Cash paid during the period for:                    2004                  2003                                                                              Interest expense                                  $     56,121           $    37,485     Income taxes                                                        -                          -

Liabilities assumed in excess of assets	$	9,204,620
Stock issued – 650,000 of common stock		578,500
Cash		350,000
Promissory note		3,500,000
Acquisition indebtedness		2,225,814

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Certified Services, Inc. and Subsidiaries

Notes to Condensed Consolidated Financial Statements

Note 1 - Basis of Presentation

The accompanying unaudited condensed financial statements have been prepared in accordance with generally accepted accounting principles for interim financial information. Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included. Operating results for the three months ended March 31, 2004, and 2003 are not necessarily indicative of the results that may be expected for the respective years ended December 31, 2004, and 2003. The unaudited condensed financial statements should be read in conjunction with the consolidated financial statements and footnotes thereto included in the Registrant's annual report on Form 10-K for the year ended December 31, 2003, supplemented by the notes included herein.

Note 2 - Acquisitions

On June 27, 2003, and effective as of April 1, 2003, the Registrant, through its wholly-owned subsidiary American HR Holdings, Inc.  ("AmerHR"), acquired from BACE International, Inc., a non-affiliated North Carolina corporation ("BACE"), all of BACE's professional employer, payroll and human resource services operations for an aggregate purchase price of approximately $6,255,015.  The purchase price was comprised of $350,000 cash, a 4% promissory note in the principal amount of $3,500,000 payable over five years, the assumption of approximately  $2,225,814 of BACE's acquisition and capital requirement debt, and the balance represented by 650,000 shares of the Registrant's restricted common stock valued at $.89 per share.  Also included is an option to  purchase  an  additional 100,000 common shares for $2 per common share if and when the Company's common stock attains a value of at least $12 per common share.

Concurrent with the acquisition, the Company retained the former chief executive of the acquired BACE business unit as a consultant for the four year period through  June 30, 2007,  at an annual rate of  $250,000,  and agreed to continue certain co-marketing  activities  with BACE through June 30, 2004, at an annual cost of $900,000.  Such payments have ceased in the fourth quarter of 2003.

 

 

The pro forma unaudited consolidated statements of operations for the years ended December 31, 2003 and 2002 for the Registrant, including BACE, prior to April 1, 2003, appear below:

 

 

   

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Certified Services, Inc. and Subsidiaries

Notes to Condensed Consolidated Financial Statements (continued)

Note 3 - Insurance Deposits

 

An integral part of the relationship with the entities participating in the Registrant’s risk management program involves the retention by those entities of security deposits, which the Registrant fulfills with cash placed in escrow, annual renewable letters of credit and other forms of collateral which amounted to $9,460,779 and $8,208,366 as of March 31, 2004 and December 31, 2003, respectively.

 

Note 4 - Other Assets

 

At March 31, 2004, and December 31, 2003 other assets consisted of the following:

 

 

   

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Certified Services, Inc. and Subsidiaries

Notes to Condensed Consolidated Financial Statements (continued)

 

Note 6 - Notes Payable

 

At March 31, 2004 and December 31, 2003 long-term indebtedness consisted of the following:

 

   

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Certified Services, Inc. and Subsidiaries

Notes to Condensed Consolidated Financial Statements (continued)

Unused credit available on the lines of credit was $360,000 and $0 at March 31, 2004 and December 31, 2003 respectively.

On June 27, 2003, in furtherance of its acquisition of BACE's PEO Operations, the Registrant executed a promissory note in favor of BACE in the principal amount of $3,500,000 with interest at the rate of 4%, payable over fifty-nine (59) monthly payments (the "BACE Note").  As a result of the Registrant's discovery that the liabilities of the PEO Operations exceeded its assets by approximately $14,300,000, and the Registrant's contractual ability to offset any sums owed to BACE by the amount of such liabilities, the Registrant has suspended payments on the BACE Note pending a determination of its arbitration against BACE.  

Note 6 - Cost of Services

Cost of services is comprised of the following:

 

 

Workers Compensation Program Cost:

 

Beginning July 1, 2003, the Company under the guidance of its Risk Manager (“Midwest”) arranged for coverage to be placed through several carriers with staggered policy ending periods between December 31, 2004 and February 15, 2005. The carriers include Union American Insurance Co., Providence Property Casualty Co., Imperial Casualty and Indemnity Co., and Cascade National Insurance Co.  The Company believes this arrangement has improved its spread of risk.

 

The workers’ compensation program provides for a sharing of risk between the Company and its Carriers whereby the Carriers assume risk in  several areas including individual claim stop loss insurance risk and premium payment credit risk. With respect to the individual claim stop loss insurance risk, the Company through its Risk Manager (Midwest), is responsible for reimbursing to the workers compensation providers claim amounts related to the first $1.0 million per occurrence. Claim amounts in excess of  $1.0 million per occurrence are insured through the Carriers. The Company remits weekly insurance program payments to its Risk Manager (Midwest). The Risk Manager remits weekly premium costs and incurred loss payments to the Carriers of record on a weekly basis.

 

  

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Certified Services, Inc. and Subsidiaries

Notes to Condensed Consolidated Financial Statements (concluded)

 

The Company’s  workers compensation program cost distributed through the Company’s Risk Manager (Midwest) increased $6.8 million for the period ending March 31, 2004 as compared to the period ending March 31, 2003. Payments made under this agreement were $14,081,653 and $8,093,381 for the 1st quarter  2004 and 2003, respectively.  The increases were the result of the Company’s acquisition of the PEO operations of BACE International and increases in premium cost.

 

Health Benefit Plans:

 

The Company’s dental plans, which include both a PPO and HMO offering are primarily provided by Aetna for all clients employees who elect coverage.  All dental plans are subject to guaranteed cost contracts that cap the Company’s annual liability.

In addition to dental coverage , the Company offers various other guaranteed cost insurance programs to client employees such as vision care, life, accidental death and dismemberment, short-term disability and long-term disability. The Company also offers a flexible spending account for healthcare and dependent care costs.

401-(k) Plan:

The Company offers a 401 (k) retirement plan, designed to be a “multiple employer” plan under the Internal Revenue Code of 1986, as amended (the “Code”) Section 413c. This plan design enables owners of clients and highly-compensated client employees, as well as highly-compensated internal employees of the Company, to participate. Generally, employee benefit plans are subject to provisions of both the Code and the Employee Retirement Income Security Act (“ERISA”).

NOTE 7 – Litigation

On April 7, 2004, the Registrant, its operating subsidiaries The Cura Group, Inc., The Cura Group II, Inc., and The Cura Group III, Inc., the Registrant’s President, Chief Executive Officer and Director Danny L. Pixler, the Registrant’s Director Ivan Dobrin, the Registrant’s former Director O. Ray McCartha, the Registrant’s principal shareholder Midwest Merger Management, LLC, and others, were served with a Summons and Complaint in an action entitled BACE International, Inc., et. al. v. Brentwood Capital Corp., et. al.  The action was commenced in the United States District Court, Western District of North Carolina and alleges that the Registrant and the other defendants conspired to defraud the Plaintiffs to transfer and sell all of their human resource service operations to the Registrant by providing allegedly fraudulent letters of credit to the Plaintiffs’ worker’s compensation insurance carriers.  The Plaintiffs demand the assumption of liabilities, payment of obligations to the Plaintiffs in the aggregate amount of $4,650,000 and delivery to the Plaintiffs of 650,000 shares of the Registrant’s common stock and an option to purchase 100,000 shares of the Registrant’s common stock.  The Registrant’s time to respond to the pleadings has not yet expired.  However, the Registrant intends to vigorously defend this action and has previously commenced two separate actions against the Plaintiffs for fraudulently over-stating the value of the Acquisition in the approximate amount of $14,300,000 and an equitable action to force the delivery of certain information and materials acquired in the Acquisition.

The Registrant is a party to certain pending claims that have arisen in the normal course of business, none of which, in the opinion of management, is expected to have a material adverse effect on the consolidated financial position or results of operations if adversely resolved.  However, the defense and settlement of such claims may impact the future availability, retention amounts and cost to the Registrant of applicable insurance coverage.

 

  

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ITEM 2. Management's Discussion and Analysis

The following discussion contains forward-looking statements regarding the Registrant, its business, prospects and results of operations that are subject to certain risks and uncertainties posed by many factors and events that could cause the Registrant's actual business, prospects and results of operations to differ materially from those that may be anticipated by such forward-looking statements. Factors that may affect such forward-looking statements include, without limitation, the Registrant's ability to successfully develop new products for new markets; the impact of competition on the Registrant's revenues, changes in law or regulatory requirements that adversely affect or preclude customers from using the Registrant's products for certain applications, delays in the Registrant's introduction of new products or services, and failure by the Registrant to keep pace with emerging technologies.

When used in this discussion, words such as "believes," "anticipates," "expects," "intends," and similar expressions are intended to identify forward-looking statements, but are not the exclusive means of identifying forward-looking statements. Readers are cautioned not to place undue reliance on these forward-looking statements, which speak only as of the date of this report. We undertake no obligation to revise any forward-looking statements in order to reflect events or circumstances that may subsequently arise. Readers are urged to carefully review and consider the various disclosures made by us in this report and other reports filed with the Securities and Exchange Commission that attempt to advise interested parties of the risks and factors that may affect our business.

Results of Operations - Three Months Ended March 31, 2004 and March 31, 2003

Revenues. Revenues for the three months ended March 31, 3004 ("1Q4") were $24,261,633 versus $12,712,527 for the three months ended March 31, 2003 ("1Q3") resulting in an increase of $11,549,106 or 91% between periods. The most significant portion of this increase was entirely attributable to the Registrant's acquisition of BACE during the second quarter of 2003, as those accounts contributed revenues of approximately $12.8 million to 1Q4. The Registrant's combined revenues however, were reduced by approximately $1.6 million consistent with its ongoing program of reviewing and eliminating high workplace risk and otherwise unprofitable business.

Cost of Services. Cost of services increased to $15,905,880 during 1Q4 compared to $6,798,444 in 1Q3; an increase of $9,107,436 or 134%. This increase resulted in cost of service rising to 66% of revenue for 1Q4 compared to 53% of revenue for 1Q3. This unfavorable cost increase was primarily due to the acquisition of BACE’s client base and increased workers compensation premium.  As a result of the foregoing, the gross profit for 1Q4 was $8,355,753 compared to $5,914,083 for 1Q3; an increase of $2,441,670 or only 41% compared to the 90% increase in revenues.

Operating Expenses. Operating expenses rose to $7,336,169 for 1Q4 compared to $5,196,640 for 1Q3; an increase of $2,139,529 or 41%, principally as a result of the addition of BACE's accounts. Operating expenses as a percent of revenues however, decreased. This favorable decrease in the relationship of operating expenses to revenues between quarters is primarily due to the Registrants’ continued efforts to consolidate the operations of recent acquisitions as well as the implementation of single software platforms for accounting and payroll operations.

As a result of the foregoing, income before taxes for 1Q4 was $1,019,584 compared to $717,443 for 1Q3; a increase of $302,141 or 42%.

Net Income. Consistent with the foregoing analysis, the Registrant reported net income of $1,019,584 or $0.11 per share for 1Q4, compared to net income of $717,443 or $0.08 per share for 1Q3, based upon weighted average shares outstanding of 9,547,811 and 8,448,922, respectively.

 

Critical Accounting Policies

 

No material changes have occured within this disclosure with respect to the Registrant's critical accounting policies set forth in our Form 10-K for the fiscal year ended December 31, 2003.

 

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Liquidity and Capital Resources

The Registrant had operating cash of $1,537,199 at March 31, 2004. The Registrant also had $3,063,101 of restricted cash on deposit collateralizing its revolving line of credit of $3,500,000. The Registrant periodically evaluates its liquidity requirements, capital needs and availability of capital resources in view of its plans for expansion, including potential acquisitions, the offering of additional employer/employee services, and other operating cash needs. Management believes that the Registrant is generating sufficient cash flow to meet its requirements through 2004. The Registrant may rely on these same resources, as well as public or private debt and/or equity financing to meet its long-term capital needs.

ITEM 4. Controls and Procedures

(a) Evaluation of Disclosure Controls and Procedures

The Registrant maintains controls and procedures designed to ensure that information required to be disclosed in the reports that the Registrant files or submits under the Securities Exchange Act of 1934, as amended, is recorded, processed, summarized and reported within the time periods specified in the rules and forms of the Securities and Exchange Commission. Based upon their evaluation of those controls and procedures performed within 90 days of the filing date of this report, the Chief Executive and Chief Financial Officers of the Registrant concluded that the Registrant's disclosure controls and procedures were adequate.

(b) Changes in Internal Controls

The Registrant made no significant changes in its internal controls or in other factors that could significantly affect these controls subsequent to the date of the evaluation of those controls by the Chief Executive and Chief Financial officers.

 

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PART II - OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS

On April 28, 2004, the registrant was served with a subpoena from the Securities and Exchange Commission (the “Commission”) to produce documents and information related to insurance deposits, security deposits and annual renewable Letters of Credit.  

ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS

On April 15, 2004, the Registrant completed a financing arrangement with Laurus Master Fund, Ltd., a Cayman Islands corporation (“Laurus”) in the aggregate amount of $8,500,000.  The financing is comprised of a three-year $8,500,000 Secured Convertible Term Note (the “Note”) with interest at the rate of prime plus two and one-half percent (2.5%) subject to reduction based upon the market price of the Registrant’s common stock par value  $0.001 per share (the “Common Stock”).  The fixed monthly payments of principal, interest and fees are convertible into shares of Common Stock at a conversion price of $0.95 per share.  Additionally, the Registrant issued a Common Stock Purchase Warrant to Laurus to purchase 1,800,000 shares of Common Stock (the “Warrant”) at exercise prices ranging between $1.111 and $1,26 per share.  The Registrant is obliged to register for resale the shares of Common Stock issuable upon conversion of the Note and the exercise of the Warrant pursuant to a Registration Rights Agreement dated April 15, 2004 between Registrant and Laurus.

Sale of Series D Preferred Stock

January 1, 2004 to March 31, 2004, pursuant to a Subscription Agreement, the Registrant sold 121 shares of its Series D Preferred Stock, par value $.001 per share (the “Series D”) to Midwest Merger Management, LLC (“Midwest”) for $1,207,145 Midwest provided pursuant to a Capital Financing Agreement (the “Capital Agreement’) pursuant to the terms of which Midwest would provide the Registrant with long-term capital under a Marketing Organization Agreement between the Registrant and Central Leasing Management, Inc., an Illinois corporation (“CLM”).  During the first quarter of 2004, Midwest deposited $1,207,145 in escrow for the benefit of CLM to meet certain capital requirements of the Registrant’s operating companies.  Accordingly, the Registrant has issued 121 Series D Preferred Stock to Midwest under the Capital Agreement

(a) Exhibits:

 

15      Report of Independent Accountants 31.1   Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 31.2   Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 32.1  Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 32.2  Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

 

(b) Reports on Form 8-K: :  During the first quarter of  2004, and to the date of the filing of this Quarterly Report the Registrant filed three Form 8-K Current Reports dated January 23, 2004, April 14, 2004 and April 23, 2004.  The January 23, 2004 Report disclosed the resignation of O. Raymond McCartha from the Registrant’s Board of Directors and the nomination and election of Eugene M. Weiss as Mr. McCartha’s replacement.  The April 14, 2004 Form 8-K reported the service of a summons and complaint against the Registrant and other parties by BACE International, Inc.  The April 23, 2004 Report disclosed the Registrant’s $8,500,000 financing transaction with Laurus Master Fund, Ltd.

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SIGNATURES

In accordance with Section 13 or 15(d) of the Exchange Act, the Registrant has caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

CERTIFIED SERVICES, INC.

 

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CERTIFICATIONS

 

I, Danny L. Pixler, the Registrant's Chief Executive Officer, certify that:

1. I have reviewed this quarterly report on Form 10-Q of Certified Services, Inc.;

2. Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report;

3. Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the Registrant as of, and for, the periods presented in this quarterly report;

4. I am responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the Registrant and I have: a) designed such disclosure controls and procedures to ensure that material information relating to the Registrant, including its consolidated subsidiaries, is made known to me by others within those entities, particularly during the period in which this quarterly report is being prepared; b) evaluated the effectiveness of the Registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the "Evaluation Date"); and c) presented in this quarterly report my conclusions about the effectiveness of the disclosure controls and procedures based on my evaluation as of the Evaluation Date;

5. I have disclosed, based on my most recent evaluation, to the Registrant's auditors and the audit committee of Registrant's board of directors (or persons performing the equivalent function): a) all significant deficiencies in the design or operation of internal controls which could adversely affect the Registrant's ability to record, process, summarize and report financial data and have identified for the Registrant's auditors any material weaknesses in internal controls; and b) any fraud, whether or not material, that involves management or other employees who have a significant role in the Registrant's internal controls; and

6. I have indicated in this quarterly report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of my most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.

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CERTIFICATIONS

 

I, Rick Steen, the Registrant's Acting Chief Financial Officer, certify that:

1. I have reviewed this quarterly report on Form 10-Q of Certified Services, Inc.;

2. Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report;

3. Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the Registrant as of, and for, the periods presented in this quarterly report;

4. I am responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the Registrant and I have: a) designed such disclosure controls and procedures to ensure that material information relating to the Registrant, including its consolidated subsidiaries, is made known to me by others within those entities, particularly during the period in which this quarterly report is being prepared; b) evaluated the effectiveness of the Registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the "Evaluation Date"); and c) presented in this quarterly report my conclusions about the effectiveness of the disclosure controls and procedures based on my evaluation as of the Evaluation Date;

5. I have disclosed, based on my most recent evaluation, to the Registrant's auditors and the audit committee of Registrant's board of directors (or persons performing the equivalent function): a) all significant deficiencies in the design or operation of internal controls which could adversely affect the Registrant's ability to record, process, summarize and report financial data and have identified for the Registrant's auditors any material weaknesses in internal controls; and b) any fraud, whether or not material, that involves management or other employees who have a significant role in the Registrant's internal controls; and

6. I have indicated in this quarterly report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of my most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.

 

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EXHIBIT INDEX 15      Report of Independent Accountants 31.1   Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 31.2   Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 32.1  Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 32.2  Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002