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                       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,December 31, 1998                

                                       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,TEAMSTAFF, 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 

DIGITAL SOLUTIONS, INC.                                           
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

---          ---

19,298,01027,617,241 shares of Common Stock, par value $.001 per share, were outstanding
as of July 24, 1998.February 8, 1999.

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                        DIGITAL SOLUTIONS,TEAMSTAFF, INC. AND SUBSIDIARIES
                                    FORM 10-Q

                                June 30,December 31, 1998


                                Table of Contents

Page No.
                                                                        --------
Part I - Financial Information

Item 1.           Consolidated Balance Sheets as of
                  June 30, 1998 (Unaudited) and
                  September 30, 1997                                        3

                  Consolidated Statements of
                  Income for the three months ended
                  June 30, 1998 and 1997 (Unaudited)                        5

                  Consolidated Statements of
                  Income for the nine months ended
                  June 30, 1998 and 1997 (Unaudited)                        6

                  Consolidated Statements of Cash Flows for the
                  nine months ended June 30, 1998 and 1997
                  (Unaudited)                                               7

                  Notes to Consolidated Financial Statements
                  (Unaudited)                                               8

Item 2.           Management's discussion and analysis of
                  financial condition and results of operations             11


Part II - Other Information

Item 1.           Legal Proceedings                                         15
Page No. -------- Part I - Financial Information Item 1. Consolidated Balance Sheets as of December 31, 1998 (Unaudited) and September 30, 1998 3 Consolidated Statements of Income for the three months ended December 31, 1998 and 1997 (Unaudited) 5 Consolidated Statements of Cash Flows for the three months ended December 31, 1998 and 1997 (Unaudited) 6 Notes to Consolidated Financial Statements (Unaudited) 7 Item 2. Management's discussion and analysis of financial condition and results of operations 11 Part II - Other Information Item 1. Legal Proceedings 14 Item 5. Other Information 15 Item 6. Exhibits and Reports on Form 8-K 15 Signatures 16 Item 6. Exhibits and Reports on Form 8-K 17 Signatures 18
2 of 16 3 DIGITAL SOLUTIONS,TEAMSTAFF, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS
JUNE 30,DECEMBER 31, SEPTEMBER 30, 1998 1997 ----------- -------------1998 ---- ---- (unaudited) ASSETS CURRENT ASSETS Cash $ 1,806,0001,300,000 $ 841,0001,530,000 Restricted Cash 738,000 738,000350,000 -- Accounts receivable, net of allowance 4,924,000 5,820,0007,139,000 6,891,000 Other current assets 901,000 402,000741,000 691,000 ----------- ----------- Total current assets 8,369,000 7,801,0009,530,000 9,112,000 EQUIPMENT AND IMPROVEMENTS Equipment 3,254,000 3,170,0003,359,000 3,336,000 Leasehold improvements 47,000 47,000 ----------- ----------- 3,301,000 3,217,0003,406,000 3,383,000 Accumulated depreciation and amortization 2,535,000 2,310,0002,682,000 2,591,000 ----------- ----------- 766,000 907,000724,000 792,000 DEFERRED TAX ASSET 1,916,000 760,0001,570,000 1,782,000 GOODWILL, net of amortization 4,158,000 4,344,0004,035,000 4,096,000 OTHER ASSETS 575,000 351,0001,008,000 866,000 ----------- ----------- TOTAL ASSETS $15,784,000 $14,163,000$16,867,000 $16,648,000 =========== ===========
The accompanying notes to the consolidated financial statements are an integral part of these consolidated balance sheets. Page 3 of 16 4 DIGITAL SOLUTIONS,TEAMSTAFF, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS
JUNE 30,DECEMBER 31, SEPTEMBER 30, 1998 1997 ------------ -------------1998 ---- ---- (unaudited) LIABILITIES AND SHAREHOLDERS' EQUITY CURRENT LIABILITIES Short-term borrowings $ -- $ 2,697,000 Current portion of long-term debt 541,000 113,000$ 538,000 $ 540,000 Accounts payable 1,680,000 2,254,0002,132,000 1,792,000 Accrued expenses and other current liabilities 2,849,000 4,138,0003,333,000 3,461,000 ------------ ------------ Total current liabilities 5,070,000 9,202,0006,003,000 5,793,000 LONG-TERM DEBT 3,096,000 89,0002,613,000 2,981,000 ------------ ------------ Total Liabilities 8,166,000 9,291,0008,616,000 8,774,000 COMMITMENTS AND CONTINGENCIES SHAREHOLDERS' EQUITY Common Stock, $.001 par value; authorized 40,000,000 shares; issued and outstanding 19,298,010 and 19,141,76019,383,833 at June 30,December 31, 1998 and 19,356,833 at September 30, 1997, respectively1998 19,000 19,000 Additional paid-in capital 13,643,000 13,393,00013,734,000 13,692,000 Accumulated deficit (6,044,000) (8,540,000)(5,502,000) (5,837,000) ------------ ------------ Total shareholders' equity 7,618,000 4,872,0008,251,000 7,874,000 ------------ ------------ TOTAL LIABILITIES AND EQUITY $ 15,784,00016,867,000 $ 14,163,00016,648,000 ============ ============
The accompanying notes to the consolidated financial statements are an integral part of these consolidated balance sheets. Page 4 of 16 5 DIGITAL SOLUTIONS,TEAMSTAFF, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF INCOME (Unaudited)
FOR THE THREE MONTHS ENDED JUNE 30, -----------------------------DECEMBER 31, --------------------------- 1998 1997 ------------ ---------------- ---- REVENUES $ 35,885,00039,699,000 $ 31,185,00033,662,000 DIRECT EXPENSES 33,182,000 28,908,00036,705,000 31,060,000 ------------ ------------ Gross profit 2,703,000 2,277,0002,994,000 2,602,000 SELLING, GENERAL AND ADMINISTRATIVE EXPENSES 2,059,000 2,034,0002,150,000 1,857,000 DEPRECIATION AND AMORTIZATION 163,000 213,000176,000 169,000 ------------ ------------ Income from operations 481,000 30,000668,000 576,000 ------------ ------------ OTHER INCOME (EXPENSE) Interest and other income 14,000 1,000104,000 12,000 Interest expense (173,000)(166,000) (88,000) ------------ ------------ (159,000) (87,000)(62,000) (76,000) ------------ ------------ Income (loss) before tax 322,000 (57,000)606,000 500,000 INCOME TAX BENEFIT 1,470,000EXPENSE (271,000) -- ------------ ------------ NET INCOME (LOSS) $ 1,792,000335,000 $ (57,000)500,000 ============ ============ BASIC EARNINGS (LOSS) PER COMMON SHARE $ 0.090.02 $ (0.00)0.03 ============ ============ WEIGHTED AVERAGE SHARES OUTSTANDING 19,298,010 19,103,85419,363,511 19,194,409 ============ ============ DILUTED EARNINGS (LOSS) PER COMMON SHARE $ 0.090.02 $ (0.00)0.03 ============ ============ DILUTED SHARES OUTSTANDING 19,548,671 19,103,85419,518,235 19,458,078 ============ ============
The accompanying notes to the consolidated financial statements are an integral part of these consolidated statements. Page 5 of 16 6 DIGITAL SOLUTIONS,TEAMSTAFF, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF INCOME (Unaudited)CASH FLOWS (UNAUDITED)
FOR THE NINETHREE MONTHS ENDED JUNE 30, -------------------------------DECEMBER 31, --------------------------- 1998 1997 ------------- ----------------- ---- REVENUESCASH FLOWS FROM OPERATING ACTIVITIES Net income $ 102,122,000335,000 $ 92,295,000 DIRECT EXPENSES 94,588,000 85,911,000 ------------- ------------- Gross profit 7,534,000 6,384,000 SELLING, GENERAL AND ADMINISTRATIVE EXPENSES 5,677,000 8,402,000 DEPRECIATION AND AMORTIZATION 502,000 830,000 ------------- ------------- Income (loss) from operations 1,355,000 (2,848,000) ------------- ------------- OTHER INCOME (EXPENSE) Interest500,000 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization 176,000 169,000 Provision for doubtful accounts 49,000 14,000 Deferred income taxes 212,000 -- Changes in operating assets and liabilities: Increase (decrease) in accounts receivable (297,000) 169,000 Increase in other assets (216,000) (32,000) Increase (decrease) in accounts payable, accrued expenses and other income 37,000 34,000 Interest expense (366,000) (284,000) ------------- ------------- (329,000) (250,000) ------------- ------------- Income (loss) before tax 1,026,000 (3,098,000) INCOME TAX BENEFIT 1,470,000current liabilities 212,000 (977,000) Increase in restricted cash (350,000) -- ------------- ------------- NET INCOME (LOSS)----------- ----------- Net cash provided by (used in) operating activities 121,000 (157,000) ----------- ----------- CASH FLOWS FROM INVESTING ACTIVITIES Purchase of equipment and improvements (23,000) (85,000) ----------- ----------- CASH FLOWS FROM FINANCING ACTIVITIES Repayments on long term debt (125,000) -- Repayments on revolving line of credit (233,000) (130,000) Payments under capital lease obligations (12,000) (34,000) Proceeds from issuance of common stock and exercise of common stock options and warrants - net 42,000 250,000 ----------- ----------- Net cash provided by (used in) financing activities (328,000) 86,000 ----------- ----------- Net decrease in cash (230,000) (156,000) CASH AT BEGINNING OF PERIOD 1,530,000 841,000 ----------- ----------- CASH AT END OF PERIOD $ 2,496,0001,300,000 $ (3,098,000) ============= ============= BASIC EARNINGS (LOSS) PER COMMON SHARE685,000 =========== =========== SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION: Cash paid during the period for interest $ 0.1389,000 $ (0.16) ============= ============= WEIGHTED AVERAGE SHARES OUTSTANDING 19,263,097 19,048,901 ============= ============= DILUTED EARNINGS (LOSS) PER COMMON SHARE $ 0.13 $ (0.16) ============= ============= DILUTED SHARES OUTSTANDING 19,504,058 19,048,901 ============= =============82,000 =========== ===========
The accompanying notes to the consolidated financial statements are an integral part of these consolidated statements. Page 6 of 16 7 DIGITAL SOLUTIONS, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)
FOR THE NINE MONTHS JUNE 30, --------------------------- 1998 1997 ----------- ----------- CASH FLOWS FROM OPERATING ACTIVITIES Net income (loss) $ 2,496,000 $(3,098,000) Adjustments to reconcile net income (loss) to net cash provided by operating activities: Depreciation and amortization 502,000 830,000 Provision for doubtful accounts 69,000 1,085,000 Deferred taxes (1,470,000) -- Other non cash items -- 1,109,000 Changes in operating assets and liabilities: Accounts receivable 827,000 403,000 Other current assets (499,000) (293,000) Notes due from officers -- 136,000 Accounts payable, accrued expenses and other current liabilities (1,865,000) 369,000 ----------- ----------- Net cash provided by operating activities 60,000 541,000 ----------- ----------- CASH FLOWS FROM INVESTING ACTIVITIES Purchase of equipment and improvements (84,000) (163,000) ----------- ----------- CASH FLOWS FROM FINANCING ACTIVITIES Proceeds from borrowings on line of credit 3,600,000 410,000 Repayments on long term debt (42,000) -- Repayments on revolving line of credit (2,697,000) (490,000) Payments under capital lease obligations (122,000) (44,000) Proceeds from letter of credit termination -- 417,000 Proceeds from issuance of common stock and exercise of common stock options and warrants - net 250,000 208,000 ----------- ----------- Net cash provided by financing activities 989,000 501,000 ----------- ----------- Net increase in cash 965,000 879,000 CASH AT BEGINNING OF PERIOD 841,000 -- ----------- ----------- CASH AT END OF PERIOD $ 1,806,000 $ 879,000 =========== =========== SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION: Cash paid during the period for interest $ 276,000 $ 265,000 =========== ===========
The accompanying notes to the consolidated financial statements are an integral part of these consolidated statements. Page 7 of 16 8 DIGITAL SOLUTIONS,TEAMSTAFF, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) (1) ORGANIZATION AND BUSINESS TeamStaff, Inc., formerly Digital Solutions, Inc. (the Company) was incorporated under the laws of the State of"Company"), a New Jersey on November 25, 1969. The Company,Corporation, with its subsidiaries, provides a broad spectrum of human resource services including Professional Employer Organization (PEO)professional employer services, payroll processing, human resource administration and placement of temporary and permanent employees. The Company has regional offices in Somerset, New Jersey; Houston, Texas; and Clearwater, Florida and sales service centers in New York, New York; El Paso and Houston, Texas; Clearwater, Florida; and Somerset, New Jersey. The Company changed its name from Digital Solutions, Inc. to TeamStaff, Inc. on February 10, 1999. Effective January 25, 1999, the Company acquired the ten entities operating under the trade name, The Teamstaff Companies. The financial data and discussion contained in this Form 10-Q do not reflect the acquisition as it occurred after the end of the quarter. (2) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Basis of PresentationBASIS 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,TeamStaff Inc., a New Jersey Corporation and its wholly-owned subsidiaries; DSI Contract Staffing, DSI Staff ConnXions - Northeast, Inc., DSI Staff ConnXions - Southwest, 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. Earnings Per Common ShareNEW ACCOUNTING PRONOUNCEMENTS- In MarchJune 1997, the FASB issued Statement of Financial Accounting Standards BoardNo. 131, "Disclosures about Segments of an Enterprise and Related Information" ("SFAS 131"). SFAS Page 7 of 16 8 131 establishes standards for the way public enterprises are to report information about operating segments in interim financial statements and requires the reporting of selected information about operating segments in interim financial reports issued to shareholders. It also establishes standards for related disclosures about products and services, geographic areas and major customers. SFAS 131 is effective for fiscal periods beginning after December 15, 1997, at which time the Company will adopt the provisions. The Company does not expect SFAS 131 to have a material effect on reported results. EARNINGS PER SHARE- In February 1997, the FASB issued Statement on Financial Accounting Standards Number 128, "Earnings Per Share" (FAS("SFAS No. 128). FAS 128128"), which requires the presentation of basic earnings per share ("Basis EPS") and diluted earnings per share for all periods presented. "Basic earnings per share" represents net("Diluted EPS"). Basic EPS is calculated by dividing income dividedavailable to common shareholders by the 8 of 16 9 weighted average number of shares outstanding. "Diluted earnings per share" represents netof common stock outstanding during the period. Diluted EPS is calculated by dividing income dividedavailable to common shareholders by weighted average shares outstanding adjusted for the incremental dilution of outstanding and vested stock options and warrants. A reconciliation of weighted average number of common shares outstanding for the period adjusted to weighted average common shares outstanding assuming dilution is as follows:reflect potentially dilutive securities. In accordance with SFAS 128, the following table reconciles net income and share amounts used to calculate basic earnings per share and diluted earnings per share:
Three Months Ended June 30, Nine Months Ended June 30, --------------------------- --------------------------December 31, 1998 1997 1998 1997 ---------- ---------- ---------- -------------- ---- Numerator: Net income $ 335,000 $ 500,000 ----------- ----------- Denominator: Weighted average number of common shares 19,298,010 19,103,854 19,263,097 19,048,901 Dilutive share equivalentsOutstanding - Basic 19,363,511 19,194,409 Incremental shares for assumed conversions of outstanding stock options 250,661 -- 240,961 -- ---------- ---------- ---------- ----------options/warrants 154,724 263,669 ----------- ----------- Weighted average number of common and Equivalent shares assuming dilution 19,548,671 19,103,854 19,504,058 19,048,901 ========== ========== ========== ==========outstanding-Diluted 19,518,235 19,458,078 ----------- ----------- Earnings per share - Basic $ 0.02 $ 0.03 Earnings per share - Diluted $ 0.02 $ 0.03
Stock options and warrants outstanding at June 30,December 31, 1998 to purchase 686,479946,229 shares of common stock were not included in the computation of earnings per share assuming dilution because the optionsDiluted EPS as they were antidilutive. 8 of 16 9 (3) INCOME TAXES Income taxesTAXES: At December 31, 1998, the Company had available operating loss carryforwards of approximately $6,000,000 to reduce future periods' taxable income. The carryforwards expire in various years beginning in 2004 and extending through 2012. The Company has recorded a $1,950,000 and a $760,000 deferred tax asset at December 31, 1998 and 1997, respectively. This represents management's estimate of the income tax benefits to be realized upon utilization of a portion of its net operating losses as well as temporary differences between the financial statement and tax bases of certain assets and liabilities, for which management believes utilization to be more likely than not. Management believes the quarter ended June 30,Company's operations can generate sufficient taxable income to realize this deferred tax asset as a result of recent business developments, its ability to meet its operating plan as well as the resolution of significant past problems which had adversely affected the Company in prior years. As of December 31, 1998 reflectedother current assets included $380,000 related to the deferred tax asset. (4) DEBT: On April 29, 1998, the Company was successful in replacing the former credit facility with a net tax benefitnew long-term credit facility from FINOVA Capital Corporation totaling $4,500,000. Substantially all assets of $1,470,000 relatingthe Company secure the credit facility. The facility includes a three-year loan for $2,500,000, with a five year amortization, at prime + 3% (10.75% as of December 31, 1998) and a $2 million revolving line of credit secured by certain accounts receivable of the Company at prime + 1% (8.75% as of December 31, 1998). The credit facility is also subject to success fees of $200,000, $225,000 and $250,000 due on the anniversary date of the loan. Taking these fees into consideration, and assuming the Company continuously fully utilizes the revolver, the effective rate of interest on the total borrowings is approximately 16.1%. The credit facility is subject to certain covenants including but not limited to a reductionminimum current ratio, debt to net worth ratio, a minimum net worth and a minimum debt service coverage ratio, as defined. The Company received an increase of its present lending facility from FINOVA Capital Corporation in order to fund the TeamStaff acquisition. The facility is comprised of (i) a three-year term loan, with a five year amortization, and a balloon payment at the end of three years, in the amount of $2,500,000; (ii) a one year bridge loan in the amount of $750,000 and (iii) an increase in the Company's valuation allowance. Asrevolving line of September 30, 1997,credit from $2,000,000 to $2,500,000. The term loan bears an interest rate of prime + 3%, the bridge loan bears a interest rate of prime + 1%. In addition, the Company had established a deferred tax valuation allowancewill incur "success" fees of $2,680,000. In view$200,000, $225,000 and $250,000 due on the anniversary dates of the continued earnings improvementloan. (5) COMMITMENTS AND CONTINGENCIES: In September 1998, the Company negotiated and settled with Liberty Mutual Insurance Company its liability on all workers' compensation claims incurred during the three year period 1995, 1996 and 1997. In return for terminating all future exposure under the Liberty Mutual workers' compensation policy, the Company agreed to make a one-time payment of approximately $919,000. The settlement was funded by allocating $738,000 of the Company over the last four quarters and its current financial position and prospects, management has determined that it is more likely than not that the majority of such valuation allowance will be realized. As of June 30, 1998, the Company's valuation allowance approximated $680,000. (4) COMMITMENTS AND CONTINGENCIES In connection with the Company's former workers' compensation insurance policyrestricted cash, 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, althoughhad been used to collateralize a portion of the claims may not be paid in the following 12 months.letter of credit to Liberty Mutual and by internal funds of $181,000. 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 is required to fund the 9 of 16 10 anticipated loss reserves on a current basis. During the ninethree months ended June 30,December 31, 1998 and 1997, the Company recognized approximately $717,000$214,000 and $694,000,$190,000, respectively, as its share of premiums collected from customers covered by these policies in excess of claims and fees paid. 9 of 16 10paid by the Company. (6) SUBSEQUENT EVENT The Company has outstanding letters of credit amountingchanged its name from Digital Solutions, Inc, to $1,193,000 as of June 30, 1998. 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 ifTeamstaff, Inc. on February 10, 1999. Effective January 25, 1999, the Company doesacquired the ten entities operating under the trade name, The Teamstaff Companies. The financial data and discussions contained in this Form 10-Q do not perform according toreflect the termsacquisition as it occurred after the end 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. (5) SHAREHOLDERS' EQUITY During the first nine months of fiscal 1998, $250,000 was received from an equity investment by the Company directors and executive officers, as well as from a former director, to be used for general corporate purposes.quarter. 10 of 16 11 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Results of OperationsRESULTS 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,TeamStaff, 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 report 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 lookingforward-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 risks of current 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 June 30,December 31, 1998 and 1997 were $35,885,000$39,699,000 and $31,185,000,$33,662,000, respectively, which represents an increase of $4,700,000$6,037,000 or 15.1%. For the nine months ended June 30, 1998 and 1997, the Company's revenues were $102,122,000 and $92,295,000, respectively, which represents an increase of $9,827,000 or 10.6%17.9%. This increase iswas due entirely to increased sales through the efforts of the Company's internal sales force to continually bring in new business which accounted for all of the increase. Revenues for the first nine months ended June 30, 1997 include approximately $8,000,000 in revenue from two contracts completed in the third quarter of fiscal 1997. Excluding these contracts, revenues for the first nine months of fiscal 1998 increased 21% over the comparable prior year period.force. Direct expenses were $33,182,000$36,705,000 for the three months ended June 30,December 31, 1998 and $28,908,000$31,060,000 for the comparable period last year, representing an increase of $4,274,000$5,645,000 or 14.8%18.2%. This increase represents the corresponding higher costs associated with higher revenues. As a percentage of revenue, direct expenses for the three months ended June 30,December 31, 1998 and 1997 were 92.5% and 92.7%92.3%. For the nine months ended June 30, 1998 and 1997, direct costs increased $8,677,000 or 10.1%, from $85,911,000 to $94,588,000, respectively. This increase represents the corresponding higher costs associated with higher revenues. As a percentage of revenue, direct costs for the nine months ended June 30, 1998 and 1997 were 92.6% and 93.1%, respectively. Gross profits were $2,703,000$2,994,000 and $2,277,000$2,602,000 for the quarters ended June 30,December 31, 1998 and 1997, respectively, or an increase of $426,000.$392,000 or 15.1%. Gross profits, as a percentage of revenue, were 7.5% and 7.3%7.7% for the quarters ended June 30,December 31, 1998 and 1997, 11 of 16 12 respectively. For the nine months ended June 30, 1998Selling, general and 1997, gross profits increased to $7,534,000 from $6,384,000, respectively. As a percentage of revenue, gross profits for the nine months ended June 30, 1998 and 1997 were 7.4% and 6.9%, respectively. The increase in gross profits as a percentage of revenue is attributed to an increase in the percentage of the medical staffing business which has a higher margin. SG&Aadministrative "SG&A" costs for the quarters ended June 30,December 31, 1998 and 1997 were $2,059,000$2,150,000 and $2,034,000,$1,857,000, respectively, representing an increase of $25,000$293,000 or 1.2%15.8%. This increase is partially attributed to the correspondingadditional employee costs necessary to generate the increased level of revenue and also to the increased commission expense associated with rise in sales. Also included in the increase in revenue. ForSG&A are the nine months ended June 30, 1998costs of additional office equipment leases and 1997 SG&A decreased from $8,402,000supplies necessary to $5,677,000, respectively. Includedsupport the increase in business and to facilitate the nine months ended June 30, 1997 SG&A costs were $2,024,000corporate move. 11 of items including $1,002,000 to increase the Company's bad debt reserve, $300,000 to absorb miscellaneous charges, $124,000 to correct unrecorded 1996 expenses, $102,000 to establish a vacation pay accrual, $81,000 to change supplies accounting, $93,000 to establish a reserve for severance costs, a $51,000 severance charge and $271,000 for various other miscellaneous items. The need to substantially increase the Company's bad debt reserve became evident after January, 1997 when previously current clients became seriously delinquent. The Company is currently filing legal claims to recover some of these amounts. Excluding these items, SG&A decreased by $701,000 which was attributable to the reduction in overhead costs implemented in the fourth fiscal quarter of 1997.16 12 Depreciation and amortization for the quarters ended June 30,December 31, 1998 and 1997 decreasedincreased to $163,000$176,000 from $213,000,$169,000, respectively, or $50,000.$7,000. The decrease was attributableincrease is reflective of the slight increase in depreciable assets. Interest expense for the quarter ended December 31, 1998 increased $78,000 to several intangible assets that have become fully amortized$166,000 from $88,000 in the current fiscal year. For the nine monthcorresponding period ended June 30, 1998in 1997 due to an increase in debt financing and 1997, depreciation and amortization decreased from $830,000 to $502,000, respectively, or $328,000. The majority of the decrease was attributable to the writing off of the intangible assets of Digital Insurance Services, Inc.an increase in the first quarter of 1997, as a result of management's decision to abandon these assets since it was decided not to remaineffective borrowing rate associated with the Company's new financing arrangements effective in the insurance business.April, 1998. Income taxes for the quarter ended June 30,December 31, 1998 reflected a net tax benefitexpense of $1,470,000 relating to a reduction$271,000 versus $0 in the Company's valuation allowance. As of September 30, 1997,same quarter last year. For the Company had established a deferred taxthree months ended December 31, 1998, the company decreased its valuation allowance of $2,680,000. In view ofby $271,000 to offset the continued earnings improvement of the Company over the last four quarters and its current financial position and prospects, management has determined that it is more likely than not that the majority of such valuation allowance will be realized. As of June 30, 1998, the Company's valuation allowance approximated $680,000.income tax provision. Net income for the quarter ended June 30,December 31, 1998 was $1,792,000$335,000 versus a net lossincome of $57,000$500,000 for the similar period in 1997. This increase of $1,849,000 is attributed to the $1,470,000decrease in net tax benefits and the overhead reductions implemented in the fourth fiscal quarter of 1997. For the nine months ended June 30, 1998 the Company reported 12 of 16 13 net income of $2,496,000 versus$165,000 reflects a losstax expense of $3,098,000$271,000 as compared to no tax in the similar period of 1997 or an increase of $5,594,000. This increase is attributable1997. The net income before tax increased $106,000 from $500,000 to $606,000 due to the $3.1 million in adjustments recorded in fiscal 1997, the net tax benefit of $1,470,000 recorded in fiscal 1998 and the overhead reductions implementedincrease in the fourth fiscalCompany's revenues in all divisions. LIQUIDITY AND CAPITAL RESOURCES Net cash provided by operating activities improved in the first quarter of 1997. Liquidity and Capital Resources1999 to $122,000, from net cash used of ($157,000) in the same period of fiscal 1998. The Company's working capital position as of June 30, 1998 was $3,299,000 versus a working capital deficit of ($1,401,000) as of September 30, 1997. The improved working capital positionincrease in cash flow from operations is attributable to the continued earnings improvement of the Company andCompany. The net cash used in financing activities increased in the successful refinancingquarter ended December 31, 1998, compared to the quarter ended December 31, 1997 due to the increase in required payments on the current line of the Company's short term borrowings,credit as discussed below,below. Cash outflow for the purchases of equipment and improvements was $23,000 in the three months ended December 31, 1998 compared to a long term credit facility.$85,000 in the three months ended December 31, 1997. The decrease is related to the timing of capital projects during the quarters. Capital expenditures have been relatively stable over the last three fiscal years. At June 30,December 31, 1998, the Company had cash of $1,806,000,$1,300,000, restricted cash of $738,000$350,000 and accounts receivable of $4,924,000. 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. At September 30, 1997 the total amount outstanding on the Line was $2,697,000.$7,139,000. On April 29, 1998, the Company was successful in replacing the former credit facility with a new long termlong-term credit facility from FINOVA Capital Corporation totaling $4.5 million. The credit facility includes a three year termthree-year loan for $2.5 million, with a five yearfive-year amortization, at prime + 3% (currently 11.5%)(10.75% at December 31, 1998) and a $2 million revolving line of credit secured by certain accounts receivable of the Company at prime + 1% (currently 9.5%)(8.75% at December 31, 1998). The credit facility is also subject to success fees of $200,000, $225,000 and $250,000 due on the anniversary date of the loan beginning in April, 1999. Taking variousthese fees into consideration and assuming the Company continuously fully utilizes the revolver, the effective rate of interest on the total borrowings is approximately 16.1%. The Balance Sheet asCompany received an increase of June 30, 1998 reflectsits present lending facility from FINOVA Capital Corporation in order to fund the categorizationTeamStaff acquisition. The facility is comprised of (i) a three-year term loan, with a five year amortization, and a balloon payment at the end of three years, in the amount of $2,500,000; (ii) a one year bridge loan in the amount of $750,000 and (iii) an increase in the Company's revolving line of credit from $2,000,000 to $2,500,000. The term loan bears an interest rate of prime + 3%, the bridge loan bears a interest rate of prime + 1%. In addition, the Company will incur "success" fees of $200,000, $225,000 and $250,000 due on the anniversary dates of the debt between short-term and long-term due to the new financing. The short-term portion reflects the next twelve months of principal payments due FINOVA starting June 1, 1998. The long-term portion reflects the balanceloan. Management of the debt owed as of JuneCompany believes that its existing cash and available borrowing capacity will be sufficient to support cash needs through September 30, 1998.1999. 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. The Company anticipates that its available funds, together with cash generated from operations and amounts that may be borrowed under the credit facility will be sufficient to fund working capital and debt service requirements for the next twelve months. Year 2000 Issue 1312 of 16 1413 YEAR 2000 ISSUE The year 2000 issue is the programming of computer systems to recognize the values "00" in a date field as the year 2000 and not the year 1900. The Company began steps in 1997 to reasonably ensure that the software it utilizes will be year 2000 compliant. The Company is utilizing internal staffhas evaluated the Year 2000 readiness of the hardware and external sources to make its information technology/computer systems year 2000 compliant.software products used by the Company. The Company's assessment covered the following phases: (1) identification of all Products, IT Systems, and non-IT Systems, such as building security and voice mail; (2) assessment of repair or replacement requirements; (3) testing and (4) implementation. The assessment and the first phases of testing and implementation were completed in fiscal 1998, and based on this, the Company believes that, with some modifications to existing software and conversions to new software, the year 2000 issue will not pose significant operational problems. The replacement, final testing and implementation will be complete in February of 1999. The costs of these modifications are not expected to have a material impact on the Company's financial position. StatementHowever, the assessment of Financial Accounting Standards In June, 1997,whether a complete system or device will operate correctly depends in large part on the Financial Accounting Standards Board (FASB) issued StatementYear 2000 compliance of Financial Accounting Standards No. 130, "Reporting Comprehensive Income" ("SFAS 130"),the product or system's other components, many of which establishes standards for reportingare supplied by parties other than the Company. The supplier of the Company's current financial and displaying comprehensive income and its components. The components of comprehensive income refer to revenues, expenses, gains and losses that are excluded from net income under current accounting standards, including unrecognized foreign currency translation items, minimum pension liability adjustments and unrealized gains and losses on certain investments in debt and equity securities. SFAS 130 requires that all items that are recognized under accounting standards as components of comprehensive income be reported in a financial statement displayed in equal prominence with the other financial statements; the total of other comprehensive income for a period is required to be transferred to a component of equity that is separately displayed in a statement of financial position at the end of an accounting period. SFAS 130 is effective for both interim and annual periods beginning after fiscal December 15, 1997, at which timesoftware has informed the Company that such software is Year 2000 compliant. Further, the Company relies on various vendors, utility companies, telecommunication service companies, delivery service companies and other service providers who are outside of the Company's control. There is no assurance that such parties will adoptnot suffer Year 2000 business disruption, which could impact the provisions. The Company does not expect SFAS 130 to have a material effect on reported results.Company's financial condition and results of operations. NEW ACCOUNTING PRONOUNCEMENTS In June 1997, the FASB issued Statement of Financial Accounting Standards No. 131, "Disclosures about Segments of an Enterprise and Related Information" ("SFAS 131"). SFAS 131 establishes standards for the way public enterprises are to report information about operating segments in interim financial statements and requires the reporting of selected information about operating segments in interim financial reports issued to shareholders. It also establishes standards for related disclosures about products and services, geographic areas and major customers. SFAS 131 is effective for periods beginning after fiscal December 15, 1997, at which time the Company will adopt the provisions. The Company does not expect SFAS 131 to have a material effect on reported results. In March, the AICPA issued Statement of Position 98-1 ("SOP 98-1"), "Accounting for the Costs of Computer Software Developed or Maintained for Internal Use." SOP 98-1 provides guidance on the treatment of costs related to internal use software. SOP 98-1 is effective for fiscal years beginning after December 15, 1998, at which time the Company will adopt the provisions. The Company does not expect SOP 98-1 to have a material effect on reported results. In April 1998, the AICPA issued Statement of Position 98-5 ("SOP 98-5"), "Reporting on the Cost of Startup Activities". SOP 98-5 provides guidance on the financial reporting of startup costs and organization costs and requires that the cost of startup activities and organization costs be 13 of 16 14 expensed as incurred. SOP 98-5 is effective for fiscal years beginning after December 15, 1998, at which time the Company will adopt the 14 of 16 15 provisions. The Company does not expect SOP 98-5 to have a material effect on reported results. PART II OTHER INFORMATION ItemITEM 1. Legal Proceedings At June 30,LEGAL PROCEEDINGS The Company's subsidiary, DSI Staff Connxions-Southwest, Inc., is the defendant in a suit (Frederico Farias v. Thomson Consumer Electronics and DSI Staff Connxions-Southwest, Inc.; 327th Judicial District Case No. 96-3036; District Court of El Paso County, Texas) whereby a former leased employee of a client obtained a judgment against the Company during August, 1998 in the amount of $315,000 including interest. The judgment includes approximately $115,000 in compensatory damages and $200,000 in punitive damages. The Company has posted a bond for the full amount of the judgment and is appealing the judgment. Management of the Company, after consultation with counsel, believes that there is no basis for the awarding of punitive damages, and that the award of compensatory damages was based on insufficient evidence. Although there can be no assurances the Company will be successful in prosecuting the appeal, the management of the Company, after consultation with counsel, believes it will obtain a reversal of the judgment. If the Company is involvednot successful with the appeal, the Company would record expense of $315,000. The Company is also a defendant in various other legal proceedings incurreda lawsuit (ASI Group, Inc. and Terri Munkirs v. Digital Solutions, Inc., George Eklund and Miriam H. Silverman; Superior Court of New Jersey, Law Division, Middlesex County, Docket No. 8906-97) which is currently pending in the normal courseSuperior Court of business. The Company continues to pursue the collection of past due accounts receivable balances. In the opinion of management and its counsel, none of these proceedings would haveNew Jersey. This action was brought by a material effect, if adversely decided, on the consolidated financial position or results of operationscompetitor of the Company. Item 5. Other Information On April 28, 1998, the Company entered into a loan and security agreement (the "Agreement") with Finova Capital Corporation ("Finova") which provided a facility in the aggregate amount of $4,500,000. The facility includes a revolving loan in the maximum amount of $2,000,000 secured by certain eligible receivables as defined in the Agreement, and a three-year term loan in the aggregate amount of $2,500.000. The term loan bears interest at the rate of prime plus 3% and the revolving loan bears interest at prime plus 1%. The proceeds of the loan were used to repay the existing balance of the Company's previous credit facility maintained with Summit Bank, and for general working capital. The timely retirement of the Summit Bank facility enabled the Company to cancel a warrant to purchase 500,000 shares of Common Stock issued to Summit upon the renewal of the bank loan in October 1997. In addition, the Company was also required to pay additional fees and expenses of Finova in connection with the establishmenttransfer of several former clients of the credit facility. On July 14, 1998,competitor to the Company. The Company has denied the material allegations of the complaint. Discovery in the case is in the preliminary stages. The plaintiffs have submitted a calculation of damages of $300,000 for the claims identified in the lawsuit which includes damages for clients which never became clients of the Company. Although there can be no assurances the Company announced that two new directors had been elected, increasingwill be successful in defending the board membershipclaim, management of the Company, after consultation with counsel, believes it has meritorious defenses against the claim. The Company is engaged in no other litigation, the effect of which would be anticipated to seven. The new directors are Mr. Charles R. Dees, Jr. Ph.D.,have a nationally known university administrator and former official inmaterial adverse impact on the U.S. DepartmentCompany. ITEM 5. OTHER INFORMATION Effective January 14, 1999, George Eklund resigned as a Director of Education and Mr. Martin J. Delaney, a prominent healthcare executive. Itemthe Company due to personal reasons. 14 of 16 15 ITEM 6. Exhibits and Reports on FormEXHIBITS AND REPORTS ON FORM 8-K (a) Exhibits - None3.1 Amendment to amended and restated certificate of incorporation (b) Reports on Form 8-K none filed during the quarter ended June 30, 1998.Date of Report Item Reported 12/24/98 Item 2 - Acquisition or Disposition of Assets 11/10/98 Item 5 - Other Events 15 of 16 16 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,TEAMSTAFF, INC. (Registrant) /s/ Donald W. Kappauf ------------------------------------------------------ Donald W. Kappauf Chief Executive Officer /s/ Donald T. Kelly ------------------------------------------------------ Donald T. Kelly Chief Financial Officer Date: July 24, 1998February 9, 1999 16 of 16