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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 September 30, 2000
[ ] 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:
39,284,158 Common shares, no par value were outstanding as of October 30, 2000.
================================================================================
<PAGE>
EMPLOYEE SOLUTIONS, INC.
FORM 10-Q
QUARTERLY REPORT FOR THE PERIOD ENDED SEPTEMBER 30, 2000
INDEX
Page
PART I. Financial Information Number
Item 1. Financial Statements
Consolidated Balance Sheets - September 30, 2000 and
December 31, 1999 2
Consolidated Statements of Operations for the
Quarters and Nine Months Ended September 30, 2000 and 1999 3
Consolidated Statement of Changes in Stockholders'
Equity for the Nine Months Ended September 30, 2000 4
Consolidated Statements of Cash Flows for the
Nine Months Ended September 30, 2000 and 1999 5
Notes to Consolidated Financial Statements 7
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations 23
Item 3. Quantitative and Qualitative Disclosure about Market Risk 33
PART II. Other Information
Item 1. Legal Proceedings 34
Item 3. Defaults Upon Senior Securities 34
Item 6. Exhibits and Reports on Form 8-K 35
Signatures 36
<PAGE>
ITEM 1. FINANCIAL STATEMENTS
EMPLOYEE SOLUTIONS, INC.
CONSOLIDATED BALANCE SHEETS
September 30, December 31,
(In thousands of dollars, except share data) 2000 1999
-------------------------------------------- --------- ---------
ASSETS
CURRENT ASSETS:
Cash and cash equivalents $ 15,930 $ 34,014
Investments and marketable securities -- 100
Restricted cash and investments 83 1,000
Accounts receivable, net 28,098 38,296
Receivables from insurance companies 6,885 6,618
Prepaid expenses and deposits 4,755 1,088
--------- ---------
Total current assets 55,751 81,116
Property and equipment, net 3,247 4,211
Goodwill and other assets, net 34,316 37,000
--------- ---------
Total assets $ 93,314 $ 122,327
========= =========
LIABILITIES AND STOCKHOLDERS' (DEFICIT) EQUITY
CURRENT LIABILITIES:
Bank overdraft $ 3,889 $ 2,472
Accrued salaries, wages and payroll taxes 19,222 31,175
Accounts payable 5,379 6,224
Accrued workers' compensation and health insurance 7,944 7,188
Income taxes payable 287 363
Other accrued expenses 11,418 6,379
Interest payable 8,259 1,905
Note payable 88,000 10,000
--------- ---------
Total current liabilities 144,398 65,706
--------- ---------
Long-term debt -- 85,000
--------- ---------
Other long-term liabilities 387 347
--------- ---------
Commitments and contingencies
STOCKHOLDERS' (DEFICIT) 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, 38,433,027 shares issued and
outstanding September 30, 2000, and 36,182,547
shares issued and outstanding December 31, 1999 41,525 39,550
Common stock to be issued 5,922 7,871
Accumulated deficit (98,918) (76,147)
Cumulative unrealized net gain on
investment securities -- --
--------- ---------
Total stockholders' (deficit) equity (51,471) (28,726)
--------- ---------
Total liabilities and stockholders' equity $ 93,314 $ 122,327
========= =========
The accompanying notes are an integral part of these
consolidated financial statements.
2
<PAGE>
EMPLOYEE SOLUTIONS, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
Quarter ended September 30, Nine months ended September 30,
(In thousands of dollars, ---------------------------- ----------------------------
except share and per share data) 2000 1999 2000 1999
-------------------------------- ------------ ------------ ------------ ------------
<S> <C> <C> <C> <C>
Revenues $ 175,180 $ 222,418 $ 544,544 $ 627,415
------------ ------------ ------------ ------------
Cost of revenues:
Salaries and wages of worksite employees 149,705 188,702 459,560 526,970
Healthcare and workers' compensation 9,521 11,490 30,298 33,307
Payroll and employment taxes 9,925 12,944 35,999 41,546
------------ ------------ ------------ ------------
Cost of revenues 169,151 213,136 525,857 601,823
------------ ------------ ------------ ------------
Gross profit 6,029 9,282 18,687 25,592
Selling, general and administrative expenses 11,037 8,821 30,654 25,205
Depreciation and amortization 1,337 1,916 3,922 5,256
------------ ------------ ------------ ------------
Loss from operations (6,345) (1,455) (15,889) (4,869)
Other income (expense):
Interest income 281 170 861 937
Interest expense (2,566) (2,139) (7,770) (6,426)
Other 14 1 27 37
------------ ------------ ------------ ------------
Loss before provision for income taxes (8,616) (3,423) (22,771) (10,321)
Income tax benefit -- -- -- --
------------ ------------ ------------ ------------
Net loss $ (8,616) $ (3,423) $ (22,771) $ (10,321)
============ ============ ============ ============
Net loss per common and
common equivalent share:
Basic $ (.21) $ (.10) $ (.56) $ (.31)
Diluted $ (.21) $ (.10) $ (.56) $ (.31)
Weighted average number of common and
common equivalent shares outstanding:
Basic 40,433,598 34,534,260 40,428,756 33,415,237
============ ============ ============ ============
Diluted 40,433,598 34,534,260 40,428,756 33,415,237
============ ============ ============ ============
</TABLE>
The accompanying notes are an integral part of these
consolidated financial statements.
3
<PAGE>
EMPLOYEE SOLUTIONS, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
NINE MONTHS ENDED SEPTEMBER 30, 2000
<TABLE>
<CAPTION>
Cumulative
Retained Unrealized Total
Common Stock Earnings Gain Stockholders' Comprehensive
(In thousands of dollars, Common To Be Accumulated (loss) on (Deficit) Income
except share data) Stock Issued (Deficit) Investments Equity (Loss)
------------------------- -------- -------- -------- -------- -------- --------
<S> <C> <C> <C> <C> <C> <C>
BALANCE, December 31, 1999 $ 39,550 $ 7,871 $(76,147) $ -- $(28,726) $ --
Issuance of 44,222 shares of common
stock in connection with Employee
Stock Purchase Plan 26 -- -- -- 26 --
Issuance of 2,206,258 shares of common
stock in connection with acquisitions 1,949 (1,949) -- -- -- --
Net loss -- -- (22,771) -- (22,771) (22,771)
-------- -------- -------- -------- -------- --------
COMPREHENSIVE LOSS $(22,771)
========
BALANCE, SEPTEMBER 30, 2000 $ 41,525 $ 5,922 $(98,918) $ -- $(51,471)
======== ======== ======== ======== ========
</TABLE>
The accompanying notes are an integral part of these
consolidated financial statements.
4
<PAGE>
EMPLOYEE SOLUTIONS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
Nine months ended
September 30,
-----------------------
(In thousands of dollars) 2000 1999
------------------------- --------- ---------
CASH FLOWS FROM OPERATING ACTIVITIES:
Cash received from customers $ 554,742 $ 614,683
Cash paid to suppliers and employees (567,384) (629,913)
Interest received 861 937
Interest paid (1,389) (4,264)
Income taxes refunded (paid), net (76) 4,529
--------- ---------
Net cash used in operating activities (13,246) (14,028)
--------- ---------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of property and equipment (246) (381)
Business acquisitions -- (5,895)
Change in investments and marketable securities 100 7,426
Decrease in restricted cash and investments 917 88
Disbursements for deferred costs -- (103)
--------- ---------
Net cash provided by investing activities 771 1,135
--------- ---------
CASH FLOWS FROM FINANCING ACTIVITIES:
Payment of deferred loan costs (52) --
Proceeds from issuance of common stock 26 3
Increase (decrease) in bank overdraft and other 1,417 (13,727)
Decrease in short-term debt (7,000) --
--------- ---------
Net cash used in financing activities (5,609) (13,724)
--------- ---------
Net decrease in cash and cash equivalents (18,084) (26,617)
CASH AND CASH EQUIVALENTS, beginning of period 34,014 39,287
--------- ---------
CASH AND CASH EQUIVALENTS, end of period $ 15,930 $ 12,670
========= =========
The accompanying notes are an integral part of these
consolidated financial statements.
5
<PAGE>
EMPLOYEE SOLUTIONS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(CONTINUED)
Nine months ended
September 30,
--------------------
2000 1999
-------- --------
RECONCILIATION OF LOSS TO NET CASH
USED IN OPERATING ACTIVITIES:
Net loss $(22,771) $(10,321)
-------- --------
ADJUSTMENTS TO RECONCILE NET LOSS TO
NET CASH USED IN OPERATING
ACTIVITIES:
Depreciation and amortization 3,922 5,256
Decrease (increase) in accounts receivable, net 10,198 (12,732)
(Increase) decrease in insurance company receivables (267) 805
Increase in prepaid expenses and deposits (3,667) (2,590)
Decrease (increase) in other assets 22 (2,479)
(Decrease) increase in accrued salaries,
wages and payroll taxes (11,951) 2,237
Increase (decrease) in accrued workers'
compensation and health insurance 756 (75)
Increase in accounts payable, other accrued expenses
and other long term liabilities 10,588 1,342
Change in income taxes payable/receivable (76) 4,529
-------- --------
9,525 (3,707)
-------- --------
Net cash used in operating activities $(13,246) $(14,028)
======== ========
The accompanying notes are an integral part of these
consolidated financial statements.
6
<PAGE>
EMPLOYEE SOLUTIONS, INC. SEPTEMBER 30, 2000
--------------------------------------------------------------------------------
EMPLOYEE SOLUTIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2000
(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
September 30, 2000, ESI serviced approximately 1,794 client companies with
approximately 30,963 worksite employees in 45 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 27%, represents
the largest concentration of clients.
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 and nine months ended
September 30, 2000 are not necessarily indicative of the results that may be
expected for the year ending December 31, 2000. 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, 1999.
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 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.
7
<PAGE>
EMPLOYEE SOLUTIONS, INC. SEPTEMBER 30, 2000
--------------------------------------------------------------------------------
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 certificates
of deposit, at September 30, 2000 and December 31, 1999, and are stated at fair
market value. Substantially all cash and cash equivalents, including restricted
cash, are not insured at September 30, 2000.
INVESTMENTS AND MARKETABLE SECURITIES
At September 30, 2000, the Company maintained approximately $9.3 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 money market and mutual funds that had an
estimated fair value of $9.3 million at September 30, 2000.
RESTRICTED CASH AND INVESTMENTS
At September 30, 2000, restricted cash was $83 thousand, which represents cash
collateral held for securing short-term indebtedness under a loan agreement. See
Note 2.
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. SEPTEMBER 30, 2000
--------------------------------------------------------------------------------
NET INCOME 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>
Quarter ended September 30,
------------------------------------------------------------
2000 1999
(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 40,433,598 40,433,598 34,534,260 34,534,260
Dilutive effect of options
and warrants outstanding -- -- -- --
------------ ------------ ------------ ------------
Weighted average of
common and common
equivalent shares 40,433,598 40,433,598 34,534,260 34,534,260
============ ============ ============ ============
Net loss $ (8,616) $ (8,616) $ (3,423) $ (3,423)
Adjustments to net loss -- -- -- --
------------ ------------ ------------ ------------
Adjusted net loss for
purposes of the income per
common share calculation $ (8,616) $ (8,616) $ (3,423) $ (3,423)
============ ============ ============ ============
Net loss per common and
common equivalent share $ (.21) $ (.21) $ (0.10) $ (0.10)
============ ============ ============ ============
</TABLE>
9
<PAGE>
EMPLOYEE SOLUTIONS, INC. SEPTEMBER 30, 2000
--------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Nine months ended September 30,
------------------------------------------------------------
2000 1999
(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 40,428,756 40,428,756 33,415,237 33,415,237
Dilutive effect of options
and warrants outstanding -- -- -- --
------------ ------------ ------------ ------------
Weighted average of
common and common
equivalent shares 40,428,756 40,428,756 33,415,237 33,415,237
============ ============ ============ ============
Net loss $ (22,771) $ (22,771) $ (10,321) $ (10,321)
Adjustments to net loss -- -- -- --
------------ ------------ ------------ ------------
Adjusted net loss for
purposes of the income per
common share calculation $ (22,771) $ (22,771) $ (10,321) $ (10,321)
============ ============ ============ ============
Net loss per common and
common equivalent share $ (.56) $ (.56) $ (0.31) $ (0.31)
============ ============ ============ ============
</TABLE>
(2) NOTE PAYABLE:
On October 26, 1999 the Company entered into a loan and security agreement (as
amended, the "Loan Agreement") with Foothill Capital Corporation and Ableco
Finance LLC (the "Lenders") providing for a term loan of $10 million at an
initial interest rate of 13.5% and a revolving loan (based on eligible accounts
receivable) to a maximum of $10 million (including letters of credit drawn
thereunder) at an interest rate of prime plus 2%. The Company received the
proceeds of the term loan on October 29, 1999. The Company has not drawn on the
revolving loan facility except as security for various letters of credit ($5.4
million at September 30, 2000). The Company paid a closing fee of $800,000 and
is paying a commitment fee of 50 basis points on the unused portion of the
revolving line, as well as letter of credit fees initially set at 2.0%. Because
the term loan then remained outstanding, a fee of $100,000 was paid after July
29, 2000 and after October 29, 2000. The Loan Agreement matures on January 1,
2001. The principal loan covenants are as follows: tangible net worth of
($72,390,000) at December 31, 1999, ($71,320,000) at March 31, 2000,
($70,220,000) at June 30, 2000, ($68,270,000) at September 30, 2000 and
($66,090,000) at December 31, 2000; and EBITDA (as defined) of $1,230,000 at
December 31, 1999, $2,560,000 at March 31, 2000, $2,780,000 at June 30, 2000,
$3,410,000 at September 30, 2000 and $3,770,000 at December 31, 2000. The Loan
Agreement also includes covenants relating to capital expenditure limits and
worksite employee headcount and average gross margin requirements. The Loan
Agreement further contains, among other limitations, restrictions on mergers or
the sale of significant assets or use of the proceeds thereof, investments and
business acquisitions, and additional indebtedness or liens. The Loan Agreement
includes certain other customary covenants, and is secured by substantially all
of the Company's assets (including pledges of the stock of the Company's
subsidiaries and control agreements over substantially all of the Company's cash
accounts). The Company has not been in compliance with one or more of the
covenants set forth above commencing as of March 31, 2000 and has therefore
classified the debt obligation as a current liability. The Company has also
classified the 10% Senior Notes due 2004 as a current note payable obligation.
See Note 3.
10
<PAGE>
EMPLOYEE SOLUTIONS, INC. SEPTEMBER 30, 2000
--------------------------------------------------------------------------------
The Company and the Lenders entered into a Waiver and Amendment Agreement dated
as of July 6, 2000, under which the Lenders waived any rights and remedies
available for defaults under designated covenants with respect to which the
Company was then in default. The annual interest rate on the term loan was
increased to 15.5% effective April 30, 2000, increasing by 25 basis points per
month beginning on September 1, 2000 so long as any portion of the term loan
remains outstanding. The fee payable for undrawn letters of credit was increased
to 6% per annum. As additional security, the Company agreed to deposit $5
million in a deposit account subject to a control agreement in form satisfactory
to the Lenders, and to deposit an additional $1 million in such account on
August 1, 2000 and on the first day of each month thereafter so long as any
amounts remain owing to the Lenders. On September 11, 2000 the Company and the
Lenders signed an additional letter agreement whereby the Lenders agreed to
waive all prepayment penalties upon the repayment of $7 million of the term
loan, which was subsequently paid by the Company in September 2000. On September
26, 2000, an additional agreement was reached whereby the Lenders agreed to
waive all future prepayment penalties on payments of $1 million each on the
first day of October, November and December (constituting the remaining
outstanding balance on the term loan). The Company believes that the Loan
Agreement will not be renewed at its maturity date (January 1, 2001). The
Company is seeking a replacement facility, though there can be no assurance that
the Company will be able to obtain one.
(3) 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 Company is engaged in negotiations with the holders of these Notes. In
connection with the negotiations, the Company's Board of Directors elected to
withhold the $4.25 million semi-annual interest payments due on each of April 15
and October 15, 2000. Under the terms of the Indenture pursuant to which the
Notes were issued, such withholding of interest constitutes an Event of Default
(as defined in the Indenture). The Company received a written agreement from the
holders of the Notes under which the holders agreed to forbear from exercising
their rights and remedies through the first to occur of August 30, 2000 or the
occurrence of a new default. The waiver has expired, though the holders of the
Notes have not sought to exercise their rights and remedies during the pendency
of the negotiations between the Company and the holders of the Notes.
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 September 30, 2000 and December 31, 1999, and the results of
operations and cash flows for each of the quarters and nine month periods ended
September 30, 2000 and September 30, 1999, of Employee Solutions, Inc. (Parent),
the guarantor subsidiaries (Guarantors) and the subsidiaries which are not
guarantors (Non-guarantors).
11
<PAGE>
EMPLOYEE SOLUTIONS, INC. SEPTEMBER 30, 2000
--------------------------------------------------------------------------------
BALANCE SHEETS
<TABLE>
<CAPTION>
September 30, 2000
--------------------------------------------------------------
Non-
(In thousands of dollars) Parent Guarantors Guarantors Eliminating Consolidated
------------------------- --------- --------- --------- --------- ---------
<S> <C> <C> <C> <C> <C>
ASSETS
CURRENT ASSETS:
Cash and cash equivalents $ 9,938 $ 2,760 $ 3,232 $ -- $ 15,930
Investments and marketable securities -- -- -- -- --
Restricted cash and investments 83 -- -- -- 83
Accounts receivable, net 8,911 18,589 598 -- 28,098
Receivables from insurance companies -- -- 6,885 -- 6,885
Prepaid expenses and deposits 4,653 83 19 -- 4,755
Income taxes receivable -- -- -- -- --
Deferred income taxes -- -- -- -- --
Due from affiliates 8,446 2,674 (7,346) (3,774) --
--------- --------- --------- --------- ---------
Total current assets 32,031 24,106 3,388 (3,774) 55,751
Property and equipment, net 3,021 222 4 -- 3,247
Deferred income taxes -- -- -- -- --
Goodwill and other assets, net 8,119 26,197 -- -- 34,316
Investment in subsidiaries 50,770 -- -- (50,770) --
--------- --------- --------- --------- ---------
Total assets $ 93,941 $ 50,525 $ 3,392 $ (54,544) $ 93,314
========= ========= ========= ========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Bank overdrafts $ 1,236 $ 2,653 $ -- $ -- $ 3,889
Accrued salaries, wages and payroll taxes 5,326 13,616 280 -- 19,222
Accounts payable 221 902 4,256 -- 5,379
Accrued workers' compensation
and healthcare 4 862 7,078 -- 7,944
Income taxes payable 359 (70) (2) -- 287
Other accrued expenses 6,904 1,137 3,377 -- 11,418
Interest payable 8,259 -- -- -- 8,259
Short-term debt 88,000 -- -- -- 88,000
Due to affiliates 34,716 (1,930) (29,012) (3,774) --
--------- --------- --------- --------- ---------
Total current liabilities 145,025 17,170 (14,023) (3,774) 144,398
--------- --------- --------- --------- ---------
Deferred income taxes -- -- -- -- --
--------- --------- --------- --------- ---------
Long-term debt -- -- -- -- --
--------- --------- --------- --------- ---------
Other long-term liabilities 387 -- -- -- 387
--------- --------- --------- --------- ---------
Commitments and contingencies
STOCKHOLDERS' (DEFICIT) EQUITY
Class A convertible preferred stock -- -- -- -- --
Common stock, no par value 41,525 2,622 771 (3,393) 41,525
Common stock to be issued 5,922 -- -- -- 5,922
Additional paid in capital -- 26,342 50 (26,392) --
(Accumulated deficit) retained earnings (98,918) 4,391 16,594 (20,985) (98,918)
Unrealized net gain on
investment securities -- -- -- -- --
--------- --------- --------- --------- ---------
Total stockholders' (deficit) equity (51,471) 33,355 17,415 (50,770) (51,471)
--------- --------- --------- --------- ---------
Total liabilities and stockholders' equity $ 93,941 $ 50,525 $ 3,392 $ (54,544) $ 93,314
========= ========= ========= ========= =========
</TABLE>
12
<PAGE>
EMPLOYEE SOLUTIONS, INC. SEPTEMBER 30, 2000
--------------------------------------------------------------------------------
BALANCE SHEETS
<TABLE>
<CAPTION>
(In thousands of dollars) For the Year Ended December 31, 1999
------------------------- --------------------------------------------------------------
Non-
Parent Guarantors Guarantors Eliminating Consolidated
--------- --------- --------- --------- ---------
<S> <C> <C> <C> <C> <C>
ASSETS
CURRENT ASSETS:
Cash and cash equivalents $ 16,452 $ 14,148 $ 3,414 $ -- $ 34,014
Investments and marketable securities 100 -- -- -- 100
Restricted cash 1,000 -- -- -- 1,000
Accounts receivable, net 14,240 23,512 544 -- 38,296
Receivables from insurance companies -- -- 6,618 -- 6,618
Prepaid expenses and deposits 1,023 64 1 -- 1,088
Due from affiliates 8,150 2,644 (7,020) (3,774) --
--------- --------- --------- --------- ---------
Total current assets 40,965 40,368 3,557 (3,774) 81,116
Property and equipment, net 3,937 265 9 -- 4,211
Goodwill and other assets, net 9,947 27,053 -- -- 37,000
Investment in subsidiaries 42,872 -- -- (42,872) --
--------- --------- --------- --------- ---------
Total assets $ 97,721 $ 67,686 $ 3,566 $ (46,646) $ 122,327
========= ========= ========= ========= =========
LIABILITIES AND STOCKHOLDERS' (DEFICIT) EQUITY
CURRENT LIABILITIES:
Bank overdraft $ 2,472 $ -- $ -- $ -- $ 2,472
Accrued salaries, wages and payroll taxes 5,607 25,276 292 -- 31,175
Accounts payable 966 1,151 4,107 -- 6,224
Accrued workers' compensation and health
insurance 5 953 6,230 -- 7,188
Income taxes payable 421 (56) (2) -- 363
Other accrued expenses 2,709 976 2,694 -- 6,379
Due to affiliates 17,015 11,300 (24,541) (3,774) --
Interest payable 1,905 -- -- -- 1,905
Note payable 10,000 -- -- -- 10,000
--------- --------- --------- --------- ---------
Total current liabilities 41,100 39,600 (11,220) (3,774) 65,706
--------- --------- --------- --------- ---------
Deferred income taxes -- -- -- -- --
--------- --------- --------- --------- ---------
Long-term debt 85,000 -- -- -- 85,000
--------- --------- --------- --------- ---------
Other long-term liabilities 347 -- -- -- 347
--------- --------- --------- --------- ---------
Commitments and contingencies
STOCKHOLDERS' (DEFICIT) EQUITY
Class A convertible preferred stock -- -- -- -- --
Common stock, no par value 39,550 2,622 771 (3,393) 39,550
Common stock to be issued 7,871 -- -- -- 7,871
Additional paid in capital -- 26,342 50 (26,392) --
(Accumulated deficit) retained earnings (76,147) (878) 13,965 (13,087) (76,147)
--------- --------- --------- --------- ---------
Total stockholders' (deficit) equity (28,726) 28,086 14,786 (42,872) (28,726)
--------- --------- --------- --------- ---------
Total liabilities and stockholders' (deficit) equity $ 97,721 $ 67,686 $ 3,566 $ (46,646) $ 122,327
========= ========= ========= ========= =========
</TABLE>
13
<PAGE>
EMPLOYEE SOLUTIONS, INC. SEPTEMBER 30, 2000
--------------------------------------------------------------------------------
STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
For the Quarter Ended September 30, 2000
--------------------------------------------------------------
Non-
(In thousands of dollars) Parent Guarantors Guarantors Eliminating Consolidated
------------------------- --------- --------- --------- --------- ---------
<S> <C> <C> <C> <C> <C>
Revenues $ 40,563 $ 130,850 $ 3,767 $ -- $ 175,180
--------- --------- --------- --------- ---------
Cost of revenues:
Salaries and wages of
worksite employees 34,433 112,053 3,219 -- 149,705
Healthcare and workers'
compensation 3,084 6,923 (486) -- 9,521
Payroll and employment taxes 2,449 7,207 269 -- 9,925
--------- --------- --------- --------- ---------
Cost of revenues 39,966 126,183 3,002 -- 169,151
--------- --------- --------- --------- ---------
Gross profit 597 4,667 765 -- 6,029
Selling, general and
administrative expenses 8,907 2,097 33 -- 11,037
Depreciation and amortization 1,020 316 1 -- 1,337
--------- --------- --------- --------- ---------
Income (loss) from operations (9,330) 2,254 731 -- (6,345)
Other income (expense):
Interest income 188 20 73 -- 281
Interest expense and other (2,560) 8 -- -- (2,552)
--------- --------- --------- --------- ---------
Income (loss) before provision
for income taxes (11,702) 2,282 804 -- (8,616)
Income tax provision (benefit) -- -- -- -- --
--------- --------- --------- --------- ---------
(11,702) 2,282 804 -- (8,616)
Income from wholly-owned
subsidiaries 3,086 -- -- (3,086) --
--------- --------- --------- --------- ---------
Net income (loss) $ (8,616) $ 2,282 $ 804 $ (3,086) $ (8,616)
========= ========= ========= ========= =========
</TABLE>
14
<PAGE>
EMPLOYEE SOLUTIONS, INC. SEPTEMBER 30, 2000
--------------------------------------------------------------------------------
STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
For the Quarter Ended September 30, 1999
--------------------------------------------------------------
Non-
(In thousands of dollars) Parent Guarantors Guarantors Eliminating Consolidated
------------------------- --------- --------- --------- --------- ---------
<S> <C> <C> <C> <C> <C>
Revenues $ 56,059 $ 160,990 $ 5,369 $ -- $ 222,418
--------- --------- --------- --------- ---------
Cost of revenues:
Salaries and wages of
worksite employees 47,450 136,605 4,647 -- 188,702
Healthcare and workers'
compensation 1,554 9,771 165 -- 11,490
Payroll and employment taxes 3,677 8,882 385 -- 12,944
--------- --------- --------- --------- ---------
Cost of revenues 52,681 155,258 5,197 -- 213,136
--------- --------- --------- --------- ---------
Gross profit 3,378 5,732 172 -- 9,282
Selling, general and
administrative expenses 5,950 2,838 33 -- 8,821
Intercompany selling, general
and administrative expense -- -- -- -- --
Depreciation and amortization 1,516 393 7 -- 1,916
--------- --------- --------- --------- ---------
Income (loss) from operations (4,088) 2,501 132 -- (1,455)
Other income (expense):
Interest income 72 65 33 -- 170
Interest expense and other (2,136) (2) -- -- (2,138)
--------- --------- --------- --------- ---------
Income (loss) before provision
for income taxes (6,152) 2,564 165 -- (3,423)
Income tax provision (benefit) -- -- -- -- --
--------- --------- --------- --------- ---------
(6,152) 2,564 165 -- (3,423)
Income from wholly-owned
subsidiaries 2,729 -- -- (2,729) --
--------- --------- --------- --------- ---------
Net income (loss) $ (3,423) $ 2,564 $ 165 $ (2,729) $ (3,423)
========= ========= ========= ========= =========
</TABLE>
15
<PAGE>
EMPLOYEE SOLUTIONS, INC. SEPTEMBER 30, 2000
--------------------------------------------------------------------------------
STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
For the Nine Months Ended September 30, 2000
--------------------------------------------------------------
Non-
(In thousands of dollars) Parent Guarantors Guarantors Eliminating Consolidated
------------------------- --------- --------- --------- --------- ---------
<S> <C> <C> <C> <C> <C>
Revenues $ 126,352 $ 405,601 $ 12,591 $ -- $ 544,544
--------- --------- --------- --------- ---------
Cost of revenues:
Salaries and wages of
worksite employees 106,535 342,292 10,733 -- 459,560
Healthcare and workers'
compensation 8,597 23,379 (1,678) -- 30,298
Payroll and employment taxes 8,649 26,375 975 -- 35,999
--------- --------- --------- --------- ---------
Cost of revenues 123,781 392,046 10,030 -- 525,857
--------- --------- --------- --------- ---------
Gross profit 2,571 13,555 2,561 -- 18,687
Selling, general and
administrative expenses 23,160 7,414 80 -- 30,654
Depreciation and amortization 2,954 950 18 -- 3,922
--------- --------- --------- --------- ---------
Income (loss) from operations (23,543) 5,191 2,463 -- (15,889)
Other income (expense):
Interest income 634 61 166 -- 861
Interest expense and other (7,760) 17 -- -- (7,743)
--------- --------- --------- --------- ---------
Income (loss) before provision
for income taxes (30,669) 5,269 2,629 -- (22,771)
Income tax provision (benefit) -- -- -- -- --
--------- --------- --------- --------- ---------
(30,669) 5,269 2,629 -- (22,771)
Income from wholly-owned
subsidiaries 7,898 -- -- (7,898) --
--------- --------- --------- --------- ---------
Net income (loss) $ (22,771) $ 5,269 $ 2,629 $ (7,898) $ (22,771)
========= ========= ========= ========= =========
</TABLE>
16
<PAGE>
EMPLOYEE SOLUTIONS, INC. SEPTEMBER 30, 2000
--------------------------------------------------------------------------------
STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
For the Nine Months Ended September 30, 1999
--------------------------------------------------------------
Non-
(In thousands of dollars) Parent Guarantors Guarantors Eliminating Consolidated
------------------------- --------- --------- --------- --------- ---------
<S> <C> <C> <C> <C> <C>
Revenues $ 163,260 $ 445,716 $ 18,439 $ -- $ 627,415
--------- --------- --------- --------- ---------
Cost of revenues:
Salaries and wages of
worksite employees 138,650 372,868 15,452 -- 526,970
Healthcare and workers'
compensation 4,939 28,543 (175) -- 33,307
Payroll and employment taxes 10,784 29,366 1,396 -- 41,546
--------- --------- --------- --------- ---------
Cost of revenues 154,373 430,777 16,673 -- 601,823
--------- --------- --------- --------- ---------
Gross profit 8,887 14,939 1,766 -- 25,592
Selling, general and
administrative expenses 17,543 7,548 114 -- 25,205
Intercompany selling, general
and administrative expense -- -- -- -- --
Depreciation and amortization 4,039 1,195 22 -- 5,256
--------- --------- --------- --------- ---------
Income (loss) from operations (12,695) 6,196 1,630 -- (4,869)
Other income (expense):
Interest income 491 104 342 -- 937
Interest expense and other (6,413) 24 -- -- (6,389)
--------- --------- --------- --------- ---------
Income (loss) before provision
for income taxes (18,617) 6,324 1,972 -- (10,321)
Income tax provision (benefit) -- -- -- -- --
--------- --------- --------- --------- ---------
(18,617) 6,324 1,972 -- (10,321)
Income from wholly-owned
subsidiaries 8,296 -- -- (8,296) --
--------- --------- --------- --------- ---------
Net income (loss) $ (10,321) $ 6,324 $ 1,972 $ (8,296) $ (10,321)
========= ========= ========= ========= =========
</TABLE>
17
<PAGE>
EMPLOYEE SOLUTIONS, INC. SEPTEMBER 30, 2000
--------------------------------------------------------------------------------
STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
For the Nine Months Ended September 30, 2000
-----------------------------------------------------------
Non-
(In thousands of dollars) Parent Guarantors Guarantors Eliminating Consolidated
------------------------- -------- -------- -------- -------- --------
<S> <C> <C> <C> <C> <C>
RECONCILIATION OF NET INCOME TO
NET CASH USED IN
OPERATING ACTIVITIES:
Net income (loss) $(22,771) $ 5,269 $ 2,629 $ (7,898) $(22,771)
-------- -------- -------- -------- --------
ADJUSTMENTS TO RECONCILE
NET INCOME TO NET CASH
USED IN
OPERATING ACTIVITIES:
Depreciation and amortization 2,954 950 18 -- 3,922
Decrease in accounts receivable, net 5,329 4,923 (54) -- 10,198
Increase in insurance
company receivable -- -- (267) -- (267)
(Increase) in prepaid
expenses and deposits (3,630) (19) (18) -- (3,667)
Decrease (increase) in other assets 41 (5) (14) -- 22
Increase (decrease) from inter-
company transactions 9,507 (13,261) (4,144) 7,898 --
Decrease in accrued salaries,
wages, and payroll taxes (281) (11,658) (12) -- (11,951)
(Decrease) increase in accrued workers'
compensation and health insurance (1) (91) 848 -- 756
Change in income taxes payable/receivable (62) (14) -- -- (76)
Increase (decrease) in accounts payable (745) (249) 149 -- (845)
Increase in other accrued
expenses and long-term liabilities 10,589 161 683 -- 11,433
-------- -------- -------- -------- --------
23,701 (19,263) (2,811) 7,898 9,525
-------- -------- -------- -------- --------
Net cash (used in) provided by
operating activities 930 (13,994) (182) -- (13,246)
-------- -------- -------- -------- --------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of property and equipment (199) (47) -- -- (246)
Change in investments
and marketable securities 917 -- -- -- 917
Cash released from restricted cash and
investments 100 -- -- -- 100
-------- -------- -------- -------- --------
Net cash (used in) provided by
investing activities 818 (47) -- -- 771
-------- -------- -------- -------- --------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from issuance of common stock 26 -- -- -- 26
Increase (decrease) in bank overdraft (1,236) 2,653 -- -- 1,417
Decrease in short-term debt (7,000) -- -- -- (7,000)
Payment of deferred
loan costs (52) -- -- -- (52)
-------- -------- -------- -------- --------
Net cash (used in) provided by
financing activities (8,262) 2,653 -- -- (5,609)
-------- -------- -------- -------- --------
Net decrease in cash and cash
equivalents (6,514) (11,388) (182) -- (18,084)
CASH AND CASH EQUIVALENTS,
beginning of period 16,452 14,148 3,414 -- 34,014
-------- -------- -------- -------- --------
CASH AND CASH EQUIVALENTS,
end of period $ 9,938 $ 2,760 $ 3,232 $ -- $ 15,930
======== ======== ======== ======== ========
</TABLE>
18
<PAGE>
EMPLOYEE SOLUTIONS, INC. SEPTEMBER 30, 2000
--------------------------------------------------------------------------------
STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
For the Nine Months Ended September 30, 1999
----------------------------------------------------------
Non-
(In thousands of dollars) Parent Guarantors Guarantors Eliminating Consolidated
------------------------- -------- -------- -------- -------- --------
<S> <C> <C> <C> <C> <C>
RECONCILIATION OF NET INCOME TO
NET CASH USED IN
OPERATING ACTIVITIES:
Net income (loss) $(10,321) $ 6,324 $ 1,972 $ (8,296) $(10,321)
-------- -------- -------- -------- --------
ADJUSTMENTS TO RECONCILE
NET INCOME TO NET CASH
USED IN
OPERATING ACTIVITIES:
Depreciation and amortization 4,039 1,195 22 -- 5,256
Increase in accounts receivable, net (3,395) (9,015) (322) -- (12,732)
Decrease in insurance
company receivable -- -- 805 -- 805
(Increase) decrease in prepaid
expenses and deposits (3,216) 616 10 -- (2,590)
(Increase) decrease in other assets (2,490) 7 4 -- (2,479)
Increase (decrease) from inter-
company transactions 2,919 (3,395) (7,820) 8,296 --
Increase (decrease) in accrued salaries,
wages, and payroll taxes 4,280 (2,243) 200 -- 2,237
Increase (decrease) in accrued workers'
compensation and health insurance (3,041) 1,025 1,941 -- (75)
Change in income taxes payable/receivable 4,531 (2) -- -- 4,529
Increase (decrease) in accounts payable (614) 249 716 -- 351
(Decrease) increase in other accrued
expenses and long-term liabilities 2,229 (1,373) 135 -- 991
-------- -------- -------- -------- --------
5,242 (12,936) (4,309) 8,296 (3,707)
-------- -------- -------- -------- --------
Net cash used in
operating activities (5,079) (6,612) (2,337) -- (14,028)
-------- -------- -------- -------- --------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of property and equipment (352) (30) 1 -- (381)
Business acquisitions (5,895) -- -- -- (5,895)
Change in investments
and marketable securities 7,426 -- -- -- 7,426
Cash released from restricted cash and
investments 88 -- -- -- 88
Disbursements for deferred costs (103) -- -- -- (103)
-------- -------- -------- -------- --------
Net cash (used in) provided by
investing activities 1,164 (30) 1 -- 1,135
-------- -------- -------- -------- --------
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 (4,220) (20,061) (2,336) -- (26,617)
CASH AND CASH EQUIVALENTS,
beginning of period 8,176 24,503 6,608 -- 39,287
-------- -------- -------- -------- --------
CASH AND CASH EQUIVALENTS,
end of period $ 3,956 $ 4,442 $ 4,272 $ -- $ 12,670
======== ======== ======== ======== ========
</TABLE>
19
<PAGE>
EMPLOYEE SOLUTIONS, INC. SEPTEMBER 30, 2000
--------------------------------------------------------------------------------
(3) SEGMENT INFORMATION
The Company, in relation to SFAS No. 131 "Disclosure About Segments of an
Enterprise and Related Information," has defined the following three reportable
segments: Core PEO services, Logistics Personnel Corp. and TEAM Services.
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 and other personal
financial services.
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 accounting policies of the segments are the same as those described in the
summary of significant accounting policies.
20
<PAGE>
EMPLOYEE SOLUTIONS, INC. SEPTEMBER 30, 2000
--------------------------------------------------------------------------------
Information concerning revenue, gross profit and assets by business segment was
as follows:
<TABLE>
<CAPTION>
Quarter Ended Nine Months Ended
September 30, September 30,
---------------------- ----------------------
(In thousands of dollars) 2000 1999 2000 1999
------------------------- --------- --------- --------- ---------
<S> <C> <C> <C> <C>
Revenue
Core PEO $ 96,984 $ 143,842 $ 313,013 $ 422,017
LPC 26,577 28,908 78,259 82,335
TEAM 51,619 49,668 153,272 123,063
--------- --------- --------- ---------
Consolidated Total 175,180 222,418 544,544 627,415
--------- --------- --------- ---------
Gross Profit
Core PEO 3,406 6,254 10,772 17,380
LPC 1,691 2,098 5,689 6,282
TEAM 932 930 2,226 1,930
--------- --------- --------- ---------
Total 6,029 9,282 18,687 25,592
Selling, General and Administrative Expense 11,037 8,821 30,654 25,205
Depreciation and Amortization 1,337 1,916 3,922 5,256
--------- --------- --------- ---------
Loss from Operations (6,345) (1,455) (15,889) (4,869)
--------- --------- --------- ---------
Other Income (expense)
Interest income 281 170 861 937
Interest expense (2,566) (2,139) (7,770) (6,426)
Other 14 1 27 37
--------- --------- --------- ---------
Loss before tax benefit (8,616) (3,423) (22,771) (10,321)
Income tax benefit -- -- -- --
--------- --------- --------- ---------
Net Loss $ (8,616) $ (3,423) $ (22,771) $ (10,321)
========= ========= ========= =========
Depreciation and Amortization
Core PEO $ 1,061 $ 1,644 $ 3,100 $ 4,422
LPC 241 242 723 733
TEAM 35 30 99 101
--------- --------- --------- ---------
Consolidated Total $ 1,337 $ 1,916 $ 3,922 $ 5,256
========= ========= ========= =========
September 30, December 30,
2000 1999
--------- ---------
Total Assets
Core PEO $ 52,604 $ 65,447
LPC 30,758 34,976
TEAM 9,952 21,904
--------- ---------
Consolidated Total $ 93,314 $ 122,327
========= =========
</TABLE>
21
<PAGE>
EMPLOYEE SOLUTIONS, INC. SEPTEMBER 30, 2000
--------------------------------------------------------------------------------
(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 September 30, 2000, the compounded interest totaled
approximately $ 360,000.
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. Plaintiff seeks damages of over $500,000 (recently
increased by plaintiff to over $1 million) plus attorneys' fees and costs and
unspecified punitive damages. The Court recently granted motions for summary
judgment filed by the Company that, among other things, defeated plaintiff's
punitive damage claims. The Company is contesting the claim vigorously. The
matter has been set for trial in January 2001.
Stirling Cooke Insurance Services Inc. filed suit in the United States District
Court for the Middle District of Florida against the Company in December 1999
alleging breach of contract and failure to pay insurance premiums in violation
of Florida law. Stirling Cooke, in its capacity as managing and general agent,
placed workers compensation insurance for the Company with three insurance
companies for calendar year 1998. Stirling Cooke alleges that ESI owes unpaid
premium in the amount of $2,797,905 to those companies. The Company believes
that Stirling Cooke's suit is without merit based on an explicit Memorandum of
Understanding between the parties that defined the applicable rates for the 1998
workers' compensation program and intends to defend the suit vigorously.
The State of Ohio has issued an assessment of $5.2 million (plus interest and
penalty) relating to sales taxes potentially applicable to certain types of PEO
services provided by the Company. Contingent upon completion of a financial
restructuring of the Company (including, in particular, the Notes), the Company
has entered into a settlement agreement with the State of Ohio whereby it has
agreed to pay an aggregate of $2.85 million in January 2001 in resolution of
applicable sales tax liabilities.
The State of Ohio also issued a sales tax assessment in the amount of
approximately $16.5 million (including interest and penalties) in July 1999
against HDVT, Inc. (the seller of certain assets acquired by the Company in
February 1997) with respect to the operations of HDVT prior to the Company's
acquisition of certain assets of HDVT (then known as Employers Trust) in
February 1997. The State of Ohio concurrently issued an assessment in the same
amount against the Company as successor to HDVT. The Company believes that
meritorious defenses are available to the assessment. In addition, $6.0 million
of cash and 675,000 shares of the Company's Common Stock are being held in
escrow for payment of amounts, if any, ultimately determined to be due pursuant
to such assessment. If the Company is held to have liability pursuant to such
assessment, the escrowed assets prove insufficient to satisfy such liability,
and HDVT is unable to pay any such shortfall, the Company's maximum liability
with respect to the assessment is approximately $3.2 million. The assessment is
not included in the settlement agreement described in the preceding paragraph
and remains outstanding.
A Demand for Arbitration was filed with the American Arbitration Association on
April 26, 2000 by the previous owners of Team Services. These individuals, along
with a former member of the Company's Board of Directors and current President
of the Company's TEAM Services subsidiary, sold TEAM Services to the Company
pursuant to a 1996 acquisition agreement. The Demand for Arbitration alleges
that the Company caused damages of approximately $800,000 by failing to provide
a price protection payment required under the 1996 agreement with respect to the
shares of the Company's Common Stock issued to the claimants in December 1999 as
consideration for the acquisition. The Company intends to contest the claim
vigorously.
22
<PAGE>
EMPLOYEE SOLUTIONS, INC. SEPTEMBER 30, 2000
--------------------------------------------------------------------------------
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, 1999. 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, 1999, 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.
In periods from and after January 1, 1998, 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 policies
expired at various dates during 1998 and as to which the Company retains
23
<PAGE>
EMPLOYEE SOLUTIONS, INC. SEPTEMBER 30, 2000
--------------------------------------------------------------------------------
liability of $250,000 per occurrence plus costs as described in the following
paragraph; and costs under the Company's self-insurance program in Ohio, with
respect to which the Company retains liability of $50,000 per occurrence.
With respect to the Ohio and defined portfolio of stand-alone policies, the
Company's accrued workers' compensation reserves are primarily based on
industry-wide data, and to a lesser extent, the Company's past claims experience
up to the retained limits. The liability recorded may be more or less than the
actual amount of the claims when they are submitted and paid. Changes in the
liability are charged or credited to operations as the estimates are revised.
Administrative costs include fees paid to the Company's insurers and costs of
claims management by third party administrators. Premium taxes include taxes and
related fees paid to various states based on premiums written. Premium for
excess reinsurance and accidental death and dismemberment relate to premium
payments to the Company's insurers for the retention of risks above specified
limits.
Health care and other employee benefits costs consist of medical and dental
insurance premiums, payments of and reserves for claims subject to deductibles
and the costs of vision care, disability, life insurance and other similar
benefit plans. The Company's health care benefit plans consist of a mixture of
fully-insured programs and 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.
See "Outlook: Issues and Risks" herein.
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.
OPERATING RESULTS
Margin comparisons are affected by the relative mix of full PEO services, TEAM
Services services, and driver leasing services 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 can
adversely affect first quarter results but positively impact the Company's
working capital and results of operations as the year progresses.
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EMPLOYEE SOLUTIONS, INC. SEPTEMBER 30, 2000
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RESULTS OF OPERATIONS--
QUARTER AND NINE MONTHS ENDED SEPTEMBER 30, 2000 COMPARED TO QUARTER AND NINE
MONTHS ENDED SEPTEMBER 30, 1999
<TABLE>
<CAPTION>
Quarter Ended September 30, Nine Months Ended September 30,
---------------------------------- ----------------------------------
Percent Percent
(In thousands of dollars) 2000 Change 1999 2000 Change 1999
------------------------- --------- --------- --------- --------- --------- ---------
<S> <C> <C> <C> <C> <C> <C>
Revenues $ 175,180 (21) $ 222,418 $ 544,544 (13) $ 627,415
--------- --------- --------- --------- --------- ---------
Cost of revenues 169,151 (21) 213,136 525,857 (13) 601,823
Gross profit 6,029 (35) 9,282 18,687 (27) 25,592
Selling, general and administrative 11,037 25 8,821 30,654 22 25,205
Depreciation and amortization 1,337 (30) 1,916 3,922 (25) 5,256
Interest income 281 65 170 861 (8) 937
Interest expense and other 2,552 20 2,138 7,743 22 6,389
Income tax benefit -- -- -- -- -- --
Net loss (8,616) (152) (3,423) (22,771) (121) (10,321)
</TABLE>
REVENUES
Revenues decreased to $175.2 million for the quarter ended September 30, 2000,
from $222.4 million for the quarter ended Sepetember 30, 1999, a decrease of
21%. For the nine months ended September 30, 2000, revenue was $544.5 million
compared to $627.4 million for the nine months ended September 30, 1999, a
decrease of 13%. The number of worksite employees decreased to approximately
30,963 covering approximately 1,794 client companies at September 30, 2000 from
approximately 37,300 covering 2,015 client companies at September 30, 1999. The
Company's 2000 operating plan depends in significant part upon achieving revenue
growth through internal sales and on the reduction of customer attrition.
However, the Company's efforts to achieve revenue growth and reduce attrition
have been materially adversely affected by the market's current negative
perception of the Company's financial stability. The Company anticipates that
this effect will continue unless and until negotiations with respect to the
Notes are concluded successfully.
COST OF REVENUES
Cost of revenues decreased 21% to $169.2 million in the quarter ended September
30, 2000 from $213.1 million for the quarter ended September 30, 1999. For the
nine month period ended September 30, 2000, the cost of revenues was $525.9
million, a decrease of 13% over the $601.8 million for the nine month period
ended September 30, 1999. This decrease was caused primarily by the reduction in
internal sales and increased customer attrition.
GROSS PROFIT
The Company's gross profit margin decreased to 3.4% in the quarter ended
September 30, 2000 from 4.2% in the quarter ended September 30, 1999. For the
nine month period ended September 30, 2000, the gross profit margin was 3.4%
compared to 4.1% for the same period in 1999. This decrease was attributable
primarily to a reduction in the proportion of gross profit derived from driver
leasing services which have higher margins, relative to the same period in 1999.
Additional factors contributing to this decline were the loss of certain higher
margin customers, and increased medical and workers' compensation costs
beginning in 2000 that the Company has been unable to pass through to its
customers due to competitive factors. While the Company's TEAM Services
subsidiary has contributed a larger proportion of revenues in recent periods,
the Company continues to derive a lower percentage of gross profit from such
revenues relative to its core PEO and driver leasing operations, and therefore
has determined to resume prior efforts to divest the subsidiary.
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EMPLOYEE SOLUTIONS, INC. SEPTEMBER 30, 2000
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The Company has been advised that renewal of its primary workers' compensation
and medical benefits programs for 2001 is dependent upon, among other things,
completion of a financial restructuring of the Company (and, in particular, the
Notes). See "OUTLOOK: ISSUES AND RISKS - INCREASES IN HEALTH INSURANCE PREMIUMS,
UNEMPLOYMENT TAXES AND WORKERS' COMPENSATION RATES; AVAILABILITY OF PROGRAMS."
If a restructuring is not completed, the Company has been advised that these
programs will expire on December 31, 2000, and the Company does not believe that
it would be able to continue normal PEO operations.
SELLING, GENERAL AND ADMINISTRATIVE
Selling, general and administrative expenses for the quarter ended September 30,
2000 increased approximately $2.2 million to $11.0 million, or 25%, from $8.8
million for the quarter ended September 30, 1999. Included in the quarter ended
September 30, 2000 was a provision for the settlement of Ohio sales tax
liabilities of $2.85 million and $350 thousand for litigation. Without these
unusual items selling, general and administrative expenses actually declined by
$1.0 million, or 12.8% from the previous year's $8.8 million. For the nine month
periods ended September 30, 2000 and 1999, selling, general and administrative
expenses were $30.7 million and $25.2 million, a 22% increase. This increase was
primarily the result of the provision of $2.85 million for the settlement of
Ohio sales tax liabilities, $900 thousand for litigation, $2.3 million for
uncollectible accounts receivable and $1.7 million of professional fees
attributable to the Company's restructuring efforts. Without these unusual items
selling, general and administrative expenses actually declined by $2.4 million,
or 9.3% from the previous year's $25.2 million.
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 September 30, 2000, depreciation and amortization expense totaled
$1.3 million compared to $1.9 million for the quarter ended September 30, 1999.
Total depreciation and amortization expense for the nine months ended September
30, 2000 was $3.9 compared to $5.3 million for the nine month period ended
September 30, 1999. The decrease is primarily due to the goodwill impairment
charge which was recorded during the fourth quarter of 1999, which has reduced
the amount of goodwill being amortized for previous acquisitions on a
prospective basis.
INTEREST
Interest expense for the quarter ended September 30, 2000 totaled $2.6 million
compared to $2.1 million for the quarter ended September 30, 1999. For the nine
month periods ended September 30, 2000 and 1999, interest expense totaled $7.8
million and $6.4 million, respectively. The increase is primarily the result of
interest expense charged on the Loan Agreement, under which the Company borrowed
$10.0 million in October 1999 at an initial interest rate of 13.5% and has paid
certain other fees and expenses. The interest rate has been increased to 15.5%
effective April 30, 2000, with additional monthly increases of 25 basis points
commencing September 1, 2000 for so long as amounts remain outstanding. (SEE
FOOTNOTE 2- NOTE PAYABLE AND "OUTLOOK: ISSUES AND RISKS - FUTURE CAPITAL AND
LIQUIDITY NEEDS; UNCERTAINTY OF ADDITIONAL FINANCING; NONCOMPLIANCE WITH LOAN
AGREEMENT" FOR ADDITIONAL INFORMATION CONCERNING THE LOAN AGREEMENT).
EFFECTIVE TAX RATE
The Company's effective tax rate provides for federal, state and local income
taxes. As of September 30, 2000, 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 operating loss will be available for
carry-forward benefit only to the extent of any subsequently generated taxable
income, subject to any limitation or the possible loss of carry-forward benefits
directly attributable to the successful completion of the Company's
restructuring efforts.
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EMPLOYEE SOLUTIONS, INC. SEPTEMBER 30, 2000
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LIQUIDITY AND CAPITAL RESOURCES
The Company's liquidity position is such that, absent a financial restructuring
of the Company (including, in particular, the Notes), the Company does not
believe that it will be able to continue normal PEO operations. See in
particular "OUTLOOK: ISSUES AND RISKS -- INCREASES IN HEALTH INSURANCE PREMIUMS,
UNEMPLOYMENT TAXES AND WORKERS' COMPENSATION RATES; AVAILABILITY OF PROGRAMS."
The Company continues to engage in negotiations with regard to such a
restructuring. However, there can be no assurance as to whether a restructuring
can be accomplished or as to the timing or terms thereof. For additional
information, see "OUTLOOK: ISSUES AND RISKS - `SUBSTANTIAL LEVERAGE;
NEGOTIATIONS WITH HOLDERS OF INDEBTEDNESS; POTENTIAL SUBSTANTIAL DILUTION OF
COMMON STOCKHOLDERS,' `FUTURE CAPITAL AND LIQUIDITY NEEDS; UNCERTAINTY OF
ADDITIONAL FINANCING; NONCOMPLIANCE WITH LOAN AGREEMENT' AND ` IMPLEMENTATION OF
OPERATING PLAN; CUSTOMER ATTRITION.'"
The Company defines liquidity as the ability to mobilize cash to meet operating
and capital needs. The Company's primary use of cash in the nine months ended
September 30, 2000 was for operating activities and the reduction of short-term
debt. The Company's liquidity position was materially reduced due to the use of
cash during the first nine months of 2000.
Cash used in operating activities was $13.3 million during the first nine months
of 2000 compared to $14.0 million during the comparable period in 1999. The
Company's primary use of cash in the nine months ended September 30, 2000 was
for the payment customer payrolls, payroll taxes, interest, legal and
professional fees, other operating activities, and the payment of prepaid
workers' compensation premiums under the Company's guaranteed cost policy.
Operating cash flows are derived from customers for 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.
Cash provided by investing activities was $771 thousand during the first nine
months of 2000, compared to $1.1 million during the comparable prior year
period. Included in investing activities in 2000 is a decrease of $917 thousand
in restricted cash.
For the nine months ended September 30, 2000 and 1999, capital expenditures were
$246,000 and $381,000, respectively. Capital expenditures in 2000 consisted
primarily of software development cost to enhance the Company's data processing
capabilities and to support the increased use of the Internet by customers to
transfer payroll information to the Company for processing. Although the Company
continuously reviews its capital expenditure needs, management expects that 2000
capital expenditures will continue at a level comparable to the first nine
months of the year.
Cash used in financing activities was $5.6 million for the nine months ended
September 30, 2000 compared to $13.7 million for the same period in 1999. Cash
used in 2000 was primarily due to the reduction of $7.0 million in short-term
debt, offset by an increase in bank overdrafts of $1.4 million, compared to a
reduction of bank overdrafts of $13.7 million during the same period in 1999.
These bank overdrafts represent outstanding checks in excess of the cash
recorded on the Company's books for specific bank accounts and generally
represent timing differences between the transfer of funds between banks, and do
not represent actual bank overdrafts of collected funds held at banks which is
available for the payment of payroll obligations.
OUTLOOK: ISSUES AND RISKS
The following issues and risks, among others (including those discussed
elsewhere herein), should be considered in evaluating the Company's outlook.
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EMPLOYEE SOLUTIONS, INC. SEPTEMBER 30, 2000
--------------------------------------------------------------------------------
SUBSTANTIAL LEVERAGE; NEGOTIATIONS WITH HOLDERS OF INDEBTEDNESS; POTENTIAL
SUBSTANTIAL DILUTION OF COMMON STOCKHOLDERS
The Company has incurred significant debt primarily in connection with the
October 1997 issuance of its $85 million 10% Senior Notes due 2004 (the "Notes")
and a secured loan facility obtained in October 1999 (the "Loan Agreement"). At
September 30, 2000, the Company had outstanding indebtedness of $3.0 million
under the Loan Agreement (not including letters of credit drawn thereunder in
the amount of $5.4 million), outstanding senior indebtedness of $85.0 million
and a deficit in stockholders' equity of approximately $51.5 million. The
Company believes that it currently is leveraged to a significantly greater
extent than any of its principal competitors.
In an effort to improve cash flows and reduce the Company's indebtedness, the
Company has been engaged in negotiations with the holders of the Notes (the
"Noteholders"). The Company is seeking to negotiate the reduction or elimination
of the outstanding principal amount of the Notes and accrued interest thereon in
exchange for the issuance of shares of its equity securities. If the Company is
able to reach agreement upon such a transaction, the Company anticipates that
the percentage ownership of the then current shareholders of the Company will be
materially reduced, and the equity securities issued to participating
Noteholders (or other sources of equity, as the case may be) also may have
rights, preferences or privileges senior to those of the holders of the
Company's Common Stock. While delays have been experienced, the Company
continues to seek to complete such negotiations, and intends to submit to
shareholders for approval a proposal or proposals relating to all or a portion
of the negotiations.
There can be no assurance whether or when a satisfactory agreement can be
reached with respect to the Notes. If the Company is unable to complete a
satisfactory agreement, the Company likely will be unable to continue PEO
operations. See "INCREASES IN HEALTH INSURANCE PREMIUM, UNEMPLOYMENT TAXES AND
WORKERS' COMPENSATION RATES; AVAILABILITY OF PROGRAMS." If no agreement is
reached, the Company also will remain subject to the current principal and
interest obligations (and other terms and conditions) associated with the Notes,
it will not likely be able to retain certain of its key employees, and its
liquidity position will be materially adversely affected. Among its obligations
under the Notes were regular semi-annual interest payments of $4.25 million due
on each of April 15 and October 15, 2000. In connection with the negotiations,
the Company's Board of Directors elected to withhold these payments, thereby
creating an event of default with respect to the Notes. The Company has received
a written agreement from the holders of the Notes under which the holders agreed
to forbear from exercising their rights and remedies relating to such default
through the first to occur of August 30, 2000 or the occurrence of a new
default. The waiver has expired, though the holders of the Notes have not sought
to exercise their rights and remedies during the pendency of negotiations
between the Company and the holders of the Notes. A default with respect to the
Notes also constitutes a default, by virtue of cross-default provisions, under
the Loan Agreement. See "FUTURE CAPITAL AND LIQUIDITY NEEDS; UNCERTAINTY OF
ADDITIONAL FINANCING; NONCOMPLIANCE WITH LOAN AGREEMENT."
FUTURE CAPITAL AND LIQUIDITY NEEDS; UNCERTAINTY OF ADDITIONAL FINANCING;
NONCOMPLIANCE WITH LOAN AGREEMENT
If a satisfactory agreement with respect to the Notes can be reached (see
"SUBSTANTIAL LEVERAGE; NEGOTIATIONS WITH HOLDERS OF INDEBTEDNESS; POTENTIAL
SUBSTANTIAL DILUTION OF COMMON STOCKHOLDERS," above), management believes that,
based on its 2000-2001 operating plan and subject to the discussion herein
concerning the Loan Agreement, 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 remaining indebtedness. The Company will need to raise
additional funds through public or private debt or equity financing if
satisfactory arrangements cannot be reached with its principal lenders, the
revenue and cash flow elements of its 2000-2001 operating plan are not met, or
to deal with unanticipated cash requirements, such as adverse litigation
outcomes or material customer payment defaults. For a discussion of risks
associated with the Company's 2000-2001 operating plan, see "IMPLEMENTATION OF
OPERATING PLAN; CUSTOMER ATTRITION" If additional funds are raised through the
issuance of equity securities, the percentage ownership of the then current
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EMPLOYEE SOLUTIONS, INC. SEPTEMBER 30, 2000
--------------------------------------------------------------------------------
shareholders of the Company will be materially 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 acceptable 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.
The Company has not been in compliance with one or more of the covenants set
forth in the Loan Agreement commencing as of March 31, 2000. The Company
recently received a waiver of such noncompliance in exchange for its agreement
to provide additional cash collateral, pay an increased interest rate and
certain additional fees, and arrange for early reduction of the outstanding
principal balance. There can be no assurance that the Company will be able to
obtain additional waivers in the event of future defaults, if any. The Company
believes that the Loan Agreement will not be renewed at its maturity date
(January 1, 2001). The Company is seeking a replacement facility, though there
can be no assurance that the Company will be able to obtain one. Unless
satisfactory refinancing arrangements can be made, of which there can be no
assurance, the Company's financial condition and ability to operate will be
materially adversely affected if the lenders under the Loan Agreement accelerate
the Company's obligations under the Loan Agreement as a result of defaults or
otherwise or at the Loan Agreement's maturity date. At September 30, 2000, the
Company had outstanding indebtedness of $3.0 million under the Loan Agreement
(not including letters of credit drawn thereunder in the amount of $5.4
million).
ABILITY TO SERVICE INDEBTEDNESS; CONSEQUENCES OF SUBSTANTIAL LEVERAGE
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
Loan Agreement and any outstanding 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. 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 Loan Agreement and the
Notes, or make anticipated capital expenditures and lease payments. See
"SUBSTANTIAL LEVERAGE; NEGOTIATIONS WITH HOLDERS OF INDEBTEDNESS; POTENTIAL
SUBSTANTIAL DILUTION OF COMMON STOCKHOLDERS," "FUTURE CAPITAL AND LIQUIDITY
NEEDS; UNCERTAINTY OF ADDITIONAL FINANCING; NONCOMPLIANCE WITH LOAN AGREEMENT"
AND "IMPLEMENTATION OF OPERATION PLAN; CUSTOMER ATTRITION."
The degree to which the Company is leveraged has 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, including
repayment of principal, 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 Loan Agreement and Notes indenture contain 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 liquidity position,
business and financial performance.
IMPLEMENTATION OF OPERATING PLAN; CUSTOMER ATTRITION
In addition to completion of a financial restructuring, the Company's 2000-2001
operating plan depends in significant part upon achieving revenue growth through
internal sales and marketing efforts. The Company recently focused its sales and
marketing efforts in 2000 on target industries and geographic territories that
it believes present the greatest opportunities for profitable growth, and to
emphasize marketing through third-party alliances. While the Company believes
that its refocused sales and marketing plan will result in consistent and
profitable revenue growth, because of the negative market perception and the
effect on sales, the Company has not yet demonstrated successful implementation
of the plan and there can be no assurance that successful implementation can be
achieved.
The Company's 2000-2001 operating plan also depends on a significant reduction
of customer attrition. The Company experienced significant attrition in 1999,
resulting in a net reduction of approximately 5,900 worksite employees during
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EMPLOYEE SOLUTIONS, INC. SEPTEMBER 30, 2000
--------------------------------------------------------------------------------
the year. Attrition during the nine months ended September 30, 2000 was an
approximate net 3,922 worksite employees. While a portion of this attrition
resulted from the Company's proactive elimination of unprofitable or high-risk
customers, the Company also experienced attrition based on violation of
noncompetition agreements by former salespersons and other factors. The
Company's 2000-2001 operating plan includes continuing improvements in customer
service functions intended to reduce attrition, and the Company is aggressively
seeking to enforce its noncompetition agreements. There can be no assurance that
customer retention can be materially improved. The Company's efforts to achieve
revenue growth and reduce attrition have been materially adversely affected by
the market's current negative perception of the Company's financial stability,
and the Company anticipates that this effect will continue unless and until
negotiations with respect to the Notes are concluded successfully.
The Company's agreements with its customers historically have been subject to
cancellation upon 30 days written notice of termination by either party, except
where different arrangements are required by applicable law. While the Company
has commenced the use of longer-term agreements, the short-term nature of most
current customer agreements means that customers could terminate a substantial
portion of the Company's business upon short NOTICE.
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.
LITIGATION AND OTHER CONTINGENCIES
While certain significant litigation matters have been resolved in 1999 and
2000, other significant matters remain unresolved. The Company faces 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.
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 an increase in claims activity for unemployment, workers'
compensation and/or healthcare, or if other factors result in higher expenses in
these areas, the Company's costs in these areas would increase. In such a case,
the Company may not be able to pass these higher costs to its customers due to
contractual or competitive factors. By way of example, the Company experienced
certain cost increases for 2000, not all of which were able to be passed onto
customers. In addition, the Company may experience difficulty competing with
PEOs with lower 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. As discussed
in "Liquidity and Capital Resources," above, the Company has been advised that
its primary workers compensation insurance and medical benefits programs renewal
for 2001 is conditioned upon, among other things, completion of a satisfactory
financial restructuring of the Company. Absent renewal on reasonable terms, the
programs will expire on December 31, 2000, and the Company does not believe that
it would be able to continue normal PEO operations under such circumstances. If
renewal of its medical benefits program can be obtained, the Company also
anticipates an increase of approximately 25% in the cost of health insurance
premiums for 2001. The Company is also expecting to incur an increase in 2001
workers' compensation cost of approximately 30%.
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EMPLOYEE SOLUTIONS, INC. SEPTEMBER 30, 2000
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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.
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 generally is
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.
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.
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EMPLOYEE SOLUTIONS, INC. SEPTEMBER 30, 2000
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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 customer
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 are
not 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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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 certificates of deposit,
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, 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.
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PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
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. Plaintiff seeks damages of over $500,000 (recently
increased by plaintiff to over $1 million) plus attorneys' fees and costs and
unspecified punitive damages. The Court recently granted motions for summary
judgment filed by the Company that, among other things, defeated plaintiff's
punitive damage claims. The Company is contesting the claim vigorously. The
matter has been set for trial in January 2001.
The State of Ohio has issued an assessment of $5.2 million (plus interest and
penalty) relating to sales taxes potentially applicable to certain types of PEO
services provided by the Company. Contingent upon completion of a financial
restructuring of the Company (including, in particular, the Notes), the Company
has entered into a settlement agreement with the State of Ohio whereby it has
agreed to pay an aggregate of $2.85 million in January 2001 in resolution of
applicable sales tax liabilities.
From time to time, the Company is named as a defendant in lawsuits in the
ordinary course of business. See Part I, Item 2 - "Management's Discussion and
Analysis - Outlook: Issues and Risks - Uncertainty of Extent of PEO's Liability;
Government Regulation of PEOs; Credit Risks."
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
The Company is engaged in negotiations with respect to its $85 million 10%
Senior Notes due 2004 (the Notes). See "OUTLOOK: ISSUES AND RISKS- SUBSTANTIAL
LEVERAGE; NEGOTIATIONS WITH HOLDERS OF INDEBTEDNESS; POTENTIAL SUBSTANTIAL
DILUTION OF COMMON STOCKHOLDERS," which is incorporated by this reference into
this Part II, Item 3. In connection with the negotiations, the Company's Board
of Directors elected to withhold the $4.25 million semi-annual interest payments
due on each of April 15 and October 15, 2000. Under the terms of the Indenture
pursuant to which the Notes were issued, such withholding of interest
constitutes an Event of Default (as defined in the Indenture). The Company
received a written agreement from the holders of the Notes under which the
holders agreed to forbear from exercising their rights and remedies through the
first to occur of August 30, 2000 or the occurrence of a new default. The waiver
has expired, though the holders of the Notes have not sought to exercise their
rights and remedies during the pendency of the negotiations between the Company
and the holders of the Notes. The Company has classified the debt obligation as
a current liability.
The Company was not in compliance with one or more of the covenants set forth in
a loan and security agreement (the "Loan Agreement") with Foothill Capital
Corporation and Ableco Finance LLC (the "Lenders") commencing as of March 31,
2000. The Company recently received a waiver of such noncompliance in exchange
for its agreement to provide additional cash collateral, pay an increased
interest rate and certain additional fees, and materially reduce the outstanding
principal balance. There can be no assurance that the Company will be able to
obtain additional waivers in the event of future defaults, if any. The Company
is actively seeking a replacement financing source. See "OUTLOOK: ISSUES AND
RISKS -- FUTURE CAPITAL AND LIQUIDITY NEEDS; UNCERTAINTY OF ADDITIONAL
FINANCING; NONCOMPLIANCE WITH LOAN AGREEMENT."
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ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) EXHIBITS
Exhibit
Number Description
------- -----------
27 Financial Data Schedule
(b) REPORTS ON FORM 8-K.
None.
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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: November 14, 2000 /s/ Quentin P. Smith, Jr.
----------------- ----------------------------------------
Quentin P. Smith, Jr.
Chief Executive Officer
/s/ John V. Prince
----------------------------------------
John V. Prince
Chief Financial Officer
