<PAGE>
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 8-K/A AMENDMENT NO. 1
CURRENT REPORT
---------------------
Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
Date of Report (Date of earliest event reported): August 10, 1998
PREFERRED EMPLOYERS HOLDINGS, INC.
(Exact name of Registrant as specified in its charter)
DELAWARE
(State or other jurisdiction of incorporation)
<TABLE>
<S> <C>
1-12677 65-0698779
(Commission File Number) (I.R.S. Employer Identification No.)
10800 BISCAYNE BLVD., MIAMI, FLORIDA 33161
(Address of principal executive offices) (Zip Code)
</TABLE>
------------------------
Registrant's telephone number, including area code: (305) 893-4040
Not Applicable
(Former name or former address, if changed since last report.)
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
<PAGE>
ITEM 7. FINANCIAL STATEMENTS AND EXHIBITS.
The Current Report on Form 8-K of Preferred Employers Holdings, Inc. (the
"Company"), dated August 10, 1998, is hereby amended to include the following
financial statements, required under Item 7 hereto, which were omitted from the
Company's Current Report on Form 8-K filed with the Commission in August 1998.
The Company's consolidated financial statements included herewith give
retroactive effect to the consummation of the merger of the Company and National
Explorers and Travelers Healthcare, Inc. on August 10, 1998, which was accounted
for as a pooling of interests, as described in the notes to the consolidated
financial statements.
(a) Audited consolidated financial statements of the Company and
National Explorers and Travelers Healthcare, Inc. for the years ended
December 31, 1997 and 1996, and unaudited financial statements of the
Company and National Explorers and Travelers Healthcare, Inc. for the six
months ended June 30, 1998, which give retroactive effect to the merger of
the Company and National Explorers and Travelers Healthcare, Inc.
(b) Unaudited consolidating financial statements of the Company and
National Explorers and Travelers Healthcare, Inc. for the years ended
December 31, 1997 and 1996 and for the six months ended June 30, 1998 and
1997, which give retroactive effect to the merger of the Company and
National Explorers and Travelers Healthcare, Inc.
2
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned hereunto duly authorized.
<TABLE>
<S> <C> <C>
PREFERRED EMPLOYERS HOLDINGS, INC.
By: /s/ WILLIAM R. DRESBACK
-----------------------------------------
William R. Dresback
Senior Vice President,
Chief Financial Officer and Secretary
(Principal Financial and Accounting
Date: October 23, 1998 Officer)
</TABLE>
3
<PAGE>
EXHIBIT INDEX
<TABLE>
<CAPTION>
EXHIBIT NO. EXHIBITS PAGE NO.
- ------------- ------------------------------------------------------------------------------------------- -------------
<C> <S> <C>
2.1* Stock Purchase Agreement, dated as of July 10, 1998, by and among Preferred Employers
Holdings, Inc., Preferred Healthcare Staffing, Inc. and Debbie Bender-Balazich, Steven
Barth, Steven Jones and Stephen M. McLaughlin.
10.1* Employment Agreement, dated as of August 10, 1998, between Preferred Healthcare Staffing,
Inc. and Debbie Bender-Balazich.
10.2* Stock Option Agreement, dated as of August 10, 1998, between Preferred Employers Holdings,
Inc. and Debbie Bender-Balazich.
10.3* Employment Agreement, dated as of August 10, 1998, between Preferred Healthcare Staffing,
Inc. and Stephen M. McLaughlin.
10.4* Stock Option Agreement, dated as of August 10, 1998, between Preferred Employers Holdings,
Inc. and Stephen M. McLaughlin.
10.5* Registration Rights Agreement, dated as of August 10, 1998, by and among Preferred
Employers Holdings, Inc. and Debbie Bender-Balazich, Steven Barth, Steven Jones and Stephen
M. McLaughlin.
27.1** Financial Data Schedule.
99.1* Press release of the Company dated August 12, 1998.
</TABLE>
- ------------------------
* Previously filed as part of the Company's Current Report on Form 8-K filed
with the Securities and Exchange Commission on August 20, 1998.
** Filed herewith.
4
<PAGE>
PREFERRED EMPLOYERS HOLDINGS, INC. AND SUBSIDIARIES
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
PAGE NO.
-----------
<S> <C>
AUDITED FINANCIAL STATEMENTS FOR THE YEARS ENDED DECEMBER 31, 1997 AND 1996 (RESTATED)
Independent Auditors' Reports......................................................................... F-2
Report of Independent Accountants..................................................................... F-3
Consolidated Balance Sheet as of December 31, 1997.................................................... F-4
Consolidated Statements of Operations for the years ended December 31, 1997 and 1996.................. F-5
Consolidated Statements of Shareholders' Equity for the years ended December 31, 1997 and 1996........ F-6
Consolidated Statements of Cash Flows for the years ended December 31, 1997 and 1996.................. F-7
Notes to Consolidated Financial Statements............................................................ F-8
UNAUDITED CONSOLIDATING FINANCIAL SCHEDULES FOR THE YEARS ENDED DECEMBER 31, 1997 AND 1996 (RESTATED)
Consolidating Balance Sheet Schedule as of December 31, 1997.......................................... F-21
Consolidating Schedules of Operations for the years ended December 31, 1997 and December 31, 1996..... F-22
Consolidating Schedules of Shareholders' Equity for the years ended December 31, 1997 and 1996........ F-23
Consolidating Schedules of Cash Flows for the years ended December 31, 1997 and 1996.................. F-24
UNAUDITED FINANCIAL STATEMENTS FOR THE SIX MONTHS ENDED JUNE 30, 1998 AND 1997 (RESTATED)
Consolidated Balance Sheet as of June 30, 1998........................................................ F-25
Consolidated Statements of Operations for the six months ended June 30, 1998 and 1997................. F-26
Consolidated Statements of Cash Flows for the six months ended June 30, 1998 and 1997................. F-27
Notes to Consolidated Financial Statements............................................................ F-28
UNAUDITED CONSOLIDATING FINANCIAL SCHEDULES FOR THE SIX MONTHS ENDED JUNE 30, 1998 AND 1997 (RESTATED)
Consolidating Balance Sheet Schedule as of June 30, 1998.............................................. F-39
Consolidating Schedules of Operations for the six months ended June 30, 1998 and 1997................. F-40
Consolidating Schedules of Cash Flows for the six months ended June 30, 1998 and 1997................. F-41
</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. The consolidated financial
statements give retroactive effect to the merger of Preferred Employers
Holdings, Inc. and subsidiaries and National Explorers and Travelers Healthcare,
Inc. on August 10, 1998, which has been accounted for using the pooling of
interests method as described in the notes to the consolidated financial
statements. We have also audited the combination of the accompanying
consolidated financial statements for the periods indicated above, after
restatement for the August 10, 1998 pooling of interests. These 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 did not audit the financial statements of National Explorers and
Travelers Healthcare, Inc. which statements reflect total assets constituting 8%
of the restated consolidated balance sheet totals, and which reflect net losses
constituting approximately 98% and 120% of the respective restated consolidated
statements of operations totals. Those statements were audited by other auditors
whose report has been furnished to us, and our opinion, insofar as it relates to
data included for National Explorers and Travelers Healthcare, Inc. is based
solely on the report of other auditors.
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 audits provide a reasonable basis for our opinion.
In our opinion, based on our audits and the report of other auditors, 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 the results of their operations and
cash flows for the years ended December 31, 1997 and 1996.
Our audits were made for the purpose of forming an opinion on the
consolidated financial statements taken as a whole. The consolidating schedules
are presented for purposes of additional analysis of the consolidated financial
statements rather than to present the financial position, results of operations,
and cash flows of the individual companies. The consolidating financial
schedules have been subjected to the auditing procedures applied in the audits
of the consolidated financial statements, and, in our opinion, based upon our
procedures and the report of other auditors, is fairly stated in all material
respects in relation to the consolidated financial statements taken as a whole.
/s/ KPMG Peat Marwick LLP
Miami, Florida
March 27, 1998, except for notes 1(b), 1(d) and 14
which are as of August 10, 1998.
F-2
<PAGE>
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors of
National Explorers and Travelers Health Care, Inc.
(d/b/a NET Healthcare, Inc.)
Fort Lauderdale, Florida
In our opinion, the accompanying balance sheet and the related statements of
operations, shareholders' deficiency and of cash flows present fairly, in all
material respects, the financial position of National Explorers and Travelers
Health Care, Inc. (d/b/a NET Healthcare, Inc.) (the "Company") at December 31,
1997, and the results of their operations and their cash flows for the years
ended December 31, 1996 and 1997, in conformity with generally accepted
accounting principles. These financial statements are the responsibility of the
Company's management; our responsibility is to express an opinion on these
financial statements based on our audits. We conducted our audits of these
statements in accordance with generally accepted auditing standards which
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, assessing the accounting principles
used and significant estimates made by management, and evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for the opinion expressed above.
Since the date of completion of our audit of the above referenced financial
statements and the initial issuance of our report dated June 22, 1998, which
contained an explanatory paragraph regarding the Company's ability to continue
as a going concern and an emphasis of a matter paragraph regarding the pending
sale of the Company, the shareholders of the Company, as discussed in Note 14,
have sold their shares of the common stock of the Company to Preferred
Healthcare Staffing, Inc., a subsidiary of Preferred Employers Holdings, Inc.
Therefore the conditions that raised substantial doubt about whether the Company
will continue as a going concern no longer exist.
PricewaterhouseCoopers LLP
Fort Lauderdale, Florida
June 22, 1998, except for the information in
Note 14, for which the date is August 10, 1998
F-3
<PAGE>
PREFERRED EMPLOYERS HOLDINGS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEET
DECEMBER 31, 1997 (RESTATED)
<TABLE>
<CAPTION>
PREVIOUSLY
REPORTED RESTATED
------------- -------------
<S> <C> <C>
ASSETS
Investments:
Held-to-maturity securities, at amortized cost (fair value of $8,237,669)........ $ 8,015,105 8,015,105
Held-to-maturity securities, at amortized cost, restricted (fair value of
$7,947,981).................................................................... 7,877,444 7,877,444
Short-term investments........................................................... 7,090,550 7,090,550
------------- -------------
Total investments............................................................ 22,983,099 22,983,099
Cash............................................................................... 4,125,147 4,125,271
Accrued investment and interest income............................................. 311,934 311,934
Receivables, net................................................................... 585,072 2,699,657
Deferred acquisition costs......................................................... 903,880 903,880
Property and equipment, net........................................................ 478,826 709,800
Deferred tax assets................................................................ 252,837 252,837
Deposits........................................................................... 24,921 154,787
Other assets....................................................................... 34,487 102,556
------------- -------------
Total assets................................................................. $ 29,700,203 32,243,821
------------- -------------
------------- -------------
LIABILITIES AND SHAREHOLDERS' EQUITY
Liabilities:
Notes payable...................................................................... $ 0 2,440,000
Unpaid losses and loss adjustment expenses......................................... 6,107,613 6,107,613
Unearned premiums.................................................................. 2,671,831 2,671,831
Premiums payable................................................................... 3,064,103 3,064,103
Commissions payable................................................................ 330,055 330,055
Other liabilities.................................................................. 4,750,082 5,215,387
Accounts payable and accrued expenses.............................................. 508,127 1,360,613
Deferred reinsurance income........................................................ 279,980 279,980
------------- -------------
Total liabilities............................................................ 17,711,791 21,469,582
------------- -------------
Shareholders' equity:
Common stock, $.01 par value; authorized 10,000,000 shares; issued 5,254,412 and
5,771,497 shares, respectively................................................... 52,544 57,715
Additional paid-in capital......................................................... 10,367,074 9,147,730
Retained earnings.................................................................. 2,074,351 2,074,351
------------- -------------
Total shareholders' equity......................................................... 12,493,969 11,279,796
Treasury stock, at cost, 529,412 shares............................................ (505,557) (505,557)
------------- -------------
Net shareholders' equity........................................................... 11,988,412 10,774,239
------------- -------------
Total liabilities and shareholders' equity......................................... $ 29,700,203 32,243,821
------------- -------------
------------- -------------
</TABLE>
See accompanying notes to consolidated financial statements.
F-4
<PAGE>
PREFERRED EMPLOYERS HOLDINGS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
YEARS ENDED DECEMBER 31, 1997 AND 1996 (RESTATED)
<TABLE>
<CAPTION>
DECEMBER 31, 1997 DECEMBER 31, 1996
---------------------- --------------------
<S> <C> <C> <C> <C>
PREVIOUSLY PREVIOUSLY
REPORTED RESTATED REPORTED RESTATED
---------- ---------- --------- ---------
REVENUES:
Premiums earned................................................. $11,674,659 11,674,659 524,760 524,760
Net commission income........................................... 2,359,445 2,359,445 2,462,625 2,462,625
Net Investment income........................................... 1,394,544 1,394,544 217,314 217,314
Staffing income................................................. 0 11,594,300 0 2,613,967
Other income.................................................... 570,464 570,464 136,431 136,431
---------- ---------- --------- ---------
Total revenues.................................................. 15,999,112 27,593,412 3,341,130 5,955,097
---------- ---------- --------- ---------
EXPENSES:
Losses and loss adjustment expenses............................. 6,257,095 6,257,095 270,251 270,251
Amortization of deferred acquisition costs...................... 4,161,884 4,161,884 177,526 177,526
Staffing costs.................................................. 0 9,610,778 0 2,218,456
Other expenses.................................................. 4,145,201 6,080,808 2,937,145 3,845,267
---------- ---------- --------- ---------
Total expenses.................................................. 14,564,180 26,110,565 3,384,922 6,511,500
---------- ---------- --------- ---------
Operating income (loss) before income taxes..................... 1,434,932 1,482,847 (43,792) (556,403)
---------- ---------- --------- ---------
Interest expense................................................ (16,534) (663,909) (41,942) (154,044)
Non-operating income............................................ 0 0 190,000 190,000
---------- ---------- --------- ---------
Net non-operating income (expense).............................. (16,534) (663,909) 148,058 35,956
---------- ---------- --------- ---------
Income (loss) before income taxes............................... 1,418,398 818,938 104,266 (520,447)
Income taxes.................................................... 208,980 208,980 0 0
---------- ---------- --------- ---------
Net income (loss)............................................... $1,209,418 609,958 104,266 (520,447)
---------- ---------- --------- ---------
---------- ---------- --------- ---------
Weighted average shares outstanding............................. 4,513,562 5,030,647 3,000,000 3,517,085
---------- ---------- --------- ---------
---------- ---------- --------- ---------
Basic earnings (loss) per share................................. $ 0.27 0.12 0.03 (0.15)
---------- ---------- --------- ---------
---------- ---------- --------- ---------
Diluted earnings (loss) per share............................... $ 0.27 0.12 0.03 (0.15)
---------- ---------- --------- ---------
---------- ---------- --------- ---------
PRO FORMA INFORMATION (UNAUDITED):
Historical income (loss) before income taxes.................... $1,209,418 609,958 104,266 (520,447)
Pro forma income tax provision (benefit)........................ 0 (459,316) 38,891 (194,127)
---------- ---------- --------- ---------
Pro forma net income (loss)..................................... $1,209,418 1,069,274 65,375 (326,320)
---------- ---------- --------- ---------
---------- ---------- --------- ---------
Weighted average shares outstanding............................. 4,513,562 5,030,647 3,000,000 3,517,085
---------- ---------- --------- ---------
---------- ---------- --------- ---------
Pro forma net basic earnings (loss) per share................... $ 0.27 0.21 0.02 (0.09)
---------- ---------- --------- ---------
---------- ---------- --------- ---------
Pro forma net diluted earnings (loss) per share................. $ 0.27 0.21 0.02 (0.09)
---------- ---------- --------- ---------
---------- ---------- --------- ---------
</TABLE>
See accompanying notes to consolidated financial statements.
F-5
<PAGE>
PREFERRED EMPLOYERS HOLDINGS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
YEARS ENDED DECEMBER 31, 1997 AND 1996 (RESTATED)
<TABLE>
<CAPTION>
DECEMBER 31, 1997 DECEMBER 31, 1996
---------------------------- --------------------------
<S> <C> <C> <C> <C>
PREVIOUSLY PREVIOUSLY
REPORTED RESTATED REPORTED RESTATED
------------- ------------- ------------ ------------
COMMON STOCK--NUMBER OF SHARES:
Balance at beginning of period......................... 3,529,412 3,529,412 3,529,412 3,529,412
Exchange of common shares.............................. 0 517,085 0 517,085
Issuance of common shares.............................. 1,725,000 1,725,000 0 0
------------- ------------- ------------ ------------
Balance at end of period............................... 5,254,412 5,771,497 3,529,412 4,046,497
------------- ------------- ------------ ------------
------------- ------------- ------------ ------------
COMMON STOCK:
Balance at beginning of period......................... $ 35,294 35,294 35,294 35,294
Exchange of common shares.............................. 0 5,171 0 5,171
Issuance of common shares.............................. 17,250 17,250 0 0
------------- ------------- ------------ ------------
Balance at end of period............................... $ 52,544 57,715 35,294 40,465
------------- ------------- ------------ ------------
------------- ------------- ------------ ------------
ADDITIONAL PAID-IN CAPITAL:
Balance at beginning of period......................... $ 0 0 0 0
Exchange of common shares.............................. 0 (1,224,173) 0 (624,713)
Issuance of common shares.............................. 10,367,074 10,371,903 0 4,829
------------- ------------- ------------ ------------
Balance at end of period............................... $ 10,367,074 9,147,730 0 (619,884)
------------- ------------- ------------ ------------
------------- ------------- ------------ ------------
RETAINED EARNINGS:
Balance at beginning of period......................... $ 864,933 864,933 760,667 760,667
Net income............................................. 1,209,418 1,209,418 104,266 104,266
------------- ------------- ------------ ------------
Balance at end of period............................... $ 2,074,351 2,074,351 864,933 864,933
------------- ------------- ------------ ------------
------------- ------------- ------------ ------------
TREASURY STOCK:
Balance at end of period............................... $ (505,557) (505,557) (505,557) (505,557)
------------- ------------- ------------ ------------
TOTAL SHAREHOLDERS' EQUITY............................. $ 11,988,412 10,774,239 394,670 (220,043)
------------- ------------- ------------ ------------
------------- ------------- ------------ ------------
</TABLE>
See accompanying notes to consolidated financial statements.
F-6
<PAGE>
PREFERRED EMPLOYERS HOLDINGS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED DECEMBER 31, 1997 AND 1996 (RESTATED)
<TABLE>
<CAPTION>
DECEMBER 31, 1997 DECEMBER 31, 1996
------------------------ ----------------------
<S> <C> <C> <C> <C>
PREVIOUSLY PREVIOUSLY
REPORTED RESTATED REPORTED RESTATED
----------- ----------- ---------- ----------
Cash flow from operating activities:
Net income (loss).......................................... $ 1,209,418 609,958 104,266 (520,447)
Adjustments to reconcile net income (loss) to net cash
provided by operating activities:
Depreciation and amortization.......................... 150,341 202,312 161,132 182,767
Amortization of deferred acquisition costs............. 4,161,884 4,161,884 177,526 177,526
Deferred income taxes.................................. (252,837) (252,837) 0 0
Provision for uncollectible accounts................... 0 106,367 0 23,212
Change in:
Accrued investment income.......................... (311,934) (311,934) 0 0
Receivables........................................ 3,344,344 2,307,487 (3,583,802) (4,325,804)
Unpaid losses and loss adjustment expenses......... 5,908,223 5,908,223 199,390 199,390
Unearned premiums.................................. 782,854 782,854 1,888,977 1,888,977
Premium payable.................................... (521,487) (521,487) 1,231,676 1,231,676
Commissions payable................................ (179,302) (179,302) 212,769 212,769
Accounts payable and accrued expenses.............. 135,437 696,852 367,215 640,177
Deferred reinsurance income........................ (1,054,421) (1,054,421) 1,334,401 1,334,401
Other, net......................................... (1,857,061) (1,949,994) 1,083,264 1,016,582
----------- ----------- ---------- ----------
Net cash provided by operating activities........ 11,515,459 10,505,962 3,176,814 2,061,226
----------- ----------- ---------- ----------
Cash flow from investing activities:
Purchase of fixed maturities............................... (15,892,549) (15,892,549) 0 0
Purchase of short-term investments, net.................... (7,090,550) (7,090,550) 0 0
Purchase of property and equipment......................... (82,677) (268,470) (130,503) (249,290)
----------- ----------- ---------- ----------
Net cash used in investing activities............ (23,065,776) (23,251,569) (130,503) (249,290)
----------- ----------- ---------- ----------
Cash flow from financing activities:
Proceeds from sale of common stock......................... 10,384,324 10,384,324 0 0
Repayment of shareholder loan.............................. (300,000) (300,000) (275,000) (275,000)
Borrowings from revolving line of credit, net.............. 0 1,114,779 0 1,285,221
Other, net................................................. 0 27,008 0 (8,899)
----------- ----------- ---------- ----------
Net cash provided by (used in) financing
activities..................................... 10,084,324 11,226,111 (275,000) 1,001,322
----------- ----------- ---------- ----------
Net (decrease) increase in cash.............................. (1,465,993) (1,519,496) 2,771,311 2,813,258
Cash at beginning of period.................................. 5,591,140 5,644,767 2,819,829 2,831,509
----------- ----------- ---------- ----------
Cash at end of period........................................ $ 4,125,147 4,125,271 5,591,140 5,644,767
----------- ----------- ---------- ----------
----------- ----------- ---------- ----------
Supplemental disclosure of cash flow information:
Income taxes paid.......................................... $ 202,300 202,300 0 0
----------- ----------- ---------- ----------
----------- ----------- ---------- ----------
Interest paid.............................................. $ 0 638,235 0 103,069
----------- ----------- ---------- ----------
----------- ----------- ---------- ----------
</TABLE>
See accompanying notes to consolidated financial statements.
F-7
<PAGE>
PREFERRED EMPLOYERS HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1997 AND 1996 (RESTATED)
(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 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 operations.
On August 10, 1998, the Company issued 517,085 shares of its common stock in
exchange for all the outstanding common stock of National Explorers and
Travelers Healthcare, Inc. ("NET Healthcare"), an employee staffing company and
provider of temporary registered nurses and other professional medical
personnel, primarily to client hospitals. This business combination was
accounted for as a pooling-of-interests combination and, accordingly, the
Company's consolidated financial statements for applicable periods prior to the
combination have been restated to include the accounts and results of operations
of NET Healthcare. The financial statements previously reported by the separate
enterprises and the combined amounts are presented in the accompanying
consolidated financial statements included herein. Prior to the combination, NET
Healthcare reported its results of operations on a calendar year basis which is
consistent with that of PEGI. In recording the pooling-of-interests combination,
NET Healthcare's financial statements as of December 31, 1997 and for the years
ended December 31, 1997 and 1996 were combined with the Company's financial
statements for the same periods.
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
F-8
<PAGE>
PREFERRED EMPLOYERS HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997 AND 1996 (RESTATED)
(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
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
assume 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 assumes 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 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 33.83%, aggregate net premiums written of approximately $15 million
($12,600,000 relating to the period from 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.
F-9
<PAGE>
PREFERRED EMPLOYERS HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997 AND 1996 (RESTATED)
(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
Income before income taxes recognized, and estimated to be recognized in the
calendar year indicated below is as follows:
<TABLE>
<CAPTION>
COMPOSITE
PROSPECTIVE RETROACTIVE/
METHOD 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.
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) STAFFING OPERATIONS
In August 1998, the Company issued 517,085 shares of its common stock in
exchange for all the outstanding common stock of National Explorers and
Travelers Healthcare, Inc. ("NET Healthcare"), an employee staffing company and
provider of temporary registered nurses and other professional medical
personnel, primarily to client hospitals. This business combination has been
accounted for as a pooling-of-interests combination.
Staffing income is recognized at the time the staffing services are
provided. In most instances, the staffing company's temporary healthcare
professionals are considered employees of the staffing company while under
assignment and costs of employment are the responsibility of the staffing
company and are included in the accompanying statements of operations.
F-10
<PAGE>
PREFERRED EMPLOYERS HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997 AND 1996 (RESTATED)
(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
Receivables include amounts due from healthcare organizations for services
provided by NET Healthcare through the placement of healthcare professionals.
These receivables are presented net of an estimated allowance for uncollectible
accounts based on NET Healthcare's evaluation of expected collections resulting
from an analysis of current and past due accounts, past collection experience in
relation to amounts billed and other relevant information. Concentration of
credit risk relating to accounts receivable is limited by number, diversity and
geographic dispersion of the healthcare organizations serviced by NET
Healthcare.
During 1995, NET Healthcare entered into a line of credit with a shareholder
to provide a total of $190,000 to fund the working capital requirements of NET
Healthcare. The line of credit bore interest at the rate of 5% per annum. In
March 1996, NET Healthcare entered into an additional line of credit with a
shareholder collateralized by outstanding accounts receivable. Interest was
payable at the rate of 2% per month on average outstanding balances. In May
1996, the agreement was amended to allow for additional funding. In May 1997,
the agreement was further amended to increase the interest rate by .5% per month
on approximately $600,000 of the balance of the line of credit. The amended line
of credit, effective April 1, 1998, established a rate of interest of 10% per
annum and eliminated restrictive covenants included in the original agreement.
The line of credit described above had an aggregate outstanding balance of
$2,440,000 at December 31, 1997. Interest expense related to the line of credit
amounted to $608,300 for the year ended December 31, 1997.
The former shareholders of NET Healthcare previously elected to have the
company treated as an "S Corporation" under the Internal Revenue Code and,
therefore, net income or loss was attributable directly to the former
shareholders. Accordingly, no pre-merger benefit for federal or state income
taxes has been reflected in the accompanying combined financial statements.
(E) 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.
(F) 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
F-11
<PAGE>
PREFERRED EMPLOYERS HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997 AND 1996 (RESTATED)
(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
provided on the straight-line basis over the shorter of the lease term or the
estimated useful lives of the improvements.
(G) 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.
(H) 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.
(I) 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 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.
(J) 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 any prior period EPS amounts to be restated. The adoption of
SFAS No. 128 had no effect on diluted EPS amounts reported for any periods
presented.
(K) 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
F-12
<PAGE>
PREFERRED EMPLOYERS HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997 AND 1996 (RESTATED)
(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
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 current financial reporting or disclosures as a result of these
pronouncements.
(L) RECLASSIFICATIONS
Certain items in the Company's 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>
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>
F-13
<PAGE>
PREFERRED EMPLOYERS HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997 AND 1996 (RESTATED)
(2) INVESTMENTS (CONTINUED)
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, receivables, accrued
investment and interest 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.
(4) STOCKHOLDERS 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 to
give effect to the Exchange) (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 stockholders loan was paid in full
during 1997.
F-14
<PAGE>
PREFERRED EMPLOYERS HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1997 AND 1996
(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 (benefit)..................................................... $ 278,439 (176,952)
State income tax, net..................................................................... 41,993 --
Tax-exempt interest....................................................................... (209,237) --
S Corporation income...................................................................... 39,535 176,952
Other, net................................................................................ 58,250 --
---------- ----------
Total income tax expense.............................................................. $ 208,980 --
---------- ----------
---------- ----------
</TABLE>
As a result of the business combination of NET Healthcare, an "S
corporation," with the Company, a "C corporation," Net Healthcare's "S
corporation" status ceased to exist. The unaudited pro forma information in the
consolidated statements of operations reflect income tax expense (benefit) had
NET Healthcare been taxed as a "C corporation," of ($459,316) and ($194,127) for
the years ended December 31, 1997 and 1996, respectively.
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>
F-15
<PAGE>
PREFERRED EMPLOYERS HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997 AND 1996
(6) INCOME TAXES (CONTINUED)
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 Company's 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 Company's 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 amount 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-16
<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........................................................................... 6,257,095 270,251
Prior year............................................................................. -- --
------------ ---------
Total incurred....................................................................... 6,257,095 270,251
------------ ---------
Paid related to:
Current year........................................................................... 348,872 70,861
Prior year............................................................................. -- --
------------ ---------
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>
WEIGHTED
OPTION 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
F-17
<PAGE>
PREFERRED EMPLOYERS HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997 AND 1996
(9) STOCK OPTIONS (CONTINUED)
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 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>
<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. In October 1995, NET
Healthcare entered into an office lease agreement which became effective on
November 15, 1995. The agreement provides for an initial 5-year term with no
renewal options. The following is a schedule of the approximate future minimum
lease payments for office space and equipment for the Company and NET Healthcare
as of December 31, 1997:
<TABLE>
<CAPTION>
YEAR ENDING DECEMBER
31,
-----------------------
<S> <C>
1998..................................................................................... $ 369,000
1999..................................................................................... 405,000
2000..................................................................................... 397,000
2001..................................................................................... 361,000
Thereafter............................................................................... 135,000
-----------
$ 1,667,000
-----------
-----------
</TABLE>
Rent expense for the years ended December 31, 1996 and 1997 was
approximately $187,000 and $249,000, respectively.
F-18
<PAGE>
PREFERRED EMPLOYERS HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997 AND 1996
(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.
(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 and NET Healthcare filed income tax returns as taxable C corporations
for 1996 and 1997, respectively.
(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 has developed
a plan to address Year 2000 issues. The plan is based on the Company's primary
software vendor having advised the Company that the necessary programming
changes related to Year 2000 issues have been made and tested and that the
software used by the Company can be upgraded to be Year 2000 compliant. The
Company has recently begun to implement this upgrade and expects to be fully
compliant with Year 2000 issues by December 31, 1998. As an integral component
of such plan, the Company will determine if they are Year 2000 compliant. It is
management's belief that for any suppliers who may not be Year 2000 compliant,
such non-compliance will not have a material adverse effect on the Company's
business. However, each major supplier's compliance will be assessed in light of
their response. The costs associated with the implementation of the above
project are not expected to be material.
(14) SUBSEQUENT EVENTS
In March 1998, the Company consummated the purchase of substantially all of
the assets of HSSI Travel Nurse Operations, Inc. ("Travel Nurse"), 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 nurses 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.
In May 1998, the Company obtained a $3 million unsecured revolving line of
credit from a bank. The terms of the loan provide for monthly interest payments
at the prime lending rate (currently 8 1/2% per annum). The loan is renewable on
an annual basis.
In May 1998, the Company concluded a private placement of $10,580,000 of 7%
convertible subordinated notes (the "Notes") due May 2003. The principal amount
of the Notes is convertible at any time by the holders prior to the earlier of
the maturity date (May 12, 2003) or 10 business days after receipt of a
Termination Notice (as defined below), into shares of the Company's common stock
at a conversion price of $9.00 (the "Conversion Price"). In the event (i) the
closing bid price of the Company's common stock equals or exceeds $13.50 per
share for twenty consecutive trading days during any period commencing upon
satisfaction of one of the conditions contained in clause (ii) hereof and (ii)
either a registration statement covering the shares of common stock issuable
upon conversion of the Notes has been declared
F-19
<PAGE>
PREFERRED EMPLOYERS HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997 AND 1996
(14) SUBSEQUENT EVENTS (CONTINUED)
effective by the Securities and Exchange Commission and remains effective or at
least two years has elapsed since the issuance date of the Notes and the shares
of common stock issuable upon conversion of the Notes are saleable, without
restriction, under Rule 144(k) promulgated under the Securities Act of 1933, as
amended, then the holders' rights to convert the outstanding principal amount of
the Notes shall be terminated by the Company by delivering to the holders a
notice of termination (the "Termination Notice"), in which event (a) the holders
will have the right at any time during 10 business days after receipt of the
Termination Notice, in their sole discretion, to convert the outstanding
principal amount of the Notes into shares of common stock of the Company at the
Conversion Price, and (b) thereafter, the holders' option to convert shall
terminate and the Notes may be prepaid by the Company at any time prior to the
Maturity Date, in whole or in part for the face amount thereof, together with
all accrued and unpaid interest through the date of prepayment.
On August 10, 1998, the Company issued 517,085 shares of its common stock in
exchange for all the outstanding common stock of National Explorers and
Travelers Healthcare, Inc., an employee staffing company and provider of
temporary registered nurses and other professional medical personnel, primarily
to client hospitals. This business combination was accounted for as a
pooling-of-interests combination and, accordingly, the Company's consolidated
financial statements for applicable periods prior to the combination have been
restated to include the accounts and results of operations of NET Healthcare.
F-20
<PAGE>
PREFERRED EMPLOYERS HOLDINGS, INC. AND SUBSIDIARIES
CONSOLIDATING BALANCE SHEET SCHEDULE
DECEMBER 31, 1997 (RESTATED)
<TABLE>
<CAPTION>
PREVIOUSLY NET HEATH-
REPORTED CARE, INC. ADJUSTMENT ADJUSTMENT RESTATED
---------- ----------- ----------- ----------- ----------
<S> <C> <C> <C> <C> <C>
ASSETS
Investments:
Held-to-maturity securities, at amortized
cost....................................... $8,015,105 0 8,015,105
Held-to-maturity securities, at amortized
cost, restricted........................... 7,877,444 0 7,877,444
Short-term investments....................... 7,090,550 0 7,090,550
---------- ----------- ----------
Total investments.......................... 22,983,099 0 22,983,099
Cash........................................... 4,125,147 124 4,125,271
Accrued investment and interest income......... 311,934 0 311,934
Receivables, net............................... 585,072 2,114,585 2,699,657
Deferred acquisition costs..................... 903,880 0 903,880
Property and equipment, net.................... 478,826 230,974 709,800
Deferred tax assets............................ 252,837 0 252,837
Deposits....................................... 24,921 129,866 154,787
Other assets................................... 34,487 68,069 102,556
---------- ----------- ----------
Total assets............................... $29,700,203 2,543,618 32,243,821
---------- ----------- ----------
---------- ----------- ----------
LIABILITIES AND SHAREHOLDERS' EQUITY
Liabilities:
Notes payable.................................. $ 0 2,440,000 2,440,000
Unpaid losses and loss adjustment expenses..... 6,107,613 0 6,107,613
Unearned premiums.............................. 2,671,831 0 2,671,831
Premiums payable............................... 3,064,103 0 3,064,103
Commissions payable............................ 330,055 0 330,055
Other liabilities.............................. 4,750,082 465,305 5,215,387
Accounts payable and accrued expenses.......... 508,127 852,486 1,360,613
Deferred reinsurance income.................... 279,980 0 279,980
---------- ----------- ----------
Total liabilities.......................... 17,711,791 3,757,791 21,469,582
---------- ----------- ----------
Shareholders' equity:
Common stock................................... 52,544 10,000 5,171(2) (10,000)(1) 57,715
Additional paid-in capital..................... 10,367,074 0 (1,224,173)(3) 4,829 )(2 9,147,730
Retained earnings (deficit).................... 2,074,351 (1,224,173) 1,224,173(3) 2,074,351
---------- ----------- ----------- ----------- ----------
Total shareholders' equity..................... 12,493,969 (1,214,173) 0 0 11,279,796
Treasury stock, at cost........................ (505,557) 0 0 0 (505,557)
---------- ----------- ----------- ----------- ----------
Net shareholders' equity....................... 11,988,412 (1,214,173) 0 0 10,774,239
---------- ----------- ----------- ----------- ----------
Total liabilities and shareholders' equity..... $29,700,203 2,543,618 0 0 32,243,821
---------- ----------- ----------- ----------- ----------
---------- ----------- ----------- ----------- ----------
</TABLE>
- ------------------------
(1) To eliminate merged company common stock.
(2) To record common stock exchanged in connection with merger.
(3) To transfer undistributed deficit to paid-in capital.
See accompanying auditors' report on supplementary consolidating schedules.
F-21
<PAGE>
PREFERRED EMPLOYERS HOLDINGS, INC. AND SUBSIDIARIES
CONSOLIDATING SCHEDULES OF OPERATIONS
YEARS ENDED DECEMBER 31, 1997 AND 1996 (RESTATED)
<TABLE>
<CAPTION>
DECEMBER 31, 1997
------------------------------------------
NET
PREVIOUSLY HEALTHCARE,
REPORTED INC. ADJUSTMENT
------------ --------------- -----------
<S> <C> <C> <C>
REVENUES:
Premiums earned............................................................ $ 11,674,659 0
Net commission income...................................................... 2,359,445 0
Net Investment income...................................................... 1,394,544 0
Staffing income............................................................ 0 11,594,300
Other income............................................................... 570,464 0
------------ ---------------
Total revenues............................................................. 15,999,112 11,594,300
------------ ---------------
EXPENSES:
Losses and loss adjustment expenses........................................ 6,257,095 0
Amortization of deferred acquisition costs................................. 4,161,884 0
Staffing costs............................................................. 0 9,610,778
Other expenses............................................................. 4,145,201 1,935,607
------------ ---------------
Total expenses............................................................. 14,564,180 11,546,385
------------ ---------------
Operating income (loss) before income taxes................................ 1,434,932 47,915
------------ ---------------
Interest expense........................................................... (16,534) (647,375)
Non-operating income....................................................... 0 0
------------ ---------------
Net non-operating income (expense)......................................... (16,534) (647,375)
------------ ---------------
Income (loss) before income taxes.......................................... 1,418,398 (599,460)
Income taxes............................................................... 208,980 0
------------ ---------------
Net income (loss).......................................................... $ 1,209,418 (599,460)
------------ ---------------
------------ ---------------
Net income (loss)--basic................................................... $ 1,209,418 (599,460)
Impact of convertible notes................................................ 0 0
------------ ---------------
Net income (loss)--diluted................................................. $ 1,209,418 (599,460)
------------ ---------------
------------ ---------------
Weighted average shares outstanding--basic................................. 4,513,562 4,513,562 517,085
Impact of convertible notes................................................ 0 0 0
------------ --------------- -----------
Weighted average shares outstanding--diluted............................... 4,513,562 4,513,562 517,085
------------ --------------- -----------
------------ --------------- -----------
Basic earnings (loss) per share............................................ $ 0.27 (0.13)
------------ ---------------
------------ ---------------
Diluted earnings (loss) per share.......................................... $ 0.27 (0.13)
------------ ---------------
------------ ---------------
PRO FORMA INFORMATION (UNAUDITED):
Historical income (loss) before income taxes............................... $ 1,209,418 (599,460)
Pro forma income tax provision (benefit)................................... 0 (459,316)
------------ ---------------
Pro forma net income (loss)................................................ $ 1,209,418 (140,144)
------------ ---------------
------------ ---------------
Pro forma net income (loss)--basic......................................... $ 1,209,418 (140,144)
Impact of potential common shares--convertible notes....................... 0 0
------------ ---------------
Pro forma net income (loss)--diluted....................................... $ 1,209,418 (140,144)
------------ ---------------
------------ ---------------
Weighted average shares outstanding--basic................................. 4,513,562 4,513,562 517,085
Impact of potential common shares--convertible notes....................... 0 0 0
------------ --------------- -----------
Weighted average shares outstanding--diluted............................... 4,513,562 4,513,562 517,085
------------ --------------- -----------
------------ --------------- -----------
Pro forma net basic earnings (loss) per share.............................. $ 0.27 (.03)
------------ ---------------
------------ ---------------
Pro forma net diluted earnings (loss) per share............................ $ 0.27 (.03)
------------ ---------------
------------ ---------------
<CAPTION>
DECEMBER 31, 1996
-----------------------------
NET
PREVIOUSLY HEALTHCARE,
RESTATED REPORTED INC.
------------ ------------ ---------------
<S> <C> <C>
REVENUES:
Premiums earned............................................................ 11,674,659 524,760
Net commission income...................................................... 2,359,445 2,462,625 0
Net Investment income...................................................... 1,394,544 217,314 0
Staffing income............................................................ 11,594,300 0 2,613,967
Other income............................................................... 570,464 136,431 0
------------ ------------ ---------------
Total revenues............................................................. 27,593,412 3,341,130 2,613,967
------------ ------------ ---------------
EXPENSES:
Losses and loss adjustment expenses........................................ 6,257,095 270,251 0
Amortization of deferred acquisition costs................................. 4,161,884 177,526 0
Staffing costs............................................................. 9,610,778 0 2,218,456
Other expenses............................................................. 6,080,808 2,937,145 908,122
------------ ------------ ---------------
Total expenses............................................................. 26,110,565 3,384,922 3,126,578
------------ ------------ ---------------
Operating income (loss) before income taxes................................ 1,482,847 (43,792) (512,611)
------------ ------------ ---------------
Interest expense........................................................... (663,909) (41,942) (112,102)
Non-operating income....................................................... 0 190,000 0
------------ ------------ ---------------
Net non-operating income (expense)......................................... (663,909) 148,058 (112,102)
------------ ------------ ---------------
Income (loss) before income taxes.......................................... 818,938 104,266 (624,713)
Income taxes............................................................... 208,980 0 0
------------ ------------ ---------------
Net income (loss).......................................................... 609,958 104,266 (624,713)
------------ ------------ ---------------
------------ ------------ ---------------
Net income (loss)--basic................................................... 609,958 104,266 (624,713)
Impact of convertible notes................................................ 0 0 0
------------ ------------ ---------------
Net income (loss)--diluted................................................. 609,958 104,266 (624,713)
------------ ------------ ---------------
------------ ------------ ---------------
Weighted average shares outstanding--basic................................. 5,030,647 3,000,000 3,000,000
Impact of convertible notes................................................ 0 0 0
------------ ------------ ---------------
Weighted average shares outstanding--diluted............................... 5,030,647 3,000,000 3,000,000
------------ ------------ ---------------
------------ ------------ ---------------
Basic earnings (loss) per share............................................ 0.12 0.03 (0.21)
------------ ------------ ---------------
------------ ------------ ---------------
Diluted earnings (loss) per share.......................................... 0.12 0.03 (0.21)
------------ ------------ ---------------
------------ ------------ ---------------
PRO FORMA INFORMATION (UNAUDITED):
Historical income (loss) before income taxes............................... 609,958 104,266 (624,713)
Pro forma income tax provision (benefit)................................... (459,316) 38,891 (233,018)
------------ ------------ ---------------
Pro forma net income (loss)................................................ 1,069,274 65,375 (391,695)
------------ ------------ ---------------
------------ ------------ ---------------
Pro forma net income (loss)--basic......................................... 1,069,274 65,375 (391,695)
Impact of potential common shares--convertible notes....................... 0 0 0
------------ ------------ ---------------
Pro forma net income (loss)--diluted....................................... 1,069,274 65,375 (391,695)
------------ ------------ ---------------
------------ ------------ ---------------
Weighted average shares outstanding--basic................................. 5,030,647 3,000,000 3,000,000
Impact of potential common shares--convertible notes....................... 0 0 0
------------ ------------ ---------------
Weighted average shares outstanding--diluted............................... 5,030,647 3,000,000 3,000,000
------------ ------------ ---------------
------------ ------------ ---------------
Pro forma net basic earnings (loss) per share.............................. 0.21 0.02 (0.13)
------------ ------------ ---------------
------------ ------------ ---------------
Pro forma net diluted earnings (loss) per share............................ 0.21 0.02 (0.13)
------------ ------------ ---------------
------------ ------------ ---------------
<CAPTION>
ADJUSTMENT RESTATED
----------- ------------
REVENUES:
Premiums earned............................................................ 524,760
Net commission income...................................................... 2,462,625
Net Investment income...................................................... 217,314
Staffing income............................................................ 2,613,967
Other income............................................................... 136,431
------------
Total revenues............................................................. 5,955,097
------------
EXPENSES:
Losses and loss adjustment expenses........................................ 270,251
Amortization of deferred acquisition costs................................. 177,526
Staffing costs............................................................. 2,218,456
Other expenses............................................................. 3,845,267
------------
Total expenses............................................................. 6,511,500
------------
Operating income (loss) before income taxes................................ (556,403)
------------
Interest expense........................................................... (154,044)
Non-operating income....................................................... 190,000
------------
Net non-operating income (expense)......................................... 35,956
------------
Income (loss) before income taxes.......................................... (520,447)
Income taxes............................................................... 0
------------
Net income (loss).......................................................... (520,447)
------------
------------
Net income (loss)--basic................................................... (520,477)
Impact of convertible notes................................................ 0
------------
Net income (loss)--diluted................................................. (520,477)
------------
------------
Weighted average shares outstanding--basic................................. 517,085 3,517,085
Impact of convertible notes................................................ 0 0
----------- ------------
Weighted average shares outstanding--diluted............................... 517,085 3,517,085
----------- ------------
----------- ------------
Basic earnings (loss) per share............................................ (0.15)
------------
------------
Diluted earnings (loss) per share.......................................... (0.15)
------------
------------
PRO FORMA INFORMATION (UNAUDITED):
Historical income (loss) before income taxes............................... (520,447)
Pro forma income tax provision (benefit)................................... (194,127)
------------
Pro forma net income (loss)................................................ (326,320)
------------
------------
Pro forma net income (loss)--basic......................................... (326,320)
Impact of potential common shares--convertible notes....................... 0
------------
Pro forma net income (loss)--diluted....................................... (326,320)
------------
------------
Weighted average shares outstanding--basic................................. 517,085 3,517,085
Impact of potential common shares--convertible notes....................... 0 0
----------- ------------
Weighted average shares outstanding--diluted............................... 517,085 3,517,085
----------- ------------
----------- ------------
Pro forma net basic earnings (loss) per share.............................. (0.09)
------------
------------
Pro forma net diluted earnings (loss) per share............................ (0.09)
------------
------------
</TABLE>
See accompanying auditors' report on supplementary consolidating schedules.
F-22
<PAGE>
PREFERRED EMPLOYERS HOLDINGS, INC. AND SUBSIDIARIES
CONSOLIDATING SCHEDULES OF SHAREHOLDERS' EQUITY
YEARS ENDED DECEMBER 31, 1997 AND 1996 (RESTATED)
<TABLE>
<CAPTION>
DECEMBER 31, 1997
-----------------------------------------------------------------------
<S> <C> <C> <C> <C>
PREVIOUSLY NET
REPORTED HEALTHCARE, INC. ADJUSTMENT RESTATED
----------- ---------------- ---------------- --------------------
COMMON STOCK-NUMBER OF SHARES:
Balance at beginning of
period...................... 3,529,412 10,000 (10,000)(1) 3,529,412
Exchange of common shares..... 0 0 517,085(2) 517,085
Issuance of common shares..... 1,725,000 0 0 1,725,000
----------- ---------------- ---------------- --------------------
Balance at end of period...... 5,254,412 10,000 507,085 5,771,497
----------- ---------------- ---------------- --------------------
----------- ---------------- ---------------- --------------------
Common stock:
Balance at beginning of
period...................... $ 35,294 10,000 (10,000)(1) 35,294
Exchange of common shares..... 0 0 5,171(2) 5,171
Issuance of common shares..... 17,250 0 0 17,250
----------- ---------------- ---------------- --------------------
Balance at end of period...... $ 52,544 10,000 (4,829) 57,715
----------- ---------------- ---------------- --------------------
----------- ---------------- ---------------- --------------------
Additional paid-in capital:
Balance at beginning of
period...................... $ 0 0 0 0
Exchange of common shares..... 0 0 (1,224,173)(3) (1,224,173)
Issuance of common shares..... 10,367,074 0 4,829(1)(2) 10,371,903
----------- ---------------- ---------------- --------------------
Balance at end of period...... $10,367,074 0 (1,219,344) 9,147,730
----------- ---------------- ---------------- --------------------
----------- ---------------- ---------------- --------------------
Retained earnings (deficit):
Balance at beginning of
period...................... $ 864,933 (624,713) 624,713(3) 864,933
Net income (loss)............. 1,209,418 (599,460) 599,460(3) 1,209,418
----------- ---------------- ---------------- --------------------
Balance at end of period...... $ 2,074,351 (1,224,173) 1,224,173 2,074,351
----------- ---------------- ---------------- --------------------
----------- ---------------- ---------------- --------------------
Treasury stock:
Balance at end of period...... $ (505,557) 0 0 (505,557)
----------- ---------------- ---------------- --------------------
Total shareholders' equity.... $11,988,412 (1,214,173) 0 10,774,239
----------- ---------------- ---------------- --------------------
----------- ---------------- ---------------- --------------------
<CAPTION>
DECEMBER 31, 1996
----------------------------------------------------------------------------
<S> <C> <C> <C> <C>
PREVIOUSLY NET
REPORTED HEALTHCARE, INC. ADJUSTMENT RESTATED
---------------- ---------------- --------------------- --------------
COMMON STOCK-NUMBER OF SHARES:
Balance at beginning of
period...................... 3,529,412 10,000 (10,000)(1) 3,529,412
Exchange of common shares..... 0 0 517,085(2) 517,085
Issuance of common shares..... 0 0 0 0
---------------- ---------------- ---------- --------------
Balance at end of period...... 3,529,412 10,000 507,085 4,046,497
---------------- ---------------- ---------- --------------
---------------- ---------------- ---------- --------------
Common stock:
Balance at beginning of
period...................... 35,294 10,000 (10,000)(1) 35,294
Exchange of common shares..... 0 0 5,171(2) 5,171
Issuance of common shares..... 0 0 0 0
---------------- ---------------- ---------- --------------
Balance at end of period...... 35,294 10,000 (4,829) 40,465
---------------- ---------------- ---------- --------------
---------------- ---------------- ---------- --------------
Additional paid-in capital:
Balance at beginning of
period...................... 0 0 0
Exchange of common shares..... 0 0 (624,713)(3) (624,713)
Issuance of common shares..... 0 0 4,829 (1)(2) 4,829
---------------- ---------------- ---------- --------------
Balance at end of period...... 0 0 (619,884) (619,884)
---------------- ---------------- ---------- --------------
---------------- ---------------- ---------- --------------
Retained earnings (deficit):
Balance at beginning of
period...................... 760,667 0 0 760,667
Net income (loss)............. 104,266 (624,713) 624,713(3) 104,266
---------------- ---------------- ---------- --------------
Balance at end of period...... 864,933 (624,713) 624,713 864,933
---------------- ---------------- ---------- --------------
---------------- ---------------- ---------- --------------
Treasury stock:
Balance at end of period...... (505,557) 0 0 (505,557)
---------------- ---------------- ---------- --------------
Total shareholders' equity.... 394,670 (614,713) 0 (220,043)
---------------- ---------------- ---------- --------------
---------------- ---------------- ---------- --------------
</TABLE>
- ------------
(1) To eliminate merged company common stock.
(2) To record common stock exchanged in connection with merger.
(3) To transfer undistributed deficit to paid-in capital.
See accompanying auditors' report on supplementary consolidating schedules.
F-23
<PAGE>
PREFERRED EMPLOYERS HOLDINGS, INC. AND SUBSIDIARIES
CONSOLIDATING SCHEDULES OF CASH FLOWS
YEARS ENDED DECEMBER 31, 1997 AND 1996 (RESTATED)
<TABLE>
<CAPTION>
DECEMBER 31, 1997 DECEMBER 31, 1996
-------------------------------------- ------------------------------------
<S> <C> <C> <C> <C> <C> <C>
PREVIOUSLY NET HEALTH- PREVIOUSLY NET HEALTH-
REPORTED CARE, INC. RESTATED REPORTED CARE, INC. RESTATED
----------- ------------ ----------- ---------- ------------ ----------
Cash flow from operating activities:
Net income (loss)....................... $ 1,209,418 (599,460) 609,958 104,266 (624,713) (520,447)
Adjustments to reconcile net income
(loss) to net cash provided by (used
in) operating activities:
Depreciation and amortization......... 150,341 51,971 202,312 161,132 21,635 182,767
Amortization of deferred acquisition
costs............................... 4,161,884 0 4,161,884 177,526 0 177,526
Deferred income taxes................. (252,837) 0 (252,837) 0 0 0
Provision for uncollectible
accounts............................ 0 106,367 106,367 0 23,212 23,212
Change in:
Accrued investment income......... (311,934) 0 (311,934) 0 0 0
Receivables....................... 3,344,344 (1,036,857) 2,307,487 (3,583,802) (742,002) (4,325,804)
Unpaid losses and loss adjustment
expenses........................ 5,908,223 0 5,908,223 199,390 0 199,390
Unearned premiums................. 782,854 0 782,854 1,888,977 0 1,888,977
Premium payable................... (521,487) 0 (521,487) 1,231,676 0 1,231,676
Commissions payable............... (179,302) 0 (179,302) 212,769 0 212,769
Accounts payable and accrued
expenses........................ 135,437 561,415 696,852 367,215 272,962 640,177
Deferred reinsurance income....... (1,054,421) 0 (1,054,421) 1,334,401 0 1,334,401
Other, net........................ (1,857,061) (92,933) (1,949,994) 1,083,264 (66,682) 1,016,582
----------- ------------ ----------- ---------- ------------ ----------
Net cash provided by (used in)
operating activities.......... 11,515,459 (1,009,497) 10,505,962 3,176,814 (1,115,588) 2,061,226
----------- ------------ ----------- ---------- ------------ ----------
Cash flow from investing activities:
Purchase of fixed maturities............ (15,892,549) 0 (15,892,549) 0 0 0
Purchase of short-term investments,
net................................... (7,090,550) 0 (7,090,550) 0 0 0
Purchase of property and equipment...... (82,677) (185,793) (268,470) (130,503) (118,787) (249,290)
----------- ------------ ----------- ---------- ------------ ----------
Net cash used in investing activities... (23,065,776) (185,793) (23,251,569) (130,503) (118,787) 249,290)
----------- ------------ ----------- ---------- ------------ ----------
Cash flow from financing activities:
Proceeds from sale of common stock...... 10,384,324 0 10,384,324 0 0 0
Repayment of shareholder loan........... (300,000) 0 (300,000) (275,000) 0 (275,000)
Borrowings from revolving line of
credit, net........................... 0 1,114,779 1,114,779 0 1,285,221 1,285,221
Other, net.............................. 0 27,008 27,008 0 (8,899) (8,899)
----------- ------------ ----------- ---------- ------------ ----------
Net cash provided by (used in) financing
activities............................ 10,084,324 1,141,787 11,226,111 (275,000) 1,276,322 1,001,322
----------- ------------ ----------- ---------- ------------ ----------
Net (decrease) increase in cash........... (1,465,993) (53,503) (1,519,496) 2,771,311 41,947 2,813,258
Cash at beginning of period............... 5,591,140 53,627 5,644,767 2,819,829 11,680 2,831,509
----------- ------------ ----------- ---------- ------------ ----------
Cash at end of period..................... $ 4,125,147 124 4,125,271 5,591,140 53,627 5,644,767
----------- ------------ ----------- ---------- ------------ ----------
----------- ------------ ----------- ---------- ------------ ----------
Supplemental disclosure of cash flow
information:
Income taxes paid....................... $ 202,300 0 202,300 0 0 0
----------- ------------ ----------- ---------- ------------ ----------
----------- ------------ ----------- ---------- ------------ ----------
Interest paid........................... $ 0 638,235 638,235 0 103,069 103,069
----------- ------------ ----------- ---------- ------------ ----------
----------- ------------ ----------- ---------- ------------ ----------
</TABLE>
See accompanying auditors' report on supplementary consolidating schedules.
F-24
<PAGE>
PREFERRED EMPLOYERS HOLDINGS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEET
JUNE 30, 1998 (UNAUDITED AND RESTATED)
<TABLE>
<CAPTION>
PREVIOUSLY
REPORTED RESTATED
------------- -------------
<S> <C> <C>
ASSETS
Investments:
Held-to-maturity securities, at amortized cost (fair value of $8,835,720)........ $ 8,695,110 8,695,110
Held-to-maturity securities, at amortized cost, restricted
(fair value of $7,792,265)..................................................... 7,716,270 7,716,270
Short-term investments........................................................... 15,043,296 15,043,296
------------- -------------
Total investments............................................................ 31,454,676 31,454,676
Cash............................................................................... 3,510,803 3,700,595
Accrued investment and interest income............................................. 257,413 257,413
Receivables, net................................................................... 7,392,331 9,802,264
Deferred acquisition costs......................................................... 2,398,856 2,398,856
Property and equipment, net........................................................ 463,665 661,521
Deferred tax assets................................................................ 1,082,238 1,082,238
Deposits........................................................................... 118,601 269,191
Other assets....................................................................... 2,512,577 2,571,782
Goodwill and other intangible assets, net.......................................... 4,920,835 4,920,835
------------- -------------
Total assets................................................................. $ 54,111,995 57,119,371
------------- -------------
------------- -------------
LIABILITIES AND SHAREHOLDERS' EQUITY
Liabilities:
Notes payable...................................................................... $ 12,580,000 15,020,000
Unpaid losses and loss adjustment expenses......................................... 9,919,218 9,919,218
Unearned premiums.................................................................. 7,090,913 7,090,913
Premiums payable................................................................... 3,087,953 3,087,953
Commissions payable................................................................ 249,216 249,216
Other liabilities.................................................................. 6,297,104 6,838,946
Accounts payable and accrued expenses.............................................. 1,946,335 3,082,213
Deferred reinsurance income........................................................ 279,980 279,980
------------- -------------
Total liabilities............................................................ 41,450,719 45,568,439
------------- -------------
Shareholders' equity:
Common stock, $.01 par value; authorized 10,000,000 shares; issued 5,257,412 and
5,771,497 shares, respectively................................................... 52,544 57,715
Additional paid-in capital......................................................... 10,367,074 9,251,559
Retained earnings.................................................................. 2,747,215 2,747,215
------------- -------------
Total shareholders' equity......................................................... 13,166,833 12,056,489
Treasury stock, at cost, 529,412 shares............................................ (505,557) (505,557)
------------- -------------
Net shareholders' equity........................................................... 12,661,276 11,550,932
------------- -------------
Total liabilities and shareholders' equity......................................... $ 54,111,995 57,119,371
------------- -------------
------------- -------------
</TABLE>
See accompanying notes to consolidated financial statements.
F-25
<PAGE>
PREFERRED EMPLOYERS HOLDINGS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE SIX MONTHS ENDED JUNE 30, 1998 AND 1997 (UNAUDITED AND RESTATED)
<TABLE>
<CAPTION>
JUNE 30, 1998 JUNE 30, 1997
---------------------- ---------------------
<S> <C> <C> <C> <C>
PREVIOUSLY PREVIOUSLY
REPORTED RESTATED REPORTED RESTATED
---------- ---------- --------- ----------
REVENUES:
Premiums earned................................................ $7,416,526 7,416,526 4,669,794 4,669,794
Net commission income.......................................... 1,069,715 1,069,715 1,131,386 1,131,386
Staffing income................................................ 6,267,362 14,863,410 0 4,664,203
Net investment income.......................................... 891,546 891,546 719,646 719,646
Other income................................................... 264,331 264,331 288,061 288,061
---------- ---------- --------- ----------
Total revenues................................................. 15,909,480 24,505,538 6,808,887 11,473,090
---------- ---------- --------- ----------
EXPENSES:
Losses and loss adjustment expenses............................ 4,004,924 4,004,924 2,526,147 2,526,147
Amortization of deferred acquisition costs..................... 2,445,353 2,445,353 1,689,564 1,689,564
Staffing costs................................................. 4,997,868 11,596,918 0 4,014,249
Other operating expenses....................................... 3,412,835 4,519,855 1,818,600 2,667,109
---------- ---------- --------- ----------
Total operating expenses....................................... 14,860,980 22,567,050 6,034,311 10,897,069
---------- ---------- --------- ----------
Operating income before income taxes........................... 1,048,500 1,938,478 774,576 576,021
---------- ---------- --------- ----------
Interest expense............................................... 154,502 458,585 12,084 279,960
Amortization of intangible assets and other non-operating
expenses..................................................... 79,165 238,621 0 0
---------- ---------- --------- ----------
Total non-operating expense.................................... 233,667 697,206 12,084 279,960
---------- ---------- --------- ----------
Income before income taxes..................................... 814,833 1,241,272 762,492 296,061
Income taxes................................................... 141,968 141,968 170,823 170,823
---------- ---------- --------- ----------
Net income..................................................... $ 672,865 1,099,304 591,669 125,238
---------- ---------- --------- ----------
---------- ---------- --------- ----------
Net income--basic.............................................. $ 672,865 1,099,304 591,669 125,238
Impact of potential common shares--convertible notes........... 79,287 79,287 0 0
---------- ---------- --------- ----------
Net income--diluted............................................ $ 752,152 1,178,591 591,669 125,238
---------- ---------- --------- ----------
---------- ---------- --------- ----------
Weighted average shares outstanding--basic..................... 4,725,000 5,242,085 4,298,619 4,815,704
Impact of potential common shares--convertible notes........... 292,127 292,127 0 0
---------- ---------- --------- ----------
Weighted average shares outstanding--diluted................... 5,017,127 5,534,212 4,298,619 4,815,704
---------- ---------- --------- ----------
---------- ---------- --------- ----------
Net basic earnings per share................................... $ 0.14 0.21 0.14 0.03
---------- ---------- --------- ----------
---------- ---------- --------- ----------
Net diluted earnings per share................................. $ 0.14 0.21 0.14 0.03
---------- ---------- --------- ----------
---------- ---------- --------- ----------
PRO FORMA INFORMATION (UNAUDITED):
Historical income before income taxes.......................... $ 672,865 1,099,304 591,669 125,238
Pro forma income tax provision (benefit)....................... 0 322,610 0 (71,268)
---------- ---------- --------- ----------
Pro forma net income........................................... $ 672,865 776,694 591,669 196,506
---------- ---------- --------- ----------
---------- ---------- --------- ----------
Pro forma net income--basic.................................... $ 672,865 776,694 591,669 196,506
Impact of potential common shares--convertible notes........... 79,287 79,287 0 0
---------- ---------- --------- ----------
Pro forma net income--diluted.................................. $ 752,152 855,981 591,669 196,506
---------- ---------- --------- ----------
---------- ---------- --------- ----------
Weighted average shares outstanding--basic..................... 4,725,000 5,242,085 4,298,619 4,815,704
Impact of potential common shares--convertible notes........... 292,127 292,127 0 0
---------- ---------- --------- ----------
Weighted average shares outstanding--diluted................... 5,017,127 5,534,212 4,298,619 4,815,704
---------- ---------- --------- ----------
---------- ---------- --------- ----------
Pro forma net basic earnings per share......................... $ 0.14 0.15 0.14 0.04
---------- ---------- --------- ----------
---------- ---------- --------- ----------
Pro forma net diluted earnings per share....................... $ 0.14 0.15 0.14 0.04
---------- ---------- --------- ----------
---------- ---------- --------- ----------
</TABLE>
See accompanying notes to consolidated financial statements.
F-26
<PAGE>
PREFERRED EMPLOYERS HOLDINGS, INC., AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE SIX MONTHS ENDED JUNE 30, 1998 AND 1997 (UNAUDITED AND RESTATED)
<TABLE>
<CAPTION>
JUNE 30, 1998 JUNE 30, 1997
------------------------ ------------------------
<S> <C> <C> <C> <C>
PREVIOUSLY PREVIOUSLY
REPORTED RESTATED REPORTED RESTATED
----------- ----------- ----------- -----------
Cash flow from operating activities:
Net income............................................... $ 672,865 1,099,304 591,669 125,238
Adjustments to reconcile net income to net cash provided
by operating activities:
Depreciation and amortization.......................... 177,788 370,644 84,508 104,972
Amortization of deferred acquisition costs............. 2,445,353 2,445,353 1,689,564 1,689,564
Deferred income taxes.................................. 829,401 829,401 0 0
Provision for uncollectible accounts................... 0 (22,420) 0 44,428
Change in:
Accrued investment income.......................... 54,521 54,521 (173,941) (173,941)
Receivables........................................ (6,807,260) (7,248,897) 3,805,897 3,085,775
Deferred acquisition costs......................... (3,940,329) (3,940,329) (1,689,564) (1,689,564)
Unpaid losses and loss adjustment expenses......... 3,811,605 3,811,605 2,351,679 2,351,679
Unearned premiums.................................. 4,419,082 4,419,082 (951,896) (951,896)
Premiums payable................................... 23,850 23,850 (175,721) (175,721)
Commissions payable................................ (80,839) (80,839) (83,274) (83,274)
Accounts payable and accrued expenses.............. 1,438,208 1,535,746 999,194 1,367,841
Deferred reinsurance income........................ 0 0 (694,257) (694,257)
Other, net......................................... (1,754,055) (1,773,150) 2,090,027 2,038,763
----------- ----------- ----------- -----------
Net cash provided by operating activities........ 1,290,190 1,523,871 7,843,885 7,039,607
----------- ----------- ----------- -----------
Cash flow from investing activities:
Purchase of subsidiary................................... (5,000,000) (5,000,000) 0 0
Purchase of short-term investments, net.................. (8,471,577) (8,471,577) 0 0
Purchase of property and equipment....................... (54,871) (54,897) (43,295) (172,452)
----------- ----------- ----------- -----------
Net cash used in investing activities.................... (13,526,448) (13,526,474) (43,295) (172,452)
----------- ----------- ----------- -----------
Cash flow from financing activities:
Proceeds from sale of common stock....................... 0 0 10,384,324 10,384,324
Repayment of shareholder loan............................ 0 0 (150,000) (150,000)
Proceeds from subordinated convertible notes payable..... 9,621,914 9,621,914 0 0
Borrowings from revolving line of credit, net............ 2,000,000 2,000,000 0 1,010,208
Other, net............................................... 0 (43,987) 0 (5,660)
----------- ----------- ----------- -----------
Net cash provided by financing activities.................. 11,621,914 11,577,927 10,234,324 11,238,872
----------- ----------- ----------- -----------
Net (decrease) increase in cash............................ (614,344) (424,676) 18,034,914 18,106,027
Cash at beginning of period................................ 4,125,147 4,125,271 5,591,140 5,644,767
----------- ----------- ----------- -----------
Cash at end of period...................................... $ 3,510,803 3,700,595 23,626,054 23,750,794
----------- ----------- ----------- -----------
----------- ----------- ----------- -----------
Supplemental disclosures of cash flow information:
Income taxes paid.......................................... $ 950,000 950,000 0 0
----------- ----------- ----------- -----------
----------- ----------- ----------- -----------
Interest paid.............................................. $ 39,900 343,983 0 267,876
----------- ----------- ----------- -----------
----------- ----------- ----------- -----------
</TABLE>
See accompanying notes to consolidated financial statements.
F-27
<PAGE>
PREFERRED EMPLOYERS HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 1998 (UNAUDITED AND RESTATED)
(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
(A) BASIS OF PRESENTATION
The accompanying unaudited consolidated financial statements have been
prepared in accordance with generally accepted accounting principles for interim
financial information. Accordingly, they do not include all of the information
and notes required by generally accepted accounting principles for complete
financial statements. In the opinion of management, all adjustments, consisting
of normal recurring accruals, considered necessary for a fair presentation have
been included. Operating results for the six month period ended June 30, 1998
are not necessarily indicative of the results that may be expected for the year
ended December 31, 1998. These consolidated financial statements and notes
should be read in conjunction with the financial statements and notes included
in the audited consolidated financial statements of the Company for the year
ended December 31, 1997.
The accompanying consolidated financial statements of the Company and its
subsidiaries 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 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. (the "Company") 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 overallotment 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 operations.
In March 1998, the Company, through a wholly-owned subsidiary, consummated
the purchase of substantially all of the assets of HSSI Travel Nurse Operations,
Inc. ("Travel Nurse"), 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 nurses 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-28
<PAGE>
PREFERRED EMPLOYERS HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
JUNE 30, 1998 (UNAUDITED AND RESTATED)
(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
In August 1998, the Company issued 517,085 shares of its common stock in
exchange for all the outstanding common stock of National Explorers and
Travelers Healthcare, Inc., an employee staffing company and provider of
temporary registered nurses and other professional medical personnel, primarily
to client hospitals. This business combination was accounted for as a
pooling-of-interests combination and, accordingly, the Company's consolidated
financial statements for applicable periods prior to the combination have been
restated to include the accounts and results of operations of NET Healthcare.
The financial statements previously reported by the separate enterprises and the
combined amounts are presented in the accompanying consolidated financial
statements included herein.
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
assume 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 assumes 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 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.
F-29
<PAGE>
PREFERRED EMPLOYERS HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
JUNE 30, 1998 (UNAUDITED AND RESTATED)
(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
The effects of prospective and retroactive insurance accounting treatment
are illustrated below. The prospective method assumes that the Agreement
incepted on January 1, 1996, and provides for a loss ratio of 51.5%, acquisition
costs of 33.83%, aggregate net premiums written of approximately $15 million
($12,600,000 relating to the period from 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>
COMPOSITE
PROSPECTIVE 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.
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) STAFFING OPERATIONS
In March 1998, the Company purchased substantially all of the assets of HSSI
Travel Nurse Operations, Inc. ("Travel Nurse") for $5.0 million in cash. Based
in Ft. Lauderdale, Florida since 1981, Travel Nurse has provided registered
nurses and other professional medical personnel, often referred to as
F-30
<PAGE>
PREFERRED EMPLOYERS HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
JUNE 30, 1998 (UNAUDITED AND RESTATED)
(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
"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.
In August 1998, the Company issued 517,085 shares of its common stock in
exchange for all the outstanding common stock of National Explorers and
Travelers Healthcare, Inc. ("NET Healthcare"), an employee staffing company and
provider of temporary registered nurses and other professional medical
personnel, primarily to client hospitals. This business combination was
accounted for as a pooling-of-interests combination.
Staffing income is recognized at the time the staffing services are
provided. In most instances, the staffing company's temporary healthcare
professionals are considered employees of the staffing company while under
assignment and costs of employment are the responsibility of the staffing
company and are included in the accompanying statements of operations.
Receivables include amounts due from healthcare organizations for services
provided by Travel Nurse and NET Healthcare through the placement of healthcare
professionals. These receivables are presented net of an estimated allowance for
uncollectible accounts based on an evaluation of expected collections resulting
from an analysis of current and past due accounts, past collection experience in
relation to amounts billed and other relevant information. Concentration of
credit risk relating to accounts receivable is limited by number, diversity and
geographic dispersion of the healthcare organizations serviced by Travel Nurse
and NET Healthcare.
During 1995, NET Healthcare entered into a line of credit with a shareholder
to provide a total of $190,000 to fund the working capital requirements of NET
Healthcare. The line of credit bore interest at the rate of 5% per annum. In
March 1996, NET Healthcare entered into an additional line of credit with a
shareholder collateralized by outstanding accounts receivable. Interest was
payable at the rate of 2% per month on average outstanding balances. In May
1996, the agreement was amended to allow for additional funding. In May 1997,
the agreement was further amended to increase the interest rate by .5% per month
on approximately $600,000 of the balance of the line of credit. The amended line
of credit, effective April 1, 1998, established a rate of interest of 10% per
annum and eliminated restrictive covenants included in the original agreement.
The line of credit described above had an aggregate outstanding balance of
$2,440,000 at June 30, 1998 and December 31, 1997. Interest expense related to
the line of credit amounted to $215,029 and $608,300 for the six months ended
June 30, 1998 and for the year ended December 31, 1997, respectively. The
aggregate outstanding balance together with its related accrued interest expense
was paid in full subsequent to the merger of NET Healthcare and the Company.
The goodwill associated with the Company's acquisition of substantially all
of the assets of Travel Nurse is amortized over 30 years.
The former shareholders of NET Healthcare previously elected to have the
company treated as an "S Corporation" under the Internal Revenue Code and,
therefore, net income or loss was attributable directly to the former
shareholders. Accordingly, no pre-merger benefit for federal or state income
taxes has been reflected in the accompanying combined financial statements. In
addition, an adjustment has been made to the restated stockholders' equity of
the Company as of June 30, 1998 and December 31, 1997 to eliminate the untaxed
effects of including NET Healthcare's results of operations in the combined
financial statements of the Company.
F-31
<PAGE>
PREFERRED EMPLOYERS HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
JUNE 30, 1998 (UNAUDITED AND RESTATED)
(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
(E) 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.
(F) 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.
(G) 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.
(H) 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.
(I) 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.
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 basis. 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.
F-32
<PAGE>
PREFERRED EMPLOYERS HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
JUNE 30, 1998 (UNAUDITED AND RESTATED)
(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
(J) NET INCOME PER SHARE
Net income per common share is based upon the weighted average number of
common shares outstanding during each period. In February 1997, SFAS No. 128,
"Earnings per Share" was issued. This statement requires specific computations,
presentation 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 any prior period EPS amounts to be restated. Stock options
outstanding at June 30, 1998 and 1997 of 616,500 and 250,000, respectively, had
no effect on diluted earnings per share amounts.
In May 1998, the Company concluded a private placement of 7% Convertible
Subordinated Notes due May 12, 2003 in the aggregate principal amount of
$10,580,000 which had no effect on diluted earnings per share amounts.
(K) RECLASSIFICATIONS
Certain items in the 1997 financial statements have been reclassified to
conform with the 1998 presentation.
(2) INVESTMENTS
At June 30, 1998 and 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 $7,716,270 and $7,877,444 were held in a
restricted account for the benefit of the ceding company (AIG) as unauthorized
reinsurance at June 30, 1998 and December 31, 1997, respectively, in accordance
with statutory requirements.
F-33
<PAGE>
PREFERRED EMPLOYERS HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
JUNE 30, 1998 (UNAUDITED AND RESTATED)
(2) INVESTMENTS (CONTINUED)
The amortized cost and estimated fair values of investments at June 30, 1998
and 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:
JUNE 30, 1998:
Fixed maturities:
Obligations of states and political
subdivisions.............................. $ 8,695,110 141,850 (1,240) 8,835,720 8,695,110
Obligations of states and political
subdivisions--restricted.................. 7,716,270 77,235 (1,240) 7,792,265 7,716,270
------------- ----------- ----------- ------------ ------------
Total fixed maturities........................ $ 16,411,380 219,085 (2,480) 16,627,985 16,411,380
------------- ----------- ----------- ------------ ------------
------------- ----------- ----------- ------------ ------------
DECEMBER 31, 1997:
Fixed maturities:
Obligations of states and political
subdivision............................... $ 8,015,105 222,564 -- 8,237,669 8,015,105
Obligations of state 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 June 30, 1998 and
December 31, 1997, by contractual maturity date, are presented below:
<TABLE>
<CAPTION>
JUNE 30, 1998 DECEMBER 31, 1997
--------------------------- --------------------------
<S> <C> <C> <C> <C>
AMORTIZED FAIR AMORTIZED FAIR
COST VALUE COST VALUE
------------- ------------ ------------ ------------
Fixed maturities held-to-maturity:
Due in one year or less................................. $ -- -- -- --
Due after one year through five years................... 7,628,149 7,744,210 6,941,072 7,139,209
Due after one year through five years- restricted....... 6,649,309 6,700,755 6,803,411 6,849,521
Due after five years through ten years.................. -- -- -- --
Due after ten years..................................... 1,066,961 1,091,510 1,074,033 1,098,460
Due after ten years-restricted.......................... 1,066,961 1,091,510 1,074,033 1,098,460
------------- ------------ ------------ ------------
16,411,380 16,627,985 15,892,549 16,185,650
Short-term investments.................................. 15,043,296 15,043,296 7,090,550 7,090,550
------------- ------------ ------------ ------------
Total............................................... $ 31,454,676 31,671,281 22,983,099 23,276,200
------------- ------------ ------------ ------------
------------- ------------ ------------ ------------
</TABLE>
F-34
<PAGE>
PREFERRED EMPLOYERS HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
JUNE 30, 1998 (UNAUDITED AND RESTATED)
(3) FINANCIAL INSTRUMENTS
The carrying amounts for short-term investments, cash, accounts,
receivables, accrued investment and interest income, notes payable, premiums
payable, commissions payable 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. The carrying amount for the Company's
7% convertible subordinated notes is $10,580,000 and the related estimated fair
value is $9,939,015 which was determined by management based on available market
information and appropriate valuation methodologies.
(4) STOCKHOLDERS 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 to
give effect to the Exchange) (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 stockholders loan was paid in full
during 1997.
(5) INCOME TAXES
U.S. Federal and state income tax expense (benefit) consists of the
following components:
<TABLE>
<CAPTION>
FOR THE SIX MONTHS ENDED CURRENT DEFERRED TOTAL
- ------------------------------------------------------------------------------- ---------- ---------- ---------
<S> <C> <C> <C>
June 30, 1998.................................................................. $ 971,369 (829,401) 141,968
June 30, 1997.................................................................. $ 170,823 -- 170,823
</TABLE>
Income tax expense for the six months ended June 30, 1998 and 1997 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>
1998 1997
---------- ---------
<S> <C> <C>
Expected income tax expense................................................................ $ 422,032 100,661
State income tax, net...................................................................... 29,578 30,500
Tax-exempt interest........................................................................ (124,598) (86,934)
S corporation income (loss)................................................................ (144,989) 158,586
Other, net................................................................................. (40,055) (31,990)
---------- ---------
Total income tax expense............................................................... $ 141,968 170,823
---------- ---------
---------- ---------
</TABLE>
F-35
<PAGE>
PREFERRED EMPLOYERS HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
JUNE 30, 1998 (UNAUDITED AND RESTATED)
(5) INCOME TAXES (CONTINUED)
As a result of the business combination of NET Healthcare, an "S
corporation," with the Company, a "C corporation," NET Healthcare's "S
corporation" status ceased to exist. The unaudited pro forma information in the
consolidated Statements of Operations reflect income tax expense (benefit) had
NET Healthcare been taxed as a "C corporation," of $332,610 and ($71,268) for
the six months ended June 30, 1998 and 1997, respectively.
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 June 30, 1998 and December 31, 1997:
<TABLE>
<CAPTION>
1998 1997
------------ ----------
<S> <C> <C>
Deferred tax assets:
Unearned premiums................................................................... $ 533,662 --
Reserve for unpaid claims........................................................... 746,607 427,414
Other, net.......................................................................... -- 44,348
------------ ----------
Gross deferred tax assets....................................................... $ 1,280,269 471,762
------------ ----------
------------ ----------
Deferred tax liabilities:
Cash to accrual change.............................................................. ($ 198,031) --
Commissions receivable.............................................................. -- (151,454)
Commissions payable................................................................. -- (67,471)
------------ ----------
Gross deferred tax liabilities.................................................. (198,031) (218,925)
------------ ----------
Net deferred tax asset...................................................... $ 1,082,238 252,837
------------ ----------
------------ ----------
</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 Company's 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 entities
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 Company's 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 "sub part 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.
F-36
<PAGE>
PREFERRED EMPLOYERS HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
JUNE 30, 1998 (UNAUDITED AND RESTATED)
(6) 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 amount 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 June 30,
1998 and December 31, 1997, the Company was in compliance with this requirement.
(7) 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 six months ended June 30, 1998 and 1997:
<TABLE>
<CAPTION>
1998 1997
------------ ----------
<S> <C> <C>
Unpaid losses and loss adjustment expenses at beginning of period...................... $ 6,107,613 199,390
Incurred related to:
Current year......................................................................... 4,004,924 2,526,147
Prior year........................................................................... -- --
------------ ----------
Total incurred..................................................................... 4,004,924 2,526,147
------------ ----------
Paid related to:
Current year......................................................................... 193,319 174,468
Prior year........................................................................... -- --
------------ ----------
Total paid......................................................................... 193,319 174,468
------------ ----------
Unpaid losses and loss adjustment expenses at end of period............................ $ 9,919,218 2,551,069
------------ ----------
------------ ----------
</TABLE>
(8) UNSECURED REVOLVING LINE OF CREDIT
In May 1998, the Company obtained a $3 million unsecured revolving line of
credit from a bank. The terms of the loan provide for monthly interest payments
at the prime lending rate (currently approximately 8 1/2% per annum). The loan
is renewable on an annual basis. As of June 30, 1998, the amount outstanding
under the line of credit was approximately $2 million.
(9) SUBORDINATED CONVERTIBLE NOTES
In May 1998, the Company concluded a private placement of $10,580,000 of 7%
convertible subordinated notes (the "Notes") due May 2003. The principal amount
of the Notes is convertible at any time by the holders prior to the earlier of
the maturity date (May 12, 2003) or 10 business days after receipt of a
Termination Notice (as defined below), into shares of the Company's common stock
at a conversion price of $9.00 (the "Conversion Price"). In the event (i) the
closing bid price of the Company's common stock equals or exceeds $13.50 per
share for twenty consecutive trading days during any period commencing upon
satisfaction of one of the conditions contained in clause (ii) hereof, and (ii)
either a registration statement covering the shares of common stock issuable
upon conversion of the Notes has been declared effective by the Securities and
Exchange Commission and remains effective or at least two years has
F-37
<PAGE>
PREFERRED EMPLOYERS HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
JUNE 30, 1998 (UNAUDITED AND RESTATED)
(9) SUBORDINATED CONVERTIBLE NOTES (CONTINUED)
elapsed since the issuance date of the Notes and the shares of common stock
issuable upon conversion of the Notes are saleable, without restriction, under
Rule 144(k) promulgated under the Securities Act of 1933, as amended, then the
holders' rights to convert the outstanding principal amount of the Notes shall
be terminated by the Company by delivering to the holders a notice of
termination (the "Termination Notice"), in which event (a) the holders will have
the right at any time during 10 business days after receipt of the Termination
Notice, in their sole discretion, to convert the outstanding principal amount of
the Notes into shares of common stock of the Company at the Conversion Price,
and (b) thereafter, the holders' option to convert shall terminate and the Notes
may be prepaid by the Company at any time prior to the Maturity Date, in whole
or in part for the face amount thereof, together with all accrued and unpaid
interest through the date of prepayment.
(10) 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.
(11) 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 has developed
a plan to address Year 2000 issues. The plan is based on the Company's primary
software vendor having advised the Company that the necessary programming
changes related to Year 2000 issues have been made and tested and that the
software used by the Company can be upgraded to be Year 2000 complaint. The
Company has recently begun to implement this upgrade and expects to be fully
compliant with Year 2000 issues by December 31, 1998. As an integral component
of such plan, the Company will determine if they are Year 2000 complaint. It is
management's belief that for any suppliers who may not be Year 2000 complaint,
such non-compliance will not have a material adverse effect on the Company's
business. However, each major supplier's compliance will be assessed in light of
their response. The costs associated with the implementation of the above
project are not expected to be material.
F-38
<PAGE>
PREFERRED EMPLOYERS HOLDINGS, INC. AND SUBSIDIARIES
CONSOLIDATING BALANCE SHEET SCHEDULE
JUNE 30, 1998 (UNAUDITED AND RESTATED)
<TABLE>
<CAPTION>
PREVIOUSLY NET HEATH- CARE,
REPORTED INC. ADJUSTMENT ADJUSTMENT
----------- --------------- --------------- ---------------
<S> <C> <C> <C> <C>
ASSETS
Investments:
Held-to-maturity securities, at amortized
cost....................................... $ 8,695,110 0
Held-to-maturity securities, at amortized
cost, restricted........................... 7,716,270 0
Short-term investments..................... 15,043,296 0
----------- ---------------
Total investments...................... 31,454,676 0
Cash......................................... 3,510,803 189,792
Accrued investment and interest income....... 257,413 0
Receivables, net............................. 7,392,331 2,409,933
Deferred acquisition costs................... 2,398,856 0
Property and equipment, net.................. 463,665 197,856
Deferred tax assets.......................... 1,082,238 0
Deposits..................................... 118,601 150,590
Other assets................................. 2,512,577 59,205
Goodwill and other intangible assets, net.... 4,920,835 0
----------- ---------------
Total assets........................... $54,111,995 3,007,376
----------- ---------------
----------- ---------------
LIABILITIES AND SHAREHOLDERS' EQUITY
Liabilities:
Notes payable................................ $12,580,000 2,440,000
Unpaid losses and loss adjustment expenses... 9,919,218 0
Unearned premiums............................ 7,090,913 0
Premiums payable............................. 3,087,953 0
Commissions payable.......................... 249,216 0
Other liabilities............................ 6,297,104 541,842
Accounts payable and accrued expenses........ 1,946,335 1,135,878
Deferred reinsurance income.................. 279,980 0
----------- ---------------
Total liabilities...................... 41,450,719 4,117,720
----------- ---------------
Shareholders' equity:
Common stock................................. 52,544 10,000 (10,000)(1) 5,171(2)
Additional paid-in capital................... 10,367,074 0 (1,120,344)(3) 4,829(1)(2)
Retained earnings (deficit).................. 2,747,215 (1,120,344) 1,120,344(3)
----------- --------------- --------------- ---------------
Total shareholders' equity................... 13,166,833 (1,110,344) 0 0
Treasury stock, at cost...................... (505,557) 0 0 0
----------- --------------- --------------- ---------------
Net shareholders' equity (deficit)........... 12,661,276 (1,110,344) 0 0
----------- --------------- --------------- ---------------
Total liabilities and shareholders' equity... $54,111,995 3,007,376 0 0
----------- --------------- --------------- ---------------
----------- --------------- --------------- ---------------
<CAPTION>
RESTATED
---------------
<S> <C>
ASSETS
Investments:
Held-to-maturity securities, at amortized
cost....................................... 8,695,110
Held-to-maturity securities, at amortized
cost, restricted........................... 7,716,270
Short-term investments..................... 15,043,296
---------------
Total investments...................... 31,454,676
Cash......................................... 3,700,595
Accrued investment and interest income....... 257,413
Receivables, net............................. 9,802,264
Deferred acquisition costs................... 2,398,856
Property and equipment, net.................. 661,521
Deferred tax assets.......................... 1,082,238
Deposits..................................... 269,191
Other assets................................. 2,571,782
Goodwill and other intangible assets, net.... 4,920,835
---------------
Total assets........................... 57,119,371
---------------
---------------
LIABILITIES AND SHAREHOLDERS' EQUITY
Liabilities:
Notes payable................................ 15,020,000
Unpaid losses and loss adjustment expenses... 9,919,218
Unearned premiums............................ 7,090,913
Premiums payable............................. 3,087,953
Commissions payable.......................... 249,216
Other liabilities............................ 6,838,946
Accounts payable and accrued expenses........ 3,082,213
Deferred reinsurance income.................. 279,980
---------------
Total liabilities...................... 45,568,439
---------------
Shareholders' equity:
Common stock................................. 57,715
Additional paid-in capital................... 9,251,559
Retained earnings (deficit).................. 2,747,215
---------------
Total shareholders' equity................... 12,056,489
Treasury stock, at cost...................... (505,557)
---------------
Net shareholders' equity (deficit)........... 11,550,932
---------------
Total liabilities and shareholders' equity... 57,119,371
---------------
---------------
</TABLE>
- ------------------------
(1) To eliminate merged company common stock.
(2) To record common stock exchanged in connection with merger.
(3) To transfer undistributed deficit to paid-in-capital.
See accompanying auditors' report on supplementary consolidating schedules.
F-39
<PAGE>
PREFERRED EMPLOYERS HOLDINGS, INC. AND SUBSIDIARIES
CONSOLIDATING SCHEDULES OF OPERATIONS
FOR THE SIX MONTHS ENDED JUNE 30, 1998 AND 1997 (UNAUDITED AND RESTATED)
<TABLE>
<CAPTION>
JUNE 30, 1998 JUNE 30, 1997
--------------------------------------------------- ------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C>
PREVIOUSLY NET HEALTH- PREVIOUSLY NET HEALTH-
REPORTED CARE, INC. ADJUSTMENT RESTATED REPORTED CARE INC. ADJUSTMENT
----------- ----------- ---------- ----------- ---------- ----------- ----------
REVENUES:
Premiums earned............... $ 7,416,526 0 7,416,526 4,669,794 0
Net commission income......... 1,069,715 0 1,069,715 1,131,386 0
Staffing income............... 6,267,362 8,596,048 14,863,410 0 4,664,203
Net investment income......... 891,545 0 891,545 719,646 0
Other income.................. 264,332 0 264,332 288,061 0
----------- ----------- ----------- ---------- -----------
Total revenues................ 15,909,480 8,596,048 24,505,538 6,808,887 4,664,203
----------- ----------- ----------- ---------- -----------
EXPENSES:
Losses and loss adjustment
expenses.................... 4,004,924 0 4,004,924 2,526,147 0
Amortization of deferred
acquisition costs........... 2,445,353 0 2,445,353 1,689,564 0
Staffing costs................ 4,997,868 6,599,050 11,596,918 0 4,014,249
Other operating expenses...... 3,412,835 1,107,020 4,519,855 1,818,600 848,509
----------- ----------- ----------- ---------- -----------
Total operating expenses...... 14,860,980 7,706,070 22,567,050 6,034,311 4,862,758
----------- ----------- ----------- ---------- -----------
Operating income (loss) before
income taxes................ 1,048,500 889,978 1,938,478 774,576 (198,555)
----------- ----------- ----------- ---------- -----------
Interest expense.............. 154,502 304,083 458,585 12,084 267,876
Amortization of intangible
assets and other
non-operating expenses...... 79,165 159,456 238,621 0 0
----------- ----------- ----------- ---------- -----------
Total non-operating
expenses.................... 233,667 463,539 697,206 12,084 267,876
----------- ----------- ----------- ---------- -----------
Income (loss) before income
taxes....................... 814,833 426,439 1,241,272 762,492 (466,431)
Income taxes.................. 141,968 0 141,968 170,823 0
----------- ----------- ----------- ---------- -----------
Net income (loss)............. $ 672,865 426,439 1,099,304 591,669 (466,431)
----------- ----------- ----------- ---------- -----------
----------- ----------- ----------- ---------- -----------
Net income (loss)--basic...... $ 672,865 426,439 1,099,304 591,669 (466,431)
Impact of potential common
shares--convertible notes... 79,287 0 79,287 0 0
----------- ----------- ----------- ---------- -----------
Net income (loss)--diluted.... $ 752,152 426,439 1,178,591 591,669 (466,431)
----------- ----------- ----------- ---------- -----------
----------- ----------- ----------- ---------- -----------
Weighted average shares
outstanding--basic.......... 4,725,000 4,725,000 517,085(1) 5,242,085 4,298,619 4,298,619 517,085(1)
Impact of potential common
shares--convertible notes... 292,127 0 0 292,127 0 0 0
----------- ----------- ---------- ----------- ---------- ----------- ----------
Weighted average shares
outstanding--diluted........ 5,017,127 4,725,000 517,085 5,534,212 4,298,619 4,298,619 517,085
----------- ----------- ---------- ----------- ---------- ----------- ----------
----------- ----------- ---------- ----------- ---------- ----------- ----------
Net basic earnings (loss) per
share....................... $ 0.14 .09 0.21 0.14 (0.11)
----------- ----------- ----------- ---------- -----------
----------- ----------- ----------- ---------- -----------
Net diluted earnings (loss)
per share................... $ 0.14 .09 0.21 0.14 (0.11)
----------- ----------- ----------- ---------- -----------
----------- ----------- ----------- ---------- -----------
PRO FORMA INFORMATION
(UNAUDITED):
Historical income (loss)
before income taxes......... $ 672,865 426,439 1,099,304 591,669 (466,431)
Pro forma income tax provision
(benefit)................... 0 322,610 322,610 0 (71,268)
----------- ----------- ----------- ---------- -----------
Pro forma net income (loss)... $ 672,865 103,829 776,694 591,669 (395,163)
----------- ----------- ----------- ---------- -----------
----------- ----------- ----------- ---------- -----------
Pro forma net income
(loss)--basic............... $ 672,865 103,829 776,694 591,669 (395,163)
Impact of potential common
shares--convertible notes... 79,287 0 79,287 0 0
----------- ----------- ----------- ---------- -----------
Pro forma net income
(loss)--diluted............. $ 752,152 103,829 855,981 591,66 (395,163)
----------- ----------- ----------- ---------- -----------
----------- ----------- ----------- ---------- -----------
Weighted average shares
outstanding--basic.......... 4,725,000 4,725,000 517,085(1) 5,242,085 4,298,619 4,298,619 517,085(1)
Impact of potential common
shares--convertible notes... 292,127 292,127 0 292,127 0 0 0
----------- ----------- ---------- ----------- ---------- ----------- ----------
Weighted average shares
outstanding--diluted........ 5,017,127 5,017,127 517,085 5,534,212 4,298,619 4,298,619 517,085
----------- ----------- ---------- ----------- ---------- ----------- ----------
----------- ----------- ---------- ----------- ---------- ----------- ----------
Pro forma net basic earnings
(loss) per share............ $ 0.14 .02 0.15 0.14 (0.09)
----------- ----------- ----------- ---------- -----------
----------- ----------- ----------- ---------- -----------
Pro forma net diluted earnings
(loss) per share............ $ 0.14 .02 0.15 0.14 (0.09)
----------- ----------- ----------- ---------- -----------
----------- ----------- ----------- ---------- -----------
<CAPTION>
<S> <C>
RESTATED
-----------
REVENUES:
Premiums earned............... 4,669,794
Net commission income......... 1,131,386
Staffing income............... 4,664,203
Net investment income......... 719,646
Other income.................. 288,061
-----------
Total revenues................ 11,473,090
-----------
EXPENSES:
Losses and loss adjustment
expenses.................... 2,526,147
Amortization of deferred
acquisition costs........... 1,689,564
Staffing costs................ 4,014,249
Other operating expenses...... 2,667,109
-----------
Total operating expenses...... 10,897,069
-----------
Operating income (loss) before
income taxes................ 576,021
-----------
Interest expense.............. 279,960
Amortization of intangible
assets and other
non-operating expenses...... 0
-----------
Total non-operating
expenses.................... 279,960
-----------
Income (loss) before income
taxes....................... 296,061
Income taxes.................. 170,823
-----------
Net income (loss)............. 125,238
-----------
-----------
Net income (loss)--basic...... 125,238
Impact of potential common
shares--convertible notes... 0
-----------
Net income (loss)--diluted.... 125,238
-----------
-----------
Weighted average shares
outstanding--basic.......... 4,815,704
Impact of potential common
shares--convertible notes... 0
-----------
Weighted average shares
outstanding--diluted........ 4,815,704
-----------
-----------
Net basic earnings (loss) per
share....................... 0.03
-----------
-----------
Net diluted earnings (loss)
per share................... 0.03
-----------
-----------
PRO FORMA INFORMATION
(UNAUDITED):
Historical income (loss)
before income taxes......... 125,238
Pro forma income tax provision
(benefit)................... (71,268)
-----------
Pro forma net income (loss)... 196,506
-----------
-----------
Pro forma net income
(loss)--basic............... 196,506
Impact of potential common
shares--convertible notes... 0
-----------
Pro forma net income
(loss)--diluted............. 195,506
-----------
-----------
Weighted average shares
outstanding--basic.......... 4,815,704
Impact of potential common
shares--convertible notes... 0
-----------
Weighted average shares
outstanding--diluted........ 4,815,704
-----------
-----------
Pro forma net basic earnings
(loss) per share............ 0.04
-----------
-----------
Pro forma net diluted earnings
(loss) per share............ 0.04
-----------
-----------
</TABLE>
- ----------------------------------------
(1) To record common stock exchanged in connection with merger.
See accompanying auditors' report on supplementary consolidating schedules.
F-40
<PAGE>
PREFERRED EMPLOYERS HOLDINGS, INC. AND SUBSIDIARIES
CONSOLIDATING SCHEDULES OF CASH FLOWS
FOR THE SIX MONTHS ENDED JUNE 30, 1998 AND 1997 (UNAUDITED AND RESTATED)
<TABLE>
<CAPTION>
JUNE 30, 1998 JUNE 30, 1997
------------------------------------- ------------------------------------
<S> <C> <C> <C> <C> <C> <C>
NET NET
PREVIOUSLY HEALTHCARE, PREVIOUSLY HEALTHCARE
REPORTED INC. RESTATED REPORTED INC. RESTATED
----------- ----------- ----------- ----------- ----------- ----------
Cash flow from operating activities:
Net income (loss)......................... $ 672,865 426,439 1,099,304 591,644 (466,431) 125,238
Adjustments to reconcile net income (loss)
to net cash provided by (used in)
operating activities:
Depreciation and amortization........... 177,788 192,856 370,644 84,508 20,464 104,972
Amortization of deferred acquisition
costs................................. 2,445,353 0 2,445,353 1,689,564 0 1,689,564
Deferred income taxes................... 829,401 0 829,401 0 0 0
Provision for uncollectible accounts.... 0 (22,420) (22,420) 0 44,428 44,428
Change in:
Accrued investment income........... 54,521 0 54,521 (173,941) 0 (173,941)
Receivables......................... (6,807,260) (441,637) (7,248,897) 3,805,897 (720,122) 3,085,775
Deferred acquisition costs.......... (3,940,329) 0 (3,940,329) (1,689,564) 0 (1,689,564)
Unpaid losses and loss adjustment
expenses............................ 3,811,605 0 3,811,605 2,351,679 0 2,351,679
Unearned premiums................... 4,419,082 0 4,419,082 (951,896) 0 (951,896)
Premiums payable.................... 23,850 0 23,850 (175,721) 0 (175,721)
Commissions payable................. (80,839) 0 (80,839) (83,274) 0 (83,274)
Accounts payable and accrued
expenses............................ 1,438,208 97,538 1,535,746 999,194 368,647 1,367,841
Deferred reinsurance income......... 0 0 0 (694,257) 0 (694,257)
Other, net.......................... (1,754,055) (19,095) (1,773,150) 2,090,027 (51,264) 2,038,763
----------- ----------- ----------- ----------- ----------- ----------
Net cash provided by (used in)
operating activities.............. 1,290,190 233,681 1,523,871 7,843,885 (804,278) 7,039,607
----------- ----------- ----------- ----------- ----------- ----------
Cash flow from investing activities:
Purchase of subsidiary.................... (5,000,000) 0 (5,000,000) 0 0 0
Purchase of short-term investments, net... (8,471,577) 0 (8,471,577) 0 0 0
Purchase of property and equipment........ (54,871) (26) (54,897) (43,295) (129,157) (172,452)
----------- ----------- ----------- ----------- ----------- ----------
Net cash used in investing activities..... (13,526,448) (26) (13,526,474) (43,295) (129,157) (172,452)
----------- ----------- ----------- ----------- ----------- ----------
Cash flow from financing activities
Proceeds from sale of common stock........ 0 0 0 10,384,324 0 10,384,324
Repayment of shareholder loan............. 0 0 0 (150,000) 0 (150,000)
Proceeds from subordinated convertible
notes payable............................. 9,621,914 0 9,621,914 0 0 0
Borrowings from revolving line of credit,
net....................................... 2,000,000 0 2,000,000 0 1,010,208 1,010,208
Other, net................................ 0 (43,987) (43,987) 0 (5,660) (5,660)
----------- ----------- ----------- ----------- ----------- ----------
Net cash provided by (used in) financing
activities................................ 11,621,914 (43,987) 11,577,927 10,234,324 1,004,548 11,238,872
----------- ----------- ----------- ----------- ----------- ----------
Net (decrease) increase in cash............. (614,344) 189,668 (424,676) 18,034,914 71,113 18,106,027
Cash at beginning of period................. 4,125,147 124 4,125,271 5,591,140 53,627 5,644,767
----------- ----------- ----------- ----------- ----------- ----------
Cash at end of period....................... $ 3,510,803 189,792 3,700,595 23,626,054 124,740 23,750,794
----------- ----------- ----------- ----------- ----------- ----------
----------- ----------- ----------- ----------- ----------- ----------
Supplemental disclosures of cash flow
information:
Income taxes paid......................... $ 950,000 0 950,000 0 0 0
----------- ----------- ----------- ----------- ----------- ----------
----------- ----------- ----------- ----------- ----------- ----------
Interest paid............................. $ 39,900 304,083 343,983 0 267,876 267,876
----------- ----------- ----------- ----------- ----------- ----------
----------- ----------- ----------- ----------- ----------- ----------
</TABLE>
See accompanying auditors' report on supplementary consolidating schedules.
F-41
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE RESTATED
(i) AUDITED FINANCIAL STATEMENTS OF THE COMPANY DATED AS OF DECEMBER 31, 1997
AND FOR THE YEAR THEN ENDED AND (ii) UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
OF THE COMPANY AS OF JUNE 30, 1998 AND FOR THE SIX MONTHS THEN ENDED AND IS
QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
<S> <C> <C>
<PERIOD-TYPE> YEAR 6-MOS
<FISCAL-YEAR-END> DEC-31-1997 DEC-31-1998
<PERIOD-START> JAN-01-1997 JAN-01-1998
<PERIOD-END> DEC-31-1997 JUN-30-1998
<CASH> 4,125,271 3,700,595
<SECURITIES> 22,983,099 31,454,676
<RECEIVABLES> 2,699,657 9,802,264
<ALLOWANCES> 0 0
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0 0
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