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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-KSB
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF
THE SECURITIES EXCHANGE ACT OF 1934
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FOR THE YEAR ENDED DECEMBER 31, 1997 COMMISSION FILE NO.
001-12677
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PREFERRED EMPLOYERS HOLDINGS, INC.
(Exact name of registrant as specified in its charter)
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DELAWARE 65-0698779
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
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10800 BISCAYNE BOULEVARD
MIAMI, FLORIDA (305) 893-4040 33161
(Address of principal executive (Registrant's telephone number, (Zip Code)
offices) including area code)
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SECURITIES REGISTERED PURSUANT TO SECTION 12(G) OF THE ACT:
Common Stock, $.01 par value
(Title of Class)
Check whether the issuer (1) filed all reports required to be filed by
Section 13 or 15(d) of the Exchange Act during the past 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 / /
Check if there is no disclosure of delinquent filers in response to Item 405
of Regulation S-B contained in this form, and no disclosure will be contained,
to the best of registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-KSB or any
amendment to this Form 10-KSB. /X/
The issuer's revenues for the year ended December 31, 1997 were $15,999,112.
The aggregate market value of the voting stock (Common Stock) held by
non-affiliates of the registrant on March 27, 1998 was $15,318,000 based on the
closing sale price of the Common Stock of $8.88 on such date, as reported by the
Nasdaq SmallCap Market-Registered Trademark-.
The number of outstanding shares of the issuer's Common Stock as of March
27, 1998 was 4,725,000.
Transitional Small Business Disclosure Format.
Yes / / No /X/
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Registrant's definitive Proxy Statement to be delivered to
stockholders in connection with its Annual Meeting of Stockholders, expected to
be held in June 1998, are incorporated by reference into Part III of this Annual
Report on Form 10-KSB.
A list of Exhibits to this Annual Report on Form 10-KSB begins on Page 18.
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PREFERRED EMPLOYERS HOLDINGS, INC.
ANNUAL REPORT ON FORM 10-KSB
FOR THE YEAR ENDED DECEMBER 31, 1997
TABLE OF CONTENTS
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PART I..................................................................................................... 1
Item 1. Description of Business............................................................................ 1
Item 2. Description of Property............................................................................ 12
Item 3. Legal Proceedings.................................................................................. 12
Item 4. Submission of Matters to a Vote of Security Holders................................................ 12
PART II.................................................................................................... 13
Item 5. Market for Common Equity and Related Stockholder Matters........................................... 13
Item 6. Management's Discussion and Analysis............................................................... 14
Item 7. Financial Statements............................................................................... 17
Item 8. Changes In and Disagreements With Accountants on Accounting and
Financial Disclosure................................................................................. 17
PART III................................................................................................... 18
Item 9. Directors, Executive Officers, Promoters and Control Persons; Compliance with
Section 16(a) of the Exchange Act.................................................................... 18
Item 10. Executive Compensation............................................................................ 18
Item 11. Security Ownership of Certain Beneficial Owners and Management.................................... 18
Item 12. Certain Relationships and Related Transactions.................................................... 18
Item 13. Exhibits and Reports on Form 8-K.................................................................. 18
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FORWARD LOOKING STATEMENTS
Certain statements contained in this Annual Report on Form 10-KSB, including
without limitation, statements containing the words "believes", "anticipates",
"may", "intends", "expects" and words of similar import constitute
"forward-looking" statements within the meaning of the Private Litigation Reform
Act of 1995. Such statements involve known and unknown risks, uncertainties and
other factors which may cause actual Company results to differ materially from
expectations. Such factors include the following: (1) circumstances which could
affect the writing of workers' compensation, liability and property insurance,
(2) economic, business and competitive conditions in the insurance industry and
innovations of new insurance products, (3) the enactment of new regulations and
laws, and the amendment of existing regulations and laws which could affect the
Company's business, (4) changes in business strategy or development plans, and
(5) the Company's ability to obtain sufficient financing. Certain of these
factors are discussed in more detail elsewhere in this Annual Report on Form
10-KSB.
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PART I
ITEM 1. DESCRIPTION OF BUSINESS
INTRODUCTION
The Company is engaged in the business of providing workers' compensation
and business insurance products and risk management services designed for the
American franchise industry, particularly fast food, family style restaurants
and convenience stores. It has been estimated that current annual premiums paid
for workers compensation insurance by the franchise industry exceed $2.5
billion, with annual premiums by the fast food and family style restaurant and
convenience store segment representing approximately $1 billion of this amount.
The Company's insurance products and services are specifically designed to
provide clients with substantial cost savings and reduce the time required of
these clients in managing this element of their business. In order to assist
clients in managing their workers' compensation costs, the Company offers
competitive rates and an opportunity for a client to receive dividends, based
upon its claims experience, and provides risk management and risk management
services, including cost containment and claims management programs. It is the
Company's belief that this innovative approach to cost containment has succeeded
in helping its clients achieve claims costs which are among the lowest in the
industry.
The franchise industry is considered potentially to be among the safest
insurance risks. However, a substantial number of businesses within this
industry have not instituted formal risk and safety awareness programs and
consequently do not receive any price advantages which should arise from their
favorable safety attributes. The Company believes segments of this industry
suffer from premium redundancy or an over charge in workers' compensation
insurance rates. Insurance programs offered by the Company are specifically
designed to reduce the impact of redundancy on this segment of the industry
while emphasizing loss control and cost containment. The Company utilizes its
proprietary information and claims analysis systems and custom designed loss
reports to promote the claims procedure in an effort to motivate client
management to promote safety and control claims expense. It further seeks to
limit the number of disputes between the insured and its employees arising from
insurance claims, and as one of the only national providers specializing in
workers' compensation insurance for the franchise industry, the Company is
uniquely positioned to accomplish this goal.
Historically, the Company has acted as a general agent on behalf of various
major insurance carriers for workers' compensation and other forms of property
and liability insurance for franchise businesses through its own sales staff as
well as through independent broker/agents. As a general agent, the Company
assumes none of the risks associated with the insurance business it produces. In
December 1996, the Company formed P.E.G. Reinsurance Company, Ltd. ("Preferred
Insurance") pursuant to which Preferred Insurance acts as the reinsurer with
respect to certain workers' compensation and employer's liability insurance
policies sold by the Company. Although Preferred Insurance assumes the risks
associated with being a reinsurer, its reinsurance agreement limits the
liability of Preferred Insurance for losses and certain defined expenses to the
first $300,000 per occurrence and limits its aggregate liability for all
coverage to an amount not to exceed 70% of the gross written premium for each
individual underwriting year.
For the year ended December 31, 1997, the Company's total revenues were
$15,999,112, with approximately 17% of these revenues derived from writing
insurance as a general agent and approximately 83% of these revenues derived
from its reinsurance business.
The Company has recently launched several new business campaigns and
marketing programs. One of these programs is a new workers' compensation program
for motor vehicle related franchises, including automobile, motorcycle and
recreational vehicle dealerships as well as auto service providers. Motor
vehicle dealerships, while not true franchises, are quite similar from dealer to
dealer and are viewed by the Company as businesses into which it can apply its
expertise in cost containment gained in the franchise
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industry. Another Company program involves workers' compensation insurance
designed to target certain smaller businesses located in 23 states which pay
annual premiums of between $5,000 and $50,000. The underwriting process under
this program has been simplified, thus enabling the Company to respond promptly
to businesses with competitively priced quotes. The Company believes that many
broker/agents, regardless of size, have accounts that are eligible to
participate in the program and therefore can be potential broker/agents
promoting the program. A new marketing program has also been developed which
involves direct mail, telemarketing and field sales targeted directly at the
consumer and follows the Company's goal of writing low risk policies.
The Company believes there are substantial opportunities for growth by
leveraging its considerable capabilities and expertise in workers' compensation
and claims cost management. In particular, the Company believes that by
combining its existing expertise in insurance matters with strategic
acquisitions of professional employer organizations ("PEO's") it can reduce
operating expenses of PEO's and increase the products offered by the Company to
its existing clients. Its current strategy for growth includes: (1) continuing
to capitalize on its business of selling insurance and risk management products
to franchise companies; (2) entering into the PEO market by making selective
acquisitions; (3) growing its existing business by offering its workers'
compensation and business insurance products, along with risk management
services to an expanding base of PEO clients; (4) offering employee leasing
related products and services to its existing franchise clients; and (5)
focusing its PEO operations on specific industry segments without regard to
geographic boundaries. It is believed that many of the problems faced by
existing PEO's stem from their lack of underwriting, actuarial and cost
containment expertise.
Consistent with one of the components of the Company's growth strategy, in
March 1998, a wholly-owned subsidiary of the Company ("Preferred Staffing")
purchased substantially all of the assets of HSSI Travel Nurse Operations, Inc.
("Travel Nurse"), a provider of temporary registered nurses and other
professional medical personnel, primarily to client hospitals. For the year
ended November 30, 1997, Travel Nurse generated revenues of approximately
$15,000,000 and placed in excess of 700 nurses. Preferred Staffing currently has
orders for approximately 1,200 nurses. Unlike daily or other very short-term
supplemental staff, travel nurses serve the client for a long enough period to
function as permanent hospital staff. The ability of travel nurses to function
as permanent staff improves the continuity and consistency of patient care and
reduces the overall administration, orientation and supervisory requirements of
the clients' permanent staff.
The Company's principal executive offices are located at 10800 Biscayne
Boulevard, Miami, Florida 33161 and the Company's telephone number at that
location is (305) 893-4040.
UNLESS THE CONTEXT OTHERWISE REQUIRES, THE TERM "COMPANY" AS USED HEREIN
MEANS PREFERRED EMPLOYERS HOLDINGS, INC., TOGETHER WITH ITS SUBSIDIARIES. IN
FEBRUARY 1997, THE COMPANY AND THE STOCKHOLDERS (COLLECTIVELY, THE "EXCHANGING
STOCKHOLDERS") OF PREFERRED EMPLOYERS GROUP, INC. ("PEGI") EFFECTED A
RECAPITALIZATION WHEREBY THE COMPANY EXCHANGED 17,647.06 SHARES OF COMMON STOCK
OF THE COMPANY FOR EACH SHARE OF COMMON STOCK OF PEGI HELD BY THE EXCHANGING
STOCKHOLDERS. AS A RESULT, PEGI BECAME A WHOLLY-OWNED SUBSIDIARY OF THE COMPANY.
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INDUSTRY OVERVIEW
WORKERS' COMPENSATION. All fifty States and the District of Columbia have
promulgated statutes, rules and regulations that require employers to provide
wage replacement and medical benefits to work accident victims regardless of
fault. As a result of these mandates, virtually all employers must either (i)
purchase workers' compensation insurance from a private insurance carrier, (ii)
obtain coverage from a state managed fund, or (iii) be self-insured if permitted
by the state in which business is conducted.
Workers' compensation is one of the major risk management issues of this
decade. In a poll of risk managers published in the July 1996 issue of Risk
Management Magazine, workers' compensation insurance was the second most
frequent concern. Nationwide, employer's workers' compensation costs increased
significantly over the last decade. Between 1984 and 1990, workers' compensation
costs increased an average of 9.6% per annum, and from 1990 through 1995 costs
increased by about 2.9% per annum. Certain additional intangible losses also
directly relate to increased workers' compensation costs such as higher
incidents of employee turnover, the cost or retraining new employees and
litigation expenses. It has been estimated that current annual premiums paid for
workers compensation insurance by the franchise industry exceed $2.5 billion,
with annual premiums by the fast food and family style restaurant and
convenience store segment representing approximately $1.6 billion of this
amount. Many employers are looking for techniques to better control their
mounting costs.
The Company believes that franchises often are the safest segment of a
particular industry. Most franchises are standardized operations based upon
successful models with demonstrated profitability. These businesses typically
have standard operating procedures and standard plant and equipment with
standardized safety programs. The design and construction of most franchises
take into account safety engineering of the workplace. For example, in a fast
food restaurant, chairs and tables are set a certain distance apart to allow for
adequate walking space, and the cooking equipment used must conform to certain
safety standards. The franchisor and the franchisee have a shared interest to
maintain safe, clean and uniform environments for their customers and employees.
Consequently, the Company believes that, in general, workers' compensation cost
of claims for franchise businesses are significantly lower than non-franchise
operations.
Franchises are often subject to the same workers' compensation rating system
that the insurance industry uses for any comparable business. As a result, fast
food franchise restaurants may pay the same rates as bars and taverns which may
be open all night, as fine dining restaurants where staff often carry heavy
trays, or as "mom and pop" restaurants without safety engineered facilities or a
formal safety program. Although these businesses may be charged the same
workers' compensation rates, their claims experience is typically significantly
higher. Consequently, most franchise companies generally suffer premium
"redundancy" or an "overcharge" in their insurance premiums in many industries.
In effect, franchise businesses subsidize the higher workers' compensation
claims costs of non-franchise operations.
REINSURANCE. Preferred Insurance provides reinsurance with respect to
certain workers' compensation and employer's liability insurance policies
written by the Company. Reinsurance is an arrangement in which an insurance
company, the reinsurer, agrees to indemnify another insurance company, the
ceding company, against all or a portion of the insurance risks underwritten by
the ceding company under one or more insurance policies. The two basic types of
reinsurance arrangements are treaty and facultative reinsurance. In treaty
reinsurance, the ceding company is obligated to cede, and the reinsurer is
obligated to assume, a specified portion of a type or category of risk insured
by the ceding company. In facultative reinsurance, the ceding company cedes and
the reinsurer generally assumes all or part of the risk under a single insurance
policy.
Both treaty and facultative reinsurance can be written on either a pro-rata
(also known as quota share or proportional) basis or an excess of loss basis.
For reinsurance written on a pro-rata basis, the reinsurer, in return for a
predetermined portion or share of the insurance premium charged by the ceding
company, indemnifies the ceding company against a predetermined portion of the
losses and the allocated portion of loss adjustment expenses ("ALAE") of the
ceding company under the covered insurance policy or policies.
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For reinsurance written on an excess of loss basis, the reinsurer generally
indemnifies the ceding company against all or a specified portion of losses and
ALAE on underlying insurance policies in excess of a specified dollar amount,
known as the ceding company's retention or attachment point, subject to a
negotiated limit.
PROFESSIONAL EMPLOYER ORGANIZATIONS. Professional Employer Organizations
provide employee leasing services to their clients. Employee leasing is a
contractual arrangement through which a business transfers its payroll and human
resource responsibilities to a firm specializing in these functions. The leasing
firm typically provides health, unemployment, and workers' compensation
insurance, plus safety training, while the work site employer retains full
operational control over the employee's activities.
The employee leading industry is rapidly expanding. According to a recent
article in Crain's New York Business, it is expected that the PEO industry will
increase revenues and earnings by approximately 30% per annum for up to the next
ten years.
BUSINESS STRATEGY
The Company believes there are substantial opportunities for growth by
leveraging its considerable capabilities and expertise in workers' compensation
and claims cost management. In particular, the Company believes that by
combining its existing expertise in insurance matters with strategic
acquisitions of PEO's it can reduce operating expenses of PEO's and increase the
products offered by the Company to its existing clients. Its current strategy
for growth includes: (1) continuing to capitalize on its business of selling
insurance and risk management products to franchise companies; (2) entering into
the PEO market by making selective acquisitions; (3) growing its existing
business by offering its workers' compensation and business insurance products,
along with risk management services to an expanding base of PEO clients; (4)
offering employee leasing related products and services to its existing
franchise clients; and (5) focusing its PEO operations on specific industry
segments without regard to geographic boundaries. It is believed that many of
the problems faced by existing PEO's stem from their lack of underwriting,
actuarial and cost containment expertise.
The Company also seeks to continue to strengthen its position as one of the
leading providers of its products and services to fast food and family style
franchise restaurants and convenience stores. It believes this goal can be
accomplished by devising and implementing programs on a state-by-state basis to:
(i) accumulate the latest approved rate information and information on
legislative changes affecting the industry; (ii) obtain approved carrier rate
filings; (iii) ascertain current factors affecting pricing in the voluntary
market and interact with insurance carriers to encourage competitive pricing
(while respecting the carriers need for profitability and to remain viable in
the marketplace); (iv) present insured clients with effective methods of
monitoring, reducing and containing claims costs; (v) monitor claims handling
procedures of claims administrators and interact with them to produce cost
effective results; (vi) market programs designed to reward preferred risks with
incentives to purchase and renew insurance coverage; and (vii) become a
"one-stop" provider of commercial insurance to selected franchise industries.
The carriers providing workers' compensation insurance have generally
entered and withdrawn from regional or local markets with some frequency. Often,
the reason for movement is attributed to (i) a change of corporate policy, (ii)
the general conditions in the insurance industry at that time, and (iii) the
carrier's experience with loss ratios. Even where cost containment programs
exist, often they are not adequately managed and are not particularly effective.
The Company is committed to its insured clients as well as its carriers. The
Company's staff has been trained to offer a level of service not otherwise
present in a generally complacent industry. By combining the talents of
specialists drawn from diverse backgrounds, the Company has created a unique
environment where sales, marketing, and risk management experts produce quality
products and results.
PRODUCTS AND SERVICES
Workers' compensation and business insurance products and risk management
services are provided by the Company for the American franchise industry. Its
insurance programs are designed specifically to
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reduce the impact of redundancy on franchise businesses while also emphasizing
loss control and cost containment. By taking advantage of this business
segment's good safety records and by providing risk management services,
including loss control and claims management, the Company affords its clients
the opportunity to effectively lower their cost of claims. It has also developed
proprietary information and claims analyses systems and custom designed loss
reports which explain the claims procedure and motivate client management to
promote safety and control claims expense.
Insurance programs are custom designed to be offered only through nationally
recognized carriers with the highest industry ratings. The Company works with
these carriers to establish competitive rates, while being mindful of a
carrier's need to maintain profitability and remain viable in the marketplace.
Additionally, it offers products and services designed to enable its clients to
realize substantial savings in their workers' compensation costs while reducing
the time required to manage this element of their business. Specifically, the
Company provides clients such savings by offering competitive rates and
dividends and cost containment programs which assist its clients in managing
their workers' compensation costs.
The Company has recently launched several new business campaigns and
marketing programs. One of these programs is a new workers' compensation program
for motor vehicle related franchises, including automobile, motorcycle and
recreational vehicle dealerships as well as auto service providers. Motor
vehicle dealerships, while not true franchises, are quite similar from dealer to
dealer and are viewed by the Company as businesses into which it can apply its
expertise in cost containment gained in the franchise industry. Another Company
program involves workers' compensation insurance designed to target certain
smaller businesses located in 23 states which pay annual premiums of between
$5,000 and $50,000. The underwriting process under this program has been
simplified, thus enabling the Company to respond promptly to businesses with
competitively priced quotes. The Company believes that many broker/agents,
regardless of size, have accounts that are eligible to participate in the
program and therefore can be potential broker/agents promoting the program. A
new marketing program has also been launched which involves direct mail,
telemarketing and field sales targeted directly at the consumer and follows the
Company's goal of writing low risk policies.
Using early intervention techniques, the Company seeks to limit the number
of disputes with injured employees. Through a third-party administrator, the
Company provides its clients with access to national 800 telephone numbers to
ensure that their claims can be reported quickly, 24 hours-a-day, seven days-a-
week. The third-party administrator has a trained medical staff available to
initiate a four party contact among the claimant, the employer, the adjuster and
the treating physician. This process helps ensure prompt and competent medical
care for the employee and management of the claim. The Company believes in the
prompt settlement of meritorious claims, but it will aggressively defend against
non-meritorious claims. It attempts to resolve cases prior to litigation and, if
litigation ensues, aggressively seeks to settle reasonable claims.
In addition to these cost containing activities, the Company's client
services staff maintains constant communication with clients. Its loss control
department conducts safety seminars and provides periodic newsletters to clients
on how to control the frequency and severity of claims. The Company believes it
has succeeded in persuading clients that safety is not just an issue of good
management but can have a significant impact on the financial success of their
businesses.
The Company has created a new, innovative, comprehensive and aggressive
approach to safety/loss control, blending old and new prevention techniques to
develop safety programs specific to each industry it serves. While the primary
thrust of the Company's programs is safety for employees and customers, emphasis
is also placed on motivating client management to implement safety programs as a
means of improving profitability. The Company conducts workshops to demonstrate
the benefits of using the Company's loss control safety programs at no
additional cost to its clients. Proprietary, custom designed loss management
information is communicated by mail and telephone to the Company's clients at no
additional cost.
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The Company believes its safety programs help reduce workers' compensation
claims costs. The basic elements of its safety programs, as recommended to its
clients, include: (i) a written safety policy with safety rules; (ii) regularly
scheduled safety meetings; (iii) new employee hiring practices and training of
all new and transferred employees; (iv) supervisor responsibility and
accountability; (v) a regular self-inspection program administered by identified
supervisors; (vi) an incentive program that rewards safety awareness; (vii) a
team safety committee program; (viii) a timely accident reporting and
investigation program; (ix) a monitored record keeping system for all accidents;
(x) a policy to implement corrective action for unsafe conditions and acts; and
(xi) a monthly review by top management of the program and its implementation.
Many states have allowed a reduction in workers' compensation insurance
premiums when an employer implements an approved safety program. The Company's
safety programs meet the requirements of most states that have approved safety
programs. Such workers' compensation safety program discounts are authorized on
a state by state basis and, therefore, guidelines are state specific. The
Company deals only with those state programs applicable to the voluntary market,
not the assigned risk market. Certain states make safety program discounts
available to all insureds, while others make them available only to those
insureds with high experience modification factors or based on the size of the
premium. Some states require state certification of the safety program on a risk
by risk basis. The employer, not the provider of the safety program, qualifies
for the program. The Company evaluates the requirements in the states where such
discounts are available and provides employers with manuals, record keeping
tools and recommendations which assist the employer in obtaining certification.
CUSTOMERS
The Company markets its products primarily to the franchise industry through
broker/agents. Its customers typically are owners of multiple unit franchises
who understand the importance of cost containment and safety features. While the
Company focuses its efforts on large, national franchisees operating multiple
outlets, it also serves smaller, regional franchise operators. For the year
ended December 31, 1997, the Company provided products and services to
approximately 973 separate insureds, none of which accounted for more than 3% of
its 1997 annual revenues. As of the date hereof, no broker/ agent accounted for
more than 3% of the Company's 1997 annual revenues.
Consumers of insurance products have traditionally focused on price rather
than cost containment. They have come to expect little or no customer service.
The Company capitalizes on these insurance industry deficiencies by tailoring
its products for each niche market, providing quality customer service and, most
importantly, providing loss control and cost containment services.
The Company conducts regional safety seminars showing how to contain costs
and reduce losses. Although not a sales effort, it is one of the ways the
Company generates new business while continuing to educate its existing clients.
Each franchisee is provided with its own personal client service
representative who is knowledgeable and available throughout the work day. An
800 "hot line" is also available to reach the manager of client services should
any issue need immediate resolution. The Company believes that over a continuing
period of time these client support services will distinguish it from its
competition.
SALES AND MARKETING
The Company's sales and marketing programs are varied. It engages in
multiple targeted direct mail programs each year. These direct mail programs,
designed to introduce the Company's products and services to franchise owners
and insurance agents, are complimented by an extensive telemarketing effort. The
Company utilizes multiple databases of franchises and insurance agents in its
direct mail and telemarketing efforts. The Company's marketing programs identify
prospective clients, client's agents and new agents to represent the Company. A
Company representative then quotes prices to identified prospective clients
and/or their agents.
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The Company's marketing programs are designed to generate new prospects for
both high revenue broker/agents (those whose client bases produce workers'
compensation annual premiums in excess of $2 million) as well as smaller
broker/agents who operate in small towns. Generally, agents must have the
ability to produce $300,000 in annualized workers' compensation premiums to
receive a contract to represent the Company.
The Company's programs relieve the broker/agent of administrative and claims
tasks as the Company and/or the insurance carrier bills and collects premiums
directly from the insured, remits the commission earned to the broker/agent,
deals directly with the insured in connection with any problems experienced by
the insured and serves as a clearinghouse, together with the third-party
administrator, with respect to the reporting, processing, reviewing and
evaluating claims. As a result of the foregoing, the broker/agent can earn more
revenue by focusing its efforts on selling Company products. Other benefits
provided to the broker/agent include (i) increasing the geographic area in which
the broker/agent can generate business, (ii) reducing the likelihood of the
broker/agent losing larger multiple store and multiple state franchisees because
the broker/agent will have many more states in which he is able to write
business, (iii) providing the broker/agent with the option of offering the
Company's other property and casualty products to his clients, and (iv)
providing the broker/agent's clients with the benefit of the Company's loss
control and cost containment programs to reduce the clients losses.
POLICY RENEWALS
Client policy renewals are critical to the Company's operations. The Company
seeks to maintain favorable renewal rates by (i) providing its clients with
quality service, (ii) ensuring that all insurance policy, endorsement and audit
documents are distributed to each client on a timely basis, and (iii) ensuring
that all documents distributed to clients are complete and accurate. It seeks to
communicate with each client at least four times each year in order to maintain
close relationships and to learn of any real or perceived problems and concerns
on a timely basis. All written and telephone communications initiated by the
client are responded to promptly. The Company believes that its quality service
is a major factor in its client retention rate, which is currently approximately
70%.
The Company's underwriting department reviews prospect applications to
identify risks that appear undesirable from a historical viewpoint and to
recognize those prospects dedicated to significant improvement in their loss
history which thereby makes them a valuable addition to the Company's customer
base and to a carrier's portfolio. The Company's underwriting department also
evaluates each client for renewal purposes. This evaluation determines whether
the particular client is eligible to receive a decrease or other form of
modification to its renewal premium. If the client has responded to loss control
recommendations and its loss history reflects improvement, a reduction in its
renewal premium rate may be implemented. The department also identifies clients
whose experience has deteriorated and who have not responded to loss control
guidance and recommendations. If the deterioration is significant enough and the
client has not demonstrated a sincere commitment to improvement in loss
experience, the underwriting department may make a recommendation not to renew
the policy.
PREFERRED INSURANCE
Historically, the Company has acted as a general agent on behalf of various
major insurance carriers for workers' compensation and other forms of property
and liability insurance for franchise businesses through its own sales staff as
well as through independent broker/agents. As a general agent, the Company
assumes none of the risks associated with the insurance business it produces. In
December 1996, the Company formed Preferred Insurance under the laws of Bermuda.
Preferred Insurance acts as the reinsurer with respect to certain workers'
compensation and employer's liability insurance policies written by the Company.
Although Preferred Insurance assumes the risks associated with being a
reinsurer, its liabilities are limited for losses and certain defined expenses
to the first $300,000 per occurrence and its aggregate liability is limited for
all coverage to an amount not to exceed 70% of the gross written premiums for
each individual underwriting year. The reinsurance arrangements are governed by
the terms of a reinsurance agreement between Preferred Insurance and three
affiliated insurance companies (the
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"AIG Affiliates"). The reinsurance agreement with Preferred Insurance is
terminable by either party upon the occurrence of certain events. For the year
ended December 31, 1997 approximately 83% of the Company's revenues were derived
from its reinsurance business.
The purchase of excess and aggregate reinsurance by the AIG Affiliates and
the stated aggregate limit of liability in the reinsurance agreement caps the
the liability of Preferred Insurance for losses and loss adjustment expenses and
permits it to quantify its aggregate maximum loss exposure. By contrast, maximum
liability under pro-rata or quota share reinsurance contracts can be more
difficult to quantify precisely. Quantification of loss exposure is fundamental
to the ability of Preferred Insurance to manage its losses.
Pursuant to the terms of the reinsurance agreement, the AIG Affiliates are
obligated to cede Preferred Insurance 100% of the net written premium less
certain expenses and commissions associated with the policies covered thereby.
The affiliates retain a commission allowance of 28.83% based on the net written
premiums, and Preferred Insurance retains the premiums ceded by the AIG
Affiliates to Preferred Insurance together with the risks and potential for
profitability associated therewith. Accordingly, the Company believes that the
operations of Preferred Insurance provides it with the opportunity to retain the
underwriting profitability that was previously retained by the AIG Affiliates,
while creating a relatively limited risk exposure under the reinsurance
agreement.
Preferred Insurance is required to provide the AIG Affiliates, as security
for the payment of losses, a combination of cash, United States government
securities and/or an irrevocable letter of credit in an aggregate amount equal
to 51.5% of the gross written premiums ceded to Preferred Insurance pursuant to
the reinsurance agreement less the amount of losses paid for the expiring
underwriting year as of December 30, 1996, and each December 30 thereafter.
INVESTMENT POLICIES. The Company's results of operations depends, in part,
on the income derived from the investment of premiums by Preferred Insurance. It
believes that the risks inherent in the reinsurance business should not be
augmented by a speculative investment policy and therefore its investment
strategy is partially defined by the need to safeguard its capital. Because of
the unpredictable nature of losses that may arise under insurance policies, the
liquidity needs of Preferred Insurance may be substantial. The Company's
investment policy has been established by its Investment Committee, and is
subject to, among other factors, the Company's liquidity requirements. Its
investments consist primarily of cash or fixed-income securities (none of which
has a rating of less than AA), the market value of which is subject to
fluctuation depending on changes in prevailing interest rates. Additionally, the
Company reserves the right to invest a limited percentage of its portfolio, to
be determined by the Investment Committee, in common stock of companies listed
on national securities exchanges. The stock of such companies may fluctuate as a
result of specific events affecting such companies as well as general market
conditions. Increases in interest rates or fluctuations in the market price of
such companies' stocks may result in losses, both realized and unrealized, on
the Company's investments.
DATA MANAGEMENT
The Company has management information systems which consist of, among other
things, a central database to keep it abreast of market trends, current premium
rates, rate filings, renewal dates and information on its competition. The
management information systems constitute an integral part of the Company's
business operations. The Company utilizes such systems to process insurance
applications, control the issuance of policies and endorsements, audit medical
fees, pay broker/agent commissions, manage claims, provide reports to its
clients, provide accounting statements and financial reports, and analyze claims
data, all of which give the Company the ability to write more effective and
competitive policies and result in a higher rate of policy renewals.
8
<PAGE>
COMPETITION
The workers' compensation insurance industry is highly competitive. The
Company competes with other general agents, numerous large insurance companies,
managed health care companies, state sponsored insurance pools, risk management
consultants and non-Company affiliated broker/agents, many of which have
significantly larger operations and greater financial, marketing, human and
other resources than the Company. Such competitors may have material advantages
over the Company as a result of forms of insurance and services they offer in
addition to workers' compensation products and services. Competitive factors
include product lines, premium rates, personalized service and effective cost
containment measures.
REGULATIONS
GENERAL. As a general agent, the Company is subject to regulation in the
various states in which it sells insurance. These regulations vary from state to
state, and may include such matters as licensing requirements, bonding
requirements, requirements regarding the Company's agreements with the insurance
carriers for which it acts as a general agent, and certain other requirements.
Penalties may be imposed for violations of such regulations. Changes in such
regulations, if any, may have a material adverse effect on the Company's
business.
Under the workers' compensation system, employer insurance or self-funded
coverage is governed by individual laws in each of the fifty states and by
certain federal laws. Changes in individual state regulation of workers'
compensation or managed health care may create a greater or lesser demand for
some or all of the Company's services, or require the Company to develop new or
modified services in order to meet the needs of the marketplace and compete
effectively in that marketplace.
REINSURANCE BUSINESS. Preferred Insurance is registered as a Class 3
insurer in Bermuda and, accordingly, is subject to the provisions of the Bermuda
Insurance Act 1978, as amended, and the regulations promulgated thereunder. The
Bermuda Insurance Act provides that no person shall carry on insurance business
in or from within Bermuda unless registered as an insurer under the Insurance
Act by the Minister of Finance. The Minister of Finance has broad discretion to
act in the public's interest. The Minister of Finance is required by the Bermuda
Insurance Act to ascertain whether the applicant is a fit and proper body to be
engaged in the insurance business and, in particular, whether it has, or has
available to it, adequate knowledge and expertise. In connection with
registration, the Minister of Finance may impose conditions relating to the
writing of certain types of insurance business.
The Bermuda Insurance Act imposes on Bermuda insurance companies such as
Preferred Insurance solvency and liquidity standards and auditing and reporting
requirements and grants to the Minister of Finance powers to supervise,
investigate and intervene in the affairs of insurance companies. Significant
aspects of the Bermuda insurance regulatory framework are set forth below.
- Preferred Insurance is required to maintain a principal office in Bermuda
and appoint and maintain a principal representative in Bermuda. The
Bermuda Insurance Act places a duty on the principal representative to
report to the Minister of Finance the occurrence of certain events,
including, but not limited to, the failure by the insurer for which he or
she acts to comply with a condition imposed by the Minister of Finance
relating to a solvency margin or a liquidity or other ratio with respect
to any other such condition not so relating. Without a reason acceptable
to the Minister of Finance, Preferred Insurance may not terminate the
appointment of its principal representative, and the principal
representative may not cease to act as such, unless 30 days' advance
notice in writing to the Minister of Finance is given of the intention to
do so.
- Preferred Insurance is required to appoint an independent auditor to
conduct an annual audit of the statutory-basis financial statements.
- Preferred Insurance is required to maintain share capital (the aggregate
par value of issued shares) of at least $120,000.
9
<PAGE>
- Preferred Insurance must maintain statutory capital and surplus exceeding
the greater of the following three criteria: (a) $1,000,000; (b) 20% of
the net premiums where the net premiums in the current financial year do
not exceed $6,000,000, or, where the net premiums exceed $6,000,000,
$1,200,000 plus 15% of the net premiums which exceed $6,000,000 (The net
premium is the gross premium after deduction for any premium ceded for
reinsurance.); and (c) 15% of reserves for losses and loss expenses.
- Preferred Insurance is required to maintain liquid assets at a level equal
to or greater than 75% of its net relevant (insurance) liabilities. For
this purpose, liquid assets include cash and time deposits, quoted
(publicly traded) investments, unquoted bonds and debentures, mortgage
loans backed by first liens on real estate, accrued investment income,
accounts and premiums receivable, reinsurance balances receivable and
funds held by ceding companies.
- Preferred Insurance is required to obtain the approval of the Minister of
Finance before reducing by 15% or more its total statutory capital
(comprised of share capital, contributed surplus and any other fixed
capital) as set out in the previous years financial statements.
- Preferred Insurance may declare and pay dividends or make distributions
out of contributed surplus or other assets legally available for
distribution provided that after the payment of any such dividend or
distribution Preferred Insurance will continue to maintain the required
statutory capital and surplus and liquid assets as summarized above.
- Preferred Insurance is required to have a copy of its statutory financial
statements available at its principal office for production to the
Registrar of Companies and to file the statutory financial statements and
a statutory financial return within four months after the end of the
financial year (or such longer period, not exceeding seven months, as the
Registrar of Companies, on application, may allow).
- Preferred Insurance is required to include in its annual statutory
financial statements the opinion of a loss reserve specialist in respect
of its loss and loss adjustment expense reserves.
- The Minister of Finance may appoint an inspector with extensive powers to
investigate the affairs of an insurer or reinsurer if the Minister of
Finance believes that an investigation is required in the interest of the
insurer's or reinsurer's policyholders or persons who may become
policyholders. To verify or supplement information otherwise provided to
him, the Minister of Finance may direct an insurer or reinsurer to produce
documents or information relating to matters connected with the insurer's
or reinsurer's business.
Under current Bermuda law, there is no Bermuda income, corporation or
profits tax, withholding tax, capital gains tax, capital transfer tax, estate
duty or inheritance tax payable by stockholders of the Company other than
stockholders ordinarily resident in Bermuda for exchange purposes. The Company
is not subject to stamp or other similar duty on the issue, transfer or
redemption of its shares of common stock.
The Company has obtained an assurance from the Minister of Finance under the
Exempted Undertakings Tax Protection Act of 1966 that if any legislation is
enacted in Bermuda imposing tax on profits or income, or on any capital assets,
gain or appreciation or any tax in the nature of estate duty or inheritance tax,
such tax shall not, until March 28, 2016, be applicable to the Company or to its
operations, or to the shares, debentures or other obligations of the Company
except insofar as such tax applies to persons ordinarily resident in Bermuda and
holding such shares, debentures or other obligations of the Company or any real
property or leasehold interests in Bermuda owned by the Company. As an exempted
company, the Company is liable to pay a registration fee in Bermuda based upon
its authorized capital and the premium on its issued shares of Common Stock at a
rate not exceeding $25,000 per annum.
PREMIUM RATE RESTRICTIONS. State regulations governing the workers'
compensation system impose restrictions and limitations that effect the business
operations of Preferred Insurance. State laws regulate what workers'
compensation benefits must be paid to injured workers. Additionally, most states
must approve the workers' compensation premium rates that may be charged. As a
consequence, the ability of
10
<PAGE>
Preferred Insurance to pay insured workers' compensation claims out of the
premium revenue generated from Preferred Insurance's assumption of such
insurance is dependent on the level of benefits and premium rates approved by
the various states. In this regard, it is significant that the state regulatory
agency that regulates workers' compensation benefits is often not the same
agency that regulates workers' compensation insurance premium rates.
POSSIBLE FUTURE REGULATIONS. Several state legislatures and the federal
government have considered and are considering a number of cost containment and
health care reform proposals. The Company believes it may benefit from some
proposals that favor the growth of managed care. However, no assurance can be
given that the state or federal government will not adopt future health care
reforms that could have a material adverse effect on the Company.
ACQUISITION OF TRAVEL NURSE BUSINESS
On March 6, 1998, a wholly-owned subsidiary of the Company, Preferred
Healthcare Staffing, Inc. ("Preferred Staffing" and formerly Preferred Employers
Acquisition Corp.), purchased substantially all of the assets of HSSI Travel
Nurse Operations, Inc. ("Travel Nurse") for an aggregate purchase price of $5.0
million in cash. Travel Nurse provided registered nurses and other professional
medical personnel, often referred to as "Travelers," primarily to client
hospitals on a contractual basis for periods generally ranging from 8 to 52
weeks, with the average being approximately 17 weeks (standard assignments are
usually for durations of thirteen or twenty-six weeks). Clients utilize
Travelers to provide cost effective interim staff to meet predictable
fluctuations in staffing requirements. In addition, unlike daily or other very
short-term supplemental staff, Travelers serve the client for a long enough
period to function as permanent hospital staff. The ability of the Travelers to
function as permanent staff improves the continuity and consistency of patient
care and reduces the overall administration, orientation and supervisory
requirements of the clients' permanent staff. Travelers are typically employed
on a full-time basis for the period of each assignment. Each Traveler is
generally provided with housing (or a housing subsidy) while on assignment,
travel allowance, and other employee benefits, including malpractice, health and
dental insurance at favorable cost to the Traveler.
For the year ended November 30, 1997, Travel Nurse placed in excess of 700
nurses. Preferred Staffing currently has orders for approximately 1,200 nurses.
CUSTOMERS. As of March 6, 1998, active clients of Preferred Staffing
consisted of approximately 300 hospitals and other clients located in 34 states
and the U.S. Virgin Islands. Travelers serve both for-profit and not-for-profit
entities which range from small rural hospitals to major teaching and research
institutions. A typical client is a hospital with approximately 250 beds which
is located in or near a major metropolitan area.
MARKETING. Preferred Staffing currently markets Travelers principally
through in-house sales personnel. Historically, the marketing approach used by
Travel Nurse targeted hospitals in major metropolitan areas and in other areas
which were attractive from a patient census perspective and which appealed
geographically to Travelers. Historically, marketing activities have been
conducted primarily by telephone contact, direct mail, attendance at national
and regional conventions, seminars, and direct contact with providers of
healthcare services. Preferred Staffing has an extensive computer database of
available, qualified personnel, which enhances its ability to match personnel
with a client's specific needs.
RECRUITMENT. Preferred Staffing currently recruits personnel through its
in-house recruiting department. Recruiting methods historically have included
national and local advertising, attendance at national and regional conventions,
personal and professional referrals and the sponsoring of local seminars in
selected cities throughout the United States and Canada.
Preferred Staffing's current database contains information on pre-screened
personnel classified by skill, experience, and choice and availability for
assignments. The database is updated on a regular basis. When called upon to
fill an assignment, its recruiters can access this database to match a client's
staffing
11
<PAGE>
needs with available personnel. Nurses and other medical personnel listed in the
database generally do not work exclusively for any one employer.
SEASONALITY. Historically, Travel Nurse's business has been seasonal, with
the demand for Travelers being the highest in the first and fourth quarters of
the fiscal year (September through March). This is due largely to increased
demand particularly during the peak tourist and winter home period in Florida.
BACKLOG OF ORDERS. As of March 30, 1998, Preferred Staffing has
approximately 1,200 unfilled requests for travel nurses. For the year ended
November 30, 1997, Travel Nurse placed in excess of 700 nurses.
YEAR 2000
Year 2000 issues arise because most computer systems and programs were
designed to handle only a two-digit year, not a four-digit year. Thus, the Year
2000 could be interpreted as the year 1900 by such computer systems and
programs, resulting in the incorrect processing of data. The Company has
developed a plan to address Year 2000 issues and recently completed the
conversion of its computer systems to be Year 2000 compliant. The Company
believes that any issues which may arise with respect to Year 2000 issues will
not have a material adverse effect on the Company's operations. However, there
can be no assurance that the Company will not be adversely affected by Year 2000
issues.
EMPLOYEES
As of March 20, 1998, excluding Preferred Staffing, the Company had
approximately 45 full-time employees, of whom 5 were executive officers, 6 were
managers, 5 were sales personnel and the balance were accounting, clerical, loss
control and underwriting staff. As of March 30, 1998, Preferred Staffing
employed approximately 340 Travelers. These Travelers do not necessarily work
full-time shifts. None of the Company's employees is subject to a collective
bargaining agreement. The Company believes that its relationships with its
employees are good.
ITEM 2. DESCRIPTION OF PROPERTY
The Company leases approximately 12,600 square feet of office space in
Miami, Florida for use as its corporate headquarters. The Company's initial
lease term expires in 2002, and has two five-year renewal options. Pursuant to
the Travel Nurse acquisition, Preferred Staffing assumed a six-month lease for a
portion of Travel Nurse's premises located at 5100 North Federal Highway, Suite
201, Fort Lauderdale, Florida consisting of approximately 6,000 square feet. The
Company anticipates that its existing leases will be renegotiated as they expire
or that alternative properties can be leased on acceptable terms. The Company
believes that its present facilities are well maintained, in good condition and
are suitable for its needs for the foreseeable future.
ITEM 3. LEGAL PROCEEDINGS
The Company is a party to various claims and lawsuits arising in the
ordinary course of business. As of March 25, 1998, the Company was not a party
to any legal proceedings, which if adversely determined, would have a material
adverse effect on the financial condition or operations of the Company.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
During the fourth quarter of the year ended December 31, 1997, no matters
were submitted by the Company to a vote of its stockholders.
12
<PAGE>
PART II
ITEM 5. MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
MARKET INFORMATION. The Company's common stock (the "Common Stock") is
currently listed on the Nasdaq SmallCap Market under the trading symbol "PEGI."
The Company first listed its Common Stock on the Nasdaq SmallCap Market in
February 1997. During the period from February 1997 to August 1997, the Common
Stock was also listed on the Boston Stock Exchange. The following table sets
forth the high and low closing sale prices of the Common Stock as reported on
the Nasdaq SmallCap Market and the Boston Stock Exchange for each calendar
quarter commencing in February 1997 through December 31, 1997 (through August
1997 in the case of the Boston Stock Exchange).
<TABLE>
<CAPTION>
NASDAQ SMALLCAP
MARKET
CLOSING SALE PRICES
--------------------
<C> <S> <C> <C>
YEAR PERIOD HIGH LOW
- --------- ------------------------------------------------------------------------------ --------- ---------
1997 First Quarter (Commencing February 6, 1997)................................... $ 9.38 $ 7.50
Second Quarter................................................................ 7.75 6.00
Third Quarter................................................................. 12.25 7.00
Fourth Quarter................................................................ 10.75 7.00
1998 First Quarter (through March 27, 1998)........................................ 8.88 7.00
</TABLE>
<TABLE>
<CAPTION>
BOSTON STOCK EXCHANGE
CLOSING SALES PRICES
------------------------
<C> <S> <C> <C>
YEAR PERIOD HIGH LOW
- --------- -------------------------------------------------------------------------------- ----------- -----------
1997 First Quarter (Commencing February 6, 1997)..................................... $ 8.38 $ 7.13
Second Quarter.................................................................. 7.14 6.00
Third Quarter (Ending August 9, 1997)........................................... 7.75 6.50
</TABLE>
As of March 27, 1998, the closing sale price of the Common Stock on the
Nasdaq SmallCap Market was $8.88 and there were approximately 18 stockholders of
record. A high percentage of the shares of Common Stock held of record are
registered in the names of brokerage firms and depository trusts.
The Company has neither declared nor paid any dividends on its Common Stock
and does not anticipate paying dividends in respect of its Common Stock in the
foreseeable future. Any payment of future dividends will be at the discretion of
the Company's Board of Directors and will depend upon, among other things, the
Company's earnings, financial condition, cash flows, capital requirements and
other relevant considerations, including the extent of its indebtedness and any
contractual restrictions with respect to the payment of dividends. See
"Management's Discussion and Analysis -- Liquidity and Capital Resources."
USE OF PROCEEDS. The Company received approximately $10,400,000 in net cash
proceeds from its initial public offering of Common Stock consummated in
February 1997. The Company used approximately $3,500,000 of the proceeds to
capitalize Preferred Insurance in February 1997 and approximately $5,000,000 of
the proceeds in connection with the Travel Nurse acquisition in March 1998.
13
<PAGE>
ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS
The following discussion and analysis should be read in conjunction with the
financial statements and notes related thereto contained elsewhere in this Form
10-KSB.
GENERAL
The Company is primarily engaged in the property and casualty insurance
business as a general agent ("GA") on behalf of the American International Group
of Companies ("AIG"), General Accident Insurance Company ("GAIC") and the Kemper
Insurance Companies ("Kemper") and as a reinsurer for certain workers'
compensation insurance policies written by the Company on behalf of AIG.
Pursuant to general agency agreements with these carriers, the Company is
authorized to solicit and bind insurance contracts on behalf of the insurers,
collect and account for premiums on business it writes, and request cancellation
or nonrenewal of any policy placed by the Company. The Company receives, as
compensation pursuant to the terms of these general agency agreements, gross
commissions on its business at rates which range from 5% to 20%. The Company has
written workers' compensation insurance since its inception in 1988 and in late
1995 began writing other forms of property and casualty insurance (such other
forms of insurance being hereinafter referred to as "Package") for family style
and fast food restaurants as a GA for GAIC. In June 1996, GAIC advised the
Company that it would no longer accept Package insurance risks for fast food
restaurants, but would continue to do so for family style restaurants. As a
result, the Company became a GA for Kemper during March 1997, through which it
writes package as well as other forms of property and casualty insurance and
workers' compensation insurance.
In December 1996, the Company formed a reinsurance subsidiary (Preferred
Insurance) under the laws of Bermuda and entered into a reinsurance agreement
with AIG pursuant to which Preferred Insurance acts as the reinsurer with
respect to certain workers' compensation and employer's liability insurance
policies in force with policy inception dates as of January 1, 1996 and
subsequent which are written by the Company on behalf of AIG. Preferred
Insurance receives as compensation pursuant to the terms of the reinsurance
agreement the related net written premiums less certain program expenses and
commissions and the losses paid associated with the business. Although Preferred
Insurance assumes the risks associated with being a reinsurer, the reinsurance
agreement limits the liability of Preferred Insurance for losses and certain
defined expenses to the first $300,000 per occurrence. In addition, the
reinsurance agreement limits the aggregate liability of Preferred Insurance for
all coverage to an amount not to exceed 70% of the gross written premium for
each individual underwriting year. Because the reinsurance agreement is
effective for all business written on or after January 1, 1996, the policies
written prior to the execution of the contract and formation of Preferred
Insurance are accounted for as retroactive reinsurance. Refer to Note 1(c) to
the Company's consolidated financial statements for a more detailed explanation
of the accounting related thereto. The reinsurance agreement with Preferred
Insurance is terminable by either party upon the occurrence of certain events.
The Company collects workers' compensation premiums from the insureds and
remits the ceding commission (net of the Company's commission) and reinsurance
charge to AIG and remits the net premium to Preferred Insurance. Commission
income on workers' compensation business is recognized as income when premiums
are collected. Package insurance premiums are principally collected by the
insurance carrier. The Package insurance carrier remits commissions on Package
premiums it collects to the Company monthly. Commission income on Package
business is recognized as income when premiums are due. Reinsurance premiums
received by Preferred Insurance are earned on a pro-rata basis over the term of
the related coverage.
14
<PAGE>
RESULTS OF OPERATIONS
FOR THE YEAR ENDED DECEMBER 31, 1997 AND 1996
TOTAL REVENUES. Total revenues for the year ended December 31, 1997 was
$15,999,000 compared to $3,341,000 for the year ended December 31, 1996,
representing a net increase of $12,658,000. The following table provides a
comparison of commission income for the years ended December 31, 1997 and 1996
by category:
<TABLE>
<CAPTION>
PERCENTAGE
1997 1996 NET CHANGE CHANGE
------------- ------------ ------------ -----------
<S> <C> <C> <C> <C>
Net commission income:
Workers' compensation............. $ 1,401,000 1,680,000 (279,000) (16.6%)
Package........................... 483,000 577,000 (94,000) (16.3%)
Other, net........................ 475,000 206,000 269,000 130.6%
------------- ------------ ------------ -----------
Total net commission income..... 2,359,000 2,463,000 (104,000) (4.2%)
Premiums earned..................... 11,675,000 525,000 11,150,000 *
Net investment income............... 1,395,000 217,000 1,178,000 *
Other income........................ 570,000 136,000 434,000 *
------------- ------------ ------------ -----------
Total revenues.................. $ 15,999,000 3,341,000 12,658,000 *
------------- ------------ ------------ -----------
------------- ------------ ------------ -----------
Workers' compensation:
Premiums collected................ $ 14,929,000 16,746,000 (1,817,000) (10.9%)
------------- ------------ ------------ -----------
------------- ------------ ------------ -----------
Ratio of net commission
income/premiums collected....... 9.39% 10.03% (0.64%)
------------- ------------ ------------
------------- ------------ ------------
</TABLE>
- ------------------------
* The percentage change is insignificant or not meaningful for comparative
purposes.
Workers' compensation commission income decreased $279,000, or 16.6%, for
the year ended December 31, 1997 as compared to the prior year as a result of
the decrease in premiums collected of $1,817,000, which is attributable to the
decrease in the workers' compensation book of business. The decrease in workers'
compensation commission income is also due to an increase in commission expense
related to the mix of business produced by brokers. Package commission income
decreased $94,000 or 16.3% for the year ended December 31, 1997 as compared to
the prior year as a result of the lack of product availability as described
above. Other net commission income increased $269,000 for the year ended
December 31, 1997 as compared to the prior year as a result of the introduction
of the small business plan which accounted for $264,000 of the increase.
Premiums earned increased $11,150,000 for the year ended December 31, 1997 as
compared to the prior year as a result of the entry by Preferred Insurance into
the reinsurance business in 1997 and reflects a full year of operations. Net
investment income increased $1,178,000 for the year ended December 31, 1997 as
compared to the prior year as a result of the investable funds raised by the
Company in its 1997 initial public offering and premiums received by Preferred
Insurance. Other income increased $434,000 for the year ended December 31, 1997
as a result of the effects of the retroactive insurance accounting treatment of
Preferred Insurance as discussed more fully in Note 1(c) to the Company's
consolidated financial statements.
15
<PAGE>
TOTAL EXPENSES. Total expenses for the year ended December 31, 1997 were
$14,581,000 compared to $3,427,000 for the year ended December 31, 1996,
representing an increase of $11,154,000. The following table provides a
comparison of total expenses for the years ended December 31, 1997 and 1996 by
category:
<TABLE>
<CAPTION>
PERCENTAGE
1997 1996 NET CHANGE CHANGE
------------- ---------- ------------ -------------
<S> <C> <C> <C> <C>
Losses and loss adjustment expenses
incurred............................. $ 6,257,000 270,000 5,987,000 *
Amortization of deferred acquisition
costs................................ 4,162,000 178,000 3,984,000 *
Other costs............................ 4,162,000 2,979,000 1,183,000 39.7%
------------- ---------- ------------ ---
Total expenses....................... $ 14,581,000 3,427,000 11,154,000 *
------------- ---------- ------------ ---
------------- ---------- ------------ ---
</TABLE>
- ------------------------
* The percentage change is insignificant or not meaningful for comparative
purposes.
Losses and loss adjustment expenses increased $5,987,000 for the year ended
December 31, 1997 as compared to the previous year. The increase is consistent
with the increase in premiums earned in 1997 as discussed above. For the year
ended December 31, 1997, the Company's ratio of losses incurred to premiums
earned was approximately 54%. Amortization of deferred acquisition costs
increased $3,984,000 for the year ended December 31, 1997 as compared to the
previous year. This increase is consistent with the increase in premiums earned
in 1997 as discussed above. For the year ended December 31, 1997, the Company's
ratio of amortization of deferred acquisition costs to premiums earned was
approximately 36%.
Other expenses increased $1,183,000 or 39.7% for the year ended December 31,
1997 as compared to the previous year. The following table provides a comparison
of other expenses for years ended December 31, 1997 and 1996 by category:
<TABLE>
<CAPTION>
PERCENTAGE
1997 1996 NET CHANGE CHANGE
------------ ---------- ----------- -------------
<S> <C> <C> <C> <C>
Personnel expenses........................ $ 2,464,000 2,056,000 408,000 19.8%
Occupancy expenses........................ 307,000 212,000 95,000 44.8%
Professional fees......................... 281,000 81,000 200,000 *
Interest expense.......................... 17,000 42,000 (25,000) (59.5%)
Other operating expenses.................. 1,093,000 588,000 505,000 85.6%
------------ ---------- ----------- -----
Total other expense..................... $ 4,162,000 2,979,000 1,183,000 39.7%
------------ ---------- ----------- -----
------------ ---------- ----------- -----
</TABLE>
- ------------------------
* The percentage change is insignificant or not meaningful for comparative
purposes.
Personnel expenses increased $408,000 or 19.8% for the year ended December
31, 1997 as compared to the previous year as a result of the hiring of three
executives in 1997 with aggregate annual compensation of $543,000 together with
a 2% aggregate annual salary increase in 1997 for all other employees plus the
retroactive effects of the salary increases. Occupancy expenses increased
$95,000 for the year ended December 31, 1997, principally as a result of the
Company's relocation to larger quarters to accommodate the Company's expansion.
Professional fees increased $200,000 for the year ended December 31, 1997,
principally as a result of increased legal fees associated with various
corporate, reinsurance and acquisition matters. Interest expense decreased
$25,000 as a result of a decrease in the principal balance of a loan from a
shareholder.
Other operating expenses increased $505,000 for the year ended December 31,
1997 as compared to the previous year, primarily related to the following: (i)
increased insurance expense of $190,000,
16
<PAGE>
(ii) increased relocation expense of $115,000, (iii) increased sales promotion
expense of $75,000, (iv) increased travel expenses of $55,000 and (v) increased
supplies expense of $45,000. Insurance expense increased as a result of the
purchase of additional coverages (i.e., directors and officers liability
insurance) and increased premiums due to increased limits. Relocation expense
increased due to the three executives hired as discussed above. Sales promotion,
travel expenses and supplies expense increased as a result of the expansion of
the business.
LIQUIDITY AND CAPITAL RESOURCES
Historically, the Company's principal source of cash has been from the
collection of workers' compensation insurance premiums from its insureds. In
February 1997, the Company consummated an initial public offering of 1,725,000
shares of Common Stock (including the underwriters' over-allotment option) and
received gross cash proceeds of approximately $12,506,250.
At December 31, 1997, net cash and investments were $24,044,000 (net of
premiums payable of $3,064,000). Net cash provided by operating activities
increased to $11,515,000 in 1997 from $3,177,000 in 1996, an increase of
$8,338,000. This increase resulted primarily from an increase in reinsurance
premiums collected of $14,716,000 offset by an increase in net premiums paid of
$849,000, an increase in net dividend trust funds paid of $470,000, an increase
in expenses paid of $1,419,000, a decrease in premiums collected of $1,881,000
and a decrease in litigation proceeds of $190,000. The increase in reinsurance
premiums collected is a result of a full year of reinsurance operations by
Preferred Insurance. The increase in net premiums paid is the result of the
remitting of premiums payable by the Company to Preferred Insurance on a more
timely basis so as to provide for a greater investment yield.
Cash flows used in investing activities increased to $23,066,000 for the
year ended December 31, 1997 from $131,000 for the year ended December 31, 1996,
an increase of $22,935,000. This increase resulted primarily from the purchase
of investments with the proceeds from the issuance of common stock of
$10,384,000 and the net premiums generated from operations as discussed above.
The Company believes that its existing cash balances and cash flows from
activities will be adequate to meet its current operations, including expected
capital expenditures, for at least the next twelve months.
In connection with the Company's current business strategy, it may seek
additional funds through equity and/or debt financings. There can be no
assurance that any such additional debt or equity will be available to the
Company, or if available, will be on terms acceptable to the Company. The
Company is currently negotiating a letter of intent with an investment banking
firm for the private placement of $10 million of subordinated convertible notes.
There can be no assurance the Company will enter into a definitive agreement
concerning the transaction or that the Company will consummate such financing.
ITEM 7. FINANCIAL STATEMENTS
The Company's audited consolidated financial statements for the years ended
December 31, 1997 and 1996, respectively, are set forth at the end of this
Annual Report on Form 10-KSB and begin on page F-1.
ITEM 8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None
17
<PAGE>
PART III
ITEM 9. DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS OF THE
REGISTRANT
Information with respect to this Item is incorporated by reference to the
Company's definitive Proxy Statement with respect to its Annual Meeting of
Stockholders expected to be held in June, 1998.
ITEM 10. EXECUTIVE COMPENSATION
Information with respect to this Item is incorporated by reference to the
Company's definitive Proxy Statement with respect to its Annual Meeting of
Stockholders expected to be held in June, 1998.
ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
Information with respect to this Item is incorporated by reference to the
Company's definitive Proxy Statement with respect to its Annual Meeting of
Stockholders expected to be held in June, 1998.
ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Information with respect to this Item is incorporated by reference to the
Company's definitive Proxy Statement with respect to its Annual Meeting of
Stockholders expected to be held in June, 1998.
ITEM 13. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits. The following exhibits are included herewith unless otherwise
indicated:
<TABLE>
<CAPTION>
EXHIBITS PAGE
- ----------- -----
<C> <S> <C>
3.1 Certificate of Incorporation of the Company (Incorporated herein by reference to Exhibit 3.1 to
the Company's Registration Statement on Form SB-2, No. 333-14103).
3.2 By-Laws of the Company (Incorporated herein by reference to Exhibit 3.2 to the Company's
Registration Statement on Form SB-2, No. 333-14103).
4.1 Form of Representative Warrants (Incorporated herein by reference to Exhibit 4.1 to the Company's
Registration Statement on Form SB-2, No. 333-14103).
4.2 Specimen Common Stock Certificate (Incorporated herein by reference to Exhibit 4.2 to the
Company's Registration Statement on Form SB-2, No. 333-14103).
10.1 Form of the Company's 1996 Employee Stock Option Agreement (Incorporated herein by reference to
Exhibit 10.1 to the Company's Registration Statement on Form SB-2, No. 333-14103).
10.2 Form of Share Escrow Agreement among the Company, Baer Marks & Upham LLP and Howard Odzer
together with the Letter Agreement Regarding Additional Terms (Incorporated herein by reference
to Exhibit 10.2 to the Company's Registration Statement on Form SB-2, No. 333-14103).
10.3 Employment Agreement, dated May 15, 1995, between the Company and Howard Odzer (Incorporated
herein by reference to Exhibit 10.3 to the Company's Registration Statement on Form SB-2, No.
333-14103).
10.4 Form of Employment Agreement between the Company and Mel Harris (Incorporated herein by reference
to Exhibit 10.4 to the Company's Registration Statement on Form SB-2, No. 333-14103).
</TABLE>
18
<PAGE>
<TABLE>
<CAPTION>
EXHIBITS PAGE
- ----------- -----
<C> <S> <C>
10.5 Letter regarding Agreement among Preferred Insurance, The Insurance Company of the State of
Pennsylvania and other AIG Affiliates and Form of Reinsurance Agreement (Incorporated herein by
reference to Exhibit 10.5 to the Company's Registration Statement on Form SB-2, No. 333-14103).
10.6 Office Space Lease Agreement, dated August 1, 1994 between the Company and K/B Opportunity Fund
I, LP and PEGI (Incorporated herein by reference to Exhibit 10.6 to the Company's Registration
Statement on Form SB-2, No. 333-14103).
10.7 Form of Advisory Services Letter Agreement between the Company and the Representative
(Incorporated herein by reference to Exhibit 10.7 to the Company's Registration Statement on Form
SB-2, No. 333-14103).
10.8 Stock Repurchase Agreement, dated as of May 15, 1995, among the Company, Howard Odzer and Ronald
Rothstein (Incorporated herein by reference to Exhibit 10.8 to the Company's Registration
Statement on Form SB-2, No. 333-14103).
10.9 Cost Sharing Agreement, between the Company and International Insurance Group, Inc. (Incorporated
herein by reference to Exhibit 10.9 to the Company's Registration Statement on Form SB-2, No.
333-14103).
10.10 Form of Share Exchange Agreement among the Company and certain stockholders of PEGI listed
therein (Incorporated herein by reference to 10.10 to the Company's Registration Statement on
Form SB-2, No. 333-14103).
10.11 Amended and Restated Shareholders Agreement dated as of May 15, 1995 among the Company, Howard
Odzer and Mel Harris (Incorporated herein by reference to 10.11 to the Company's Registration
Statement on Form SB-2, No. 333-14103).
10.12 Form of Employment Agreement between the Company and Howard Odzer (Incorporated herein by
reference to Exhibit 10.12 to the Company's Registration Statement on Form SB-2, No. 333-14103).
10.13 Agency Agreement dated September 1, 1994 among the Company, GAIC and certain affiliates of GAIC
(Incorporated herein by reference to Exhibit 10.13 to the Company's Registration Statement on
Form SB-2, No. 333-14103).
10.14 General Agency Agreement dated January 1, 1993 among the Company, The Insurance Company of the
State of Pennsylvania and certain affiliates of AIG (Incorporated herein by reference to Exhibit
10.14 to the Company's Registration Statement on Form SB-2, No. 333-14103).
*10.15 The Company's 1996 Employee Stock Option Plan.
*21.1 Subsidiaries of the Company.
*27.1 Financial Data Schedule.
</TABLE>
- ------------------------
* Filed herewith.
(b) Current Reports on Form 8-K.
None.
19
<PAGE>
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
<TABLE>
<S> <C>
Independent Auditors' Report.......................................................... F-2
Consolidated Balance Sheet as of December 31, 1997.................................... F-3
Consolidated Statements of Operations for the years ended December 31, 1997 and
1996................................................................................ F-4
Consolidated Statements of Shareholders' Equity for the years ended December 31, 1997
and 1996............................................................................ F-5
Consolidated Statements of Cash Flows for the years ended December 31, 1997 and 1996 F-6
Notes to Consolidated Financial Statements............................................ F-7
</TABLE>
F-1
<PAGE>
INDEPENDENT AUDITORS' REPORT
The Board of Directors
Preferred Employers Holdings, Inc.:
We have audited the accompanying consolidated balance sheet of Preferred
Employers Holdings, Inc. and subsidiaries as of December 31, 1997 and the
related consolidated statements of operations, shareholders' equity, and cash
flows for the years ended December 31, 1997 and 1996. These consolidated
financial statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audit.
We conducted our audit in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the 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 audit provides a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of Preferred
Employers Holdings, Inc. and subsidiaries as of December 31, 1997 and 1996, and
the results of their operations and their cash flows for each of the years then
ended in conformity with generally accepted accounting principles.
KPMG Peat Marwick LLP
Miami, Florida
March 27, 1998
F-2
<PAGE>
PREFERRED EMPLOYERS HOLDINGS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEET
DECEMBER 31, 1997
<TABLE>
<S> <C>
ASSETS
Investments:
Held-to-maturity securities, at amortized cost (fair value of $8,237,669).... $8,015,105
Held-to-maturity securities, at amortized cost -- restricted (fair value of
$7,947,981)................................................................ 7,877,444
Short-term investments....................................................... 7,090,550
----------
Total investments.......................................................... 22,983,099
Cash........................................................................... 4,125,147
Accrued investment and interest income......................................... 311,934
Commissions and premiums receivable, net....................................... 585,072
Deferred acquisition costs..................................................... 903,880
Property and equipment, net.................................................... 478,826
Deferred tax assets............................................................ 252,837
Deposits....................................................................... 24,921
Other assets................................................................... 34,487
----------
Total assets............................................................... $29,700,203
----------
----------
LIABILITIES AND SHAREHOLDERS' EQUITY
Liabilities:
Unpaid losses and loss adjustment expenses..................................... $6,107,613
Unearned premiums.............................................................. 2,671,831
Premiums payable............................................................... 3,064,103
Commissions payable............................................................ 330,055
Other liabilities.............................................................. 4,750,082
Accounts payable and accrued expenses.......................................... 508,127
Deferred reinsurance income.................................................... 279,980
----------
Total liabilities.............................................................. 17,711,791
----------
Shareholders' equity:
Common stock, $0.01 par value; authorized 10,000,000 shares; issued 5,254,412
shares..................................................................... 52,544
Additional paid-in capital................................................... 10,367,074
Retained earnings............................................................ 2,074,351
----------
Total shareholders' equity................................................. 12,493,969
Treasury stock, at cost, 529,412 shares...................................... (505,557)
----------
Net shareholders' equity................................................... 11,988,412
----------
Total liabilities and shareholders' equity................................. $29,700,203
----------
----------
</TABLE>
See accompanying notes to consolidated financial statements
F-3
<PAGE>
PREFERRED EMPLOYERS HOLDINGS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
YEARS ENDED DECEMBER 31, 1997 AND 1996
<TABLE>
<CAPTION>
1997 1996
------------- ------------
<S> <C> <C>
Revenues:
Premiums earned.................................................................... $ 11,674,659 524,760
Net investment income.............................................................. 1,394,544 217,314
Net commission income.............................................................. 2,359,445 2,462,625
Other income....................................................................... 570,464 136,431
------------- ------------
Total revenues................................................................... 15,999,112 3,341,130
------------- ------------
Expenses:
Losses and loss adjustment expenses incurred....................................... 6,257,095 270,251
Amortization of deferred acquisition costs......................................... 4,161,884 177,526
Other expenses..................................................................... 4,161,735 2,979,087
------------- ------------
Total expenses................................................................... 14,580,714 3,426,864
------------- ------------
Operating income (loss) before income taxes.......................................... 1,418,398 (85,734)
Non operating income................................................................. -- 190,000
------------- ------------
Income before income taxes........................................................... 1,418,398 104,266
Income taxes......................................................................... 208,980 --
------------- ------------
Net income....................................................................... $ 1,209,418 104,266
------------- ------------
------------- ------------
Net basic income per share........................................................... $ .27
-------------
-------------
Net diluted income per share......................................................... $ .27
-------------
-------------
Common shares and common share equivalents used in computing net income per share.... 4,513,562
-------------
-------------
Proforma information (unaudited):
Historical income before income taxes.............................................. $ 104,266
Proforma income tax provision...................................................... 38,891
Proforma net income................................................................ 65,375
Proforma basic income per share.................................................... .02
Proforma diluted income per share.................................................. .02
Weighted average shares outstanding................................................ 3,000,000
</TABLE>
See accompanying notes to consolidated financial statements.
F-4
<PAGE>
PREFERRED EMPLOYERS HOLDINGS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
YEARS ENDED DECEMBER 31, 1997 AND 1996
<TABLE>
<CAPTION>
1997 1996
------------- ----------
<S> <C> <C>
Common stock-number of shares:
Balance at beginning of period.................................................... 3,529,412 3,529,412
Issuance of common shares......................................................... 1,725,000 --
------------- ----------
Balance at end of period.......................................................... 5,254,412 3,529,412
------------- ----------
------------- ----------
Common stock:
Balance at beginning of period.................................................... $ 35,294 35,294
Issuance of common shares......................................................... 17,250 --
------------- ----------
Balance at end of period.......................................................... 52,544 35,294
------------- ----------
Additional paid-in capital:
Balance at beginning of period.................................................... -- --
Issuance of common shares......................................................... 10,367,074 --
------------- ----------
Balance at end of period.......................................................... 10,367,074 --
------------- ----------
Retained earnings:
Balance at beginning of period.................................................... 864,933 760,667
Net income........................................................................ 1,209,418 104,266
------------- ----------
Balance at end of period.......................................................... 2,074,351 864,933
------------- ----------
Treasury Stock:
Balance at end of period.......................................................... (505,557) (505,557)
------------- ----------
Total shareholders' equity........................................................ $ 11,988,412 394,669
------------- ----------
------------- ----------
</TABLE>
See accompanying notes to consolidated financial statements.
F-5
<PAGE>
PREFERRED EMPLOYERS HOLDINGS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED DECEMBER 31, 1997 AND 1996
<TABLE>
<CAPTION>
1997 1996
------------- -------------
<S> <C> <C>
Cash flow from operating activities:
Net income........................................................................ $ 1,209,418 104,266
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization................................................... 150,341 161,132
Amortization of deferred acquisition costs...................................... 4,161,884 177,526
Deferred income taxes........................................................... (252,837) --
Change in:
Accrued investment and interest income........................................ (311,934) --
Commissions and premiums receivable........................................... 3,344,344 (3,583,802)
Unpaid losses and loss adjustment expenses.................................... 5,908,223 199,390
Unearned premiums............................................................. 782,854 1,888,977
Deferred reinsurance income................................................... (1,054,421) 1,334,401
Premiums payable.............................................................. (521,487) 1,231,676
Commissions payable........................................................... (179,302) 212,769
Accounts payable and accrued expenses......................................... 135,437 367,215
Other, net.................................................................... (1,857,061) 1,083,264
------------- -------------
Net cash provided by operating activities................................... 11,515,459 3,176,814
------------- -------------
Cash flow from investing activities:
Purchase of fixed maturities...................................................... (15,892,549) --
Increase in short-term investments................................................ (7,090,550) --
Purchase of property and equipment................................................ (82,677) (130,503)
------------- -------------
Net cash used in investing activities....................................... (23,065,776) (130,503)
------------- -------------
Cash flow from financing activities:
Proceeds from sale of common stock................................................ 10,384,324 --
Repayment of shareholder loan..................................................... (300,000) (275,000)
------------- -------------
Net cash provided by (used in) financing activities......................... 10,084,324 (275,000)
------------- -------------
Net increase (decrease) in cash..................................................... (1,465,993) 2,771,311
Cash at beginning of period......................................................... 5,591,140 2,819,829
------------- -------------
Cash at end of period............................................................... $ 4,125,147 5,591,140
------------- -------------
------------- -------------
Supplemental disclosure of cash flow information:
Income taxes paid................................................................. $ 202,300 --
------------- -------------
------------- -------------
</TABLE>
See accompanying notes to consolidated financial statements.
F-6
<PAGE>
PREFERRED EMPLOYERS HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1997 AND 1996
(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
(A) BASIS OF PRESENTATION
The accompanying consolidated financial statements of Preferred Employers
Holdings, Inc. (the "Company") and its subsidiaries, as described below, are
prepared in accordance with generally accepted accounting principles. These
principles vary in certain respects from statutory accounting practices
prescribed or permitted by regulatory authorities. The preparation of financial
statements in conformity with generally accepted accounting principles requires
management to make estimates, based on the best information available, in
recording transactions resulting from business operations. The balance sheet
amounts that involve a greater extent of accounting estimates and actuarial
determinations subject to future changes are the Company's liabilities for
unpaid losses and loss adjustment expenses. As additional information becomes
available (or actual amounts are determinable), the recorded estimates may be
revised and reflected in operating results. While management believes that the
liability for unpaid losses and loss adjustment expenses is adequate to cover
the ultimate liability, such estimates may be more or less than the amounts
actually paid when claims are settled.
(B) ORGANIZATION
Preferred Employers Holdings, Inc. is the successor company to Preferred
Employers Group, Inc. ("PEGI"). In February, 1997, the Company completed an
initial public offering of 1,725,000 shares of common stock (including the
underwriter's over-allotment option) at a price of $7.25 per share. Immediately
prior to the Company's initial public offering, the Company and the stockholders
of PEGI (the "Exchanging Stockholders") effected a recapitalization whereby the
Company exchanged 17,647.06 shares of common stock for each share of common
stock of PEGI held by the Exchanging Stockholders (the "Exchange"). As a result
of the Exchange, PEGI became a wholly owned subsidiary of the Company. Except as
otherwise specified or when the context otherwise requires, references to the
Company herein include Preferred Employers Holdings, Inc. and PEGI, through
which the Company conducts certain of its business.
The Company was appointed as a general agent ("GA") by the American
International Group of Companies ("AIG"), a major group of international
insurance carriers, on January 1, 1993. In this regard, the Company is
authorized to write workers' compensation as well as other forms of "property
and casualty" business (such other forms of insurance being hereinafter referred
to as "Package") on behalf of AIG. In addition, the Company was appointed as a
GA by General Accident Insurance Company of America ("GAIC") on September 1,
1994, with the authority to write all forms of commercial property and casualty
business for family style and fast-food restaurants. On June 11, 1996, GAIC
advised the Company that it would no longer write Package insurance for
fast-food restaurants; however, on March 20, 1997, the Company was appointed as
a GA by the Kemper Group of Insurance Companies with the authority to write
workers' compensation and other forms of commercial property and casualty
business for family style and fast-food restaurants and convenience stores.
(C) INSURANCE OPERATIONS
In 1996, the Company formed a Bermuda licensed reinsurance subsidiary (the
"Reinsurer") and entered into a reinsurance agreement (the "Agreement") with AIG
during the fourth quarter of 1996. The Agreement provides that the Reinsurer
assumes certain workers' compensation and employer's liability insurance
policies from AIG with policy inception dates as of January 1, 1996 and
subsequent. Although the Reinsurer will assume the risks associated with being a
reinsurer, the Agreement limits the liability of the Reinsurer for losses and
certain defined expenses to the first $300,000 per occurrence. In addition, the
F-7
<PAGE>
PREFERRED EMPLOYERS HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997 AND 1996
(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
Agreement limits the aggregate liability of the Reinsurer for all coverage to an
amount not to exceed 70 percent of the gross written premium for each individual
underwriting year.
Because the Agreement is effective for all business written on or after
January 1, 1996, the policies written prior to the execution of the Agreement
and formation of the Reinsurer are accounted for as retroactive reinsurance.
The principal difference between the accounting for retroactive and
prospective reinsurance is that revenue and costs of retroactive reinsurance are
deferred and accreted into income over the claim-settlement period, rather than
over the period for which contractual coverage is provided, as would be the case
under prospective reinsurance.
Retroactive insurance accounting does not change the amount of income to be
recognized, but rather extends the period of recognition from one year--the
period of coverage, to six years--the period over which claims liabilities from
the business are expected to be settled. Cash flows from the reinsurance
transactions are not affected by the accounting treatment.
The accompanying financial statements reflect a composite
retroactive/prospective accounting treatment with business written prior to
October 1, 1996, being accounted for as retroactive and business written
subsequent thereto accounted for as prospective.
The effects of prospective and retroactive reinsurance accounting treatment
are illustrated below. The prospective method assumed that the Agreement
incepted on January 1, 1996, and provides for a loss ratio of 51.5%, acquisition
costs of 33.38%, aggregate net premiums written of approximately $15 million
($12,600,000 relating to the period January 1 through September 30, 1996) and an
investment yield of 6.5% on net cash flows. The retroactive (deposit) method
uses the same assumptions except that since the Agreement was not executed until
October 1996, any investment income on net cash flows earned for the period from
January through September 1996 are deferred and recognized as "other income"
over the payment period of the remaining claim liabilities.
Income before income taxes recognized, and estimated to be recognized in the
calendar year indicated below is as follows:
<TABLE>
<CAPTION>
PROSPECTIVE COMPOSITE
METHOD RETROACTIVE/PROSPECTIVE
YEARS (PRO FORMA) (ACTUAL)
- --------------------------------------------------------- ------------ ---------------------
<S> <C> <C>
1996..................................................... $ 1,658,000 324,000
1997..................................................... 1,288,000 1,372,000
1998-2001................................................ 1,314,000 2,564,000
------------ ----------
$ 4,260,000 4,260,000
------------ ----------
------------ ----------
</TABLE>
It should be noted that the table presented above is for illustrative
purposes only to highlight that the basis of accounting used only impacts the
timing of the net revenue recognition and not the aggregate economic results.
Further, it should be noted that the above table is based on estimates as to the
amount and timing of aggregate loss and loss expense payments, available
investment yields and acquisition and other costs associated with the provision
of insurance protection. Actual results may vary, perhaps materially, from those
illustrated above. No assurance is given or may be taken that subsequent
revisions of estimates will not have a material impact on the illustration
above.
F-8
<PAGE>
PREFERRED EMPLOYERS HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997 AND 1996
(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
Prospective reinsurance premiums are earned on a pro-rata basis over the
term of the related coverage. The reserve for unearned premiums represents the
portion of the net premiums written relating to the unexpired term of coverage.
Acquisition costs are deferred and amortized over the period in which the
related prospective reinsurance premiums are earned.
Losses and loss adjustment expenses are charged to income as incurred. The
reserve for unpaid claims represents the accumulation of estimates for reported
losses and includes provisions for losses incurred but not reported. The methods
of determining such estimates and establishing resulting reserves are
continually reviewed and updated. Adjustments, if any, resulting therefrom are
reflected in income, currently. The Company does not discount its loss reserves.
(D) INVESTMENTS
Fixed maturity securities which the Company has the positive intent and
ability to hold to maturity are classified as "held to maturity" and are
reported at amortized cost. Fixed maturity and equity securities that are bought
and held principally for the purpose of selling them in the near term are
classified as "trading" and are reported at fair value, with unrealized gains
and losses included in income. Fixed maturity and equity securities not
classified as either held to maturity or trading are classified as "available
for sale" and are reported at fair value, with unrealized gains and losses (net
of deferred taxes) charged or credited as a separate component of shareholders'
equity.
Investment income is recorded as earned on the accrual basis and includes
amortization of premiums and accretion of discounts relating to investments
acquired at other than par value. Realized gains or losses on disposal of
investments are determined on a specific identification basis and are included
in revenues.
The Company does not own any on-balance sheet or off-balance sheet
derivative instruments.
(E) PROPERTY AND EQUIPMENT, NET
Property and equipment is stated at cost less accumulated depreciation.
Depreciation is computed using an accelerated method of depreciation over the
estimated useful lives of the related assets, which range from five to seven
years. Leasehold improvements are carried at cost less accumulated amortization
provided on the straight-line basis over the shorter of the lease term or the
estimated useful lives of the improvements.
(F) PREMIUMS PAYABLE
Premiums which are collected from insureds are reported as assets of the
Company and as corresponding liabilities to the insurance carriers. Premiums
received from insureds but not yet remitted to the carriers are held as invested
cash in a fiduciary capacity.
(G) COMMISSION INCOME
Commission income is recognized when premiums are received. Any subsequent
commission adjustments, including policy cancellations, are recognized upon
notification from the insurance carrier or broker.
(H) INCOME TAXES
Prior to the formation of the Company, PEGI had elected to be taxed as an S
corporation under the provisions of the Internal Revenue Code. PEGI's
stockholders included in their tax returns the Company's income or loss.
Accordingly, no provision for income taxes is provided in the consolidated
financial
F-9
<PAGE>
PREFERRED EMPLOYERS HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997 AND 1996
(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
statements related to 1996. However, subsequent to the formation of the Company,
PEGI is taxed as a C corporation under the provisions of the Internal Revenue
Code. As such, deferred tax assets and liabilities are recognized for the future
tax consequences attributable to differences between the financial statement
carrying amounts of existing assets and liabilities and their respective tax
bases. Deferred tax assets and liabilities are measured using enacted tax rates
expected to apply to taxable income in the years in which those temporary
differences are expected to be recovered or settled. The effect on deferred tax
assets and liabilities of a change in tax rates is recognized in income in the
period that includes the enactment date.
(I) NET INCOME PER SHARE
Net income per common share is based upon the weighted average number of
common shares outstanding during each year. In February 1997, SFAS No. 128,
"Earnings per Share" was issued. This statement requires specific computations,
presentations and disclosures for earnings per share (EPS) amounts in order to
make EPS amounts more compatible with international accounting standards. The
Company adopted SFAS No.128 for the period ended December 31, 1997. This
statement requires that any prior period EPS amounts be restated. The adoption
of SFAS No. 128 had no effect on diluted EPS amounts reported for any periods
presented.
(J) ACCOUNTING PRONOUNCEMENTS
SFAS No. 129, DISCLOSURES OF INFORMATION ABOUT CAPITAL STRUCTURE, was also
issued in February 1997 and is also effective December 31, 1997. This statement
establishes standards for disclosing information about an entity's capital
structure.
On June 30, 1997, the FASB released SFAS No. 130, Reporting Comprehensive
Income. This statement establishes standards for reporting and displaying
comprehensive income and its components in a full set of financial statements.
SFAS No. 130 requires that all components of comprehensive income be reported in
a financial statement that is displayed with the same prominence as other
financial statements. An example of an item that will be included in the
Company's presentation of comprehensive income, in addition to net income, is
unrealized gains and losses on securities available for sale. This statement is
effective beginning in 1998.
Management believes that there will be no significant impact on the
Company's financial reporting or disclosures as a result of these
pronouncements.
(K) RECLASSIFICATIONS
Certain items in the 1996 financial statements have been reclassified to
conform with the 1997 presentation.
(2) INVESTMENTS
Net investment income for the years ended December 31, 1997 and 1996 is
summarized as follows:
<TABLE>
<CAPTION>
1997 1996
------------ ----------
<S> <C> <C>
Fixed maturities.................................................... $ 973,839 --
Short-term investments and cash..................................... 420,705 217,314
------------ ----------
Net investment income............................................... $ 1,394,544 217,314
------------ ----------
------------ ----------
</TABLE>
F-10
<PAGE>
PREFERRED EMPLOYERS HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997 AND 1996
(2) INVESTMENTS (CONTINUED)
At December 31, 1997, the Company did not hold fixed-maturity securities
which individually exceeded 10% of shareholders' equity except U.S. government
and government agency securities.
Bonds with an amortized cost of $7,877,444 were held in a restricted account
for the benefit of the ceding company (AIG) as unauthorized reinsurance at
December 31, 1997, in accordance with statutory requirements.
The amortized cost and estimated fair values of investments at December 31,
1997 are as follows:
<TABLE>
<CAPTION>
AMOUNT AT
WHICH SHOWN
GROSS GROSS ESTIMATED IN THE
AMORTIZED UNREALIZED UNREALIZED FAIR BALANCE
COST GAINS LOSSES VALUE SHEET
------------- ----------- --------------- ------------ -------------
<S> <C> <C> <C> <C> <C>
Securities held to maturity:
Fixed maturities:
Obligations of states and political
subdivisions.......................... $ 8,015,105 222,564 -- 8,237,669 8,015,105
Obligations of states and political
subdivisions --restricted............. 7,877,444 70,537 -- 7,947,981 7,877,744
--
------------- ----------- ------------ -------------
Total fixed maturities................ $ 15,892,549 293,101 -- 16,185,650 15,892,549
--
--
------------- ----------- ------------ -------------
------------- ----------- ------------ -------------
</TABLE>
The amortized cost and fair value of securities at December 31, 1997, by
contractual maturity date, are presented below:
<TABLE>
<CAPTION>
AMORTIZED FAIR
COST VALUE
------------- ------------
<S> <C> <C>
Fixed maturities held-to-maturity:
Due in one year or less........................................ $ -- --
Due after one year through five years.......................... 6,941,072 7,139,209
Due after one year through five years--restricted.............. 6,803,411 6,849,521
Due after five years through ten years......................... -- --
Due after ten years............................................ 1,074,033 1,098,460
Due after ten years--restricted................................ 1,074,033 1,098,460
------------- ------------
15,892,549 16,185,650
Short-term investments........................................... 7,090,550 7,090,550
------------- ------------
Total........................................................ $ 22,983,099 23,276,200
------------- ------------
------------- ------------
</TABLE>
(3) FINANCIAL INSTRUMENTS
The carrying amounts for short-term investments, cash, commissions and
premiums receivable, accrued investment income, and accounts payable and accrued
expenses approximate their fair values due to the short-term nature of these
instruments.
Estimated fair values for fixed maturities were provided by outside
consultants using market quotations, prices provided by market makers or
estimates of fair values obtained from yield data relating to investment
securities with similar characteristics.
F-11
<PAGE>
PREFERRED EMPLOYERS HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997 AND 1996
(4) STOCKHOLDER LOAN
In May 1995, the Company entered into a repurchase agreement with
stockholders (the "Agreement") whereby the Company agreed to repurchase from
them an aggregate of 30 shares of common stock (529,412 shares as adjusted) (the
"Shares") of the Company. The aggregate purchase price for the Shares was
$600,000 (including interest) to be paid in 24 installments of $25,000. The
closing of the Agreement was subject to the Company's completion of a $600,000
distribution to the stockholders of the Company, pro rata based on the number of
shares of common stock of the Company outstanding and paid to the stockholders
of record on the Agreement date, without giving effect to the repurchase. The
$600,000 distribution was made by the Company on May 26, 1995.
Pursuant to a subsequent agreement made with the stockholders, the
outstanding loan balance at December 31, 1995 was to be repaid in 23 monthly
installments of $25,000 (including interest) commencing in February 1996. The
outstanding balance of the above-referenced stockholder loan was paid in full
during 1997.
(5) NONOPERATING INCOME
In January 1996, the Company settled a lawsuit with a major brokerage firm
that had unilaterally canceled an insurance-brokerage agreement. The Company
received $190,000 in settlement of the lawsuit.
(6) INCOME TAXES
U.S. Federal and state income tax expense consists of the following
components:
<TABLE>
<CAPTION>
CURRENT DEFERRED TOTAL
---------- ---------- ---------
<S> <C> <C> <C>
December 31, 1997.......................................... $ 461,817 (252,837) 208,980
December 31, 1996.......................................... -- -- --
</TABLE>
State income tax aggregated $97,833 for the year ended December 31, 1997.
Income tax expense for the years ended December 31, 1997 and 1996 differed
from the amount computed by applying the U.S. Federal income tax rate of 34% to
income before Federal income taxes as a result of the following:
<TABLE>
<CAPTION>
1997 1996
----------- ----------
<S> <C> <C>
Expected income tax expense.......................................... $ 482,255 35,450
State income tax, net................................................ 41,993 --
Tax-exempt interest.................................................. (209,237) --
S Corporation income................................................. (164,281) (35,450)
Other, net........................................................... 58,249 --
----------- ----------
Total income tax expense......................................... $ 208,980 --
----------- ----------
----------- ----------
</TABLE>
F-12
<PAGE>
PREFERRED EMPLOYERS HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997 AND 1996
(6) INCOME TAXES (CONTINUED)
Deferred income taxes are based upon temporary differences between the
financial statement and tax bases of assets and liabilities. The following
deferred taxes are recorded for 1997:
<TABLE>
<S> <C>
Deferred tax assets:
Reserve for unpaid claims....................................... $ 427,414
Other, net...................................................... 44,348
---------
Gross deferred tax assets..................................... 471,762
---------
---------
Deferred tax liabilities:
Commissions receivable.......................................... (151,454)
Commissions payable............................................. (67,471)
---------
Gross deferred tax liabilities................................ (218,925)
---------
Net deferred tax asset...................................... $ 252,837
---------
---------
</TABLE>
A valuation allowance has not been established as the Company believes it is
more likely than not that the deferred tax asset will be realized.
As a Bermuda domiciled corporation, the Reinsurance Subsidiary does not file
United States tax returns. The Company currently expects to operate in such a
manner that it is not directly subject to U.S. tax (other than U.S. excise tax
on reinsurance premiums where the risks covered thereby are reinsured with
another foreign insurer which is neither a resident of Bermuda nor a resident of
a third country with a United States tax treaty which entitles the foreign
insurer to exemption from excise tax, and withholding tax on certain investment
income from U.S. sources) because it does not engage in business or have a
permanent establishment in the United States.
The Reinsurance Subsidiary does, however, constitute a "controlled foreign
corporation" ("CFC") for United States federal income tax purposes. As a result,
the Company includes in its gross income for United States federal income tax
purposes its pro-rata share of the CFC's "subpart F income," even if such
subpart F income is not distributed. Substantially all of the Reinsurance
Subsidiary's income is subpart F income.
The Company is considering an election under section 953(d) of the Internal
Revenue Code to tax the Reinsurance Subsidiary as a domestic corporation for
U.S. Income Tax purposes. The Company believes this election, if made, will not
have a material effect on its income tax expense.
(7) STATUTORY SOLVENCY REQUIREMENTS
The Bermuda Insurance Act of 1978 and related regulations (the "Act")
requires the Company to meet a minimum solvency margin. Statutory capital and
surplus as of December 31, 1997 was $7,309,143 and the amounts required to be
maintained by the company was $3,300,000. In addition, a minimum liquidity ratio
must be maintained whereby relevant assets, as defined by the Act, must exceed
75% of relevant liabilities. Once these requirements have been met, there is no
restriction on the retained earnings available for distribution. At December 31,
1997, the Company was in compliance with this requirement.
F-13
<PAGE>
PREFERRED EMPLOYERS HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997 AND 1996
(8) LIABILITY FOR UNPAID LOSSES AND LOSS ADJUSTMENT EXPENSES
Activity in the liability for unpaid losses and loss adjustment expenses is
summarized as follows for the years ended December 31, 1997 and 1996:
<TABLE>
<CAPTION>
1997 1996
------------ ---------
<S> <C> <C>
Net unpaid losses and loss adjustment expenses at beginning of
year............................................................... $ 199,390 --
------------ ---------
Incurred related to:
Current year....................................................... 5,284,268 270,251
Prior year......................................................... 972,827 --
------------ ---------
Total incurred................................................... 6,257,095 270,251
------------ ---------
Paid related to:
Current year....................................................... -- 70,861
Prior year......................................................... 348,872 --
------------ ---------
Total paid....................................................... 348,872 70,861
------------ ---------
Net unpaid losses and loss adjustment expenses at end of year........ $ 6,107,613 199,390
------------ ---------
------------ ---------
</TABLE>
(9) STOCK OPTIONS
The following table summarizes stock option activity for 1997:
<TABLE>
<CAPTION>
OPTION WEIGHTED AVERAGE
SHARES EXERCISE PRICE
--------- -----------------
<S> <C> <C>
Granted.......................................................... 511,500 $ 7.48
Exercised........................................................ -- --
--------- -----
Outstanding at December 31, 1997................................. 511,500 $ 7.48
--------- -----
--------- -----
</TABLE>
The Company had no options outstanding prior to 1997.
The following table summarizes information about stock options outstanding
at December 31, 1997:
<TABLE>
<CAPTION>
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
---------------------------- ------------------------
<S> <C> <C> <C> <C> <C>
WEIGHTED
AVERAGE WEIGHTED WEIGHTED
RANGE OF REMAINING AVERAGE AVERAGE
EXERCISE NUMBER CONTRACTUAL EXERCISE NUMBER EXERCISE
PRICES OUTSTANDING LIFE PRICE EXERCISABLE PRICE
- -------------------------------- ----------- --------------- ----------- ----------- -----------
$7.00........................... 75,000 9.52 $ 7.00 -- $ 7.00
7.25........................... 160,000 9.64 7.25 35,000 7.25
7.75........................... 276,500 9.10 7.75 300 7.75
----------- --- ----- ----------- -----
$7.00-7.75...................... 511,500 9.45 $ 7.48 35,300 $ 7.48
----------- --- ----- ----------- -----
----------- --- ----- ----------- -----
</TABLE>
The Company has elected to follow Accounting Principles Board Opinion No.
25, "Accounting for Stock Issued to Employees" (APB 25) and related
Interpretations in accounting for its employee stock options as allowed pursuant
to FASB Statement No. 123, "Accounting for Stock Based Compensation" (FASB
Statement 123). FASB Statement 123 requires use of option valuation models that
require the input
F-14
<PAGE>
PREFERRED EMPLOYERS HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997 AND 1996
(9) STOCK OPTIONS (CONTINUED)
of highly subjective assumptions, including expected stock price volatility.
Because the Company's employee stock options have characteristics significantly
different from traded options and because changes in the subjective input
assumptions can materially affect the fair value estimate, in management's
opinion, the existing models do not necessarily provide a reliable measure of
the fair value of its employee stock options.
Had compensation cost for the Company's stock option plans been determined
based on the fair value at the grant date for awards under those plans,
consistent with FASB Statement No. 123, the reduction in the Company's 1997 net
income and net income per share would have been insignificant. The effect of
applying the fair method of accounting for stock options on reported net income
and net income per share for 1997 may not be representative of the effects for
future years because outstanding options vest over a period of several years and
additional awards are generally made each year.
The fair value of options granted was estimated at the date of grant using
the Black-Scholes option pricing model with the following weighted average
assumptions for 1997:
<TABLE>
<CAPTION>
<S> <C>
Risk-free interest rate............................................................ 6.46%
Expected Life...................................................................... 7 years
Expected volatility................................................................ 25%
Expected dividend yield............................................................ 0
</TABLE>
(10) LEASES
In August 1994, the Company entered into an office lease agreement which
became effective on April 1, 1995. The agreement provides for an initial
seven-year term with two five-year renewal options. The following is a schedule
of the approximate future minimum lease payments as of December 31, 1997:
<TABLE>
<CAPTION>
YEAR ENDING
DECEMBER 31, TOTAL
------------- ------------
<S> <C>
1998............................................................................ $ 191,000
1999............................................................................ 199,000
2000............................................................................ 211,000
2001............................................................................ 214,000
Thereafter...................................................................... 54,000
------------
$ 1,052,000
------------
------------
</TABLE>
Rent expense for the years ended December 31, 1996 and 1997 was $135,018 and
$80,078, respectively.
(11) LITIGATION
The Company is a defendant in various litigation matters considered to be in
the normal course of business. While the outcome of these matters cannot be
estimated with certainty, it is the opinion of management (after consultation
with legal counsel) that the resolution of such litigation will not have a
material adverse effect on the Company's financial statements.
F-15
<PAGE>
PREFERRED EMPLOYERS HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997 AND 1996
(12) UNAUDITED PRO FORMA INFORMATION
Pro forma adjustments for income taxes represent the difference between
historical income taxes and income taxes that would have been reported had the
Company filed income tax returns as a taxable C corporation for 1996.
(13) YEAR 2000
Year 2000 issues are the result of computer programs being written using two
digits rather than four to define the applicable year. The Company developed a
plan to address Year 2000 issues and has recently completed the converion of its
computer systems to be Year 2000 compliant. The cost associated with the project
was immaterial.
(14) SUBSEQUENT EVENT
In March 1998, the Company consummated the purchase of substantially all of
the assets of HSSI Travel Nurse Operations, Inc., a wholly-owned subsidiary of
Hospital Staffing Services, Inc. for $5.0 million in cash. Based in Ft.
Lauderdale, Florida since 1981, Travel Nurse has provided registered nurse and
other professional medical personnel, often referred to as "travelers,"
primarily to client hospitals in the United States and the Caribbean on a
contractual basis for periods generally ranging from 8 to 52 weeks. During 1997,
Travel Nurse placed in excess of 700 nurses.
F-16
<PAGE>
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) 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, in the City of Miami,
State of Florida, on March 31, 1998.
PREFERRED EMPLOYERS HOLDINGS, INC.
BY: /S/ MEL HARRIS
-----------------------------------------
Mel Harris
Chairman and Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of Registrant
and in the capacities indicated on March , 1998.
SIGNATURE TITLE DATE
- ------------------------------ --------------------------- -------------------
Chairman of the Board and
/s/ MEL HARRIS Chief Executive Officer
- ------------------------------ (Principal Executive March 31, 1998
Mel Harris Officer)
Senior Vice President,
/s/ WILLIAM R. DRESBACK Chief Financial Officer
- ------------------------------ and Secretary (Principal March 31, 1998
William R. Dresback Financial and Accounting
Officer)
/s/ HOWARD ODZER President and Director
- ------------------------------ March 31, 1998
Howard Odzer
/s/ STUART J. GORDON Director
- ------------------------------ March 31, 1998
Stuart J. Gordon
/s/ JACK D. BURSTEIN Director
- ------------------------------ March 31, 1998
Jack D. Burstein
Director
- ------------------------------
Maxwell M. Rabb
<PAGE>
Exhibit 10.15
PREFERRED EMPLOYERS HOLDINGS, INC.
1996 STOCK OPTION PLAN
1. PURPOSE
The purpose of this plan (the "Plan") is to secure for PREFERRED
EMPLOYERS HOLDINGS, INC. (the "Company") and its stockholders the benefits
arising from capital stock ownership by employees, officers and directors (who
are also either employees or officers) of the Company and its subsidiary
corporations who are expected to contribute to the Company's future growth and
success. Those provisions of the Plan which make express reference to Section
422 of the Internal Revenue Code of 1986, as amended or replaced from time to
time (the "Code"), shall apply only to Incentive Stock Options (as that term is
defined in the Plan).
2. TYPE OF OPTIONS AND ADMINISTRATION
(a) TYPES OF OPTIONS. Options granted pursuant to the Plan shall be
authorized by action of the Board of Directors (the "Board") of the Company (or
a committee designated by the Board) and may be either incentive stock options
("Incentive Stock Options") meeting the requirements of Section 422 of the Code
or non-statutory options which are not intended to meet the requirements of
Section 422 of the Code.
(b) ADMINISTRATION. The Plan will be administered by the Board or by
a committee consisting of two or more directors each of whom shall be a
"non-employee director" within the meaning of Rule 16b-3 promulgated under the
Securities Exchange Act of 1934, as amended (the "Exchange Act"), or any
successor rule ("Rule 16b-3") and an "outside director" within the meaning of
Treasury Regulation Section 1.162-27(e)(3) promulgated under Section 162(m) of
the Code (the "Committee") appointed by the Board of the Company, in each case
whose construction and interpretation of the terms and provisions of the Plan
shall be final and conclusive. If the Board determines to create a Committee to
administer the Plan, the delegation of powers to the Committee shall be
consistent with applicable laws or regulations (including, without limitation,
applicable state law and Rule 16b-3). The Board or Committee may in its sole
discretion grant options to purchase shares of the Company's Common Stock, $0.01
par value per share ("Common Stock"), and issue shares upon exercise of such
options as provided in the Plan. The Board or Committee shall have authority,
subject to the express provisions of the Plan, to construe the respective option
agreements and the Plan; to prescribe, amend and rescind rules and regulations
relating to the Plan; to determine the terms and provisions of the respective
option agreements, which need not be identical; and to make all other
determinations in the judgment of the Board or Committee necessary or desirable
for the administration of the Plan. The Board or Committee may correct any
defect or supply any omission or reconcile any inconsistency in the Plan or in
any option agreement
<PAGE>
in the manner and to the extent it shall deem expedient to carry the Plan into
effect and it shall be the sole and final judge of such expediency. No director
or person acting pursuant to authority delegated by the Board shall be liable
for any action or determination under the Plan made in good faith.
3. ELIGIBILITY
Options may be granted to persons who are, at the time of grant,
employees, officers or directors (who are also either employees or officers) of
the Company or any subsidiaries of the Company as defined in Sections 424(e) and
424(f) of the Code, PROVIDED, that Incentive Stock Options may only be granted
to individuals who are employees of the Company (within the meaning of Section
3401(c) of the Code). A person who has been granted an option may, if he or she
is otherwise eligible, be granted additional options if the Board or Committee
shall so determine.
4. STOCK SUBJECT TO PLAN
The stock subject to options granted under the Plan shall be shares of
authorized but unissued or reacquired Common Stock. Subject to adjustment as
provided in Section 15 below, the maximum number of shares of Common Stock of
the Company which may be issued and sold under the Plan is 300,000. If an
option granted under the Plan shall expire, terminate or is cancelled for any
reason without having been exercised in full, the unpurchased shares subject to
such option shall again be available for subsequent option grants under the
Plan.
5. FORMS OF OPTION AGREEMENTS
As a condition to the grant of an option under the Plan, each
recipient of an option shall execute an option agreement in such form not
inconsistent with the Plan as may be approved by the Board. Such option
agreements may differ among recipients.
6. PURCHASE PRICE
(a) GENERAL. The purchase price per share of stock issuable upon the
exercise of an option shall be determined by the Board or the Committee at the
time of grant of such option, PROVIDEd, HOWEVER, that in the case of an
Incentive Stock Option, the exercise price shall not be less than 100% of the
Fair Market Value (as hereinafter defined) of such stock at the time of grant of
such option, or less than 110% of such Fair Market Value in the case of options
described in Section 11(b). "Fair Market Value" of a share of Common Stock of
the Company as of a specified date for the purposes of the Plan shall mean the
closing price of a
2
<PAGE>
share of the Common Stock on the principal securities exchange (including The
Nasdaq SmallCap Market or The Nasdaq National Market) on which such shares are
traded on the day immediately preceding the date as of which Fair Market Value
is being determined, or on the next preceding date on which such shares are
traded if no shares were traded on such immediately preceding day, or if the
shares are not traded on a securities exchange, Fair Market Value shall be
deemed to be the average of the high bid and low asked prices of the shares in
the over-the-counter market on the day immediately preceding the date as of
which Fair Market Value is being determined or on the next preceding date on
which such high bid and low asked prices were recorded. If the shares are not
publicly traded, Fair Market Value of a share of Common Stock (including, in the
case of any repurchase of shares, any distributions with respect thereto which
would be repurchased with the shares) shall be determined in good faith by the
Board. In no case shall Fair Market Value be determined with regard to
restrictions other than restrictions which, by their terms, will never lapse.
(b) PAYMENT OF PURCHASE PRICE. Options granted under the Plan may
provide for the payment of the exercise price by delivery of cash or a check to
the order of the Company in an amount equal to the exercise price of such
options, or by any other means which the Board determines are consistent with
the purpose of the Plan and with applicable laws and regulations (including,
without limitation, the provisions of Rule 16b-3 and Regulation T promulgated by
the Federal Reserve Board).
7. EXERCISE OPTION PERIOD
Subject to earlier termination as provided in the Plan, each option
and all rights thereunder shall expire on such date as determined by the Board
or the Committee and set forth in the applicable option agreement, PROVIDED,
that such date shall not be later than ten (10) years after the date on which
the option is granted.
8. EXERCISE OF OPTIONS
Each option granted under the Plan shall be exercisable either in full
or in installments at such time or times and during such period as shall be set
forth in the option agreement evidencing such option, subject to the provisions
of the Plan. Subject to the requirements in the immediately preceding sentence,
if an option is not at the time of grant immediately exercisable, the Board may
(i) in the agreement evidencing such option, provide for the acceleration of the
exercise date or dates of the subject option upon the occurrence of specified
events, and/or (ii) at any time prior to the complete termination of an option,
accelerate the exercise date or dates of such option.
3
<PAGE>
9. NONTRANSFERABILITY OF OPTIONS
No option granted under this Plan shall be assignable or otherwise
transferable by the optionee, except by will or by the laws of descent and
distribution. An option may be exercised during the lifetime of the optionee
only by the optionee. In the event an optionee dies during his employment by
the Company or any of its subsidiaries, or during the three (3) month period
following the date of termination of such employment, his option shall
thereafter be exercisable within a period of one (1) year after the date of
death (or within such lesser period specified in the applicable option
agreement), by his executors or administrators to the full extent to which such
option was exercisable by the optionee at the time of his death during the
periods set forth in Section 10 or 11(d).
10. EFFECT OF TERMINATION OF EMPLOYMENT OR OTHER RELATIONSHIP
Except as provided in Section 11(d) with respect to Incentive Stock
Options and except as otherwise determined by the Board or Committee at the date
of grant of an option, and subject to the provisions of the Plan, an optionee
may exercise an option at any time within three (3) months following the
termination of the optionee's employment or other relationship with the Company
or within one (1) year if such termination was due to the death or disability of
the optionee but in no event later than the expiration date of the option. If
the termination of the optionee's employment is for cause or is otherwise
attributable to a breach by the optionee of an employment or confidentiality or
non-disclosure agreement, the option shall expire immediately upon such
termination. The Board shall have the power to determine what constitutes a
termination for cause or a breach of an employment or confidentiality or
non-disclosure agreement, whether an optionee has been terminated for cause or
has breached such an agreement, and the date upon which such termination for
cause or breach occurs. Any such determinations shall be final and conclusive
and binding upon the optionee.
11. INCENTIVE STOCK OPTIONS
Options granted under the Plan which are intended to be Incentive
Stock Options shall be subject to the following additional terms and conditions:
(a) EXPRESS DESIGNATION. All Incentive Stock Options granted under
the Plan shall, at the time of grant, be specifically designated as such in the
option agreement covering such Incentive Stock Options.
(b) 10% SHAREHOLDER. If any employee to whom an Incentive Stock
Option is to be granted under the Plan is, at the time of the grant of such
option, the owner of stock possessing more than 10% of the total combined voting
power of all classes of stock of the Company (after taking into account the
attribution of stock ownership rules of Section 424(d)
4
<PAGE>
of the Code), then the following special provisions shall be applicable to the
Incentive Stock Option granted to such individual:
(i) the purchase price per share of the Common Stock subject to
such Incentive Stock Option shall not be less than 110% of the Fair Market
Value of one share of Common Stock at the time of grant; and
(ii) the option exercise period shall not exceed five (5) years
from the date of grant.
(c) DOLLAR LIMITATION. For so long as the Code shall so provide,
options granted to any employee under the Plan (and any other incentive stock
option plans of the Company) which are intended to constitute Incentive Stock
Options shall not constitute Incentive Stock Options to the extent that such
options, in the aggregate, become exercisable for the first time in any one
calendar year for shares of Common Stock with an aggregate Fair Market Value, as
of the respective date or dates of grant, of more than $100,000.
(d) TERMINATION OF EMPLOYMENT, DEATH OR DISABILITY. No Incentive
Stock Option may be exercised unless, at the time of such exercise, the optionee
is, and has been continuously since the date of grant of his or her option,
employed by the Company, except that:
(i) an Incentive Stock Option may be exercised within the period
of three (3) months after the date the optionee ceases to be an employee of
the Company (or within such lesser period as may be specified in the
applicable option agreement), PROVIDED, that the agreement with respect to
such option may designate a longer exercise period and that the exercise
after such three (3) month period shall be treated as the exercise of a
non-statutory option under the Plan,
(ii) if the optionee dies while in the employ of the Company, or
within three (3) months after the optionee ceases to be such an employee,
the Incentive Stock Option may be exercised by the person to whom it is
transferred by will or the laws of descent and distribution within the
period of one (1) year after the date of death (or within such lesser
period as may be specified in the applicable option agreement), and
(iii) if the optionee becomes disabled (within the meaning of
Section 22(e)(3) of the Code or any successor provisions thereto) while in
the employ of the Company, the Incentive Stock Option may be exercised
within the period of one (1) year after the date the optionee ceases to be
such an employee because of such disability (or within such lesser period
as may be specified in the applicable option agreement).
For all purposes of the Plan and any option granted hereunder, "employment"
shall be defined in accordance with the provisions of Section 1.421-7(h) of the
Income Tax Regulations (or any
5
<PAGE>
successor regulations). Notwithstanding the foregoing provisions, no Incentive
Stock Option may be exercised after its expiration date.
12. ADDITIONAL PROVISIONS
(a) ADDITIONAL OPTION PROVISIONS. The Board or the Committee may, in
its sole discretion, include additional provisions in option agreements covering
options granted under the Plan, including without limitation, restrictions on
transfer, repurchase rights, rights of first refusal, commitments to pay cash
bonuses or to make, arrange for or guaranty loans or to transfer other property
to optionees upon exercise of options, or such other provisions as shall be
determined by the Board or the Committee, PROVIDED, that such additional
provisions shall not be inconsistent with any other term or condition of the
Plan and such additional provisions shall not cause any Incentive Stock Option
granted under the Plan to fail to qualify as an Incentive Stock Option within
the meaning of Section 422 of the Code.
(b) ACCELERATION, EXTENSION, ETC. The Board or the Committee may, in
its sole discretion (i) accelerate the date or dates on which all or any
particular option or options granted under the Plan may be exercised, or (ii)
extend the dates during which all, or any particular, option or options granted
under the Plan may be exercised, PROVIDED, however that no such extension shall
be permitted if it would cause the Plan to fail to comply with Section 422 of
the Code or with Rule 16b-3 (if applicable to such option).
13. GENERAL RESTRICTIONS
(a) INVESTMENT REPRESENTATIONS. The Company may require any person
to whom an option is granted, as a condition of exercising such option or award,
to give written assurances in substance and form satisfactory to the Company to
the effect that such person is acquiring the Common Stock subject to the option
or award for his or her own account for investment and not with any present
intention of selling or otherwise distributing the same, and to such other
effects as the Company deems necessary or appropriate in order to comply with
federal and applicable state securities laws, or with covenants or
representations made by the Company in connection with any public offering of
its Common Stock, including any "lock-up" or other restriction on
transferability.
(b) COMPLIANCE WITH SECURITIES LAW. Each option shall be subject to
the requirement that if, at any time, counsel to the Company shall determine
that the listing, registration or qualification of the shares subject to such
option or award upon any securities exchange or automated quotation system or
under any state or federal law, or the consent or approval of any governmental
or regulatory body, or that the disclosure of non-public information or the
satisfaction of any other condition, is necessary as a condition of, or in
connection with the issuance or purchase of shares thereunder, such option or
award may not be exercised, in whole or in part, unless such listing,
registration, qualification, consent or
6
<PAGE>
approval or satisfaction of such condition shall have been effected or obtained
on conditions acceptable to the Board or the Committee. Nothing herein shall be
deemed to require the Company to apply for or to obtain such listing,
registration or qualification, or to satisfy such condition.
14. RIGHTS AS A STOCKHOLDER
The holder of an option shall have no rights as a stockholder with
respect to any shares covered by the option (including, without limitation, any
right to vote or to receive dividends or non-cash distributions with respect to
such shares) until the effective date of exercise of such option and then only
to the extent of the shares of Common Stock so purchased. No adjustment shall
be made for dividends or other rights for which the record date is prior to the
date of exercise.
15. ADJUSTMENT PROVISIONS FOR RECAPITALIZATIONS,
REORGANIZATIONS AND RELATED TRANSACTIONS
(a) RECAPITALIZATIONS AND RELATED TRANSACTIONS. If, through or as a
result of any recapitalization, reclassification, stock dividend, stock split,
reverse stock split or other similar transaction (i) the outstanding shares of
Common Stock are increased, decreased or exchanged for a different number or
kind of shares or other securities of the Company, or (ii) additional shares or
new or different shares or other non-cash assets are distributed with respect to
such shares of Common Stock or other securities, an appropriate and
proportionate adjustment shall be made in (x) the maximum number and kind of
shares reserved for issuance under or otherwise referred to in the Plan, (y) the
number and kind of shares or other securities subject to any then-outstanding
options under the Plan, and (z) the price for each share subject to any
then-outstanding options under the Plan, without changing the aggregate purchase
price as to which such options remain exercisable. Notwithstanding the
foregoing, no adjustment shall be made pursuant to this Section 15 if such
adjustment (A) would cause the Plan to fall to comply with Section 422 of the
Code or with Rule 16b-3 (if applicable to such option), or (B) would be
considered as the adoption of a new plan requiring stockholder approval.
(b) REORGANIZATION, MERGER AND RELATED TRANSACTIONS. All outstanding
options under the Plan shall become fully exercisable for a period of sixty (60)
days following the occurrence of any Trigger Event (as defined below), whether
or not such options are then exercisable under the provisions of the applicable
agreements relating thereto. For purposes of the Plan, a "Trigger Event" is any
one of the following events:
(i) the date on which shares of Common Stock are first purchased
pursuant to a tender offer or exchange offer (other than such an offer by
the Company, any subsidiary of the Company, any employee benefit plan of
the Company or of any
7
<PAGE>
subsidiary of the Company or any entity holding shares or other securities
of the Company for or pursuant to the terms of such plan), whether or not
such offer is approved or opposed by the Company and regardless of the
number of shares purchased pursuant to such offer;
(ii) the date the Company acquires knowledge that any person or
group deemed a person under Section 13(d)-3 of the Exchange Act (other than
the Company, any subsidiary of the Company, any employee benefit plan of
the Company or of any subsidiary of the Company or any entity holding
shares of Common Stock or other securities of the Company for or pursuant
to the terms of any such plan or any individual or entity or group or
affiliate thereof which acquired its beneficial ownership interest prior to
the date the Plan was adopted by the Board), in a transaction or series of
transactions, has become the beneficial owner, directly or indirectly (with
beneficial ownership determined as provided in Rule 13d-3, or any successor
rule, under the Exchange Act), of securities of the Company entitling the
person or group to 30% or more of all votes (without consideration of the
rights of any class or stock to elect directors by a separate class vote)
to which all stockholders of the Company would be entitled in the election
of the Board were an election held on such date;
(iii) the date, during any period of two (2) consecutive years,
when individuals who at the beginning of such period constitute the Board
cease for any reason to constitute at least a majority thereof, unless the
election, or the nomination for election by the stockholders of the
Company, of each new director was approved by a vote of at least a majority
of the directors then still in office who were directors at the beginning
of such period; and
(iv) the date of approval by the stockholders of the Company of
an agreement (a "reorganization agreement") providing for:
(A) The merger or consolidation of the Company with another
corporation (x) where the stockholders of the Company, immediately
prior to the merger or consolidation, do not beneficially own,
immediately after the merger or consolidation, shares of the
corporation issuing cash or securities in the merger or consolidation
entitling such stockholders to 80% or more of all votes (without
consideration of the rights of any class of stock to elect directors
by a separate class vote) to which all stockholders of such
corporation would be entitled in the election of directors, or (y)
where the members of the Board of the Company, immediately prior to
the merger or consolidation, do not, immediately after the merger or
consolidation, constitute a majority of the Board of Directors of the
corporation issuing cash or securities in the merger or consolidation,
or
8
<PAGE>
(B) The sale or other disposition of all or substantially all
the assets of the Company.
(c) BOARD AUTHORITY TO MAKE ADJUSTMENTS. Any adjustments under this
Section 15 will be made by the Board or the Committee, whose determination as to
what adjustments, if any, will be made and the extent thereof will be final,
binding and conclusive. No fractional shares will be issued under the Plan on
account of any such adjustments.
16. MERGER, CONSOLIDATION, ASSET SALE, LIQUIDATION, ETC
(a) GENERAL. In the event of any sale, merger, transfer or
acquisition of the Company or substantially all of the assets of the Company in
which the Company is not the surviving corporation, provided that after the
merger, transfer or acquisition the Company shall have requested the acquiring
or succeeding corporation (or an affiliate thereof) that equivalent options
shall be substituted and such successor corporation shall have refused or failed
to assume all options outstanding under the Plan or issue substantially
equivalent options, then any or all outstanding options under the Plan shall
accelerate and become exercisable in full immediately prior to such event. The
Board or Committee will notify holders of options under the Plan that any such
options shall be fully exercisable for a period of fifteen (15) days from the
date of such notice, and the options will terminate upon expiration of such
notice.
(b) SUBSTITUTE OPTIONS. The Company may grant options under the Plan
in substitution for options held by employees of another corporation who become
employees of the Company, or a subsidiary of the Company, as the result of a
merger or consolidation of the employing corporation with the Company or a
subsidiary of the Company, or as a result of the acquisition by the Company, or
one of its subsidiaries, of property or stock of the employing corporation. The
Company may direct that substitute options be granted on such terms and
conditions as the Board considers appropriate in the circumstances.
17. NO SPECIAL EMPLOYMENT RIGHTS
Nothing contained in the Plan or in any option shall confer upon any
optionee any right with respect to the continuation of his or her employment by
the Company or interfere in any way with the right of the Company at any time to
terminate such employment or to increase or decrease the compensation of the
optionee.
18. OTHER EMPLOYEE BENEFITS
Except as to plans which by their terms include such amounts as
compensation, the amount of any compensation deemed to be received by an
employee as a result of the
9
<PAGE>
exercise of an option or the sale of shares received upon such exercise will not
constitute compensation with respect to which any other employee benefits of
such employee are determined, including, without limitation, benefits under any
bonus, pension, profit-sharing, life insurance or salary continuation plan,
except as otherwise specifically determined by the Board.
19. AMENDMENT, MODIFICATION OR TERMINATION OF THE PLAN
(a) The Board may at any time modify, amend or terminate the Plan
PROVIDED, HOWEVER, that if at any time the approval of the stockholders of the
Company is required under Section 422 of the Code or any successor
provision with respect to Incentive Stock Options, or under Rule 16b-3, the
Board may not effect such modification or amendment without such approval.
(b) The modification, amendment or termination of the Plan shall not,
without the consent of an optionee, affect his or her rights under an option
previously granted to him or her. With the consent of the optionee affected,
the Board or the Committee may amend or modify outstanding option agreements in
a manner not inconsistent with the Plan. The Board shall have the right to
amend or modify (i) the terms and provisions of the Plan and of any outstanding
Incentive Stock Options granted under the Plan to the extent necessary to
qualify any or all such options for such favorable federal income tax treatment
(including deferral of taxation upon exercise) as may be afforded incentive
stock options under Section 422 of the Code, and (ii) the terms and provisions
of the Plan and of any outstanding option to the extent necessary to ensure the
qualification of the Plan under Rule 16b-3.
20. WITHHOLDING
(a) The Company shall have the right to deduct from payments of any
kind otherwise due to the optionee any federal, state or local taxes of any kind
required by law to be withheld with respect to any shares issued upon exercise
of options under the Plan. Subject to the prior approval of the Company, which
may be withheld by the Company in its sole discretion, the optionee may elect to
satisfy such obligations, in whole or in part (i) by causing the Company to
withhold shares of Common Stock otherwise issuable pursuant to the exercise of
an option, or (ii) by delivering to the Company shares of Common Stock already
owned by the optionee. The shares so delivered or withheld shall have a Fair
Market Value equal to such withholding obligation as of the date that the amount
of tax to be withheld is to be determined. An optionee who has made an election
pursuant to this Section 20(a) may only satisfy his or her withholding
obligation with shares of Common Stock which are not subject to any repurchase,
forfeiture, unfulfilled vesting or other similar requirements.
(b) The acceptance of shares of Common Stock upon exercise of an
Incentive Stock Option shall constitute an agreement by the optionee (i) to
notify the Company if any
10
<PAGE>
or all of such shares are disposed of by the optionee within two (2) years from
the date the option was granted or within one (1) year from the date the shares
were issued to the optionee pursuant to the exercise of the option, and (ii) if
required by law, to remit to the Company, at the time of and in the case of any
such disposition, an amount sufficient to satisfy the Company's federal, state
and local withholding tax obligations with respect to such disposition, whether
or not, as to both (i) and (ii), the optionee is in the employ of the Company at
the time of such disposition.
21. CANCELLATION AND NEW GRANT OF OPTIONS, ETC.
The Board or the Committee shall have the authority to effect, at any
time and from time to time, with the consent of the affected optionees (i) the
cancellation of any or all outstanding options under the Plan and the grant in
substitution therefor of new options under the Plan covering the same or
different numbers of shares of Common Stock and having an option exercise price
per share which may be lower or higher than the exercise price per share of the
cancelled options, or (ii) the amendment of the terms of any and all outstanding
options under the Plan to provide an option exercise price per share which is
higher or lower than the then-current exercise price per share of such
outstanding options.
22. EFFECTIVE DATE AND DURATION OF THE PLAN
(a) EFFECTIVE DATE. The Plan shall become effective when adopted by
the Board, but no Incentive Stock Option granted under the Plan shall become
exercisable unless and until the Plan shall have been approved by the Company's
stockholders. If such stockholder approval is not obtained within twelve (12)
months after the date of the Board's adoption of the Plan, no options previously
granted under the Plan shall be deemed to be Incentive Stock Options and no
Incentive Stock Options shall be granted thereafter. Amendments to the Plan not
requiring stockholder approval shall become effective when adopted by the Board
and amendments requiring stockholder approval (as provided in Section 19) shall
become effective when adopted by the Board, but no Incentive Stock Option
granted after the date of such amendment shall become exercisable (to the extent
that such amendment to the Plan was required to enable the Company to grant such
Incentive Stock Option to a particular optionee) unless and until such amendment
shall have been approved by the Company's stockholders. If such stockholder
approval is not obtained within twelve (12) months of the Board's adoption of
such amendment, any Incentive Stock Options granted on or after the date of such
amendment shall terminate to the extent that such amendment to the Plan was
required to enable the Company to grant such option to a particular optionee.
Subject to this limitation, options may be granted under the Plan at any time
after the effective date and before the date fixed for termination of the Plan.
(b) TERMINATION. Unless sooner terminated by the Board, the Plan
shall terminate upon the close of business on the day next preceding the tenth
anniversary of the
11
<PAGE>
date of its adoption by the Board. After termination of the Plan, no further
options may be granted under the Plan; PROVIDED HOWEVER, that such termination
will not affect any options granted prior to termination of the Plan.
23. PROVISION FOR FOREIGN PARTICIPANTS
The Board may, without amending the Plan, modify awards or options
granted to participants who are foreign nationals or employed outside the United
States to recognize differences in laws, rules, regulations or customs of such
foreign jurisdictions with respect to tax, securities, currency, employee
benefit or other matters.
24. GOVERNING LAW
The provisions of this Plan shall be governed and construed in
accordance with the laws of the State of Delaware without regard to the
principles of conflicts of laws.
12
<PAGE>
Exhibit 21.1
SUBSIDIARIES OF THE COMPANY
Name Jursdiction of Incorporation
---- ----------------------------
P.E.G. Reinsurance Company, Ltd. Bermuda
Preferred Employers Group, Inc. Florida
Preferred Healthcare Staffing, Inc. Delaware
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE AUDITED
FINANCIAL STATEMENTS OF THE COMPANY DATED AS OF DECEMBER 31, 1997 AND FOR THE
YEAR THEN ENDED.
</LEGEND>
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> DEC-31-1997
<PERIOD-START> JAN-01-1997
<PERIOD-END> DEC-31-1997
<CASH> 4,125,147
<SECURITIES> 22,983,019
<RECEIVABLES> 585,072
<ALLOWANCES> 0
<INVENTORY> 0
<CURRENT-ASSETS> 28,943,619
<PP&E> 478,826
<DEPRECIATION> 0
<TOTAL-ASSETS> 29,700,203
<CURRENT-LIABILITIES> 0
<BONDS> 0
0
0
<COMMON> 52,544
<OTHER-SE> 0
<TOTAL-LIABILITY-AND-EQUITY> 29,700,203
<SALES> 0
<TOTAL-REVENUES> 15,999,112
<CGS> 0
<TOTAL-COSTS> 14,580,714
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 0
<INCOME-PRETAX> 1,418,398
<INCOME-TAX> 208,980
<INCOME-CONTINUING> 1,418,398
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 1,209,418
<EPS-PRIMARY> 0.27
<EPS-DILUTED> 0.27
</TABLE>
