1
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 December 31, 1996
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OR
/ / TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from to
---------------- ------------------
Commission File No. 0-18492
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DIGITAL SOLUTIONS, INC.
- --------------------------------------------------------------------------------
(Exact name of registrant as specified in its charter)
New Jersey 22-1899798
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(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification Number)
4041 Hadley Road, South Plainfield, NJ 07080
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(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (908) 561-1200
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Former name, former address and former fiscal year, if changed
since last report.
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 reports), and (2) has been subject to such
filing requirements for the past 90 days.
Yes /X/ No / /
19,091,187 shares of Common Stock, par value $.001 per share, were outstanding
as of February 7, 1997.
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DIGITAL SOLUTIONS, INC. AND SUBSIDIARIES
FORM 10-Q
December 31, 1996
Table of Contents
Page No.
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Part I - Financial Information
Item 1. Consolidated Balance Sheets as of
December 31, 1996 (Unaudited) and
September 30, 1996 3
Consolidated Statements of
Income for the three months ended
December 31, 1996 and 1995 (Unaudited) 5
Consolidated Statements of Cash Flows for the
three months ended December 31, 1996 and 1995
(Unaudited) 6
Notes to Consolidated Financial Statements
(Unaudited) 7
Item 2. Management's discussion and analysis of
financial condition and results of operations 10
Part II - Other Information
Item 1. Legal Proceedings 12
Item 5. Other Information 12
Item 6. Exhibits and Reports on Form 8-K 13
Signatures 14
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DIGITAL SOLUTIONS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
DECEMBER 31, SEPTEMBER 30,
1996 1996
------------ ------------
(Unaudited)
ASSETS
CURRENT ASSETS
Cash $ - $ -
Restricted Cash (Note 3) 811,000 1,155,000
Accounts receivable, net of allowance 7,825,000 6,338,000
Notes due from officers 76,000 136,000
Other current assets 507,000 189,000
Total current assets ------------ ------------
9,219,000 7,818,000
EQUIPMENT AND IMPROVEMENTS
Equipment 2,883,000 2,883,000
Leasehold improvements 180,000 180,000
------------ ------------
3,063,000 3,063,000
Accumulated depreciation and amortization
2,285,000 2,226,000
------------ ------------
778,000 837,000
DEFERRED TAX ASSET 760,000 760,000
GOODWILL, net of amortization 4,716,000 4,780,000
OTHER ASSETS 550,000 605,000
------------ ------------
TOTAL ASSETS $ 16,023,000 $ 14,800,000
============ ============
The accompanying notes to the consolidated financial statements
are an integral part of these consolidated financial statements.
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DIGITAL SOLUTIONS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
DECEMBER 31 SEPTEMBER 30,
1996 1996
------------ ------------
(Unaudited)
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES
Short-term borrowings $ 3,017,000 $ 2,907,000
Current portion of long-term debt 131,000 88,000
Accounts payable 1,669,000 1,620,000
Accrued expenses and other current liabilities 3,559,000 2,917,000
------------ ------------
Total current liabilities 8,376,000 7,532,000
LONG-TERM DEBT 64,000 100,000
------------ ------------
Total Liabilities 8,440,000 7,632,000
COMMITMENTS AND CONTINGENCIES (Note 3)
SHAREHOLDERS' EQUITY
Common Stock, $.001 par value; authorized 40,000,000 shares;
issued and outstanding 19,079,669 and 18,786,609 at
December 31, 1996 and September 30, 1996, respectively 19,000 19,000
Additional paid-in capital 13,071,000 12,857,000
Accumulated deficit (5,507,000) (5,708,000)
------------ ------------
Total shareholders' equity 7,583,000 7,168,000
------------ ------------
TOTAL LIABILITIES AND EQUITY $ 16,023,000 $ 14,800,000
============ ============
The accompanying notes to the consolidated financial statements
are an integral part of these consolidated financial statements.
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DIGITAL SOLUTIONS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(Unaudited)
FOR THE THREE MONTHS ENDED
DECEMBER 31,
--------------------------
1996 1995
---- ----
OPERATING REVENUES $ 30,885,000 $ 23,090,000
DIRECT OPERATING EXPENSES 28,370,000 20,916,000
------------ ------------
Gross profit 2,515,000 2,174,000
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES 2,061,000 1,619,000
DEPRECIATION AND AMORTIZATION 179,000 139,000
------------ ------------
Income from operations 275,000 416,000
------------ ------------
OTHER INCOME (EXPENSE)
Interest and other income 17,000 58,000
Interest expense (91,000 (82,000)
------------ ------------
(74,000 (24,000)
------------ ------------
Income before tax 201,000 392,000
INCOME TAX EXPENSE - -
------------ ------------
NET INCOME $ 201,000 $ 392,000
============ ============
NET INCOME PER COMMON SHARE $ 0.01 $ 0.03
============ ============
WEIGHTED AVERAGE NUMBER OF COMMON SHARES
OUTSTANDING 20,097,204 14,280,774
============ ============
The accompanying notes to the consolidated financial statements
are an integral part of these consolidated financial statements.
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DIGITAL SOLUTIONS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
FOR THE THREE MONTHS ENDED
DECEMBER 31,
--------------------------
1996 1995
---- ----
CASH FLOWS FROM OPERATING ACTIVITIES
Net income $ 201,000 $ 392,000
----------- -----------
Adjustments to reconcile net income to net
cash used in operating activities:
Depreciation and amortization 179,000 140,000
Provision for doubtful accounts 13,000 82,000
Amortization of rent deferral -- (7,000)
Changes in operating assets and liabilities:
Accounts receivable (1,500,000) (463,000)
Other current assets (318,000) (203,000)
Notes due from officers 60,000 --
Accounts payable, accrued expenses and
other current liabilities 733,000 (166,000)
----------- -----------
Net cash used in operating activities (632,000) (225,000)
----------- -----------
CASH FLOWS FROM INVESTING ACTIVITIES
Purchase of equipment and improvements -- (28,000)
----------- -----------
Net cash used in investing activities -- (28,000)
----------- -----------
CASH FLOWS FROM FINANCING ACTIVITIES
(Repayments) proceeds from borrowings on revolving
line of credit - net 110,000 (70,000)
Repayments of long-term debt (36,000) (16,000)
(Repayments) proceeds from subordinated bridge loan (250,000)
Proceeds from reduction of required Letters of Credit 344,000
Proceeds from issuance of common stock and
exercise of common stock options and warrants - net 214,000 835,000
----------- -----------
Net cash provided by financing activities 632,000 499,000
----------- -----------
Net increase in cash and cash equivalents -- 246,000
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD -- 20,000
----------- -----------
CASH AND CASH EQUIVALENTS AT END OF PERIOD $ -- $ 266,000
=========== ===========
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid during the period for interest $ 80,868 $ 97,000
=========== ===========
The accompanying notes to the consolidated financial statements
are an integral part of these consolidated financial statements.
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DIGITAL SOLUTIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(1) ORGANIZATION AND BUSINESS
Digital Solutions, Inc. (the Company) was incorporated under the laws
of the State of New Jersey on November 25, 1969. The Company, with its
subsidiaries, provides a broad spectrum of human resource services
including Professional Employer Organization (PEO) services, payroll
processing, human resource administration and placement of temporary
and permanent employees.
(2) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Basis of Presentation
The consolidated financial statements included herein have been
prepared by the registrant, without audit, pursuant to the rules and
regulations of the Securities and Exchange Commission. Certain
information and footnote disclosures normally included in financial
statements prepared in accordance with generally accepted accounting
principles have been condensed or omitted pursuant to such rules and
regulations, although the registrant believes that the disclosures are
adequate to make the information presented not misleading. It is
suggested that these consolidated financial statements be read in
conjunction with the consolidated financial statements and the notes
thereto included in the Company's latest annual report on Form 10-K.
This financial information reflects, in the opinion of management, all
adjustments necessary to present fairly the results for the interim
periods. The results of operations for such interim periods are not
necessarily indicative of the results for the full year.
The accompanying consolidated financial statements include those of
DSI, a New Jersey Corporation and its wholly-owned subsidiaries; DSI
Contract Staffing, DSI Staff ConnXions, Staff ConnXions - Northeast,
Inc., Digital Insurance Services, Inc., DSI Staff ConnXions of
Mississippi, DSI Staff ConnXions - Southwest, MLB Medical Staffing,
Inc., Ram Technical Services, Inc. and DSI Staff Rx, Inc. The results
of operations of acquired companies have been included in the
consolidated financial statements from the date of acquisition. All
significant intercompany balances and transactions have been eliminated
in the consolidated financial statements.
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Revenue Policy
The Company recognizes revenue in connection with its PEO business and
its temporary placement service program when the services have been
provided. The corresponding cost of providing those services are
reflected as direct operating expenses. Payroll services, commissions
and other fees for administrative services are recognized as revenue as
the related service is provided.
Equipment and Improvements
Equipment and improvements are stated at cost. Depreciation and
amortization are provided using straight-line and accelerated methods
over the estimated useful asset lives (3 to 5 years) and the shorter of
the lease term or estimated useful life for leasehold improvements.
Goodwill
Goodwill represents the excess of the cost of companies acquired over
the fair value of their net assets at dates of acquisition and is being
amortized on a straight line basis over 20 years for substantially all
of the Company's acquisitions.
Earnings Per Common Share
Earnings per common share are based upon the weighted average number of
shares outstanding as well as the dilutive effect of stock options and
warrants. The dilutive effect of stock options and warrants was to
increase the weighted average number of shares outstanding by 1,133,046
shares for the quarter ended December 31, 1996
Statements of Cash Flows
For purposes of the consolidated statements of cash flows, the Company
considers all highly liquid investments purchased with a maturity of
three months or less to be cash equivalents.
(3) COMMITMENTS AND CONTINGENCIES
In connection with the Company's workers compensation insurance policy,
the insurance company develops reserve factors on each claim that may
or may not materialize after the claim is fully investigated. Generally
Accepted Accounting Principles require that all incurred, but not paid
claims, as well as an estimate for
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claims incurred, but not reported (IBNR), be accrued on the balance
sheet as a current liability, although a portion of the claims may not
be paid in the following 12 months. As of December 31, 1996 and
September 30, 1996, this accrual amounted to $790,000 and $630,000,
respectively. During the three months ended December 31, 1996 and 1995,
the Company recognized approximately $345,000 and $380,000,
respectively, as its share of premiums collected in excess of claims
and fees paid and established reserves.
The Company has outstanding letters of credit amounting to $1,266,000
as of December 31, 1996. The letters of credit are required to
collateralize unpaid claims in connection with the workers compensation
insurance policy and can only be drawn upon by the beneficiary if the
Company does not perform according to the terms of the related
agreement. The Company has collateralized these letters of credit by
maintaining compensating restricted cash balances of $810,000 and
utilizing $455,000 of amounts available under its line of credit.
(4) SHAREHOLDERS' EQUITY
During the first quarter of fiscal 1997, $214,000 was raised from the
exercise of stock options and warrants.
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MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Results of Operations
Certain statements contained herein constitute "forward-looking
statements" within the meaning of the Private Securities Litigation Reform Act
of 1995 (the "1995 Reform Act"). Digital Solutions, Inc. (the "Company")
desires to avail itself of certain "safe harbor provisions of the 1995 Reform
Act and is therefore including this special note to enable the Company to do
so. Forward-looking statements included in this Memorandum involve known and
unknown risks, uncertainties, and other factors which could cause the Company's
actual results, performance (financial or operating) or achievements to differ
from the future results, performance (financial or operating) achievements
expressed or implied by such forward looking statements. Such future results
are based upon management's best estimates based upon current conditions and
the most recent results of operations. These risks include, but are not
limited to risks associated with the Company's recent losses (prior to the
December 31, 1996 quarter), the Company's ongoing need for a new credit
facility, need for additional capital, risks of recently consummated
acquisitions as well as future acquisitions, effects of competition and
technological changes and dependence upon key personnel.
The Company's operating revenues for the three months ended December
31, 1996 and 1995 were $30,885,000 and $23,090,000, respectively, which
represents an increase of $7,795,000 or 34%. This increase is due to the efforts
of the internal sales force to continually bring in new business which accounted
for all the increase. PEO services accounted for $7,047,000 or 90% of the
increase in new billings.
Direct Operating Expenses were $28,370,000 for the three months ended
December 31, 1996 and $20,916,000 for the comparable period last year,
representing an increase of $7,454,000 or 36%. In the quarter ended December
31, 1995 profits from workers' compensation were recorded as a reduction in
selling, general and administrative ("SG&A"), whereas in the quarter ended
December 31, 1996 these profits were recorded as a reduction of direct
operating expenses. After adjusting direct operating expenses in the quarter
ended December 31, 1995 to account for workers' compensation profits in the
same manner as done in the quarter ended December 31, 1996, direct operating
expenses for the quarter ended December 31, 1996 increased $ 7,834,000 or 38%
over the comparable period last year. This increase represents the
corresponding higher costs associated with the increase in revenue and a
greater mix of PEO business.
Gross Profit was $2,515,000 and $2,174,000 for the quarters ended
December 31, 1996 and 1995, respectively, or an increase of $341,000 or 16%.
After adjusting the quarter ended December 31, 1995 for the change in accounting
for the workers' compensation profits as mentioned above, gross profit for this
period was $ 2,554,000 or essentially the same as the quarter ended December 31,
1996. Gross profit, as a percent of revenue, was 8.1% for the quarter ended
December 31, 1996 and 11.1% for the same period last year after the workers'
compensation adjustment. This reduction in gross profit percent reflects the
company's continued drive towards PEO services which have a lower margin as a
percentage of revenue than payroll services or contract services, but which adds
more dollars of gross profit per client than these other services.
Selling, general and administrative ("SG&A") costs were $2,061,000 for the
quarter ended December 31, 1996 and $1,619,000 for the quarter ended December
31, 1995 or an increase of $442,000 or 27%. After adjusting the quarter ended
December 31, 1995 for the change in accounting for workers' compensation
profits as mentioned above, SG&A for the quarter ended December 31, 1996
increased $ 62,000 or 3.1% over the comparable period last year. This small
increase reflects management's efforts to continue to control SG&A expenses.
Net income for the three months ended December 31, 1996 and 1995 was
$201,000 and $392,000 respectively. This decrease in net income is attributed to
a change in
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accounting for medical costs which resulted in a $ 65,000 higher charge against
earnings in the first quarter of fiscal 1997; an anticipated and desired loss of
some business in the Southwest from the first quarter of fiscal 1996 which
accounted for approximately $ 51,000 in gross profit (desired loss due to
subsequent workers' compensation exposure or credit difficulties); increased
depreciation and amortization charges of $ 40,000 to reflect the increased
write-offs established in fiscal 1996; and $ 35,000 less in workers'
compensation profits.
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Liquidity and Capital Resources
The Company's working capital as of December 31, 1996 amounted to
$843,000 or a ratio of 1.10 to one versus $286,000 as of December 31, 1995 or
1.04 to one. This improvement includes capital contributions through the
exercise of options and warrants of $214,000 plus a $344,000 contribution from
the reduction in the amount of cash required to collateralize the Company's
workers' compensation program (see below).
In February 1995, the Company entered into a one year revolving line facility
(the "Line") with a bank which was subsequently extended on four occasions and
modified. Each loan extension has been for limited periods of time. Under the
terms of the current agreement, the Company may borrow up to the lesser of
$3,500,000 (including letters of credit), or 75% of eligible accounts
receivable, as defined. The Company is obligated to make monthly payments of
interest on the outstanding amounts at the bank's floating base rate plus two
and one-half percent (10.75% at December 31, 1996).
The Line is collateralized by substantially all of the Company's accounts
receivable. However, the line has matured and the Company is presently unable
to borrow any further under the line. The Company is presently negotiating with
the bank to develop mutually agreeable terms and conditions in response to the
Company's request for extending the line. The bank has proposed certain minimum
weekly payments by the Company of $10,000. While the Company believes it will
be able to negotiate terms and renew the line, in the event that this does not
occur, the Company is pursuing other financing alternatives.
In addressing the capital needs of the Company, management is presently in
negotiation with a potential lender to provide a line of credit to replace the
matured line. As currently being discussed, this facility will be secured by
substantially all assets of the Company and will be available based on a
percentage of eligible receivables. Management believes that this facility, if
obtained, will be sufficient to cover its cash needs for the foreseeable
future. There can be no assurance that the Company will be successful in its
efforts to obtain a new line of credit.
In December 1996, due to favorable trends in losses in its workers'
compensation program, the Company's carrier reduced its letter of credit
requirement from $1,600,000 to $1,150,000 which resulted in $450,000 of
additional cash available. Of this availability, $344,000 has been added to
working capital during the quarter ended December 31, 1996.
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PART II
OTHER INFORMATION
Item 1. Legal Proceedings
In October 1995, the Company entered into a note and finance
agreement with LNB Investment Corporation (LNB) providing for the loan
to the Company of up to $3,000,000. The loan was for a term of 15
months and was to be secured by shares of the Company's common stock
having a market value of no less than four times the outstanding
balance of the loan. LNB agreed not to sell or otherwise liquidate the
shares unless the Company were to default under the loan agreement and
failed to cure such default after notice. A total of 7,500,000 shares
to be pledged as collateral were registered under a registration
statement filed under the Securities Act of 1933, as amended.
The Company issued 1,783,334 shares in the name of LNB and delivered
the shares to a depository to secure the first portion of the loan of
$1,000,000. In January 1996, the Company determined that the shares
pledged as collateral had been transferred and sold in violation of the
loan and finance agreement. As a result, the financing agreement was
terminated and never funded. Through the efforts of the Company,
1,258,334 of these shares were recovered and the Company received
proceeds of $229,000 for a portion of the 525,000 shares not recovered.
In March 1996, the Company commenced action against LNB, Donaldson,
Lufkin & Jenrette Securities Corporation and other individuals to
recover damages on account of the wrongful sale of the Company's common
stock. The Company seeks to recover 525,000 shares which were not
returned and damages against all of the defendants. The Company is
currently engaged in discovery proceedings in the action.
At December 31, 1996 the Company is involved in various other legal
proceedings incurred in the normal course of business. In the opinion
of management and its counsel, none of these proceedings would have a
material effect, if adversely decided, on the consolidated financial
position or results of operations of the Company.
Item 5. Other information
On October 9, 1996 the Company announced it had signed a
letter of intent to acquire the assets of a Texas PEO company.
The acquisition was subject to due diligence, negotiation and execution
of a final agreement, which is ongoing. No assurance can be given that
the accquisition will be consummated.
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Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits - None
(b) Reports on Form 8-K
none filed during the quarter ended December 31, 1996.
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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.
DIGITAL SOLUTIONS, INC.
(Registrant)
/s/ George J. Eklund
-----------------------------------
George J. Eklund
Chief Executive Officer
/s/ Donald T. Kelly
-----------------------------------
Donald T. Kelly
Chief Financial Officer
Date: February 14, 1997
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3-MOS
SEP-30-1997
OCT-01-1996
DEC-31-1996
0
0
8,176,000
351,000
0
9,219,000
3,063,000
2,285,000
16,023,000
8,376,000
0
0
0
19,000
7,564,000
16,023,000
0
30,885,000
0
28,370,000
17,000
25,000
91,000
201,000
0
0
0
0
0
201,000
.01
.01
