Management's strategy going forward involves three elements: those related to our balance sheet and capitalization; those related to staffing the organization; and those related to our revenues, market presence, margins and operating metrics.
a) Balance Sheet and Capitalization
Improving our balance sheet is a priority in order to attract the additional capital needed to improve our financial viability and to allow us to implement our growth strategy (see "Revenues, Margins and Metrics" below). As part of this process, we raised more than $2.0 million in March 2004 through the sale of convertible preferred stock. We have also entered into certain new credit agreements with lenders on better terms than previously available to us. When the opportunity arises, we have settled some liabilities at a discount.
b) Staffing and New Business Development
We are constantly seeking ways to upgrade our organization through aggressive recruitment of talented professional recruiters. We look for individuals with strong "corporate books" of business. We have the systems in place to track various performance metrics at the individual recruiter level. We also monitor productivity at the agency level, the regional level and the industry level. We endeavor for every manager to understand the interrelationship between "team building" and productivity. Managers are instructed to assess teams and individual personalities in order to find the right combination of personalities and skill sets that will meet the client's needs. Corporate management tracks the organization's macro efficiency through several key "efficiency metrics" which include: gross margin, net margin and operating income at the agency level. Management also reviews actual and projected revenues for direct placements versus temporary and contract staffing in each of our core industries in order to determine potential gross profits and where management needs to focus its attention for future profitability. Management believes that these metrics allow it to gauge our ability to generate cash from our core operations. Selling and administrative expenses and other overhead costs, financing costs and other corporate activities are assessed separately and distinctly for their financial impacts.
c) Revenues, Margins and Metrics
Management believes that the worst of the recession is over. We expect acquisitions and other business combinations to represent the bulk of our growth going forward. During 2005, we experienced some year-over-year growth in our higher-margin temporary business. Through growth (both in the form of acquisitions and internal) we plan to seek direct placement revenues of approximately 25% of total net revenues and at least $12 million. We also seek to grow our temporary and contract revenues to at least $36 million of total net revenues.
Management believes that profitability will depend on maintaining sufficient contract revenues to cover all fixed costs and on achieving a proper balance with direct placement revenues. Therefore, we are actively seeking merger and/or acquisition candidates in our target industries that meet our goals for margins and customer quality.
Even though margins in the temporary and contract staffing business are lower than in the direct placement business, the revenue is recurring and more predictable and generates margins that help cover fixed costs. We also have seen that as economic conditions decline, a higher mix of temporary and contract staffing revenue is essential to survival in the staffing industry; however, as the market improves, a shift to a higher mix of direct placement revenue should be implemented. Management will, therefore, focus concurrently on its stated acquisition strategy, improving core productivity of its existing businesses, as well as our revenue mix.
To obtain greater visibility with our customers, we have also been actively seeking to be designated as an "approved vendor" with some of our larger current and prospective clients, offering to undergo the rigorous review of our processes and capabilities that such designation generally entails. Overall, we serve our customers by maintaining and growing our database of approximately 850,000 highly specialized individuals in the technology, engineering and healthcare industries. These individuals have skill sets to place primarily in the $50,000 - $200,000 salary range for full-time positions or approximately $50 - $175 per hour on temporary assignments.
Trademark and Marketing
Our MAGIC trademark, which is registered with the United States Patent and Trademark Office, is and will be the brand name of our business.
Historically, our marketing efforts have been implemented at the local agency level and relied primarily on telephone solicitation, online advertising, referrals from other Company offices and, to a lesser extent, yellow pages, newspaper advertising, and direct mail. Currently, we operate under several subsidiary names, including Datatek, Texcel, and Management Alliance plus several agency names. We have begun a review to determine the most effective way to capitalize on the strong local brands of our existing business units, with a view towards creating an organization with a small family of established brands and one national identity: MAGIC.
Competition
The employment services industry is very competitive and fragmented. There are limited barriers to entry and new competitors frequently enter the market. A significant number of our competitors possess substantially greater resources than the Company. Additionally, we face substantial competition for potential clients and for technical and professional personnel from providers of outsourcing services, systems integrators, computer systems consultants, other providers of staffing services, temporary personnel agencies and search firms, which range from large national companies to local employment staffing entities. Large national companies that offer employment staffing services include the appropriate technical services, information technology and direct placement business units of Adecco SA, CDI Corp, MPS Inc., Kforce Inc., and Manpower Inc. as well as several other privately held firms. Other companies we compete with include Butler International, Inc., General Employment Enterprises, Inc., RCM Technologies, Inc., Robert Half International Inc., Professional Staff, PLC, Comforce Corp., Kelly Services, Inc., National Technical Systems, Inc., and TechTeam Global, Inc. Local employment staffing entities are typically operator-owned, and each market generally has one or more significant competitors. In addition, we compete with national clerical and light industrial staffing firms, such as Spherion Corporation and Administaff Inc., which also offer contract staffing services. National and regional consulting firms also offer certain employment staffing services. In addition, we are always exposed to the risk that certain of our current and prospective clients will decide to hire full-time employees who will provide the relevant services internally. There can be no assurance that we will be able to continue to compete effectively with existing or potential competitors.
Regulation
Most states require direct placement firms to be licensed in order to conduct business or bid on certain government contracts. Such licenses may be revoked upon material noncompliance with state regulations. Any such revocations would have a materially adverse effect on our business within that market. We believe that we are in substantial compliance with all such regulations and possess all licenses necessary to engage in the direct placement of personnel in the jurisdictions in which we do business. Various government agencies have advocated proposals from time to time to license or regulate the placement of temporary personnel. We do not believe that such proposals, if enacted, would have a material adverse effect on our business.
Employees
We had 149 full-time employees as of December 31, 2005. Of these employees, 109 were personnel consultants and office managers and 40 were administrative employees located in seven offices nationwide. We consider our relations with our employees to be good.
Additionally, we have non-permanent and contract personnel employed from time to time by our Company for placement with clients. As of December 31, 2005, we had 70 temporary and contract personnel on assignment providing staffing services to our clients.
Risk Factors
We will require additional financing to conduct our operations and fund acquisitions.
We do not currently have sufficient financial resources to fund our operations for the next twelve months without obtaining additional debt or equity funding or selling a portion of our assets. While our lenders continue to supply our capital needs, we received a notice of default from one of our lenders and certain vendors. Our factoring and borrowing arrangements have not supplied adequate funds for our operations. We have had to use other means to provide liquidity.
We have not paid certain vendors when due and have withheld from the IRS our employer and employee payroll taxes. The amount of unpaid payroll taxes as of December 31, 2005 was approximately $3,567,000 plus penalties and interest. The IRS has placed liens on the assets of two of our subsidiaries, although the liens are currently subordinated to our senior lender. As part of the agreement with the IRS, we have made timely payments on all payroll taxes since November 2004. If we fail to maintain timely payments of all federal tax liabilities, the IRS will cancel its subordination agreement, which will cause our senior lenders to cut off our funding. To repay the IRS, provide operating funds and continue our acquisition strategy, we need to find additional financing.
Management believes that we will be able to secure other financing. Such financing will allow us to pursue an acquisition strategy, which, when combined with improved market conditions and the restructuring of our present businesses, would eventually produce enough new revenues and gross profit to cover the operating funds shortfall we are currently experiencing. However, we cannot guarantee that funds will be available, that any acquisitions will, if made, be accretive to our cash flow, or that our creditors will give us the time needed to implement our plan. The inability to obtain additional financing will have a material adverse effect on our financial condition. It may cause us to delay or curtail our business plans. It could also force us to seek protection under bankruptcy laws.
Competition for acquisition opportunities may restrict the Company's future growth by limiting our ability to make acquisitions at reasonable valuations.
Our business strategy includes increasing market share and presence in the staffing industry through strategic acquisitions of companies that complement or enhance our business. We have historically faced competition for acquisitions. In the future, competition could limit our ability to grow through acquisitions or could raise the price of acquisitions to a level where they are less accretive or possibly non-accretive to us. In addition, we may be limited by our ability to obtain financing to consummate desirable acquisitions.
The recent economic downturn, particularly in the information technology ("IT") sector, has adversely affected the demand for the Company's services.
Historically, the general level of economic activity has significantly affected the demand for employment services. As economic activity slows, the use of temporary and contract personnel tend to be curtailed before permanent employees are laid off. The current economic downturn has adversely affected the demand for temporary and contract personnel, which in turn has had an adverse effect on our operating results and financial condition. We expect that future economic downturns will continue to have similar effects. In addition, the slowdown in economic activity reduces our direct placement services as well as companies do not hire new employees. Overall, the recent economic downturn resulted in lowered demand for our services. There can be no assurance that demand will increase with improving economic conditions.
We have experienced the economic slowdown in the IT industry that reflected the continued rationalization of excess capacity in this industry and a general reduction in demand for personnel with expertise in leading hardware, software or networking technologies. This has reduced the demand for our services, and there can be no assurance that demand will increase with improving economic conditions.
The Company's current market share may decrease as a result of limited barriers to entry for new competitors and a discontinuation of clients' outsourcing of their staffing needs.
We face significant competition in the markets we serve and there are few barriers to entry for new competitors. The competition among staffing services companies is intense. We compete for potential clients with providers of outsourcing services, systems integrators, computer systems consultants, temporary personnel agencies, search companies and other providers of staffing services. A number of our competitors possess substantially greater resources than we do. We may face increased competitive pricing pressures and may not be able to recruit the personnel necessary to fill our clients' needs. We also face the risk that certain of our current and prospective clients will decide to fill their needs internally. Further, many staffing customers are now seeking an "offshore" solution, which we do not offer, to support their technology and business process functions. Minimal barriers to entry for new competitors and client demands for lower pricing will continue to exert pressure on our business.
The Company faces significant employment liability risk.
We employ and place people in the workplaces of other businesses. An inherent risk of such activity includes possible claims of errors and omissions, misuse of client proprietary information, misappropriation of funds, discrimination and harassment, employment of illegal aliens, theft of client property, other criminal activity, torts or other claims. We have policies and guidelines in place to reduce our exposure to such risks. However, failure of any employee or personnel to follow these policies and guidelines may result in: negative publicity; injunctive relief; the payment by us of monetary damages or fines; or other material adverse effects upon our business. Moreover, we could be held responsible for the actions at a workplace of persons not under our immediate control. To reduce our exposure, we maintain insurance covering general liability, workers compensation claims, errors and omissions, and employee theft. Due to the nature of our assignments, in particular, access to client information systems and confidential information, and the potential liability with respect thereto, we may not be able to obtain insurance coverage in amounts adequate to cover any such liability on acceptable terms. Our move into healthcare staffing services also exposes us to increasing litigation in this area. In addition, we face various employment-related risks not covered by insurance, such as wage and hour laws and employment tax responsibility.
The Company may be adversely affected by government regulation of the staffing business and the workplace.
Our business is subject to regulation and licensing in many states. While we have had no material difficulty complying with regulations in the past, there can be no assurance that we will be able to continue to obtain all necessary licenses and approvals or that the cost of compliance will not prove to be material. If we fail to comply, such failure could have a material adverse affect on our financial results. We could also be impacted by changes in reimbursement regulations by states or the federal government which make it difficult for our healthcare customers to pay us or require us to lower our rates. In general, increased government regulation of the workplace, or of the employer-employee relationship, could have a material adverse affect on our business.
The Company may not be able to recruit and retain qualified personnel.
We depend upon the abilities of our staff to attract and retain personnel, particularly technical and professional personnel, who possess the skills and experience necessary to meet the staffing requirements of our clients. We must continually evaluate and upgrade our base of available qualified personnel to keep pace with changing client needs and emerging technologies. We expect continued competition for individuals with proven technical or professional skills for the foreseeable future. If qualified personnel are not available to us in sufficient numbers and upon economic terms acceptable to us, it could have a material adverse affect on our business.
The Company relies on short-term contracts with most of our clients.
Because long-term contracts are not a significant part of our business, future results cannot be reliably predicted by considering past trends or extrapolating past results. Further, our reliance on short-term contracts exerts continued pressure on us when we try to renew contracts with existing clients who may seek better terms at each renewal.
The Company has a high concentration of revenues with a limited number of clients so that customer retention is key.
Revenues from the top ten customers represented approximately 47% of total billings in both 2005 and 2004, with the top two customer representing approximately 20% and 17% of total billings in 2005 and 2004, respectively. There were no other customers representing over 10% of billings in either 2005 or 2004. Accounts receivable from one customer represented approximately 12% of total accounts receivable at December 31, 2005.
As such, a loss of one or more of these customers could have a material adverse impact on our business. Our high customer concentration, combined with the inherent difficulty of adding new customers in a tough external environment, means retention of existing customers is critical.
The Company may face difficulties integrating acquisitions into existing operations and face unforeseen problems that can accompany acquiring another company.
We continually evaluate opportunities to acquire staffing companies that complement or enhance our business. These acquisitions involve numerous risks, including:
- potential loss of key employees or clients of acquired companies;
- difficulties integrating acquired personnel and distinct cultures into our business;
- diversion of management attention from existing operations; and
- assumption of liabilities and exposure to unforeseen liabilities of acquired companies.
Although not expected, the potential operational, cultural and financial strains of any acquisition may ultimately have a negative impact on our business and financial condition.
The Company depends on the proper functioning of its information systems.
We are dependent on the proper functioning of information systems in operating our business. Critical information systems are used in every aspect of our daily operations, including the identification and matching of staffing resources to client assignments, customer billing and consultant payment functions. Our information systems are protected through physical and software safeguards, including the use of a third party data storage service. However, we and our systems are still vulnerable to natural disasters, fire, terrorist acts, power loss, telecommunications failures, physical or software break-ins, computer viruses and similar events. If our critical information systems fail or are otherwise unavailable, we would have to accomplish these functions manually, which could temporarily impact our ability to identify placement opportunities, to maintain billing records, and to bill for services. In addition, we depend on third party vendors for certain functions whose future performance and reliability we cannot warranty.
The Company's success depends upon retaining the services of its management team.
We are highly dependent on our management team and expect that continued success will depend largely upon their efforts and abilities. The loss of the services of certain key executives for any reason could have a material adverse effect upon us. Our success also depends upon our ability to identify, develop, and retain qualified operating employees, particularly management, client servicing, and candidate recruiting employees. We expend significant resources in the recruiting and training of our employees, as the pool of available applicants for these positions is limited. The loss of some of our key operating employees could have an adverse effect on our operations, including our ability to establish and maintain client and candidate professional and technical relationships.
Significant control over the Company is exercised by a limited number of persons.
A majority of our issued and outstanding voting shares are held by a limited number of shareholders. By acting in concert, these shareholders have the ability to control the outcome of matters submitted to a vote of shareholders.
The Company may be adversely affected by material liabilities under its self-insured programs.
We provide medical coverage to our employees through a partially self-insured preferred provider organization. If we become subject to substantial medical coverage liabilities, our financial results may be adversely affected. However, we have excess loss insurance coverage which currently limits our liability for one individual in any one year to $55,000. There is an aggregate limit on the excess loss coverage of approximately $1,250,000.
The Company has not made contributions to its 401(k) plan, deferred compensation plan, and medical plan on a timely basis.
We have not made some of our 401(k) plan contribution payments on a timely basis, which could result in penalties from the US Department of Labor. To avoid or reduce any potential penalties, we may have to make additional contributions for employees for investment losses, if any, they may have suffered as a result of the late payments. At December 31, 2005, we had not remitted approximately $366,000 of employee contributions and company matching contributions to the 401(k) plan and deferred compensation plan on a timely basis. Also, certain medical payments under our medical plan have not been made on a timely basis. At December 31, 2005, we had not remitted approximately $432,000 of medical payments.
Adverse results in tax audits could result in significant cash expenditures or exposure to unforeseen liabilities.
We are subject to periodic federal, state and local income tax audits for various tax years. Although we attempt to comply with all taxing authority regulations, adverse findings or assessments made by the taxing authorities as the result of an audit could have a material adverse affect on us.
The Company's stock has limited liquidity.
Our common stock trades on the Over The Counter Bulletin Board ("OTCBB") electronic inter-dealer trading network under the symbol, "HIRD". Our shareholders may experience significant illiquidity as float held by non-affiliates as of March 31, 2006 was roughly 1,758,000 shares. In addition, this illiquidity may make our ability to use our common stock in acquisitions substantially more difficult.
If the Company obtains new debt or equity financing, that financing may dilute current shareholders or may limit the Company's right to pay future dividends.
Any future issuances of equity securities may result in a dilution of our current shareholders. In addition, the issuance of new equity or debt securities may also limit the dividends that we may pay, prevent us from redeeming or purchasing our own stock or result in a change in control of the Company.
We issued convertible preferred stock in March 2004. Each share of preferred stock has 10 votes on any matter that is subject to stockholder approval, thus diluting the voting rights of the current shareholders. In addition, the dividends on our preferred stock issued in 2004 are in arrears; therefore, we cannot pay dividends on, make other distributions to, redeem or purchase our common stock.
We have also signed a new debt agreement with a senior lender that prevents us from paying dividends on our common stock or purchasing our own stock.
Potential increase in costs related to being a public company.
The Company has and may continue to incur substantial additional costs related to compliance with certain provisions of the Sarbanes-Oxley Act. These additional costs relate to higher audit fees and legal fees we have and may continue to incur as well as for the cost involved in complying with the audit of our internal controls. For example, the audit of our 2004 and 2005 financial statements was more expensive than anticipated and included additional personnel costs and professional service fees required to complete the preparation of these financial statements and to prepare the 2005 quarterly financial statements.
Significant increases in payroll-related costs could adversely affect the Company's business.
We are required to pay a number of federal, state, and local payroll and related costs, including unemployment taxes, workers compensation insurance, FICA, and Medicare, among others, for our employees and personnel. Significant increases in the effective rates of any payroll-related cost likely would have a material adverse effect upon us. Costs could also increase as a result of health care reforms or the possible imposition of additional requirements and restrictions related to the placement of personnel. Recent federal and state legislative proposals have included provisions extending health insurance benefits to personnel who currently do not receive such benefits. We may not be able to increase the fees charged to our clients in a timely manner and in a sufficient amount to cover increased costs, if any such proposals are adopted.
