U.S. SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 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 August 9, 2000.
<PAGE>
EMPLOYEE SOLUTIONS, INC.
FORM 10-Q
QUARTERLY REPORT FOR THE PERIOD ENDED JUNE 30, 2000
INDEX
Page
PART I. Financial Information Number
------
Item 1. Financial Statements
Consolidated Balance Sheets - June 30, 2000 and
December 31, 1999 2
Consolidated Statements of Operations for the
Quarters and Six Months Ended June 30, 2000 and 1999 3
Consolidated Statement of Changes in Stockholders'
Equity for the Six Months Ended June 30, 2000 4
Consolidated Statements of Cash Flows for the
Six Months Ended June 30, 2000 and 1999 5
Notes to Consolidated Financial Statements 7
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 23
Item 3. Quantitative and Qualitative Disclosure About Market Risk 32
PART II. Other Information
Item 1. Legal Proceedings 33
Item 3. Defaults Upon Senior Securities 33
Item 6. Exhibits and Reports on Form 8-K 34
Signatures 35
<PAGE>
ITEM 1. FINANCIAL STATEMENTS
EMPLOYEE SOLUTIONS, INC.
CONSOLIDATED BALANCE SHEETS
June 30, December 31,
(In thousands of dollars, except share data) 2000 1999
--------- ---------
ASSETS
CURRENT ASSETS:
Cash and cash equivalents $ 16,300 $ 34,014
Investments and marketable securities 100 100
Restricted cash and investments 5,000 1,000
Accounts receivable, net 31,537 38,296
Receivables from insurance companies 6,925 6,618
Prepaid expenses and deposits 4,699 1,088
Income taxes receivable -- --
Deferred income taxes -- --
--------- ---------
Total current assets 64,561 81,116
Property and equipment, net 3,632 4,211
Deferred income taxes -- --
Goodwill and other assets, net 35,226 37,000
--------- ---------
Total assets $ 103,419 $ 122,327
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Bank overdraft $ 3,273 $ 2,472
Accrued salaries, wages and payroll taxes 19,742 31,175
Accounts payable 5,532 6,224
Accrued workers' compensation and health insurance 7,507 7,188
Income taxes payable 316 363
Other accrued expenses 14,530 8,284
Note Payable 95,000 10,000
--------- ---------
Total current liabilities 145,900 65,706
--------- ---------
Deferred income taxes -- --
--------- ---------
Long-term debt -- 85,000
--------- ---------
Other long-term liabilities 374 347
--------- ---------
Commitments and contingencies
STOCKHOLDERS' EQUITY
Class A convertible preferred stock, nonvoting,
no par value, 10,000,000 shares authorized,
no shares issued and outstanding -- --
Common stock, no par value, 75,000,000 shares
authorized, 38,433,027 shares issued and
outstanding June 30, 2000, and 36,182,547 shares
issued and outstanding December 31, 1999 41,525 39,550
Common stock to be issued 5,922 7,871
Accumulated deficit (90,302) (76,147)
Cumulative unrealized gain on investment securities -- --
--------- ---------
Total stockholders' equity (42,855) (28,726)
--------- ---------
Total liabilities and stockholders' equity $ 103,419 $ 122,327
========= =========
The accompanying notes are an integral part of these
consolidated balance sheets.
2
<PAGE>
EMPLOYEE SOLUTIONS, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
Quarter ended June 30, Six months ended June 30,
(In thousands of dollars, except ---------------------------- ----------------------------
share and per share data) 2000 1999 2000 1999
------------ ------------ ------------ ------------
<S> <C> <C> <C> <C>
Revenues $ 178,883 $ 206,088 $ 369,364 $ 404,998
------------ ------------ ------------ ------------
Cost of revenues:
Salaries and wages of worksite employees 150,901 172,574 309,855 338,268
Healthcare and workers' compensation 9,843 11,265 20,777 21,817
Payroll and employment taxes 11,688 13,674 26,074 28,601
------------ ------------ ------------ ------------
Cost of revenues 172,432 197,513 356,706 388,686
------------ ------------ ------------ ------------
Gross profit 6,451 8,575 12,658 16,312
Selling, general and administrative expenses 11,311 8,872 19,617 16,384
Depreciation and amortization 1,299 1,673 2,585 3,340
------------ ------------ ------------ ------------
Loss from operations (6,159) (1,970) (9,544) (3,412)
Other income (expense):
Interest income 240 523 580 767
Interest expense (2,692) (2,002) (5,204) (4,288)
Other 9 13 13 36
------------ ------------ ------------ ------------
Loss before benefit for income taxes (8,602) (3,436) (14,155) (6,897)
Income tax benefit -- -- -- --
------------ ------------ ------------ ------------
Net loss $ (8,602) $ (3,436) $ (14,155) $ (6,897)
============ ============ ============ ============
Net loss per common and
common equivalent share:
Basic $ (.21) $ (.10) $ (.35) $ (.21)
Diluted $ (.21) $ (.10) $ (.35) $ (.21)
Weighted average number of common and
common equivalent shares outstanding:
Basic 40,433,598 33,266,969 40,426,309 32,846,452
============ ============ ============ ============
Diluted 40,433,598 33,266,969 40,426,309 32,846,452
============ ============ ============ ============
</TABLE>
The accompanying notes are an integral part of these
consolidated balance sheets.
3
<PAGE>
EMPLOYEE SOLUTIONS, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
SIX MONTHS ENDED JUNE 30, 2000
<TABLE>
<CAPTION>
Common Retained Cumulative Total
Stock Earnings Unrealized Stockholders' Comprehensive
(In thousands of dollars, Common To Be Accumulated Gain (loss) on (Deficit) Income
Income except share data) Stock Issued (Deficit) Investments Equity (Loss)
-------- -------- -------- --------- -------- --------
<S> <C> <C> <C> <C> <C> <C>
BALANCE, December 31, 1999 $ 39,550 $ 7,871 $(76,147) $ -- $(28,726) $(56,063)
Issuance of 44,222 shares of common
stock in connection with Employee
Stock Purchase Plan 26 -- -- -- 26 --
Issuance of 2,206,258 shares of common
stock in connection with acquisitions 1,949 (1,949) -- -- -- --
Net loss -- -- (14,155) -- (14,155) (14,155)
-------- -------- -------- --------- -------- --------
COMPREHENSIVE LOSS $(14,155)
========
BALANCE, JUNE 30, 2000 $ 41,525 $ 5,922 $(90,302) $ -- $(42,855)
======== ======== ========= ========= ========
</TABLE>
The accompanying notes are an integral part of these
consolidated financial statements.
4
<PAGE>
CONSOLIDATED STATEMENTS OF CASH FLOWS
Six months ended June 30,
----------------------
(In thousands of dollars) 2000 1999
--------- ---------
CASH FLOWS FROM OPERATING ACTIVITIES:
Cash received from customers $ 376,123 $ 396,089
Cash paid to suppliers and employees (390,037) (411,531)
Interest received 544 767
Interest paid (846) (4,252)
Income taxes refunded (paid), net (47) 4,391
--------- ---------
Net cash used in operating activities (14,263) (14,536)
--------- ---------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of property and equipment (226) (128)
Business acquisitions -- (5,879)
Change in investments and marketable securities -- 8,509
(Increase) decrease in restricted cash and investments (4,000) 88
Disbursements for deferred costs -- (3)
--------- ---------
Net cash (used in) provided by investing activities (4,226) 2,587
--------- ---------
CASH FLOWS FROM FINANCING ACTIVITIES:
Payment of deferred loan costs (52) --
Proceeds from issuance of common stock 26 555
Increase (decrease) in bank overdraft 801 (13,727)
--------- ---------
Net cash (used in) provided by financing activities 775 (13,172)
--------- ---------
Net decrease in cash and cash equivalents (17,714) (25,121)
CASH AND CASH EQUIVALENTS, beginning of period 34,014 39,287
--------- ---------
CASH AND CASH EQUIVALENTS, end of period $ 16,300 $ 14,166
========= =========
The accompanying notes are an integral part of these
consolidated financial statements.
5
<PAGE>
EMPLOYEE SOLUTIONS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(CONTINUED)
Six months ended June 30,
----------------------
2000 1999
--------- ---------
RECONCILIATION OF NET LOSS TO NET CASH
(USED IN) PROVIDED BY OPERATING ACTIVITIES:
Net loss $ (14,155) $ (6,897)
--------- ---------
ADJUSTMENTS TO RECONCILE NET INCOME (LOSS) TO
NET CASH (USED IN) PROVIDED BY OPERATING ACTIVITIES:
Depreciation and amortization 2,585 3,340
(Increase) decrease in accounts receivable, net 6,759 (8,909)
Decrease (increase) in insurance company receivables (307) 8
Increase in prepaid expenses and deposits (3,612) (2,822)
Decrease in deferred income taxes, net -- --
Decrease in other assets 47 518
Increase (decrease) in accrued salaries,
wages and payroll taxes (11,433) 329
Increase (decrease) in accrued workers'
compensation and health insurance 319 (1,564)
Increase in other long term debt 27 --
(Decrease) increase in accounts payable (692) 477
(Decrease) increase in income taxes payable/receivable (47) 4,391
(Decrease) increase in other accrued expenses
and long-term liabilities 6,246 (3,407)
--------- ---------
(108) (7,639)
--------- ---------
Net cash used in operating activities $ (14,263) $ (14,536)
========= =========
The accompanying notes are an integral part of these
consolidated financial statements.
6
<PAGE>
EMPLOYEE SOLUTIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2000
(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:
NATURE OF CORPORATION
Employee Solutions, Inc. (together with its subsidiaries, "ESI" or the
"Company") is a leading professional employer organization (PEO) providing
employers throughout the United States with comprehensive employee payroll,
human resources and benefits outsourcing services. The Company's integrated
outsourcing services include payroll processing and reporting, human resources
administration, employment regulatory compliance management, risk
management/workers' compensation services, retirement and health care programs,
and other products and services provided directly to worksite employees. At June
30, 2000, ESI serviced approximately 1,859 client companies with approximately
32,727 worksite employees in 45 states.
The Company conducts its business on a national scale across many industries and
is not concentrated to any material extent within a single local market or
industry, although the transportation industry, at approximately 26%, represents
the largest concentration of clients.
BASIS OF PRESENTATION
The accompanying unaudited consolidated financial statements of the Company have
been prepared by the Company pursuant to the rules and regulations of the
Securities and Exchange Commission. Certain information and footnote disclosures
normally included in consolidated financial statements prepared in accordance
with generally accepted accounting principles have been omitted pursuant to such
rules and regulations. In the opinion of management the consolidated financial
statements include all adjustments, consisting only of normal recurring
adjustments, necessary in order to make the consolidated financial statements
not misleading. Results of operations for the quarter and six months ended June
30, 2000 are not necessarily indicative of the results that may be expected for
the year ending December 31, 2000. For further information, refer to the
consolidated financial statements and footnotes thereto included in the
Company's Annual Report on Form 10-K for the year ended December 31, 1999.
PRINCIPLES OF CONSOLIDATION
The consolidated financial statements include the activities of Employee
Solutions, Inc. and its wholly owned subsidiaries from their respective
acquisition dates. All acquisitions were accounted for as purchases. All
significant intercompany accounts and transactions have been eliminated.
USE OF ESTIMATES
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities and disclosure of
contingent assets and liabilities at the date of the financial statements, and
the reported amounts of revenues and expenses during the reporting period. The
nature of the Company's business requires significant estimates to be made in
the areas of workers' compensation and revenue recognized for retrospectively
rated insurance policies. The actual results of these estimates may be unknown
for a period of years. Actual results could differ from those estimates.
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 June 30, 2000 and December 31, 1999, and are stated at fair
market value. Substantially all cash and cash equivalents, including restricted
cash, are not insured at June 30, 2000.
INVESTMENTS AND MARKETABLE SECURITIES
At June 30, 2000, the Company maintained approximately $10.9 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
7
<PAGE>
estimated fair value of $10.8 million at June 30, 2000. Securities with original
maturities greater than 90 days consisted of a certificate of deposit with a
fair value of approximately $100,000.
RESTRICTED CASH AND INVESTMENTS
At June 30, 2000, restricted cash was $5.0 million, which represents cash
collateral held for securing short-term indebtedness under a loan agreement.
(See Footnote 2 - Note Payable).
BANK OVERDRAFT
Bank overdraft represents outstanding checks in excess of cash on hand at the
applicable bank, and generally result from timing differences in the transfer of
funds between banks. Historically, these checks are covered when presented for
payment through the transfer of funds from other Company cash accounts held in
other banks.
CREDIT RISK
The Company conducts only a limited credit investigation prior to accepting most
new clients and thus may encounter collection problems which could adversely
affect its cash flow. The nature of the Company's business is such that a small
number of client credit failures could have an adverse effect on its business
and financial condition.
8
<PAGE>
EMPLOYEE SOLUTIONS, INC. JUNE 30, 2000
--------------------------------------------------------------------------------
NET INCOME PER COMMON AND COMMON EQUIVALENT SHARE
The computation of adjusted net loss and weighted average common and common
equivalent shares used in the calculation of net loss per common share is as
follows:
<TABLE>
<CAPTION>
Quarter ended June 30,
------------------------------------------------------------
2000 1999
---------------------------- ----------------------------
(In thousands of dollars, except
share and per share data) Basic Diluted Basic Diluted
------------ ------------ ------------ ------------
<S> <C> <C> <C> <C>
Weighted average of
common shares outstanding 40,433,598 40,433,598 33,266,969 33,266,969
Dilutive effect of options
and warrants outstanding -- -- -- --
------------ ------------ ------------ ------------
Weighted average of
common and common
equivalent shares 40,433,598 40,433,598 33,266,969 33,266,969
============ ============ ============ ============
Net loss $ (8,602) $ (8,602) $ (3,436) $ (3,436)
Adjustments to net loss -- -- -- --
------------ ------------ ------------ ------------
Adjusted net loss for
purposes of the income per
common share calculation $ (8,602) $ (8,602) $ (3,436) $ (3,436)
============ ============ ============ ============
Net loss per common and
common equivalent share $ (.21) $ (.21) $ (0.10) $ (0.10)
============ ============ ============ ============
</TABLE>
9
<PAGE>
EMPLOYEE SOLUTIONS, INC. JUNE 30, 2000
--------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Six months ended June 30,
------------------------------------------------------------
2000 1999
---------------------------- ----------------------------
(In thousands of dollars, except
share and per share data) Basic Diluted Basic Diluted
------------ ------------ ------------ ------------
<S> <C> <C> <C> <C>
Weighted average of
common shares outstanding 40,426,309 40,426,309 32,846,452 32,846,452
Dilutive effect of options
and warrants outstanding -- -- -- --
------------ ------------ ------------ ------------
Weighted average of
common and common
equivalent shares 40,426,309 40,426,309 32,846,452 32,846,452
============ ============ ============ ============
Net loss $ (14,155) $ (14,155) $ (6,897) $ (6,897)
Adjustments to net loss -- -- -- --
------------ ------------ ------------ ------------
Adjusted net loss for
purposes of the income per
common share calculation $ (14,155) $ (14,155) $ (6,897) $ (6,897)
============ ============ ============ ============
Net loss per common and
common equivalent share $ (.35) $ (.35) $ (0.21) $ (0.21)
============ ============ ============ ============
</TABLE>
The calculation of weighted average common and common equivalent shares for
purposes of calculating the June 30, 2000 diluted earnings per share, excludes
approximately 438,463 weighted average shares of options, warrants, and
contingently issuable shares computed under the treasury stock method, as their
effects would be anti-dilutive.
(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 initial interest rate
of 13.5% and a revolving loan (based on eligible accounts receivable) to a
maximum of $10 million (including letters of credit drawn thereunder) at an
interest rate of prime plus 2%. The Company received the proceeds of the term
loan on October 29, 1999. The Company does not currently intend to draw on the
revolving loan facility except as security for various letters of credit ($5.4
million at June 30, 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 interest rate applicable to the term loan and the
letter of credit commitment fee have been changed by agreement of the parties;
see discussion below.) 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
was not in compliance with one or more of the covenants set forth above
commencing as of March 31, 2000 and has therefore classified the debt obligation
as a current liability. The Company has also classified the 10% Senior Notes due
2004 as a current note payable obligation. See Note 3.
The Company and the Lenders entered into a Waiver and Amendment Agreement dated
as of July 6, 2000, under which the Lenders waived any rights and remedies
available for defaults under designated covenants with respect to which the
Company was then in default. The annual interest rate on the term loan was
increased to 15.5% effective April 30, 2000, increasing by 25 basis points per
10
<PAGE>
EMPLOYEE SOLUTIONS, INC. JUNE 30, 2000
--------------------------------------------------------------------------------
month beginning on September 1, 2000 so long as any portion of the term loan
remains outstanding. The fee payable for undrawn letters of credit was increased
to 6% per annum. As additional security, the Company agreed to deposit $5
million in a deposit account subject to a control agreement in form satisfactory
to the Lenders, and to deposit an additional $1 million in such account on
August 1, 2000 and on the first day of each month thereafter so long as any
amounts remain owing to the Lenders.
(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 constituted an Event of Default (as defined in the
Indenture) upon the expiration of a 30-day grace period on May 17, 2000. The
Company has received a written agreement from the holders of the Notes under
which the holders have agreed to forbear from exercising their rights and
remedies through the first to occur of August 30, 2000 or the occurrence of a
new default. While the Company anticipates that it will receive an additional
waiver if discussions with the holders are not completed at the expiration of
the forbearance agreement, there can be no assurance that an additional waiver
can be obtained. The Company 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 June 30, 2000 and December 31, 1999, and the results of
operations and cash flows for each of the quarters ended June 30, 2000 and June
30, 1999, of Employee Solutions, Inc. (Parent), the guarantor subsidiaries
(Guarantors) and the subsidiaries which are not guarantors (Non-guarantors).
11
<PAGE>
EMPLOYEE SOLUTIONS, INC. JUNE 30, 2000
--------------------------------------------------------------------------------
BALANCE SHEETS
<TABLE>
<CAPTION>
June 30, 2000
--------------------------------------------------------------
Non-
(In thousands of dollars) Parent Guarantors Guarantors Eliminating Consolidated
--------- --------- --------- --------- ---------
<S> <C> <C> <C> <C> <C>
ASSETS
CURRENT ASSETS:
Cash and cash equivalents $ 10,185 $ 2,699 $ 3,416 $ -- $ 16,300
Investments and marketable securities 100 -- -- -- 100
Restricted cash and investments 5,000 -- -- -- 5,000
Accounts receivable, net 9,106 21,825 606 -- 31,537
Receivables from insurance companies -- -- 6,925 -- 6,925
Prepaid expenses and deposits 4,623 56 20 -- 4,699
Income taxes receivable -- -- -- -- --
Deferred income taxes -- -- -- -- --
Due from affiliates 8,338 2,673 (7,237) (3,774) --
--------- --------- --------- --------- ---------
Total current assets 37,352 27,253 3,730 (3,774) 64,561
Property plant and equipment, net 3,392 234 6 -- 3,632
Deferred income taxes -- -- -- -- --
Goodwill and other assets, net 8,749 26,479 (2) -- 35,226
Investment in subsidiaries 48,384 -- -- (48,384) --
--------- --------- --------- --------- ---------
Total assets $ 97,877 $ 53,966 $ 3,734 $ (52,158) $ 103,419
========= ========= ========= ========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
LIABILITIES:
Bank overdrafts $ 2,005 $ 1,268 $ -- $ -- $ 3,273
Accrued salaries, wages and payroll taxes 5,432 14,001 309 -- 19,742
Accounts payable 375 957 4,200 -- 5,532
Accrued workers' compensation
and health insurance 27 571 6,909 -- 7,507
Income taxes payable 368 (50) (2) -- 316
Other accrued expenses 10,429 942 3,159 -- 14,530
Short-term debt 95,000 -- -- -- 95,000
Due to affiliates 26,022 5,204 (27,452) (3,774) --
--------- --------- --------- --------- ---------
Total current liabilities 139,658 22,893 (12,877) (3,774) 145,900
--------- --------- --------- --------- ---------
Deferred income taxes -- -- -- -- --
--------- --------- --------- --------- ---------
Long-term debt -- -- -- -- --
--------- --------- --------- --------- ---------
Other long-term liabilities 374 -- -- -- 374
--------- --------- --------- --------- ---------
STOCKHOLDERS' 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 (90,302) 2,809 15,790 (18,599) (90,302)
Unrealized gain on investment securities -- -- -- -- --
--------- --------- --------- --------- ---------
Total stockholders' equity (42,855) 31,773 16,611 (48,384) (42,855)
--------- --------- --------- --------- ---------
Total liabilities and stockholders' equity $ 97,177 $ 54,666 $ 3,734 $ (52,158) $ 103,419
========= ========= ========= ========= =========
</TABLE>
12
<PAGE>
EMPLOYEE SOLUTIONS, INC. JUNE 30, 2000
--------------------------------------------------------------------------------
BALANCE SHEETS
<TABLE>
<CAPTION>
(In thousands of dollars) For the Year Ended December 31, 1999
--------------------------------------------------------------
Non-
Parent Guarantors Guarantors Eliminating Consolidated
--------- --------- --------- --------- ---------
<S> <C> <C> <C> <C> <C>
ASSETS
CURRENT ASSETS:
Cash and cash equivalents $ 16,452 $ 14,148 $ 3,414 $ -- $ 34,014
Investments and marketable securities 100 -- -- -- 100
Restricted cash 1,000 -- -- -- 1,000
Accounts receivable, net 14,240 23,512 544 -- 38,296
Receivables from insurance companies -- -- 6,618 -- 6,618
Prepaid expenses and deposits 1,023 64 1 -- 1,088
Due from affiliates 8,150 2,644 (7,020) (3,774) --
--------- --------- --------- --------- ---------
Total current assets 40,965 40,368 3,557 (3,774) 81,116
Property and equipment, net 3,937 265 9 -- 4,211
Goodwill and other assets, net 9,947 27,053 -- -- 37,000
Investment in subsidiaries 42,872 -- -- (42,872) --
--------- --------- --------- --------- ---------
Total assets $ 97,721 $ 67,686 $ 3,566 $ (46,646) $ 122,327
========= ========= ========= ========= =========
LIABILITIES AND STOCKHOLDERS' (DEFICIT) EQUITY
CURRENT LIABILITIES:
Bank overdraft $ 2,472 $ -- $ -- $ -- $ 2,472
Accrued salaries, wages and payroll taxes 5,607 25,276 292 -- 31,175
Accounts payable 966 1,151 4,107 -- 6,224
Accrued workers' compensation and health
insurance 5 953 6,230 -- 7,188
Income taxes payable 421 (56) (2) -- 363
Other accrued expenses 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>
13
<PAGE>
EMPLOYEE SOLUTIONS, INC. JUNE 30, 2000
--------------------------------------------------------------------------------
STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
For the Quarter Ended June 30, 2000
---------------------------------------------------------------
Non-
(In thousands of dollars) Parent Guarantors Guarantors Eliminating Consolidated
--------- --------- --------- --------- ---------
<S> <C> <C> <C> <C> <C>
Revenues $ 43,958 $ 130,931 $ 3,994 $ -- $ 178,883
--------- --------- --------- --------- ---------
Cost of revenues:
Salaries and wages of
worksite employees 37,216 110,298 3,387 -- 150,901
Healthcare and workers'
compensation 2,839 7,644 (640) -- 9,843
Payroll and employment taxes 2,913 8,490 285 -- 11,688
--------- --------- --------- --------- ---------
Cost of revenues 42,968 126,432 3,032 -- 172,432
--------- --------- --------- --------- ---------
Gross profit 990 4,499 962 -- 6,451
Selling, general and
administrative expenses 8,331 2,960 20 -- 11,311
Depreciation and amortization 965 318 16 -- 1,299
--------- --------- --------- --------- ---------
Income (loss) from operations (8,306) 1,221 926 -- (6,159)
Other income (expense):
Interest income 174 28 38 -- 240
Interest expense and other (2,690) 7 -- -- (2,683)
--------- --------- --------- --------- ---------
Income (loss) before provision
for income taxes (10,822) 1,256 964 -- (8,602)
Income tax provision (benefit) -- -- -- -- --
--------- --------- --------- --------- ---------
(10,822) 1,256 964 -- (8,602)
Income from wholly-owned
subsidiaries 2,220 -- -- (2,220) --
--------- --------- --------- --------- ---------
Net income (loss) $ (8,602) $ 1,256 $ 964 $ (2,220) $ (8,602)
========= ========= ========= ========= =========
</TABLE>
14
<PAGE>
EMPLOYEE SOLUTIONS, INC. JUNE 30, 2000
--------------------------------------------------------------------------------
STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
For the Quarter Ended June 30, 1999
---------------------------------------------------------------
Non-
(In thousands of dollars) Parent Guarantors Guarantors Eliminating Consolidated
--------- --------- --------- --------- ---------
<S> <C> <C> <C> <C> <C>
Revenues $ 49,357 $ 150,504 $ 6,227 $ -- $ 206,088
--------- --------- --------- --------- ---------
Cost of revenues:
Salaries and wages of
worksite employees 41,717 125,861 4,996 -- 172,574
Healthcare and workers'
compensation 1,507 9,571 187 -- 11,265
Payroll and employment taxes 3,135 10,055 484 -- 13,674
--------- --------- --------- --------- ---------
Cost of revenues 46,359 145,487 5,667 -- 197,513
--------- --------- --------- --------- ---------
Gross profit 2,998 5,017 560 -- 8,575
Selling, general and
administrative expenses 6,285 2,548 39 -- 8,872
Depreciation and amortization 1,265 401 7 -- 1,673
--------- --------- --------- --------- ---------
Income (loss) from operations (4,552) 2,068 514 -- (1,970)
Other income (expense):
Interest income 219 24 280 -- 523
Interest expense (1,991) (11) -- -- (2,002)
Other income (expense) -- 13 -- -- 13
--------- --------- --------- --------- ---------
Income (loss) before provision
for income taxes (6,324) 2,094 794 -- (3,436)
Income tax provision (benefit) -- -- -- -- --
--------- --------- --------- --------- ---------
(6,324) 2,094 794 -- (3,436)
Income from wholly-owned
subsidiaries 2,888 -- -- (2,888) --
--------- --------- --------- --------- ---------
Net income (loss) $ (3,436) $ 2,094 $ 794 $ (2,888) $ (3,436)
========= ========= ========= ========= =========
</TABLE>
15
<PAGE>
EMPLOYEE SOLUTIONS, INC. JUNE 30, 2000
--------------------------------------------------------------------------------
STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
For the Six Months Ended June 30, 2000
--------------------------------------------------------------
Non-
(In thousands of dollars) Parent Guarantors Guarantors Eliminating Consolidated
--------- --------- --------- --------- ---------
<S> <C> <C> <C> <C> <C>
Revenues $ 85,789 $ 274,751 $ 8,824 $ -- $ 369,364
--------- --------- --------- --------- ---------
Cost of revenues:
Salaries and wages of
worksite employees 72,102 230,239 7,514 -- 309,855
Healthcare and workers'
compensation 5,513 16,456 (1,192) -- 20,777
Payroll and employment taxes 6,200 19,168 706 -- 26,074
--------- --------- --------- --------- ---------
Cost of revenues 83,815 265,863 7,028 -- 356,706
--------- --------- --------- --------- ---------
Gross profit 1,974 8,888 1,796 -- 12,658
Selling, general and
administrative expenses 14,253 5,317 47 -- 19,617
Depreciation and amortization 1,934 634 17 -- 2,585
--------- --------- --------- --------- ---------
Income (loss) from operations (14,213) 2,937 1,732 -- (9,544)
Other income (expense):
Interest income 446 41 93 -- 580
Interest expense (5,200) (4) -- -- (5,204)
Other income (expense) -- 13 -- -- 13
--------- --------- --------- --------- ---------
Income (loss) before provision
for income taxes (18,967) 2,987 1,825 -- (14,155)
Income tax provision (benefit) -- -- -- -- --
--------- --------- --------- --------- ---------
(18,967) 2,987 1,825 -- --
Income from wholly-owned
subsidiaries 4,812 -- -- (4,812) --
--------- --------- --------- --------- ---------
Net income (loss) $ (14,155) $ 2,987 $ 1,825 $ (4,812) $ (14,155)
========= ========= ========= ========= =========
</TABLE>
16
<PAGE>
EMPLOYEE SOLUTIONS, INC. JUNE 30, 2000
--------------------------------------------------------------------------------
STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
For the Six Months Ended June 30, 1999
--------------------------------------------------------------
Non-
(In thousands of dollars) Parent Guarantors Guarantors Eliminating Consolidated
--------- --------- --------- --------- ---------
<S> <C> <C> <C> <C> <C>
Revenues $ 107,202 $ 284,727 $ 13,069 $ -- $ 404,998
--------- --------- --------- --------- ---------
Cost of revenues:
Salaries and wages of
worksite employees 91,200 236,263 10,805 -- 338,268
Healthcare and workers'
compensation 3,385 18,771 (339) -- 21,817
Payroll and employment taxes 7,107 20,483 1,011 -- 28,601
--------- --------- --------- --------- ---------
Cost of revenues 101,692 275,517 11,477 -- 388,686
--------- --------- --------- --------- ---------
Gross profit 5,510 9,210 1,592 -- 16,312
Selling, general and
administrative expenses 11,592 4,711 81 -- 16,384
Depreciation and amortization 2,524 802 14 -- 3,340
--------- --------- --------- --------- ---------
Income (loss) from operations (8,606) 3,697 1,497 -- (3,412)
Other income (expense):
Interest income 419 40 308 -- 767
Interest expense (4,277) (11) -- -- (4,288)
Other income (expense) -- 36 -- -- 36
--------- --------- --------- --------- ---------
Income (loss) before provision
for income taxes (12,464) 3,762 1,805 -- (6,897)
Income tax provision (benefit) -- -- -- -- --
--------- --------- --------- --------- ---------
(12,464) 3,762 1,805 -- (6,897)
Income from wholly-owned
subsidiaries 5,567 -- -- (5,567) --
--------- --------- --------- --------- ---------
Net income (loss) $ (6,897) $ 3,762 $ 1,805 $ (5,567) $ (6,897)
========= ========= ========= ========= =========
</TABLE>
17
<PAGE>
EMPLOYEE SOLUTIONS, INC. JUNE 30, 2000
--------------------------------------------------------------------------------
STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
For the Six Months Ended June 30, 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) $(14,155) $ 2,987 $ 1,825 $ (4,812) $(14,155)
-------- -------- -------- -------- --------
ADJUSTMENTS TO RECONCILE NET LOSS TO
NET CASH PROVIDED BY (USED IN)
OPERATING ACTIVITIES:
Depreciation and amortization 1,934 634 17 -- 2,585
Increase (decrease) in accounts
receivable, net 5,134 1,687 (62) -- 6,759
Increase in insurance
company receivable -- -- (307) -- (307)
(Increase) decrease in prepaid
expenses and deposits (3,601) 8 (19) -- (3,612)
(Increase) decrease in other assets 61 (2) (12) -- 47
Increase (decrease) from inter-
company transactions 4,008 (6,126) (2,694) 4,812 --
Increase (decrease) in accrued salaries,
wages, and payroll taxes (175) (11,275) 17 -- (11,433)
Increase (decrease) in accrued workers'
compensation and health insurance 22 (382) 679 -- 319
Increase in accounts payable (591) (194) 93 -- (692)
(Decrease) increase in income taxes payable (53) 6 -- -- (47)
Increase in other long-term debt 27 -- -- -- 27
Increase (decrease) in other accrued
expenses 5,815 (34) 465 -- 6,246
-------- -------- -------- -------- --------
12,581 (15,678) (1,823) 4,812 (108)
-------- -------- -------- -------- --------
Net cash (used in) provided
by operating activities (1,574) (12,691) 2 -- (14,263)
-------- -------- -------- -------- --------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of property and equipment (200) (26) -- -- (226)
Business acquisitions -- -- -- -- --
Purchase of investments, net -- -- -- -- --
Change in restricted accounts, net (4,000) -- -- -- (4,000)
Disbursements for deferred costs -- -- -- -- --
-------- -------- -------- -------- --------
Net cash used in investing
activities (4,200) (26) -- -- (4,226)
-------- -------- -------- -------- --------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from issuance of common stock 26 -- -- -- 26
Payment of deferred loan costs (52) -- -- -- (52)
Decrease in bank overdraft (467) 1,268 -- -- 801
-------- -------- -------- -------- --------
Net cash used in financing
activities (493) 1,268 -- -- 775
-------- -------- -------- -------- --------
Net decrease in cash and cash
equivalents (6,267) (11,449) 2 -- (17,714)
CASH AND CASH EQUIVALENTS,
beginning of period 16,452 14,148 3,414 -- 34,014
-------- -------- -------- -------- --------
CASH AND CASH EQUIVALENTS,
end of period $ 10,185 $ 2,699 $ 3,416 $ -- $ 16,300
======== ======== ======== ======== ========
</TABLE>
18
<PAGE>
EMPLOYEE SOLUTIONS, INC. JUNE 30, 2000
--------------------------------------------------------------------------------
STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
For the Six Months Ended June 30, 1999
----------------------------------------------------------
Non-
(In thousands of dollars) Parent Guarantors Guarantors Eliminating Consolidated
-------- -------- -------- -------- --------
<S> <C> <C> <C> <C> <C>
RECONCILIATION OF NET LOSS TO
NET CASH PROVIDED BY (USED IN)
OPERATING ACTIVITIES:
Net income (loss) $ (6,897) $ 3,762 $ 1,805 $ (5,567) $ (6,897)
-------- -------- -------- -------- --------
ADJUSTMENTS TO RECONCILE NET LOSS TO
NET CASH PROVIDED BY (USED IN)
OPERATING ACTIVITIES:
Depreciation and amortization 2,524 802 14 -- 3,340
Increase in accounts
receivable, net (376) (8,201) (332) -- (8,909)
Decrease in insurance
company receivable -- -- 8 -- 8
(Increase) decrease in prepaid
expenses and deposits (3,401) 584 (5) -- (2,822)
Increase in deferred income taxes, net -- -- -- -- --
Decrease in other assets 512 3 3 -- 518
Increase (decrease) from inter-
company transactions 1,643 (1,252) (5,958) 5,567 --
Increase (decrease) in accrued salaries,
wages, and payroll taxes 2,557 (2,512) 284 -- 329
Increase (decrease) in accrued workers'
compensation and health insurance (3,085) 779 742 -- (1,564)
Decrease in income taxes payable/receivable 4,391 -- -- -- 4,391
Increase (decrease) in accounts payable (422) 350 549 -- 477
(Decrease) increase in other accrued
expenses and long-term liabilities (2,232) (1,307) 132 -- (3,407)
-------- -------- -------- -------- --------
2,111 (10,754) (4,563) 5,567 (7,639)
-------- -------- -------- -------- --------
Net cash used in
operating activities (4,786) (6,992) (2,758) -- (14,536)
-------- -------- -------- -------- --------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of property and equipment (118) (11) 1 -- (128)
Business acquisitions (5,879) -- -- -- (5,879)
Change in investments
and marketable securities 8,509 -- -- -- 8,509
Cash released from restricted cash and
investments 88 -- -- -- 88
Disbursements for deferred costs (3) -- -- -- (3)
-------- -------- -------- -------- --------
Net cash (used in) provided by
investing activities 2,597 (11) 1 -- 2,587
-------- -------- -------- -------- --------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from issuance of common stock 555 -- -- -- 555
Decrease in bank overdraft (308) (13,419) -- -- (13,727)
-------- -------- -------- -------- --------
Net cash (used in) provided by
financing activities 247 (13,419) -- -- (13,172)
-------- -------- -------- -------- --------
Net decrease in cash and cash
equivalents (1,942) (20,422) (2,757) -- (25,121)
CASH AND CASH EQUIVALENTS,
beginning of period 8,176 24,503 6,608 -- 39,287
-------- -------- -------- -------- --------
CASH AND CASH EQUIVALENTS,
end of period $ 6,234 $ 4,081 $ 3,851 $ -- $ 14,166
======== ======== ======== ======== ========
</TABLE>
19
<PAGE>
EMPLOYEE SOLUTIONS, INC. JUNE 30, 2000
--------------------------------------------------------------------------------
(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 and other personal
financial services.
Logistics Personnel Corp (LPC) provides specialized leasing of all types of
distribution personnel, including drivers, warehouse workers, mechanics,
dispatchers, forklift operators and administrators. A full range of services,
including employee recruiting, hiring and management; payroll administration;
claims and audit handling; workers' compensation insurance coverage; employee
benefits programs and tax reporting is provided to its customers.
TEAM Services specializes in leasing commercial talent (actors and actresses),
musicians and recording engineers to the music and advertising segments of the
entertainment industry. In addition, TEAM generates revenue from touring bands
with the entertainment industry.
The accounting policies of the segments are the same as those described in the
summary of significant accounting policies.
20
<PAGE>
EMPLOYEE SOLUTIONS, INC. JUNE 30, 2000
--------------------------------------------------------------------------------
Information concerning revenue, gross profit and assets by business segment was
as follows (in thousands):
<TABLE>
<CAPTION>
QUARTER ENDED JUNE 30, SIX MONTHS ENDED JUNE 30,
---------------------- ----------------------
2000 1999 2000 1999
--------- --------- --------- ---------
<S> <C> <C> <C> <C>
Revenue
Core PEO $ 106,063 $ 136,085 $ 216,029 $ 278,176
US Xpress -- -- -- --
LPC 25,080 28,067 51,683 53,427
TEAM 47,740 41,936 101,652 73,395
--------- --------- --------- ---------
Consolidated Total 178,883 206,088 369,364 404,998
--------- --------- --------- ---------
Gross Profit
Core PEO 3,859 5,904 7,366 11,127
US Xpress -- -- -- --
LPC 1,941 2,155 3,998 4,184
TEAM 651 516 1,294 1,001
--------- --------- --------- ---------
Total 6,451 8,575 12,658 16,312
Selling, General and Administrative Expense 11,311 8,872 19,617 16,384
Depreciation and Amortization 1,299 1,673 2,585 3,340
--------- --------- --------- ---------
Loss from Operations (6,159) (1,970) (9,544) (3,412)
--------- --------- --------- ---------
Other Income (expense)
Interest income 240 523 580 767
Interest expense (2,692) (2,002) (5,204) (4,288)
Other 9 13 13 36
--------- --------- --------- ---------
Loss before tax benefit (8,602) (3,436) (14,155) (6,897)
Income tax benefit -- -- -- --
--------- --------- --------- ---------
Net loss $ (8,602) $ (3,436) $ (14,155) $ (6,897)
========= ========= ========= =========
Depreciation and Amortization
Core PEO $ 1,025 $ 1,392 $ 2,038 $ 2,778
LPC 241 245 482 491
TEAM 33 36 65 71
--------- --------- --------- ---------
Consolidated Total $ 1,299 $ 1,673 $ 2,585 $ 3,340
========= ========= ========= =========
JUNE 30, DECEMBER 30,
2000 1999
--------- ---------
Total assets
Core PEO $ 60,134 $ 65,447
LPC 32,336 34,976
TEAM 10,949 21,904
--------- ---------
Consolidated Total $ 103,419 $ 122,327
========= =========
</TABLE>
21
<PAGE>
EMPLOYEE SOLUTIONS, INC. JUNE 30, 2000
--------------------------------------------------------------------------------
(5) CONTINGENCIES:
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 and to collect a promissory note from the defendant in
the amount of $350,000. Various counterclaims were filed against the Company. In
May 2000, the parties reached a verbal settlement agreement whereby the former
officer 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 parties subsequently executed a formal settlement
agreement, and the arbitration and related litigation have been dismissed.
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 June 30, 2000, the compounded interest totaled
approximately $345,000.
The Company was 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
parties have entered into a settlement agreement and the litigation has been
dismissed.
International Color Services, L.L.C. filed for arbitration in December 1998
alleging breach of contract regarding fee issues under the PEO service agreement
between the parties. Plaintiff seeks damages of over $500,000 (recently
increased by plaintiff to over $1 million) plus attorneys' fees and costs and
unspecified punitive damages. The Company is contesting the claim vigorously.
The matter has been set for trial in September 2000.
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.
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.
22
<PAGE>
EMPLOYEE SOLUTIONS, INC. JUNE 30, 2000
--------------------------------------------------------------------------------
ITEM 2. - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
The following discussion should be read in conjunction with, and is qualified in
its entirety by, the Company's Consolidated Financial Statements and the Notes
thereto appearing elsewhere herein and in the Company's Report on Form 10-K for
the year ended December 31, 1999. Historical results are not necessarily
indicative of trends in operating results for any future period.
Except for the historical information contained herein, the discussion in this
Form 10-Q contains or may contain forward-looking statements (which include
statements in the future tense and statements using the terms "believe,"
"anticipate," "expect," "intend" or similar terms) that involve risks and
uncertainties. The Company's actual results could differ materially from those
discussed here. Factors that could cause or contribute to such differences
include, but are not limited to, those discussed in this Management's Discussion
and Analysis (particularly in "Outlook: Issues and Risks") in addition to those
discussed in "Item 1 - Business" and "Item 7 - Management's Discussion and
Analysis of Financial Condition and Results of Operations" of the Company's
Report on Form 10-K for the year ended December 31, 1999, as well as those
factors discussed elsewhere herein or in any document incorporated herein by
reference.
RESULTS OF OPERATIONS -- OVERVIEW
The following is a summary of certain factors which affect results of operations
and which have generally applied to the Company in all periods presented.
REVENUES
The most significant components of the Company's revenues are payments received
from customers for gross salaries and wages paid to PEO worksite employees and
the Company's service fee. The Company negotiates service fees on a
client-by-client basis based on factors such as market conditions, client needs
and services requested, the clients' workers' compensation and benefit plan
experience, Company administrative resources required, expected profit, and
other factors. These are generally expressed as a fixed percentage of the
client's gross salaries and wages except for certain costs, primarily employer's
health care contributions, which are billed to clients on an add-on basis.
Because the service fees are negotiated separately with each client and vary
according to circumstances, the Company's service fees, and therefore its gross
margin, will fluctuate based on the Company's client mix.
COSTS OF REVENUES
The Company's direct costs of revenues include salaries and wages paid to
worksite employees, employment related taxes, costs of health and welfare
benefit plans, and workers' compensation insurance costs.
The largest component of direct costs is salaries and wages to worksite
employees. Although this cost is generally directly passed through to clients,
the Company may be responsible for payment of these costs even if not reimbursed
by its clients.
Employment related taxes consist of the employer's portion of payroll taxes
required under FICA, which includes Social Security and Medicare; and federal
and state unemployment taxes. The federal tax rates are defined by the
appropriate federal regulations. State unemployment rates are subject to change
each year based on claims histories and vary from state to state.
In periods from and after January 1, 1998, workers' compensation liabilities are
fully insured under a guaranteed cost policy, subject to limited exceptions
described below. Accordingly, workers' compensation expense includes premiums
paid to the Company's third party insurance carriers for workers' compensation
insurance. Workers' compensation expense also includes the cost of a defined
portfolio of stand-alone policies in place at December 31, 1997 which policies
expired at various dates during 1998 and as to which the Company retains
liability of $250,000 per occurrence plus costs as described in the following
paragraph; and costs under the Company's self-insurance program in Ohio, with
respect to which the Company retains liability of $50,000 per occurrence.
With respect to the Ohio and defined portfolio of stand-alone policies, the
Company's accrued workers' compensation reserves are primarily based on
industry-wide data, and to a lesser extent, the Company's past claims experience
up to the retained limits. The liability recorded may be more or less than the
actual amount of the claims when they are submitted and paid. Changes in the
23
<PAGE>
EMPLOYEE SOLUTIONS, INC. JUNE 30, 2000
--------------------------------------------------------------------------------
liability are charged or credited to operations as the estimates are revised.
Administrative costs include fees paid to the Company's insurers and costs of
claims management by third party administrators. Premium taxes include taxes and
related fees paid to various states based on premiums written. Premium for
excess reinsurance and accidental death and dismemberment relate to premium
payments to the Company's insurers for the retention of risks above specified
limits.
Health care and other employee benefits costs consist of medical and dental
insurance premiums, payments of and reserves for claims subject to deductibles
and the costs of vision care, disability, life insurance and other similar
benefit plans. The Company's health care benefit plans consist of a mixture of
fully-insured programs and one self-insured program with a built-in maximum
coverage cap of $100,000 per person per year. The Company recognizes a liability
for self-insured and partially self-insured health insurance claims at the time
a claim is reported to the Company by the third party claims administrator, and
also provides for claims incurred, but not reported based on industry-wide data
and the Company's past claims experience. The liability recorded may be more or
less than the actual amount of ultimate claims. While the Company believes that
its reserves for healthcare and workers' compensation claims are adequate for
future claims payments, there can be no assurance that this will be the case.
See "Outlook: Issues and Risks" herein.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES
The Company's primary operating expenses are personnel expenses, other general
and administrative expenses, and sales and marketing expenses. Personnel
expenses include compensation, fringe benefits and other personnel expenses
related to the Company's internal employees. Other general and administrative
expenses include rent, office supplies and expenses, legal and accounting fees,
bad debt expenses, insurance and other operating expenses. Sales and marketing
expenses include commissions to sales personnel and related expenses.
DEPRECIATION AND AMORTIZATION
Depreciation and amortization consists primarily of the amortization of goodwill
and acquisition costs from the Company's prior acquisitions. The Company
amortizes goodwill and acquisition costs over periods of three to thirty years,
depending on the assets acquired, using the straight-line method.
OPERATING RESULTS
Margin comparisons are affected by the relative mix of full PEO services, TEAM
Services services, and driver leasing services in any particular period.
Certain employment-related taxes are based on the cumulative earnings of
individual employees up to a specified wage level. Therefore, these expenses
tend to decline over the course of a year. Since the Company's revenues for an
individual client are generally earned and collected at a relatively constant
rate throughout each year, payment of such unemployment tax obligations can
adversely affect first quarter results but positively impact the Company's
working capital and results of operations as the year progresses.
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RESULTS OF OPERATIONS--
QUARTER AND SIX MONTHS ENDED JUNE 30, 2000 COMPARED TO QUARTER AND SIX MONTHS
ENDED JUNE 30, 1999
<TABLE>
<CAPTION>
Quarter Ended June 30, Six Months Ended June 30,
------------------------------- -------------------------------
Percent Percent
(In thousands of dollars) 2000 Change 1999 2000 Change 1999
--------- ------- --------- --------- ------- ---------
<S> <C> <C> <C> <C> <C> <C>
Revenues $ 178,883 (13) $ 206,088 $ 369,364 (9) $ 404,998
Cost of revenues 172,432 (13) 197,513 356,706 (8) 388,686
Gross profit 6,451 (25) 8,575 12,658 (22) 16,312
Selling, general and administrative 11,311 27 8,872 19,617 20 16,384
Depreciation and amortization 1,299 (22) 1,673 2,585 (23) 3,340
Interest income 240 (54) 523 580 (24) 767
Interest expense 2,692 34 2,002 5,204 21 4,288
Net loss (8,602) 150 (3,436) (14,155) 105 (6,897)
</TABLE>
REVENUES
Revenues decreased to $178.9 million for the quarter ended June 30, 2000 from
$206.1 million for the quarter ended June 30, 1999, a decrease of 13%. For the
six months ended June 30, 2000, revenue was $369.4 million compared to $405.0
million for the six months ended June 30, 1999, a decrease of 9%. The number of
worksite employees decreased to approximately 32,727 covering approximately
1,859 client companies at June 30, 2000 from approximately 38,100 covering 2,000
client companies at June 30, 1999. The Company's 2000 operating plan depends in
significant part upon achieving revenue growth through internal sales and on the
reduction of customer attrition. The Company's efforts to achieve revenue growth
and reduce attrition have been materially adversely affected by the market's
current negative perception of the Company's financial stability. The Company
anticipates that this effect will continue unless and until negotiations with
respect to the Notes are concluded successfully.
COST OF REVENUES
Cost of revenues decreased 13% to $172.4 million in the quarter ended June 30,
2000 from $197.5 million for the quarter ended June 30, 1999. For the six-month
period ended June 30, 2000, the cost of revenues was $356.7 million, a decrease
of 8% over the $388.7 million for the six-month period ended June 30, 1999. This
decrease was caused primarily by the reduction in internal sales offset by
increased customer attrition.
GROSS PROFIT
The Company's gross profit margin decreased to 3.6% in the quarter ended June
30, 2000 from 4.2% in the quarter ended June 30, 1999. For the six-month period
ended June 30, 2000, the gross profit margin was 3.4% compared to 4.0% for the
same period in 1999. This decrease was attributable primarily to a reduction in
the proportion of gross profit derived from driver leasing services which have
higher margins, relative to the same period in 1999. Additional factors
contributing to this decline were the loss of certain higher margin customers,
and increased medical and workers' compensation costs beginning in 2000 that the
Company has been in part unable to pass through to its customers due to
competitive factors.
SELLING, GENERAL AND ADMINISTRATIVE
Selling, general and administrative expenses for the quarter ended June 30, 2000
increased approximately $2.4 million to $11.3 million, or 28%, from $8.9 million
for the quarter ended June 30, 1999. For the six month periods ended June 30,
2000 and 1999, respectively, selling, general and administrative expenses were
$19.6 million and $16.3 million, a 20% increase. Included in the six months
ended June 30, 2000 were approximately $1.2 million of legal and professional
fees attributable to the Company's restructuring efforts, $550,000 for various
litigation matters and $2.3 million of bad debts.
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DEPRECIATION AND AMORTIZATION
Depreciation and amortization represents depreciation of property and equipment
and amortization of organizational costs, customer lists and goodwill. For the
quarter ended June 30, 2000, depreciation and amortization expense totaled $1.3
million compared to $1.7 million for the quarter ended June 30, 1999. Total
depreciation and amortization expense for the six months ended June 30, 2000 was
$2.6 compared to $3.3 million for the six-month period ended June 30, 1999. The
decrease is primarily due to the goodwill impairment charge which was recorded
during the fourth quarter of 1999, which has reduced the amount of goodwill
being amortized for previous acquisitions on a prospective basis.
INTEREST
Interest expense for the quarter ended June 30, 2000 totaled $2.7 million
compared to $2.0 million for the quarter ended June 30, 1999. For the six-month
periods ended June 30, 2000 and 1999, interest expense totaled $5.2 million and
4.3 million respectively. The increase is primarily the result of interest
expense charged on the Loan Agreement, under which the Company borrowed $10.0
million at an initial interest rate of 13.5% and has paid certain other fees and
expenses. The interest rate has been increased to 15.5% effective April 30,
2000, with additional monthly increases of 25 basis points commencing September
1, 2000 for so long as amounts remain outstanding. (SEE FOOTNOTE 2- NOTE PAYABLE
AND "OUTLOOK: ISSUES AND RISKS - FUTURE CAPITAL AND LIQUIDITY NEEDS; UNCERTAINTY
OF ADDITIONAL FINANCING; NONCOMPLIANCE WITH LOAN AGREEMENT" for additional
information concerning the loan agreement).
EFFECTIVE TAX RATE
The Company's effective tax rate provides for federal, state and local income
taxes. As of June 30, 2000, the Company has incurred losses in excess of what
can be carried back and applied against prior years' income to generate federal
income tax refunds. The remaining operating loss will be available for
carry-forward benefit only to the extent of any subsequently generated taxable
income.
LIQUIDITY AND CAPITAL RESOURCES
The Company defines liquidity as the ability to mobilize cash to meet operating
and capital needs. The Company's primary use of cash in the six months ended
June 30, 2000 was for operating activities. The Company's liquidity position was
materially reduced due to the use of cash during the first six months of 2000.
Cash used in operating activities was $14.3 million during the first six months
of 2000 compared to cash used in operating activities of $14.5 million during
the comparable period in 1999. The Company's primary use of cash in the six
months ended June 30, 2000 was for the payment customer payrolls, payroll taxes,
interest, legal and professional fees, other operating activities, and the
payment of prepaid workers' compensation premiums under the Company's guaranteed
cost policy. Operating cash flows are derived from customers for PEO services
rendered by the Company. Payments from PEO customers typically are received on
or within a few days of the date on which payroll checks are delivered to
customers, and cover the cost of the payroll, payroll taxes, insurance, other
benefit costs and the Company's administration fee. The Company's TEAM Services
and LPC operations extend credit terms generally from 15 to 45 days as is
customary in their respective market segments.
Cash used in investing activities was $4.2 million during the first six months
of 2000, compared to $2.6 million of cash provided by investing activities
during the comparable prior year period. Included in investing activities in
2000 is the increase of $4.0 million in restricted cash, which represents cash
pledged for security purposes under the Company's short-term Loan Agreement. At
June 30, 2000 the Company had $5 million held in restricted cash, and will be
required to increase the security deposit by an additional $1 million on August
1, 2000 and on the first day of each month thereafter so long as any amounts
remain owing to the Lenders.
For the six months ended June 30, 2000 and 1999, capital expenditures were
$226,000 and $128,000, 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 half of
the year.
Cash provided by financing activities was $775,000 for the six months ended June
30, 2000 compared to cash used by financing activities of $13.2 million for the
same period in 1999. Cash provided in 2000 was primarily due to an increase in
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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. For further
information concerning the Company's liquidity and capital resources, see
"OUTLOOK; ISSUES AND RISKS," immediately below.
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
June 30, 2000, the Company had outstanding indebtedness of $10.0 million under
the Loan Agreement (not including letters of credit drawn thereunder in the
amount of $5.4 million), outstanding senior indebtedness of $85.0 million and a
deficit in stockholders' equity of approximately $42.6 million. The Company
believes that it currently is leveraged to a significantly greater extent than
any of its principal competitors.
In an effort to improve cash flows and reduce the Company's indebtedness, the
Company has been engaged in negotiations with the holders of the Notes (the
"Noteholders"). The Company is seeking to negotiate the reduction or elimination
of the outstanding principal amount of the Notes and accrued interest thereon in
exchange for the issuance of shares of its equity securities. If the Company is
able to reach agreement upon such a transaction, the Company anticipates that
the percentage ownership of the then current shareholders of the Company will be
materially reduced, and the equity securities issued to participating
Noteholders (or other sources of equity, as the case may be) also may have
rights, preferences or privileges senior to those of the holders of the
Company's Common Stock. While delays have been experienced, the Company
continues to seek to complete such negotiations, and currently intends to submit
to shareholders for approval during the third fiscal quarter 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 respect to the Notes. If the Company is unable to complete a
satisfactory agreement , 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,
thereby creating a default upon the expiration of the applicable grace period on
May 17, 2000. The Company has received a written agreement from the holders of
the Notes under which the holders have agreed to forbear from exercising their
rights and remedies relating to such default through the first to occur of
August 30, 2000 or the occurrence of a new default. While the Company
anticipates that it will receive an additional waiver if discussions with the
holders are not completed at the expiration of the forbearance agreement, there
can be no assurance that an additional waiver can be obtained. A default with
respect to the Notes also constitutes a default, by virtue of cross-default
provisions, under the Loan Agreement. See "FUTURE CAPITAL AND LIQUIDITY NEEDS;
UNCERTAINTY OF ADDITIONAL FINANCING; NONCOMPLIANCE WITH LOAN AGREEMENT."
FUTURE CAPITAL AND LIQUIDITY NEEDS; UNCERTAINTY OF ADDITIONAL FINANCING;
NONCOMPLIANCE WITH LOAN AGREEMENT
If a satisfactory agreement with respect to the Notes can be reached (see
"SUBSTANTIAL LEVERAGE; NEGOTIATIONS WITH HOLDERS OF INDEBTEDNESS; POTENTIAL
SUBSTANTIAL DILUTION OF COMMON STOCKHOLDERS," above), management believes that,
based on its 2000 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
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rights, preferences or privileges senior to those of the holders of the
Company's Common Stock. There can be no assurance that additional financing will
be available on terms acceptable to the Company, or at all. If adequate funds
are not available or are not available on acceptable terms, the Company's
business, operating results, financial condition and ability to operate will be
materially adversely affected.
The Company has not been in compliance with one or more of the covenants set
forth in the Loan Agreement commencing as of March 31, 2000. The Company
recently received a waiver of such noncompliance in exchange for its agreement
to provide additional cash collateral and pay an increased interest rate and
certain additional fees. There can be no assurance that the Company will be able
to obtain additional waivers in the event of future defaults, if any. The
Company is actively seeking a replacement financing source. Unless satisfactory
refinancing arrangements can be made, of which there can be no assurance, the
Company's financial condition and ability to operate will be materially
adversely affected if the lenders under the Loan Agreement accelerate the
Company's obligations under the Loan Agreement as a result of defaults or
otherwise or at the Loan Agreement's maturity date (January 1, 2001). At June
30, 2000, the Company had outstanding indebtedness of $10.0 million under the
Loan Agreement (not including letters of credit drawn thereunder in the amount
of $5.4 million).
ABILITY TO SERVICE INDEBTEDNESS; CONSEQUENCES OF SUBSTANTIAL LEVERAGE
The Company's ability to make scheduled principal payments in respect of, or to
pay the interest on, or to refinance, any of its indebtedness (including the
Loan Agreement and any outstanding Notes) will depend on its future performance,
which, to a certain extent, is subject to general economic, financial,
competitive, regulatory and other factors beyond its control. There can be no
assurance that the Company's business will generate sufficient cash flow from
operations, that anticipated growth will occur or that funds will be available
from other sources or otherwise in an amount sufficient to enable the Company to
service or refinance its indebtedness, including the Loan Agreement and the
Notes, or make anticipated capital expenditures and lease payments. See
"SUBSTANTIAL LEVERAGE; NEGOTIATIONS WITH HOLDERS OF INDEBTEDNESS; POTENTIAL
SUBSTANTIAL DILUTION OF COMMON STOCKHOLDERS," "FUTURE CAPITAL AND LIQUIDITY
NEEDS; UNCERTAINTY OF ADDITIONAL FINANCING; NONCOMPLIANCE WITH LOAN AGREEMENT"
and "IMPLEMENTATION OF 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 half 2000 attrition was an approximate net 3,200 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's efforts to achieve revenue growth and reduce attrition
have been materially adversely affected by the market's current negative
perception of the Company's financial stability, and the Company anticipates
that this effect will continue unless and until negotiations with respect to the
Notes are concluded successfully.
The Company's agreements with its customers historically have been subject to
cancellation upon 30 days written notice of termination by either party, except
where different arrangements are required by applicable law. While the Company
has commenced the use of longer-term agreements, the short-term nature of most
current customer agreements means that customers could terminate a substantial
portion of the Company's business upon short notice.
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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
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
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several ways. With respect to benefit plans, the tax qualified status of the
Company's 401(k) plans could be revoked, and the Company's cafeteria and medical
reimbursement plans may lose their favorable tax status. If an adverse IRS
determination were applied retroactively to disqualify benefit plans, employees'
vested account balances under 401(k) plans would become taxable, an
administrative employer such as the Company would lose its tax deductions to the
extent its matching contributions were not vested, a 401(k) plan's trust could
become a taxable trust and the administrative employer could be subject to
liability with respect to its failure to withhold applicable taxes and with
respect to certain contributions and trust earnings. In such event, the Company
also would face the risk of client dissatisfaction and potential litigation by
clients or worksite employees.
As the employer of record for many client companies and their worksite
employees, the Company must account for and remit payroll, unemployment and
other employment-related taxes to numerous federal, state and local tax, labor
and unemployment authorities, and is subject to substantial penalties for
failure to do so. From time to time, the Company has received notices or
challenges which may adversely affect its tax rates and payments. In light of
the IRS Market Segment Study Group and the general uncertainty in this area,
certain proposed legislation has been drafted to clarify the employer status of
PEOs in the context of the Code and benefit plans. However, there can be no
assurance that such legislation will be proposed and adopted or in what form it
would be adopted. Even if it were adopted, the Company may need to change
aspects of its operations or programs to comply with any requirements which may
ultimately be adopted. In particular, the Company may need to retain increased
sole or shared control over worksite employees if the legislation is passed in
its current form.
CREDIT RISKS
As the employer of record for its worksite employees, the Company generally is
contractually obligated to pay their wages, benefit costs and payroll taxes
whether or not the Company receives payment from its customer. The Company
typically bills a client company for these amounts in advance of or at each
payroll date, and reserves the right to terminate its agreement with the client,
and thereby the Company's liability for future payrolls to the client's worksite
employees, if timely payment is not received. Limited extended payment terms are
offered in certain cases subject to local competitive conditions. The rapid
turnaround necessary to process and make payroll payments leaves the Company
vulnerable to client credit risks, some of which may not be identified prior to
the time payroll payments are made. There can be no assurance that the Company
will be able to timely terminate any delinquent accounts or that its contractual
termination rights will be judicially enforced.
In addition, the Company competes in several market segments in which PEOs
typically advance wages, benefit costs and payroll taxes to their clients. The
Company intends to continue this practice despite the potentially greater credit
risk posed by such practices. The Company conducts a limited credit review
before accepting new clients. However, the nature of the Company's business and
pricing margins is such that a small number of client credit failures could have
an adverse effect on its business and financial performance.
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.
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While many states do not explicitly regulate PEOs, various states have passed
laws that have licensing or registration requirements and other states are
considering such regulation. Such laws vary from state to state but generally
provide for monitoring the fiscal responsibility of PEOs. There can be no
assurance that the Company will be able to satisfy licensing requirements or
other applicable regulations of any particular state from time to time.
ADEQUACY OF LOSS RESERVES
The Company obtained fully-insured guaranteed cost workers' compensation
coverage effective January 1, 1998, thereby eliminating, with certain
exceptions, the Company's risk retention on workers' compensation claims arising
after that date. The Company retained risk up to $250,000 per occurrence with
respect to a defined portfolio of stand-alone policies, which expired at various
dates during 1998. The Company also retained risk up to $50,000 per occurrence
for claims under Ohio's monopolistic workers' compensation structure, with an
aggregate liability limitation.
The Company's reserves for losses and loss adjustment expenses under the Ohio
and stand-alone programs referred to in the preceding paragraph are estimates of
amounts needed to pay reported and unreported claims and related loss adjustment
expenses. Loss reserves are inherently uncertain and are subject to a number of
circumstances that are highly variable and difficult to predict. If the
Company's reserves prove to be inadequate, the Company will be required to
increase reserves or corresponding loss payments with a corresponding reduction,
which may be material, to the Company's operating results in the period in which
the deficiency is identified.
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ITEM 3. - QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company is primarily exposed to market risks from fluctuations in interest
rates and the effects of those fluctuations on the market values of its
investments and marketable securities that are classified as AVAILABLE-FOR-SALE
marketable securities. Cash equivalent short-term investments consist primarily
of high quality investment grade instruments, such as certificates of deposit,
which are not significantly exposed to interest rate risk, except to the extent
that changes in interest rates will ultimately affect the amount of interest
income earned on these investments. The available-for-sale marketable securities
are subject to interest rate risk because these securities generally include
financial instruments, such as certificates of deposit, that have an original
maturity of greater than 90 days. Because these instruments are considered
highly liquid, they are not significantly exposed to interest rate risk.
However, the market values of these securities may be affected by changes in
prevailing interest rates. The Company attempts to limit its exposure to
interest rate risk primarily through diversification and strict adherence to the
Company's investment policy. The Company's investment policy is designed to
maximize interest income while preserving its principal investment.
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EMPLOYEE SOLUTIONS, INC. JUNE 30, 2000
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PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
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 and to collect a promissory
note from the defendant in the amount of $350,000. Various counterclaims were
filed against the Company . 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 parties
subsequently executed a formal settlement agreement, and the arbitration and
related litigation have been dismissed.
The Company was 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
parties have entered into a settlement agreement and the litigation has been
dismissed.
International Color Services, L.L.C. filed for arbitration in December 1998
alleging breach of contract regarding fee issues under the PEO service agreement
between the parties. Plaintiff seeks damages of over $500,000 (recently
increased by plaintiff to over $1 million) plus attorneys' fees and costs and
unspecified punitive damages. The Company is contesting the claim vigorously.
The matter has been set for trial in September 2000.
From time to time, the Company is named as a defendant in lawsuits in the
ordinary course of business. See Part I, Item 2 - "Management's Discussion and
Analysis - Outlook: Issues and Risks - Uncertainty of Extent of PEO's Liability;
Government Regulation of PEOs; Credit Risks."
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
The Company is engaged in negotiations with respect to its $85 million 10%
Senior Notes due 2004 (the Notes). See "OUTLOOK: ISSUES AND RISKS- SUBSTANTIAL
LEVERAGE; NEGOTIATIONS WITH HOLDERS OF INDEBTEDNESS; POTENTIAL SUBSTANTIAL
DILUTION OF COMMON STOCKHOLDERS," which is incorporated by this reference into
this Part II, Item 3. In connection with the negotiations, the Company's Board
of Directors elected to withhold the $4.25 million semi-annual interest payment
due April 15, 2000. Under the terms of the Indenture pursuant to which the Notes
were issued, such withholding of interest constituted an Event of Default (as
defined in the Indenture) upon the expiration of a 30-day grace period on May
17, 2000. The Company has received a written agreement from the holders of the
Notes under which the holders have agreed to forbear from exercising their
rights and remedies with regard to such default through the first to occur of
August 30, 2000 or the occurrence of a new default. While the Company
anticipates that it will receive an additional waiver if discussions with the
holders are not completed at the expiration of the forbearance agreement, there
can be no assurance that an additional waiver can be obtained.
The Company was not in compliance with one or more of the covenants set forth in
a loan and security agreement (the "Loan Agreement") with Foothill Capital
Corporation and Ableco Finance LLC (the "Lenders") commencing as of March 31,
2000. The Company recently received a waiver of such noncompliance in exchange
for its agreement to provide additional cash collateral and pay an increased
interest rate and certain additional fees. There can be no assurance that the
Company will be able to obtain additional waivers in the event of future
defaults, if any. The Company is actively seeking a replacement financing
source. See "OUTLOOK: ISSUES AND RISKS -- FUTURE CAPITAL AND LIQUIDITY NEEDS;
UNCERTAINTY OF ADDITIONAL FINANCING; NONCOMPLIANCE WITH LOAN AGREEMENT."
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ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) EXHIBITS
Exhibit
Number Description
------- -----------
10.16 Standstill Agreement dated as of May 31, 2000 among
Registrant, the Holders of Registrant's 10% Senior Notes and
Huntington National Bank, as trustee
10.17 Second Standstill Agreement dated as of July 31, 2000 among
Registrant, the Holders of Registrant's 10% Senior Notes and
Huntington National Bank, as trustee
10.18 Waiver and Amendment Agreement among Registrant, Ableco
Finance LLC and Foothill Capital Corporation dated as of
July 6, 2000
27 Financial Data Schedule
(b) REPORTS ON FORM 8-K.
The Company filed a Report on Form 8-K dated May 3, 2000 reporting a change
in the Company's certified public accountants from Arthur Andersen LLP to
Ernst & Young LLP. No financial statements were filed with such Form 8-K.
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EMPLOYEE SOLUTIONS, INC. JUNE 30, 2000
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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: August 14, 2000 /s/ Quentin P. Smith, Jr.
----------------------- ----------------------------------------
Quentin P. Smith, Jr.
Chief Executive Officer
/s/ John V. Prince
----------------------------------------
John V. Prince
Chief Financial Officer
35
