<PAGE>
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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
------------------------
FORM 10-Q
/X/ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED JUNE 30, 1999
COMMISSION FILE NUMBER 1-12677
------------------------
PREFERRED EMPLOYERS HOLDINGS, INC.
(Exact name of registrant as specified in its charter)
DELAWARE 65-0698779
(State or other jurisdiction of (I.R.S. Employer Identification
incorporation or organization) No.)
10800 BISCAYNE BOULEVARD, MIAMI, FLORIDA 33161
(Address of principal executive offices)
(305) 893-4040
(Registrant's telephone number, including area code)
------------------------
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the past 12 months (or for such shorter period that the registrant
was required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes /X/ No / /
APPLICABLE ONLY TO CORPORATE ISSUERS
The number of shares outstanding of each of the issuer's classes of common
stock, as of August 12, 1999 was 5,247,085 shares of Common Stock.
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<PAGE>
PREFERRED EMPLOYERS HOLDINGS, INC.
FORM 10-Q--FOR THE QUARTER ENDED JUNE 30, 1999
INDEX
<TABLE>
<CAPTION>
PAGE
---------
<S> <C> <C>
PART I -- FINANCIAL INFORMATION
Item - 1 -- Quarterly Financial Statements
Consolidated Balance Sheets................................................................ 3
Consolidated Statements of Operations...................................................... 4
Consolidated Statements of Cash Flows...................................................... 6
Notes to Consolidated Financial Statements................................................. 8
Item - 2 -- Management's Discussion and Analysis of Financial Condition and Results of Operations...... 23
Item - 3 -- Quantitative and Qualitative Discussions About Market Risk................................. 30
PART II -- OTHER INFORMATION
Item - 1 -- Legal Proceedings.......................................................................... 31
Item - 2 -- Changes in Securities and Use of Proceeds.................................................. 31
Item - 3 -- Defaults Upon Senior Securities............................................................ 31
Item - 4 -- Submission of Matters to a Vote of Security Holders........................................ 31
Item - 5 -- Other Information.......................................................................... 31
Item - 6 -- Exhibits and Reports on Form 8-K........................................................... 31
SIGNATURE................................................................................................... 32
</TABLE>
2
<PAGE>
PART I: FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
PREFERRED EMPLOYERS HOLDINGS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
JUNE 30, 1999 (UNAUDITED) AND DECEMBER 31, 1998
<TABLE>
<CAPTION>
JUNE 30, 1999 DECEMBER 31, 1998
------------- -----------------
<S> <C> <C>
ASSETS
Investments:
Held-to-maturity securities, at amortized cost (fair value of $19,438,700 in
1999 and $15,692,019 in 1998).............................................. $ 19,610,103 15,454,481
Held-to-maturity securities, at amortized cost-restricted (fair value of
$9,191,460 in 1999 and $8,388,009 in 1998)................................. 9,265,583 8,257,053
Short-term investments....................................................... 3,852,725 7,032,027
------------- -----------------
Total investments............................................................ 32,728,411 30,743,561
Cash........................................................................... 6,785,535 3,714,883
Accrued investment and interest income......................................... 471,100 408,538
Accounts, commissions and premiums receivables, net............................ 11,899,245 11,200,923
Deferred acquisition costs..................................................... 2,083,056 1,807,841
Property and equipment, net.................................................... 939,341 897,625
Deferred tax assets............................................................ 827,594 447,878
Deposits....................................................................... 436,719 344,165
Goodwill and other intangible assets, net...................................... 4,688,896 4,805,560
Prepaid expenses............................................................... 777,414 427,502
Deferred convertible note issue costs.......................................... 863,507 979,137
Other assets................................................................... 490,269 629,814
------------- -----------------
Total assets............................................................... $ 62,991,087 56,407,427
------------- -----------------
------------- -----------------
LIABILITIES AND SHAREHOLDERS' EQUITY
Liabilities:
Notes payable................................................................ $ 11,021,417 12,430,000
Unpaid losses and loss adjustment expenses................................... 18,113,136 13,878,892
Premiums, commissions and other insurance balances payable................... 7,243,435 7,175,659
Unearned premiums............................................................ 6,295,120 5,463,405
Accounts payable and accrued expenses........................................ 2,124,095 1,588,326
Escrow and trust funds....................................................... 3,666,111 1,891,966
Other liabilities............................................................ 784,183 1,002,317
------------- -----------------
Total liabilities.......................................................... 49,247,497 43,430,565
------------- -----------------
Shareholders' equity:
Common stock, $0.01 par value; authorized 20,000,000 shares; issued 5,776,497
shares in 1999 and 5,771,497 shares in 1998................................ 57,765 57,715
Additional paid-in capital................................................... 9,936,512 9,891,562
Retained earnings............................................................ 4,254,870 3,533,142
------------- -----------------
Total shareholders' equity................................................. 14,249,147 13,482,419
Treasury stock, at cost, 529,412 shares...................................... (505,557) (505,557)
------------- -----------------
Net shareholders' equity................................................... 13,743,590 12,976,862
------------- -----------------
Total liabilities and shareholders' equity................................. $ 62,991,087 56,407,427
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</TABLE>
See accompanying notes to consolidated financial statements.
3
<PAGE>
PREFERRED EMPLOYERS HOLDINGS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)
FOR THE THREE MONTHS ENDED JUNE 30, 1999, 1998 (RESTATED) AND 1997 (RESTATED)
<TABLE>
<CAPTION>
(RESTATED) (RESTATED)
1999 1998 1997
----------- ----------- ----------
<S> <C> <C> <C>
Revenues:
Staffing income............................................................... $11,318,878 8,941,998 2,419,269
Premiums earned............................................................... 4,141,662 4,349,917 2,625,364
Net commission income......................................................... 341,086 526,585 497,072
Net investment income......................................................... 456,760 505,561 505,994
Other income.................................................................. 75,790 125,426 142,977
----------- ----------- ----------
Total revenues.............................................................. 16,334,176 14,449,487 6,190,676
----------- ----------- ----------
Expenses:
Staffing costs................................................................ 8,732,954 6,820,469 2,150,538
Losses and loss adjustment expenses incurred.................................. 2,277,914 2,348,955 1,422,830
Amortization of deferred acquisition costs.................................... 1,371,322 1,464,038 952,255
Other operating expenses...................................................... 3,339,802 2,738,872 1,382,855
----------- ----------- ----------
Total expenses.............................................................. 15,721,992 13,372,334 5,908,478
----------- ----------- ----------
Operating income before income taxes............................................ 612,184 1,077,153 282,198
----------- ----------- ----------
Interest expense................................................................ 255,513 256,635 162,997
Amortization of intangible assets and other non-operating expenses.............. 81,131 138,060 --
----------- ----------- ----------
Total non-operating expenses................................................ 336,644 394,695 162,997
----------- ----------- ----------
Income before income taxes...................................................... 275,540 682,458 119,201
Income taxes.................................................................... 7,646 91,629 41,233
----------- ----------- ----------
Net income.................................................................... $ 267,894 590,829 77,968
----------- ----------- ----------
----------- ----------- ----------
Net income-basic................................................................ $ 267,894 590,829 77,968
Impact of potential common shares-convertible notes............................. 152,536 79,287 --
----------- ----------- ----------
Net income-diluted.............................................................. $ 420,430 670,116 77,968
----------- ----------- ----------
----------- ----------- ----------
Weighted average outstanding shares-basic....................................... 5,247,085 5,242,085 5,242,085
Impact of potential common shares-convertible notes............................. 1,170,000 581,044 --
----------- ----------- ----------
Common shares and common shares equivalents used in computing net earnings per
shares-diluted................................................................ 6,417,085 5,823,129 5,242,085
----------- ----------- ----------
----------- ----------- ----------
Net basic earnings per share.................................................... $ 0.05 0.11 0.01
----------- ----------- ----------
----------- ----------- ----------
Net diluted earnings per share.................................................. $ 0.05 0.11 0.01
----------- ----------- ----------
----------- ----------- ----------
PRO FORMA INFORMATION (NOTES 6 AND 13):
Historical income before income taxes........................................... $ 275,540 682,458 119,201
Pro forma income tax provision.................................................. 7,646 256,350 5,229
----------- ----------- ----------
Pro forma net income............................................................ $ 267,894 426,108 113,972
----------- ----------- ----------
----------- ----------- ----------
Pro forma net income-basic...................................................... $ 267,894 426,108 113,972
Impact of potential common shares-convertible notes............................. 152,536 79,287 --
----------- ----------- ----------
Pro forma net income-diluted.................................................... $ 420,430 505,395 113,972
----------- ----------- ----------
----------- ----------- ----------
Weighted average outstanding shares-basic....................................... 5,247,085 5,242,085 5,242,085
Impact of potential common shares-convertible notes............................. 1,170,000 581,044 --
----------- ----------- ----------
Weighted average outstanding shares-diluted..................................... 6,417,085 5,823,129 5,242,085
----------- ----------- ----------
----------- ----------- ----------
Pro forma net basic earnings per share.......................................... $ 0.05 0.08 0.02
----------- ----------- ----------
----------- ----------- ----------
Pro forma net diluted earnings per share........................................ $ 0.05 0.08 0.02
----------- ----------- ----------
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</TABLE>
See accompanying notes to consolidated financial statements.
4
<PAGE>
PREFERRED EMPLOYERS HOLDINGS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)
FOR THE SIX MONTHS ENDED JUNE 30, 1999, 1998 (RESTATED) AND 1997 (RESTATED)
<TABLE>
<CAPTION>
(RESTATED) (RESTATED)
1999 1998 1997
----------- ----------- -----------
<S> <C> <C> <C>
Revenues:
Staffing income............................................................... $22,171,854 14,863,410 4,664,203
Premiums earned............................................................... 7,883,505 7,416,526 4,669,794
Net commission income......................................................... 721,824 1,069,715 1,131,386
Net investment income......................................................... 891,924 891,546 719,646
Other income.................................................................. 210,709 264,331 288,061
----------- ----------- -----------
Total revenues.............................................................. 31,879,816 24,505,528 11,473,090
----------- ----------- -----------
Expenses:
Staffing costs................................................................ 17,060,963 11,596,918 4,014,249
Losses and loss adjustment expenses incurred.................................. 4,335,927 4,004,924 2,526,147
Amortization of deferred acquisition costs.................................... 2,609,364 2,445,353 1,689,564
Other operating expenses...................................................... 6,326,620 4,519,855 2,667,109
----------- ----------- -----------
Total expenses.............................................................. 30,332,874 22,567,050 10,897,069
----------- ----------- -----------
Operating income before income taxes............................................ 1,546,942 1,938,478 576,021
----------- ----------- -----------
Interest expense................................................................ 536,691 458,585 279,960
Amortization of intangible assets and other non-operating expenses.............. 139,463 238,621 --
----------- ----------- -----------
Total non-operating expenses................................................ 676,154 697,206 279,960
----------- ----------- -----------
Income before income taxes...................................................... 870,788 1,241,272 296,061
Income taxes.................................................................... 149,060 141,968 170,823
----------- ----------- -----------
Net income.................................................................... $ 721,728 1,099,304 125,238
----------- ----------- -----------
----------- ----------- -----------
Net income-basic................................................................ $ 721,728 1,099,304 125,238
Impact of potential common shares-convertible notes............................. 306,633 79,287 --
----------- ----------- -----------
Net income-diluted.............................................................. $ 1,028,361 1,178,591 125,238
----------- ----------- -----------
----------- ----------- -----------
Weighted average outstanding shares-basic....................................... 5,247,085 5,242,085 4,815,704
Impact of potential common shares-convertible notes............................. 1,170,000 292,127 --
----------- ----------- -----------
Common shares and common shares equivalents used in computing net earnings per
shares-diluted................................................................ 6,417,085 5,534,212 4,815,704
----------- ----------- -----------
----------- ----------- -----------
Net basic earnings per share.................................................... $ 0.14 0.21 0.03
----------- ----------- -----------
----------- ----------- -----------
Net diluted earnings per share.................................................. $ 0.14 0.21 0.03
----------- ----------- -----------
----------- ----------- -----------
PRO FORMA INFORMATION (NOTES 6 AND 13):
Historical income before income taxes........................................... $ 870,787 1,241,272 296,061
Pro forma income tax provision.................................................. 149,060 464,578 102,122
----------- ----------- -----------
----------- ----------- -----------
Pro forma net income............................................................ $ 721,728 776,694 193,939
----------- ----------- -----------
----------- ----------- -----------
Pro forma net income-basic...................................................... $ 721,728 776,694 193,939
Impact of potential common shares-convertible notes............................. 306,633 79,287 --
----------- ----------- -----------
Pro forma net income-diluted.................................................... $ 1,028,361 855,981 193,939
----------- ----------- -----------
----------- ----------- -----------
Weighted average outstanding shares-basic....................................... 5,247,085 5,242,085 4,815,704
Impact of potential common shares-convertible notes............................. 1,170,000 292,127 --
----------- ----------- -----------
Weighted average outstanding shares-diluted..................................... 6,417,085 5,534,212 4,815,704
----------- ----------- -----------
----------- ----------- -----------
Pro forma net basic earnings per share.......................................... $ 0.14 0.15 0.04
----------- ----------- -----------
----------- ----------- -----------
Pro forma net diluted earnings per share........................................ $ 0.14 0.15 0.04
----------- ----------- -----------
----------- ----------- -----------
</TABLE>
See accompanying notes to consolidated financial statements.
5
<PAGE>
PREFERRED EMPLOYERS HOLDINGS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
FOR THE THREE MONTHS ENDED JUNE 30, 1999, 1998 (RESTATED) AND 1997 (RESTATED)
<TABLE>
<CAPTION>
(RESTATED) (RESTATED)
1999 1998 1997
------------- -------------- -------------
<S> <C> <C> <C>
Cash flow from operating activities:
Net Income........................................................ $ 267,894 590,829 77,968
Adjustments to reconcile net income to net cash provided by
operating activities:
Depreciation and amortization................................... 185,542 219,880 60,430
Loss on sale of property and equipment.......................... 22,799 -- --
Amortization of deferred acquisition costs...................... 1,371,321 1,464,038 952,255
Deferred income taxes........................................... (297,725) (477,630) --
Provision for uncollectible accounts............................ (7,275) (38,969) 18,107
Change in:
Accrued investment and interest income.......................... (148,625) (13,453) (173,941)
Accounts, commissions and premiums receivable................... 419,862 (4,380,750) 395,959
Deferred acquisition costs...................................... (1,409,782) (3,288,725) (1,689,564)
Unpaid losses and loss adjustment expenses...................... 2,227,595 2,155,636 1,335,597
Unearned premiums............................................... 116,228 3,846,284 (348,461)
Premiums, commissions and other insurance balances.............. (1,147,581) (718,749) (931,135)
Accounts payable and accrued expenses........................... (64,090) 725,115 464,494
Other, net...................................................... 883,949 (75,013) 404,287
------------- -------------- -------------
Net cash provided by operating activities..................... 2,420,112 8,493 565,996
------------- -------------- -------------
Cash flow from investing activities:
Purchases of short-term investments, net.......................... (1,726,055) (10,922,753) (2,329,458)
Proceeds from disposal of property and equipment.................. 6,000 -- --
Purchases of property and equipment............................... (55,368) (32,529) (111,450)
------------- -------------- -------------
Net cash used in investing activities......................... (1,775,423) (10,955,282) (2,440,908)
------------- -------------- -------------
Cash flow from financing activities:
Proceeds from subordinated convertible notes payable.............. -- 9,621,914 --
Repayment of shareholder loan..................................... -- -- (75,000)
Borrowings from revolving line of credit, net..................... -- 2,000,000 699,195
Repayment of line of credit....................................... (663,583) -- (289,271)
Other, net........................................................ -- (2,830) (20,635)
------------- -------------- -------------
Net cash (used in) provided by financing activities........... (663,583) 11,619,084 314,289
------------- -------------- -------------
Net increase (decrease) in cash..................................... (18,894) 672,295 (1,560,623)
Cash at beginning of period......................................... 6,804,429 3,028,300 5,576,023
------------- -------------- -------------
Cash at end of period............................................... $ 6,785,535 3,700,595 4,015,400
------------- -------------- -------------
------------- -------------- -------------
Supplemental disclosure of cash flow information:
Income taxes paid................................................. $ 343,000 950,000 --
------------- -------------- -------------
------------- -------------- -------------
Interest paid..................................................... $ 195,750 135,010 180,134
------------- -------------- -------------
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</TABLE>
See accompanying notes to consolidated financial statements.
6
<PAGE>
PREFERRED EMPLOYERS HOLDINGS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF CASH FLOWS (UNAUDITED)
FOR THE SIX MONTHS ENDED JUNE 30, 1999, 1998 (RESTATED) AND 1997 (RESTATED)
<TABLE>
<CAPTION>
(RESTATED) (RESTATED)
1999 1998 1997
------------- ------------- -------------
<S> <C> <C> <C>
Cash flow from operating activities:
Net Income............................................................. $ 721,728 1,099,304 125,238
Adjustments to reconcile net income to net cash provided by operating
activities:
Depreciation and amortization........................................ 372,432 370,644 104,972
Loss on sale of property and equipment............................... 22,799 -- --
Amortization of deferred acquisition costs........................... 2,609,364 2,445,353 1,689,564
Deferred income taxes................................................ (379,716) (829,401) --
Provision for uncollectible accounts................................. 6,274 (22,420) 44,428
Change in:
Accrued investment and interest income............................... (62,562) 54,521 (173,941)
Accounts, commissions and premiums receivable........................ (704,596) (7,248,897) 3,085,775
Deferred acquisition costs........................................... (2,884,579) (3,940,329) (1,689,564)
Unpaid losses and loss adjustment expenses........................... 4,234,244 3,811,605 2,351,679
Unearned premiums.................................................... 831,715 4,419,082 (951,896)
Premiums, commissions and other insurance balances................... 67,776 (56,989) (953,252)
Accounts payable and accrued expenses................................ 535,769 1,535,746 1,367,841
Other, net........................................................... 1,764,154 (114,348) 2,038,763
------------- ------------- -------------
Net cash provided by operating activities.......................... 7,134,801 1,523,871 7,039,607
------------- ------------- -------------
Cash flow from investing activities:
Purchase of subsidiary................................................. -- (5,000,000) --
Purchases of short-term investments, net............................... (1,984,850) (8,471,577) (19,735,394)
Proceeds from disposal of property and equipment....................... 6,000 -- --
Purchases of property and equipment.................................... (203,671) (54,897) (172,452)
------------- ------------- -------------
Net cash used in investing activities.............................. (2,182,520) (13,526,474) (19,907,846)
------------- ------------- -------------
Cash flow from financing activities:
Proceeds from sale of common stock..................................... -- -- 10,384,324
Proceeds from subordinated convertible notes payable................... -- 9,621,914 --
Repayment of shareholder loan.......................................... -- -- (150,000)
Borrowings from revolving line of credit, net.......................... -- 2,000,000 1,579,195
Repayment of line of credit............................................ (1,363,583) -- (568,987)
Bank overdraft......................................................... (518,046) (38,327) --
Other, net............................................................. -- (5,660) (5,660)
------------- ------------- -------------
Net cash (used in) provided by financing activities................ (1,881,629) 11,577,927 11,238,872
------------- ------------- -------------
Net increase (decrease) in cash.......................................... 3,070,652 (424,676) (1,629,367)
Cash at beginning of period.............................................. 3,714,883 4,125,271 5,644,767
------------- ------------- -------------
Cash at end of period.................................................... $ 6,785,535 3,700,595 4,015,400
------------- ------------- -------------
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Supplemental disclosure of cash flow information:
Income taxes paid...................................................... $ 523,000 950,000 --
------------- ------------- -------------
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Interest paid.......................................................... $ 417,844 343,983 267,876
------------- ------------- -------------
------------- ------------- -------------
</TABLE>
See accompanying notes to consolidated financial statements.
7
<PAGE>
PREFERRED EMPLOYERS HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 1999 (UNAUDITED)
(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
(A) BASIS OF PRESENTATION
The accompanying unaudited consolidated financial statements of Preferred
Employers Holdings, Inc. (the "Company") and its subsidiaries 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 months period ended June 30, 1999
are not necessarily indicative of the results that may be expected for the year
ending December 31, 1999. 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, 1998.
The accompanying unaudited 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 Holding, Inc. is the successor company to Preferred
Employers Group, Inc. ("PEGI"). Except as otherwise specified or when the
context otherwise requires, references to the Company herein include Preferred
Employers Holdings, Inc. and PEGI, through which the Company conducts certain of
its business operations.
In March 1998, the Company, through a wholly-owned subsidiary, consummated
the purchase of substantially all 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.
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 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.
8
<PAGE>
PREFERRED EMPLOYERS HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
JUNE 30, 1999 (UNAUDITED)
(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
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 ("Kemper") 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. In
September 1998, Kemper advised the Company that they would no longer accept
Package insurance risks for fast food restaurants, but retained its contract
with the Company to serve as a program administrator for certain risks. On June
1, 1999, the Company entered into an agreement with a division of United States
Fidelity and Guaranty Company to provide Package insurance for franchise, fast
food and family style restaurants.
(C) INSURANCE OPERATIONS
In 1996, the Company formed a Bermuda licensed reinsurance subsidiary (the
"Reinsurer") and entered into a reinsurance agreement (the "Agreement") with
certain affiliates of 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% 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 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
9
<PAGE>
PREFERRED EMPLOYERS HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
JUNE 30, 1999 (UNAUDITED)
(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
Agreement was not executed until October 1996, any investment income on net cash
flows earned for the period from January through September 1996 are deferred and
recognized as "other income" over the payment period of the remaining claim
liabilities.
Income before income taxes recognized, and estimated to be recognized in the
calendar year indicated below is as follows:
<TABLE>
<CAPTION>
PROSPECTIVE COMPOSITE
METHOD RETROACTIVE/PROSPECTIVE
YEARS (PRO FORMA) (ACTUAL)
- --------------------------------------------------------- ------------ ---------------------
<S> <C> <C>
1996..................................................... $ 1,658,000 324,000
1997..................................................... 1,288,000 1,372,000
1998..................................................... 400,000 840,000
1999..................................................... 332,000 658,000
2000..................................................... 300,000 563,000
2001..................................................... 282,000 503,000
------------ ----------
$ 4,260,000 4,260,000
------------ ----------
------------ ----------
</TABLE>
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, 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
Travel Nurse for $5.0 million in cash. Based in Fort 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.
10
<PAGE>
PREFERRED EMPLOYERS HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
JUNE 30, 1999 (UNAUDITED)
(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
In August 1998, the Company issued 517,085 shares of its common stock in
exchange for all of the outstanding common stock of 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 the staffing company 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 the staffing
company.
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.
Interest expense related to the line of credit amounted to $215,030 and $267,959
for the six months ended June 30, 1998 and 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 21 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 the federal or state income
taxes has been reflected in the accompanying financial statements. In addition,
an adjustment has been made to the restated stockholders' equity of the Company
as of December 31, 1998 to eliminate the untaxed effects of including NET
Healthcare's results of operations in the financial statements of the Company.
(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
11
<PAGE>
PREFERRED EMPLOYERS HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
JUNE 30, 1999 (UNAUDITED)
(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
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 billed. Any subsequent
commission adjustments, including policy cancellations, are recognized upon
notification from the insurance carrier or broker.
(I) INCOME TAXES
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) EARNINGS PER SHARE
Earnings per common share is based upon the weighted average number of
common shares outstanding during each period. On December 31, 1998, the Company
adopted SFAS No. 128, Earnings per Share ("SFAS No. 128"). SFAS No. 128 requires
specific computations, presentations and disclosures for earnings per share
(EPS) amounts in order to make EPS amounts more compatible with international
accounting standards. Stock options outstanding at June 30, 1999, 1998 and 1997
of 1,263,000, 616,500 and 250,000, respectively, had no effect on diluted
earnings per share amounts.
12
<PAGE>
PREFERRED EMPLOYERS HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
JUNE 30, 1999 (UNAUDITED)
(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
In May 1998, the Company consummated a private placement of 7% convertible
subordinated notes due May 12, 2003 in the aggregate principal amount of
$10,580,000. Principal balances outstanding as of June 30, 1999 and December 31,
1998 were $10,535,000 and $10,580,000, respectively. The effect on diluted
earnings per share amounts is presented in the accompanying consolidated
statements of operations.
(K) RECLASSIFICATIONS
Certain items in the Company's 1998 and 1997 financial statements have been
reclassified to conform them with the presentation of the Company's financial
statements as of and for the three months and six months ended June 30, 1999.
(2) INVESTMENTS
At June 30, 1999 and December 31, 1998, 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 $9,265,583 and $8,257,053 were held in a
restricted account for the benefit of the ceding company (AIG) as unauthorized
reinsurance at June 30, 1999 and December 31, 1998, respectively, in accordance
with statutory requirements.
The amortized cost and estimated fair values of the Company's investments at
June 30, 1999 and December 31, 1998 are as follows:
<TABLE>
<CAPTION>
AMOUNT AT
WHICH
SHOWN
GROSS GROSS ON THE
AMORTIZED UNREALIZED UNREALIZED ESTIMATED BALANCE
COST GAINS LOSSES FAIR VALUE SHEET
------------- ----------- ----------- ------------ ------------
<S> <C> <C> <C> <C> <C>
JUNE 30, 1999:
Securities held to maturity:
Fixed maturities:
Obligations of states and political
subdivision............................... $ 19,610,103 64,587 (235,990) 19,438,700 19,610,103
Obligations of states and political
subdivisions--restricted.................. 9,265,583 6,740 (80,863) 9,191,460 9,265,583
------------- ----------- ----------- ------------ ------------
Total fixed maturities........................ $ 28,875,686 71,327 (316,853) 28,630,160 28,875,686
------------- ----------- ----------- ------------ ------------
------------- ----------- ----------- ------------ ------------
DECEMBER 31, 1998:
Securities held to maturity:
Fixed maturities:
Obligations of states and political
subdivision................................. $ 15,454,481 241,667 (4,129) 15,692,019 15,454,481
Obligations of state and political
subdivisions--restricted.................... 8,257,053 130,956 -- 8,388,009 8,257,053
------------- ----------- ----------- ------------ ------------
Total fixed maturities........................ $ 23,711,534 372,623 (4,129) 24,080,028 23,711,534
------------- ----------- ----------- ------------ ------------
------------- ----------- ----------- ------------ ------------
</TABLE>
13
<PAGE>
PREFERRED EMPLOYERS HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
JUNE 30, 1999 (UNAUDITED)
(2) INVESTMENTS (CONTINUED)
The amortized cost and fair value of securities at June 30, 1999 and
December 31, 1998, by contractual maturity date, are presented below:
<TABLE>
<CAPTION>
JUNE 30, 1999 DECEMBER 31, 1998
--------------------------- --------------------------
<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................. 17,497,971 17,376,380 14,394,846 14,600,179
Due after one year through five years-- restricted.... 9,265,583 9,191,460 7,197,418 7,296,169
Due after five years through ten years................ 1,049,756 1,024,300 -- --
Due after ten years................................... 1,062,376 1,038,020 1,059,635 1,091,840
Due after ten years-restricted........................ -- -- 1,059,635 1,091,840
------------- ------------ ------------ ------------
28,875,686 28,630,160 23,711,534 24,080,028
Short-term investments................................ 162,965 162,965 1,515,347 1,515,347
Short-term investments-restricted..................... 3,689,760 3,689,760 5,516,680 5,516,680
------------- ------------ ------------ ------------
Total................................................... $ 32,728,411 32,482,885 30,743,561 31,112,055
------------- ------------ ------------ ------------
------------- ------------ ------------ ------------
</TABLE>
(3) FINANCIAL INSTRUMENTS
The carrying amounts for short-term investments, cash, accounts, commissions
and premiums receivable, accrued investment and interest income, notes payable,
premiums, commissions and other insurance balances 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 7%
convertible subordinated notes at June 30, 1999 and December 31, 1998 was
$10,535,000 and $10,580,000, respectively, and the related estimated fair value
at June 30, 1999 and December 31, 1998 was $10,265,465 and $10,280,955,
respectively, which was determined by management based on available market
information and appropriate valuation methodologies.
14
<PAGE>
PREFERRED EMPLOYERS HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
JUNE 30, 1999 (UNAUDITED)
(4) ACCOUNTS, COMMISSIONS AND PREMIUMS RECEIVABLE
Accounts, commissions and premiums receivable consists of the following at
June 30, 1999 and December 31,1998:
<TABLE>
<CAPTION>
JUNE 30, 1999 DECEMBER 31, 1998
------------- -----------------
<S> <C> <C>
Staffing accounts receivable-billed........................ $ 4,038,581 5,626,113
Staffing accounts receivable-unbilled...................... 1,907,833 1,000,370
------------- -----------------
5,946,414 6,626,483
Less allowance for uncollectible accounts.................. (102,328) (96,054)
------------- -----------------
Staffing accounts receivable, net.......................... 5,844,086 6,530,429
Premiums receivable........................................ 4,949,709 3,652,463
Commissions receivable..................................... 1,105,450 1,018,031
------------- -----------------
Total...................................................... $ 11,899,245 11,200,923
------------- -----------------
------------- -----------------
</TABLE>
The allowance for uncollectible accounts as of June 30, 1999 and December
31, 1998 consists of the following:
<TABLE>
<CAPTION>
JUNE 30, 1999 DECEMBER 31, 1998
------------- -----------------
<S> <C> <C>
Beginning balance........................................... $ 96,054 125,367
Provision for uncollectible accounts........................ 47,116 96,624
Write-offs.................................................. (40,842) (125,937)
------------- --------
Ending Balance.............................................. $ 102,328 96,054
------------- --------
------------- --------
</TABLE>
(5) STOCKHOLDERS LOAN
In May 1995, the Company entered into a repurchase agreement with PEGI
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 recapitalization of the Company in February 1997 whereby the
Company exchanged 17,647.06 shares of Common Stock for each share of PEGI Common
Stock held by the stockholders of PEGI) (the "Shares") of the Company. The
aggregate purchase price for the Shares was $600,000 (including interest) to be
paid in 24 installments of $25,000. The closing of the Agreement was subject to
the Company's completion of a $600,000 distribution to the stockholders of the
Company, pro rata based on the number of shares of common stock of the Company
outstanding and paid to the stockholders of record on the Agreement date,
without giving effect to the repurchase. The $600,000 distribution was made by
the Company on May 26, 1995.
Pursuant to a subsequent agreement made with the stockholders, the
outstanding loan balance at December 31, 1995 was to be repaid in 23 monthly
installments of $25,000 (including interest) commencing in February 1996. The
outstanding balance of the above-referenced stockholder loan was paid in full
during 1997.
15
<PAGE>
PREFERRED EMPLOYERS HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
JUNE 30, 1999 (UNAUDITED)
(6) INCOME TAXES
U.S. Federal and state income tax expense (benefit) consists of the
following components:
<TABLE>
<CAPTION>
FOR THE THREE MONTHS ENDED CURRENT DEFERRED TOTAL
- ----------------------------------------------------------- ---------- ---------- ---------
<S> <C> <C> <C>
June 30, 1999.............................................. $ 305,371 (297,725) 7,646
June 30, 1998.............................................. 569,259 (477,630) 91,629
June 30, 1997.............................................. 41,233 -- 41,233
<CAPTION>
FOR THE SIX MONTHS ENDED CURRENT DEFERRED TOTAL
- ----------------------------------------------------------- ---------- ---------- ---------
<S> <C> <C> <C>
June 30, 1999.............................................. $ 528,776 (379,716) 149,060
June 30, 1998.............................................. 971,369 (829,401) 141,968
June 30, 1997.............................................. 170,823 -- 170,823
</TABLE>
Income tax expense for the three months and six months ended June 30, 1999,
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>
FOR THE THREE MONTHS FOR THE SIX MONTHS
ENDED JUNE 30, ENDED JUNE 30,
------------------------------- ---------------------------------
<S> <C> <C> <C> <C> <C> <C>
1999 1998 1997 1999 1998 1997
--------- --------- --------- ---------- ---------- ---------
Expected income tax expense............................ $ 93,684 232,036 40,528 296,068 422,032 100,661
State income tax, net.................................. 9,738 16,361 4,768 31,837 29,578 11,842
Tax-exempt investment income........................... (93,303) (58,694) (67,873) (182,678) (124,598) (86,934)
Travel and entertainment expense....................... 6,646 -- -- 23,584 -- --
"S Corporation" (income) expense....................... -- (78,785) 62,281 -- (144,989) 158,586
Other, net............................................. (9,119) (19,289) 1,529 (19,751) (40,055) (13,332)
--------- --------- --------- ---------- ---------- ---------
Total income tax expense........................... $ 7,646 91,629 41,233 149,060 141,968 170,823
--------- --------- --------- ---------- ---------- ---------
--------- --------- --------- ---------- ---------- ---------
</TABLE>
As a result of the August 1998 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 had NET
Healthcare been taxed as a "C corporation," of $256,350 and $5,229 for the three
months ended June 30, 1998 and 1997, respectively, and $464,578 and $102,122 for
the six months ended June 30, 1998 and 1997, respectively.
16
<PAGE>
PREFERRED EMPLOYERS HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
JUNE 30, 1999 (UNAUDITED)
(6) INCOME TAXES (CONTINUED)
Deferred income taxes are based upon temporary differences between the
financial statement and tax bases of assets and liabilities. The following
deferred taxes are recorded for June 30, 1999, and December 31, 1998,
respectively:
<TABLE>
<CAPTION>
1999 1998
------------- ----------
<S> <C> <C>
Deferred tax assets:
Unearned premiums............................................... $ 473,771 411,176
Reserve for unpaid losses and loss adjustment expenses.......... 1,305,205 971,252
Other, net...................................................... 59,105 59,105
------------- ----------
Gross deferred tax assets..................................... 1,838,081 1,441,533
------------- ----------
Deferred tax liabilities:
Cash to accrual change.......................................... (219,704) (284,575)
Deferred acquisition costs...................................... (783,854) (680,291)
Other, net...................................................... (6,929) (28,789)
------------- ----------
Gross deferred tax liabilities................................ (1,010,487) (993,655)
------------- ----------
Net deferred tax asset...................................... $ 827,594 447,878
------------- ----------
------------- ----------
</TABLE>
A valuation allowance has not been established as the Company believes it is
more likely than not that the net deferred tax asset will be realized.
The Company's reinsurance subsidiary is a Bermuda domiciled corporation. The
reinsurance subsidiary is 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 income of the reinsurance subsidiary's income is
subpart F income.
The Company has elected under section 953(d) of the Internal Revenue Code to
tax its reinsurance subsidiary as a domestic corporation for U.S. income tax
purposes. The Company does not believe this election has a material effect on
its income tax expense.
(7) ANNUAL STATUTORY SOLVENCY REQUIREMENTS
The Bermuda Insurance Act of 1978 and related regulations (the "Act")
requires the Company's reinsurance subsidiary to meet a minimum solvency margin.
Statutory capital and surplus as of December 31, 1998 was $10,531,208 and the
amount required to be maintained by the Company's reinsurance subsidiary was
$3,163,000. 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, 1999 and December 31, 1998, the
Company's reinsurance subsidiary was in compliance with this requirement.
17
<PAGE>
PREFERRED EMPLOYERS HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
JUNE 30, 1999 (UNAUDITED)
(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 six months ended June 30, 1999, 1998 and 1997:
<TABLE>
<CAPTION>
1999 1998 1997
------------- ---------- ----------
<S> <C> <C> <C>
Net unpaid losses and loss adjustment expenses at beginning of period.... $ 13,878,892 6,107,613 199,390
------------- ---------- ----------
Incurred related to
Current year........................................................... 3,677,961 4,004,924 2,526,147
Prior year............................................................. 657,966 -- --
------------- ---------- ----------
Total incurred....................................................... 4,335,927 4,004,924 2,526,147
------------- ---------- ----------
Paid related to:
Current year........................................................... 100,021 193,319 174,468
Prior year............................................................. 1,662 -- --
------------- ---------- ----------
Total paid........................................................... 101,683 193,319 174,468
------------- ---------- ----------
Net unpaid losses and loss adjustment expenses at end of period.......... $ 18,113,136 9,919,218 2,551,069
------------- ---------- ----------
------------- ---------- ----------
</TABLE>
(9) 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 bank's prime lending rate (7 3/4% per annum at June 30, 1999). The loan
is renewable on an annual basis. As of June 30, 1999 and December 31, 1998, the
aggregate amount outstanding under the line of credit was $486,417 and
$1,850,000, respectively.
(10) SUBORDINATED CONVERTIBLE NOTES
In May 1998, the Company consummated 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 the option of the noteholders into shares
of the Company's common stock at a conversion price of $9.00 per share (the
"Conversion Price") at any time prior to the earlier of the maturity date (May
12, 2003) or 10 business days after receipt of a termination notice. 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)
described herein 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 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' right 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
18
<PAGE>
PREFERRED EMPLOYERS HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
JUNE 30, 1999 (UNAUDITED)
(10) SUBORDINATED CONVERTIBLE NOTES (CONTINUED)
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. As of June 30, 1999, the aggregate principal amount of Notes
outstanding was $10,535,000. Notes in an aggregate principal amount of $45,000
were converted into 5,000 shares of common stock of the Company during the first
quarter of 1999.
(11) SEGMENT REPORTING
The Company's reportable business segments are strategic business units that
offer distinctive products and services that are marketed through different
channels. They are managed separately because of their unique marketing and
distribution requirements.
There are two reportable segments: insurance and employee staffing. The
insurance segment sells, on behalf of others, business insurance principally to
the franchise industry and provides reinsurance of certain workers' compensation
and employers' liability insurance policies sold by the Company. The employee
staffing segment provides temporary registered nurses and other professional
medical personnel primarily to client hospitals.
The accounting policies of the segments are the same as those described in
the summary of significant accounting policies. Management evaluates segment
performance based on profit or loss from operations before income taxes not
including non-recurring gains and losses and intersegment transactions. Sales
and services between segments are accounted for as if the sale or services were
provided to third parties, that is at current market prices.
Certain information concerning the Company's reporting segments for the
three months and six months ended June 30, 1999, 1998 and 1997 is as follows:
FOR THE THREE MONTHS ENDED JUNE 30,
<TABLE>
<CAPTION>
EMPLOYEE
1999 INSURANCE STAFFING TOTALS
- ---------------------------------------------------- ------------ ------------ ------------
<S> <C> <C> <C>
Revenues from external customers.................... $ 4,558,538 11,318,878 15,877,416
Intersegment revenue................................ 6,507 -- 6,507
Interest revenue.................................... 452,289 302 452,591
Segment profit...................................... 529,022 949,034 1,478,056
1998
- ----------------------------------------------------
Revenues from external customers.................... $ 5,001,928 8,941,998 13,943,926
Interest revenue.................................... 505,561 -- 505,561
Segment profit...................................... 756,348 365,079 1,121,427
1997
- ----------------------------------------------------
Revenues from external customers.................... $ 3,265,511 2,419,269 5,684,780
Interest revenue.................................... 425,887 -- 425,887
Segment profit...................................... 354,967 (293,047) 61,920
</TABLE>
19
<PAGE>
PREFERRED EMPLOYERS HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
JUNE 30, 1999 (UNAUDITED)
(11) SEGMENT REPORTING (CONTINUED)
FOR THE SIX MONTHS ENDED JUNE 30,
<TABLE>
<CAPTION>
EMPLOYEE
1999 INSURANCE STAFFING TOTALS
- ------------------------------------------------------------------------ ------------ ------------ ------------
<S> <C> <C> <C>
Revenues from external customers........................................ $ 8,816,038 22,171,854 30,987,892
Intersegment revenue.................................................... 16,341 -- 16,341
Interest revenue........................................................ 868,479 302 868,781
Segment profit.......................................................... 1,184,475 1,768,158 2,952,633
Segment assets.......................................................... 49,114,134 12,832,371 61,946,505
1998
- ------------------------------------------------------------------------
Revenues from external customers........................................ $ 8,750,572 14,863,410 23,613,982
Interest revenue........................................................ 891,546 -- 891,546
Segment profit.......................................................... 1,310,984 555,044 1,866,028
Segment assets.......................................................... 36,802,571 12,083,921 48,886,492
1997
- ------------------------------------------------------------------------
Revenues from external customers........................................ $ 6,089,042 4,664,203 10,753,245
Interest revenue........................................................ 606,778 -- 606,778
Segment profit.......................................................... 672,153 (466,431) 205,722
Segment assets.......................................................... 18,597,890 1,906,885 20,504,775
</TABLE>
Information for the Company's reportable segments relates to the
enterprise's consolidated totals as follows:
<TABLE>
<CAPTION>
FOR THE THREE MONTHS ENDED JUNE 30,
1999 1998 1997
------------- ------------ ----------
<S> <C> <C> <C>
REVENUES:
Total revenues for reportable segments.................................. $ 16,336,514 14,449,487 6,110,667
Intersegment revenue.................................................... (6,507) -- --
Unallocated corporate interest revenue.................................. 4,169 -- 80,009
------------- ------------ ----------
Total consolidated revenues............................................. $ 16,334,176 14,449,487 6,190,676
------------- ------------ ----------
------------- ------------ ----------
PROFIT OR LOSS:
Total profit or loss for reportable segments............................ $ 1,478,056 1,121,427 61,920
Unallocated amounts:
General corporate expenses............................................ (1,206,685) (438,969) (22,728)
Corporate interest revenue............................................ 4,169 -- 80,009
------------- ------------ ----------
Income before income taxes.............................................. $ 275,540 682,458 119,201
------------- ------------ ----------
------------- ------------ ----------
</TABLE>
20
<PAGE>
PREFERRED EMPLOYERS HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
JUNE 30, 1999 (UNAUDITED)
(11) SEGMENT REPORTING (CONTINUED)
Other items:
<TABLE>
<CAPTION>
REPORTABLE UNALLOCATED
SEGMENT CORPORATE CONSOLIDATED
TOTAL TOTAL TOTAL
------------ ------------- ------------
<S> <C> <C> <C>
1999
- ------------------------------------------------------------------------
Depreciation and amortization........................................... $ 121,765 4,674 126,439
Amortization of deferred acquisition costs.............................. 1,371,322 -- 1,371,322
1998
- ------------------------------------------------------------------------
Depreciation and amortization........................................... $ 191,191 -- 191,191
Amortization of deferred acquisition costs.............................. 1,464,038 -- 1,464,038
1997
- ------------------------------------------------------------------------
Depreciation and amortization........................................... $ 43,809 -- 43,809
Amortization of deferred acquisition costs.............................. 952,255 -- 952,255
</TABLE>
<TABLE>
<CAPTION>
FOR THE SIX MONTHS ENDED JUNE 30,
1999 1998 1997
------------- ------------ ------------
<S> <C> <C> <C>
REVENUES:
- ----------------------------------------------------------------------
Total revenues for reportable segments................................ $ 31,873,014 24,505,528 11,360,023
Intersegment revenue.................................................. (16,341) -- --
Unallocated corporate interest revenue................................ 23,143 -- 113,067
------------- ------------ ------------
Total consolidated revenues........................................... $ 31,879,816 24,505,528 11,473,090
------------- ------------ ------------
------------- ------------ ------------
PROFIT OR LOSS:
Total profit or loss for reportable segments.......................... $ 2,952,633 1,866,028 205,722
Unallocated amounts:
General corporate expenses.......................................... (2,104,989) (624,756) (22,728)
Corporate interest revenue.......................................... 23,143 -- 113,067
------------- ------------ ------------
Income before income taxes............................................ $ 870,787 1,241,272 296,061
------------- ------------ ------------
------------- ------------ ------------
ASSETS:
- ----------------------------------------------------------------------
Total assets for reportable segments.................................. $ 61,946,505 48,886,492 20,504,775
Elimination of intersegment receivables............................... (276,286) (539,748) --
Unallocated general corporate assets.................................. 2,799,477 9,349,268 6,104,104
Elimination of receivable from corporate.............................. (1,478,609) (576,641) (201,641)
------------- ------------ ------------
Total consolidated assets............................................. $ 62,991,087 57,119,371 26,407,238
------------- ------------ ------------
------------- ------------ ------------
</TABLE>
21
<PAGE>
PREFERRED EMPLOYERS HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
JUNE 30, 1999 (UNAUDITED)
(11) SEGMENT REPORTING (CONTINUED)
Other items:
<TABLE>
<CAPTION>
REPORTABLE UNALLOCATED
SEGMENT CORPORATE CONSOLIDATED
TOTAL TOTAL TOTAL
------------ ------------- ------------
<S> <C> <C> <C>
1999
- ------------------------------------------------------------------------
Depreciation and amortization........................................... $ 240,871 8,949 249,820
Amortization of deferred acquisition costs.............................. 2,609,364 -- 2,609,364
1998
- ------------------------------------------------------------------------
Depreciation and amortization........................................... $ 341,955 -- 341,955
Amortization of deferred acquisition costs.............................. 2,445,353 -- 2,445,353
1997
- ------------------------------------------------------------------------
Depreciation and amortization........................................... $ 82,472 -- 82,472
Amortization of deferred acquisition costs.............................. 1,689,564 -- 1,689,564
</TABLE>
The Company does not attribute revenues or long-lived assets by geographic
areas. The Company does not have any single customer that can be identified as
material when considering the Company's consolidated revenues.
(12) 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.
(13) 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 NET
Healthcare filed income tax returns as a taxable "C corporation" for 1998 and
1997.
(14) 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 vendors 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. During
the first quarter of 1999, the Company completed the implementation of this
upgrade. The additional costs associated with the implementation of the above
project were not material.
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.
22
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The following discussion and analysis should be read in conjunction with the
Company's consolidated financial statements and notes related thereto contained
elsewhere in this Form 10-Q. In August 1998, the Company consummated the merger
of NET Healthcare with and into one of the Company's wholly-owned subsidiaries,
and in connection therewith issued 517,085 shares of common stock in exchange
for all of the outstanding common stock of NET Healthcare. The business
combination was accounted for as a "pooling-of-interests" and, accordingly, our
consolidated financial statements for applicable periods prior to the
combination have been restated to include the accounts and results of operations
of NET Healthcare.
GENERAL
The Company engages in the following activities:
- it provides temporary registered nurses and other professional medical
personnel primarily to client hospitals;
- it sells, on behalf of others, business insurance, including workers'
compensation, property, liability, casualty, and other types of coverage,
and provides risks management services, including cost containment, safety
management and claims management services, designed for segments of the
franchise industry (particularly fast food restaurants, family-style
restaurants and convenience stores); and
- it provides reinsurance for certain workers' compensation and employers'
liability insurance policies it sells.
EMPLOYEE STAFFING. In March and August of 1998, the Company acquired
businesses providing temporary registered nurses and other professional medical
personnel (often referred to as "Travelers") mainly to client hospitals.
Travelers serve clients for periods ranging from 8 to 52 weeks and function
essentially as permanent hospital staff rather than short-term, supplemental
staff. The Company believes that the ability of Travelers to function as
permanent staff improves the continuity and consistency of patient care and
reduces its clients' overall administration, orientation and supervisory
requirements relating to permanent staff, as well as reducing turnover of their
temporary staff.
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.
INSURANCE. The Company is engaged in the property and casualty insurance
business and has conducted business as a general agent on behalf of AIG, General
Accident Insurance Company ("General Accident") and Kemper Insurance Companies
("Kemper") and as a reinsurer for certain workers' compensation insurance
policies written by the Company on behalf of affiliates of AIG. Pursuant to our
general agency agreements, the Company is authorized to solicit and bind
insurance contracts on behalf of the insurers, collect and account for premiums
on business it writes, and request cancellation or nonrenewal of any policy it
places. The Company receives, as compensation pursuant to the terms of these
general agency agreements, gross commissions on its business at rates which
range from approximately 5% to 20%. The Company has written workers'
compensation insurance since its inception in 1988 and in late 1995 began
writing other forms of property and casualty insurance (such other forms of
insurance being hereinafter referred to as "Package") for family style and fast
food restaurants as a general agent for General Accident. In June 1996, General
Accident advised the Company that it would no longer accept Package insurance
risks for fast food restaurants. As a result, the Company became a general agent
for Kemper during March 1997, through which it wrote Package as well as other
forms of property and
23
<PAGE>
casualty insurance and workers' compensation insurance. In September 1998,
Kemper advised the Company that it would no longer accept Package insurance
risks for fast food restaurants but retained its contract with the Company to
serve as a program administrator for certain risks. On June 1, 1999, the Company
entered into an agreement with a division of United States Fidelity and Guaranty
Company to provide Package insurance for franchise, fast food and family style
resturants.
REINSURANCE. In December 1996, the Company formed Preferred Reinsurance and
entered into a reinsurance agreement with affiliates of AIG pursuant to which
Preferred Reinsurance acts as a reinsurer with respect to certain workers'
compensation and employer's liability insurance policies in force with policy
inception dates as of January 1, 1996 and subsequent which are written by the
Company on behalf of affiliates of AIG. Preferred Reinsurance is required to
provide affiliates of AIG, as security for the payment of losses, a combination
of cash, United States government securities and/or an irrevocable letter of
credit in an aggregate amount equal to 51.5% of the net written premiums ceded
to Preferred Reinsurance pursuant to the insurance agreement less the amount of
losses paid. Preferred Reinsurance receives, as compensation pursuant to the
terms of the reinsurance agreement, the related net written premiums less
certain program expenses and commissions and the losses paid. Preferred
Reinsurance receives, as compensation pursuant to the terms of the reinsurance
agreement, the related net written premiums less certain program expenses and
commissions and the losses paid associated with the business. Although Preferred
Reinsurance assumes the risks associated with being a reinsurer, the reinsurance
agreement limits the liability of Preferred Reinsurance for losses and certain
defined expenses to the first $300,000 per occurrence. In addition, the
reinsurance agreement limits the aggregate liability of Preferred Reinsurance
for all coverage to an amount not to exceed 70% of the gross written premiums
for each individual underwriting year. Because the reinsurance agreement is
effective for all business written on or after January 1, 1996, the policies
written prior to the execution of the contract and formation of Preferred
Reinsurance were accounted for as retroactive reinsurance. The reinsurance
agreement with Preferred Reinsurance is terminable by either party upon the
occurrence of certain events. In the event the Company's reinsurance agreement
is terminated, the Company, in all likelihood, would be materially and adversely
affected.
The Company collects workers' compensation premiums from the insureds and
remits the ceding commission (net of its commission) and reinsurance charges to
affiliates of AIG and remits the net premium to Preferred Reinsurance.
Commission income on workers' compensation business is recognized as income when
premiums are billed. Package insurance premiums are principally collected by the
insurance carrier. The package insurance carrier remits commissions to the
Company monthly on package premiums it collects. Commission income on package
business is recognized as income when premiums are due. Reinsurance premiums
received are earned on a pro-rata basis over the term of the related coverage.
For the three months ended June 30, 1999, the Company's total revenues were
$16,334,000 as compared to $14,449,000 for the 1998 comparable period,
representing a net increase of $1,885,000. For the three months ended June 30,
1998, the Company's total revenues were $14,449,000 as compared to total
revenues of $6,191,000 for the 1997 comparable period, representing a net
increase of $8,258,000. For the three months ended June 30, 1999, approximately,
69%, 29% and 2% of the Company's total revenues were derived from its staffing,
reinsurance captive and general agency businesses, respectively. For the three
months ended June 30, 1998, approximately 62%, 34%, and 4% of the Company's
total revenues were derived from its staffing, reinsurance captive and general
agency businesses, respectively. For the three months ended June 30, 1997,
approximately 39%, 53% and 8% of the Company's total revenues were derived from
its staffing, reinsurance captive and general agency businesses, respectively.
For the six months ended June 30, 1999, the Company's total revenues were
$31,880,000 compared to $24,506,000 for the 1998 comparable period, representing
a net increase of $7,374,000. For the six months ended June 30, 1998, the
Company's total revenues were $24,506,000 as compared to total revenue of
$11,473,000 for the 1997 comparable period, representing a net increase of
$13,033,000. For the six months ended June 30, 1999, approximately, 70%, 28% and
2% of the Company's total revenues were derived
24
<PAGE>
from its staffing, reinsurance captive and general agency business,
respectively. For the six months ended June 30, 1998, approximately 61%, 35%,
and 4% of Company's total revenue were derived from its staffing, reinsurance
captive and general agency business, respectively. For the six months ended June
30, 1997, approximately 41%, 49% and 10% of the Company's total revenues were
derived from its staffing, reinsurance captive and general agency business,
respectively.
Historically, our employee staffing business has been seasonal with the
demand for Travelers being the highest in fourth and first quarters of the
calendar year (September through March), due largely to increased demand,
particularly during the peak tourist and winter home period in Florida.
RESULTS OF OPERATIONS
FOR THE THREE MONTHS ENDED JUNE 30, 1999 AND 1998
TOTAL REVENUES. Total revenues for the three months ended June 30, 1999
were $16,334,000 compared to $14,449,000 for the 1998 comparable period,
representing a net increase of $1,885,000 or 13.0%. Total revenues for the three
months ended June 30, 1998 were $14,449,000 compared to $6,191,000 for the 1997
comparable period, representing a net increase of $8,258,000 or 133.4%.
The following table provides a comparison of revenues for the three months
ended June 30, 1999 and 1998 by category:
<TABLE>
<CAPTION>
NET PERCENTAGE
1999 1998 CHANGE CHANGE
------------- ------------ ---------- -----------------
<S> <C> <C> <C> <C>
Staffing Income........................................ $ 11,319,000 8,942,000 2,377,000 26.6%
Premiums earned........................................ 4,141,000 4,350,000 (209,000) (4.8)%
Net commission income:
Workers' compensation................................ 284,000 393,000 (109,000) (27.7)%
Package.............................................. 17,000 93,000 (76,000) (81.7)%
Other, net........................................... 40,000 41,000 (1,000) (2.4)%
------------- ------------ ---------- -----
Total net commission income........................ 341,000 527,000 (186,000) (35.3)%
Net investment income.................................. 457,000 505,000 (48,000) (9.5)%
Other income........................................... 76,000 125,000 (49,000) (39.2)%
------------- ------------ ---------- -----
Total revenues..................................... $ 16,334,000 14,449,000 1,885,000 13.0%
------------- ------------ ---------- -----
------------- ------------ ---------- -----
Workers' compensation:
Premiums collected................................... $ 3,437,000 4,276,000
------------- ------------
------------- ------------
Ratio of net commission income/premiums collected.... 8.3% 9.2%
------------- ------------
------------- ------------
</TABLE>
Staffing income increased $2,377,000 or 26.6% as a result of the acquisition
of certain of the assets of Travel Nurse (acquired in March 1998) and the
increase in business related to the acquisition and merger of NET Healthcare.
Premiums earned decreased $209,000 or 4.8% for the three months ended June 30,
1999 as compared to the 1998 comparable period as a result of the decrease in
the book of business. Workers' compensation commission income decreased $109,000
or 27.7% for the three months ended June 30, 1999 as compared to the 1998
comparable period as a result of the decrease in premiums collected of $839,000,
which was attributable to the decrease in the workers' compensation book of
business. Package commission income decreased $76,000 or 81.7% for the three
months ended June 31, 1999 as compared to the 1998 comparable period as a result
of a reduction in the business written for fast food restaurants. Other net
commission income decreased $1,000 or 2.4% for the three months ended June 30,
1999 as compared to the 1998 comparable period as a result of the decrease in
volume of small business plan premiums collected. Net investment income
decreased $48,000 or 9.5% and other income
25
<PAGE>
decreased $49,000 or 39.2% for the three months ended June 30, 1999 as compared
to the 1998 comparable period as a result of the effects of the retroactive
insurance accounting treatment of Preferred Reinsurance as discussed more fully
in Note 1 (c) to the Company's consolidated financial statements.
TOTAL OPERATING EXPENSES. Total operating expenses for the three months
ended June 30, 1999 were $15,722,000 compared to $13,372,000 for the 1998
comparable period, representing an increase of $2,350,000 or 17.6%. Total
operating expenses for the three months ended June 30, 1998 were $13,372,000
compared to $5,908,000 for the 1997 comparable period, representing an increase
of $7,464,000 or 126.3%.
The following table provides a comparison of total operating expenses for
the three months ended June 1999 and 1998 by category:
<TABLE>
<CAPTION>
NET PERCENTAGE
1999 1998 CHANGE CHANGE
------------- ------------ ---------- -----------------
<S> <C> <C> <C> <C>
Staffing costs......................................... $ 8,733,000 6,820,000 1,913,000 28.0%
Losses and loss adjustment expenses incurred........... 2,278,000 2,349,000 (71,000) (3.0)%
Amortization of deferred acquisition costs............. 1,371,000 1,464,000 (93,000) (6.4)%
Other operating expenses............................... 3,340,000 2,739,000 601,000 21.9%
------------- ------------ ---------- ---
Total operating expenses............................. $ 15,722,000 13,372,000 2,350,000 17.6%
------------- ------------ ---------- ---
------------- ------------ ---------- ---
</TABLE>
Staffing costs increased $1,913,000 or 28.0% consistent with the increase in
staffing revenues for the three months ended June 30, 1999 as discussed above.
Losses and loss adjustment expenses incurred decreased $71,000 or 3.0% which is
consistent with the decrease in premiums earned for the three months ended June
30, 1999 as discussed above. For the quarter ended June 30, 1999, the Company's
ratio of losses incurred to premiums earned was approximately 55%. Amortization
of deferred acquisition costs decreased $93,000 or 6.4% which is also consistent
with the decrease in premiums earned for the second quarter as discussed above.
Other operating expenses increased $601,000 or 21.9%. The following table
provides a comparison of other operating expenses for the three months ended
June 30, 1999 and 1998 by category:
<TABLE>
<CAPTION>
NET PERCENTAGE
1999 1998 CHANGE CHANGE
------------ ---------- ----------- ---------------
<S> <C> <C> <C> <C>
Personnel costs............................................ $ 1,881,000 1,592,000 289,000 18.2%
Occupancy expenses......................................... 214,000 223,000 (9,000) (4.0)%
Professional fees.......................................... 462,000 189,000 273,000 144.4%
Other operating expenses................................... 783,000 735,000 48,000 6.5%
------------ ---------- ----------- -----
Total other operating expenses........................... $ 3,340,000 2,739,000 601,000 21.9%
------------ ---------- ----------- -----
------------ ---------- ----------- -----
</TABLE>
Personnel costs increased $289,000 or 18.2% as a result of annual salary
increases together with the increased staff related to the acquisition of the
assets of Travel Nurse and the growth in the business of NET Healthcare.
Occupancy expenses decreased $9,000 or 4.0% principally as a result of changing
to a long distance carrier with lower rates. Professional fees increased
$273,000 or 144.4% principally as a result of increased legal, accounting and
actuarial fees associated with various corporate and acquisition matters. Other
operating expenses increased $48,000 or 6.5% primarily related to the increased
advertising and promotional expenses, which increased as a result of the
expansion of the staffing business.
TOTAL NON-OPERATING EXPENSES. Total non-operating expenses for the three
months ended June 30, 1999 were $337,000 compared to $395,000 for the 1998
comparable period. Amortization of intangible assets and other non-operating
expenses decreased $57,000, primarily related to the acquisition and merger of
NET Healthcare.
26
<PAGE>
FOR THE SIX MONTHS ENDED JUNE 30, 1999 AND 1998
TOTAL REVENUES Total revenues for the six months ended June 30, 1999 were
$31,880,000 compared to $24,506,000 for the 1998 comparable period, representing
a net increase of $7,374,000 or 30.1%. Total revenues for the six months ended
June 30, 1998 were $24,506,000 compared to $11,473,000 in the 1997 comparable
period, representing a net increase of $13,033,000 or 113.6%.
The following table provides a comparison of revenues for the six months
ended June 30, 1999 and 1998 by category:
<TABLE>
<CAPTION>
NET PERCENTAGE
1999 1998 CHANGE CHANGE
------------- ------------ ---------- -----------------
<S> <C> <C> <C> <C>
Staffing Income........................................ $ 22,172,000 14,863,000 7,309,000 49.2%
Premiums earned........................................ 7,883,000 7,417,000 466,000 6.3%
Net commission income:
Workers' compensation................................ 570,000 809,000 (239,000) (29.5)%
Package.............................................. 71,000 182,000 (111,000) (61.0)%
Other, net........................................... 81,000 79,000 2,000 2.5%
------------- ------------ ---------- -----
Total net commission income........................ 722,000 1,070,000 (348,000) (32.5)%
Net investment income.............................. 892,000 892,000 -- --
Other income....................................... 211,000 264,000 (53,000) (20.1)%
------------- ------------ ---------- -----
Total revenues..................................... $ 31,880,000 24,506,000 7,374,000 30.1%
------------- ------------ ---------- -----
------------- ------------ ---------- -----
Workers' compensation:
Premiums collected................................... $ 6,366,000 7,982,000
------------- ------------
------------- ------------
Ratio of net commission income/premiums collected.... 9.0% 10.1%
------------- ------------
------------- ------------
</TABLE>
Staffing income increased $7,309,000 or 49.2% as a result of the acquisition
of certain of the assets of Travel Nurse (acquired in March 1998) and the
increase in business related to the acquisition and merger of NET Healthcare.
Premiums earned increased $466,000 or 6.3% for the six months ended June 30,
1999 as compared to the prior year as a result of new business and renewals of
the prior year business. Workers' compensation commission income decreased
$239,000 or 29.5% for the six months ended June 30, 1999 as compared to the 1998
comparable period as a result of the decrease in premiums collected of
$1,616,000, which was attributable to the decrease in the workers' compensation
book of business. Package commission income decreased $111,000 or 61.0% for the
six months ended June 30, 1999 as compared to the 1998 comparable period as a
result of a reduction in the business written for fast food restaurants. Other
net commission income increased $2,000 or 2.5% for the six months ended June 30,
1999 as compared to the 1998 comparable period as a result of the increase in
volume of small business plan premiums collected. Other income decreased $53,000
or 20.1% as a result of the effects of the retroactive insurance accounting
treatment of Preferred Reinsurance as discussed more fully in Note 1(c) to the
Company's consolidated financial statements.
TOTAL OPERATING EXPENSES. Total operating expenses for the six months ended
June 30, 1999 were $30,333,000 as compared to $22,567,000 for the 1998
comparable period, representing an increase of $7,766,000 or 34.4%. Total
operating expenses for the six months ended June 30, 1998 were $22,567,000 as
compared to $10,897,000 for the 1997 comparable period, representing an increase
of $11,670,000 or 107.1%.
27
<PAGE>
The following table provides a comparison of total operating expenses for
the six months ended June 30, 1999 and 1998 by category:
<TABLE>
<CAPTION>
NET PERCENTAGE
1999 1998 CHANGE CHANGE
------------- ------------ ---------- -----------------
<S> <C> <C> <C> <C>
Staffing costs......................................... $ 17,061,000 11,597,000 5,464,000 47.1%
Losses and loss adjustment expenses incurred........... 4,336,000 4,005,000 331,000 8.3%
Amortization of deferred acquisition costs............. 2,609,000 2,445,000 164,000 6.7%
Other operating expenses............................... 6,327,000 4,520,000 1,807,000 40.0%
------------- ------------ ---------- ---
Total operating expenses............................. $ 30,333,000 22,567,000 7,766,000 34.4%
------------- ------------ ---------- ---
------------- ------------ ---------- ---
</TABLE>
Staffing costs increased $5,464,000 or 47.1% consistent with the increase in
staffing revenues for the six months ended June 30, 1999 as discussed above.
Losses and loss adjustment expenses incurred increased $331,000 or 8.3% which is
consistent with the increase in premiums earned in 1999 as discussed above. For
the six months ended June 30, 1999, the Company's ratio of losses incurred to
premiums earned was approximately 55%. Amortization of deferred acquisition
costs increased $164,000 or 6.7% which is also consistent with the increase in
premiums earned for the six months ended June 30, 1999 as discussed above. Other
operating expenses increased $1,807,000 or 40.0%. The following table provides a
comparison of other operating expenses for the six months ended June 30, 1999
and 1998 by category:
<TABLE>
<CAPTION>
NET PERCENTAGE
1999 1998 CHANGE CHANGE
------------ ---------- ---------- ---------------
<S> <C> <C> <C> <C>
Personnel costs........................................... $ 3,637,000 2,673,000 964,000 36.1%
Occupancy expenses........................................ 432,000 344,000 88,000 25.6%
Professional fees......................................... 737,000 332,000 405,000 122.0%
Other operating expenses.................................. 1,521,000 1,171,000 350,000 29.9%
------------ ---------- ---------- -----
Total other operating expenses.......................... $ 6,327,000 4,520,000 1,807,000 40.0%
------------ ---------- ---------- -----
------------ ---------- ---------- -----
</TABLE>
Personnel costs increased $964,000 or 36.1% as a result of annual salary
increases together with the increased staff related to the acquisition of the
assets of Travel Nurse and the growth in the business of NET Healthcare.
Occupancy expenses increased $88,000 or 25.6% principally as a result of the
lease of additional office space and relocation of our subsidiary Preferred
Healthcare Staffing, Inc. Professional fees increased $405,000 or 122.0%
principally as a result of increased legal, accounting and actuarial fees
associated with various corporate and acquisition matters. Other operating
expenses increased $350,000 or 29.9% primarily related to the following: (i)
increased insurance expense of $20,000, (ii) increased corporate fees and
services of $64,000, (iii) increased investment and service fees of $40,000, and
(iv) increased advertising and promotional expenses of $147,000. Insurance
expense increased as a result of the purchase of additional coverages (i.e.,
directors and officers liability insurance) and increased premiums due to
increased limits. Corporate fees and services, advertising and promotional, and
investment and service fees increased as a result of the expansion of the
staffing business.
TOTAL NON-OPERATING EXPENSES. Total non-operating expenses for the six
months ended June 30, 1999 were $676,000 compared to $697,000 for the 1998
comparable period. Interest expense increased $78,000 as a result of the
Company's private placement in May 1998 of 7% convertible subordinated notes in
the aggregate principal amount of $10,580,000 and borrowings under a revolving
line of credit.
Amortization of intangible assets and other non-operating expenses decreased
$100,000, primarily related to the acquisition and merger of NET Healthcare.
28
<PAGE>
LIQUIDITY AND CAPITAL RESOURCES
GENERAL. Our principal source of cash is the collection of staffing
revenues from client hospitals and workers' compensation insurance premiums from
our insureds. In February 1997, we consummated an initial public offering of
1,725,000 shares of Common Stock (including the underwriters' over-allotment
option) and received gross cash proceeds of approximately $12,506,000. In May
1998, we consummated a $10,580,000 private placement of 7% convertible
subordinated notes due May 2003.
For the six months ended June 30, 1999, net cash and investments were
$37,679,000 (net of premiums payable of $1,835,000). Net cash provided by
operating activities for the six months ended June 30, 1999 increased to
$7,135,000 from $1,524,000 in the 1998 comparable period, an increase of
$5,611,000. This increase resulted primarily from decreases in accounts
receivable, deferred acquisition costs, and unearned premiums of $6,544,000,
$1,056,000, and $3,587,000, respectively, and increases in unpaid losses and
loss adjustment expenses and premiums, commissions and other insurance balances
of $423,000 and $125,000, respectively. The decrease in accounts receivable was
primarily associated with increased collection efforts of the staffing company
during 1999. The increases in unpaid losses and loss adjustment expenses and
premiums, commissions and other insurance balances are consistent with the
increase in premiums earned during 1999. The decreases in unearned premiums and
deferred acquisition costs are consistent with a decrease in reinsurance
premiums receivable during 1999.
Cash flows used in investing activities decreased to $2,183,000 for the six
months ended June 30, 1999 from $13,526,000 for the six months ended June 30,
1998, a decrease of $11,343,000. This decrease resulted primarily from the
decrease of net investment purchases of $6,487,000 and the acquisition of
certain of the assets of Travel Nurse for $5,000,000 in cash during the first
quarter of 1998 as discussed in the Note 1 (b) to our consolidated financial
statements included herein.
A decrease in cash flows from financing activities for the six months ended
June 30, 1999 reflects the repayment of a portion of the revolving line of
credit of $1,364,000 and payment of a bank overdraft of $518,000, compared to
the net proceeds received from the private placement of convertible subordinated
notes of $9,622,000 and borrowings under the revolving line of credit of
$2,000,000 and the repayment of a bank overdraft of $38,000 for the comparable
period in 1998.
FINANCINGS. In May 1998, Preferred Staffing entered into a $3,000,000
unsecured revolving line of credit with a bank (the "Credit Facility").
Outstanding borrowings under the Credit Facility bear interest at the bank's
base rate of interest. Interest under the Credit Facility is due and payable
monthly and all unpaid principal and interest is due on May 2, 2000. Outstanding
borrowings under the Credit Facility are secured by our guarantee. As of June
30, 1999, outstanding borrowings under the Credit Facility were approximately
$486,000 and bore interest at the rate of 7 3/4% per annum.
In May 1998, we also consummated a $10,580,000 private placement of 7%
convertible subordinated notes due May 2003. The principal amount of the notes
is convertible at the option of the holder into shares of our common stock, at a
conversion price of $9.00 per share, at any time prior to the earlier of May 12,
2003 or ten business days after the receipt of a termination notice (as defined
in the notes). The notes generally prohibit or restrict, among other things, our
ability to incur liens and indebtedness, make certain fundamental corporate
changes and specified investments and conduct certain transactions with
affiliates. At June 30, 1999, the principal amount outstanding under the 7%
convertible subordinated notes was $10,535,000.
We believe that our existing cash balances and cash flows from activities
will be adequate to meet our current operations, including expected capital
expenditures, for at least the next twelve months. In connection with our
current business strategy of making strategic acquisitions, we may seek
additional funds through equity and /or debt financings. There can be no
assurance that any such additional debt or equity financings will be available
to us, or if available, will be on favorable terms to us.
29
<PAGE>
YEAR 2000
The Year 2000 presents potential concerns for businesses. The consequences
of this issue may include system failures and business process interruption. In
addition to the well-known calculation problems with the use of 2-digit date
formats as the year changes from 1999 to 2000, the Year 2000 is a special case
leap year which may cause similar problems in many systems unless remediated.
We have developed a plan with respect to evaluating and upgrading our core
information technology systems so that they are Year 2000 compliant. Two vendors
primarily supply software to us for use in our operations. One vendor supplies
the software used by our insurance operations and another vendor supplies the
software used by our staffing operations. The vendors have each advised us that
the latest upgrades of the software used in our operations are Year 2000
compliant. We implemented these software upgrades, and we are currently testing
the upgraded software for Year 2000 compliancy. We intend to finish the testing
step during the third quarter of 1999. The historical and currently projected
costs relating to these upgrades and Year 2000 compliance are not material.
We are in the process of developing a plan with respect to evaluating and
upgrading our non-core information technology systems and other systems using
embedded technology so that they will be Year 2000 compliant. We expect to
complete and implement that plan during the third quarter of 1999.
We also intend to make inquiries of other third parties supplying us with
products and services to receive assurances that they are Year 2000 complaint.
We believe that we will complete that review by the end of the third quarter of
1999.
We have not developed a "worst case" scenario with respect to Year 2000
issues. Although we have not done a cost analysis, we believe that no material
adverse effect on our business will occur if our non-core technology systems are
not Year 2000 compliant. We anticipate that the costs related to such non-
compliance, if any, will not be material.
Although we do not have a Year 2000 contingency plan, we are developing such
a plan, which we expect to complete by the end of the third quarter of 1999.
If we or third parties with which we have relationships were to cease or not
successfully complete Year 2000 remediation efforts, we could encounter
disruptions to our business. In addition, we could be materially and adversely
impacted by widespread economic or financial market disruption, or by Year 2000
computer system failures of third parties, that may generally occur as a result
of the Year issues.
Certain statements relating to the Year 2000 issues are forward-looking
statements and have been made pursuant to the safe harbor provision of the
Private Securities Litigation Reform Act of 1995. Forward-looking statements
involve known and unknown risks and uncertainties which may cause the actual
results in future periods or plans for future periods to differ materially from
those described herein as anticipated, believed or estimated.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCUSSIONS ABOUT MARKET RISK
Not Applicable.
30
<PAGE>
PART II: OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS.
Not Applicable.
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS.
Not Applicable.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES.
Not Applicable.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
Not Applicable.
ITEM 5. OTHER INFORMATION.
Not Applicable.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.
(a) The following exhibits are included in this Quarterly Report a Form
10-Q:
27.1 Financial Data Schedule
(b) Reports on Form 8-K. The Company's Current Report on Form 8-K dated May
7, 1999 (filed on May 12, 1999).
31
<PAGE>
SIGNATURE
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 thereunto duly authorized.
<TABLE>
<S> <C> <C>
PREFERRED EMPLOYERS HOLDINGS, INC.
By: /s/ WILLIAM R. DRESBACK
-----------------------------------------
William R. Dresback
Senior Vice President and Chief Financial
Officer (principal and chief accounting
officer and duly authorized to sign on
Date: August 13, 1999 behalf of the Registrant)
</TABLE>
32
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<LEGEND>
This schedule contains summary financial information extracted from the
unaudited Consolidated Financial Statements of the Company as of June 30, 1999
and for the three months then ended and is qualified in its entirety by
reference to such financial statements.
</LEGEND>
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> DEC-31-1999
<PERIOD-START> APR-01-1999
<PERIOD-END> JUN-30-1999
<CASH> 6,785,535
<SECURITIES> 32,728,411
<RECEIVABLES> 11,899,245
<ALLOWANCES> 0
<INVENTORY> 0
<CURRENT-ASSETS> 60,787,433
<PP&E> 939,341
<DEPRECIATION> 0
<TOTAL-ASSETS> 62,991,087
<CURRENT-LIABILITIES> 0
<BONDS> 0
0
0
<COMMON> 57,765
<OTHER-SE> 0
<TOTAL-LIABILITY-AND-EQUITY> 62,991,087
<SALES> 0
<TOTAL-REVENUES> 16,334,176
<CGS> 0
<TOTAL-COSTS> 15,721,992
<OTHER-EXPENSES> 81,131
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 255,513
<INCOME-PRETAX> 275,540
<INCOME-TAX> 7,646
<INCOME-CONTINUING> 275,540
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 267,894
<EPS-BASIC> .05
<EPS-DILUTED> .05
</TABLE>
