EXHIBIT 7.1
PROFESSIONAL STAFF MANAGEMENT
Combined Financial Statements
Years Ended December 31, 2002 and 2001
PROFESSIONAL STAFF MANAGEMENT
Table of Contents
Independent Auditors' Report on the Combined Financial Statements.....Page 1
Financial Statements
Combined Balance Sheets........................................... 2
Combined Statements of Operations and Retained Earnings........... 3
Combined Statements of Cash Flows................................. 4
Notes to Combined Financial Statements............................ 5
Independent Auditors' Report
To the Board of Directors
PROFESSIONAL STAFF MANAGEMENT
Richmond, Indiana
We have audited the accompanying combined balance sheets of PROFESSIONAL STAFF
MANAGEMENT as of December 31, 2002 and 2001, and the related combined statements
of operations and retained earnings and cash flows for the years then ended.
These combined financial statements are the responsibility of the Companies
management. Our responsibility is to express an opinion on these combined
financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing standards
of the United States. Those standards require that we plan and perform the
audits to obtain reasonable assurance about whether the combined financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the combined
financial statements. An audit also includes assessing the accounting principles
used and significant estimates made by management, as well as evaluating the
overall financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the combined financial statements referred to above present
fairly, in all material respects, the financial position of PROFESSIONAL STAFF
MANAGEMENT, as of December 31, 2002 and 2001, and the results of its combined
operations, and its cash flows for the years then ended in conformity with
generally accepted accounting principles of the United States.
/s/ Whipple & Company, PC
Indianapolis, Indiana
December 5, 2003
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PROFESSIONAL STAFF MANAGEMENT
Combined Balance Sheets
December 31, 2002 and 2001
2002 2001
----------- -----------
Assets
Current Assets
Cash and cash equivalents $ 2,179,538 $ 415,141
Restricted savings account 101,000 0
Certificates of deposit 1,386,926 1,488,116
Accounts receivable, net 640,789 575,446
Interest receivable 9,316 1,027
Prepaid expenses 178,414 60,965
Deferred tax asset 0 297,000
----------- -----------
Total Current Assets 4,495,983 2,837,695
----------- -----------
Property and Equipment
Equipment and vehicles 187,461 191,461
Accumulated depreciation (141,305) (106,326)
----------- -----------
Total Property and Equipment 46,156 85,135
----------- -----------
Other Assets
Certificates of deposit - long term 0 63,267
Deposits 44,176 43,680
Other assets 25,000 25,000
----------- -----------
Total Other Assets 69,176 131,947
----------- -----------
Total Assets $ 4,611,315 $ 3,054,777
=========== ===========
2002 2001
----------- -----------
Liabilities and Shareholder's Equity
Current Liabilities
Current maturities of notes payable $ 7,829 $ 6,910
Accounts payable 154,113 82,891
Payroll taxes and withholdings 508,737 391,519
Accrued worksite employee payroll cost 297,471 116,339
Health and workers' compensation reserves 2,593,680 1,911,518
Due to shareholder 14,772 12,975
Customer deposits 234,639 255,392
Other accrued liabilities 85,649 67,431
----------- -----------
Total Current Liabilities 3,896,890 2,844,975
Long-term Liabilities
Notes payable, less current maturities 1,921 9,817
----------- -----------
Total Liabilities 3,898,811 2,854,792
----------- -----------
Shareholder's Equity
Common stock 100 100
Additional paid-in capital 4,778 4,778
Retained earnings 707,626 195,107
----------- -----------
Total Shareholder's Equity 712,504 199,985
----------- -----------
Total Liabilities and Shareholder's Equity $ 4,611,315 $ 3,054,777
=========== ===========
See accompanying notes
2
PROFESSIONAL STAFF MANAGEMENT
Combined Statements of Operations and Retained Earnings
For the Years Ended December 31, 2002 and 2001
2002 % 2001 %
------------ ----- ------------ -----
Revenues (gross billings of $105,880,000
$81,570,000, less worksite employee
payroll cost of $90,504,089 and
$70,304,321, respectively) $ 15,375,911 100.0 $ 11,265,679 100.0
Direct cost of services 12,577,425 81.8 10,424,930 92.5
------------ ----- ------------ -----
Gross Profit 2,798,486 18.2 840,749 7.5
------------ ----- ------------ -----
Operating Expenses
Salaries, wages and payroll taxes 1,490,400 9.7 1,199,722 10.6
General and administrative expenses 518,273 3.4 424,448 3.8
Advertising 16,890 0.1 43,309 0.4
Depreciation 38,179 0.2 37,863 0.3
------------ ----- ------------ -----
Income (Loss) from Operations 734,744 4.8 (864,593) (7.6)
------------ ----- ------------ -----
Other Income (Expense)
Interest income) 71,145 0.5 115,384 1.0
Interest expense (1,574) 0.0 (2,672) 0.0
Other income 15,204 0.1 7,121 0.1
------------ ----- ------------ -----
Total Other Income (Expense) 84,775 0.6 119,833 1.1
------------ ----- ------------ -----
Income (loss) before income taxes 819,519 5.4 (744,760) (6.5)
Provision for income tax expense (benefit) 307,000 2.0 (297,000) (2.6)
------------ ----- ------------ -----
Net Income (Loss) 512,519 3.4 (447,760) (3.9)
===== =====
Retained Earnings, Beginning of Year 195,107 642,867
------------ ----------
Retained Earnings, End of Year $ 707,626 $ 195,107
============ ==========
See accompanying notes.
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PROFESSIONAL STAFF MANAGEMENT
Combined Statements of Cash Flows
For the Years Ended December 31, 2002 and 2001
2002 2001
----------- -----------
Cash Flows from Operating Activities
Net income (loss) $ 512,519 ($ 447,760)
----------- -----------
Adjustments to reconcile net income (loss) to net cash
provided by (used in) operating activities:
Depreciation 38,179 37,863
Changes in operating assets and liabilities:
Accounts receivable, net (65,343) 59,814
Interest receivable (8,289) (1,027)
Prepaid expenses (117,449) (9,934)
Deferred tax asset 297,000 (297,000)
Other assets (496) (32,696)
Accounts payable 71,222 55,264
Other accrued liabilities 18,218 (11,673)
Payroll taxes and withholdings 117,218 (101,605)
Accrued worksite employee payroll cost 181,132 (35,542)
Health and workers' compensation reserves 682,162 626,119
Customer deposits (20,753) (87,996)
----------- -----------
Total Adjustments 1,192,801 201,587
----------- -----------
Net cash provided by (used in) operating activities 1,705,320 (246,173)
----------- -----------
Cash Flows from Investing Activities
Proceeds from the sale of property 800 0
Purchases of certificate of deposit (1,322,240) (1,386,964)
Maturities of certificate of deposit 1,486,697 707,085
----------- -----------
Net cash provided by (used in) investing activities 165,257 (679,879)
----------- -----------
Cash Flows from Financing Activities
Principal payments on long-term debt (6,977) (5,315)
Changes in due to shareholder 1,797 6,637
----------- -----------
Net cash proivided by (used in) financing activities (5,180) 1,322
----------- -----------
Net Increase (Decrease) in Cash and Cash Equivalents 1,865,397 (924,730)
Cash and Cash Equivalents, Beginning of Year) 415,141 1,339,871
----------- -----------
Cash and Cash Equivalents, End of Year $ 2,280,538 $ 415,141
=========== ===========
Supplemental Cash Disclosures
Interest paid $ 1,574 $ 2,672
=========== ===========
Income taxes paid $ 14,000 $ 15,000
=========== ===========
See accompanying notes.
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PROFESSIONAL STAFF MANAGEMENT
Notes to Combined Financial Statements
December 31, 2002 and 2001
Note 1 - Nature of Operations and Summary of Significant Accounting Policies:
Nature of Operations
Professional Staff Management ("the Companies") are common ownership
professional employer organizations ("PEO"). The Companies provide an integrated
approach to the management and administration of the human resources and
employer risks of their clients. The Companies are able to achieve this by
contractually assuming substantial employer rights, responsibilities, and risks;
and through the establishment and maintenance of an employer relationship with
the workers assigned to their clients. The Companies retain the following rights
in connection with services performed for their clients:
o Assumes responsibility as an employer for purposes of the workers
assigned to that location
o Reserves right of direction and control of the employees and can share
responsibility with their clients, consistent with their client's
responsibility for their products and services
o Pays the wages and employment taxes of the employee out of the
Companies' own accounts
o Establish and maintain an employment relationship with its employees
which is intended to be long-term and not temporary
o Retains right to hire, reassign, and fire their employees
The combined financial statements of the Companies consist of two related
entities wholly owned by one shareholder. Intercompany accounts and transactions
have been eliminated in combination. Subsequent to December 31, 2002, and before
the business combination discussed in Note 11, the Companies' sole shareholder
formed a third PEO Company.
The Companies' corporate office is located in Richmond, Indiana, with an
additional office located in Carmel, Indiana. The primary market and the
majority of these PEO employees are in Indiana.
Revenue and Cost Recognition
The gross billings in which the Companies charge their clients under their
Professional Services Agreement include each worksite employee's gross wages, a
service fee and, to the extent elected by the clients, health and welfare
benefit plan costs. The Companies' service fee, which is computed as a
percentage of gross wages, is intended to yield a profit to the Companies and
cover the cost of employment-related taxes, workers' compensation insurance
coverage, and administrative and field services provided by the Companies to the
client, including payroll administration and record keeping, as well as safety,
human resources, and regulatory compliance consultation. The component of the
service fee related to administration varies, in part, according to the size of
the client, the amount and frequency of payroll payments and the method of
delivery of such payments. The component of the service fee related to workers'
compensation and unemployment insurance is based, in part, on the client's
historical claims experience. All charges by the Companies are invoiced along
with each periodic payroll delivered to the client.
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PROFESSIONAL STAFF MANAGEMENT
Notes to Combined Financial Statements
December 31, 2002 and 2001
Note 1 - Nature of Operations and Summary of Significant Accounting Policies
(Continued):
Revenue and Cost Recognition (Continued)
The Companies report revenues in accordance with Emerging Issues Task Force
("EITF") No. 99-19, Reporting Revenue Gross as a Principal versus Net as an
Agent. The Companies report revenues on a gross basis, the total amount billed
to clients for service fees, health and welfare benefit plan fees, workers'
compensation, unemployment insurance fees, and employment related taxes. The
Companies report these revenues on a gross basis for such fees because the
Companies are the primary obligor and deemed to be the principal in these
transactions under EITF No. 99-19. However, the Companies report revenues on a
net basis for the amount billed to clients for worksite employee salaries and
wages. The Companies account for their revenues using the accrual method of
accounting. Under the accrual method of accounting, the Companies recognize
their revenues in the period in which the worksite employee performs work. The
Companies accrue revenues for service fees, health and welfare benefit plan
fees, workers' compensation and unemployment insurance fees relating to work
performed by worksite employees but unpaid at the end of each period. The
Companies accrue unbilled receivables for payroll and payroll taxes, service
fees, health and welfare benefits plan fees, workers' compensation and
unemployment insurance fees relating to work performed by worksite employees but
unpaid at the end of each period. In addition, the related costs of services are
accrued as a liability for the same period. Subsequent to the end of each year,
such costs are paid and the related service fees are billed.
This accounting policy of reporting revenues net as an agent was adopted by the
Companies as a result of recommendations by the Securities and Exchange
Commission staff to public companies subject to reporting requirements under
section 13 or 15(d) of the securities exchange act of 1934. To conform to this
method, the Companies reclassified worksite employee payroll costs of
$90,509,089 and $70,304,321 for the years ended December 31, 2002 and 2001,
respectively. This reclassification has no effect on gross profit, operating
income (loss), or net income (loss).
Accounts Receivable
Accounts receivable consists of both trade accounts receivable and unbilled
accounts receivable. Trade accounts receivable represent revenues recognized and
billed during the year. Unbilled accounts receivable include revenues that have
been recognized, but not invoiced at the end of the year.
The Companies carry their accounts receivable at invoiced amounts less an
allowance for doubtful accounts. On a periodic basis, the Companies evaluate
their accounts receivable and establish an allowance for doubtful accounts,
based on history of past write-offs and collections and current credit
conditions. Management has established an allowance for doubtful accounts of
$36,501 and $22,129 as of December 31, 2002 and 2001, respectively. The
Companies' policy is not to accrue interest on past due accounts receivables.
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PROFESSIONAL STAFF MANAGEMENT
Notes to Combined Financial Statements
December 31, 2002 and 2001
Note 1 - Nature of Operations and Summary of Significant Accounting Policies
(Continued):
Shipping and Handling
The Companies charge shipping and handling costs as a component of general and
administrative expenses. Shipping and handling costs amounted to $29,781 and
$33,110 for the years ended December 31, 2002 and 2001, respectively. The
corresponding revenue charges to the customers are included in other income.
Property, Equipment, and Depreciation
Property and equipment are carried at cost and includes expenditures for new
additions and those, which substantially increase the useful lives of existing
assets. Depreciation is computed by use of the straight-line method. Depreciable
lives are generally as follows:
Vehicles 5 years
Office furniture and Equipment 5 years
Expenditures for normal repairs and maintenance are charged to operations as
incurred. The cost of property or equipment retired or otherwise disposed of and
the related accumulated depreciation are removed from the accounts in the year
of disposal with the resulting gain or loss reflected in earnings or in the cost
of the replacement asset.
The provision for depreciation amounted to $38,179 and $37,863 for the years
ended December 31, 2002 and 2001, respectively.
Income Taxes
Income taxes are provided for the tax effects of transactions reported in the
combined financial statements and consist of taxes currently due plus deferred
taxes. Deferred tax assets and liabilities are recognized for the differences
between the basis of assets and liabilities for financial reporting and income
tax purposes. Those differences relate primarily to health and workers'
compensation reserves and certain accrued expenses. The deferred tax assets and
liabilities represent the future tax consequences of those differences, which
will either be taxable or deductible when the assets and liabilities are
recovered or settled. Deferred taxes are also recognized for any operating loss
carryforward, charitable contribution carryforward, and tax credit carryforward
that are available to offset future income taxes.
Advertising
The Companies charge advertising costs to expense as incurred. Advertising
expenses amounted to $16,890 and $43,309 for the years ended December 31, 2002
and 2001, respectively.
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PROFESSIONAL STAFF MANAGEMENT
Notes to Combined Financial Statements
December 31, 2002 and 2001
Note 1 - Nature of Operations and Summary of Significant Accounting Policies
(Continued):
Cash Flows
For purposes of the Statements of Cash Flows, the Companies consider all highly
liquid instruments that are purchased within three months or less of an
instruments maturity date to be cash equivalents.
Use of Estimates
The preparation of combined financial statements in conformity with generally
accepted accounting principles of the United States require management to make
estimates and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at the date of
the combined financial statements and the reported amounts of revenues and
expenses during the reporting period. Actual results could differ from those
estimates.
Note 2 - Long-term Debt:
2002 2001
-------- --------
Notes payable to bank:
Due in monthly installments of $652, including
interest at 7% through March 22, 2004. Secured
by a vehicle $ 9,750 $ 16,727
-------- --------
9,750 16,727
Less current maturities (7,829) (6,910)
-------- --------
$ 1,921 $ 9,817
======== ========
Principal payments due on long-term debt outstanding at December
31, 2002, are as follows:
Year Ending December 31,
2003 $ 1,921
Later Years 0
--------
$ 1,921
========
Note 3 - Restricted Savings Account and Letter of Credit Arrangements:
The Companies maintain a savings account, which serves as collateral in
connection with the Companies' workers' compensation and has been classified as
restricted in the accompanying combined balance sheets. The interest earned on
this savings account is recognized as interest income in the Companies' combined
statements of operations.
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PROFESSIONAL STAFF MANAGEMENT
Notes to Combined Financial Statements
December 31, 2002 and 2001
Note 3 - Restricted Savings Account and Letter of Credit Arrangements
(Continued):
The Companies have an irrevocable standby letter of credit with a bank in the
amount of $101,000 at December 31, 2002. The beneficiary is the Companies' prior
workers' compensation carrier. The arrangement expired February 1, 2003.
Subsequent to December 31, 2002, the Companies renewed the arrangement through
February 1, 2004, in the amount of $116,000.
Subsequent to December 31, 2002, the Companies entered into an additional
irrevocable standby letter of credit with a bank in the amount of $130,000. The
beneficiary is the Companies' current workers' compensation carrier and the
arrangement expires December 31, 2003.
Note 4 - Retirement Plan:
The Companies maintain a profit-sharing plan that covers all employees who meet
the eligibility requirements set forth in the plan. Company contributions are
made at management's discretion and are allocated based upon each participant's
eligible compensation.
The plan includes a 401(k) savings plan whereby employees can contribute and
defer taxes on compensation contributed to the plan. The Companies are not
required to contribute to the plan but may make a discretionary contribution.
The following summarizes the Companies' contributions for the years ended
December 31, 2002 and 2001:
2002 2001
-------- --------
Profit-sharing contribution $ 0 $ 0
401(k) contribution 10,000 9,000
-------- --------
$ 10,000 $ 9,000
======== ========
Leased employees are not included in these amounts as these retirement plan
costs are billed through the Companies customers.
Note 5 - Common Stock:
The Companies have voting stock with equal voting rights. All of the stock is no
par value.
The following summarizes the Companies' shares of common stock as of December
31, 2002 and 2001:
Authorized 1,000
Issued 625
Outstanding 625
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PROFESSIONAL STAFF MANAGEMENT
Notes to Combined Financial Statements
December 31, 2002 and 2001
Note 6 - Income Taxes:
The Companies account for income taxes in accordance with Statement of Financial
Accounting Standards ("SFAS") No. 109, "Accounting for Income Taxes", requires
deferred tax assets and liabilities be recognized using enacted tax rates for
the effect of temporary differences between book and tax basis of assets and
liabilities. SFAS No. 109 also requires deferred tax assets be reduced by a
valuation allowance if it is more likely than not that some portion or all of
the deferred tax assets will not be realized. Recognition of a deferred tax
asset is dependent on generating sufficient future taxable income in the United
States. In its evaluation of the adequacy of the valuation allowance, the
Companies assess prudent and feasible tax planning strategies.
A reconciliation of recorded Federal income tax expense (benefit) to the
expected expense (benefit) computed by applying the Federal statutory rate of
35% for all periods to income before income taxes follows:
2002 2001
--------- ---------
Computed expenses at 35% of pre-tax income $ 269,000 $(260,000)
State and local taxes (net of federal tax benefit) 38,000 (37,000)
--------- ---------
Provision for Income Taxes $ 307,000 $(297,000)
========= =========
The significant components of the Companies' deferred tax asset are as follows:
2002 2001
--------- ---------
Deferred Tax Assets
Claims Reserves $ 200,000 $ 139,000
Customer Deposits 100,000 102,000
Worker's Compensation 95,000 78,000
Allowance for Doubtful Accounts 9,000 9,000
Net Operating Losses 0 297,000
Less: Deferred Tax Liabilities 404,000 328,000
--------- ---------
Net Deferred Tax Asset $ 0 $ 297,000
========= =========
Note 7 - Operating Lease Commitments:
The Companies lease their Richmond, Indiana office from a related party, owned
by the Companies' sole shareholder. The lease is on a month-to-month basis and
currently provides for monthly payments of $1,571. Rent expense under this
arrangement amounted to $18,852 for both years ended December 31, 2002 and 2001.
10
PROFESSIONAL STAFF MANAGEMENT
Notes to Combined Financial Statements
December 31, 2002 and 2001
Note 8 - Self-Funded Health Insurance:
The Companies' Employee Benefit Plan provides their employees and their
dependents with comprehensive health care coverage. A portion of that coverage
is self-funded by the Companies. Under the insurance policy with the Plan's
underwriter, the Companies' self-funded liability is limited for each plan year
to $100,000, $150,000, and $150,000 per employee for the plan years ended June
30, 2001, 2002, and 2003, respectively, with an aggregate liability limit of
$9,000,000, $10,000,000, and $10,578,000, respectively. The liability limits are
adjusted monthly, based on the number of participants.
The plan is administered by Unified Group Services for the plan year ended June
30, 2003. Key Benefit Administrators (KBA) was the TPA for the years ended June
30, 2002 and 2001. In addition, the Companies pay a monthly fee to provide
administrative, cost containment, prescription card, and preferred provider
organization fees.
Note 9 - Related Party Transactions:
Amounts due to the Companies sole shareholder are comprised of the following at
December 31, 2002 and 2001:
2002 2001
-------- --------
Due to Shareholder $ 14,772 $ 12,975
As discussed in Note 7, the Companies lease their Richmond, Indiana office from
a related party. The lease is on a month-to-month basis and provides for monthly
payments of $1,571.
Note 10 - Concentration of Credit Risk:
The Companies financial instruments that are exposed to concentrations of credit
risk consist primarily of cash and cash equivalents, certificates of deposit,
and accounts receivables. The Companies place their cash and cash equivalents
with high credit quality institutions. At times, such amounts may be in excess
of the FDIC insured limit. At December 31, 2002 and 2001, the Companies cash
exceeded federally insured limits by approximately $2,065,000 and $75,000,
respectively.
The Companies routinely assess the financial strength of its customers and, as a
consequence, believe that their accounts receivable credit risk exposure is
limited.
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PROFESSIONAL STAFF MANAGEMENT
Notes to Combined Financial Statements
December 31, 2002 and 2001
Note 11 - Subsequent Event - Business Combination:
Merger with Fortune Diversified Industries, Inc.
On October 1, 2003, Fortune Diversified Industries, Inc. (FDVI) acquired all of
the outstanding shares of common stock of the Companies pursuant to the
following agreements:
AGREEMENT AND PLAN OF MERGER entered into the 1st day of October 2003,
by and among Professional Staff Management, Inc., an Indiana
corporation, PSM Acquisition, Inc., an Indiana corporation and wholly
owned subsidiary of FDVI, Harlan M. Schafir, and FDVI.
AGREEMENT AND PLAN OF MERGER entered into the 1st day of October 2003 by
and among Professional Staff Management, Inc. II, an Indiana
corporation, PSM Acquisition II, Inc., an Indiana corporation and wholly
owned subsidiary of FDVI, Harlan M. Schafir, and FDVI.
AGREEMENT AND PLAN OF MERGER entered into the 1st day of October 2003 by
and among Pro Staff, Inc., an Indiana corporation, PSM Acquisition III,
Inc., an Indiana corporation and wholly owned subsidiary of FDVI, Harlan
M. Schafir, and FDVI.
The agreements were intended to qualify as a "reorganization" pursuant to the
provisions of Section 368 of the Internal Revenue Code and specifically as a
reverse-triangular merger under Code Section 368(a)(2)(E). For accounting
purposes the business combination is being accounted for as a purchase under
SFAS No. 141, "Business Combinations". The Merger Agreements' terms include,
among other things, the exchange of all of the outstanding shares of the
Companies three wholly owned subsidiaries as of the purchase date, Professional
Staff Management, Inc. (125 shares); Professional Staff Management, Inc., II
(500 shares); and Pro Staff, Inc. (500 shares), all held by Harlan M. Schafir,
for a combination of cash and FDVI common stock.
The principle followed in determining the amount of consideration paid was the
ongoing value of the three companies, with adjustments thereto for certain
aspects of the transaction, including earnings benchmarks as defined by the
Agreement. Professional Staff Management, Inc., Professional Staff Management,
Inc. II, and Pro Staff, Inc., were acquired through the parties identified
above.
Prior to the Merger Agreements, there was no material relationship between FDVI
or any of its subsidiaries and the Companies.
12