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 March 31, 1999
[ ] TRANSITION REPORT UNDER SECTION 13 OR 15(D) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from _______________ to _________________
Commission file number: 000-22600
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
Rights to Purchase Shares of Series A Junior Participating Preferred 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: 32,413,413 Common shares,
no par value were outstanding as of May 12, 1999.
<PAGE>
EMPLOYEE SOLUTIONS, INC.
FORM 10-Q
QUARTERLY REPORT FOR THE PERIOD ENDED MARCH 31, 1999
- --------------------------------------------------------------------------------
INDEX
Page
PART I. Financial Information Number
------
Item 1. Financial Statements
Consolidated Balance Sheets - March 31, 1999 and
December 31, 1998 2
Consolidated Statements of Operations for the
Quarters Ended March 31, 1999 and 1998 3
Consolidated Statement of Stockholders'
Equity for the Quarters Ended March 31, 1999 and 1998 4
Consolidated Statements of Cash Flows for the
Quarters Ended March 31, 1999 and 1998 5
Notes to Consolidated Financial Statements 7
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 21
Item 3. Quantitative and Qualitative Disclosure About Market Risk 32
PART II. Other Information
Item 1. Legal Proceedings 33
Item 6. Exhibits and Reports on Form 8-K 34
Signatures 35
- --------------------------------------------------------------------------------
<PAGE>
ITEM 1. FINANCIAL STATEMENTS
EMPLOYEE SOLUTIONS, INC.
CONSOLIDATED BALANCE SHEETS
- --------------------------------------------------------------------------------
March 31, December 31,
(In thousands of dollars, except share data) 1999 1998
- --------------------------------------------------------------------------------
ASSETS
CURRENT ASSETS:
Cash and cash equivalents $ 17,187 $ 39,287
Investments and marketable securities 10,389 9,997
Restricted cash and investments 2,088 1,088
Accounts receivable, net 44,917 38,742
Receivables from insurance companies 7,130 6,704
Prepaid expenses and deposits 4,993 2,303
Income taxes receivable 5,040 5,040
Deferred income taxes 797 811
--------- ---------
Total current assets 92,541 103,972
Property and equipment, net 4,242 4,543
Deferred income taxes 54 60
Goodwill and other assets, net 75,415 66,530
--------- ---------
Total assets $ 172,252 $ 175,105
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Bank overdraft $ -- $ 13,727
Accrued salaries, wages and payroll taxes 30,839 28,719
Accounts payable 6,316 5,898
Accrued workers' compensation and health insurance 10,104 9,617
Income taxes payable 721 751
Other accrued expenses 24,950 13,595
--------- ---------
Total current liabilities 72,930 72,307
Deferred income taxes 851 871
--------- ---------
Long-term debt 85,000 85,000
--------- ---------
Other long-term liabilities 1,211 1,211
--------- ---------
Commitments and contingencies
STOCKHOLDERS' EQUITY
Class A convertible preferred stock, nonvoting,
no par value, 10,000,000 shares authorized,
no shares issued and outstanding -- --
Common stock, no par value, 75,000,000 shares
authorized, 32,421,263 shares issued and
outstanding March 31, 1999, and 32,419,595
shares issued and outstanding December 31, 1998 35,803 35,800
Accumulated deficit (23,547) (20,085)
Cumulative unrealized gain on investment securities 4 1
--------- ---------
Total stockholders' equity 12,260 15,716
--------- ---------
Total liabilities and stockholders' equity $ 172,252 $ 175,105
========= =========
- --------------------------------------------------------------------------------
The accompanying notes are an integral part of these consolidated
financial statements.
2
<PAGE>
EMPLOYEE SOLUTIONS, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
- --------------------------------------------------------------------------------
Quarter ended March 31,
(In thousands of dollars, except --------------------------------
share and per share data) 1999 1998
- --------------------------------------------------------------------------------
Revenues $ 198,909 $ 220,930
------------ ------------
Cost of revenues:
Salaries and wages of worksite employees 165,608 180,684
Healthcare and workers' compensation 10,553 14,267
Payroll and employment taxes 15,012 16,513
------------ ------------
Cost of revenues 191,173 211,464
----------- ------------
Gross profit 7,736 9,466
Selling, general and administrative expenses 7,513 7,771
Depreciation and amortization 1,667 1,286
------------ ------------
Income (loss) from operations (1,444) 409
Other income (expense):
Interest income 244 770
Interest expense (2,286) (2,120)
Other 24 3
------------ ------------
Loss before benefit for income taxes (3,462) (938)
Income tax benefit -- (33)
------------ ------------
Net loss $ (3,462) $ (905)
============ ============
Loss per common and common equivalent share:
Basic $ (.11) $ (.03)
Diluted $ (.11) $ (.03)
Weighted average number of common and
common equivalent shares outstanding:
Basic 32,421,263 31,701,036
============ ============
Diluted 32,421,263 31,701,036
============ ============
- --------------------------------------------------------------------------------
The accompanying notes are an integral part of these consolidated
financial statements.
3
<PAGE>
EMPLOYEE SOLUTIONS, INC.
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY
QUARTER ENDED MARCH 31, 1999
<TABLE>
<CAPTION>
- -----------------------------------------------------------------------------------------------------------
Unrealized Total Comprehensive
(In thousands of dollars, Common Accumulated Gain on Stockholders' Income
except share data) Stock Deficit Investments Equity (Loss)
- -----------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
BALANCE, December 31, 1998 $ 35,800 $(20,085) $ 1 $15,716 $ --
Issuance of 1,668 shares of common
stock in connection with exercise of
common stock options 3 -- -- 3 --
Change in unrealized net gains,
net of applicable taxes -- -- 3 3 3
Net loss -- (3,462) -- (3,462) (3,462)
-------- -------- ----- ------- -------
COMPREHENSIVE LOSS $(3,459)
=======
BALANCE, MARCH 31, 1999 $ 35,803 $(23,547) $ 4 $12,260
======== ======== ===== =======
- -----------------------------------------------------------------------------------------------------------
EMPLOYEE SOLUTIONS, INC.
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY
QUARTER ENDED MARCH 31, 1998
- -----------------------------------------------------------------------------------------------------------
Unrealized Total Comprehensive
(In thousands of dollars, Common Retained Gain on Stockholders' Income
except share data) Stock Earnings Investments Equity (Loss)
- -----------------------------------------------------------------------------------------------------------
BALANCE, December 31, 1997 $ 34,420 $ 7,866 $ 103 $42,389 $ --
Issuance of 56,675 shares of common
stock in connection with exercise of
common stock options 117 -- -- 117 --
Tax benefit related to the exercise of
Stock options 63 -- -- 63 --
Change in unrealized net gains,
net of applicable taxes -- -- (100) (100) (100)
Net loss -- (905) -- (905) (905)
-------- -------- ------ ------- -------
COMPREHENSIVE LOSS $(1,005)
=======
BALANCE, MARCH 31, 1998 $ 34,600 $ 6,961 $ 3 $41,564
======== ======== ====== =======
- -----------------------------------------------------------------------------------------------------------
</TABLE>
The accompanying notes are an integral part of these consolidated
financial statements.
4
<PAGE>
EMPLOYEE SOLUTIONS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
- --------------------------------------------------------------------------------
Quarter ended March 31,
---------------------------
(In thousands of dollars) 1999 1998
- --------------------------------------------------------------------------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Cash received from customers $ 192,734 $ 227,917
Cash paid to suppliers and employees (199,771) (225,161)
Interest received 244 770
Interest paid (137) --
Income taxes refunded (paid), net (30) 133
----------- ----------
Net cash (used in) provided by operating
activities (6,960) 3,659
----------- ----------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of property and equipment (19) (1,203)
Business acquisitions (2) (123)
Purchase of investments, net (392) (30,937)
Cash invested in restricted accounts, net (1,000) --
Disbursements for deferred costs (3) --
---------- ----------
Net cash used in investing activities (1,416) (32,263)
---------- ----------
CASH FLOWS FROM FINANCING ACTIVITIES:
Payment of deferred loan costs -- (177)
Proceeds from issuance of common stock 3 117
Decrease in bank overdraft (13,727) --
---------- ----------
Net cash used in financing activities (13,724) (60)
---------- -----------
Net decrease in cash and cash equivalents (22,100) (28,664)
CASH AND CASH EQUIVALENTS, beginning of period 39,287 40,110
---------- ----------
CASH AND CASH EQUIVALENTS, end of period $ 17,187 $ 11,446
========== ==========
- --------------------------------------------------------------------------------
The accompanying notes are an integral part of these consolidated
financial statements.
5
<PAGE>
EMPLOYEE SOLUTIONS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(CONTINUED)
- --------------------------------------------------------------------------------
Quarter ended March 31,
-----------------------
1999 1998
- --------------------------------------------------------------------------------
RECONCILIATION OF NET LOSS TO NET CASH
PROVIDED BY (USED IN) OPERATING ACTIVITIES:
Net loss $ (3,462) $ (905)
-------- --------
ADJUSTMENTS TO RECONCILE NET LOSS TO
NET CASH PROVIDED BY (USED IN) OPERATING
ACTIVITIES:
Depreciation and amortization 1,667 1,286
(Increase) decrease in accounts receivable, net (6,175) 6,987
(Increase) decrease in insurance company receivables (426) 102
Increase in prepaid expenses and deposits (2,690) (2,023)
Decrease in deferred income taxes, net -- 100
Decrease (increase) in other assets 176 (225)
Increase in accrued salaries,
wages and payroll taxes 2,120 1,740
Increase (decrease) in accrued workers'
compensation and health insurance 487 (5,001)
Increase in interest payable -- 2,120
Decrease in other long-term liabilities -- (2)
Increase in accounts payable 418 251
Decrease in income taxes payable (30) --
Increase (decrease) in other accrued expenses 955 (771)
-------- --------
(3,498) 4,564
-------- --------
Net cash provided by (used in) operating
activities $ (6,960) $ 3,659
======== ========
- --------------------------------------------------------------------------------
The accompanying notes are an integral part of these consolidated
financial statements.
6
<PAGE>
EMPLOYEE SOLUTIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 1999
(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. At
March 31, 1999, ESI serviced approximately 2,090 client companies with
approximately 38,500 worksite employees in 47 states.
The Company conducts its business on a national scale across many industries and
is not concentrated to any material extent within a single local market or
industry, although the transportation industry, at approximately 34%, represents
the largest concentration of customers, including one former customer that
generated approximately 20% of total revenues in the first quarter of 1998.
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 quarter ended March 31, 1999 are
not necessarily indicative of the results that may be expected for the year
ending December 31, 1999. 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, 1998.
PRINCIPLES OF CONSOLIDATION
The consolidated financial statements include the activities of Employee
Solutions, Inc. and its wholly owned subsidiaries from their respective
acquisition dates. All acquisitions were accounted for as purchases. All
significant intercompany accounts and transactions have been eliminated.
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
retrospectively rated insurance policies. The actual results of these estimates
may be unknown for a period of years. Actual results could differ from those
estimates.
CASH AND CASH EQUIVALENTS
Cash and cash equivalents consist of cash and highly liquid investments with
original maturities of three months or less when purchased. All cash equivalents
are invested in high quality investment grade instruments, such as commercial
paper, at March 31, 1999 and December 31, 1998, and are stated at fair market
value. Substantially all cash and cash equivalents, including restricted cash
and investments, are not insured at March 31, 1999.
RESTRICTED CASH AND INVESTMENTS
At March 31, 1999, restricted cash was approximately $2.1 million, which
represented amounts held for settlement of a legal matter. Restricted
investments consist of U.S. Treasury and other short term corporate debt
securities, purchased in accordance with the Company's investment policy
guidelines, with varying maturities to coincide with expected
7
<PAGE>
liquidity requirements to meet future anticipated claims, and are accounted for
in accordance with Statement of Financial Accounting Standards (SFAS) No. 115,
"Accounting for Investments in Certain Debt and Equity Securities."
INVESTMENTS AND MARKETABLE SECURITIES
At March 31, 1999, the Company maintained approximately $16.7 million of
investments in its cash and cash equivalents and investments and marketable
securities accounts. These securities are considered available-for-sale and,
accordingly, are recorded at market value. Securities with original maturities
of 90 days or less consisted of commercial paper, certificates of deposit, money
market and mutual funds that had an estimated fair value of $6.3 million at
March 31, 1999. Securities with original maturities greater than 90 days
consisted of $4.2 million in commercial paper, $5.4 million in corporate bonds
and $800,000 in U.S. Treasury securities and agency notes and had an estimated
fair value of $10.4 million at March 31, 1999.
BANK OVERDRAFT
Bank overdraft represents outstanding checks in excess of cash on hand at the
applicable bank, and generally result from timing differences in the transfer of
funds between banks. Historically, these checks are covered when presented for
payment through the transfer of funds from other Company cash accounts held in
other banks.
CREDIT RISK
The Company conducts only a limited credit investigation prior to accepting most
new clients and thus may encounter collection problems which could adversely
affect its cash flow. The nature of the Company's business is such that a small
number of client credit failures could have an adverse effect on its business
and financial condition.
8
<PAGE>
EMPLOYEE SOLUTIONS, INC. MARCH 31, 1999
- --------------------------------------------------------------------------------
NET LOSS PER COMMON AND COMMON EQUIVALENT SHARE
The computation of adjusted net loss and weighted average common and common
equivalent shares used in the calculation of net loss per common share is as
follows:
<TABLE>
<CAPTION>
- -----------------------------------------------------------------------------------------------
Three months ended March 31,
---------------------------------------------------------
1999 1998
(In thousands of dollars, except -------------------------- --------------------------
share and per share data) Basic Diluted Basic Diluted
- -----------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Weighted average of
common shares outstanding 32,421,263 32,421,263 31,701,036 31,701,036
Dilutive effect of options
and warrants outstanding -- -- -- --
----------- ----------- ---------- -----------
Weighted average of
common and common
equivalent shares 32,421,263 32,421,263 31,701,036 31,701,036
=========== =========== ========== ===========
Net loss $ (3,462) $ (3,462) $ (905) $ (905)
Adjustments to net loss -- -- -- --
----------- ----------- ---------- -----------
Adjusted net loss for
purposes of the loss per
common share calculation $ (3,462) $ (3,462) $ (905) $ (905)
=========== =========== ========== ===========
Net loss per common and
common equivalent share $ (0.11) $ (0.11) $ (0.03) $ (0.03)
=========== =========== ========== ===========
- -----------------------------------------------------------------------------------------------
</TABLE>
The calculation of weighted average common and common equivalent shares for
purposes of calculating the March 31, 1999 diluted loss per share, excludes
approximately 1,150,418 weighted average shares of options, warrants, and
contingently issuable shares computed under the treasury stock method, as their
effects would be anti-dilutive.
9
<PAGE>
EMPLOYEE SOLUTIONS, INC. MARCH 31, 1999
- --------------------------------------------------------------------------------
(2) LONG-TERM DEBT:
NOTE OFFERING
On October 21, 1997, the Company issued $85 million of 10% Senior Notes due 2004
(the Notes) in an Offering (the Offering) exempt from registration under the
Securities Act of 1933 as amended (Securities Act). Interest under the Notes is
payable semi-annually commencing April 15, 1998, and the Notes are not callable
until October 2001 subject to the terms of the Indenture under which the Notes
were issued. The Company filed a registration statement under the Securities
Act, relating to an exchange offer for these Notes, which was declared effective
in April 1998. The indenture under which the Notes were issued includes certain
restrictions on use of cash, and other expenditures, by the Company including
limitations on dividends, repurchases of Company shares and the incurrence of
new indebtedness.
The Notes are general unsecured obligations of the Company and are
unconditionally guaranteed on a joint and several basis by certain of the
Company's wholly-owned current and future subsidiaries. The Company's
wholly-owned insurance subsidiary, which is a non-guarantor subsidiary, is
subject to certain statutory and contractual restrictions which limit its
ability to pay dividends or make loans to the Company or other subsidiaries. The
financial statements presented below include the separate or combined financial
position as of March 31, 1999 and December 31, 1998, and the results of
operations and cash flows for each of the quarters ended March 31, 1999 and
March 31, 1998, of Employee Solutions, Inc. (Parent), the guarantor subsidiaries
(Guarantors) and the subsidiaries which are not guarantors (Non-guarantors).
10
<PAGE>
EMPLOYEE SOLUTIONS, INC. MARCH 31, 1999
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
BALANCE SHEETS
- ------------------------------------------------------------------------------------------------------------
March 31, 1999
----------------------------------------------------------------
Non-
(In thousands of dollars) Parent Guarantors Guarantors Eliminating Consolidated
- ------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
ASSETS
CURRENT ASSETS:
Cash and cash equivalents $ 7,326 $ 5,210 $ 4,651 $ -- $ 17,187
Investments and marketable securities 10,389 -- -- -- 10,389
Restricted cash and investments 2,088 -- -- -- 2,088
Accounts receivable, net 16,641 27,316 960 -- 44,917
Receivable from insurance companies -- -- 7,130 -- 7,130
Prepaid expenses and deposits 4,654 316 23 -- 4,993
Income taxes receivable 5,040 -- -- -- 5,040
Deferred income taxes 797 -- -- -- 797
Due from affiliates 9,879 1,998 (7,057) (4,820) --
--------- --------- --------- ------------ ----------
Total current assets 56,814 34,840 5,707 (4,820) 92,541
Property and equipment, net 3,941 287 14 -- 4,242
Deferred income taxes 54 -- -- -- 54
Goodwill and other assets, net 43,295 31,848 272 -- 75,415
Investment in subsidiaries 36,665 -- -- (36,665) --
--------- --------- -------- ------------ ----------
Total assets $ 140,769 $ 66,975 $ 5,993 $ (41,485) $ 172,252
========= ========= ======== ============ ==========
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Bank overdraft $ -- $ -- $ -- $ -- $ --
Accrued salaries, wages and payroll taxes 9,809 19,989 1,041 -- 30,839
Accounts payable 1,827 1,203 3,286 -- 6,316
Accrued workers' compensation
And health insurance 2,264 1,490 6,350 -- 10,104
Income taxes payable 721 -- -- -- 721
Other accrued expenses 21,215 1,401 2,334 -- 24,950
Due to affiliates 7,869 14,508 (17,557) (4,820) --
--------- --------- --------- ------------ ----------
Total current liabilities 43,705 38,591 (4,546) (4,820) 72,930
--------- --------- --------- ------------ ----------
Deferred income taxes 851 -- -- -- 851
--------- --------- -------- ----------- ----------
Long-term debt 85,000 -- -- -- 85,000
--------- --------- -------- ----------- ----------
Other long-term liabilities -- 1,211 -- -- 1,211
--------- --------- -------- ----------- ----------
Commitments and contingencies
STOCKHOLDERS' EQUITY
Class A convertible preferred stock -- -- -- -- --
Common stock, no par value 35,803 2,622 771 (3,393) 35,803
Additional paid in capital -- 26,342 50 (26,392) --
(Accumulated deficit) retained earnings (24,594) (1,791) 9,718 (6,880) (23,547)
Unrealized gain on
investments 4 -- -- -- 4
--------- --------- -------- ----------- ----------
Total stockholders' equity 11,213 27,173 10,539 (36,665) 12,260
--------- --------- -------- ------------ ----------
Total liabilities and stockholders'
equity $ 140,769 $ 66,975 $ 5,993 $ (41,485) $ 172,252
========= ========= ======== =========== =========
- ----------------------------------------------------------------------------------------------------------
</TABLE>
11
<PAGE>
EMPLOYEE SOLUTIONS, INC. MARCH 31, 1999
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
BALANCE SHEETS
- ----------------------------------------------------------------------------------------------------------
December 31, 1998
-----------------------------------------------------------------
Non-
(In thousands of dollars) Parent Guarantors Guarantors Eliminating Consolidated
- ----------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
ASSETS
CURRENT ASSETS:
Cash and cash equivalents $ 8,176 $ 24,503 $ 6,608 $ -- $ 39,287
Investments and marketable securities 9,997 -- -- -- 9,997
Restricted cash and
investments 1,088 -- -- -- 1,088
Accounts receivable, net 15,460 22,495 787 -- 38,742
Receivable from insurance
companies -- -- 6,704 -- 6,704
Prepaid expenses and deposits 1,532 753 18 -- 2,303
Income taxes receivable 5,040 -- -- -- 5,040
Deferred income taxes 811 -- -- -- 811
Due from affiliates 7,789 2,711 (6,726) (3,774) --
--------- ----------- ----------- ----------- ------------
Total current assets 49,893 50,462 7,391 (3,774) 103,972
Property and equipment, net 4,213 314 16 -- 4,543
Deferred income taxes 60 -- -- -- 60
Goodwill and other assets, net 34,044 32,208 278 -- 66,530
Investment in subsidiaries 36,005 -- -- (36,055) --
--------- ----------- ---------- ----------- ------------
Total assets $ 124,215 $ 82,984 $ 7,685 $ (39,779) $ 175,105
========= =========== ========== =========== ============
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Bank overdraft $ 308 $ 13,419 $ -- $ -- $ 13,727
Accrued salaries, wages and
payroll taxes 5,932 22,167 620 -- 28,719
Accounts payable 1,584 1,051 3,263 -- 5,898
Accrued workers' compensation
and health insurance 3,141 618 5,858 -- 9,617
Income taxes payable 751 -- -- -- 751
Other accrued expenses 9,123 2,316 2,156 -- 13,595
Due to affiliates 1,789 16,030 (14,045) (3,774) --
--------- ----------- ----------- ----------- ------------
Total current liabilities 22,628 55,601 (2,148) (3,774) 72,307
--------- ----------- ----------- ----------- ------------
Deferred income taxes 871 -- -- -- 871
--------- ----------- ---------- ----------- ------------
Long-term debt 85,000 -- -- -- 85,000
--------- ----------- ---------- ----------- ------------
Other long-term liabilities -- 1,211 -- -- 1,211
--------- ----------- ---------- ----------- ------------
Commitments and contingencies
STOCKHOLDERS' EQUITY
Class A convertible preferred stock -- -- -- -- --
Common stock, no par value 35,800 2,622 771 (3,393) 35,800
Additional paid in capital -- 26,342 50 (26,392) --
(Accumulated deficit) retained earnings (20,085) (2,792) 9,012 (6,220) (20,085)
Unrealized gain on
investments 1 -- -- -- 1
--------- ----------- ---------- ----------- ------------
Total stockholders' equity 15,716 26,172 9,833 (36,005) 15,716
--------- ----------- ---------- ----------- ------------
Total liabilities and stockholders'
equity $ 124,215 $ 82,984 $ 7,685 $ (39,779) $ 175,105
========= =========== ========== =========== ===========
- ----------------------------------------------------------------------------------------------------------
</TABLE>
12
<PAGE>
EMPLOYEE SOLUTIONS, INC. MARCH 31, 1999
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
STATEMENTS OF OPERATIONS
- -----------------------------------------------------------------------------------------------------
For the Quarter Ended March 31, 1999
------------------------------------------------------------------
Non-
(In thousands of dollars) Parent Guarantors Guarantors Eliminating Consolidated
- -----------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Revenues $ 57,844 $ 134,223 $ 6,842 $ -- $ 198,909
---------- ----------- ---------- ---------- -----------
Cost of revenues:
Salaries and wages of
worksite employees 49,483 110,316 5,809 -- 165,608
Healthcare and workers'
compensation 1,879 9,200 (526) -- 10,553
Payroll and employment taxes 3,970 10,514 528 -- 15,012
---------- ----------- ---------- ---------- -----------
Cost of revenues 55,332 130,030 5,811 -- 191,173
---------- ----------- ---------- ---------- -----------
Gross profit 2,512 4,193 1,031 -- 7,736
Selling, general and
administrative expenses 5,308 2,163 42 -- 7,513
Intercompany selling, general
and administrative expense -- -- -- -- --
Depreciation and amortization 1,259 401 7 -- 1,667
---------- ----------- ---------- ---------- -----------
Income (loss) from operations (4,055) 1,629 982 -- (1,444)
Other income (expense):
Interest income 200 15 29 -- 244
Interest expense and other (2,361) 24 75 -- (2,262)
---------- ----------- ---------- ---------- -----------
Income (loss) before provision
(benefit) for income taxes (6,216) 1,668 1,086 -- (3,462)
Income tax provision (benefit) -- 667 380 (1,047) --
--------- ----------- ---------- ---------- -----------
Income from wholly-owned
subsidiaries 1,707 -- -- (1,707) --
---------- ----------- ---------- ---------- -----------
Net income (loss) $ (4,509) $ 1,001 $ 706 $ (660) $ (3,462)
========== =========== ========== ========== ===========
- -----------------------------------------------------------------------------------------------------
</TABLE>
13
<PAGE>
EMPLOYEE SOLUTIONS, INC. MARCH 31, 1999
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
STATEMENTS OF OPERATIONS
- -----------------------------------------------------------------------------------------------------
For the Quarter Ended March 31, 1998
----------------------------------------------------------------
Non-
(In thousands of dollars) Parent Guarantors Guarantors Eliminating Consolidated
- -----------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Revenues $ 69,667 $ 142,939 $ 9,422 $ (1,098) $ 220,930
-------- ----------- ------- -------- ---------
Cost of revenues:
Salaries and wages of
worksite employees 56,379 117,229 7,076 -- 180,684
Healthcare and workers'
compensation 3,655 9,975 637 -- 14,267
Payroll and employment taxes 6,046 9,715 752 -- 16,513
-------- ----------- ------- -------- ---------
Cost of revenues 66,080 136,919 8,465 -- 211,464
-------- ----------- ------- -------- ---------
Gross profit 3,587 6,020 957 (1,098) 9,466
Selling, general and
administrative expenses 6,111 1,581 79 -- 7,771
Intercompany selling, general
and administrative expense 311 754 33 (1,098) --
Depreciation and amortization 902 380 4 -- 1,286
-------- ----------- ------- -------- ---------
Income (loss) from operations (3,737) 3,305 841 -- 409
Other income (expense):
Interest income 357 20 393 -- 770
Interest expense and other (2,194) 2 75 -- (2,117)
-------- ----------- ------- -------- ---------
Income (loss) before provision
(benefit) for income taxes (5,574) 3,327 1,309 -- (938)
Income tax provision (benefit) (572) 117 422 -- (33)
------- ----------- ------- -------- ---------
(5,002) 3,210 887 -- (905)
Income from wholly-owned
subsidiaries 4,097 -- -- (4,097) --
-------- ----------- ------- -------- ---------
Net income (loss) $ (905) $ 3,210 $ 887 $ (4,097) $ (905)
======== =========== ======= ======== =========
- ---------------------------------------------------------------------------------------------------
</TABLE>
14
<PAGE>
EMPLOYEE SOLUTIONS, INC. MARCH 31, 1999
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
STATEMENTS OF CASH FLOWS
- -----------------------------------------------------------------------------------------------------------
For the Quarter Ended March 31, 1999
------------------------------------------------------------------
Non-
(In thousands of dollars) Parent Guarantors Guarantors Eliminating Consolidated
- -----------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
RECONCILIATION OF NET LOSS TO
NET CASH USED IN OPERATING
ACTIVITIES:
Net income (loss) $ (4,509) $ 1,001 $ 706 $ (660) $ (3,462)
--------- ----------- ---------- ------------ -------------
ADJUSTMENTS TO RECONCILE
NET LOSS TO NET CASH
USED IN OPERATING
ACTIVITIES:
Depreciation and amortization 1,259 401 7 -- 1,667
Increase in accounts receivable, net (1,181) (4,821) (173) -- (6,175)
Increase in insurance company
receivable -- -- (426) -- (426)
(Increase) in prepaid expenses and deposits (3,122) 437 (5) -- (2,690)
(Increase) decrease in other assets (190) 360 6 -- 176
Increase (decrease) from inter-
company transactions 3,702 (1,176) (3,186) 660 --
Increase (decrease) in accrued salaries,
wages, and payroll taxes 3,877 (2,178) 421 -- 2,120
Increase (decrease) in accrued workers'
compensation and health insurance (877) 872 492 -- 487
Increase in accounts payable 243 152 23 -- 418
Decrease in income taxes payable (30) -- -- -- (30)
Increase in other accrued expenses 1,692 (915) 178 -- 955
--------- ------------ ---------- ----------- ------------
5,373 (6,868) (2,663) 660 (3,498)
--------- ------------ ----------- ----------- -------------
Net cash (used in) provided by
operating activities 864 (5,867) (1,957) -- (6,960)
--------- ------------ ----------- ----------- -------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of property and equipment (12) (7) -- -- (19)
Business acquisitions (2) -- -- -- (2)
Purchases of investments, net (392) -- -- -- (392)
Cash invested in restricted accounts, net (1,000) -- -- -- (1,000)
Disbursements for deferred costs (3) -- -- -- (3)
---------- ----------- ---------- ----------- -------------
Net cash used in investing
activities (1,409) (7) -- -- (1,416)
---------- ------------ ---------- ----------- -------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from issuance of common stock 3 -- -- -- 3
Decrease in bank overdraft (308) (13,419) -- -- (13,727)
---------- ------------ ---------- ----------- -------------
Net cash used in
financing activities (305) (13,419) -- -- (13,724)
---------- ------------ ---------- ----------- -------------
Net decrease in cash and cash
equivalents (850) (19,293) (1,957) -- (22,100)
CASH AND CASH EQUIVALENTS,
beginning of period 8,176 24,503 6,608 -- 39,287
--------- ----------- ---------- ----------- ------------
CASH AND CASH EQUIVALENTS,
end of period $ 7,326 $ 5,210 $ 4,651 $ -- $ 17,187
========= =========== ========== =========== ============
- -----------------------------------------------------------------------------------------------------------
</TABLE>
15
<PAGE>
EMPLOYEE SOLUTIONS, INC. MARCH 31, 1999
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
STATEMENTS OF CASH FLOWS
- -----------------------------------------------------------------------------------------------------------
For the Quarter Ended March 31, 1998
-------------------------------------------------------------------
Non-
(In thousands of dollars) Parent Guarantors Guarantors Eliminating Consolidated
- -----------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
RECONCILIATION OF NET INCOME TO
NET CASH PROVIDED BY (USED IN)
OPERATING ACTIVITIES:
Net income (loss) $ (905) $ 3,210 $ 887 $ (4,097) $ (905)
---------- ----------- ---------- ----------- ------------
ADJUSTMENTS TO RECONCILE
NET INCOME TO NET CASH
PROVIDED BY (USED IN)
OPERATING ACTIVITIES:
Depreciation and amortization 902 380 4 -- 1,286
Decrease (increase) in accounts
receivable, net 8,280 (2,031) 738 -- 6,987
Decrease (increase) decrease in
insurance company receivable -- 127 (25) -- 102
(Increase) decrease in prepaid
expenses and deposits (1,835) (421) 233 -- (2,023)
Decrease in deferred income taxes, net 100 -- -- -- 100
(Increase) decrease in other assets (502) 222 55 -- (225)
Increase (decrease) from inter-
company transactions 3,168 (7,653) 388 4,097 --
(Decrease) increase in accrued salaries,
wages, and payroll taxes (2,946) 5,304 (618) -- 1,740
Decrease in accrued workers'
compensation and health insurance (1,612) (1,371) (2,018) -- (5,001)
Increase in interest payable 2,120 -- -- -- 2,120
Decrease in other long-term liabilities -- (2) -- -- (2)
Increase (decrease) in accounts payable (1,148) 518 881 -- 251
(Decrease) increase in other
accrued expenses (1,536) 1,478 (713) -- (771)
---------- ----------- ---------- ----------- ------------
4,991 (3,449) (1,075) 4,097 4,564
---------- ----------- ---------- ----------- ------------
Net cash provided by (used in)
operating activities 4,086 (239) (188) -- 3,659
---------- ----------- ---------- ----------- ------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of property and equipment (1,113) (90) -- -- (1,203)
Business acquisitions (101) -- (22) -- (123)
Cash invested in investments
and marketable securities (20,170) (8,838) (1,929) -- (30,937)
---------- ----------- ---------- ----------- ------------
Net cash used in investing
activities (21,384) (8,928) (1,951) -- (32,263)
---------- ----------- ---------- ----------- ------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from issuance of common stock 117 -- -- -- 117
Payment of deferred
loan costs (177) -- -- -- (177)
---------- ----------- ---------- ----------- ------------
Net cash used in
financing activities (60) -- -- -- (60)
---------- ----------- ---------- ----------- ------------
Net decrease in cash and cash
equivalents (17,358) (9,167) (2,139) -- (28,664)
CASH AND CASH EQUIVALENTS,
beginning of period 22,692 11,848 5,570 -- 40,110
---------- ----------- ---------- ----------- ------------
CASH AND CASH EQUIVALENTS,
end of period $ 5,334 $ 2,681 $ 3,431 $ -- $ 11,446
========== =========== ========== =========== ============
- -----------------------------------------------------------------------------------------------------------
</TABLE>
16
<PAGE>
EMPLOYEE SOLUTIONS, INC. MARCH 31, 1999
- --------------------------------------------------------------------------------
(3) SEGMENT INFORMATION
The Company, in relation to SFAS No. 131 "Disclosure About Segments of an
Enterprise and Related Information," has defined the following five reportable
segments: Core PEO services, Logistics Personnel Corp, TEAM Services and
Stand-Alone Workers' Compensation services and US Xpress.
The Company, through its Core PEO segment, provides a full-range of services and
products to its customers. Typically, ESI becomes the "employer of record" for
the client company's employees and provides payroll administration, workers'
compensation insurance and risk management administration, human resources
administration and benefits programs. Additionally, other products and services
are offered directly to worksite employees, such as employee payroll deduction
programs for disability and specialty health insurance, debit cards, prepaid
telephone cards and other personal financial services.
Formerly, the Company provided its Core PEO services to US Xpress, a large
transportation company. US Xpress was the Company's largest customer with
approximately 6,200 worksite employees. The Company terminated its subscriber
service agreement with US Xpress effective August 19, 1998.
Logistics Personnel Corp (LPC) provides specialized leasing of all types of
distribution personnel, including drivers, warehouse workers, mechanics,
dispatchers, forklift operators and administrators. A full range of services,
including employee recruiting, hiring and management; payroll administration;
claims and audit handling; workers' compensation insurance coverage; employee
benefits programs and tax reporting is provided to its customers.
TEAM Services specializes in leasing commercial talent (actors and actresses),
musicians and recording engineers to the music and advertising segments of the
entertainment industry. In addition, TEAM generates revenue from touring bands
with the entertainment industry.
The Company, formerly through its Stand-Alone Workers' Compensation segment,
provided its workers' compensation program to non-PEO customers on a stand-alone
basis. Based on a change in business strategy as of 1998, the Company will no
longer market new stand-alone policies. This change is the result of a
determination to emphasize other PEO marketing strategies and because of the
decreased profit opportunities resulting from increased price competition in the
overall workers' compensation market.
The accounting policies of the segments are the same as those described in the
summary of significant accounting policies.
17
<PAGE>
EMPLOYEE SOLUTIONS, INC. MARCH 31, 1999
- --------------------------------------------------------------------------------
Information concerning revenue, gross profit and assets by business segment was
as follows (in thousands):
<TABLE>
<CAPTION>
FOR THE QUARTER ENDED MARCH 31,
-------------------------------------
1999 1998
--------------- ---------------
<S> <C> <C>
Revenue
Core PEO $ 142,090 $ 123,216
US Xpress -- 45,913
LPC 25,360 23,209
TEAM 31,459 27,551
Stand-Alone -- 1,041
--------------- ---------------
Consolidated Total 198,909 220,930
--------------- ---------------
Gross Profit
Core PEO 5,222 6,254
US Xpress -- 485
LPC 2,029 2,423
TEAM 485 487
Stand-Alone -- (183)
--------------- ---------------
Total 7,736 9,466
Selling, General And Administrative Expense 7,513 7,771
Depreciation And Amortization 1,667 1,286
--------------- ---------------
Income (Loss) From Operations (1,444) 409
--------------- ---------------
Other Income/(Expense)
Interest income 244 770
Interest expense (2,286) (2,120)
Other 24 3
--------------- ---------------
Loss Before Provision For Income Taxes (3,462) (938)
Income Tax Benefit -- (33)
--------------- ---------------
Net Loss $ (3,462) (905)
=============== ===============
Depreciation And Amortization
Core PEO $ 1,386 $ 484
LPC 246 223
TEAM 35 35
Stand-Alone -- 544
--------------- ---------------
Consolidated Total $ 1,667 $ 1,286
=============== ===============
Total Assets
Core PEO $ 127,662 $ 108,542
LPC 33,526 34,796
TEAM 11,064 14,202
Stand-Alone -- 47,263
--------------- ---------------
Consolidated Total $ 172,252 $ 204,803
=============== ===============
</TABLE>
18
<PAGE>
EMPLOYEE SOLUTIONS, INC. MARCH 31, 1999
- --------------------------------------------------------------------------------
(4) 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. 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 March 31, 1999, the compounded interest totaled
approximately $265,000.
The State of New York has asserted that the Company is a successor for state
unemployment insurance (SUI) purposes to certain entities from which the Company
acquired limited assets in connection with the Hazar acquisition effective
January 1996. The State further asserts that the Company was subject to
increased tax rates during 1996 and 1997 as a result of successor status. The
liabilities asserted are approximately $500,000. The Company is appealing the
determination.
The State of Ohio has issued a preliminary assessment of $5.2 million (plus
penalty) relating to sales taxes potentially applicable to certain types of
services. While the Company believes that no tax ultimately will be payable
based on the preliminary assessment, there can be no assurance that this will be
the case.
As previously reported, the Company and certain of its present and former
directors and executive officers were named as defendants in securities class
action litigation filed between March 1997 and May 1997. In November 1998, the
Company entered into a settlement agreement calling for the claims against the
Company and all other defendants to be dismissed with prejudice without
presumption or admission of any liability or wrongdoing. Final terms of the
settlement call for payment to the plaintiffs of $13.8 million in cash and $1.2
million in shares of the Company's Common Stock. A substantial majority of both
the cash portion of the settlement and litigation-related expenses have been
paid by the Company's directors and officers' insurance carriers. The Court
approved the settlement agreement on March 11, 1999. The number of shares of
Common Stock to be issued in connection with the settlement has been determined
to be 1,198,801 shares, of which 347,652 shares have been issued as of May 13,
1999. The balance of the shares will be issued upon receipt of appropriate
instructions from plaintiffs' counsel.
The Company was named as a defendant in an action filed by Ladenburg Thalmann &
Co., Inc. in the United States District Court, Southern District of New York in
May 1997 alleging breach of contract under certain stock warrants. The plaintiff
sought damages of at least $2.5 million. In March 1999, the Court granted the
Company's motion for summary judgment and dismissed the plaintiff's case. The
plaintiff has commenced an appeal process.
Subsequent to March 31, 1999, the Company's primary bank asked it to maintain
collateral at the bank for the various transactions, such as payroll checks, tax
payments, and other transactions conducted through the bank in the ordinary
course of the Company's business. The Company has agreed to maintain a deposit
of $5 million as collateral.
An arbitration panel awarded HDVT, Inc. (the seller of certain assets acquired
by the Company from Employers Trust in February 1997) a total of $10.4 million
in additional acquisition purchase price in February 1999. HDVT's motion to
confirm the award was granted in Superior Court, Maricopa County, Arizona in
April 1999. The Company is appealing the lower court decision to confirm the
arbitration award and has posted an appeal bond in the amount of $7.5 million,
and the funds on deposit with the Company's primary bank described above are
additional security for the appeal bond. The Company also is pursuing other
available remedies, including seeking a significant reduction of the purchase
19
<PAGE>
EMPLOYEE SOLUTIONS, INC. MARCH 31, 1999
- --------------------------------------------------------------------------------
price pursuant to a provision of the purchase agreement relating to the
determination of certain workers' compensation expense items. The Company has
been advised that HDVT will seek additional purchase price of approximately $1
million under this same provision of the purchase agreement, though the Company
does not expect any additional purchase price to become due thereby. At the time
of final resolution, the payment will be accounted for as an acquisition cost
and will be amortized over the remaining term of 13 years of the acquisition's
original 15-year amortization schedule.
An arbitration proceeding between the Company and US Xpress Enterprises, Inc.
(US Xpress) is scheduled for May 1999 regarding issues under a PEO service
agreement between the parties that was terminated by the Company in August 1998.
The parties recently stipulated to dismiss related proceedings pending in the
United States District Court for the Eastern District of Tennessee, including US
Xpress' request for a preliminary injunction. US Xpress seeks recovery of
approximately $3.0 million plus unspecified punitive damages primarily relating
to unpaid medical claims. The Company intends to contest the claim vigorously.
As part of the same arbitration, the Company is seeking recovery of damages for
misrepresentations made by US Xpress (relating primarily to the costs associated
with US Xpress's medical programs) at the time the parties entered into the PEO
service agreement.
As previously reported in the Company's 1998 Report on Form 10-K, the Company
was named as a defendant in an action filed by an employee in February 1999 in
Superior Court, Maricopa County, Arizona alleging breach of contract with
respect to certain payments claimed to be owing during and after his employment
with the Company. The action has been dismissed with prejudice pursuant to a
settlement agreement whereby the Company provided a cash payment of $373,333 to
the plaintiff. The Company also entered into a three-year arrangement under
which sales and marketing services will be provided by the plaintiff on an
independent contractor basis. The 10-K also reported that a director of the
Company had agreed to indemnify the Company personally for amounts paid by the
Company to the employee in connection with this matter, if any. The Company has
been advised by the director that he believes that his indemnification agreement
does not extend to the settlement agreement terms agreed to by the Company. The
Company currently is evaluating its options regarding this matter.
International Color Services, L.L.C. filed for arbitration in December 1998
alleging breach of contract regarding fee issues under the PEO service agreement
between the parties. The Company has filed a complaint in Superior Court,
Maricopa County, Arizona in January 1999 seeking a declaratory judgment that the
dispute is not subject to arbitration. Plaintiff has filed a motion to compel
arbitration and a counterclaim seeking damages of over $400,000 plus attorneys
fees and costs and unspecified punitive damages. The Company intends to contest
the claim vigorously.
From time to time, the Company is named as a defendant in lawsuits in the
ordinary course of business. These lawsuits are not expected to have a material
adverse effect on the Company's financial position or results of operations.
20
<PAGE>
EMPLOYEE SOLUTIONS, INC. MARCH 31, 1999
- --------------------------------------------------------------------------------
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, 1998. 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 addition to those
discussed in "Item 1 - Business" and "Item 7 - Management's Discussion and
Analysis of Financial Condition and Results of Operations" of the Company's
Report on Form 10-K for the year ended December 31, 1998, 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, expected profit, and
other factors. These 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.
COSTS OF REVENUES
The Company's 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 may be responsible for payment of these costs even if not reimbursed
by its clients.
Employment related taxes consist of the employer's portion of payroll taxes
required under 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 vary from state to state.
Workers' compensation liabilities are fully insured under a guaranteed cost
policy, subject to limited exceptions described below. Accordingly, workers'
compensation expense includes premiums paid to the Company's third party
insurance carriers for workers' compensation insurance. Workers' compensation
expense also includes the cost of a defined portfolio of stand-alone policies in
place at December 31, 1997 which expired at various dates during 1998 and as to
which the Company retains liability of $250,000 per occurrence plus fees as
described above; and costs under the Company's self-insurance program in Ohio,
with respect to which the Company retains liability of $50,000 per occurrence.
21
<PAGE>
EMPLOYEE SOLUTIONS, INC. MARCH 31, 1999
- --------------------------------------------------------------------------------
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 one self-insured program with a built-in maximum
coverage cap of $100,000 per person per year. The Company recognizes a liability
for self-insured and 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 for healthcare and workers' compensation claims are adequate for
future claims payments, there can be no assurance that this will be the case.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES
The Company's primary operating expenses are personnel expenses, other general
and administrative expenses, and sales and marketing expenses. Personnel
expenses include compensation, fringe benefits and other personnel expenses
related to the Company's internal employees. Other general and administrative
expenses include rent, office supplies and expenses, legal and accounting fees,
bad debt expenses, insurance and other operating expenses. Sales and marketing
expenses include commissions to sales personnel 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 growth
through acquisition of other companies providing PEO services. The Company has
accounted for its acquisitions using the "purchase" method of accounting,
whereby the results of such acquired companies are reflected in the Company's
financial statements prospectively from the date of acquisition. 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. Further during the transition period after an acquisition the Company
may act to implement pricing changes where appropriate and to eliminate client
relationships which do not meet the Company's risk or profitability profiles.
Acquisition activity historically has increased the Company's workers'
compensation expense, primarily by accelerating the Company's overall growth
rate and accelerating its exposure in specific higher-risk segments, such as
transportation. The Company also seeks to eliminate certain general and
administrative costs of acquired companies although such results may not be
achieved.
OPERATING RESULTS
Margin comparisons are affected by the relative mix of stand-alone risk
management/workers' compensation services, full PEO services, TEAM Services
services, and driver leasing services acquired in the Leaseway acquisition (LPC)
in any particular period.
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
positively impacts on the Company's working capital and results of operations as
the year progresses. Also, fourth quarter revenues are typically increased by
year-end bonuses and distributions paid to worksite employees, historically
resulting in little or no revenue growth from fourth to first quarter (excluding
acquisitions). In addition, the Company's first quarter revenues tend to be
adversely affected by decreased activity by various of its transportation
clients due to seasonal factors.
22
<PAGE>
EMPLOYEE SOLUTIONS, INC. MARCH 31, 1999
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
RESULTS OF OPERATIONS--QUARTER ENDED MARCH 31, 1999 COMPARED TO QUARTER ENDED MARCH 31, 1998
- --------------------------------------------------------------------------------------------
Percent
(In thousands of dollars) 1999 Change 1998
- --------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Revenues $ 198,909 (10%) $ 220,930
Cost of revenues 191,173 (10%) 211,464
Gross profit 7,736 (18%) 9,466
Selling, general and administrative 7,513 (3%) 7,771
Depreciation and amortization 1,667 30% 1,286
Interest income 244 (68%) 770
Interest expense 2,286 8% 2,120
Net loss (3,462) (283%) (905)
- --------------------------------------------------------------------------------------------
</TABLE>
REVENUES
Revenues decreased to $198.9 million for the quarter ended March 31, 1999 from
$220.9 million for the quarter ended March 31, 1998, a decrease of 10%. The
primary contributing factor to the decline in first quarter 1999 revenue was the
loss of US Xpress Enterprises, Inc. (US Xpress) as a major customer, which
contributed $45.9 million to the first quarter 1998 revenue. Growth from
internal sales and acquisitions during the first quarter of 1999 was also less
than that achieved during the first quarter of 1998, primarily as a result of
factors such as increased attrition of clients and competitive pressures in the
PEO and workers' compensation industries. Further, the Company transitioned
operations from two operations centers in Angola, Indiana and Framingham,
Massachusetts to Phoenix during the third and fourth quarters of 1998 which has
had a negative impact on internal sales. While the Company expects that these
steps will improve customer service, retention, and support internal sales
growth in the long run, there can be no assurance that this will be the case.
The number of worksite employees decreased to approximately 38,500 covering
approximately 2,090 client companies at March 31, 1999 from approximately 46,400
covering 1,800 client companies at March 31, 1998.
COST OF REVENUES
Cost of revenues decreased 10% to $191.2 million in the quarter ended March 31,
1999 from $211.5 million for the quarter ended March 31, 1998. This decrease is
primarily due to the decrease in the Company's business as described above.
GROSS PROFIT
The Company's gross profit margin decreased from 4.3% in the quarter ended March
31, 1998 to 3.9% in the quarter ended March 31, 1999. Gross profit margin in the
first quarter of 1998 benefited by a reduction of the Company's effective
unemployment insurance tax rate and the switch to a guaranteed cost workers'
compensation program, while the first quarter of 1999 was adversely affected by
1999 price increases experienced under the guaranteed cost workers' compensation
program as a result of switching to a new insurance carrier. Additionally, the
proportion of gross profit related to TEAM Services revenues, which have lower
margins, increased in the period ended March 31, 1999 relative to the same
period in 1998.
SELLING, GENERAL AND ADMINISTRATIVE
Selling, general and administrative expenses for the quarter ended March 31,
1999 decreased by approximately $258,000 to $7.5 million, or 3%, from $7.8
million for the quarter ended March 31, 1998. Selling, general and
administrative expenses in 1999 include the positive effects of various cost
reduction initiatives completed during the third and fourth quarters of 1998, as
well as other cost reductions implemented during the first quarter of 1999. Such
initiatives include improved systems utilization and economies of scale achieved
within the Company's operations. Selling, general and administrative expenses
incurred in the ordinary course of business are expected to increase to meet the
needs of new business, but the proportion of the rate of growth relative to the
rate of growth in gross revenue is expected to decline, primarily as a result of
the improved efficiencies and economies of scale referred to above.
DEPRECIATION AND AMORTIZATION
Depreciation and amortization represents depreciation of property and equipment
and amortization of organizational costs, customer lists and goodwill. For the
quarter ended March 31, 1999, depreciation and amortization
23
<PAGE>
EMPLOYEE SOLUTIONS, INC. MARCH 31, 1999
- --------------------------------------------------------------------------------
expense totaled $1.7 million compared to $1.3 million for the quarter ended
March 31, 1998. The increase was due primarily to goodwill amortization
resulting from acquisitions in 1998. Goodwill amortization of these acquisitions
was recognized from the date of acquisition.
INTEREST
Interest expense for the quarter ended March 31, 1999 totaled $2.3 million
compared to $2.1 million for the quarter ended March 31, 1998. The increase in
interest expense is primarily due to interest on the HDVT arbitration award. For
the quarter ended March 31, 1999 interest income totaled $244,000 compared to
$770,000 for the quarter ended March 31, 1998. The decrease in interest income
is primarily due to the reduction in the balance of cash and investments.
EFFECTIVE TAX RATE
The Company's effective tax rate provides for federal and state income taxes. As
of March 31, 1999, the Company has incurred losses in excess of what can be
carried back and applied against prior years' income to generate federal income
tax refunds. The remaining net operating loss will be available for
carry-forward benefit only to the extent of any subsequently generated taxable
income.
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 use of cash in
the quarter ended March 31, 1999 was for operating activities and the reduction
in bank overdrafts. The Company's liquidity position was materially reduced due
to the use of cash during the quarter and subsequent commitments of cash. The
subsequent commitments result primarily from developments in litigation with
HDTV, Inc. over the purchase price payable for the Company's February 1997
acquisition of assets from Employers' Trust, including the need to post
collateral for an appeal bond earlier than anticipated and prior to the
anticipated receipt of a significant federal income tax refund (see discussion
below). While the Company believes it has sufficient liquidity resources to meet
anticipated cash needs in accordance with its plan, it may not have sufficient
liquidity to meet unanticipated or unplanned cash needs.
Cash used in operating activities was $7.0 million during the first quarter of
1999 compared to cash provided by operations of $3.7 million during the first
quarter of 1998. Cash was primarily used during the first quarter of 1999 for
payroll tax payments and prepaid workers' compensation premium expenses under
the Company's guaranteed cost policy. Operating cash flows are derived from
customers for full PEO services rendered by the Company. 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 Company's TEAM Services and LPC operations extend credit terms
generally from 15 to 45 days as is customary in their respective market
segments. 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 receivable of
approximately $1.4 million from a single stand-alone client as to which disputes
have risen. The Company has initiated litigation against the former client
seeking, among other remedies, collection of the receivable. While the Company
believes that it will prevail in the litigation, there can be no assurance that
this will be the case and an adverse outcome could result in the write-off of
all or a substantial portion of the receivable.
Cash used in investing activities was $1.4 million and $32.3 million in the
three months ended March 31, 1999 and 1998, respectively. Included in investing
activities in 1999 is $1.0 million of cash representing the Company's investment
in a certificate of deposit to secure a letter of credit issued on behalf of the
Company during the first quarter of 1999. The Company used $30.9 million of cash
in its investment in marketable securities during the first quarter of 1998.
Future acquisitions are not expected to be a significant use of cash. However,
cash purchase price payments remain due in the acquisition of Employers' Trust.
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These may be in addition to the arbitration award of $10.4 million to HDTV, the
seller of the Employers' Trust assets, discussed below. The amounts of the
payments are based on the terms of the applicable purchase agreements and have
not yet been determined. For the quarter ended March 31, 1999 and 1998, capital
expenditures were $19,000 and $1.2 million, respectively. Capital expenditures
in 1998 consisted primarily of computer equipment to enhance the Company's
ability to support the Company's increased client base and the centralization of
payroll processing and accounting systems. Although the Company continuously
reviews its capital expenditure needs, management expects that 1999 capital
expenditures will continue in order to meet the needs of the Company's base of
worksite employees.
Cash used in financing activities was $13.7 million for the three months ended
March 31, 1999 compared to $60,000 for the same period in 1998. The increase was
primarily due to the reduction in bank overdrafts.
At March 31, 1999 and December 31, 1998, the Company had working capital of
$19.6 million and $31.7 million, respectively.
Subsequent to March 31, 1999, the Company's primary bank asked it to maintain
collateral at the bank for the various transactions, such as payroll checks, tax
payments, and other transactions conducted through the bank in the ordinary
course of the Company's business. The Company has agreed to maintain a deposit
of $5 million as collateral. The Company also has deposited $7.5 million to
collateralize an appeal bond as part of the appeal process in the HDVT
arbitration. The funds on deposit with the Company's primary bank described in
the preceding sentence are additional security for the appeal bond. The Company
also made its scheduled $4.2 million interest payment in April on its notes.
These items have materially reduced the Company's liquidity position, and the
Company may not be able to meet unanticipated cash needs. The Company is
reviewing various financing strategies, and sources of liquidity, including
negotiating the return of all or a substantial portion of the $1 million
invested in IPEO in January 1999. The Company has also filed its 1998
consolidated federal income tax return and anticipates receiving a refund in an
aggregate amount of approximately $4.5 million. While there can be no assurance,
the Company anticipates it will receive the refund in June 1999. There can be no
assurance that these strategies can be developed or implemented successfully on
a timely basis. See "Outlook: Issues and Risks" below and, in particular,
"Future Capital and Liquidity Needs; Uncertainty of Additional Financing;"
Substantial Leverage;" and "Litigation and Other Contingencies" and "Credit
Risks."
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.
FUTURE CAPITAL AND LIQUIDITY NEEDS; UNCERTAINTY OF ADDITIONAL FINANCING
The Company currently anticipates that its available cash resources combined
with anticipated funds from operations will be sufficient to meet its presently
anticipated working capital and capital expenditures requirements under its 1999
operating plan, though the Company's liquidity position recently was reduced
materially as a result of providing certain collateral to its primary bank and
posting an appeal bond in the HDVT arbitration matter. See "Liquidity and
Capital Resources." The Company's liquidity could be affected by the litigation
discussed elsewhere herein. In the event the Company's cash needs are greater
than expected, it will need additional souces of liquidity. The Company will
need to raise additional funds through public or private debt or equity
financing if the revenue and cash flow elements of its 1999 operating plan are
not met, to take advantage of unanticipated opportunities, to respond to
unanticipated competitive pressures or adverse outcomes associated with
litigation or other claims, or to deal with unanticipated cash requirements,
such as material customer payment defaults. If additional funds are raised
through the issuance of equity securities, the percentage ownership of the then
current shareholders of the Company will be reduced and such equity securities
may have rights, preferences or privileges senior to those of the holders of the
Company's Common Stock. There can be no assurance that additional financing will
be available on terms favorable to the Company, or at all. If adequate funds are
not available or are not available on acceptable terms, the Company's business,
operating results, financial condition and ability to operate will be materially
adversely affected.
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SUBSTANTIAL LEVERAGE
The Company has incurred significant debt primarily in connection with its
expansion through acquisitions and its October 1997 issuance of its 10% Senior
Notes due 2004. As of March 31, 1999, the Company had outstanding senior
indebtedness of approximately $85 million and stockholders' equity of
approximately $12 million, respectively.
The Company's ability to make scheduled principal payments in respect of, or to
pay the interest on, or to refinance, any of its indebtedness (including the
Notes) will depend on its future performance, which, to a certain extent, is
subject to general economic, financial, competitive, regulatory and other
factors beyond its control. Based upon the Company's current level of
operations, management believes that cash flow from operations and other
available cash will be adequate to meet the Company's anticipated future
requirements for working capital expenditures, scheduled lease payments and
scheduled payments of interest on its indebtedness, including the Notes, for the
foreseeable future. However, the Company may not have sufficient liquidity to
deal with unanticipated cash needs. Also, the Company may need to refinance all
or a portion of the principal of the Notes at or prior to maturity. There can be
no assurance that the Company's business will generate sufficient cash flow from
operations, that anticipated growth will occur or that funds will be available
from other sources or otherwise in an amount sufficient to enable the Company to
service or refinance its indebtedness, including the Notes, or make anticipated
capital expenditures and lease payments. In addition, there can be no assurance
that the Company will be able to effect any such refinancing (or any equity
financing) on commercially reasonable terms. Also, the Company is facing several
matters in litigation or arbitration as discussed elsewhere herein, as well as
litigation incidental to its business. The Company's liquidity position could be
materially adversely affected depending on the outcome of these matters. See
"Litigation and Other Contingencies" and "Liquidity and Capital Resources."
The degree to which the Company is leveraged could have important consequences,
including, but not limited to, the following: (i) a substantial portion of the
Company's cash flow from operations will be dedicated to debt service and will
not be available for other purposes; (ii) the Company's ability to obtain
additional financing in the future could be limited; and (iii) the Notes
indenture contains financial and restrictive covenants that limit the ability of
the Company to, among other things, borrow additional funds. Failure by the
Company to comply with such covenants could result in an event of default which,
if not cured or waived, could have a material adverse effect on the Company's
business and financial performance.
LITIGATION AND OTHER CONTINGENCIES
While certain significant litigation matters have been resolved recently,
including the settlement of a major securities class action brought against the
Company and certain of its officers and directors in March 1997, other
significant matters remain unresolved. For example, the Company is appealing a
$10.4 million arbitration award obtained by HDVT, Inc. (the seller of assets
acquired by the Company from Employers Trust in February 1997) against the
Company in February 1999; the award was confirmed in April 1999. A separate
arbitration is scheduled for May 1999 to resolve a claim against the Company by
its former client, US Xpress, for approximately $3 million in unpaid medical
claims and to resolve a counterclaim by the Company against US Xpress for
damages resulting from misrepresentations made by it at the time of contract
formation with respect to US Xpress's medical cost history. The State of Ohio
has assessed sales and use taxes of approximately $5.2 million against the
Company that the Company believes have been assessed erroneously and is
contesting vigorously. The Company faces other claims relating to prior
contractual relationships and other matters. While the Company will continue to
seek vigorously to resolve these matters favorably, there can be no assurance
that the outcome of these matters, or any of them, will not have a material
adverse effect upon the Company's results of operations or financial position.
RESTRUCTURING AND COST-REDUCTION PLAN; EFFECT ON CLIENT RETENTION
In 1998, the Company completed a restructuring and cost-reduction plan primarily
involving the closing of remote payroll processing centers and other offices and
various other expense reduction strategies. Back office functions were
consolidated at the Company's corporate headquarters. While the Company believes
that completion of the plan will result in long-term improvements in its
operational and customer service capabilities (in addition to significant
operating expense reductions), the plan resulted in increases in client
attrition and decreases in internal sales due primarily to short-term
disruptions in client service. While the Company has recently taken measures to
improve customer service and reduce attrition, there can be no assurance that
the effectiveness of these measures can be maintained.
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RISKS ASSOCIATED WITH SIGNIFICANT GROWTH, INCLUDING GROWTH THROUGH ACQUISITIONS
The Company has experienced significant growth that has challenged the Company's
management, personnel, resources and systems. A significant portion of the
Company's growth has been accomplished through the acquisition of other PEOs.
Growth through acquisition involves substantial risks, including the risk of
improper valuation of the acquired business and the risks inherent in
integrating such businesses with the Company's operations. As part of its
business strategy, the Company intends to pursue continued growth. There can be
no assurance that the Company will be able to achieve growth in the future or
manage this growth effectively.
INCREASES IN HEALTH INSURANCE PREMIUMS, UNEMPLOYMENT TAXES AND WORKERS'
COMPENSATION RATES; AVAILABILITY OF PROGRAMS
State unemployment taxes are, in part, determined by the Company's unemployment
claims experience. Medical claims experience also greatly impacts the Company's
health insurance rates and claims cost from year to year. Similarly, workers'
compensation costs are directly affected by experience. Should the Company
experience a large increase in claims activity for unemployment, workers'
compensation and/or healthcare, 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 due to contractual or competitive factors. In addition, the Company
would have difficulty competing with PEOs with lower claims rates that may offer
lower rates to clients.
The maintenance of health and workers' compensation insurance plans that cover
worksite employees is a significant part of the Company's business. While the
Company believes that replacements for its current contracts could be obtained
on competitive terms, if doing so became necessary, without causing significant
disruption to the Company's business, there can be no assurance in this regard.
TAX TREATMENT
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). The Internal Revenue Service
(IRS) has formed a Market Segment Study Group to examine whether PEOs, such as
the Company, are for certain employee benefit and 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. With respect to benefit plans, the tax qualified status of the
Company's 401(k) plans could be revoked, and the Company's cafeteria and medical
reimbursement plans may lose their favorable tax status. 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 litigation by
clients or worksite employees.
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As the employer of record for many client companies and their 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. 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. 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.
CREDIT RISKS
As the employer of record for its worksite employees, the Company may be
contractually obligated to pay their wages, benefit costs and payroll taxes
whether or not the Company receives payment from its customer. 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 timely payment is not received. Limited extended payment terms are
offered in certain cases subject to local competitive conditions. 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.
By way of example, a group of employees filed suit against the Company in 1998
alleging that they were employees of the Company and that they had not been paid
certain wages. The maximum amount claimed could have exceeded $500,000. The
Company does not believe that it has any liability to the plaintiffs based on
the facts of the case and successfully obtained a dismissal of the suit.
Plaintiffs have commenced an appeal process.,
In addition, the Company competes in several market segments 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. 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.
CLIENT RELATIONSHIPS
The Company's subscriber agreements with its clients generally may be canceled
upon 30 days written notice of termination by either party, except where
different arrangements are required by applicable law. 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. See RESTRUCTURING AND
COST-REDUCTION PLAN; EFFECT ON CLIENT RETENTION. The short-term nature of most
customer agreements means that clients could terminate a substantial portion of
the Company's business upon short notice.
Through recent acquisitions and internal growth, the percentage of the Company's
clients in the transportation industry has increased. Increased concentration in
a single industry could make the Company 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 through LPC, in which the Company acts as
sole employer, which may increase risk to the Company as a result of the direct
nature of the employment relationship.
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UNCERTAINTY OF EXTENT OF PEO'S LIABILITY; GOVERNMENT REGULATION OF PEOS
Employers 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
"co-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. 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 (such as in the driver leasing program), 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 material adverse effect on
the Company. In addition, the Company believes that a portion of its clients may
not be maintaining the insurance coverage required under their service
agreements with 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 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, various 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.
ADEQUACY OF LOSS RESERVES
The Company obtained fully-insured guaranteed cost workers' compensation
coverage effective January 1, 1998, thereby eliminating, with certain
exceptions, the Company's risk retention on workers' compensation claims arising
after that date. The Company retained risk up to $250,000 per occurrence with
respect to a defined portfolio of stand-alone policies, which expired at various
dates during 1998. The Company also retained risk up to $50,000 per occurrence
for claims under Ohio's monopolistic workers' compensation structure, with an
aggregate liability limitation.
The Company's reserves for losses and loss adjustment expenses under the Ohio
and stand-alone programs referred to in the preceding paragraph are estimates of
amounts needed to pay reported and unreported claims and related loss adjustment
expenses. Loss reserves are inherently uncertain and are subject to a number of
circumstances that are highly variable and difficult to predict. 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, to the Company's operating results in the period in which
the deficiency is identified.
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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,
though several are larger than or comparable to the Company in size. The Company
also competes with non-PEO companies, whose offerings overlap with some of the
Company's 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, have entered or will enter the PEO market.
ISSUANCE OF ADDITIONAL SHARES
As discussed elsewhere herein, the Company anticipates issuing additional shares
of its Common Stock during 1999 (1) in connection with the settlement of the
securities class action litigation (see Item Part II, Item 1 - "Legal
Proceedings"); (2) in payment of the purchase price for the June 1996
acquisition of TEAM Services and (3) in payment of the remaining purchase price
for the September 1997 ERC acquisition. The Company also is obligated to issue
certain additional shares of Common Stock (or pay additional cash, in its
discretion) in connection with the December 1998 acquisition of Fidelity
Resources Corp. if the price of the Company's Common Stock is less than $4 per
share during approximately November 1999, subject to certain conditions. The
numbers of shares to be issued in connection with the class action settlement,
TEAM purchase price and (should the Company elect to make payment in the form of
shares of Common Stock) supplemental Fidelity purchase price varies in
proportion to the Nasdaq trading price of the Common Stock (i.e. the number of
shares increases to the extent the Nasdaq trading price decreases, and vice
versa).
YEAR 2000 COMPLIANCE
Many computer programs process transactions based on using two digits for the
year of the transaction rather than a full four year digits (e.g. "98" for
1998). Systems that process Year 2000 transactions with the year "00" may
encounter significant processing inaccuracies or inoperability. Management has
determined that, like most other companies, it will be required to modify or
replace portions of its software so that its information systems will be able to
properly utilize dates subsequent to December 31, 1999.
STATE OF READINESS
The Company began developing its plan to address Year 2000 in 1997. The plan
includes hardware, software, electronic equipment and building systems, and
evaluates risk associated with vendor readiness. The plan includes (1)
inventorying Year 2000 items; (2) assigning priorities to identified items; (3)
assessing Year 2000 compliance of material items (whether internal or third
party-related); (4) repairing or replacing material items determined not to be
Year 2000 compliant; (5) testing material items; and (6) assessing contingency
plans.
At March 31, 1999, the inventory, priority assessment and internal compliance
assessment phases are substantially completed except for elements of the
operations of the Company's LPC subsidiary. The Company intends to substantially
complete those phases for LPC by mid-year. Prioritization of items is assigned
based on the level of disruption to Company operations and client service that
would result from noncompliance. While Year 2000 issues present significant
risks for the Company due to the nature of its business, no significant
noncompliance issues were identified during these phases, though there can be no
assurance that such issues will not be identified in the future. Due in part to
the Company's relatively short operating history, the Company operates only one
so-called "legacy" system, limiting its exposure to certain Year 2000 issues.
The repair and replacement phase of the Company's plan has been implemented
primarily through various systems upgrades that have been conducted in the
ordinary course of business, which upgrades primarily were implemented to meet
the Company's needs in view of its rapid growth and independently of Year 2000
considerations. The Company anticipates that repair and replacement
considerations relevant to its LPC subsidiary, if any, will be managed through a
transition of LPC functions onto the Company's core software platform, which
transition previously had been scheduled for operational reasons independent of
Year 2000 considerations. A limited amount of software has been purchased
primarily for Year 2000 compliance purposes.
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The Company has commenced the testing phase of its Year 2000 plan. The Company
intends to test its systems for accuracy through the use of test data on a wide
variety of the Company's normal operating transactions under various date
conditions. The testing phase is approximately 70% complete. The Company is
reviewing software products to assist it in completing the testing phase on an
automated basis. The Company believes that these tests can be completed in
sufficient time to permit required modifications, if any, to be made on a timely
basis.
The Company believes that it does not have material risks associated with Year
2000 issues for non-information technology systems due to the nature of its
operations.
The Company has also assessed its third party relationships and has identified a
list of vendors that it considers most significant to its operations. These
vendors primarily include third party hardware and software vendors, financial
institutions, taxing authorities, third party administrators and benefit
providers. The Company already has obtained compliance statements from a
substantial majority of its key vendors (generally through information publicly
available from such vendors), and has commenced the process of requesting
written information from designated key vendors regarding their Year 2000 plans
and state of readiness. Upon completion of the third-party evaluation and the
testing of its internal systems, the Company intends to test significant data
interfaces with third party vendors to verify their compliant status.
COSTS TO ADDRESS YEAR 2000 ISSUE
The Company has not incurred and does not expect to incur significant costs
related to Year 2000 issues other than the time of internal personnel to
complete the Company's Year 2000 plans. As referred to above, the Company has
expended significant resources to upgrade various systems in the ordinary course
of its business, which upgrades were implemented primarily to meet the Company's
needs in view of its rapid growth and independently of Year 2000 considerations.
A limited amount of software has been purchased primarily for Year 2000
compliance purposes. As noted above, the Company currently is considering
purchasing an additional software product to assist in completing the testing
phase. Total costs for Year 2000 upgrades are expected to be less than $25,000.
RISKS ASSOCIATED WITH YEAR 2000 ISSUES; CONTINGENCY PLANNING
The Company presently believes that the Year 2000 issues will not pose
significant operational problems for the Company. However, if all Year 2000
issues are not properly identified, or assessment, repair or replacement, and
testing are not effected timely with respect to Year 2000 problems that are
identified, there can be no assurance that the Year 2000 issues will not
materially adversely impact the Company's results of operations or materially
adversely affect the Company's relationships with customers, vendors or others.
Additionally, there can be no assurance that the Year 2000 issues of other
entities will not have a material adverse impact on the Company's systems or
results of operations. Among the problems which might occur without appropriate
planning and testing are: the inability to transmit direct deposit payroll
through banking systems to deposit funds into worksite employees' bank accounts;
the inability to collect funds electronically in payment of the Company's
service fees; the failure to properly calculate payroll information; the
untimely transmission of benefits enrollment or claims data to and from benefit
providers; and the inability to deliver payroll checks to employees due to
failure in transportation or courier systems.
The Company has begun, but not yet completed, an analysis of the operational
problems and costs (including loss of revenues) that would be reasonably likely
to result from the failure by the Company and key third parties to complete
efforts necessary to achieve Year 2000 compliance on a timely basis. A
contingency plan has not yet been finalized for dealing with the most reasonably
likely worst case scenario, and such scenario has not yet been clearly
identified. The Company currently plans to complete such analysis and
contingency planning mid-year.
The costs of the Company's Year 2000 efforts and the dates on which the Company
believes it will complete such efforts are based upon management's best
estimates, which were derived using numerous assumptions regarding future
events, including the continued availability of certain resources, third-party
compliance, and other factors. There can be no assurance that these estimates
will prove to be accurate, and actual results could differ materially from those
currently anticipated. Specific factors that could cause such material
differences include, but are not limited to, the availability and cost of
personnel trained in Year 2000 issues, the ability of the Company and third
parties (including vendors, customers and, in particular, federal, state and
local governments) to identify, assess, replace or repair and test all relevant
items (including embedded technology), the ability of third parties to
communicate compliance issues to the Company on a timely basis, unforeseen
expenses, and similar uncertainties.
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ITEM 3. - QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company is primarily exposed to market risks from fluctuations in interest
rates and the effects of those fluctuations on the market values of its
investments and marketable securities that are classified as AVAILABLE-FOR-SALE
marketable securities. Cash equivalent short-term investments consist primarily
of high quality investment grade instruments, such as commercial paper, which
are not significantly exposed to interest rate risk, except to the extent that
changes in interest rates will ultimately affect the amount of interest income
earned on these investments. The available-for-sale marketable securities are
subject to interest rate risk because these securities generally include
financial instruments such as certificates of deposit, corporate bonds, and U.S.
Treasury securities and agency notes that have an original maturity of greater
than 90 days. Because these instruments are considered highly liquid, they are
not significantly exposed to interest rate risk. However, the market values of
these securities may be affected by changes in prevailing interest rates. The
Company attempts to limit its exposure to interest rate risk primarily through
diversification and strict adherence to the Company's investment policy. The
Company's investment policy is designed to maximize interest income while
preserving its principal investment.
32
<PAGE>
EMPLOYEE SOLUTIONS, INC. MARCH 31, 1999
- --------------------------------------------------------------------------------
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
As previously reported, the Company and certain of its present and former
directors and executive officers were named as defendants in securities class
action litigation filed between March 1997 and May 1997. In November 1998, the
Company entered into a settlement agreement calling for the claims against the
Company and all other defendants to be dismissed with prejudice without
presumption or admission of any liability or wrongdoing. Final terms of the
settlement call for payment to the plaintiffs of $13.8 million in cash and $1.2
million in shares of the Company's Common Stock. A substantial majority of both
the cash portion of the settlement and litigation-related expenses have been
paid by the Company's directors and officers' insurance carriers. The Court
approved the settlement agreement on March 11, 1999. The number of shares of
Common Stock to be issued in connection with the settlement has been determined
to be 1,198,801 shares, of which 347,652 shares have been issued as of May 13,
1999. The balance of the shares will be issued upon receipt of appropriate
instructions from plaintiffs' counsel.
The Company was named as a defendant in an action filed by Ladenburg Thalmann &
Co., Inc. in the United States District Court, Southern District of New York in
May 1997 alleging breach of contract under certain stock warrants. The plaintiff
sought damages of at least $2.5 million. In March 1999, the Court granted the
Company's motion for summary judgment and dismissed the plaintiff's case. The
plaintiff has commenced an appeal process.
An arbitration panel awarded HDVT, Inc. (the seller of certain assets acquired
by the Company from Employers Trust in February 1997) a total of $10.4 million
in additional acquisition purchase price in February 1999. HDVT's motion to
confirm the award was granted in Superior Court, Maricopa County, Arizona in
April 1999. The Company is appealing the lower court decision to confirm the
arbitration award and has posted an appeal bond in the amount of $7.5 million.
The Company also is pursuing other available remedies, including seeking a
significant reduction of the purchase price pursuant to a provision of the
purchase agreement relating to the determination of certain workers'
compensation expense items. The Company has been advised that HDVT will seek
additional purchase price of approximately $1 million under this same provision
of the purchase agreement, though the Company does not expect any additional
purchase price to become due thereby. At the time of final resolution, the
payment will be accounted for as an acquisition cost and will be amortized over
the remaining term of 13 years of the acquisition's original 15-year
amortization schedule.
As previously reported in the Company's 1998 Report on Form 10-K, the Company
was named as a defendant in an action filed by Bertram Danzig in February 1999
in Superior Court, Maricopa County, Arizona alleging breach of contract with
respect to certain payments claimed to be owing during and after his employment
with the Company. The action has been dismissed with prejudice pursuant to a
settlement agreement whereby the Company provided a cash payment of $373,333 to
the plaintiff. The Company also entered into a three-year arrangement under
which sales and marketing services will be provided by the plaintiff on an
independent contractor basis. The 10-K also reported that a director of the
Company had agreed to indemnify the Company personally for amounts paid by the
Company to Mr. Danzig in connection with this matter, if any. The Company has
been advised by the director, Marvin D. Brody, that he believes that his
indemnification agreement does not extend to the settlement agreement terms
agreed to by the Company. The Company currently is evaluating its options
regarding this matter.
From time to time, the Company is named as a defendant in lawsuits in the
ordinary course of business. See PartI, Item 2 - "Management's Discussion and
Analysis - Outlook: Issues and Risks - Uncertainty of Extent of PEO's Liability;
Government Regulation of PEOs; Credit Risks."
33
<PAGE>
EMPLOYEE SOLUTIONS, INC. MARCH 31, 1999
- --------------------------------------------------------------------------------
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) EXHIBITS
Exhibit
Number Description
------ -----------------------------------------------------
27 Financial Data Schedule
(b) REPORTS ON FORM 8-K.
Not applicable.
34
<PAGE>
EMPLOYEE SOLUTIONS, INC. MARCH 31, 1999
- --------------------------------------------------------------------------------
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: May 17, 1999 /s/ Quentin P. Smith, Jr.
-------------- ----------------------------------------
Quentin P. Smith, Jr.
Chief Executive Officer
/s/ John V. Prince
----------------------------------------
John V. Prince
Chief Financial Officer
35
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
COMPANY'S FORM 10-Q FOR THE PERIOD ENDED MARCH 31, 1999 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> 3-MOS
<FISCAL-YEAR-END> DEC-31-1999
<PERIOD-START> JAN-01-1999
<PERIOD-END> MAR-31-1999
<EXCHANGE-RATE> 1
<CASH> 19,275
<SECURITIES> 10,389
<RECEIVABLES> 52,047
<ALLOWANCES> 0
<INVENTORY> 0
<CURRENT-ASSETS> 92,541
<PP&E> 4,242
<DEPRECIATION> 0
<TOTAL-ASSETS> 172,252
<CURRENT-LIABILITIES> 72,930
<BONDS> 0
0
0
<COMMON> 35,803
<OTHER-SE> (23,543)
<TOTAL-LIABILITY-AND-EQUITY> 172,252
<SALES> 0
<TOTAL-REVENUES> 198,909
<CGS> 0
<TOTAL-COSTS> 191,173
<OTHER-EXPENSES> 9,180
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 2,286
<INCOME-PRETAX> (3,462)
<INCOME-TAX> 0
<INCOME-CONTINUING> (3,462)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (3,462)
<EPS-PRIMARY> (0.11)
<EPS-DILUTED> (0.11)
</TABLE>
