the Company, lower than
anticipated losses on these policies may negatively affect the Company because
the Company may have recorded a higher premium which would have resulted from
the expected loss level.
State unemployment taxes are, in part, determined by the Company's unemployment
claims experience. 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 its costs in these areas would increase. In such a
case, the Company may not be able to pass these higher costs to its clients and
would therefore have difficulty competing with the PEOs with lower claims rates
that may offer lower rates to clients.
Tax Code Treatment
The IRS has formed a Market Segment Study Group to examine whether PEOs, such as
the Company, are for certain tax purposes the "employers" of worksite employees
under the Code. The Company cannot predict either the timing or the nature of
any final decision that may be reached by the IRS with respect to the Market
Segment Study Group or the ultimate outcome of any such decision, nor can the
Company predict whether the Treasury Department will issue a policy statement
with respect to its position on these issues or, if issued, whether such
statement would be favorable or unfavorable to the Company. If the IRS were to
determine that the Company is not an "employer" under certain provisions of the
Code, it could materially adversely affect the Company in several ways. First,
with respect to benefit plans, the tax qualified status of the Company's 401(k)
plans would be revoked, and the Company's cafeteria and medical reimbursement
plans may lose their favorable tax status. Effective as of January 1, 1997, the
Company has implemented a new 401(k) retirement plan which involves both the
client and the Company as co-sponsors of the plan and is intended to be a
"multiple employer" plan under Code Section 413(c). The Company believes that
this multiple employer plan is less likely to be adversely affected by any IRS
determination that no employer relationship exists between the Company and
worksite employees. While the Company does sponsor some sole employer plans
covering worksite employees which the Company assumed in connection with other
acquired PEO operations and which could be adversely affected by any unfavorable
IRS determination, the Company intends to convert the majority of the sole
employer plans into one or more multiple employer plans, and the Company
believes that any unfavorable IRS determination, if applied prospectively (that
is, applicable only to periods after such a determination is reached), would
probably not have a material adverse effect on the Company's financial position
or results of operations. However, if an adverse IRS determination were applied
retroactively to disqualify benefit plans, employees' vested account balances
under 401(k) plans would become taxable, an administrative employer such as the
Company would lose its tax deductions to the extent its matching contributions
were not vested, a 401(k) plan's trust could become a taxable trust and the
administrative employer could be subject to liability with respect to its
failure to withhold applicable taxes and with respect to certain contributions
and trust earnings. In such event, the Company also would face the risk of
client dissatisfaction and potential claims by clients or worksite employees.
A determination by the IRS that the Company is not an "employer" under certain
provisions of the Code also could lead the IRS to conclude that federal taxes
were not paid by the proper party because such taxes must be paid by the
employer. This conclusion could lead to actions by the IRS against clients of
the Company seeking direct payment of taxes, plus penalties and interest, even
though the taxes were previously paid by the Company.
In light of the IRS Market Segment Study Group and the general uncertainty in
this area, certain proposed legislation has been drafted to clarify the employer
status of PEOs in the context of the Code and benefit plans.
22
<PAGE>
However, there can be no assurance that such legislation will be proposed and
adopted or in what form it would be adopted. Even if it were adopted, the
Company may need to change aspects of its operations or programs to comply with
any requirements which may ultimately be adopted. In particular, the Company may
need to retain increased sole or shared control over worksite employees if the
legislation is passed in its current form.
The attractiveness to clients of a full-service PEO arrangement depends in part
upon the tax treatment of payments for particular services and products under
the Code (for example, the opportunity of employees to pay for certain benefits
under a cafeteria plan using pre-tax dollars). An adverse determination of the
IRS Market Segment Study Group, changes to the Code, related IRS regulations or
other laws and regulations could adversely affect the Company's business and
financial performance.
Credit Risks
As the employer of record for its worksite employees, the Company is obligated
to pay their wages, benefit costs and payroll taxes. The Company typically bills
a client company for these amounts in advance of or at each payroll date, and
reserves the right to terminate its agreement with the client, and thereby the
Company's liability for future payrolls to the client's worksite employees, if
payment is not received within two days of the invoice date. However, the rapid
turnaround necessary to process and make payroll payments leaves the Company
vulnerable to client credit risks, some of which may not be identified prior to
the time payroll payments are made. There can be no assurance that the Company
will be able to timely terminate any delinquent accounts or that its contractual
termination rights will be judicially enforced.
In addition, the Company has recently entered several market segments through
acquisitions in which PEOs typically advance wages, benefit costs and payroll
taxes to their clients. The Company intends to continue this practice despite
the potentially greater credit risk posed by such practices. Also, in its
stand-alone risk management/worker's compensation program, the Company
structures certain of its clients' premium payments so that less than the full
premium is billed periodically through the policy year, with the difference to
be paid by the client on a deferred basis after the end of the policy year. In
each case, the Company conducts a limited credit review before accepting new
clients. However, the nature of the Company's business and pricing margins is
such that a small number of client credit failures could have an adverse effect
on its business and financial performance.
Litigation
The Company and several of its present and former executive officers and
directors have been named as defendants in several actions alleging violations
of securities laws with respect to the accuracy of certain statements regarding
Company reserves and other disclosures made by the Company and certain of its
directors and officers. These suits were filed shortly after a significant drop
in the trading price of shares of the Company's common stock in March 1997. The
suits have been consolidated before a single judge of the U.S. District Court in
Phoenix, Arizona. The Court has before it motions by the plaintiffs for the
appointment of representative plaintiffs and approval of selection of lead
counsel. Once these motions are ruled upon, it is anticipated that a
consolidated, amended complaint will be filed.
While the complaints do not specify alleged damages, the Company expects the
requests for damages to be substantial. The Company believes the claims are
without merit, and intends to defend these actions vigorously. However, the cost
of defending these actions could have a material adverse effect on the Company's
results of operations in future periods, and their ultimate resolution could
have a material adverse effect on the Company's results of operations and
financial condition. In addition, publicity relating to the litigation could
have a negative effect on the Company's relationships with its current and
prospective clients, employees and suppliers.
Client Relationships
The Company's subscriber agreements with its clients generally may be canceled
upon 30 days written notice of termination by either party. While the Company
believes that it has experienced favorable client retention in the past, there
can be no assurance that those relationships will continue or that historical
rates of retention will continue to be achieved. The short-term nature of most
customer agreements means that clients could terminate a substantial portion of
the Company's business upon short notice.
23
<PAGE>
Through recent acquisitions and internal growth, the percentage of Company's
clients in the transportation industry has increased. While the Company has
targeted this industry, which it believes could benefit from Company services
and expertise, increased concentration in a single industry could make the
Company more subject to risks and trends of that industry. Also, certain aspects
of the transportation industry may be subject to particular risks, such as the
risk of property damage, injury and death from accidents inherent in the
operation of a motor vehicle. In addition, the Company is providing driver
leasing services, in which the Company acts as sole employer, which results in
increased employee related litigation and otherwise increases risk to the
Company as a result of the direct nature of the employment relationship.
Dependence on One Insurer
The Company believes that its risk management/workers' compensation services
program has been and will continue to be an important competitive factor in its
growth and profitability. The Company's risk management/workers' compensation
services program is currently being conducted principally in coordination with
one insurer, Reliance. The Company's contract with Reliance is priced annually
and was last renewed as of May 1, 1997, and is subject to further annual renewal
and pricing decisions. The contract may also be canceled by Reliance under
certain conditions. There can be no assurance that upon expiration of the
current term the Company can renew the Reliance program on commercially
reasonable terms. The Company would be materially adversely affected by a
termination of its arrangements with Reliance if the Company could not quickly
make similar arrangements with another insurer. In part to lessen its dependence
upon Reliance, the Company is seeking to establish relationships with additional
insurers. While it had entered into an agreement with Legion for certain Company
programs, the Legion relationship was terminated effective August 1, 1997 due to
cost and capital considerations. However, this change increases the Company's
dependence upon Reliance. The Company's ability to make similar arrangements
with other insurers is limited, however, because other insurers generally
require large segregated books of business in order to lessen the risk of
adverse selection by the Company and to maximize the economic potential of the
arrangement for the insurer. There can therefore be no assurance that the
Company will be able to significantly lessen its dependence on Reliance in the
near future.
Uncertainty of Extent of PEO's Liability; Government Regulation of PEOs
The Company's clients are regulated by numerous federal and state 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 PEO services, many of these laws do not
specifically address the obligations and responsibilities of non-traditional
employers such as the Company, and there are many legal uncertainties about
employee relationships created by PEOs, such as the extent of the PEO'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. 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 forms of client service agreement establish 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, and in some instances acts as sole employer, the Company may be
subject to liability for violations of these or other laws despite these
contractual provisions, even if it does not participate in such violations. The
circumstances in which the Company acts as sole employer may expose the Company
to increased risk of such liabilities for an employee's actions. The Company has
been sued in tort actions alleging responsibility for employee actions (which it
considers to be incidental to its business). Although it believes it has
meritorious defenses, and maintains insurance (and requires its clients to
maintain insurance) covering certain of such liabilities, there can be no
assurances that the Company will not be found to be liable for damages in any
such suit, or that such liability would not have a materially adverse effect on
the Company. Although the client generally is required to indemnify the Company
for any liability attributable to the conduct of the client or employee, the
Company may not be able to collect on such a
24
<PAGE>
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.
While many states do not explicitly regulate PEOs, an increasing number of
states have passed laws that have licensing or registration requirements and
other states are considering such regulation. Such laws vary from state to state
but generally provide for monitoring the fiscal responsibility of PEOs. 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
As part of its risk management/workers' compensation programs, the Company
utilizes Camelback. Insurance companies such as Camelback are subject to the
insurance laws and regulations of the jurisdictions in which they are chartered;
such laws and regulations generally are designed to protect the interests of
policyholders rather than the interests of shareholders such as the Company. In
general, insurance regulatory authorities have broad administrative authority
over insurers domiciled in their respective jurisdictions, including authority
over insurers' capital and surplus levels, dividend payments, financial
disclosure, reserve requirements, investment parameters and premium rates. The
jurisdictions also limit the ability of an insurer to transfer or loan statutory
capital or surplus to its affiliates. The regulation of Camelback could
materially adversely affect the Company's operations and results.
The Company's risk management/workers' compensation services program is
conducted via "fronting" arrangements with insurers. The National Association of
Insurance Commissioners (NAIC) recently adopted a model act concerning
"fronting" arrangements. 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. No determination
can be made as to whether, or in what form, such act may ultimately be adopted
by any state and, the Company is therefore unable to predict whether the model
act will affect its relationships with its insurers.
State regulation requires licensing of persons soliciting the sale of workers'
compensation insurance within that state. In certain states, licenses are
obtained by individual agents rather than a corporate entity. The Company, or
one of its employees, is licensed in 41 states, and has applied to be licensed
in others. Although the Company does not believe that its activities require
such licenses because it solicits through other licensed entities, the Company
may be adversely affected if it is deemed to be making sales without a license
in jurisdictions where it is not licensed, or it ceases to maintain necessary
licenses upon the departure of the employee who holds certain of such licenses.
Acquisitions
The Company has grown substantially in recent years through the acquisition of
other PEO and similar companies. A key component of the Company's long-term
growth strategy is to continue to pursue attractive acquisition opportunities.
However, there can be no assurance that the Company will be able to find
attractive acquisition candidates at reasonable prices or, if it does, that
other potential acquirers will not compete successfully with the Company for
these candidates. Also, there can be no assurance that the Company will have or
be able to obtain the resources necessary to successfully make future
acquisitions or to integrate acquired operations into the Company. Because of
the need to integrate acquisitions into the Company's operations and the high
volume of acquisitions in 1996, the Company does not currently expect 1997
acquisition activity to be as extensive as in 1996. Any significant increase in
the number of companies competing with the Company to acquire PEOs would likely
increase the cost of acquisitions and thereby limit the Company's ability to
grow profitably through acquisitions. In addition, although the Company attempts
to evaluate each acquisition candidate thoroughly prior to an acquisition, there
can also be no assurance that, once acquired, the Company will be able to
integrate the acquired company with the Company's existing operations or achieve
acceptable levels of revenues, profitability or productivity from the acquired
company.
25
<PAGE>
In addition, because the Company generally accounts for its acquisitions using
the "purchase" method of accounting, prior periods are not restated to reflect
those acquisitions. Therefore, the Company's period-to-period results may vary
significantly as a result of acquisitions.
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. Any health care reform proposal which
mandated health insurance benefits based on the number of employees employed by
an entity could adversely affect PEOs such as the Company, which for some
purposes are deemed to employ all their clients' employees. In addition, certain
reform proposals have sought to include medical costs for workers' compensation
in the reform package. If such proposals increased the cost of medical payments
or limited the Company's ability to control its workers' compensation costs, the
Company's ability to offer competitively-priced workers' compensation coverage
to its clients could be adversely affected. 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.
The Health Insurance Portability and Accountability Act of 1996 may increase the
Company's risks relating to worksite employee health insurance programs because
it extends the periods for which, and circumstances under which, an employer
must allow an employee to participate in the employer's health plans. Such
expanded availability may adversely affect the risk profile and claims
experience of groups insured through the Company, and thereby affect the
Company's premiums and the Company's retained risks under its self-insured
programs.
Tax Liabilities
As the employer of record for approximately 1,444 client companies and their
42,900 worksite employees, the Company must account for and remit payroll,
unemployment and other employment-related taxes to numerous federal, state and
local tax, labor and unemployment authorities, and is subject to substantial
penalties for failure to do so. From time to time, the Company has received
notices or challenges which may adversely affect its tax rates and payments. The
Company has received a letter from the Arizona Department of Economic Security
with respect to its unemployment tax rate for the year ended December 31, 1994
which, if determined adversely to the Company, would result in an amount due of
approximately $500,000 (before interest and income tax effect). In addition, the
Company has notices from the IRS and various states alleging late payment of
payroll taxes relating to an acquired company. Although the penalties proposed
to be assessed against the Company for post-acquisition filings have been abated
by the IRS, the penalties to be assessed against the predecessor company total
approximately $130,000 (plus interest), after IRS reduction, for the period
during which the Company performed designated management services on behalf of
the predecessor. The Company believes that it has defenses to these actions, and
has objected vigorously to payment of such past taxes and remaining penalties.
However, it is not possible to predict if the Company will be successful in
abating these taxes and penalties, or other claims which could arise in the
future. The Company would be required to record these amounts as additional
expense and liability if, at any time in the future, it appeared probable that
the Company would not prevail in these matters.
Competition
The market for many of the services provided by the Company is highly
fragmented, with over 2,300 PEOs currently competing in the United States. Many
of these PEOs have limited operations with relatively few worksite employees,
but the Company believes at least one is larger than the Company and several
others approach the Company's size. The Company also competes less directly with
non-PEO companies whose offerings overlap with some of the Company's PEO
services, including payroll processing firms, insurance companies, temporary
personnel companies and human resource consulting firms. In addition, the
Company expects that as the PEO industry becomes better established, competition
will increase because existing PEO firms will likely consolidate into fewer and
better competitors and well-organized new entrants with greater resources than
the Company, including some of the non-PEO companies described above, will enter
the PEO market.
In the stand-alone risk management/workers' compensation services area, the
Company considers state insurance funds and other private insurance carriers to
be its primary competition. The Company recently has experienced the
26
<PAGE>
effects of an increase in competition, and a general softening of the market, in
the workers' compensation and benefits areas, which affects the Company's growth
and margins.
Dependence Upon Certain Officers and Key Employees
The Company is highly dependent upon the services of certain of its officers and
key employees, particularly Marvin D. Brody, its Chief Executive Officer. The
loss of services of any of these individuals would have a material adverse
effect upon the Company. The Company does not have employment or non-competition
agreements with Mr. Brody or employment agreements with certain other of these
individuals.
Volatility of Securities Prices
The market price of the Company's common stock has risen substantially since its
initial public offering in August 1993, and in that time has been and may
continue to be highly volatile. The market has experienced particularly severe
volatility since March 1997. Factors such as the Company's actual or anticipated
operating results, acquisition activity, or other announcements by or about the
Company or its competitors have, and may continue to have, a significant effect
on the market price of the Company's securities. In addition, the Company's
Common Stock is quoted on the NASDAQ National Market, which market has
experienced, and is likely to experience in the future, significant price and
volume fluctuations which could adversely affect the price of the Company's
Common Stock without regard to the operating performance of the Company.
Authorization of Preferred Stock
The Company's Articles of Incorporation authorize the issuance of up to
10,000,000 shares of Preferred Stock with such rights and preferences as may be
determined from time to time by the Board of Directors. No shares of Preferred
Stock are currently outstanding. Accordingly, under the Articles of
Incorporation, the Board of Directors may, without shareholder approval, issue
Preferred Stock with dividend, liquidation, conversion, voting, redemption or
other rights which could adversely affect the voting power or other rights of
the holders of the Common Stock. The issuance of any shares of Preferred Stock
having rights superior to those of the Common Stock may result in a decrease of
the value or market price of the Common Stock and could further be used by the
Board as a device to prevent a change in control of the Company.
Item 3. Quantitative and Qualitative Disclosure About Market Risk
Not yet required by Company.
27
<PAGE>
PART II - OTHER INFORMATION
Item 1. Legal Proceedings
As the Company has previously reported, the Company, and certain of its
executive officers, have been named as defendants in several securities actions
filed in 1997. While the exact claims and allegations vary, they all allege
violations by the Company of Section 10(b) of the Securities Exchange Act, and
Rule 10b-5 promulgated thereunder, with respect to the accuracy of statements
regarding Company reserves and other disclosures made by the Company and certain
directors and officers. These suits were filed shortly after a significant drop
in the trading price of the Company's Common Stock in March 1997. Each of the
actions seek certification of a class consisting of purchasers of securities of
the Registrant over specified periods of time. Each of the complaints seeks the
award of compensatory damages in amounts to be determined at trial, including
interest thereon, and costs of the action, including attorneys fees. The Company
believes the actions are without merit and intends to defend the cases
vigorously.
The Company previously reported being named as a defendant in two lawsuits,
filed by M & M Services, Inc. and B&B Amusements, Inc., respectively,
purportedly as class actions, challenging the manner in which the Company billed
its customers for payroll taxes. These suits have been dismissed by the court
with prejudice, without any payments to the plaintiffs and without liability to
the Company.
The Company previously reported that it had received a payroll tax penalty
notice from the Internal Revenue Service relating to the operations it acquired
from Hazar, Inc. alleging certain late payment of the payroll taxes in early
1996. Penalty amounts had totaled approximately $470,000, before interest. The
Company contested such penalties, and upon consideration, the Internal Revenue
Service has abated all such penalties. (A request for abatement relating to
penalties proposed to be assessed against Hazar operations, totaling $390,000,
plus accrued interest, for a period during which the Company performed
designated management services on behalf of Hazar, remains pending. The proposed
penalties against Hazar have been reduced to $130,000 by an IRS appeal officer;
however, the Company understands that such amount has not yet been collected
from Hazar. The Company believes that it has no liability for such amounts.)
Item 4. Submission of Matters to a Vote of Security Holders
The Company held its Annual Meeting of Shareholders on July 9, 1997. Of the
30,871,107 outstanding shares of the company's common stock as of the May 5,
1997 record date, 26,542,026 shares, or 85.98% of the total, were voted by
proxy.
(a) At the Annual Meeting of the Shareholders, the shareholders elected six
directors. With respect to the election of directors, the following
votes were cast in favor of, or withheld authority, for each of the
following directors:
=======================================================================
Directors In Favor of Withheld
------------------ ----------- --------
Marvin D. Brody 26,247,489 307,137
Harvey A. Belfer 26,256,599 298,027
Edward L. Cain, Jr. 26,269,679 284,947
Jeffery A. Colby 26,271,999 282,627
Robert L. Mueller 26,269,924 284,702
Henry G. Walker 26,270,924 283,702
-----------------------------------------------------------------------
(b) At the Annual Meeting of Shareholders, the shareholders also voted on a
proposal to amend the Company's 1995 Stock Option Plan (Plan) to limit
the number of shares of Company Common Stock which may be subject to an
option granted to any individual in any calendar year. With respect to
that amendment, of the reported 26,554,626 votes cast, 26,233,948 were
for, 236,742 were against and 83,936 abstained.
Item 6. Exhibits and Reports on Form 8-K
28
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(a) Exhibits
Exhibit
Number Description
------ -----------------------------------------------------
4.1 Third Modification Agreement effective as of June 30,
1997 between Employee Solutions, Inc. and Bank One
Arizona, NA.
27 Financial Data Schedule
(b) Reports on Form 8-K.
The Company filed no Reports on Form 8-K during the quarter ended June
30, 1997.
29
<PAGE>
SIGNATURES
Pursuant to the requirements of The Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
EMPLOYEE SOLUTIONS, INC.
Date: August 19, 1997 /S/ Marvin D. Brody
------------------- ------------------------------
Marvin D. Brody
Chief Executive Officer
/S/ Morris C. Aaron
------------------------------
Morris C. Aaron
Chief Financial Officer
/S/ John V. Prince
------------------------------
John V. Prince
Chief Accounting Officer
30
THIRD MODIFICATION AGREEMENT
----------------------------
EFFECTIVE DATE: June 30, 1997
- --------------
PARTIES: Borrower: Employee Solutions, Inc.,
- ------- an Arizona corporation
Borrower 2929 East Camelback Road, Suite 220
Address: Phoenix, Arizona 85016-4426
Bank: Bank One, Arizona, NA,
a national banking association
Bank P.O. Box 71
Address: Phoenix, Arizona 85001
RECITALS:
- --------
A. Bank has extended to Borrower credit ("Loan") in the current
principal amount of $60,000,000.00 pursuant to the Loan Agreement dated August
1, 1996 ("Credit Agreement"), and evidenced by the Secured Promissory Note dated
August 1, 1996 ("Note"). The unpaid principal of the Loan as of the date hereof
is $47,300,000.00.
B. The Loan is secured by, among other things, the Security Agreement
dated August 1, 1996, as modified by the Letter Agreement dated August 22, 1996
("Security Agreement"), between the Obligor (as defined therein) and Bank (the
agreements, documents, and instruments securing the Loan and the Note are
referred to individually and collectively as the "Security Documents").
C. Bank and Borrower have executed and delivered previously the
following agreements ("Modifications") modifying the terms of the Loan, the
Note, the Credit Agreement, and/or the Security Documents: Letter Agreement
dated August 22, 1996, Modification Agreement dated October 15, 1996, and Second
Modification Agreement dated February 19, 1997. The Note, the Credit Agreement,
the Security Documents, any arbitration resolution, any environmental
certification and indemnity agreement, and all other agreements, documents, and
instruments evidencing, securing, or otherwise relating to the Loan, as modified
in the Modifications, are sometimes referred to individually and collectively as
the "Loan Documents".
D. Borrower has requested that Bank modify the Loan and the Loan
Documents as provided herein. Bank is willing to so modify the Loan and the Loan
Documents, subject to the terms and conditions herein.
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AGREEMENT:
- ---------
For good and valuable consideration, the receipt and sufficiency of which are
hereby acknowledged, Borrower and Bank agree as follows:
1. ACCURACY OF RECITALS.
--------------------
Borrower acknowledges the accuracy of the Recitals.
2. MODIFICATION OF LOAN DOCUMENTS.
------------------------------
2.1 The Loan Documents are modified as follows:
2.1.1 Sections 6.12.1, 6.12.2, 6.12.4, 7.4 and 7.5 of the Credit
Agreement are hereby deleted in their entirety and replaced with the following:
6.12.1 Current Ratio. A minimum current ratio, calculated by
dividing Borrower's current assets by Borrower's current liabilities,
of 1.30 to 1.00. For purposes of this calculation, this credit
facility will be considered a current liability except the portion
which was used for cash acquisitions.
6.12.2 Minimum Net Worth. Minimum Net Worth of the amounts
indicated for the end of each period specified below:
Period Amount
------ ------
fiscal quarter $45,000,000.00
ending
June 30, 1997
Each and every
fiscal quarter
thereafter $45,000,000.00 increasing by 75% of Net
Income plus 100% of any additional equity
amounts raised by Borrower.
"Net Worth" is defined as the aggregate of total stockholders' equity.
6.12.4 Funded Debt to EBITDA. Total Funded Debt divided by EBITDA
not at any time greater than the amounts indicated for each period
ending on the date specified below:
Period Ratio
------ -----
June 30, 1997 2.5:1.0
2
<PAGE>
September 30, 1997 2.5:1.0
December 31, 1997 2.5:1.0
March 31, 1998 2.25:1.0
June 30, 1998, and thereafter 2.0:1.0
"Total Funded Debt" defined as current and long term portions of all
debt, excluding accounts payables, bank overdrafts, contingent
liabilities, income taxes payable, accrued expenses and deferred
income taxes. This covenant shall be tested as of the end of each
fiscal quarter, commencing for the fiscal quarter ending September 30,
1996, for such fiscal quarter and the immediately preceding three (3)
fiscal quarters taken as a whole. In addition, pro forma EBITDA of all
companies acquired with cash by Borrower from time to time shall be
included in the calculation of this covenant, provided pro forma
EBITDA shall be substantiated by audited financial statements or other
financial statements acceptable to Bank.
7.4 Loans, Investments, Guaranties, Subordinations. Without
Bank's consent, and except as provided herein, Borrower shall not
directly or indirectly (i) make any loan or advance to any other
Person in excess of $250,000.00, (ii) purchase or otherwise acquire
any capital stock or other securities of any other Person, any limited
liability company interest or partnership interest in any other
Person, or any warrants or other options or rights to acquire any
capital stock or securities of any other Person or any limited
liability company interest or partnership interest in any other
Person, (iii) make any capital contribution to any other Person, (iv)
otherwise invest in or acquire any interest in any other Person, (v)
guaranty or otherwise become obligated in respect of any indebtedness
of any other Person, (vi) subordinate any claim against or obligation
of any other Person to Borrower to any other indebtedness of such
Person, or (vii) create, incur, assume or permit to exist any
indebtedness or liabilities resulting from borrowings, loans or
advances, whether secured or unsecured, matured or unmatured,
liquidated or unliquidated, joint or several, except (a) the
liabilities of Borrower to Bank, and (b) any other liabilities of
Borrower existing as of, and disclosed to Bank prior to June 30, 1997.
7.5 Acquisition or Disposition of All or Substantially All
Assets. Borrower shall not acquire by purchase, lease, or otherwise
all or substantially all the assets of any other Person. Borrower
shall not sell, transfer, lease, or otherwise dispose of all or any
substantial part of the assets, business, operations, or property of
Borrower. Notwithstanding the preceding, Borrower shall have the right
to acquire all or substantially all the assets of Prompt Pay, Phoenix
Capital Management, and the four companies commonly referred to as
Employer Resources Corporation (an "Acquisition").
2.1.2 The following new Sections are hereby added to the Credit
Agreement:
3
<PAGE>
6.14 Pricing Change. Notwithstanding anything contained herein or
in the Loan Documents to the contrary, effective January 1, 1998, if,
and only if, as of December 31, 1997 the Funded Debt to EBITDA ratio
as calculated and defined in accordance with Section 6.12.4 is greater
than 1.50:1.0, Borrower covenants and agrees that the interest rates
set forth in the Note shall automatically be modified to (i) with
respect to the Variable Rate, the rate per annum equal to one and
one-quarter percent (1.25%) above the rate per annum most recently
publicly announced by Bank, or its successors, in Phoenix, Arizona, as
its "prime rate", as in effect from time to time, and (ii) with
respect to the Fixed Rate, the rate per annum equal to the sum of (A)
three and one-half percent (3.50%) per annum, and (B) the rate per
annum obtained by dividing (a) the rate of interest determined by
Bank, based on Telerate System reports or such other source as may be
selected by Bank, to be the "London Interbank Offered Rate" at which
deposits in United States dollars are offered by major banks in
London, England, one (1) Business Day before the first day of the
respective Interest Period by (b) a percentage equal to one hundred
percent (100%) minus the Eurodollar Rate Reserve Percentage for the
period equal to such Interest Period.
7.7 Dividends and Other Distributions. Borrower will not, without
the prior written consent of Bank in its absolute and sole discretion,
declare, make, order, authorize, or pay, directly or indirectly: (a)
any dividend or other distribution on or on account of any shares of
any class of capital stock of Borrower now or hereafter outstanding;
(b) any management fee; (c) any loans to shareholders of Borrower; or
(d) any purchase, redemption, retirement, or other acquisition of any
shares of any class of capital stock of Borrower now or hereafter
outstanding or of any warrants or rights to purchase any such stock or
partnership interest.
2.2 Each of the Loan Documents is modified to provide that it shall be
a default or an event of default thereunder if Borrower shall fail to comply
with any of the covenants of Borrower herein or if any representation or
warranty by Borrower herein or by any guarantor in any related Consent and
Agreement of Guarantor(s) is materially incomplete, incorrect, or misleading as
of the date hereof.
2.3 Each reference in the Loan Documents to any of the Loan Documents
shall be a reference to such document as modified herein.
3. RATIFICATION OF LOAN DOCUMENTS AND COLLATERAL.
---------------------------------------------
The Loan Documents are ratified and affirmed by Borrower and shall remain in
full force and effect as modified herein. Any property or rights to or interests
in property granted as security in the Loan Documents shall remain as security
for the Loan and the obligations of Borrower in the Loan Documents.
4
<PAGE>
4. BORROWER REPRESENTATIONS AND WARRANTIES.
---------------------------------------
Borrower represents and warrants to Bank:
4.1 No default or event of default under any of the Loan Documents as
modified herein, nor any event, that, with the giving of notice or the passage
of time or both, would be a default or an event of default under the Loan
Documents as modified herein has occurred and is continuing.
4.2 There has been no material adverse change in the financial
condition of Borrower or any other person whose financial statement has been
delivered to Bank in connection with the Loan from the most recent financial
statement received by Bank.
4.3 Each and all representations and warranties of Borrower in the
Loan Documents are accurate on the date hereof.
4.4 Borrower has no claims, counterclaims, defenses, or set-offs with
respect to the Loan or the Loan Documents as modified herein.
4.5 The Loan Documents as modified herein are the legal, valid, and
binding obligation of Borrower, enforceable against Borrower in accordance with
their terms.
4.6 Borrower is validly existing under the laws of the State of its
formation or organization and has the requisite power and authority to execute
and deliver this Agreement and to perform the Loan Documents as modified herein.
The execution and delivery of this Agreement and the performance of the Loan
Documents as modified herein have been duly authorized by all requisite action
by or on behalf of Borrower. This Agreement has been duly executed and delivered
on behalf of Borrower.
5. BORROWER COVENANTS.
------------------
Borrower covenants with Bank:
5.1 Borrower shall execute, deliver, and provide to Bank such
additional agreements, documents, and instruments as reasonably required by Bank
to effectuate the intent of this Agreement.
5.2 Borrower fully, finally, and forever releases and discharges Bank
and its successors, assigns, directors, officers, employees, agents, and
representatives from any and all actions, causes of action, claims, debts,
demands, liabilities, obligations, and suits, of whatever kind or nature, in law
or equity, that Borrower has or in the future may have, whether known or
unknown, arising from events occurring prior to the date of this Agreement and
in respect of the Loan, the Loan Documents, or the actions or omissions of Bank
in respect of the Loan or the Loan Documents.
5
<PAGE>
5.3 Contemporaneously with the execution and delivery of this
Agreement, Borrower has paid to Bank:
5.3.1 All accrued and unpaid interest under the Note and all
amounts, other than interest and principal, due and payable by Borrower under
the Loan Documents as of the date hereof.
5.3.2 All of the internal and external costs and expenses
incurred by Bank in connection with this Agreement (including, without
limitation, inside and outside attorneys, processing, filing, and all other
costs, expenses, and fees).
5.3.3 A modification fee equal to $75,000.00.
6. EXECUTION AND DELIVERY OF AGREEMENT BY BANK.
-------------------------------------------
Bank shall not be bound by this Agreement until each of the following shall have
occurred: (i) Bank has executed and delivered this Agreement, (ii) Borrower has
performed all of the obligations of Borrower under this Agreement to be
performed contemporaneously with the execution and delivery of this Agreement,
(iii) each guarantor(s) of the Loan, if any, has executed and delivered to Bank
a Consent and Agreement of Guarantor(s), and (iv) if required by Bank, Borrower
and any guarantor(s) have executed and delivered to Bank an arbitration
resolution, an environmental questionnaire, and an environmental certification
and indemnity agreement.
7. ENTIRE AGREEMENT, CHANGE, DISCHARGE, TERMINATION, OR WAIVER.
-----------------------------------------------------------
The Loan Documents as modified herein contain the entire understanding and
agreement of Borrower and Bank in respect of the Loan and supersede all prior
representations, warranties, agreements, arrangements, and understandings. No
provision of the Loan Documents as modified herein may be changed, discharged,
supplemented, terminated, or waived except in a writing signed by Bank and
Borrower.
8. BINDING EFFECT.
--------------
The Loan Documents as modified herein shall be binding upon, and inure to the
benefit of, Borrower and Bank and their respective successors and assigns.
9. CHOICE OF LAW.
-------------
This Agreement shall be governed by and construed in accordance with the laws of
the State of Arizona, without giving effect to conflicts of law principles.
10. COUNTERPART EXECUTION.
---------------------
This Agreement may be executed in one or more counterparts, each of which shall
be deemed an original and all of which together shall constitute one and the
same document. Signature pages may
6
<PAGE>
be detached from the counterparts and attached to a single copy of this
Agreement to physically form one document.
11. ARBITRATION.
-----------
11.1 Binding Arbitration. Bank, Borrower and each guarantor executing
a Consent and Agreement of Guarantor(s) with respect to this Agreement hereby
agree that all controversies and claims arising directly or indirectly out of
this Agreement and the Loan Documents, shall at the written request of any party
be arbitrated pursuant to the applicable rules of the American Arbitration
Association. The arbitration shall occur in the State of Arizona. Judgment upon
any award rendered by the arbitrator(s) may be entered in any court having
jurisdiction. The Federal Arbitration Act shall apply to the construction and
interpretation of this arbitration agreement.
11.2 Arbitration Panel. A single arbitrator shall have the power to
render a maximum award of one hundred thousand dollars. When any party files a
claim in excess of this amount, the arbitration decision shall be made by the
majority vote of three arbitrators. No arbitrator shall have the power to
restrain any act of any party.
11.3 Provisional Remedies; Self Help; and Foreclosure. No provision of
Section 11.1 shall limit the right of any party to exercise self help remedies,
to foreclose against any real or personal property collateral, or to obtain any
provisional or ancillary remedies (including but not limited to injunctive
relief or the appointment of a receiver) from a court of competent jurisdiction.
At Bank's option, it may enforce its right under a mortgage by judicial
foreclosure, and under a deed of trust either by exercise of power of sale or by
judicial foreclosure. The institution and maintenance of any remedy permitted
above shall not constitute a waiver of the rights to submit any controversy or
claim to arbitration. The statute of limitations, estoppel, waiver, laches, and
similar doctrines which would otherwise be applicable in an action brought by a
party shall be applicable in any arbitration proceeding.
7
<PAGE>
DATED as of the date first above stated.
EMPLOYEE SOLUTIONS, INC., an Arizona
corporation
By: /s/ M D Brody
--------------------------------------
Name: Marvin D. Brody
------------------------------------
Title: Chief Executive Officer
-----------------------------------
BANK ONE, ARIZONA, NA, a national banking
association
By: /s/ Mary K. Martuscelli
--------------------------------------
Name: MARY K. MARTUSCELLI
------------------------------------
Title: Vice President
-----------------------------------
8
<PAGE>
CONSENT AND AGREEMENT OF GUARANTOR(S)
-------------------------------------
With respect to the Third Modification Agreement dated effectively June 30,
1997 ("Agreement"), between Employee Solutions, Inc., an Arizona corporation
("Borrower") and Bank One, Arizona, NA, a national banking association ("Bank"),
the undersigned (individually and, if more than one, collectively "Guarantor")
agrees for the benefit of Bank as follows:
1. Guarantor acknowledges (i) receiving a copy of and reading the
Agreement, (ii) the accuracy of the Recitals in the Agreement, and (iii) the
effectiveness of (A) the Continuing Guaranty of Payment dated August 1, 1996, or
any later date ("Guaranty"), by the undersigned for the benefit of Bank, as
modified herein, and (B) any other agreements, documents, or instruments
securing or otherwise relating to the Guaranty, (including, without limitation,
any arbitration resolution and any environmental certification and indemnity
agreement previously executed and delivered by the undersigned), as modified
herein. The Guaranty and such other agreements, documents, and instruments, as
modified herein, are referred to individually and collectively as the "Guarantor
Documents". All capitalized terms used herein and not otherwise defined shall
have the meaning given to such terms in the Agreement.
2. Guarantor consents to the modification of the Loan Documents and all
other matters in the Agreement. Guarantor agrees to the arbitration provisions
set forth in Section 11.1 of the Agreement.
3. Guarantor fully, finally, and forever releases and discharges Bank and
its successors, assigns, directors, officers, employees, agents, and
representatives from any and all actions, causes of action, claims, debts,
demands, liabilities, obligations, and suits of whatever kind or nature, in law
or equity, that Guarantor has or in the future may have, whether known or
unknown, arising from events occurring prior to the date hereof and in respect
of the Loan, the Loan Documents, the Guarantor Documents, or the actions or
omissions of Bank in respect of the Loan, the Loan Documents, or the Guarantor
Documents.
4. Guarantor agrees that all references, if any, to the Note, the Credit
Agreement, the Deed of Trust, the Security Documents, and the Loan Documents in
the Guarantor Documents shall be deemed to refer to such agreements, documents,
and instruments as modified by the Agreement.
5. Guarantor reaffirms the Guarantor Documents and agrees that the
Guarantor Documents continue in full force and effect and remain unchanged,
except as specifically modified by this Consent and Agreement of Guarantor(s).
Any property or rights to or interests in property granted as security in the
Guarantor Documents shall remain as security for the Guaranty and the
obligations of Guarantor in the Guaranty.
6. Guarantor represents and warrants that the Loan Documents, as modified
by the Agreement, and the Guarantor Documents, as modified by this Consent and
Agreement of Guarantor(s), are the legal, valid, and binding obligations of
Borrower and the undersigned,
9
<PAGE>
respectively, enforceable in accordance with their terms against Borrower and
the undersigned, respectively.
7. Guarantor represents and warrants that Guarantor has no claims,
counterclaims, defenses, or off sets with respect to the enforcement against
Guarantor of the Guarantor Documents.
8. Guarantor represents and warrants that there has been no material
adverse change in the financial condition of any Guarantor from the most recent
financial statement received by Bank.
9. Guarantor agrees that this Consent and Agreement of Guarantor(s) may be
executed in one or more counterparts, each of which shall be deemed an original
and all of which together shall constitute one and the same document. Signature
and acknowledgment pages may be detached from the counterparts and attached to a
single copy of this Consent and Agreement of Guarantor(s) to physically form one
document.
DATED as of the date of the Agreement.
LOGISTICS PERSONNEL CORP., a Nevada corporation
By: /s/ M D Brody
--------------------------------------------
Name: Marvin D. Brody
------------------------------------------
Title: Chief Executive Officer
-----------------------------------------
EMPLOYEE SOLUTIONS OF TEXAS, INC., a Texas
corporation
By: /s/ M D Brody
--------------------------------------------
Name: Marvin D. Brody
------------------------------------------
Title: President
-----------------------------------------
EMPLOYEE SOLUTIONS-EAST INC., a Georgia
corporation
By: /s/ M D Brody
--------------------------------------------
Name: Marvin D. Brody
------------------------------------------
Title: Chief Executive Office
-----------------------------------------
10
<PAGE>
EMPLOYEE SOLUTIONS - MIDWEST, INC., a Michigan
corporation
By: /s/ M D Brody
--------------------------------------------
Name: Marvin D. Brody
------------------------------------------
Title: Chairman of the Board
-----------------------------------------
ESI AMERICA, INC., a Nevada corporation
By: /s/ M D Brody
--------------------------------------------
Name: Marvin D. Brody
------------------------------------------
Title: President
-----------------------------------------
ESI-MIDWEST, INC., a Nevada corporation
By: /s/ M D Brody
--------------------------------------------
Name: Marvin D. Brody
------------------------------------------
Title: Chief Executive Officer
-----------------------------------------
EMPLOYEE SOLUTIONS OF CALIFORNIA, INC., a
Nevada corporation
By: /s/ M D Brody
--------------------------------------------
Name: Marvin D. Brody
------------------------------------------
Title: President
-----------------------------------------
EMPLOYEE SOLUTIONS - OHIO, INC., an Indiana
corporation, formerly known as POKAGON OFFICE
SERVICES, INC.
By: /s/ M D Brody
--------------------------------------------
Name: Marvin D. Brody
------------------------------------------
Title: Chief Executive Officer
-----------------------------------------
ESI RISK MANAGEMENT AGENCY, INC., an Arizona
corporation
By: /s/ M D Brody
--------------------------------------------
Name: Marvin D. Brody
------------------------------------------
Title: President
-----------------------------------------
11
<PAGE>
EMPLOYEE SOLUTIONS OF ALABAMA, INC., an
Alabama corporation
By: /s/ M D Brody
--------------------------------------------
Name: Marvin D. Brody
------------------------------------------
Title: President
-----------------------------------------
GCK ENTERTAINMENT SERVICES I, INC., a Delaware
corporation
By: /s/ M D Brody
--------------------------------------------
Name: Marvin D. Brody
------------------------------------------
Title: Chief Executive Officer
-----------------------------------------
TALENT, ENTERTAINMENT AND MEDIA SERVICES,
INC., a Delaware corporation
By: /s/ M D Brody
--------------------------------------------
Name: Marvin D. Brody
------------------------------------------
Title: Chief Executive Officer
-----------------------------------------
12
<PAGE>
CONSENT TO THIRD MODIFICATION AGREEMENT
---------------------------------------
With respect to the Loan, as defined in the foregoing Third
Modification Agreement dated effectively June 30, 1997, Bank One, Arizona, NA, a
national banking association ("Bank") and THE FIRST NATIONAL BANK OF CHICAGO, a
national banking association ("FNBC"), assignee of NBD Bank, a Michigan banking
corporation, have entered into that certain Participation Agreement dated August
1, 1996 (the "FNBC Participation Agreement"). In addition, Bank and Bank of
Hawaii, a Hawaiian banking corporation ("Bank of Hawaii") have entered into that
certain Participation Agreement dated February 19, 1997 (the "Hawaii
Participation Agreement").
FNBC and Bank of Hawaii hereby consent to, and approve, the foregoing
Third Modification Agreement to which this Consent to Third Modification
Agreement is attached.
Dated: August 11, 1997.
THE FIRST NATIONAL BANK OF CHICAGO,
a national banking association
By:_______________________________
Name:_____________________________
Title:____________________________
BANK OF HAWAII, a Hawaiian banking
corporation
By: /s/ Joseph T. Donalson
-------------------------------
Name: JOSEPH T. DONALSON
-----------------------------
Title: VICE PRESIDENT
----------------------------
13
<PAGE>
CONSENT TO THIRD MODIFICATION AGREEMENT
---------------------------------------
With respect to the Loan, as defined in the foregoing Third
Modification Agreement dated effectively June 30, 1997, Bank One, Arizona, NA, a
national banking association ("Bank") and THE FIRST NATIONAL BANK OF CHICAGO, a
national banking association ("FNBC"), assignee of NBD Bank, a Michigan banking
corporation, have entered into that certain Participation Agreement dated August
1, 1996 (the "FNBC Participation Agreement"). In addition, Bank and Bank of
Hawaii, a Hawaiian banking corporation ("Bank of Hawaii") have entered into that
certain Participation Agreement dated February 19, 1997 (the "Hawaii
Participation Agreement").
FNBC and Bank of Hawaii hereby consent to, and approve, the foregoing
Third Modification Agreement to which this Consent to Third Modification
Agreement is attached.
Dated: August 12, 1997.
THE FIRST NATIONAL BANK OF CHICAGO,
a national banking association
By: /s/ James D. Benko
-------------------------------
Name: JAMES D. BENKO
-----------------------------
Title: VICE PRESIDENT
----------------------------
BANK OF HAWAII, a Hawaiian banking
corporation
By:_______________________________
Name:_____________________________
Title:____________________________
13
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION
EXTRACTED FROM THE COMPANY'S FORM 10-Q FOR THE PERIOD
ENDED JUNE 30, 1997 AND IS QUALIFIED IN ITS ENTIRETY BY
REFERENCE TO SUCH FORM 10-Q.
</LEGEND>
<MULTIPLIER> 1,000
<CURRENCY> U.S. DOLLARS
<S> <C>
<PERIOD-TYPE> 6-MOS
<FISCAL-YEAR-END> DEC-31-1997
<PERIOD-START> JAN-01-1997
<PERIOD-END> JUN-30-1997
<EXCHANGE-RATE> 1
<CASH> 10,609
<SECURITIES> 14,000
<RECEIVABLES> 57,372
<ALLOWANCES> 0
<INVENTORY> 0
<CURRENT-ASSETS> 88,508
<PP&E> 2,105
<DEPRECIATION> 0
<TOTAL-ASSETS> 151,757
<CURRENT-LIABILITIES> 53,489
<BONDS> 0
0
0
<COMMON> 31,747
<OTHER-SE> 17,872
<TOTAL-LIABILITY-AND-EQUITY> 151,757
<SALES> 0
<TOTAL-REVENUES> 422,024
<CGS> 0
<TOTAL-COSTS> 399,871
<OTHER-EXPENSES> 17,960
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 2,065
<INCOME-PRETAX> 2,517
<INCOME-TAX> 1,007
<INCOME-CONTINUING> 1,510
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 1,510
<EPS-PRIMARY> 0.05
<EPS-DILUTED> 0.05
</TABLE>
