U.S. SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the quarterly period ended March 31, 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:
38,433,027 Common shares, no par value were outstanding as of May 12, 2000.
<PAGE>
EMPLOYEE SOLUTIONS, INC.
FORM 10-Q
QUARTERLY REPORT FOR THE PERIOD ENDED MARCH 31, 2000
INDEX
Page
PART I. Financial Information Number
------
Item 1. Financial Statements
Consolidated Balance Sheets - March 31, 2000 and
December 31, 1999 2
Consolidated Statements of Operations for the
Quarters Ended March 31, 2000 and 1999 3
Consolidated Statement of Stockholders'
Equity for the Quarters Ended March 31, 2000 and 1999 4
Consolidated Statements of Cash Flows for the
Quarters Ended March 31, 2000 and 1999 5
Notes to Consolidated Financial Statements 7
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 20
Item 3. Quantitative and Qualitative Disclosure About Market Risk 28
PART II. Other Information
Item 1. Legal Proceedings 29
Item 3. Defaults Upon Senior Securities 29
Item 5. Other Information 29
Item 6. Exhibits and Reports on Form 8-K 30
Signatures 31
<PAGE>
ITEM 1. FINANCIAL STATEMENTS
EMPLOYEE SOLUTIONS, INC.
CONSOLIDATED BALANCE SHEETS
March 31, December 31,
(In Thousands of Dollars, Except Share Data) 2000 1999
- --------------------------------------------------------------------------------
ASSETS
CURRENT ASSETS:
Cash and cash equivalents $ 25,774 $ 34,014
Investments and marketable securities 100 100
Restricted cash -- 1,000
Accounts receivable, net 37,748 38,296
Receivables from insurance companies 6,530 6,618
Prepaid expenses and deposits 5,010 1,088
--------- ---------
Total current assets 75,162 81,116
Property and equipment, net 3,969 4,211
Goodwill and other assets, net 36,167 37,000
--------- ---------
Total assets $ 115,298 $ 122,327
========= =========
LIABILITIES AND STOCKHOLDERS' (DEFICIT) EQUITY
CURRENT LIABILITIES:
Bank overdraft $ 5,856 $ 2,472
Accrued salaries, wages and payroll taxes 22,837 31,175
Accounts payable 6,099 6,224
Accrued workers' compensation and health insurance 7,467 7,188
Income taxes payable 323 363
Other accrued expenses 11,609 8,284
Note payable 95,000 10,000
--------- ---------
Total current liabilities 149,191 65,706
--------- ---------
Long-term debt -- 85,000
--------- ---------
Other long-term liabilities 360 347
--------- ---------
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 March 31, 2000, and 36,182,547
shares issued and outstanding December 31, 1999 41,525 39,550
Common stock to be issued, no par value,
2,000,571 shares at March 31, 2000 and 4,206,829
shares at December 31, 1999 5,922 7,871
(Accumulated deficit) retained earnings (81,700) (76,147)
--------- ---------
Total stockholders' (deficit) equity (34,253) (28,726)
--------- ---------
Total liabilities and stockholders'
(deficit) equity $ 115,298 $ 122,327
========= =========
The accompanying notes are an integral part of these
consolidated balance sheets.
2
<PAGE>
EMPLOYEE SOLUTIONS, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
Quarter Ended March 31,
(In Thousands of Dollars, Except ----------------------------
Share and Per Share Data) 2000 1999
- -------------------------------------------------------------------------------
Revenues $ 190,481 $ 198,909
------------ ------------
Cost of revenues:
Salaries and wages of worksite employees 158,954 165,608
Healthcare and workers' compensation 10,934 10,553
Payroll and employment taxes 14,386 15,012
------------ ------------
Cost of revenues 184,274 191,173
------------ ------------
Gross profit 6,207 7,736
Selling, general and administrative expenses 8,306 7,513
Depreciation and amortization 1,286 1,667
------------ ------------
Income (loss) from operations (3,385) (1,444)
Other income (expense):
Interest income 340 244
Interest expense (2,512) (2,286)
Other 4 24
------------ ------------
Loss before benefit for income taxes (5,553) (3,462)
Income tax benefit -- --
------------ ------------
Net loss $ (5,553) $ (3,462)
============ ============
Loss per common and common equivalent share:
Basic $ (.14) $ (.11)
Diluted $ (.14) $ (.11)
Weighted average number of common and
common equivalent shares outstanding:
Basic 40,419,019 32,421,263
============ ============
Diluted 40,419,019 32,421,263
============ ============
The accompanying notes are an integral part of these
consolidated financial statements.
3
<PAGE>
EMPLOYEE SOLUTIONS, INC.
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY
QUARTER ENDED MARCH 31, 2000
<TABLE>
<CAPTION>
Common Retained Cumulative
Stock Earnings Unrealized Total Comprehensive
(In thousands of dollars, Common To Be Accumulated Gain (Loss) on Stockholders' Income
except share data) Stock Issued (Deficit) Investments (deficit) 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
acqusitions 1,949 (1,949) -- -- -- --
Change in unrealized net gains,
net of applicable taxes -- -- -- -- -- --
Net loss -- -- (5,553) -- (5,553) (5,553)
-------- -------- -------- ------ -------- --------
COMPREHENSIVE LOSS
BALANCE, MARCH 31, 2000 $ 41,525 $ 5,922 $(81,700) $ -- $(34,253) $ (5,553)
======== ======== ======== ====== ======== ========
</TABLE>
EMPLOYEE SOLUTIONS, INC.
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY
QUARTER ENDED MARCH 31, 1999
<TABLE>
<CAPTION>
Common Retained Cumulative
Stock Earnings Unrealized Total Comprehensive
(In thousands of dollars, Common To Be Accumulated Gain (Loss) on Stockholders' Income
except share data) Stock Issued (Deficit) Investments (deficit) Equity (Loss)
-------- -------- -------- -------- -------- --------
<S> <C> <C> <C> <C> <C> <C>
BALANCE, December 31, 1998 $ 35,800 $ -- $(20,085) $ 1 $ 15,716 $ --
Issuance of 1,668 shares of common
stock in connection with exercise of
common stock options 3 -- -- -- 3 --
Change in unrealized net gains,
net of applicable taxes -- -- -- 3 3 3
Net loss -- (3,462) -- (3,462) (3,462)
-------- -------- -------- -------- -------- --------
COMPREHENSIVE LOSS
BALANCE, MARCH 31, 1999 $ 35,803 $ -- $(23,547) $ 4 $ 12,260 $ (3,459)
======== ======== ======== ======== ======== ========
</TABLE>
The accompanying notes are an integral part of these
consolidated financial statements.
4
<PAGE>
EMPLOYEE SOLUTIONS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
Quarter Ended March 31,
-----------------------
(In Thousands of Dollars) 2000 1999
- --------------------------------------------------------------------------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Cash received from customers $ 191,028 $ 192,734
Cash paid to suppliers and employees (203,380) (199,771)
Interest received 340 244
Interest paid (390) (137)
Income taxes paid, net (40) (30)
--------- ---------
Net cash (used in) operating activities (12,442) (6,960)
--------- ---------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of property and equipment (156) (19)
Business acquisitions (2)
Purchase of investments, net (392)
Cash (invested in) released from
restricted accounts, net 1,000 (1,000)
Disbursements for deferred costs (3)
--------- ---------
Net cash provided by (used in) investing
activities 844 (1,416)
--------- ---------
CASH FLOWS FROM FINANCING ACTIVITIES:
Payment of deferred loan costs (52) --
Proceeds from issuance of common stock 26 3
Increase (decrease) in bank overdraft 3,384 (13,727)
--------- ---------
Net cash provided by (used in) financing
activities 3,358 (13,724)
--------- ---------
Net decrease in cash and cash equivalents (8,240) (22,100)
CASH AND CASH EQUIVALENTS, beginning of period 34,014 39,287
--------- ---------
CASH AND CASH EQUIVALENTS, end of period $ 25,774 $ 17,187
========= =========
The accompanying notes are an integral part of these
consolidated financial statements.
5
<PAGE>
EMPLOYEE SOLUTIONS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(CONTINUED)
Quarter Ended March 31,
-----------------------
2000 1999
- --------------------------------------------------------------------------------
RECONCILIATION OF NET LOSS TO NET CASH
PROVIDED BY (USED IN) OPERATING ACTIVITIES:
Net loss $ (5,553) $ (3,462)
-------- --------
ADJUSTMENTS TO RECONCILE NET LOSS TO NET CASH
PROVIDED BY (USED IN) OPERATING ACTIVITIES:
Depreciation and amortization 1,286 1,667
Decrease (increase) in accounts receivable, net 547 (6,175)
Decrease (increase) in insurance company receivables 88 (426)
Increase in prepaid expenses and deposits (3,922) (2,690)
(Increase) decrease in other assets (2) 176
(Decrease) increase in accrued salaries,
wages and payroll taxes (8,338) 2,120
Increase in accrued workers'
compensation and health insurance 279 487
Increase in other long-term liabilities 13 --
(Decrease) increase in accounts payable (125) 418
Decrease in income taxes payable (40) (30)
Increase in other accrued expenses 3,325 955
-------- --------
(6,889) (3,498)
-------- --------
Net cash provided by (used in) operating activities $(12,442) $ (6,960)
======== ========
The accompanying notes are an integral part of these
consolidated financial statements.
6
<PAGE>
EMPLOYEE SOLUTIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 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
March 31, 2000, ESI serviced approximately 1,920 client companies with
approximately 34,200 worksite employees in 47 states.
BASIS OF PRESENTATION
The accompanying unaudited consolidated financial statements of the Company have
been prepared by the Company pursuant to the rules and regulations of the
Securities and Exchange Commission. Certain information and footnote disclosures
normally included in consolidated financial statements prepared in accordance
with generally accepted accounting principles have been omitted pursuant to such
rules and regulations. In the opinion of management the consolidated financial
statements include all adjustments, consisting only of normal recurring
adjustments, necessary in order to make the consolidated financial statements
not misleading. Results of operations for the quarter ended March 31, 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 reserves and revenue recognized for
retrospectively rated insurance policies. The actual results of these estimates
may be unknown for a period of years. Actual results could differ from those
estimates.
CASH AND CASH EQUIVALENTS
Cash and cash equivalents consist of cash and highly liquid investments with
original maturities of three months or less when purchased. All cash equivalents
are invested in high quality investment grade instruments, such as certificates
of deposit, at March 31, 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 March 31, 2000.
INVESTMENTS AND MARKETABLE SECURITIES
At March 31, 2000, the Company maintained approximately $19.2 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 $19.1 million at March 31, 2000. Securities with
original maturities greater than 90 days consisted of a certificate of deposit
with a fair value of approximately $100,000.
7
<PAGE>
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.
NET LOSS PER COMMON AND COMMON EQUIVALENT SHARE
The computation of adjusted net loss and weighted average common and common
equivalent shares used in the calculation of net loss per common share is as
follows:
<TABLE>
<CAPTION>
Three Months Ended March 31,
------------------------------------------------------------
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 40,419,019 40,419,019 32,421,263 32,421,263
Dilutive effect of options
and warrants outstanding -- -- -- --
------------ ------------ ------------ ------------
Weighted average of
common and common
equivalent shares 40,419,019 40,419,019 32,421,263 32,421,263
============ ============ ============ ============
Net loss $ (5,553) $ (5,553) $ (3,462) $ (3,462)
Adjustments to net loss -- -- -- --
------------ ------------ ------------ ------------
Adjusted net loss for
purposes of the loss per
common share calculation $ (5,553) $ (5,553) $ (3,462) $ (3,462)
============ ============ ============ ============
Net loss per common and
common equivalent share $ (0.14) $ (0.14) $ (0.11) $ (0.11)
============ ============ ============ ============
</TABLE>
The calculation of weighted average common and common equivalent shares for
purposes of calculating the March 31, 2000 diluted loss per share, excludes
535,903 options computed under the treasury stock method, as their effects would
be anti-dilutive.
8
<PAGE>
(2) NOTE PAYABLE:
On October 26, 1999 the Company entered into a loan and security agreement (the
"Loan Agreement") with Foothill Capital Corporation and Ableco Finance LLC (the
"Lenders") providing for a term loan of $10 million at an 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 does not currently intend to draw on the revolving loan
facility except as security for various letters of credit ($5.4 million at March
31, 2000). The Company paid a closing fee of $800,000 and will pay a commitment
fee of 50 basis points on the unused portion of the revolving line, as well as
letter of credit fees of 2.0%. If the term loan then remains outstanding, the
interest rate thereon increases by 25 basis points per month beginning on July
29, 2000 and a fee of $100,000 is payable on July 29, 2000 and on 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
is not in compliance with one or more of the covenants set forth above 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.
(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 payment due April 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) upon the expiration of a 30-day grace period on May 17, 2000. While
the Company anticipates receiving a waiver on the payment due, it has classified
the debt obligation as a current liability.
The Notes are general unsecured obligations of the Company and are
unconditionally guaranteed on a joint and several basis by certain of the
Company's wholly-owned current and future subsidiaries. The Company's
wholly-owned insurance subsidiary, which is a non-guarantor subsidiary, is
subject to certain statutory and contractual restrictions which limit its
ability to pay dividends or make loans to the Company or other subsidiaries. The
financial statements presented below include the separate or combined financial
position as of March 31, 2000 and December 31, 1999, and the results of
operations and cash flows for each of the quarters ended March 31, 2000 and
March 31, 1999, of Employee Solutions, Inc. (Parent), the guarantor subsidiaries
(Guarantors) and the subsidiaries which are not guarantors (Non-guarantors).
9
<PAGE>
BALANCE SHEETS
<TABLE>
<CAPTION>
March 31, 2000
---------------------------------------------------------------
Non-
(In Thousands of Dollars) Parent Guarantors Guarantors Eliminating Consolidated
- ------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
ASSETS
CURRENT ASSETS:
Cash and cash equivalents $ 15,722 $ 6,329 $ 3,723 $ -- $ 25,774
Investments and marketable securities 100 -- -- -- 100
Restricted cash -- -- -- -- --
Accounts receivable, net 12,137 24,942 669 -- 37,748
Receivables from insurance companies -- -- 6,530 -- 6,530
Prepaid expenses and deposits 4,926 64 20 -- 5,010
Due from affiliates 8,261 2,647 (7,134) (3,774) --
--------- --------- --------- --------- ---------
Total current assets 41,146 33,982 3,808 (3,774) 75,162
Property and equipment, net 3,714 248 7 -- 3,969
Goodwill and other assets, net 9,404 26,763 -- -- 36,167
Investment in subsidiaries 45,464 -- -- (45,464) --
--------- --------- --------- --------- ---------
Total assets $ 99,728 $ 60,993 $ 3,815 $ (49,238) $ 115,298
========= ========= ========= ========= =========
LIABILITIES AND STOCKHOLDERS' (DEFICIT) EQUITY
CURRENT LIABILITIES:
Bank overdraft $ 1,011 $ 4,845 $ -- $ -- $ 5,856
Accrued salaries, wages and
payroll taxes 5,833 16,520 484 -- 22,837
Accounts payable 783 1,176 4,140 -- 6,099
Accrued workers' compensation
and health insurance 2 852 6,613 -- 7,467
Income taxes payable 381 (56) (2) -- 323
Other accrued expenses 7,976 1,040 2,593 -- 11,609
Due to affiliates 22,635 6,799 (25,660) (3,774) --
Note payable 95,000 -- -- -- 95,000
--------- --------- --------- --------- ---------
Total current liabilities 133,621 31,176 (11,832) (3,774) 149,191
--------- --------- --------- --------- ---------
Deferred income taxes -- -- -- -- --
--------- --------- --------- --------- ---------
Long-term debt -- -- -- -- --
--------- --------- --------- --------- ---------
Other long-term liabilities 360 -- -- -- 360
--------- --------- --------- --------- ---------
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 (81,700) 853 14,826 (15,679) (81,700)
--------- --------- --------- --------- ---------
Total stockholders' (deficit) equity (34,253) 29,817 15,647 (45,464) (34,253)
--------- --------- --------- --------- ---------
Total liabilities and stockholders'
(deficit) equity $ 99,728 $ 60,993 $ 3,815 $ (49,238) $ 115,298
========= ========= ========= ========= =========
</TABLE>
10
<PAGE>
BALANCE SHEETS
<TABLE>
<CAPTION>
December 31, 1999
---------------------------------------------------------------
Non-
(In Thousands of Dollars) Parent Guarantors Guarantors Eliminating Consolidated
- ------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
ASSETS
CURRENT ASSETS:
Cash and cash equivalents $ 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 4,614 976 2,694 -- 8,284
Due to affiliates 17,015 11,300 (24,541) (3,774) --
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>
11
<PAGE>
STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
For the Quarter Ended March 31, 2000
--------------------------------------------------------------
Non-
(In Thousands of Dollars) Parent Guarantors Guarantors Eliminating Consolidated
- -----------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Revenues $ 41,831 $ 143,820 $ 4,830 $ -- $ 190,481
--------- --------- --------- --------- ---------
Cost of revenues:
Salaries and wages of
worksite employees 34,886 119,941 4,127 -- 158,954
Healthcare and workers'
compensation 2,674 8,812 (552) -- 10,934
Payroll and employment taxes 3,287 10,678 421 -- 14,386
--------- --------- --------- --------- ---------
Cost of revenues 40,847 139,431 3,996 -- 184,274
--------- --------- --------- --------- ---------
Gross profit 984 4,389 834 -- 6,207
Selling, general and
administrative expenses 5,922 2,357 27 -- 8,306
Intercompany selling, general
and administrative expense -- -- -- -- --
Depreciation and amortization 969 316 1 -- 1,286
--------- --------- --------- --------- ---------
Income (loss) from operations (5,907) 1,716 806 -- (3,385)
Other income (expense):
Interest income 272 13 55 -- 340
Interest expense and other (2,510) 2 -- -- (2,508)
--------- --------- --------- --------- ---------
Income (loss) before provision
(benefit) for income taxes (8,145) 1,731 861 -- (5,553)
Income tax provision (benefit) -- -- -- -- --
--------- --------- --------- --------- ---------
Income from wholly-owned
subsidiaries 2,592 -- -- (2,592) --
--------- --------- --------- --------- ---------
Net income (loss) $ (5,553) $ 1,731 $ 861 $ (2,592) $ (5,553)
========= ========= ========= ========= =========
</TABLE>
12
<PAGE>
STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
For the Quarter Ended March 31, 1999
--------------------------------------------------------------
Non-
(In Thousands of Dollars) Parent Guarantors Guarantors Eliminating Consolidated
- -----------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Revenues $ 57,844 $ 134,223 $ 6,842 $ -- $ 198,909
--------- --------- --------- --------- ---------
Cost of revenues:
Salaries and wages of
worksite employees 49,483 110,316 5,809 -- 165,608
Healthcare and workers'
compensation 1,879 9,200 (526) -- 10,553
Payroll and employment taxes 3,970 10,514 528 -- 15,012
--------- --------- --------- --------- ---------
Cost of revenues 55,332 130,030 5,811 -- 191,173
--------- --------- --------- --------- ---------
Gross profit 2,512 4,193 1,031 -- 7,736
Selling, general and
administrative expenses 5,308 2,163 42 -- 7,513
Intercompany selling, general
and administrative expense -- -- -- -- --
Depreciation and amortization 1,259 401 7 -- 1,667
--------- --------- --------- --------- ---------
Income (loss) from operations (4,055) 1,629 982 -- (1,444)
Other income (expense):
Interest income 200 15 29 -- 244
Interest expense and other (2,361) 24 75 -- (2,262)
--------- --------- --------- --------- ---------
Income (loss) before provision
(benefit) for income taxes (6,216) 1,668 1,086 -- (3,462)
Income tax provision (benefit) -- 667 380 (1,047) --
--------- --------- --------- --------- ---------
Income from wholly-owned
subsidiaries 1,707 -- -- (1,707) --
--------- --------- --------- --------- ---------
Net income (loss) $ (4,509) $ 1,001 $ 706 $ (660) $ (3,462)
========= ========= ========= ========= =========
</TABLE>
13
<PAGE>
STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
For the Quarter Ended March 31, 2000
------------------------------------------------------------
Non-
(In Thousands of Dollars) Parent Guarantors Guarantors Eliminating Consolidated
- ----------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
RECONCILIATION OF NET LOSS TO
NET CASH USED IN OPERATING
ACTIVITIES:
Net income (loss) $ (5,553) $ 1,731 $ 861 $ (2,592) $ (5,553)
-------- -------- -------- -------- --------
ADJUSTMENTS TO RECONCILE
NET LOSS TO NET CASH
USED IN OPERATING
ACTIVITIES:
Depreciation and amortization 969 316 1 -- 1,286
Decrease (increase) in accounts receivable,
net 2,102 (1,430) (125) -- 547
Increase in insurance company
receivable -- -- 88 -- 88
Increase in prepaid expenses and deposits (3,903) -- (19) -- (3,922)
(Increase) in other assets (1) (1) -- -- (2)
Increase (decrease) from inter-
company transactions 2,917 (4,504) (1,005) 2,592 --
(Decrease) increase in accrued salaries,
wages, and payroll taxes 226 (8,756) 192 -- (8,338)
Increase (decrease) in accrued workers'
compensation and health insurance (3) (101) 383 -- 279
(Decrease) increase in accounts payable (183) 25 33 -- (125)
Decrease in income taxes payable (40) -- -- -- (40)
Increase in other accrued expenses 3,375 64 (101) -- 3,338
-------- -------- -------- -------- --------
5,459 (14,387) (553) 2,592 (6,889)
-------- -------- -------- --------
Net cash (used in) provided by
operating activities (94) (12,656) 308 -- (12,442)
-------- -------- -------- -------- --------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of property and equipment (149) (8) 1 -- (156)
Business acquisitions -- -- -- -- --
Purchases of investments, net -- -- -- -- --
Cash invested in restricted accounts, net 1,000 -- -- -- 1,000
Disbursements for deferred costs -- -- -- -- --
-------- -------- -------- -------- --------
Net cash provided by (used in)
investing activities 851 (8) 1 -- 844
-------- -------- -------- -------- --------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from issuance of common stock 26 -- -- -- 26
Payment of deferred loan costs (52) -- -- -- (52)
Increase (decrease) in bank overdraft (1,461) 4,845 -- -- 3,384
-------- -------- -------- -------- --------
Net cash provided by (used in)
financing activities (1,487) 4,845 -- -- 3,358
-------- -------- -------- -------- --------
Net increase (decrease) in cash and cash
equivalents (730) (7,819) 309 -- (8,240)
CASH AND CASH EQUIVALENTS,
beginning of period 16,452 14,148 3,414 -- 34,014
-------- -------- -------- -------- --------
CASH AND CASH EQUIVALENTS,
end of period $ 15,722 $ 6,329 $ 3,723 $ -- $ 25,774
======== ======== ======== ======== ========
</TABLE>
14
<PAGE>
STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
For the Quarter Ended March 31, 1999
------------------------------------------------------------
Non-
(In Thousands of Dollars) Parent Guarantors Guarantors Eliminating Consolidated
- ----------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
RECONCILIATION OF NET LOSS TO
NET CASH USED IN OPERATING
ACTIVITIES:
Net income (loss) $ (4,509) $ 1,001 $ 706 $ (660) $ (3,462)
-------- -------- -------- -------- --------
ADJUSTMENTS TO RECONCILE
NET LOSS TO NET CASH
USED IN OPERATING
ACTIVITIES:
Depreciation and amortization 1,259 401 7 -- 1,667
Increase in accounts receivable, net (1,181) (4,821) (173) -- (6,175)
Increase in insurance company
receivable -- -- (426) -- (426)
(Increase) in prepaid expenses and deposits (3,122) 437 (5) -- (2,690)
(Increase) decrease in other assets (190) 360 6 -- 176
Increase (decrease) from inter-
company transactions 3,702 (1,176) (3,186) 660 --
Increase (decrease) in accrued salaries,
wages, and payroll taxes 3,877 (2,178) 421 -- 2,120
Increase (decrease) in accrued workers'
compensation and health insurance (877) 872 492 -- 487
Increase in accounts payable 243 152 23 -- 418
Decrease in income taxes payable (30) -- -- -- (30)
Increase in other accrued expenses 1,692 (915) 178 -- 955
-------- -------- -------- -------- --------
5,373 (6,868) (2,663) 660 (3,498)
-------- -------- -------- -------- --------
Net cash (used in) provided by
operating activities 864 (5,867) (1,957) -- (6,960)
-------- -------- -------- -------- --------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of property and equipment (12) (7) -- -- (19)
Business acquisitions (2) -- -- -- (2)
Purchases of investments, net (392) -- -- -- (392)
Cash invested in restricted accounts, net (1,000) -- -- -- (1,000)
Disbursements for deferred costs (3) -- -- -- (3)
-------- -------- -------- -------- --------
Net cash used in investing
activities (1,409) (7) -- -- (1,416)
-------- -------- -------- -------- --------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from issuance of common stock 3 -- -- -- 3
Decrease in bank overdraft (308) (13,419) -- -- (13,727)
-------- -------- -------- -------- --------
Net cash used in
financing activities (305) (13,419) -- -- (13,724)
-------- -------- -------- -------- --------
Net decrease in cash and cash
equivalents (850) (19,293) (1,957) -- (22,100)
CASH AND CASH EQUIVALENTS,
beginning of period 8,176 24,503 6,608 -- 39,287
-------- -------- -------- -------- --------
CASH AND CASH EQUIVALENTS,
end of period $ 7,326 $ 5,210 $ 4,651 $ -- $ 17,187
======== ======== ======== ======== ========
</TABLE>
15
<PAGE>
(4) 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, debit cards, prepaid
telephone cards 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.
16
<PAGE>
Information concerning revenue, gross profit and assets by business segment was
as follows (in thousands):
For the Quarter Ended March 31,
-------------------------------
2000 1999
--------- ---------
Revenue
Core PEO $ 109,967 $ 142,090
LPC 26,602 25,360
TEAM 53,912 31,459
--------- ---------
Consolidated Total 190,481 198,909
--------- ---------
Gross Profit
Core PEO 3,507 5,222
LPC 2,057 2,029
TEAM 643 485
--------- ---------
Total 6,207 7,736
Selling, General And Administrative Expense 8,306 7,513
Depreciation And Amortization 1,286 1,667
--------- ---------
Income (Loss) From Operations (3,385) (1,444)
--------- ---------
Other Income/(Expense)
Interest income 340 244
Interest expense (2,512) (2,286)
Other 4 24
--------- ---------
Loss Before Provision For Income Taxes (5,553) (3,462)
Income Tax Benefit -- --
--------- ---------
Net Loss $ (5,553) $ (3,462)
========= =========
Depreciation And Amortization
Core PEO $ 1,013 $ 1,386
LPC 241 246
TEAM 32 35
--------- ---------
Consolidated Total $ 1,286 $ 1,667
========= =========
Total Assets
Core PEO $ 65,713 $ 127,662
LPC 33,780 33,526
TEAM 15,805 11,064
--------- ---------
Consolidated Total $ 115,298 $ 172,252
========= =========
17
<PAGE>
(5) CONTINGENCIES:
Four individuals brought suit in Steuben County Superior Court, Angola, Indiana
in 1998 alleging that they were employees of the Company and that they had not
been paid certain wages in connection with the bankruptcy of a former customer
with which the Company had commenced a limited service arrangement. The
individuals purport to represent a class of employees. Plaintiffs seek from the
Company unpaid wages, vacation and other benefits owed by the former customer in
a total amount for the purported class in excess of $600,000, potentially
subject to trebling under applicable wage statutes. The Company successfully
obtained a dismissal of the suit in the trial court. Plaintiffs thereafter
commenced an appeal process in the Indiana Court of Appeals. In April 2000, the
appellate court upheld the lower court's dismissal of the plaintiffs' case.
The Company initiated an arbitration proceeding and related suit in November
1999 in the United States District Court for the District of Arizona seeking to
enjoin a former executive officer and director of the Company from violating a
noncompetition agreement. The Company's action also seeks collection of a
promissory note from the defendant in the amount of $350,000. A company
affiliated with the defendant has filed a related suit in Georgia state court
seeking to have the noncompetition agreement ruled unenforceable and to prevent
the Company from enforcing it. Counterclaims have been filed against the Company
for unspecified damages based on various tort theories, for a declaratory
judgment voiding the noncompetition agreement, and for cancellation of the
promissory note. In May 2000, the parties reached a verbal settlement agreement
whereby the former officer has agreed to pay the Company a confidential amount
in exchange for a release of the officer from his noncompetition agreement and
dismissal of the Company's claims. The settlement is subject to completion of
formal documentation.
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 December 31, 1999, the compounded interest totaled
approximately $330,000.
The Company has been named as a defendant in an action filed by James E. Gorman
in Arizona Superior Court in August 1999 alleging breach of contract, fraud,
defamation and related matters in connection with the termination of Mr. Gorman
as the Company's president and chief executive officer in April 1999. The
complaint seeks contractual damages of approximately $588,000 plus unspecified
tort damages. The Company is contesting the claim vigorously. The Court
dismissed the plaintiff's principal tort claims in November 1999.
International Color Services, L.L.C. filed for arbitration in December 1998
alleging breach of contract regarding fee issues under the PEO service agreement
between the parties. The Company has filed a complaint in Superior Court,
Maricopa County, Arizona in January 1999 seeking a declaratory judgment that the
dispute is not subject to arbitration. Plaintiff has filed a motion to compel
arbitration and a counterclaim seeking damages of over $500,000 plus attorneys
fees and costs and unspecified punitive damages. The Company is contesting the
claim vigorously.
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. While the Company believes that no tax
ultimately will be payable based on the preliminary assessment, there can be no
assurance that this will be the case.
The State of Ohio further 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.
18
<PAGE>
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 member of the Company's Board of Directors and 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.
19
<PAGE>
ITEM 2. - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
The following discussion should be read in conjunction with, and is qualified in
its entirety by, the Company's Consolidated Financial Statements and the Notes
thereto appearing elsewhere herein and in the Company's Report on Form 10-K for
the year ended December 31, 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
liability of $250,000 per occurrence plus costs as described in the following
paragragh; 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
20
<PAGE>
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.
21
<PAGE>
RESULTS OF OPERATIONS--QUARTER ENDED MARCH 31, 2000 COMPARED TO QUARTER ENDED
MARCH 31, 1999
Percent
(In Thousands of Dollars) 2000 Change 1999
- --------------------------------------------------------------------------------
Revenues $ 190,481 (4%) $ 198,909
Cost of revenues 184,274 (4%) 191,173
Gross profit 6,207 (20%) 7,736
Selling, general and administrative 8,306 11% 7,513
Depreciation and amortization 1,286 (23%) 1,667
Interest income 340 39% 244
Interest expense 2,512 10% 2,286
Net loss (5,553) (60%) (3,462)
REVENUES
Revenues decreased to $190.5 million for the quarter ended March 31, 2000 from
$198.9 million for the quarter ended March 31, 1999, a decrease of 4%. The
primary contributing factor to the decline in first quarter 2000 revenue was the
lack of growth from internal sales primarily as a result of customer prospect
apprehension regarding the Company's financial condition, delays in new sales
during the Company's re-organization of the internal sales force and factors
such as increased attrition of clients due to normal client attrition
experienced at the end of each calendar year. Core PEO revenues experienced a
significant decline in the first quarter 2000 in comparison to first quarter
1999, which decline was offset in part by a significant increase in Team
Services revenues. The number of worksite employees decreased to approximately
34,200 covering approximately 1,920 companies at March 31, 2000 from
approximately 38,500 covering 2,090 client companies at March 31, 1999.
COST OF REVENUES
Cost of revenues decreased 4% to $184.3 million in the quarter ended March 31,
2000 from $191.2 million for the quarter ended March 31, 1999. This decrease is
primarily due to the decrease in the Company's business as described above.
GROSS PROFIT
The Company's gross profit margin decreased from 3.9% in the quarter ended March
31, 1999 to 3.3% in the quarter ended March 31, 2000. The primary contributing
factor included an increase in Team Services revenue of approximately $23
million, which earned a gross profit of approximately 1.2%, which is
substantially less than the gross margins generally achieved by ESI's other core
PEO and Logistics Personnel Corp. business segments. Workers' compensation cost
also increased at a higher rate than the rate of increase earned for providing
such services. SEE NOTE 4: BUSINESS SEGMENTS.
SELLING, GENERAL AND ADMINISTRATIVE
Selling, general and administrative expenses for the quarter ended March 31,
2000 increased by approximately $793,000 to $8.3 million, or 11%, from $7.5
million for the quarter ended March 31, 1999. The primary contributing factor is
an increase in legal fees of approximately $230,000 related to litigation and
professional fees of approximately $430,000 for consulting services provided in
the negotiations with the holders of the Notes. SEE NOTE 4: LONG TERM DEBT AND
"OUTLOOK: ISSUES AND RISKS -SUBSTANTIAL LEVERAGE; NEGOTIATIONS WITH HOLDERS OF
INDEBTEDNESS; POTENTIAL SUBSTANTIAL DILUTION OF COMMON STOCKHOLDERS."
DEPRECIATION AND AMORTIZATION
Depreciation and amortization represents depreciation of property and equipment
and amortization of customer lists and goodwill. For the quarter ended March 31,
2000, depreciation and amortization expense totaled $1.3 million compared to
$1.7 million for the quarter ended March 31, 1999. The decrease was due
primarily to a $42.2 million write-down of impaired goodwill during the fourth
quarter of 1999, which resulted in a reduction of future amortization expense.
22
<PAGE>
INTEREST
Interest expense for the quarter ended March 31, 2000 totaled $2.5 million
compared to $2.3 million for the quarter ended March 31, 1999. The increase in
interest expense is primarily due to interest on the $10 million loan and
security agreement entered into during the fourth quarter of 1999. For the
quarter ended March 31, 2000 interest income totaled $340,000 compared to
$244,000 for the quarter ended March 31, 1999. The increase in interest income
is primarily due to the additional cash provided by the $10 million loan and
security agreement that is held in interest bearing bank accounts.
EFFECTIVE TAX RATE
The Company's effective tax rate provides for federal and state income taxes. As
of March 31, 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 net operating loss will be available for
carry-forward benefit only to the extent of any subsequently generated taxable
income.
LIQUIDITY AND CAPITAL RESOURCES
The Company defines liquidity as the ability to mobilize cash to meet operating,
capital and acquisition financing needs. The Company's primary use of cash in
the quarter ended March 31, 2000 was for operating activities. The Company's
liquidity position was materially reduced due to the use of cash during the
quarter.
Cash used in operating activities was $12.4 million during the first quarter of
2000 compared to cash used in operations of $7.0 million during the first
quarter of 1999. Cash was primarily used during the first quarter of 2000 for
payroll tax payments and prepaid workers' compensation premium expenses under
the Company's guaranteed cost policy. Operating cash flows are derived from
customers for 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 $844 thousand during the first quarter
of 2000, compared to $1.4 million of cash used in investing activities during
the same period in 1999. Included in investing activities in 2000 is $1.0
million of cash that was released from a restricted account held by a bank for
certain types of controlled disbursement transaction risk. During the comparable
period in 1999 cash used in investing activities of $1.4 million included a $1.0
million investment in a certificate of deposit to secure a letter of credit
issued on behalf of the Company. Future acquisitions are not expected to be a
significant use of cash. For the quarter ended March 31, 2000 and 1999, capital
expenditures were $156,000 and $19,000, 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 quarter.
Cash provided by financing activities was $3.4 million in the first quarter of
2000 compared to $13.7 million of cash used in financing activities during the
comparable period in 1999. Cash provided in 2000 was primarily due to an
increase in bank overdrafts compared to a reduction of bank overdrafts 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.
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OUTLOOK: ISSUES AND RISKS
The following issues and risks, among others (including those discussed
elsewhere herein), should also be considered in evaluating the Company's
outlook.
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
March 31, 2000, the Company had outstanding indebtedness of $10.0 million under
the Loan Agreement, outstanding senior indebtedness of $85.0 million and a
deficit in stockholders' equity of approximately $34.3 million, respectively.
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 begun 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 with the Noteholders 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 also may have rights, preferences
or privileges senior to those of the holders of the Company's Common Stock. The
Company is seeking to complete negotiations with the Noteholders and currently
intends to submit to shareholders for approval on or before July 15, 2000 a
proposal relating to all or a portion of the negotiations.
There can be no assurance whether or when a satisfactory agreement can be
reached with the Noteholders. If the Company is unable to complete a
satisfactory agreement with the Noteholders, the Company 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 and ability to operate will be
materially adversely affected. Among its obligations under the Notes was a
regular semi-annual interest payment of $4.25 million due on April 15, 2000. In
connection with the negotiations, the Company's Board of Directors elected to
withhold the $4.25 million semi-annual interest payment due April 15, 2000.
Failure to make such interest payment for thirty (30) days following April 17,
2000 without the consent of the Noteholders would constitute a default under the
Notes and, by virtue of cross-default provisions, 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 the Noteholders 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 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 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 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 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 is currently not in compliance with one or more of the covenants set
forth in the Loan Agreement as of March 31, 2000. The Company anticipates
requesting a waiver of such noncompliance, but there can be no assurance that a
waiver or similar agreement can be reached on satisfactory terms. 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
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the Company's obligations under the Loan Agreement as a result of such
noncompliance or otherwise. At March 31, 2000, the Company had outstanding
indebtedness of $10.0 million under the Loan Agreement.
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 OPERATING 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
The Company's 2000 operating plan depends in significant part upon achieving
revenue growth through internal sales and marketing efforts. The Company
recently refocused its sales and marketing efforts to 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 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
the year. First quarter 2000 attrition was an approximate net 700 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 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 anticipates that its efforts to achieve revenue growth and
reduce attrition will be adversely affected by the market's current negative
perception of the Company's financial stability.
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.
DE-LISTING OF COMMON STOCK FROM NASDAQ
Effective March 22, 2000, the Company's Common Stock was delisted from the
Nasdaq SmallCap Market due to noncompliance with the following requirements for
continued listing of its Common Stock: maintenance of a market capitalization of
at least $35 million and a minimum bid price of $1.00 per share. As a result of
the de-listing, trading in the Company's Common Stock currently is conducted in
the Over-the-Counter Bulletin Board of the National Association of Securities
Dealers, Inc. and/or the so-called "pink sheets." As a consequence of such
de-listing, investors may find it more difficult to dispose of, or to obtain
accurate quotations as to the price of the Company's Common Stock.
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
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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 were resolved in 1999, other
significant matters remain unresolved. For example, the State of Ohio has
assessed significant sales and use taxes against the Company that the Company
believes have been assessed erroneously and is contesting vigorously. The
Company faces other claims relating to prior contractual relationships and other
matters. While the Company will continue to seek vigorously to resolve these
matters favorably, there can be no assurance that the outcome of these matters,
or any of them, will not have a material adverse effect upon the Company's
results of operations or financial position.
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. While the
Company believes that replacements for its current contracts could be obtained
on competitive terms, if doing so became necessary, without causing significant
disruption to the Company's business, there can be no assurance in this regard.
TAX TREATMENT
The attractiveness to clients of a full-service PEO arrangement depends in part
upon the tax treatment of payments for particular services and products under
the Code (for example, the opportunity of employees to pay for certain benefits
under a cafeteria plan using pre-tax dollars). The Internal Revenue Service
(IRS) has formed a Market Segment Study Group to examine whether PEOs, such as
the Company, are for certain employee benefit and tax purposes the "employers"
of worksite employees under the Code. The Company cannot predict either the
timing or the nature of any final decision that may be reached by the IRS with
respect to the Market Segment Study Group or the ultimate outcome of any such
decision, nor can the Company predict whether the Treasury Department will issue
a policy statement with respect to its position on these issues or, if issued,
whether such statement would be favorable or unfavorable to the Company. If the
IRS were to determine that the Company is not an "employer" under certain
provisions of the Code, it could materially adversely affect the Company in
several ways. With respect to benefit plans, the tax qualified status of the
Company's 401(k) plans could be revoked, and the Company's cafeteria and medical
reimbursement plans may lose their favorable tax status. If an adverse IRS
determination were applied retroactively to disqualify benefit plans, employees'
vested account balances under 401(k) plans would become taxable, an
administrative employer such as the Company would lose its tax deductions to the
extent its matching contributions were not vested, a 401(k) plan's trust could
become a taxable trust and the administrative employer could be subject to
liability with respect to its failure to withhold applicable taxes and with
respect to certain contributions and trust earnings. In such event, the Company
also would face the risk of client dissatisfaction and potential litigation by
clients or worksite employees.
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
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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.
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
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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.
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, corporate bonds, and U.S.
Treasury securities and agency notes that have an original maturity of greater
than 90 days. Because these instruments are considered highly liquid, they are
not significantly exposed to interest rate risk. However, the market values of
these securities may be affected by changes in prevailing interest rates. The
Company attempts to limit its exposure to interest rate risk primarily through
diversification and strict adherence to the Company's investment policy. The
Company's investment policy is designed to maximize interest income while
preserving its principal investment.
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PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
Four individuals brought suit in Steuben County Superior Court, Angola, Indiana
in 1998 alleging that they were employees of the Company and that they had not
been paid certain wages in connection with the bankruptcy of a former customer
with which the Company had commenced a limited service arrangement. The
individuals purport to represent a class of employees. Plaintiffs seek from the
Company unpaid wages, vacation and other benefits owed by the former customer in
a total amount for the purported class in excess of $600,000, potentially
subject to trebling under applicable wage statutes. The Company successfully
obtained a dismissal of the suit in the trial court. Plaintiffs thereafter
commenced an appeal process in the Indiana Court of Appeals. In April 2000, the
appellate court upheld the lower court's dismissal of the plaintiffs' case.
The Company initiated an arbitration proceeding and related suit in November
1999 in the United States District Court for the District of Arizona seeking to
enjoin Edward L. Cain, Jr., a former executive officer and director of the
Company, from violating a noncompetition agreement. The Company's action also
seeks collection of a promissory note from the defendant in the amount of
$350,000. A company affiliated with the defendant, MyBenefitSource.com, LLC, has
filed a related suit in Georgia state court seeking to have the noncompetition
agreement ruled unenforceable and to prevent the Company from enforcing it.
Counterclaims have been filed against the Company for unspecified damages based
on various tort theories, for a declaratory judgment voiding the noncompetition
agreement, and for cancellation of the promissory note. In May 2000, the parties
reached a verbal settlement agreement whereby the former officer has agreed to
pay the Company a confidential amount in exchange for a release of the officer
from his noncompetition agreement and dismissal of the Company's claims. The
settlement is subject to completion of formal documentation.
A Demand for Arbitration was filed with the American Arbitration Association on
April 26, 2000 by Bruce Konheim, Michael Konheim, Lawrence Berkowitz, Richard K.
Gottlieb, Thomas Fagan and Andrew Shaddock. These individuals, along with
Jeffery A. Colby, a member of the Company's Board of Directors and 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. Mr. Colby is not currently a party to the
arbitration. The Company intends to contest the claim vigorously.
From time to time, the Company is named as a defendant in lawsuits in the
ordinary course of business. See PartI, Item 2 - "Management's Discussion and
Analysis - Outlook: Issues and Risks - Uncertainty of Extent of PEO's Liability;
Government Regulation of PEOs; Credit Risks."
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
The Company is engaged in negotiations with the holders of 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 payment
due April 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) upon the expiration of a 30-day grace period on May
17, 2000.
ITEM 5. OTHER INFORMATION
In connection with the negotiations between the Company and the bondholders, the
Company recently announced the resignation of Quentin P. Smith, Jr. from the
position of Chairman of the Board of Directors and the appointment of Sara R.
Dial to the position. Mr. Smith continues to serve as the Company's Chief
Executive Officer and President and as a member of the Board of Directors.
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ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) EXHIBITS
Exhibit
Number Description
------ -----------
10.15 Severance, Release and Cooperation Agreement Between
Registrant and Paul M. Gales dated February 16, 2000
27 Financial Data Schedule
(b) REPORTS ON FORM 8-K.
Not applicable.
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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: May 15, 2000 /s/ Quentin P. Smith, Jr.
-------------------- ----------------------------------------
Quentin P. Smith, Jr.
Chief Executive Officer
/s/ John V. Prince
----------------------------------------
John V. Prince
Chief Financial Officer
31
SEVERANCE, RELEASE AND COOPERATION AGREEMENT
THIS AGREEMENT, made as of the 16th day of February, 2000, is entered into
by and between PAUL M. GALES (hereafter "Executive") and EMPLOYEE SOLUTIONS,
INC., (hereafter "Employer") and arises out of the cessation of Executive's
employment with Employer. In consideration of the material promises contained
herein, the parties agree as follows:
1. COMPENSATION AND BENEFITS. Employer agrees to pay or provide, or arrange
for the payment or provision of the following:
a. BALANCE OF SALARY. Employer will continue to pay Executive salary
at a monthly rate of $17,500 through April 7, 2000 in accordance with Employer's
normal bi-weekly payroll practices.
b. SEVERANCE PAYMENTS. Executive will also be entitled to severance
payments of an additional $105,000 payable in thirteen (13) equal bi-weekly
installments of $8,076.92 (less legally required withholdings) in accordance
with Employer's normal payroll practices beginning with the first regular payday
following the Termination Date (as defined in Section 2.a.). For example, if the
Termination Date is April 7, 2000, the payments under this section shall extend
from bi-weekly pay period ending April 22, 2000 through and including pay period
ending October 7, 2000.
c. FRINGE BENEFITS. Employer shall continue coverage of Executive and
Executive's dependents under its medical and dental plans at Employer's expense
through the earlier of October 2000, or the date that Executive commences other
employment and is eligible to commence group medical coverage in connection
therewith, (unless continuation of coverage under Employer's plans is not
feasible, in which event Employer shall provide substantially similar benefits
at its expense during such periods). Employer will continue to provide
Executive's automobile expense allowance on the first pay date of each month
through the earlier of (1) April 2000 or, (2) the date that Executive commences
other full-time employment or, (3) the Termination Date if the Termination Date
is earlier than April 7, 2000. Upon the first occurrence of any of these three
events, Employer shall have no further obligation for payment of automobile
expense allowance.
d. ACCRUED BUT UNUSED VACATION. Upon the first pay date following the
Termination Date, Employer will pay Executive a lump sum amount attributable to
Executive's accrued vacation days that remain unused as of the date of this
Agreement. Such amount (subject to withholding for applicable federal, state and
local taxes) will be equal to $17,769.22.
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e. REIMBURSEMENT OF BUSINESS EXPENSES. Employer will reimburse
Executive for business expenses incurred by Executive in the course of his
employment with Employer and submitted to Employer in accordance with Employer's
policies and practices regarding expense reimbursements.
f. EXPENSES. Each party shall be responsible for its own fees and
expenses (including legal fees) in connection with this Agreement.
If Executive dies prior to receiving all amounts payable hereunder, all
remaining amounts will be paid to Executive's spouse or, if she is not then
living, to his estate.
2. RESIGNATION.
a. This Agreement will reflect Executive's resignation as Employer's
Senior Vice President and Corporate Secretary and any office or position with
any of Employer's subsidiaries, effective as of January 6, 2000. Employer will
take with all reasonable speed those actions necessary so that Executive is
removed as a "controlling person" of Employer and/ or its subsidiaries in
Florida, Texas and any other applicable jurisdiction. The Employment Agreement
dated March 19, 1997 between Employer and Executive is hereby terminated for all
purposes. Executive's employment with Employer shall terminate automatically on
April 7, 2000 or such earlier date as is specified by Executive in writing (the
"Termination Date"), provided that the reason for Executive's notification of
said earlier termination date shall be exclusively due to his commencement of
employment with a new employer. If Executive specifies a Termination Date prior
to April 7, 2000, there shall be no change to the aggregate amount of payments
due under Section 1.a. and 1.b. of this Agreement or the method of payment of
such amount, but any remaining amounts due under Section 1.a. after such earlier
specified termination date shall be characterized as severance rather than
salary. If Executive specifies an earlier termination date in accordance with
the provisions above, payments for automobile expense allowance described in
Section 1.c. will cease as of the termination date so specified.
b. Employer will not disclose to any third party any information
relating to Executive's resignation other than the information contained in an
email distributed to all of Employer's employees on January 7, 2000 or such
additional information as may otherwise be required by law.
c. Employer will continue to retain Executive for corporate and
securities legal services subject to and pursuant to an engagement letter
mutually agreed upon by Executive and Employer and provided that Executive
affiliates with a law firm acceptable to Employer (in a reasonable time frame)
with an established practice in such areas.
d. Employer shall direct employees assigned to answer telephones to
advise callers who ask for Executive that Executive has resigned and that
Executive is continuing to provide post-resignation corporate and securities law
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services to Employer, and to provide callers who wish to speak with Executive
other than with respect to Employer's business with Executive's home telephone
number (or such other number as Executive may specify).
e. Employer further agrees that it will maintain Executive's personnel
records and personnel information in confidence and will not release any
information other than Executive's dates of employment by the Employer and job
title to any person without the express written consent of Executive, except as
required by law. Notwithstanding the foregoing sentence, Employer will provide a
positive reference for Executive with respect to Executive's securities-related
corporate services if requested by Executive.
f. Employer (meaning, solely for this purpose, Employer's directors
and executive officers and other individuals authorized to make official
communications on Employer's behalf) will not disparage Executive or Executive's
performance or otherwise take any action which could reasonably be expected to
adversely affect Executive's personal or professional reputation. Similarly,
Executive will not disparage Employer or any of its directors, officers, agents
or employees or otherwise take any action which could reasonably be expected to
adversely affect the personal or professional reputation of Employer or any of
its directors, officers, agents or employees.
3. STOCK OPTIONS. Executive's current stock options, as evidenced in
Employer's minutes or grant letters, shall remain outstanding pursuant to their
terms for 90 days past the Termination Date. Options that are exercisable on the
Termination Date shall remain exercisable during such 90-day period.
4. RELEASE. Executive hereby fully and forever releases and discharges
Employer and its parents, affiliates and subsidiaries, including all
predecessors and successors, assigns, officers, directors, trustees, executives,
agents and attorneys, past and present (collectively, the "Released Parties")
from any and all claims, demands, liens, agreements, contracts, covenants,
actions, suits, causes of action, obligations, controversies, debts, costs,
expenses, damages, judgments, orders and liabilities, of whatever kind or
nature, direct or indirect, in law, equity or otherwise, whether known or
unknown, arising out of Executive's employment by Employer or the termination
thereof, including, but not limited to, any claims for relief or causes of
action under federal, state or local statute, ordinance or regulation regarding
discrimination in employment and any claims, demands or actions based upon
alleged wrongful or retaliatory discharge or breach of contract under any state
or federal law. By this agreement Executive affirms that he is releasing all
claims for age discrimination or any other legal rights or claims pursuant to
the Age Discrimination in Employment Act as amended by the age discrimination
provisions of applicable state laws that exist as of the date of the execution
of this agreement, whether presently known or hereafter discovered. In
connection with this release for any or all claims of age discrimination,
Executive has been given the opportunity to consider entering into this
Agreement for twenty-one (21) days preceding its execution. Executive
acknowledges that he has had the opportunity to be represented by independent
legal counsel prior to the execution of this Agreement, as well as the
opportunity to consult with legal counsel as to the meaning and legal
significance of this Agreement. The foregoing release does not extend to (i)
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<PAGE>
claims solely to enforce Employer's obligations under this Agreement; or (ii)
claims solely to enforce the Non-Director Officer's Indemnification Agreement
between Employer and Executive dated November 21, 1996, or claims for
indemnification under any applicable law of Employer's Articles of Incorporation
or By-laws (collectively with the Non-Director Officer's Indemnification
Agreement, the "Indemnification Agreements").
5. REVOCATION. Executive understands that he may revoke this agreement
within seven (7) days after the agreement has been signed by all parties
("Revocation Period"). During this Revocation Period, Executive understands that
no payment will be made under Section 1.b of this agreement, even it said
payment would otherwise have been paid in accordance with the terms of that
section. Executive further understands that if the agreement is not revoked
within or by the conclusion of the Revocation Period, the agreement will be
effective and enforceable. In order to revoke this agreement, Executive must
deliver to Employer at 6225 N. 24th Street, Phoenix, Arizona 85016, a signed
letter or other written notice stating that he is canceling or revoking the
agreement. Executive also understands that under these circumstances, Employer
has no obligation to pay any of the consideration described in Section 1.b or in
Section 1.c if the consideration in Section 1.c would have otherwise occurred
absent the revocation, after the Termination Date.
6. COOPERATION AGREEMENT. Executive further agrees that he will cooperate
fully with Employer and its counsel with respect to any matter (including
litigation, investigations, or governmental proceedings) with which Executive
was involved in his capacity as General Counsel or Corporate Secretary during
the term of employment with Employer. Executive will be available to perform
such services on a reasonable basis to the extent requested by Employer,
including on a full-time basis as needed, until the Termination Date.
Thereafter, Executive will be available to perform such services to the extent
reasonably requested by Employer for up to an average of 15 hours per month
through October 7, 2000. The times and places for the performance of these
services will be mutually agreeable to the parties, and Employer agrees to
cooperate with Executive in scheduling such services to minimize disruption of
any new employment or similar relationship which Executive may have commenced.
Subject to the foregoing sentence, Executive shall render such cooperation in a
timely manner on reasonable notice from Employer, and agrees to travel as
reasonably requested by Employer in connection with performing such services.
Employer will reimburse Executive's reasonable out-of-pocket expenses incurred
in connection with providing such services in accordance with Employer's
policies as in effect from time to time.
7. RETURN OF EMPLOYER PROPERTY. Employer acknowledges receipt of all
documents and files from Executive, as well as Employer property such as
Executive's personal digital assistant. Employer acknowledges that Executive may
possess copies of Employer-related documents from time to time as needed to
provide requested services. On or prior to the earlier of the Termination Date,
or the date that Executive commences other employment, Executive will return to
Employer the cellular phone and accessories previously furnished to Executive.
The business use (and incidental personal use) of the cellular phone during this
period is intended for the Executive only, as reasonable and necessary in the
performance of services for the Employer. Other office equipment purchased by
Employer for Executive's use (e.g. a laptop computer and docking station,
discarded desktop computer and fax machine) will become property of Executive
and need not be returned to Employer.
-4-
<PAGE>
8. EXECUTIVE'S ACKNOWLEDGMENT. Executive has fully reviewed the terms of
this Agreement, acknowledges that he understands the terms of this Agreement and
states that he is entering into this Agreement knowingly and voluntarily.
9. EXECUTIVE'S SUCCESSORS. This Agreement will be binding upon and inure to
the benefit of the parties hereto, their representatives, agents and assigns,
and as to Executive, his spouse, heirs, legatees, administrators and personal
representatives.
10. ENTIRE AGREEMENT OF THE PARTIES. This Agreement, together with the
Indemnification Agreements and Employee's confidentiality/noncompete agreement,
constitutes the exclusive and complete agreement between the parties hereto
relating to the subject matter hereof. No amendment of this Agreement will be
binding unless in writing and signed by the parties.
11. SEVERABILITY. The provisions of this Agreement are severable. If any
provision or the scope of any provision is found to be unenforceable or is
modified by a court of competent jurisdiction, the other provisions or the
affected provisions as so modified shall remain fully valid and enforceable.
12. GOVERNING LAW. This Agreement shall be governed by the law of the
Arizona, without regard to the application of the principles of conflicts of
laws. Exclusive venue for any dispute or disagreement with respect to this
Agreement shall lie in Maricopa County, Arizona.
13. COMMUNICATIONS. Executive shall not discuss, with any ESI employee or
any other person, any matter relating to Employer or its subsidiaries,
affiliates, officers, directors, employees or agents without the prior written
authorization of Employer's Chief Executive Officer. The foregoing shall not
apply to (i) communications to persons other than Employer's employees and
independent contractors consisting solely of information publicly available
through Employer's Securities and Exchange Commission filings or press releases;
(ii) communications in the course of services being provided to persons with a
need to receive such communications to perform the specific business functions
with respect to which Executive has been requested to provide services; (iii)
factual communications to prospective employers concerning Executive's duties
and responsibilities with Employer to the extent necessary in connection with
job interviews; or (iv) testimony in a judicial or administrative proceeding.
14. TENDER BACK. Should Executive attempt to challenge the enforceability
of this Agreement or any provision herein, or attempt to initiate any legal
proceedings, including but not limited to administrative agency or court
proceedings arising out of or related to Executive's employment or termination
of employment with Employer, Executive shall initially tender to Employer, by
certified check delivered to counsel for Employer, the full amount of cash
consideration paid to him hereunder, plus interest at the legal rate from the
date of Executive's execution of this Agreement, and shall invite Employer to
cancel this Agreement. If Employer accepts the offer to cancel the Agreement,
-5-
<PAGE>
this Agreement shall be canceled. If Employer does not accept this offer to
cancel, Employer shall so notify Executive and shall place the amount tendered
by Executive in an interest-bearing account pending a determination of the
enforceability of this Agreement. If the Agreement is determined to be
enforceable, 100% of the amount of the account shall be repaid to Executive; if
this Agreement is not determined to be enforceable, the amount in the account
shall be retained by Employer or its designee. This Section 14 shall not be
applicable to actions brought by Executive to enforce Employer's obligations
hereunder.
IN WITNESS WHEREOF, the undersigned acknowledge that they have executed
this instrument as their free and voluntary act, for the uses and purposes set
forth herein on the dates set forth below.
EMPLOYEE SOLUTIONS, INC.
By: /s/ Quentin P. Smith, Jr.
------------------------------------
Title: Chief Executive Officer
Date: February 16, 2000
PAUL M. GALES
By: /s/ Paul M. Gales
------------------------------------
Date: February 10, 2000
-6-
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<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
COMPANY'S FORM 10-Q FOR THE PERIOD ENDED MARCH 31, 2000 AND IS QUALIFIED IN ITS
ENTIRETY BY REFERENCE TO SUCH FORM 10-Q.
</LEGEND>
<MULTIPLIER> 1,000
<CURRENCY> U.S. DOLLARS
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> DEC-31-2000
<PERIOD-START> JAN-01-2000
<PERIOD-END> MAR-31-2000
<EXCHANGE-RATE> 1
<CASH> 25,774
<SECURITIES> 100
<RECEIVABLES> 44,278
<ALLOWANCES> 0
<INVENTORY> 0
<CURRENT-ASSETS> 75,162
<PP&E> 3,969
<DEPRECIATION> 0
<TOTAL-ASSETS> 115,298
<CURRENT-LIABILITIES> 149,191
<BONDS> 0
0
0
<COMMON> 47,447
<OTHER-SE> (81,700)
<TOTAL-LIABILITY-AND-EQUITY> 115,298
<SALES> 0
<TOTAL-REVENUES> 190,481
<CGS> 0
<TOTAL-COSTS> 184,274
<OTHER-EXPENSES> 9,592
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 2,512
<INCOME-PRETAX> (5,553)
<INCOME-TAX> 0
<INCOME-CONTINUING> (5,553)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (5,553)
<EPS-BASIC> (0.14)
<EPS-DILUTED> (0.14)
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