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, 1997
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
DIGITAL SOLUTIONS, INC.
(Exact name of registrant as specified in its charter)
New Jersey 22-1899798
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification Number)
300 Atrium Drive, Somerset, NJ 08873
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (732) 748-1700
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
--- ---
19,298,010 shares of Common Stock, par value $.001 per share, were outstanding
as of February 11, 1998.
1 of 13
2
DIGITAL SOLUTIONS, INC. AND SUBSIDIARIES
FORM 10-Q
December 31, 1997
Table of Contents
Page No.
--------
Part I - Financial Information
Item 1. Consolidated Balance Sheets as of
December 31, 1997 (Unaudited) and
September 30, 1997 3
Consolidated Statements of
Income for the three months ended
December 31, 1997 and 1996 (Unaudited) 5
Consolidated Statements of Cash Flows for the
three months ended December 31, 1997 and 1996
(Unaudited) 6
Notes to Consolidated Financial Statements
(Unaudited) 7
Item 2. Management's discussion and analysis of
financial condition and results of operations 9
Part II - Other Information
Item 1. Legal Proceedings 11
Item 5. Other Information 12
Item 6. Exhibits and Reports on Form 8-K 12
Signatures 13
2 of 13
3
DIGITAL SOLUTIONS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
DECEMBER 31, SEPTEMBER 30,
1997 1997
------------ -------------
(unaudited)
ASSETS
CURRENT ASSETS
Cash $ 685,000 $ 841,000
Restricted Cash 738,000 738,000
Accounts receivable, net of allowance 5,637,000 5,820,000
Other current assets 444,000 402,000
----------- -----------
Total current assets 7,504,000 7,801,000
EQUIPMENT AND IMPROVEMENTS
Equipment 3,253,000 3,170,000
Leasehold improvements 49,000 47,000
----------- -----------
3,302,000 3,217,000
Accumulated depreciation and amortization 2,385,000 2,310,000
----------- -----------
917,000 907,000
DEFERRED TAX ASSET 760,000 760,000
GOODWILL, net of amortization 4,282,000 4,344,000
OTHER ASSETS 309,000 351,000
----------- -----------
TOTAL ASSETS $13,772,000 $14,163,000
=========== ===========
The accompanying notes to the consolidated financial statements are an integral
part of these consolidated financial statements.
Page 3 of 13
4
DIGITAL SOLUTIONS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
DECEMBER 31, SEPTEMBER 30,
1997 1997
------------ -------------
(unaudited)
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES
Short-term borrowings $ 2,567,000 $ 2,697,000
Current portion of long-term debt 93,000 113,000
Accounts payable 1,836,000 2,254,000
Accrued expenses and other current liabilities 3,579,000 4,138,000
------------ ------------
Total current liabilities 8,075,000 9,202,000
LONG-TERM DEBT 75,000 89,000
------------ ------------
Total Liabilities 8,150,000 9,291,000
COMMITMENTS AND CONTINGENCIES
SHAREHOLDERS' EQUITY
Common Stock, $.001 par value; authorized 40,000,000 shares;
issued and outstanding 19,298,010 and 19,141,760 at
December 31, 1997 and September 30, 1997, respectively 19,000 19,000
Additional paid-in capital 13,643,000 13,393,000
Accumulated deficit (8,040,000) (8,540,000)
------------ ------------
Total shareholders' equity 5,622,000 4,872,000
------------ ------------
TOTAL LIABILITIES AND EQUITY $ 13,772,000 $ 14,163,000
============ ============
The accompanying notes to the consolidated financial statements are an integral
part of these consolidated financial statements.
4 of 13
5
DIGITAL SOLUTIONS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(Unaudited)
FOR THE THREE MONTHS
DECEMBER 31,
------------------------
1997 1996
----------- -----------
REVENUES $33,662,000 $30,885,000
DIRECT EXPENSES 31,060,000 28,370,000
----------- -----------
Gross profit 2,602,000 2,515,000
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES 1,857,000 2,061,000
DEPRECIATION AND AMORTIZATION 169,000 179,000
----------- -----------
Income from operations 576,000 275,000
----------- -----------
OTHER INCOME (EXPENSE)
Interest and other income 12,000 17,000
Interest expense (88,000) (91,000)
----------- -----------
(76,000) (74,000)
----------- -----------
NET INCOME $ 500,000 $ 201,000
=========== ===========
BASIC EARNINGS PER COMMON SHARE $ 0.03 $ 0.01
=========== ===========
WEIGHTED AVERAGE SHARES OUTSTANDING 19,194,409 18,964,158
=========== ===========
DILUTED EARNINGS PER COMMON SHARE $ 0.03 $ 0.01
=========== ===========
DILUTED SHARES OUTSTANDING 19,458,078 19,914,159
=========== ===========
The accompanying notes to the consolidated financial statements are
an integral part of these consolidated financial statements.
5 of 13
6
DIGITAL SOLUTIONS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
FOR THE THREE MONTHS
DECEMBER 31,
-------------------------
1997 1996
--------- -----------
CASH FLOWS FROM OPERATING ACTIVITIES
Net income $ 500,000 $ 201,000
Adjustments to reconcile net income to net
cash used in operating activities:
Depreciation and amortization 169,000 179,000
Provision for doubtful accounts 14,000 13,000
Changes in operating assets and liabilities:
Accounts receivable 169,000 (1,440,000)
Other current assets (32,000) (318,000)
Accounts payable, accrued expenses and
other current liabilities (977,000) 733,000
--------- -----------
Net cash used in operating activities (157,000) (632,000)
--------- -----------
CASH FLOWS FROM INVESTING ACTIVITIES
Purchase of equipment and improvements (85,000) --
--------- -----------
Net cash used in investing activities (85,000) --
--------- -----------
CASH FLOWS FROM FINANCING ACTIVITIES
(Repayments) proceeds from borrowings on revolving
line of credit - net (130,000) 110,000
Payments under capital lease obligations (34,000) (36,000)
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 250,000 214,000
--------- -----------
Net cash provided by financing activities 86,000 632,000
--------- -----------
Net decrease in cash (156,000) --
CASH AT BEGINNING OF PERIOD 841,000 --
--------- -----------
CASH AT END OF PERIOD $ 685,000 $ --
========= ===========
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid during the period for interest $ 82,000 $ 81,000
========= ===========
The accompanying notes to the consolidated financial statements are an integral
part of these consolidated financial statements.
Page 6 of 13
7
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. These consolidated
financial statements should 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., DSI Staff ConnXions -
Southwest, 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.
Earnings Per Common Share
7 of 13
8
In March 1997, the Financial Accounting Standards Board issued Statement on
Financial Accounting Standards Number 128, "Earnings Per Share" (FAS No. 128).
FAS 128 requires the presentation of basic earnings per share and diluted
earnings per share. "Basic earnings per share" represents net income divided by
the weighted average shares outstanding. "Diluted earnings per share" represents
net income divided by weighted average shares outstanding adjusted for the
incremental dilution of outstanding employee stock options and awards.
(3) COMMITMENTS AND CONTINGENCIES
In connection with the Company's former workers' compensation insurance policy
which expired on April 1, 1997, the insurance company developed 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 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, 1997 and December 31, 1996, this accrual amounted to $628,000
and $790,000, respectively. On April 1, 1997, the Company entered into a
workers' compensation policy with a new carrier. Under the terms of the new
workers' compensation insurance program the Company fully accrues the maximum
loss on a monthly basis. During the three months ended December 31, 1997 and
1996, the Company recognized approximately $190,000 and $345,000, respectively,
as its share of premiums collected from customers covered by these policies in
excess of claims and fees paid. The decrease in reported workers' compensation
profit is due to the revised methodology in evaluating the Company's exposure as
previously discussed and the new insurance program.
The Company has outstanding letters of credit amounting to $1,193,000 as of
December 31, 1997. The letters of credit are required to collateralize unpaid
claims in connection with the Company's former 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 $738,000 and utilizing $455,000 of amounts available under its
line of credit. The Company's current policy does not require a letter of credit
because the Company funds the estimated loss reserves on a monthly basis.
(4) SHAREHOLDERS' EQUITY
During the first quarter of fiscal 1998, $250,000 was received from an equity
investment by the Company's directors and executive officers, as well as from a
former director, to be used for general corporate purposes. The raising of these
funds was a requirement of the recently negotiated bank line of credit
extension.
8 of 13
9
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATION
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, 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 revenues for the three months ended December 31, 1997 and
1996 were $33,662,000 and $30,885,000, respectively, which represents an
increase of $2,777,000 or 9.0%. This increase is due to the efforts of the
internal sales force to continually bring in new business which accounted for
all of the increase.
Direct expenses were $31,060,000 for the three months ended December
31, 1997 and $28,370,000 for the comparable period last year, representing an
increase of $2,690,000 or 9.5%. Of this increase, $155,000 is due to reporting
less profit on the workers' compensation program in the quarter ended December
31, 1997 due to the revised methodology in evaluating workers' compensation
reserves and the new insurance program. As a percentage of revenue, direct
expenses for the three months ending December 31, 1997 and 1996 were 92.3% and
91.8%, respectively. These increases represent the corresponding higher costs
associated with the increase in revenue and a greater mix of PEO business plus
lower workers' compensation profit. These increases were attributed to the
increase in the PEO business.
Gross profits were $2,602,000 and $2,515,000 for the quarters ended
December 31, 1997 and 1996, respectively, or a increase of $87,000. Gross
profits, as a percentage of revenue, were 7.7% and 8.1% for the quarters ended
December 31, 1997 and 1996, respectively, reflecting the higher mix of PEO
business.
9 of 13
10
SG&A costs for the quarters ended December 31, 1997 and 1996 were
$1,857,000 and $2,061,000, respectively, for an decrease of $204,000 or 9.9%.
The decrease was attributable to the reduction in overhead costs implemented in
the fourth fiscal quarter of 1997.
Depreciation and amortization for the quarters ended December 31, 1997
and 1996 decreased to $169,000 from $179,000, respectively, or $10,000.
Net income for the quarter ended December 31, 1997 was $500,000 versus
net income of $201,000 for the similar period in 1996. This increase of $299,000
is attributed to the increase in the PEO business and the reduction in overhead
costs.
Liquidity and Capital Resources
The Company's negative working capital position as of December 31, 1997
improved to ($571,000) versus ($1,401,000) as of September 30, 1997. The
increase reflects the continued earnings improvement of the Company. At December
31, 1997, the Company had cash of $685,000, restricted cash of $738,000 and
accounts receivable, net of $5,637,000.
In February 1995, the Company entered into a one year revolving credit
line facility (the "Line") with a bank which was subsequently extended and
amended on seven occasions. Each loan extension has been for limited periods of
time. The fifth amendment executed as of December 31, 1996, restricted the
Company from borrowing any additional funds available on the Line and required
weekly principal payments of $10,000, effective February 24, 1997. Effective
October 31, 1997, the Company entered into the seventh amendment to the loan
agreement. Under the terms of this agreement, which expires October 31, 1998,
the Company was required to grant to the bank 500,000 warrants to purchase the
Company's common stock. The warrants will vest in amounts of 200,000 and 300,000
as of April 30, 1998 and October 31, 1998, respectively, if the obligations
under the loan agreement are not paid in full by these dates. The warrants have
an exercise price of $2.4375 per share, which was the fair market value of the
stock at the date of the agreement. The Company is obligated to make monthly
payments of interest on the outstanding amounts at the bank's floating base rate
plus three percent (11.5% at September 30, 1997). Under the present amendment,
the Company can not borrow additional funds and continues to make weekly
principal payments of $10,000. The line is collateralized by all of the
Company's assets. At September 30, 1997 and December 31, 1997, the total amount
outstanding on the Line was $2,697,000 and $2,567,000, respectively. In December
1997, the Company's directors and executive officers, as well as a former
director, made an equity investment of $250,000 for general
10 of 13
11
corporate purposes. The raising of these funds was a requirement of the recently
negotiated bank line of credit extension.
To address the capital needs of the Company, management is presently in
discussions with several financial institutions. There can be no assurance that
the Company will be successful in its efforts to raise additional funds. At the
present time, the Company does not have funds available to repay the Line.
Repayment of the Line is due in full on October 31, 1998.
Inflation and changing prices have not had a material effect on the
Company's net revenues and results of operations in the last three fiscal years,
as the Company has been able to modify its prices to respond to inflation and
changing prices.
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 partial payment on 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. On July
2, 1997, the Company settled the action. Without admitting or denying the
allegations in the complaint, the defendants agreed to pay $676,000 of which
$426,000 ($202,000, net of expenses) has been paid with the balance of $250,000
to be paid by LNB on or before August 4, 1997. As of February 11, LNB failed to
make the $250,000 payment due under the settlement agreement. The Company is
currently pursuing enforcement alternatives. The subsequent payment is secured
by a confession of judgment and a mortgage in the amount
11 of 13
12
of $625,000. The payments under the settlement agreement are in addition to
$229,000 previously received from LNB bringing the total recovered to
approximately $905,000, assuming LNB complies with the terms of the settlement
and remits the last payment of $250,000. The agreement also provides that upon
payment of all sums due under the settlement agreement, LNB shall be deemed to
have made full restitution to the Company for the claims alleged in the action.
At December 31, 1997 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 Events
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, 1997.
12 of 13
13
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/ Donald W. Kappauf
-----------------------
Donald W. Kappauf
Chief Executive Officer
/s/ Donald T. Kelly
-----------------------
Donald T. Kelly
Chief Financial Officer
Date: February 11, 1998
13 of 13
5
3-MOS
SEP-30-1998
OCT-01-1997
DEC-31-1997
685,000
0
6,513,000
(876,000)
0
7,504,000
3,302,000
(2,385,000)
13,772,000
8,075,000
0
0
0
(19,000)
(5,603,000)
13,772,000
0
33,662,000
0
31,060,000
0
(14,000)
(88,000)
500,000
0
500,000
0
0
0
500,000
.03
.03
