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[NOVACARE LOGO]
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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-K
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED JUNE 30, 1998
COMMISSION FILE NUMBER 000-23343
NOVACARE EMPLOYEE SERVICES, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
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DELAWARE 23-2866146
(STATE OF INCORPORATION) (I.R.S. EMPLOYER IDENTIFICATION NO.)
VALLEY FORGE CORPORATE CENTER
2621 VAN BUREN AVENUE
NORRISTOWN, PA 19403
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICE) (ZIP CODE)
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REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (610) 650-4700
SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT: NONE
SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:
TITLE OF EACH CLASS
COMMON STOCK, PAR VALUE $.01 PER SHARE
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 PRECEDING 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
INDICATE BY CHECK MARK IF DISCLOSURE OF DELINQUENT FILERS PURSUANT TO ITEM
405 OF REGULATION S-K IS NOT CONTAINED HEREIN, AND WILL NOT BE CONTAINED, TO THE
BEST OF REGISTRANT'S KNOWLEDGE, IN DEFINITIVE PROXY OR INFORMATION STATEMENTS
INCORPORATED BY REFERENCE IN PART III OF THIS FORM 10-K OR ANY AMENDMENT TO THIS
FORM 10-K. [ ]
AS OF SEPTEMBER 14, 1998, 27,837,718 SHARES OF COMMON STOCK WERE
OUTSTANDING, AND THE AGGREGATE MARKET VALUE OF THE SHARES OF COMMON STOCK HELD
BY NON-AFFILIATES WAS APPROXIMATELY $33,763,802. (DETERMINATION OF STOCK
OWNERSHIP BY NON-AFFILIATES WAS MADE SOLELY FOR THE PURPOSE OF RESPONDING TO
THIS REQUIREMENT AND THE REGISTRANT IS NOT BOUND BY THIS DETERMINATION FOR ANY
OTHER PURPOSE.)
DOCUMENTS INCORPORATED BY REFERENCE
PART III INCORPORATES INFORMATION BY REFERENCE FROM PORTIONS OF THE REGISTRANT'S
PROXY STATEMENT FOR
THE 1998 ANNUAL MEETING OF SHAREHOLDERS TO BE HELD ON DECEMBER 8, 1998.
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NOVACARE EMPLOYEE SERVICES, INC. AND SUBSIDIARIES
FORM 10-K -- FISCAL YEAR ENDED JUNE 30, 1998
CONTENTS AND CROSS REFERENCE SHEET
FURNISHED PURSUANT TO GENERAL INSTRUCTION G(4) OF FORM 10-K
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FORM 10-K FORM 10-K FORM 10-K
PART NO. ITEM NO. DESCRIPTION PAGE NO.
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I 1 Business.................................................... 1
The Company............................................... 1
Professional Employer Organization Industry............... 2
Company Strategy.......................................... 3
Growth Strategy......................................... 4
Operating Strategy...................................... 5
Business Profile.......................................... 6
Relationship with the Parent............................ 9
Information Technology.................................. 9
Marketing and Sales..................................... 10
Workers' Compensation and Health Care Program........... 12
Competition............................................... 12
Regulation................................................ 13
Employees................................................. 16
Insurance................................................. 16
Executive Officers of the Registrant...................... 17
2 Properties.................................................. 18
3 Legal Proceedings........................................... 18
4 Submission of Matters to a Vote of Security Holders......... 18
II 5 Market for Registrant's Common Equity and Related
Stockholder Matters....................................... 19
6 Selected Financial Data..................................... 20
7 Management's Discussion and Analysis of Financial Condition
and Results of Operations................................. 22
8 Financial Statements and Supplementary Data................. 31
9 Changes in and Disagreements with Accountants on Accounting
and Financial Disclosures................................. 62
III 10 Directors and Executive Officers of the Registrant.......... 62
11 Executive Compensation...................................... 62
12 Security Ownership of Certain Beneficial Owners and
Management................................................ 62
13 Certain Relationships and Related Transactions.............. 62
IV 14 Exhibits, Financial Statement Schedules and Reports on Form
8-K....................................................... 63
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SIGNATURES.......................................................................... 64
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PART I
ITEM 1. BUSINESS
THE COMPANY
NovaCare Employee Services, Inc (the "Company") is the second largest
(measured by number of worksite employees) professional employer organization
("PEO") in the United States. The Company is an employee services company that
provides small-to medium-sized businesses with comprehensive, fully integrated
outsourcing solutions to human resource needs, including payroll management,
workers' compensation risk management, benefits administration, unemployment
services and human resource consulting services. The Company believes it offers
better solutions at the best value by providing a convenient, integrated
complement of services. The Company believes its services enable small and
medium-sized businesses to cost-effectively manage and enhance the employment
relationship by: (i) controlling the risks and costs associated with workers'
compensation, workplace safety and employee-related litigation; (ii) providing
employees with high quality health care coverage and related benefits; (iii)
managing the increasingly complex legal and regulatory environment affecting
employment; (iv) providing payroll and human resource administrative services
that are reliable, accurate and delivered in a friendly and caring way; and (v)
achieving scale advantages typically available to larger organizations. As of
June 30, 1998, the Company served 3,001 clients with 52,852 employees at more
than 5,000 worksites in 45 states, primarily in nine different industries.
The Company was established by NovaCare, Inc (the "Parent") in September
1996 and began operations in October 1996 with the acquisition of Resource One,
Inc., a PEO based in Maitland, Florida. In February 1997, the Company acquired
three additional PEOs -- Employee Services of America, Inc., The TPI Group, Ltd.
and Prostaff Human Resources, Inc. -- and entered into an agreement with the
Parent to co-employ the Parent's workforce (the "NovaCare Contract"). On July 1,
1997, the Company acquired from the Parent the assets of the Parent's NovaPro
rehabilitation temporary staffing business. The Company completed its initial
public offering in November 1997 of 5,750,000 shares of common stock. On
December 1, 1997, the Company acquired AmeriCare Employers Group, Inc., a PEO
based in Phoenix, Arizona. On May 1, 1998, the Company acquired Staff Leasing
Systems, Inc., a PEO based in Bowie, Maryland. At June 30, 1998, the Parent
owned approximately 71% of the Company's outstanding common stock.
The Company contractually assumes certain administrative, regulatory and
financial employer responsibilities with respect to worksite employees in a
"co-employment" relationship. The Company believes its clients benefit from the
Company's services by: (i) improving profitability through lowering or
controlling costs associated with workers' compensation, health insurance, other
benefit coverage and regulatory compliance; (ii) improving productivity through
reducing the time and effort expended by business owners and executives to deal
with the complexities of employment management, enabling them to focus on their
business core competencies and growth; and (iii) improving employee satisfaction
and performance. The Company helps its worksite employers improve job
satisfaction and performance of worksite employees by providing improved health
care and related benefits, delivering training programs and delivering
dependable payroll and benefits administration.
As co-employer of worksite employees, the Company assumes responsibility
for and manages the risks associated with: (i) worksite employee payroll; (ii)
employee-related benefits, such as workers' compensation and health care
insurance coverage; and (iii) compliance with certain employment-related
governmental regulations that can be effectively managed offsite from the
client's business. The client retains responsibility for supervision and
direction of the worksite employees' services in its business and generally
remains responsible for compliance with other employment-related governmental
regulations that are more closely related to worksite employee supervision. The
service fee charged by the Company to its clients includes the cost of certain
employment-related taxes, workers' compensation insurance coverage and risk
management services, administrative and field services, wages of worksite
employees and the client's portion of health and retirement benefit plan costs.
The Company also provides other value-added services such as temporary staffing,
recruiting, training and human resource consulting.
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PROFESSIONAL EMPLOYER ORGANIZATION INDUSTRY
According to industry analysts, the PEO industry has approximately $22
billion in annual revenues with an historical growth rate over the last five
years of approximately 30% per year. According to the U. S. Small Business
Administration, there are nearly six million businesses in the United States
with fewer than 500 employees, employing over 52 million persons and with $1.2
trillion in aggregate annual payroll. The National Association of Professional
Employer Organizations ("NAPEO") estimates that the PEO industry co-employs
fewer than three million worksite employees. The Company believes, therefore,
that approximately 49 million of these employees are currently unserved by the
PEO industry.
The PEO industry is highly fragmented. NAPEO data suggest that there are at
least 2,400 PEOs currently in operation. According to industry analysts, the ten
largest PEOs account for approximately 35% of existing revenues in the industry.
The Company believes that significant consolidation opportunities exist within
the PEO industry due to increasing industry regulatory complexity and capital
requirements associated with developing larger service delivery infrastructures,
more diversified services and more sophisticated management information systems.
Demand for Services. The PEO industry evolved in the early 1980s in
response to increasing employment and benefit costs, and the complexities of the
legal and regulatory environment for the rapidly expanding small-to medium-sized
business sector. The Company believes demand for PEO services will continue to
increase as: (i) employment-related governmental regulation grows more complex;
(ii) growth continues within the small-to medium-sized business community; (iii)
the need to provide health and retirement benefits in a cost-effective
convenient manner increases; and (iv) the business and regulatory communities
accept and recognize the PEO industry. While various service providers, such as
payroll processing firms, benefits and safety consultants and temporary services
firms, are available to assist these businesses with specific tasks, such
organizations do not typically provide the more comprehensive range of services
generally offered by PEOs. PEOs enter into agreements with numerous small-to
medium-sized employers, and can therefore, achieve economies of scale as
professional employers and offer benefits packages and human resource services
at a level typically available only to larger companies which have greater
resources to devote to human resources management. The Company believes PEO
services will continue to experience growing demand because of the increasing
trend among small-to medium-sized employers to: (i) outsource non-core
competencies; (ii) seek to reduce employee benefit costs; (iii) manage employee-
related risks and regulatory complexities; and (iv) attract better employees and
retain them through improved benefit plans.
Effectiveness of Services. According to estimates by the U.S. Small
Business Administration, the management of an average small-to medium-sized
business devotes from 7% to 25% of its time to employee-related matters, leaving
management with less time to focus on core competencies. A National Federation
of Independent Business survey of small businesses in 1996 showed that six of
the top 13 major problem areas for small business are issues that can be
addressed by PEOs. These include (with their rank in importance according to the
survey) cost of health insurance (1), workers' compensation costs (3), Federal
paperwork (7), frequent changes in Federal tax laws (9), finding qualified
employees (11) and state/local paperwork (13). Work-related injuries cost
employers over $53 billion in medical expenses and lost employee productivity
each year, according to industry estimates. A PEO can manage these costs through
effective workers' compensation injury prevention, medical management,
rehabilitation and return to work programs. Employees are typically attracted to
small and medium-sized businesses that provide employees with human resource
benefits and services more characteristic of large employers. An industry
analyst's study indicated that 40% of the companies that outsourced services to
a PEO upgraded their employee benefits offerings and one-fourth of those clients
offered health care and other benefits for the first time.
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COMPANY STRATEGY
VALUES-BASED BUSINESS
The Company believes that the most important and differentiating quality of
outstanding organizations is a set of values that inspires, unites and sustains
them. Values are constant and enduring, and precede and underlie business plans,
policies, procedures, practices, performance and outcomes. The Company's Values
are:
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Credo Helping Make Life a Little Better
Beliefs Respect for the Individual
Service to the Customer
Pursuit of Excellence
Commitment to Personal Integrity
Purpose To effectively provide better human resource solutions at
the best value to our customers through service leadership.
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It is management's belief that these Values unify the Company and mandate
an open participation and empowered environment. The Company's strong commitment
to these Values by all employees enables the Company to provide a unique level
of service to its customers thereby enabling employees to build the business and
enhance their careers. The pursuit of the Company's Values unlocks an inherent
capacity to drive change, creating substantial opportunity. It is management's
opinion that the Company's greatest strengths and competitive advantages are its
people, values driven culture and capacity for change.
STRATEGY STATEMENT
OVERALL
The Company's strategy is to be the preferred human resources partner by
leveraging operational excellence, technology and strategic alliances to achieve
market leadership. This strategy is based on management's beliefs that:
- PEO services will continue to experience growing demand because of the
trend among small-to medium-sized employers to: (i) outsource non-core
competencies; (ii) reduce employee benefit costs; (iii) avoid
employee-related risks and regulatory complexities; and (iv) attract
better employees through improved benefit plans.
- The market for PEO services, based on analyst reports, is more than 95%
unserved and is expected to grow at the rate of 30% per year for the next
five years.
- The PEO industry is highly fragmented with significant consolidation
opportunities for companies with access to capital, larger service
delivery infrastructures, and sophisticated management information
systems.
- PEOs typically take a transaction processing approach to their services
and do not emphasize the improved workforce performance characteristics
of satisfied employees.
- In selecting PEO providers, small-to medium-sized businesses will
increase their emphasis on cost-effectiveness, service excellence and
breadth of services provided.
- Employees are attracted to small and medium-sized businesses that provide
employees with human resources services more characteristic of large
employers.
- Strategic alliances will enable PEOs to enhance endorsement
opportunities, expand the distribution channel and broaden the
service/product offering.
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GROWTH STRATEGY
The Company intends to grow through: (i) increasing investment in marketing
and sales; (ii) focusing on geographic expansion; (iii) targeting high potential
industries and services; (iv) acquiring PEOs and other employee service
providers; (v) entering into strategic alliances; and (vi) leveraging the growth
in the Parent's employee base.
Increasing Investment in Marketing and Sales. The Company's management is
experienced in building businesses utilizing focused marketing strategies and
professional sales forces. A significant part of the Company's marketing
strategy is the continued development of its brand identity. A recognized brand
name is a valuable marketing tool. By utilizing the nationally advertised brand
name of the Parent, the Company believes it will achieve a strong brand identity
at lower cost. The Company believes that its marketing efforts will benefit from
its brand strategy. The Company's brand promise is to provide better solutions
at the best value. The Company seeks to create a more satisfying and more
productive relationship between its worksite employees and clients by "caring
for and about people." By effectively and consistently delivering against this
service commitment, the Company believes it will attain a brand name reputation
for operational excellence among existing and potential clients.
The Company has invested heavily in improving the quality of its sales
force over the past year. Investments included recruiting and training strong
professional sales people and sales management from inside and outside the PEO
industry. These investments have resulted in the Company doubling its sales
productivity over the past year, as measured by monthly sales closed per
salesperson.
Focusing on Geographic Expansion. The Company has identified key
attractive geographic target markets and has established a plan for entering
those markets in a disciplined manner. The target markets are primarily those
markets in which the relationship with the Parent provides existing employee and
potential new client base density. The Company believes that the Parent's
clients and other extensive business-to-business relationships represent
significant opportunities to grow in these target markets. By concentrating on
markets where the Parent has achieved density, the Company will seek to have
scale economies immediately because it already co-employs the Parent's employees
pursuant to the NovaCare Contract. The Company believes its market development
model will enable it to penetrate new markets quickly. This market development
model consists of a highly structured sales management control system and an
efficient selling process. The model includes market research to identify
potential client businesses and a direct mail and telemarketing campaign to
reach those businesses. In the Company's first target market of Atlanta
approximately 12,000 candidates were identified and the Company generated new
sales totaling 1,200 worksite employees during the first six months of
operation. In certain cases, the Company may rely on platform acquisitions to
achieve scale in a market.
Entry priority for specific markets is determined by the number and growth
of small-to medium-sized businesses, the state regulatory environment and access
to infrastructure to support operations. Once a market is selected, the Company
executes an entry plan which includes defining benefit plans and service
offerings, recruiting a manager and sales team, site selection, training and
orientation and launching a specific marketing plan to begin the selling
process.
Since November 1997, the Company has entered Atlanta and Philadelphia as
start-up operations, while Phoenix and Maryland/Washington, D.C. were entered
via acquisition. This new market expansion model is expected to provide a
significant basis for future growth.
Targeting High Potential Industries. Targeted industries vary from market
to market depending on the economic characteristics and business demographics of
each geographic location. The Company intends to focus on industries with high
gross profit per worksite employee and significant workers' compensation profit
opportunities. High potential industries are those, such as health care and
construction, that the Company believes could benefit most from the Company's
risk management expertise (e.g., traditional high workers' compensation
classifications) and the Company's offering of an extensive benefits package
(e.g., industries facing a shortage of workers). Other high potential industries
include those characterized by rapid growth or change. The sales force is
expected to utilize the key industry strategy and become an expert in one or
more select industries in the markets in which they operate.
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Acquiring PEOs and Other Employee Service Providers. The Company believes
that the opportunities for PEO consolidation are substantial with at least 2,400
PEOs (according to an estimate by NAPEO) operating in a highly fragmented
industry. The Company believes that industry consolidation will be driven by
increasing industry and regulatory complexity, increasing capital requirements
and the significant economies of scale available to PEOs with a concentration of
clients and employees in target markets. The Company intends to make
opportunistic acquisitions where appropriate to achieve greater density in
targeted geographic markets or expand its service offering.
Entering into Strategic Alliances. The Company is creating strategic
alliances with service providers to small and medium-sized businesses. For
example, the Florida Home Builders Association, an organization that has 17,000
members with 450,000 worksite employees, has endorsed the Company as the PEO of
choice for its members. Additionally, the Greater Philadelphia Chamber of
Commerce has endorsed the Company as the exclusive PEO of choice for its 6,000
business client members under a three year arrangement. With the trend toward
outsourcing non-core competencies, small and medium-sized businesses typically
have service relationships with accountants, attorneys, banks, trade
associations and other business advisors. Alliances with these service providers
offer cross-selling opportunities for the Company's employee services. Other
potential alliances being pursued include additional product or service
offerings, as well as creating additional sales distribution channels. The
Company intends to develop such alliance opportunities as an extension of its
marketing and sales capability.
Leveraging the Parent's Growth. The Company believes that the Parent is
the PEO industry's largest client with over 18,000 worksite employees. Growth in
the Parent's worksite employee base directly increases the Company's worksite
employee population and revenue without the need for additional marketing and
sales expenditures or client start-up costs.
OPERATING STRATEGY
The Company has developed an operating strategy designed to control costs
while supporting growth. The operating strategy encompasses implementing a
sophisticated business model and leveraging the Parent's existing
infrastructure.
Implementing a Sophisticated Business Model. The Company's business model
includes a portfolio based management control system and an efficient operating
model that is designed around best demonstrated practices for service
industries.
Management Control System. The Company has implemented a portfolio
based management control system designed to control and improve its performance
in the selection of new business, assurance in meeting its brand promise with
respect to existing customers and analyzing lapsed business. The new business
criteria include target industries with high gross profit per worksite employee
and acceptable underwriting risk. The criteria include number of worksite
employees, credit rating, three-year workers' compensation loss ratios, state
unemployment experience, expected administrative fee and predicted gross profit
per employee.
The current business portfolio component of the management control system
enables management to monitor new client start-ups, review client-specific
financial and risk performance and employee and employer satisfaction. By
focusing management attention on key business variables, the system permits
day-to-day management to direct actions consistent with the Company's strategy
and business plan. The business variables measured are the same as those used to
assess new business, and include service delivery performance metrics, accounts
receivable, health claims filed, at-risk clients and employer and employee
satisfaction. The Company believes that attention to these variables increases
gross profit per worksite employee. Lapsed business is analyzed to facilitate
identification of service delivery system issues and to improve future client
retention.
Efficient Operating Model. The Company believes it has established an
operating model that delivers customer intimacy with efficiency. The operating
model facilitates customer responsiveness while maximizing administrative
support productivity. The Company's local service center delivers the customer
intimate activities including sales management, personalized customer care, new
client and employee orientation and enrollment, temporary staffing and local
risk management services. Local risk management services include worksite safety
evaluations, safety promotion, client meetings, early intervention of workers'
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compensation reported claims and early return to work monitoring. Economies of
scale are achieved through centralized activities including nationally directed
telemarketing, branding, marketing material development and benefits
procurement. Efficiencies are also gained regionally where the Company performs
customer care management, payroll processing, benefits and human resource
administration, underwriting and claims management.
Staffing of the local service centers and the centralized regional centers
is based on metrics identifying the number of worksite employees or other
applicable customers who can be adequately served by each kind of service
representative, including customer care representatives, payroll technicians,
benefits specialists, human resources consultants, workers' compensation
specialists, safety consultants and underwriters. These staffing metrics are
designed to provide efficient service at a carefully controlled cost. The
Company believes it can achieve its strategic objectives by implementing the
local service model in each strategic market it enters.
Leveraging the Parent's Existing Infrastructure. As a national provider of
physical rehabilitation services, the Parent has developed the core competencies
for: (i) managing a dispersed workforce in third-party worksites; (ii)
establishing and maintaining national information systems networks connecting
clients, worksite employees and service providers; (iii) developing and
implementing workplace safety and injury prevention programs; and (iv) managing
regulatory change. This infrastructure is utilized by the Company pursuant to
its management services agreement with the Parent. The agreement permits the
Company to purchase access to the infrastructure at the Parent's out-of-pocket
cost excluding depreciation and amortization. The relationship with the Parent
also brings: (i) leverage to negotiate advantageous health care, workers'
compensation and other benefit program costs given the Parent's status as a
large employer in many geographic markets in which the Company operates; and
(ii) the availability of health care services for Company employees from the
Parent and other health care providers in the Parent's integrated delivery
systems in the Company's target markets.
The Company is leveraging the Parent's experience and business synergies to
control and reduce costs by utilizing the Parent's integrated delivery system
network of health care providers. Integrated delivery systems comprise health
care providers that are networked as referral sources to facilitate integrated
patient care and to ease administration for payors and providers. The Parent has
established, and continues to develop, networks of rehabilitation providers,
principally outpatient rehabilitation and occupational health providers, in
targeted geographic markets. These networks can be used to provide
rehabilitation to the Company's injured worksite employees, allowing the Company
to benefit from the skill and expertise of the Parent in rehabilitating and
returning to work injured employees.
As a health care provider, the Parent has been an industry leader in
responding to regulatory and legislative change in a highly regulated market.
The Parent's experience in the regulatory environment is a valuable resource to
the Company as states and the Federal government seek to implement new
approaches to regulating the PEO industry. The Parent's regulatory compliance
experience is available to the Company under a management services agreement
between the Company and the Parent.
BUSINESS PROFILE
In order to implement its strategy to provide better solutions at the best
value the Company provides six primary categories of employee services: (i)
workers' compensation cost containment and safety management; (ii) unemployment
insurance cost containment; (iii) employee benefits procurement and
administration; (iv) human resource and compliance management; (v) payroll
management; and (vi) other value-added services, including temporary staffing,
recruiting and human resource consulting services. By engaging the Company to
provide these services, clients can focus on their core competencies.
These services are provided under the Company's PEO client service
agreement, which typically has an initial one-year term; thereafter, the
agreement is renewed periodically. The agreement is subject to termination by
the Company or the client upon 30 days' prior written notice. Service revenues,
billed to clients along with each periodic payroll, are based on a pricing model
that takes into account the gross pay of each employee and a mark-up that
includes the estimated costs of employment-related taxes, providing insurance
coverage and benefit plans, performing human resources administration, payroll,
benefits and compliance management and other services and an administration fee.
The specific mark-up varies by client based
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principally on the workers' compensation classification of the worksite
employees, their human resource needs and the size of the client. Accordingly,
the Company's average mark-up percentage will fluctuate based on client mix.
Clients are required to pay the Company its total fee concurrent with the
applicable payroll date. Although the Company is ultimately liable as the
co-employer to pay employees for work previously performed, it retains the right
to terminate the PEO client services agreement as well as the worksite employees
upon non-payment by a client, which limits any future liability. This right and
the periodic nature of payroll, combined with client credit verifications and
the Company's client selection process, are used to control this exposure. Bad
debt expense was $292,000 for the fiscal year ended June 30, 1998.
Workers' Compensation Cost Containment and Safety Management. Workers'
compensation is a state-mandated, comprehensive insurance program that requires
employers to fund medical expenses, lost wages and other costs that result from
work-related injuries and illnesses, regardless of fault and without any co-
payment by the employees. Pursuant to the Company's PEO client service
agreement, the Company assumes the obligations of its clients to pay workers'
compensation claims. The Company seeks to control its workers' compensation
costs through comprehensive risk evaluation of prospective clients, the
prevention of workplace injuries, timely intervention with employee injuries,
aggressive management of the medical costs related to such injuries and the
prompt return of employees to work. The Company seeks to prevent workplace
injuries by implementing a wide variety of training and safety programs. The
Company's efforts to return employees to work quickly involve both
rehabilitation services and the placement of employees in transitional,
light-duty positions until they are able to resume their former positions.
Unemployment Insurance Cost Containment. Pursuant to the Company's PEO
client service agreement, the Company also assumes the obligation of its clients
to pay unemployment insurance costs. The Company manages its unemployment
insurance costs by establishing employee termination procedures, responding on a
timely basis to unemployment claims, attending unemployment hearings and
attempting to reassign employees to other worksites when a reduction in force
occurs at any one worksite location.
Employee Benefits Procurement and Administration. Pursuant to the
Company's PEO client service agreement, the Company is required to provide
mandated employee benefits to the worksite employees. Additionally the Company
offers worksite employees a voluntary benefits package, that includes several
health care options, such as point-of-service, preferred provider organizations,
health maintenance organizations ("HMOs") and indemnity plans. Supplemental
benefit programs offer dental care, prescription drugs, and life and disability
insurance options. The Company also offers 401(k) retirement savings and
cafeteria style plans to its eligible employees. The Company believes that its
ability to provide and administer a wide variety of employee benefits on behalf
of its clients tends to mitigate the competitive disadvantage small and medium-
sized businesses normally face in the areas of employee benefit cost control and
employee recruiting and retention.
Human Resources and Compliance Management. Pursuant to the Company's PEO
client service agreement, the Company provides comprehensive human resources
services to its clients. These services reduce the employment-related
administrative burdens faced by its clients, and provide worksite employees with
a wide array of benefits typically offered by large employers. The Company
develops and administers human resource policies and procedures for each of its
clients, relating to, among other things, recruiting, retention programs,
performance management, discipline and terminations. The Company also provides
orientation, training and development, counseling and substance abuse awareness
for worksite employees.
By contract, the Company generally assumes responsibility for complying
with many employment-related regulatory requirements. In addition, the Company
assists its clients in understanding and complying with other employment-related
laws for which the Company does not assume responsibility. Laws and regulations
applicable to employers include state and Federal tax laws, state workers'
compensation laws, state unemployment laws, safety and health laws, immigration
laws, and discrimination, sexual harassment and other civil rights laws.
Payroll Management. Pursuant to the PEO client service agreement, the
Company is responsible for payroll processing, check preparation, distribution
and recordkeeping, payroll tax deposits, payroll tax reporting, employee file
maintenance, unemployment claims and monitoring and responding to changing
regulatory requirements. The Company indemnifies the client against the
Company's failure to comply with
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regulatory requirements. Payroll reports are prepared for clients for financial
and other recordkeeping purposes. The provision of these services by the Company
generally reduces the client's employment liabilities and allows clients to
focus on their core business.
Other Value-Added Services. Since the acquisition of NovaPro on July 1,
1997, the Company has offered rehabilitation temporary staffing in the long-term
care industry. The rehabilitation temporary staffing service currently can draw
on a pool of over 6,000 rehabilitation clinicians to provide staff to health
care providers at which more than 2,500 worksite employees were performing
services at June 30, 1998. This business is supported by technology which
provides detailed recruitment and sales productivity information for management
purposes. It also generates billing and utilization reports for clients.
Effective July 1, 1998, the Company began performing certain additional services
on behalf of its Parent including recruiting, employee orientation and training,
outplacement and human resource consulting.
The Company also plans to offer additional value-added services to clients
and worksite employees. Such services may include temporary staffing to
non-Parent clients, employee recognition programs, travel discount arrangements,
vision care, credit union membership, smart cards, warehouse club memberships
and various financial services. Some of these services may generate fee income
or commissions for the Company.
The Company's standard PEO client service agreement also establishes the
division of responsibilities between the Company and the client as co-employers.
The division of responsibilities is generally as follows:
<TABLE>
<CAPTION>
THE COMPANY CLIENT SHARED
----------- ------ ------
<S> <C> <C>
- - Payment of payroll - Supervision of job-specific - Implementation of policies
activities of worksite and practice relating to the
- - Tax reporting and payment employees, including employer-employee
(state and Federal designation of job relationship
withholding, Federal descriptions and duties and
Insurance Contributions Act responsibilities - Selection of fringe
("FICA"), Federal benefits, including employee
Unemployment Tax Act - Assignment to, and leave policies (other than
("FUTA") and state ownership of, all as controlled by the Family
unemployment insurance intellectual property and Medical Leave Act of
administration) 1993 or other laws)
- Product liability
- - Workers' compensation - Compliance with provisions
compliance, procurement, - Professional liability or of the Internal Revenue Code
management, payment and malpractice of 1986, as amended (the
reporting "Code"), regarding benefits
- Compliance with OSHA discrimination
- - Employee benefit regulations, state and
procurement, administration local government - Hiring, terminating and
and payment contracting provisions, disciplining worksite
professional licensing employees
- - Compliance with Immigration requirements and fidelity
Reform and Control Act and bonding requirements - Compliance with Title VII
Consumer Credit Protection of the Civil Rights Act of
Act, as well as monitoring - Negligent or tortious 1964, the Age
changes in other government conduct of worksite employees Discrimination in
regulations governing the acting under the direction Employment Act, the
employer-employee and control of the client Americans with Disabilities
relationship and updating Act, the Fair Labor
the client when necessary - Determination of Standards Act and similar
compensation of worksite state or local legislation
employees
- Safety management and
training
</TABLE>
8
<PAGE> 11
RELATIONSHIP WITH THE PARENT
The Parent is the founder of the Company, and at June 30, 1998, owned
approximately 71% of the common stock. The Parent established the Company and
entered into the NovaCare Contract primarily for two reasons. The Company
enables the Parent to leverage its core competencies and investments in human
resource management, information systems, relationship selling, workers'
compensation risk management, outsourcing and management of a dispersed
workforce. By leveraging the investments already made in its core competencies,
the Parent expects to increase the return to its shareholders from those
investments. The Parent believes its shareholders will benefit from its
relationship with the Company through appreciation in the value of the Parent's
investment in the Company.
In February 1997, the Parent entered into the NovaCare Contract, a
five-year contract to provide typical PEO services, including payroll and
benefits administration, worksite safety evaluation, employment-related risk
management and compensation and benefits consultation. The Parent paid the
Company a fee for its services equal to approximately 117% of the gross earnings
of the employees covered by the NovaCare Contract. The NovaCare Contract was
amended as of July 1, 1998, to include the Company's provision of the above
services plus recruiting, employee training and orientation, outplacement and
human resource consulting. All services will be provided on a fee for services
basis. The NovaCare Contract expires on June 30, 2002. The Parent may not
terminate the NovaCare Contract except in the event of: (i) the breach of any of
the Company's agreements, duties, or performance standards under the NovaCare
Contract; (ii) the making of false or misleading representations, warranties, or
statements of material fact in documents submitted by or on behalf of the
Company to the Parent; or (iii) the insolvency, bankruptcy, or receivership of
the Company.
The Parent is considering separating its physical rehabilitation services
businesses into two publicly held companies -- a long-term care,
geriatric-oriented business and an outpatient physical rehabilitation business.
The precise course and timing of this separation strategy will depend on a
variety of capital markets, tax, regulatory and operational issues.
INFORMATION TECHNOLOGY
The Company is leveraging the Parent's nationwide information systems
network to connect its local customer service centers, regional processing
centers, worksite employees, clients and service providers. Through this
relationship with the Parent, the Company benefits from the technological
advances the Parent deploys in its business to provide value, help reduce costs
and provide operating efficiencies. These technologies include, but are not
limited to, a combined Internet/Intranet access and electronic mail system,
client server-based expertise, which provides distributed processing and rapid
implementation of business changes, telecopier to data technology (which
eliminates the need for manual data entry), and a state-of-the-art long-term
care facility management system. The Company's regional processing centers
utilize the Parent's network to meet the processing requirements of the
Company's clients. By utilizing the Parent's network, the regional processing
centers can serve as disaster recovery backup sites, having the capability to
handle the Company's operations for a short period of time.
The Company currently uses commercially available software to manage
information related to payroll processing, benefits administration, human
resource management and employee enrollment. The Company has also developed the
requirements and key vendor relationships to create a proprietary information
management system to handle the expected growth in worksite employees. The
Company is following the Parent's information technology strategy of creating
relational databases on state-of-the-art client server development systems.
9
<PAGE> 12
MARKETING AND SALES
The Company's client base as of June 30, 1998 consisted of 3,001 client
companies, representing 52,852 worksite employees. The Parent represented
approximately 60% of the Company's fiscal 1998 revenues. The Company's clients,
excluding the Parent, have an average of 11 worksite employees. As of June 30,
1998, the Company's approximate distribution of worksite employees by major
Standard Industrial Classification ("SIC") code industry grouping was:
<TABLE>
<CAPTION>
WITHOUT WITH
THE PARENT THE PARENT
---------- ----------
<S> <C> <C>
Wholesale/Retail Trade................................. 27% 19%
Construction........................................... 18% 11%
Health Care............................................ 14% 45%
Hospitality............................................ 12% 8%
Restaurants............................................ 12% 8%
Finance, Insurance and Real Estate..................... 6% 3%
Manufacturing.......................................... 5% 3%
Agriculture............................................ 4% 2%
Transportation......................................... 2% 1%
</TABLE>
The Company is focused on serving clients in targeted industries that
generate high gross profit per worksite employee. See "Growth Strategy" above.
All prospective clients are evaluated individually on the basis of workers'
compensation risk, group medical history, unemployment history and operating
stability.
The Company's marketing and sales efforts are focused on the Company's
target markets and industries. The Company currently markets its services
through 65 sales professionals who specialize in one or more of the Company's
target industries. All sales representatives are direct employees. Employed
sales representatives are paid a combination of salary and incentive
compensation. The incentive is based on the gross profit projected to be earned
with respect to a customer contract and is paid after the contract has been in
effect for one full calendar month. The incentive is required to be repaid by
the sales representative if the applicable contract is terminated within 120
days after inception. The Company's sales materials are client specific and
communicate the Company's broad range of high quality services and the potential
benefits to employers and employees.
The Company utilizes professional marketing tools and strategies, including
public relations and advertising, to communicate its brand promise and
performance to target audiences. First, the Company will seek to identify target
audiences through market research. The Company uses market research firms to
assist in designing the messages to be delivered to the target audiences.
Referrals from the Parent, existing clients and professionals, as well as
telemarketing and direct mail, are used to generate qualified customer leads.
The sales force will then deliver targeted presentations to qualified prospects
using industry and customer-specific marketing materials. The Company benefits
from joint public relations and advertising with the Parent. These media are
intended to supplement and enhance the effectiveness of the Company's marketing
efforts and reinforce brand loyalty on the part of employees and clients. Brand
loyalty is expected to generate referrals, improve client retention and thereby
improve profitability. The Company plans to survey the marketplace, its worksite
employees and potential clients on a continuous basis to measure satisfaction
and the effectiveness of its marketing efforts.
For its worksite employees, the Company believes its brand promise is
fulfilled by: (i) establishing a respectful and trusting relationship between
the Company and its worksite employees through clearly defined policies and
procedures, and competitive health care and related benefits; (ii) providing a
positive work environment by way of risk prevention and safety and recognition
programs; (iii) consistently rendering dependable and responsive employee
services, most notably payroll and benefits administration and management; and
(iv) providing reassignment during cyclical changes in its client businesses.
10
<PAGE> 13
For its clients, the Company seeks to: (i) improve employee satisfaction
and thereby improve workforce performance and productivity; (ii) reduce the time
and effort required by business owners and executives to deal with the
complexities of employment and payroll management; (iii) improve client business
performance by enabling management to focus on core competencies, increasing
workforce productivity through training, recognition, risk prevention and safety
programs, and lowering costs associated with workers' compensation, health
insurance, other benefit coverage, and regulatory compliance; and (iv) establish
a respectful and trusting relationship between the Company and its clients
through expert, responsive and dependable service and accountability for
performance.
The Company has benefited from a high level of client retention (86% for
the year ended June 30, 1998), resulting in a significant recurring revenue
stream. The Company's client attrition is attributable to a variety of factors,
including: (i) client business failure; (ii) sale or acquisition of the client
company; (iii) termination by the Company resulting from the client's inability
to make timely payments or implement safety recommendations; and (iv) client
nonrenewal due to price or dissatisfaction with service. The Company believes
that only a small percentage of nonrenewing clients withdrew due to
dissatisfaction with service or to retain the services of a competitor. The
Company's portfolio management approach, utilizing a management control system
focused on key operating variables, is designed to reduce further the incidence
of non-renewal.
The Company plans to enter new geographic markets on a regular basis. The
Company believes its market development model, which consists of a structured
sales management control system and selling process, will enable it to penetrate
new markets quickly.
Each new salesperson attends the Company's NovaCare University training
program. The Company provides at least three weeks of training for new sales
people to familiarize them with the Company's services, policies and procedures.
The training focuses on the Company's values, business model and target market
approach. The composition of the sales force assigned to each target market is
determined by business objectives related to worksite employees, profit, client
growth and individual sales productivity.
The Company's sales management control system, which monitors activity both
on an individual and a consolidated basis, is designed to ensure an efficient
sales process in support of the Company's objectives. The measurement criteria
used in the sales management process include the number of qualified sales leads
generated, proposals presentated, contract close ratio, profit per worksite
employee and client retention.
Referrals from existing clients and professionals (such as accountants,
bankers and lawyers) are a primary source of sales leads. Each sales person
visits his or her clients periodically in order to maintain an ongoing
relationship and to benefit from referrals. Referrals are also expected to
result from the Company's brand recognition and the Company's strategic
alliances with other outsourcing service providers to small and medium-sized
businesses, including the Company's relationship with the Parent.
The sales leads result in initial presentations to prospective clients. The
Company's sales executives then gather information about the prospective client,
employees, workers' compensation job classifications and claims history, health
insurance claims history, compatibility with the Company's workplace safety
program philosophy, salary and the desired level of employee benefits and credit
history. These various factors are reviewed in the context of the Company's
pricing model and client selection profile. A client proposal is prepared for
potential clients. This prospective client screening process plays a vital role
in controlling the Company's cost and limiting exposure to liability.
Once a prospective client accepts the Company's proposal, the new client is
incorporated into the Company's system by a new account start-up team. A
customer service manager then assumes responsibility for ensuring service
performance for the client and its employees.
11
<PAGE> 14
WORKERS' COMPENSATION AND HEALTH CARE PROGRAM
Historically, the majority of the Company's controllable direct costs
related to workers' compensation benefits and health care. Consequently, the
Company's ability to manage these worksite employee costs is critical to its
success and profitability. To effectively manage its workers' compensation and
health care costs, the Company utilizes: (i) careful underwriting and selection
of new clients; (ii) effective workers' compensation injury prevention, medical
management, rehabilitation and return to work techniques; and (iii) the health
care services of the Parent and other health care provider networks in key
markets.
If an injury occurs, the Company's goal is to take control of the claim
within 24 hours after receipt of the injury report, aggressively medically
manage the injury by coordinating with the worksite employer, employee and
provider, and return the employee to work as early as is safe and feasible. This
approach substantially lowers injury-related costs, particularly the most
expensive cost component, lost workdays. Temporarily placing injured employees
in light duty positions until they are able to return to their previous duties
is an opportunity afforded the Company in its more densely penetrated markets.
The Company's workers' compensation insurance coverage is currently
provided by Liberty Mutual, the largest workers' compensation insurance carrier
in the United States. The coverage is provided under a workers' compensation
deductible program with an aggregate stop loss that limits the liability of the
Company to a capped percentage of the standard premium. Under this program, the
Company receives a benefit if it reduces actual claims experience below the cap.
The Company accrues workers' compensation expense based on management's
evaluation of the nature and severity of individual claims and past claims
experience. Actual claims experience is then recognized against the amount
accrued. The Liberty Mutual arrangement extends through June 30, 2000 and
provides for: (i) a dedicated claims processing unit; (ii) intensive training of
the Company's safety consultants and risk assessors; and (iii) favorable rates
and payment terms.
When buying health care coverage for its employees, the Company believes it
is in a favorable position with insurers, as a result of the participation of
the Parent in local market integrated health care delivery systems as well as
the leverage that the Company's scale provides. Accordingly, the Company
believes that it will be able to achieve attractive health care rates by forming
strategic partnerships with national and regional providers in each local
market.
COMPETITION
The PEO industry consists of at least 2,400 companies (according to an
estimate by NAPEO), most of which serve a single market or region. The Company
is the second largest PEO (measured by number of worksite employees) in the
United States. According to industry analysts, the ten largest PEOs account for
approximately 35% of the existing revenues in the industry. The Company
considers its primary competition to include: (i) traditional in-house human
resource departments; (ii) other PEOs; and (iii) providers of unbundled
employment-related services, such as payroll processing firms, temporary
employment firms, commercial insurance brokers, human resource consultants,
workers' compensation insurers, HMOs and other specialty managed care providers.
Competition in the highly fragmented PEO industry is generally on a local
or regional basis. Management believes that the primary elements of competition
are quality of service, choice and quality of benefits, reputation and price.
The Company believes that brand recognition, regulatory expertise, financial
resources, risk management, information technology capability, strategic
alliances, and economies of scale can distinguish a large-scale PEO from the
rest of the industry. The Company believes that it competes favorably in these
areas.
The Company believes that barriers to entry in the PEO industry are
increasing primarily due to the following factors: (i) the complexity of the PEO
business and the need for expertise in multiple disciplines; (ii) the three-to
five years of experience required to establish experience-rates in key cost
areas of workers' compensation, health insurance and unemployment; and (iii) the
need for sophisticated management information systems to track all aspects of
business in a high growth environment.
12
<PAGE> 15
REGULATION
The Company is subject to local, state and Federal regulations, which
include operating, fiscal and licensing requirements. Adding complexity to the
Company's regulatory environment are: (i) uncertainties resulting from the
non-traditional employment relationships created by PEOs; (ii) variations in
state regulatory schemes; and (iii) the ongoing evolution of regulations
regarding health care and workers' compensation.
Many of the Federal and state laws and regulations relating to tax, benefit
and employment matters applicable to employers were enacted prior to the
development of non-traditional employment relationships and, accordingly, do not
specifically address the obligations and responsibilities of PEOs or the
co-employment relationship. Moreover, the Company's PEO services are regulated
primarily at the state level. Regulatory requirements regarding the Company's
business therefore vary from state to state, and as the Company enters new
states it will be faced with new regulatory and licensing environments. There
can be no assurance that the Company: (i) will be able to satisfy the licensing
requirements or other applicable regulations of any particular state; (ii) will
be able to provide the full range of services currently offered; or (iii) will
be able to operate profitably within the regulatory environment of any state in
which it does not obtain regulatory approval. The absence of required licenses
would require the Company to restrict the services it offers. New legislation or
new interpretations of current licensing and regulatory requirements could
impose operating or licensing requirements on the Company which it may not be
able to satisfy or which could have a material adverse effect on the Company's
business, financial condition, results of operations and liquidity.
Additionally, interpretation of such legislation or regulation by regulatory
agencies with broad discretionary powers could require the Company to materially
modify its existing operations in order to comply with applicable regulations.
The application of many laws to the Company's PEO services will depend on
whether the Company is considered an employer under the relevant statutes and
regulations. The Internal Revenue Service ("IRS") is currently examining this
issue. See "Employee Benefit Plans" below. In addition, from time to time there
have been proposals to enact a statutory definition of employer for certain
purposes of the Code.
Regulation in the health care and workers' compensation fields continues to
evolve. Numerous reform proposals have been the subject of debate at both the
Federal and state government levels. The Company cannot predict what effect any
such proposed reform will have on its business. If new legislation results in
increased health care or workers' compensation costs, which comprise a
significant portion of the Company's direct costs, and if the Company is not
able to reflect promptly such increased costs in its service fees, such
legislation could have a material adverse impact on the Company's business,
financial condition, results of operations and liquidity.
PEO Licensing Requirements. A critical aspect of the growth of the PEO
industry has been the increasing recognition and acceptance of PEOs by state
authorities. As the concept of PEO services has become more understood by
regulatory authorities, the regulatory environment has begun to shift from one
of skepticism to one of recognition. During the mid-to late-1980s, legitimate
industry participants were challenged to overcome well publicized failures of
financially unsound and, in some cases, unscrupulous operators.
While many states do not explicitly regulate PEOs, approximately one-third
have licensing or registration requirements for PEOs and several additional
states, including Pennsylvania, are considering such regulation. Such laws vary
from state to state but generally provide for monitoring the fiscal
responsibility of PEOs. The Company is licensed or registered in thirteen states
and expects to be licensed or registered in several more over the next twelve
months. State regulation assists in screening insufficiently capitalized PEO
operations, imposes requirements regarding payment of wages, taxes, benefits and
workers' compensation and resolves issues concerning an employee's status for
specific purposes under applicable state law. Because existing regulations are
relatively new, there is limited interpretive or enforcement guidance available.
The development of additional regulations and interpretation of existing
regulations can be expected to evolve over time.
13
<PAGE> 16
In Florida, the Company's PEO operations are licensed under the Florida
Employee Leasing Licensing Act of 1991 (the "Florida Licensing Act"). The
Florida Licensing Act requires PEOs and their controlling persons to be
licensed, mandates reporting requirements and allocates several employer
responsibilities. The Florida Licensing Act also requires licensed PEOs to
submit annual audited financial statements and maintain a tangible accounting
net worth and positive working capital. The Florida Licensing Act also requires
PEOs to, among other things: (i) reserve the right of direction and control over
the leased employees; (ii) enter into a written agreement with the client
company; (iii) pay wages to the leased employees; (iv) pay and collect payroll
taxes; (v) maintain authority to hire, terminate, discipline and reassign
employees; (vi) reserve a right to direct and control the management of safety,
risk and hazard control at the worksite; (vii) promulgate and administer
employment and safety policies; and (viii) manage workers' compensation claims.
Federal and State Employment Taxes. The Company assumes the responsibility
and liability for the payment of Federal and state employment taxes with respect
to wages and salaries paid to its employees, including worksite employees. There
are essentially three types of Federal employment tax obligations: (i) income
tax withholding requirements; (ii) social security and Medicare obligations
under FICA; and (iii) unemployment obligations under FUTA. Under the applicable
Code sections, the employer has the obligation to remit the employer portion
and, where applicable, to withhold and remit the employee portion of these
taxes.
To date, the IRS has relied extensively on the common law test of
employment in determining employer status and the resulting liability for
failure to withhold. However, the IRS has formed a Market Segment Study Group
for the stated purpose of examining whether PEOs, such as the Company, are the
employers of the worksite employees under the Code provisions applicable to
Federal employment taxes and, consequently, whether they are exclusively
responsible for payment of employment taxes on wages and salaries paid to such
employees. Another stated purpose of the Market Segment Study Group is to
determine whether owners of client companies can be employees of PEOs under the
Federal employment tax laws.
IRS officials have reported that the Market Segment Study is near
completion and that the issuance of a tax advice memorandum has been delayed
pending the outcome of legislation proposed by the PEO and other staffing
industries. NAPEO, through coordination with other staffing trade associations,
has introduced a bill known as the Staffing Firm Workers Benefit Act of 1997
("HR 1891"). HR 1891 would establish that the PEO is the employer for the
purposes of tax collection, reporting and remittance. Further, HR 1891 would
clarify and establish that a PEO is an employer and can sponsor employee benefit
plans, including defined contribution plans, such as, 401(k) plans. The staffing
industries believe that HR 1891 will become law at some point in the future.
The interpretive uncertainties raised by the Market Segment Study Group may
affect the Company's ability to report employment taxes on its own account
rather than for the accounts of its clients and would increase administrative
burdens on the Company's payroll service function. In addition, while the
Company believes that it can contractually assume the client company's
withholding obligations, in the event the Company fails to meet these
obligations, the client company may be held jointly and severally liable for
those obligations.
Employee Benefit Plans. The Company offers various employee benefit plans
to its worksite employees, including 401(k) plans (a profit-sharing plan with an
employer contribution feature), cafeteria plans, group health plans, group life
insurance plans, group disability insurance plans and employee assistance
programs. Generally, employee benefit plans are subject to provisions of both
the Code and the Employee Retirement Income Security Act of 1974, as amended
("ERISA"). In order to qualify for favorable tax treatment under the Code, the
plans must be established and maintained by an employer for the exclusive
benefit of its employees.
The Market Segment Study Group established by the IRS is examining whether
PEOs, such as the Company, are the employers of worksite employees under Code
provisions applicable to employee benefit plans and consequently able to offer
to worksite employees benefit plans that qualify for favorable tax treatment.
The Market Segment Study Group is also examining whether client company owners
are employees of PEOs under Code provisions applicable to employee benefit
plans. The Company is unable to
14
<PAGE> 17
predict the actual timing or nature of the findings of the Market Segment Study
Group or the ultimate outcome of such conclusions or findings. If the IRS study
were to conclude that a PEO is not an employer of its worksite employees for
plan purposes, worksite employees might not be able to continue to make
contributions to the Company's 401(k) plans or cafeteria plans. The Company
believes that, although unfavorable to the Company, a prospective application by
the IRS of an adverse conclusion would not have a material adverse effect on its
financial position and results of operations. If such conclusion were applied
retroactively, employees' vested account balances would become taxable
immediately, the Company would lose its tax deduction to the extent the
contributions were not vested, the plans' trusts would become taxable trusts and
penalties could be assessed. In such a case, the Company would face the risk of
client dissatisfaction as well as potential litigation. A retrospective
application by the IRS could have a material adverse effect on the Company's
business, financial position, results of operations and liquidity. While the
Company believes that a retroactive disqualification is unlikely, there can be
no assurance as to the ultimate resolution of these issues.
In addition to the employer/employee relationship requirement described
above, pension and profit-sharing plans, including the Company's 401(k) plans,
must satisfy certain other requirements under the Code. These other requirements
are generally designed to prevent discrimination in favor of highly compensated
employees to the detriment of non-highly compensated employees with respect to
both the availability of, and the benefits, rights and features offered in,
qualified employee benefit plans. The Company applies the nondiscrimination
requirements of the Code at both a consolidated and client company level to
ensure that its 401(k) plans are in compliance with the requirements of the
Code.
Employee pension and welfare benefit plans are also governed by ERISA.
ERISA defines the term employer as "any person acting directly as an employer,
or indirectly in the interest of an employer, in relation to an employee benefit
plan." ERISA defines the term employee as "any individual employed by an
employer." The United States Supreme Court has held that the common law test of
employment must be applied to determine whether an individual is an employee or
an independent contractor under ERISA.
A definitive judicial interpretation of employer in the context of a PEO or
employee leasing arrangement has not been established. If the Company were found
not to be an employer for ERISA purposes, its plans might not comply with ERISA,
the level of services the Company could offer may be materially adversely
affected, and the Company and its plans might not enjoy the preemption of state
laws provided by ERISA and could be subject to varying state laws and
regulations, as well as to claims based upon state common laws.
Workers' Compensation. Workers' compensation is a state-mandated,
comprehensive insurance program that requires employers to fund or insure
medical expenses, lost wages and other costs resulting from work-related
injuries and illnesses. In exchange for providing workers' compensation coverage
for employees, employers are not subject to litigation by employees for benefits
in excess of those provided by the relevant state statute. In most states, the
extensive benefits coverage (for both medical costs and lost wages) is provided
through the purchase of commercial insurance from private insurance companies,
participation in state-run insurance funds or employer self-insurance. Workers'
compensation benefits and arrangements vary on a state-by-state basis and are
often highly complex. These laws establish the rights of workers to receive
benefits and to appeal benefit denials. Workers' compensation laws also regulate
the methods and procedures that the Company may employ in its workers'
compensation managed care programs. For example, workers' compensation laws
prohibit medical co-payment and deductible payment by employees. In addition,
certain states restrict employers' rights to direct health care providers and
establish maximum fee levels for treatment of injured workers.
As a creation of state law, workers' compensation is subject to change by
each state's legislature and is influenced by the political processes in each
state. Several states have mandated that employers receive coverage only from
state-operated funds. Florida and other states have adopted legislation
requiring that all workers' compensation injuries be treated through a managed
care program. While such legislation may increase the market for the Company's
workers' compensation managed care services, it may also intensify the
competition faced by the Company for such services. In addition, Federal health
care reform proposals include a proposal that may require 24-hour health
coverage, in which the coverage of traditional employer-sponsored
15
<PAGE> 18
health plans is combined with workers' compensation coverage to provide a single
insurance plan for health problems, whether or not related to work.
Incorporating workers' compensation coverage into conventional health plans may
adversely affect the market for the Company's services and may intensify the
competition faced by the Company from HMOs and other health care providers.
Moreover, because workers' compensation benefits are mandated by law and are
subject to extensive regulation, payers and employers do not have the same
flexibility to alter benefits as they have with other health benefit programs.
Finally, because workers' compensation programs vary from state to state, it is
difficult for payers and multi-state employers to adopt uniform policies to
administer, manage and control the costs of benefits.
Other Employer-Related Requirements. As an employer, the Company is
subject to a wide variety of Federal, state and local laws and regulations
governing employer-employee relationships, including the Immigration Reform and
Control Act, the Americans with Disabilities Act, the Family and Medical Leave
Act, the Occupational Safety and Health Act, wage and hour regulations, and
comprehensive local, state and Federal civil rights laws and regulations,
including those prohibiting discrimination and sexual harassment. The definition
of employer may be broadly interpreted under these laws.
Responsibility for complying with various state and Federal laws and
regulations is allocated by agreement between the Company and its clients, or in
some cases is the shared responsibility of both. See "Business Profile" above.
Because the Company acts as a co-employer with the client company, it is
possible that the Company could incur a liability for violations of laws even
though the Company is not contractually or otherwise responsible for the conduct
giving rise to such liability. The Company's standard client service agreement
generally provides that the client will indemnify the Company for liability
incurred as a result of an act of negligence of a worksite employee under the
direction and control of the client or to the extent the liability is
attributable to the client's failure to comply with any law or regulation for
which it has specified contractual responsibility. However, there can be no
assurance that the Company will be able to enforce such indemnification and the
Company may therefore be ultimately responsible for satisfying the liability in
question.
CORE (NON-WORKSITE) EMPLOYEES
At June 30, 1998, the Company had 357 core employees. None of the Company's
core employees are represented by a collective bargaining agreement and the
Company is not aware of any current activity to organize any of its core
employees. The Company considers relations with its core employees to be good.
For information with respect to the Company's worksite employees, see "Marketing
and Sales" above.
INSURANCE
The Company believes that it maintains the types and amounts of insurance
customary in the industry, including coverage for general liability, directors
and officers, crime, fiduciary and workers' compensation. The Company considers
its insurance coverage to be adequate both as to risks and amounts.
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<PAGE> 19
EXECUTIVE OFFICERS OF THE REGISTRANT
The executive officers of the Company who served during the fiscal year are
as follows:
<TABLE>
<CAPTION>
NAME AGE POSITION
- ---- --- --------
<S> <C> <C>
Loren J. Hulber................................. 56 President, Chief Executive Officer and
Director
Aven A. Kerr.................................... 52 Executive Vice President and Chief Operating
Officer
Thomas D. Schubert.............................. 37 Senior Vice President and Chief Financial and
Accounting Officer
Kenneth J. Jankowski............................ 43 Senior Vice President of Client Services and
Chief Information Officer
Andrew W. Stith................................. 30 Senior Vice President of Marketing and Sales
Christina D. Harris, Esquire.................... 36 Senior Vice President of Regulatory Affairs
and Compliance and General Counsel
Ronald N. Shostack.............................. 43 Senior Vice President of Strategic Planning
</TABLE>
The following is a brief summary of the business experience of each of the
executive officers of the Company:
Loren J. Hulber. Mr. Hulber has been the President, Chief Executive
Officer and a director of the Company since March 3, 1997. For the previous ten
years, he served in various capacities for Fortune Brands, Inc., most recently
as President and Chief Executive Officer of Day-Timers, Inc., a subsidiary
specializing in time management and personal organization. From 1973 until 1981,
Mr. Hulber was President and Chief Executive Officer of Durand Corporation, an
office products company. Upon Durand Corporation's acquisition by Jostens, Inc.
in 1981 and until 1987, Mr. Hulber was President of that company's Business
Products Group, a provider of business products and services. Mr. Hulber
currently serves as Vice Chairman of the Board of Trustees of Lehigh Valley
Hospital and Health Network.
Aven A. Kerr. Ms. Kerr became Executive Vice President and Chief Operating
Officer of the Company in June 1998. Ms. Kerr was previously Senior Vice
President, Human Resources of NovaCare Inc. since October 1996. From November
1995 to September 1996, she was Senior Vice President, Administration and
Systems at United Healthcare. She was Senior Vice President, Human Resources at
MetraHealth from May 1995 to November 1995. Prior to that, she was employed by
Prudential Insurance Company for 27 years in various positions, most recently as
Senior Vice President, Central Atlantic Operations.
Thomas D. Schubert. Mr. Schubert has been the Senior Vice President and
Chief Financial and Accounting Officer of the Company since June 4, 1997. Prior
to joining the Company, he served in various capacities with Chemical Leaman
Tank Lines, Inc., a transportation and logistics company, since 1991, most
recently as Vice President of Finance. From 1984 to 1990, he worked in the
accounting/auditing practice with the Philadelphia office of Ernst & Young where
he managed a variety of client engagements in the manufacturing and service
sectors.
Kenneth J. Jankowski. Mr. Jankowski became Senior Vice President of Client
Services and Chief Information Officer in January 1998. Prior to joining the
Company, Mr. Jankowski was most recently Vice President and Chief Information
Officer for Whirlpool Financial Corporation from March 1995 to January 1998,
where he was responsible for all information service functions and system
operations worldwide. Prior to this appointment, Mr. Jankowski served in various
corporate and staff management positions with Whirlpool from July 1989 to
February 1995. Mr. Jankowski had additional management positions with TRW, Inc.,
First National Bank of Chicago and Baxter International from March 1982 through
June 1989.
Andrew W. Stith. Mr. Stith became Senior Vice President of Marketing and
Sales of the Company on March 3, 1997. In 1994, he joined the Parent as
Assistant to the Chairman of the Parent. In 1995, Mr. Stith assumed the position
of Vice President of Sales for the Long-Term Care Services Division of the
Parent. Prior to joining the Parent, from 1992 to 1994, Mr. Stith obtained his
M.B.A. from the Amos Tuck School of
17
<PAGE> 20
Management of Dartmouth College. From 1989 to 1992, he was associated with River
Capital, Inc. as a venture capital associate.
Christina D. Harris, Esq. Ms. Harris became Senior Vice President of
Regulatory Affairs and Compliance of the Company on July 18, 1997 and assumed
the position of General Counsel on May 1, 1998. Prior to joining the Company,
she was National Vice President of Marketing (Alternative Staffing) for AIG Risk
Management, Inc. ("AIG") from April 1996 to July 1997. Before joining AIG, she
was Vice President for Legal and Regulatory Affairs and General Counsel for The
Vincam Group, Inc., a PEO, from December 1991 to April 1996. Ms. Harris has
served as NAPEOs chief delegate on employment law to its government affairs
committees and as Chairperson of its Legal Advisory Council. She is also the
current President of Mid-Atlantic Association of Professional Employers
("MAAPE") and the immediate past president of the Florida Association of
Professional Employer Organizations ("FAPEO"), both chapters of NAPEO.
Ronald N. Shostack. Mr. Shostack became Senior Vice President of Strategic
Planning in January 1998. Previously, Mr. Shostack was founder, President, Chief
Executive Officer and majority shareholder of AmeriCare Employers Group, Inc.
("AmeriCare"), a PEO based in Phoenix, Arizona, which was established in 1982
and acquired by the Company in December 1997. Prior to founding AmeriCare, Mr.
Shostack was a Certified Public Accountant with Laventhol and Horwath.
ITEM 2. PROPERTIES
The Company's principal executive offices are located at the Valley Forge
Corporate Center, 2621 Van Buren Avenue, Norristown, Pennsylvania 19403 where
the Company leases approximately 30,000 square feet. The lease for this office
space expires in July 2004. In addition, the Company leases other office space
at approximately 20 locations in various cities within the United States. The
terms of these lease arrangements are typically three to five years in duration.
See Note 9 of Notes to Consolidated Financial Statements for further information
concerning the Company's leases for its facilities.
The Company does not anticipate that it will experience any difficulty in
renewing any leases upon their expiration or obtaining alternate space on
comparable terms if such leases are not renewed. The Company believes that its
facilities are suitable for operations, are well maintained and are of adequate
size for present needs and planned expansion in the near future.
ITEM 3. LEGAL PROCEEDINGS
From time to time, the Company is party to certain claims, suits and
complaints which arise in the ordinary course of business. Currently, there are
no such claims, suits or complaints which, in the opinion of management, would
have a material adverse effect on the Company's business, financial condition,
results of operations and liquidity.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
18
<PAGE> 21
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
The Company's common stock is traded on the NASDAQ National Market under
the symbol "NCES".
The following table sets forth, for the quarters indicated, the high and
low bid prices per share of common stock from November 11, 1997 (the first day
the common stock was publicly traded) as reported on the NASDAQ National Market.
<TABLE>
<CAPTION>
COMMON STOCK PRICES
-------------------
HIGH LOW
------- ------
<S> <C> <C>
YEAR ENDED JUNE 30, 1998
Second Quarter (beginning November 11, 1997)............ $10.00 $6.31
Third Quarter........................................... 8.00 5.13
Fourth Quarter.......................................... 10.19 6.94
</TABLE>
As of September 14, 1998, there were approximately 56 shareholders of
record of common stock. This number does not include beneficial owners of the
common stock whose shares are held in "nominee" or "street name" by various
dealers, clearing agencies, banks, brokers and other fiduciaries.
The Company has never paid a cash dividend on its common stock and does not
anticipate paying any cash dividends in the foreseeable future. The payment of
cash dividends in the future will depend on the Company's earnings, financial
condition and capital needs and on other factors deemed pertinent by the
Company's Board of Directors. It is the current policy of the Company's Board of
Directors to retain earnings to finance the operations and expansion of the
Company's business.
On November 11, 1997, the Company's Registration Statement on Form S-1 (No.
333-35071), covering 5,000,000 shares of Common Stock was declared effective by
the Securities and Exchange Commission. The Company's initial public offering
(the "Offering") was completed on November 14, 1997. Subsequent to the Offering,
the Company issued an additional 750,000 shares pursuant to the exercise of an
over-allotment provision, for a total issuance of 5,750,000 shares. The Offering
was underwritten by BancBoston Robertson Stephens and Salomon Smith Barney Inc.
The aggregate offering price of the shares sold by the Company, including
the over-allotment provision, approximated $51.8 million. The net proceeds from
the Offering, after deducting offering costs of $6.1 million, amounted to $45.7
million and were used by the Company to pay: (i) the Company's outstanding
revolving credit loan of $28.4 million from the Parent; (ii) $1.0 million to an
affiliate of the Company who is a former owner of a business acquired by the
Company; and (iii) $16.2 million to retire deferred purchase obligations. The
remaining proceeds have been allocated for general corporate purposes.
19
<PAGE> 22
ITEM 6. SELECTED FINANCIAL DATA
The selected financial data set forth below has been derived from the
audited financial statements of the Company, and the predecessor company,
Resource One, Inc., which are included elsewhere herein. The selected financial
data for the Company and its predecessor should be read in conjunction with the
financial statements and notes thereto, as well as "Management's Discussion and
Analysis of Financial Condition and Results of Operations".
NOVACARE EMPLOYEE SERVICES, INC. AND SUBSIDIARIES
FINANCIAL SUMMARY
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
THE COMPANY PREDECESSOR COMPANY
----------------------------------------------------------------------------------
FOR THE NINE
FOR THE YEAR PERIOD FROM MONTHS ENDED FOR THE YEAR ENDED DECEMBER 31,
ENDED OCTOBER 1, 1996 SEPTEMBER 30, -------------------------------
JUNE 30, 1998 TO JUNE 30, 1997 1996(1) 1995 1994 1993
------------- ---------------- ------------- -------- -------- -------
<S> <C> <C> <C> <C> <C> <C>
STATEMENT OF OPERATIONS
DATA:(2)
Revenues(3)............... $1,271,757 $394,193 $23,465 $18,749 $11,987 $7,780
========== ======== ======= ======= ======= ======
Gross profit.............. 41,547 12,238 1,838 2,096 2,005 1,843
Selling, general and
administrative
expenses................ 27,848 8,273 1,767 1,763 1,683 1,704
Amortization of excess
cost of net assets
acquired................ 2,801 1,034 -- -- -- --
---------- -------- ------- ------- ------- ------
Income from operations.... 10,898 2,931 71 333 322 139
Interest (expense) income,
net..................... (699) (697) 6 (5) 1 (2)
---------- -------- ------- ------- ------- ------
Income before income
taxes................... 10,199 2,234 77 328 323 137
Income taxes.............. 4,743 1,542 21 64 94 --
---------- -------- ------- ------- ------- ------
Net income................ $ 5,456 $ 692 $ 56 $ 264 $ 229 $ 137
========== ======== ======= ======= ======= ======
Historical net income
(loss) per share, after
accretion adjustment:
Basic(5)................ $ .17 $ (.02) $ -- $ -- $ -- $ --
Assuming dilution(5).... $ .17 $ (.02) $ -- $ -- $ -- $ --
Proforma net income per
share, excluding
accretion adjustment:
Basic(5)................ $ .22 $ .04 $ -- $ -- $ -- $ --
Assuming dilution(5).... $ .22 $ .04 $ -- $ -- $ -- $ --
</TABLE>
<TABLE>
<CAPTION>
THE COMPANY PREDECESSOR COMPANY
-------------------------------------------------------------------------------
AS OF
AS OF JUNE 30, SEPTEMBER 30, AS OF DECEMBER 31,
-------------------------------- ------------- ----------------------------
1998 1997 1996(1) 1995 1994 1993
------------- ---------------- ------------- ------- ------- ------
<S> <C> <C> <C> <C> <C> <C>
BALANCE SHEET DATA:
Current assets............ $ 76,532 $ 39,879 $ 1,320 $ 986 $ 821 $ 573
Total assets.............. 157,421 95,998 1,544 1,241 1,006 828
Current liabilities(4).... 84,431 88,721 1,087 748 591 285
Financing
arrangements(4)......... 739 1,068 8 101 164 18
Shareholders' equity...... 61,806 301 449 393 345 530
</TABLE>
20
<PAGE> 23
- ---------------
(1) The Company commenced operations effective October 1, 1996, concurrent with
the acquisition of Resource One, Inc., which was accounted for as a
purchase. In February 1997, the Company acquired three additional
PEOs -- Employee Services of America, Inc., Prostaff Human Resources, Inc.
and The TPI Group, Ltd. and entered into a contract with the Parent to
co-employ substantially all of the Parent's workforce (the "NovaCare
Contract"). The Company completed three acquisitions during the year ended
June 30, 1998, that included NovaPro, a rehabilitation temporary staffing
business, acquired from the Parent on July 1, 1997, AmeriCare Employers
Group Inc., acquired December 1, 1997 and Staff Leasing Systems, Inc.,
acquired on May 1, 1998. See Note 1 of the Notes to the Consolidated
Financial Statements.
(2) Results of operations from business combinations and the NovaCare Contract
are included from the dates of acquisition and the date of contract
inception, respectively.
(3) Revenues include all amounts billed to clients for gross salaries and wages,
related employment taxes and health care and workers' compensation coverage
of worksite employees.
(4) The current portion of financing arrangements is included in current
liabilities.
(5) Historical net income per share is computed by dividing net income, net of
the accretion of mandatorily redeemable common stock, by the weighted
average number of shares outstanding. Pro forma net income per share
excludes the accretion of mandatorily redeemable common stock. See Note 1 of
the Notes to the Consolidated Financial Statements.
21
<PAGE> 24
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS.
NOVACARE EMPLOYEE SERVICES, INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
OVERVIEW
NovaCare Employee Services, Inc. (the "Company") is the second largest
(measured by number of worksite employees) professional employer organization
("PEO") in the United States. The Company provides small-to medium-sized
businesses with comprehensive, fully integrated outsourcing solutions to human
resource issues, including payroll management, workers' compensation risk
management, health care and other employee benefits administration, unemployment
services, rehabilitation temporary staffing and human resource consulting
services. The Company was established by NovaCare, Inc. (the "Parent"), in
September 1996, as a subsidiary and commenced operations on October 1, 1996,
concurrent with the acquisition of Resource One, Inc. In February 1997, the
Company acquired three additional PEO businesses -- Employee Services of
America, Inc.; The TPI Group, Ltd.; and Prostaff Human Resources, Inc., and
entered into a contract with the Parent to provide traditional PEO services to
principally all of the Parent's worksite employees (the "NovaCare Contract").
During fiscal 1998, the Company completed three additional
acquisitions -- NovaPro, a rehabilitation temporary staffing business acquired
from the Parent on July 1, 1997; AmeriCare Employers Group, Inc. ("AmeriCare"),
a PEO based in Arizona, acquired on December 1, 1997; and Staff Leasing Systems,
Inc. ("SLS"), a PEO based in Maryland, acquired on May 1, 1998. In addition, in
November 1997 and June 1998, the Company expanded via start-up operations into
two new markets, Atlanta and Philadelphia, respectively. Subsequent to June 30,
1998, the Company acquired Pay America, Inc., a PEO based in Utah, effective
August 1, 1998. At June 30, 1998, the Company served 3,001 client organizations
with 52,852 employees at over 5,000 worksites in 45 states, principally in nine
different industries.
Initial Public Offering
In November 1997, the Company completed an initial public offering (the
"Offering") of 5,000,000 shares of its common stock. Subsequent to the Offering
an additional 750,000 shares were issued pursuant to the exercise of an
over-allotment provision for a total issuance of 5,750,000 shares. The net
proceeds from the Offering (including the exercise of the over-allotment
provision), after deducting offering costs of $6.1 million, amounted to $45.7
million and were used by the Company to pay an outstanding revolving credit loan
to the Parent and to retire deferred purchase price obligations due to the
former owners of the businesses acquired. At June 30, 1998, the Parent owned
approximately 71% of the Company's outstanding common stock.
Contractual Arrangement with Parent
The Parent is a leading provider of physical rehabilitation services which
are delivered to more than 2,000 facilities nationwide. The Parent established
the Company and entered into the NovaCare Contract primarily to leverage the
Parent's core competencies and investments in human resource management,
information systems, relationship selling, workers' compensation risk
management, outsourcing and management of a dispersed workforce. By leveraging
the investments already made in its core competencies, the Parent seeks to
increase the return to its shareholders from those investments. The Company
believes that these competencies are highly correlated with success in the PEO
business.
The Parent and the Company entered into the NovaCare Contract in February
1997, whereby principally all of the Parent's employees are co-employed by the
Company. Under the NovaCare Contract, the Company provides traditional PEO
services such as payroll and benefits administration, worksite safety
evaluation, employment-related risk management and compensation and benefits
consultation. In fiscal 1998, the Parent paid the Company a fee for its services
equal to the salary and Federal payroll costs plus an average base fee of
22
<PAGE> 25
NOVACARE EMPLOYEE SERVICES, INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS -- (CONTINUED)
9.7% of gross earnings of employees, or approximately 117% of the gross earnings
of employees covered under the NovaCare Contract.
In January 1998, the Parent initiated a restructuring plan to favorably
position one of its operating divisions for recent changes in the Medicare
reimbursement system as mandated by the Balanced Budget Act of 1997. The intent
of the plan is to substantially reduce the cost of its workforce by
transitioning to a business model which relies on lower cost and higher quality
services. In support of this transition and to address the increased demand from
the Parent for additional human resource services, the Company and the Parent
amended the NovaCare Contract. The new contract, which became effective July 1,
1998, provides the existing PEO services and a broader array of services,
including recruiting, employee training and orientation, outplacement and human
resource consulting. The new contract is principally a fee-for-service contract,
replacing the previous contract which was priced as a percentage of payroll. Due
to the specialty nature of the additional services, the Company expects
increased gross profit and operating profit margins on the new contract compared
with the previous arrangement. The new contract will expire on June 30, 2002.
The Parent may not terminate the NovaCare Contract except in the event of (i)
the breach of any of the Company's agreements, duties, or performance standards
under the NovaCare Contract; (ii) the making of false or misleading
representations, warranties, or statements of material fact in documents
submitted by or on behalf of the Company to the Parent; or (iii) the insolvency,
bankruptcy, or receivership of the Company.
The Parent is considering separating its physical rehabilitation services
businesses into two publicly held companies -- a long-term care,
geriatric-oriented business and an outpatient physical rehabilitation business.
The precise course and timing of this separation strategy will depend on a
variety of capital markets, tax, regulatory and operational issues.
Revenues
The Company enters into a PEO services agreement with its clients,
establishing a three-party relationship among the Company, the client and the
worksite employees. The agreement generally provides for an initial one-year
term, subject to termination without cause on 30 days' notice by either the
Company or the client. Although PEO client service agreements are periodically
canceled, no such termination singly, or in the aggregate, has had a material
adverse effect on the Company's financial position or results of operations. The
PEO client service agreement also sets forth the service fee payable to the
Company. Such service fee, which constitutes the Company's revenues, is based on
the gross earnings of each employee plus a mark-up which includes the estimated
costs of employment-related taxes, providing human resource services, performing
administrative functions, providing insurance coverages and benefit plans and an
administration fee. This structure yields a comprehensive service fee percentage
to be applied to each employee's gross pay. These fees are invoiced along with
each periodic payroll. The Company's revenues are subject to fluctuations as the
result of: (i) changes in the wage base and employment tax rates of worksite
employees serviced by the Company; (ii) changes in the volume of clients and
worksite employees serviced by the Company; (iii) changes in the mark-up charged
by the Company for its services based upon client mix; and (iv) the number of
worksite employees enrolled in benefit plans.
Pursuant to the PEO client service agreement, the Company has the
obligation to provide the benefits and services enumerated in that agreement as
well as to pay the direct costs associated with such services, regardless of
whether the client company makes timely payment to the Company. Worksite
employees' salaries and wages comprise the largest portion of direct costs
associated with each PEO client service agreement, and are generally disbursed
promptly after the applicable client service fee is received. For a description
of additional costs of services, see "Direct Costs" below.
23
<PAGE> 26
NOVACARE EMPLOYEE SERVICES, INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS -- (CONTINUED)
Direct Costs
The Company's primary direct costs are: (i) the salaries and wages of
worksite employees (gross earnings) and the employer's portion of Social
Security, Medicare and Federal unemployment taxes; (ii) employee benefit plan
costs; (iii) workers' compensation costs; and (iv) state unemployment taxes.
Salaries and wages of worksite employees are affected by the inflationary
effects on wage levels and by differences in the local economies of the
Company's markets. Changes in gross earnings have a proportionate impact on the
Company's revenues. The Company can significantly impact its gross profit margin
by actively managing the direct costs described in clauses (ii), (iii) and (iv)
(hereinafter referred to as "controllable direct costs").
Federal employment-related taxes consist of the employer's portion of
payroll taxes required under FICA, which includes Social Security and Medicare,
and Federal unemployment taxes. The Federal tax rates are defined by the
appropriate Federal regulations.
Employee benefit plan costs consist of medical insurance premiums, payments
of and reserves for claims subject to deductibles, and the costs of dental care,
vision care, disability, employee assistance and other similar benefit plans.
The Company's health care benefit plans consist of guaranteed cost programs,
with third party insurers providing insurance. A portion of the NovaCare
Contract worksite employees are covered by a self-insured plan with reinsurance
for claims that exceed certain levels ("stop loss coverage"). Liabilities for
health care self-insured claims are recorded based on the Company's evaluation
of the nature and severity of individual claims and past claims experience. The
Company's current group health care benefit plans are provided by national and
regional health care providers under separate contracts.
Workers' compensation costs include premiums, administrative costs and
claims-related expenses under the Company's workers' compensation program.
Currently, the coverage is provided under a workers' compensation deductible
program with an aggregate stop loss that limits the liability to the Company at
a capped percentage of the standard premium. Through June 30, 1997, certain of
the Company's worksite employees were covered by large deductible workers'
compensation policies and certain other worksite employees were covered by
guaranteed cost or low deductible workers' compensation insurance policies.
Costs related to these prior plans include estimates of ultimate claims amounts
that are recorded as accrued workers' compensation claims. Changes in these
estimates are reflected as a component of direct costs in the period of the
change.
State unemployment taxes are based on rates which vary from state to state.
Generally they are subject to certain minimum rates, but the aggregate rates
payable by an employer are affected by the employer's claims history. The
Company controls unemployment claims by aggressively contesting unfounded claims
and, when possible, quickly returning employees to work by reassigning them to
other worksites.
Selling, General and Administrative Expenses
The Company's principal selling, general and administrative expenses are
salaries, wages, benefits and other personnel expenses of administrative
employees and sales associates, general and administrative expenses and
marketing and sales expenses.
Income Taxes
The Company's provision for income taxes typically differs from the U.S.
statutory rate of 35% due primarily to state income taxes and non-deductible
goodwill amortization.
24
<PAGE> 27
NOVACARE EMPLOYEE SERVICES, INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS -- (CONTINUED)
Operating Income
The Company's operating income is determined in part by its ability to
manage controllable direct costs and its ability to incorporate such costs into
the service fees charged to clients. The Company manages these costs through:
(i) appropriately designed health care benefit plans; (ii) effective risk
management through new client underwriting, effective loss prevention and claims
management of existing clients relative to the fixed cost workers' compensation
program; and (iii) aggressive management of state unemployment tax exposure. The
Company attempts to reflect changes in the controllable direct costs through
adjustments in service fees charged to clients, subject to contractual
arrangements.
The following table sets forth certain income statement and statistical
data for the year ended June 30, 1998 and the period from October 1, 1996
(inception) to June 30, 1997.
<TABLE>
<CAPTION>
FOR THE PERIOD FROM
----------------------------------------
JULY 1, 1997, OCTOBER 1, 1996
TO (INCEPTION), TO
JUNE 30, 1998 JUNE 30, 1997
(TABLE IN THOUSANDS, EXCEPT PERCENTAGES) ------------------- -----------------
$ % $ %
---------- ----- -------- -----
<S> <C> <C> <C> <C>
OPERATING RESULTS:
Revenues.......................................... $1,271,757 100.0% $394,193 100.0%
Direct costs:
Salaries, wages and employment taxes of worksite
employees...................................... 1,136,547 89.3 357,238 90.6
Health care, workers' compensation, state
unemployment taxes and other................... 93,663 7.4 24,717 6.3
---------- ----- -------- -----
Gross profit................................... 41,547 3.3 12,238 3.1
Selling, general and administrative expenses...... 27,848 2.2 8,273 2.1
Amortization of excess cost of net assets
acquired....................................... 2,801 0.2 1,034 0.3
---------- ----- -------- -----
Income from operations......................... 10,898 0.9 2,931 0.7
Interest expense, net............................. (699) (0.1) (697) (0.2)
---------- ----- -------- -----
Income before income taxes..................... 10,199 0.8 2,234 0.5
Income tax expense................................ 4,743 0.4 1,542 0.4
---------- ----- -------- -----
Net income..................................... $ 5,456 0.4% $ 692 0.1%
========== ===== ======== =====
</TABLE>
25
<PAGE> 28
NOVACARE EMPLOYEE SERVICES, INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS -- (CONTINUED)
<TABLE>
<CAPTION>
FOR THE PERIOD FROM
-------------------------------
JULY 1, 1997 OCTOBER 1, 1996
TO (INCEPTION) TO
JUNE 30, JUNE 30,
1998 1997
------------ ---------------
<S> <C> <C>
STATISTICAL DATA:
EBITDA (in thousands)(1).................................. $14,726 $ 4,217
======= =======
Number of clients at period end........................... 3,001 1,742
Worksite employees at period end:
Third parties.......................................... 34,105 18,634
Related party.......................................... 18,747 16,394
------- -------
Total............................................. 52,852 35,028
======= =======
Weighted average worksite employees paid during the
period:
Third parties.......................................... 26,728 11,764
Related party.......................................... 16,634 15,879
------- -------
Weighted average....................................... 43,362 18,582
======= =======
Year-to-date gross profit per weighted average worksite
employee (in whole $'s):
Third parties.......................................... $ 801 $ 665
Related party.......................................... 1,210 650
Weighted average....................................... 958 659
</TABLE>
- ---------------
(1) EBITDA is defined as earnings before interest, income taxes, depreciation
and amortization. EBITDA is presented because it is a widely accepted
financial indicator of a company's ability to incur and service debt.
However, EBITDA should not be considered in isolation or as a substitute for
net income or cash flow data prepared in accordance with generally accepted
accounting principles or as a measure of a company's profitability or
liquidity. Also, the EBITDA definition used herein may not be comparable to
similarly titled measures reported by other companies.
Year Ended June 30, 1998 Compared With the Period from October 1, 1996 (date
of inception) to June 30, 1997
Revenues for the year ended June 30, 1998 were $1.271 billion compared to
$394 million for the period October 1, 1996 to June 30, 1997, representing an
increase of $877 million or 223%. The increase is attributable to an increased
number of clients and worksite employees. From June 30, 1997 to June 30, 1998,
the number of clients increased 72% from 1,742 to 3,001 and the number of
weighted average worksite employees increased 133% from 18,582 to 43,362. The
increases are attributable to: (i) a full year of operations in fiscal 1998 for
the NovaCare Contract and the three PEOs acquired in February 1997 versus five
months of operations in fiscal 1997; (ii) the fiscal 1998 PEO acquisitions of
AmeriCare and SLS completed in December 1997 and May 1998, respectively; (iii)
internal growth in existing markets and start-up of new markets; and (iv) the
acquisition of a rehabilitation temporary staffing business (NovaPro) in July
1997. The Company expects continued growth in the number of clients and worksite
employees in fiscal 1999 based upon internal growth in existing markets and
expansion into new markets through either platform acquisitions or start-up
operations.
Gross profit for the year ended June 30, 1998 was $41.5 million compared to
$12.2 million for the period October 1, 1996 to June 30, 1997, representing an
increase of $29.3 million or 240%. This increase was due to the higher volume of
salaries and wages paid in fiscal 1998 which was a direct function of the growth
in clients
26
<PAGE> 29
NOVACARE EMPLOYEE SERVICES, INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS -- (CONTINUED)
and worksite employees as discussed above. Gross profit as a percentage of
revenues increased from 3.1% in the prior year to 3.3% for the year ended June
30, 1998. The improvement is attributable to: (i) gross profit margins realized
from fiscal 1998 acquisitions that exceeded the consolidated gross profit
percentage in the prior year; (ii) the provision of temporary staffing services;
and (iii) the relative impact of the NovaCare Contract which was greater in the
prior year, and has a lower gross profit percentage compared with the
traditional PEO businesses, due to a more highly compensated employee
population. The gross profit per third party weighted average worksite employee
increased to $801 for fiscal 1998 from $665 for fiscal 1997. The increase is
attributable to a full year of operations in fiscal 1998 for the three PEOs
acquired in February 1997 compared to five months of operations in fiscal 1997
and the impact of fiscal 1998 acquisitions. The gross profit per related party
weighted average worksite employee increased to $1,210 for fiscal 1998 from $650
for fiscal 1997 due to the full year effect of the NovaCare Contract for the
year ended June 30, 1998 versus five months of activity in the prior year and
the provision of additional temporary staffing services at higher margins.
Selling, general and administrative expenses increased $19.5 million, from
$8.3 million for the period October 1, 1996 to June 30, 1997 to $27.8 million
for the year ended June 30, 1998. The increased costs resulted primarily from
increases in staffing and other expenses associated with: (i) the timing of
acquisitions and the start-up of the NovaCare Contract; (ii) opening new
markets; and (iii) executing the Company's internal growth strategy. As a
percentage of revenues, selling, general and administrative expenses increased
from 2.1% to 2.2% for the same periods, respectively. The increase is
attributable to: (i) the addition of operating and sales personnel, consistent
with the Company's strategy to increase its client base in its existing and
acquired markets; (ii) operating expenses incurred in the expansion of new
markets, which include compensation related costs, recruiting and training costs
of newly hired sales personnel, advertising and promotion costs and general
office expenses; and (iii) the NovaCare Contract, which has lower selling,
general and administrative expenses as a percentage of revenue, which comprised
a larger portion of fiscal 1997 expenses. The Company anticipates that selling,
general and administrative expenses will continue to increase in future periods
to the extent that the Company continues to experience growth and expand its
service offerings.
Amortization of excess cost of net assets acquired increased to $2.8
million for the year ended June 30, 1998 from $1.0 million for the period
October 1, 1996 to June 30, 1997, principally as a result of fiscal 1998
acquisitions and the full year effect of businesses acquired in fiscal 1997.
Interest expense, net for the year ended June 30, 1998 was $699,000 versus
$697,000 for the period October 1, 1996 to June 30, 1997. Interest expense, net,
for both periods resulted primarily from interest due to the Parent for amounts
loaned to the Company to finance the acquisition of the four PEO businesses
acquired in fiscal 1997. Interest was charged to the Company at the Parent's
borrowing rate (Eurodollar rate plus a range of 0.5% to 1.125%). The weighted
average borrowing rate for fiscal 1998 and 1997 was 6.8% and 6.6%, respectively.
Interest expense for the year ended June 30, 1998 also included interest charges
from borrowings under the Company's revolving credit facility. See "Liquidity
and Capital Resources" for a further discussion of the Company's revolving
credit facility.
Income tax expense as a percentage of pre-tax income decreased to 46.5% for
the year ended June 30, 1998 from 69.0% for the period from October 1, 1996 to
June 30, 1997. The principal reasons for the reduction in the tax rate were the
relative impact of non-deductible amortization of excess costs of net assets
acquired on pre-tax income for fiscal 1998 compared with fiscal 1997, and lower
effective state income tax rates.
27
<PAGE> 30
NOVACARE EMPLOYEE SERVICES, INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS -- (CONTINUED)
LIQUIDITY AND CAPITAL RESOURCES
As of June 30, 1998, the Company's cash and cash equivalents totaled $5.9
million, an increase of $4.1 million from June 30, 1997. As of the same date,
the Company had a working capital deficit of $7.9 million compared to a working
capital deficit of $48.8 million at June 30, 1997. The $40.9 million improvement
in working capital results primarily from the receipt of $45.7 million of net
proceeds from the Offering which were utilized to pay the Parent indebtedness of
$28.4 million and retire deferred purchase obligations of $17.2 million.
The Company's cash flows provided by operating activities increased by
$20.1 million from fiscal 1997 to fiscal 1998. The increase results principally
from: (i) a net increase in cash flows of $9.9 million for accounts receivable
and accrued salaries, wages and payroll taxes; (ii) a $9.3 million increase in
cash flows for workers' compensation and health claims liabilities; (iii) a $4.8
million increase in net income; and (iv) a $2.8 million increase in non-cash
charges consisting of amortization, depreciation and provision for uncollectible
accounts. The above increases are offset by a net cash use of $6.7 million from
payment of accounts payable and accrued expenses, accrued interest-related
party, income taxes payable and other current assets. Accounts receivable,
accrued salaries, wages and payroll taxes, and health benefit premiums payable
are subject to fluctuations depending on the correlation between the financial
reporting cycle and the payroll cycle.
Cash expended for investing activities was $32.0 million in fiscal 1998
compared to $25.0 million in fiscal 1997, an increase of $7.0 million. During
fiscal 1998, the Company retired $17.2 million of deferred purchase price
obligations related to acquisitions completed in fiscal 1997. Cash paid for
acquisitions totaled $11.5 million in fiscal 1998 compared to $24.3 million in
fiscal 1997, a decline of $12.8 million. Capital expenditures increased by $2.5
million to support the Company's internal growth strategy and expansion into new
markets.
The Company's major financing activities consisted of completing the
Offering of 5,750,000 shares of the Company's common stock and establishing a
revolving credit facility. The proceeds from the Offering were $45.7 million,
net of offering costs. Of the proceeds, $28.4 million was used to retire the
outstanding revolving credit loan from the Parent borrowed in fiscal 1997 to
finance the acquisition of four PEO businesses (see Note 4 of Notes to the
Consolidated Financial Statements).
In November 1997, the Company entered into a $25.0 million three-year
revolving credit facility with a syndicate of lenders. The credit facility
provides for interest at a variable rate, depending on certain financial ratios,
equal to (a) the Eurodollar rate plus a range of 1.375% to 2.50%, or (b) the
lead lender's prime rate plus a range of 0.125% to 1.25%. In addition, the
Company has agreed to pay a commitment fee ranging from 0.30% to 0.50% per annum
on the unused portion of the commitment. Loans made under the Credit Facility
are collateralized by a pledge of all of the: (i) Company's interest in the
common stock of its subsidiaries; (ii) assets of the Company and its
subsidiaries; and (iii) Parent's interest in the common stock of the Company.
The revolving credit facility requires the maintenance of minimum capitalization
and net worth amounts, capital expenditure thresholds as well as certain
financial ratios. At June 30, 1998, the Company was in compliance with these
requirements. During fiscal 1998, the Company borrowed $9.3 million under the
revolving credit facility for short-term working capital needs and to finance
acquisitions. The Company repaid all outstanding amounts under the revolving
credit facility, prior to June 30, 1998, through cash generated from operations.
At June 30, 1998, $23.9 million of the revolving credit facility was available
after reduction for letters of credit totaling $1.1 million.
The Company's primary short-term liquidity requirements relate to the
payment of accrued payroll and payroll taxes of its worksite and internal
employees, accounts payable and the payment of accrued workers' compensation
expense and health benefit plan premiums. The Company anticipates additional
short-term requirements in fiscal 1999 related to cash payments for acquisitions
and capital expenditures to support the Company's internal growth strategy and
expansion into new markets. The Company believes the cash flows
28
<PAGE> 31
NOVACARE EMPLOYEE SERVICES, INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS -- (CONTINUED)
generated by the Company's operations, together with its existing cash and
availability of credit under the credit facility, will be sufficient to meet the
Company's short and long-term cash needs.
Inflation
A significant portion of the Company's operating expenses and revenues is
subject to inflationary increases, particularly worksite employee salary
increases which are directly reimbursed by the Company's customers. The Company
believes the effects of inflation have not had a significant impact on its
results of operations or its financial condition.
YEAR 2000 READINESS
The "Year 2000 issue" is the result of historical computer programming of
date sensitive software. Many existing computer programs have been written using
only two digits to define an applicable year (e.g. 98 for 1998), rather than
four digits. On January 1, 2000, any date recording mechanism, including date
sensitive software, may recognize a date using "00" as the year 1900 rather than
the year 2000. This could result in systems failures or create erroneous
results, including among other things, a temporary inability to process
transactions.
Generally, the scope of the Company's exposure to the Year 2000 issue is
limited to its core business systems (payroll, human resources and financial
reporting systems) and the computer systems used by third party service
providers and suppliers. The Company has completed its initial assessment and
believes that all internal Year 2000 issues will be addressed timely to ensure
the core business systems are in the appropriate state of readiness.
In January 1998, the Company launched a Year 2000-review program, which
included a dedicated Year 2000 project team, review process and internal and
external communication activities. At June 30, 1998, all of the core business
systems have been identified, evaluated and risk assessed for Year 2000
readiness. The Company's primary area of risk and exposure lies with the
business acquired subsequent to June 30, 1998 that has not yet completed a Year
2000 readiness assessment. The Company plans to complete its assessment of this
newly acquired business in the second quarter of fiscal 1999. All significant
external suppliers, comprised primarily of financial institutions, third party
insurers and service providers and information technology suppliers, have been
contacted to determine the extent to which the Company is vulnerable to any
external Year 2000 issues. While the Company is not currently aware of any
significant Year 2000 issues related to its business with service providers and
suppliers, there can be no guarantee that the Company will not be adversely
affected by the failure of its primary vendors to remediate their own Year 2000
issues.
The Company expects to complete Year 2000 testing and remediation by June
30, 1999. Remediation activities will consist of developing new programs to
enhance or provide additional functionality to the Company's core business
systems. Given the Company's current state of readiness and limited exposure,
the cost of remediation activities should approximate $150,000. As of June 30,
1998, the Company's incurred costs related to Year 2000 readiness have been
limited to salary and benefits costs of internal information systems personnel,
and are included as an expense in the fiscal 1998 operating results. If the
Company is unsuccessful in completing remediation of non-compliant systems or
third party vendors are not capable of rectifying Year 2000 issues, the Company
could be subjected to the following risks: (i) disruption of payroll, benefits
and compensation administration; (ii) information from internal management
control and reporting systems may lack integrity; (iii) the quality of service
to clients could decline, resulting in higher attrition and loss of business;
and (iv) eligibility information from third party insurers could be compromised
resulting in denial of benefits to health benefit plan participants.
In the event the Company would be subject to the above risks, an
appropriate contingency plan would be implemented. At June 30, 1998, the Company
continued to refine the contingency plan, which includes: (i) a
29
<PAGE> 32
NOVACARE EMPLOYEE SERVICES, INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS -- (CONTINUED)
dedicated internal group of information systems professionals that will be
primarily focused on system or process disruption; (ii) the creation of a
partnership with external service providers and suppliers to respond to a
disruption; (iii) labor intensive efforts in place of core business system
processing; and (iv) on a selective basis engaging external consultants. The
contingency plan is expected to be completed in the second quarter of fiscal
1999.
RECENTLY ISSUED ACCOUNTING STANDARDS
In June 1997, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 131, "Disclosures about Segments of an
Enterprise and Related Information" (SFAS 131), which the Company is required to
adopt no later than the first quarter of fiscal 1999. SFAS 131 uses a
"management approach" to defining and reporting the activities of operating
segments. The management approach defines operating segments along the lines
used by management to assess performance and make operating and capital
decisions. The Company is in the process of evaluating the effect this new
standard will have on the Company's annual and interim reporting requirements.
Adoption of this accounting standard is for disclosure purposes only and will
not have an adverse effect on the Company's financial position or results of
operations.
In March 1998, the Accounting Standards Executive Committee of the American
Institute of Certified Public Accountants issued Statement of Position ("SOP")
98-1 "Accounting for the Costs of Computer Software Developed or Obtained for
Internal Use". SOP 98-1 provides guidance on accounting for the costs of
computer software developed or obtained for internal use. The SOP is effective
for the year ending June 30, 2000. Management does not believe the adoption of
SOP 98-1 will have a material effect on the Company's financial position or
results of operations.
In June 1998, the Accounting Standards Executive Committee of the American
Institute of Certified Public Accountants issued SOP 98-5 "Reporting on the Cost
of Start-Up Activities" which the Company is required to adopt no later than
June 30, 2000. SOP 98-5 provides the reporting standards for the costs of start-
up activities, including organizational costs, which should be expensed as
incurred. Management does not believe the adoption of SOP 98-5 will have a
material effect on the Company's financial position or results of operations.
CAUTIONARY STATEMENT
Except for historical information, matters discussed above including, but
not limited to, statements concerning future growth and Year 2000 readiness, are
forward-looking statements that are based on management's estimates, assumptions
and projections. Important factors that could cause results to differ materially
from those expected by management include: (i) management retention and
development; (ii) management's success in integrating acquired businesses, in
developing and introducing new products and lines of business and in entering
new markets; (iii) the ability of the Company, its customers and its suppliers
to complete assessment, testing and remediation of Year 2000 issues; (iv)
adverse Internal Revenue Service rulings and state regulations with respect to
the employer status of employee services businesses; (v) the Company's ability
to implement its employee services business model; and (vi) any adverse impact
on the operating results of the NovaCare Contract in the event the Parent
executes some form of a separation strategy (see "Overview" above).
30
<PAGE> 33
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
NOVACARE EMPLOYEE SERVICES, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
AS OF JUNE 30,
-------------------
1998 1997
-------- -------
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents................................. $ 5,926 $ 1,782
Accounts receivable:
Related party.......................................... 45,083 27,607
Unbilled............................................... 13,903 7,215
Third parties, net of allowance for doubtful accounts
at June 30, 1998 and 1997 of $318 and $26,
respectively.......................................... 7,660 1,910
Prepaid assets............................................ 1,948 577
Deferred income taxes..................................... 1,688 296
Other current assets...................................... 324 492
-------- -------
Total current assets.............................. 76,532 39,879
Property and equipment, net................................. 4,490 1,326
Excess cost of net assets acquired, net..................... 75,570 53,691
Other assets, net........................................... 829 1,102
-------- -------
$157,421 $95,998
======== =======
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Current portion of financing arrangements................. $ 217 $ 298
Accounts payable and accrued expenses..................... 3,748 6,172
Accrued salaries, wages and payroll taxes................. 59,759 28,159
Current portion of accrued workers' compensation and
health claims.......................................... 17,948 5,423
Note payable to related party............................. -- 28,382
Current portion of deferred purchase price obligations.... 750 18,905
Income taxes payable...................................... 2,009 1,382
-------- -------
Total current liabilities......................... 84,431 88,721
Financing arrangements, net of current portion.............. 739 1,068
Accrued workers' compensation and health claims, net of
current portion........................................... 4,466 1,910
Deferred purchase price obligations, net of current
portion................................................... 5,456 856
Other....................................................... 523 411
-------- -------
Total liabilities................................. 95,615 92,966
Mandatorily redeemable common stock......................... -- 2,731
Commitments and contingencies............................... -- --
Shareholders' equity:
Preferred stock, $.01 par value; authorized 1,000 shares;
no shares issued or outstanding........................ -- --
Common stock, $.01 par value; authorized 60,000 shares;
issued 27,349 shares at June 30, 1998 and 19,193 shares
at June 30, 1997....................................... 273 192
Additional paid-in capital................................ 57,365 1,189
Retained earnings......................................... 4,271 --
-------- -------
61,909 1,381
Less: Common stock in treasury (at cost), 563 shares at
June 30, 1997....................................... -- (1,080)
Deferred compensation, net.......................... (103) --
-------- -------
Total shareholders' equity........................ 61,806 301
-------- -------
$157,421 $95,998
======== =======
</TABLE>
The accompanying Notes to Consolidated Financial Statements are an integral part
of these statements.
31
<PAGE> 34
NOVACARE EMPLOYEE SERVICES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
FOR THE PERIOD
FOR THE OCTOBER 1, 1996
YEAR ENDED (INCEPTION) TO
JUNE 30, 1998 JUNE 30, 1997
------------- ---------------
<S> <C> <C>
Revenues:
Related party............................................. $ 761,262 $255,289
Third parties............................................. 510,495 138,904
---------- --------
Total revenues....................................... 1,271,757 394,193
Direct costs:
Related party:
Salaries, wages and employment taxes of worksite
employees............................................ 685,916 234,182
Healthcare and workers' compensation, state
unemployment and other............................... 55,214 15,368
Third parties:
Salaries, wages and employment taxes of worksite
employees............................................ 450,631 123,056
Healthcare and workers' compensation, state
unemployment and other............................... 38,449 9,349
---------- --------
Gross profit......................................... 41,547 12,238
Selling, general and administrative expenses................ 27,556 8,247
Provision for uncollectible accounts........................ 292 26
Amortization of excess cost of net assets acquired.......... 2,801 1,034
---------- --------
Income from operations............................... 10,898 2,931
Investment income........................................... 220 52
Interest expense............................................ (308) (56)
Interest expense -- related party........................... (611) (693)
---------- --------
Income before income taxes........................... 10,199 2,234
Income taxes................................................ 4,743 1,542
---------- --------
Net income........................................... $ 5,456 $ 692
========== ========
Historical information, after accretion adjustment (Note 1):
Net income (loss) applicable to common
stockholders...................................... $ 4,271 $ (341)
========== ========
Net income (loss) per share:
Basic............................................. $ .17 $ (.02)
========== ========
Assuming dilution................................. $ .17 $ (.02)
========== ========
Pro forma information, excluding accretion adjustment (Note
1):
Net income........................................... $ 5,456 $ 692
========== ========
Net income per share:
Basic............................................. $ .22 $ .04
========== ========
Assuming dilution................................. $ .22 $ .04
========== ========
Weighted average number of common shares outstanding:
Basic............................................. 24,942 18,078
========== ========
Assuming dilution................................. 25,135 18,078
========== ========
</TABLE>
The accompanying Notes to Consolidated Financial Statements are an integral part
of these statements.
32
<PAGE> 35
NOVACARE EMPLOYEE SERVICES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
(IN THOUSANDS)
<TABLE>
<CAPTION>
COMMON
SHARES ISSUED STOCK ADDITIONAL DEFERRED
----------------- ($.01 PAR TREASURY PAID-IN COMPEN- RETAINED
COMMON TREASURY VALUE) STOCK CAPITAL SATION EARNINGS
------ -------- --------- -------- ---------- -------- --------
<S> <C> <C> <C> <C> <C> <C> <C>
Balance at October 1, 1996
(inception).................... -- -- $ -- $ -- $ -- $ -- $ --
Issued to related party.......... 6,200 -- 62 -- -- -- --
Issued to employees.............. 430 -- 4 -- 870 -- --
Common stock split............... 12,000 -- 120 -- (120) -- --
Repurchase of common stock....... 563 (563) 6 (1,080) 780 -- --
Accretion of mandatorily
redeemable common stock........ -- -- -- -- (341) -- (692)
Net income....................... -- -- -- -- -- -- 692
------ ---- ---- ------- ------- ----- ------
Balance at June 30,1997.......... 19,193 (563) $192 $(1,080) $ 1,189 $ -- $ --
ISSUED THROUGH INITIAL PUBLIC
OFFERING, NET OF OFFERING COSTS
OF $6,041...................... 5,750 -- 57 -- 45,652 -- --
ISSUED IN CONNECTION WITH
ACQUISITIONS................... 1,585 563 16 1,080 6,470 -- --
ACCRETION OF MANDATORILY
REDEEMABLE COMMON STOCK........ -- -- -- -- -- -- (1,185)
CONVERSION OF MANDATORILY
REDEEMABLE COMMON STOCK........ 813 -- 8 -- 3,907 -- --
ISSUED IN CONNECTION WITH STOCK
OPTION PLAN.................... -- -- -- -- 124 (124) --
ISSUED UPON EXERCISE OF STOCK
OPTIONS........................ 8 -- -- -- 23 -- --
AMORTIZATION OF DEFERRED
COMPENSATION................... -- -- -- -- -- 21 --
NET INCOME....................... -- -- -- -- -- -- 5,456
------ ---- ---- ------- ------- ----- ------
BALANCE AT JUNE 30, 1998......... 27,349 -- $273 $ -- $57,365 $(103) $4,271
====== ==== ==== ======= ======= ===== ======
</TABLE>
The accompanying Notes to Consolidated Financial Statements are an integral part
of these statements.
33
<PAGE> 36
NOVACARE EMPLOYEE SERVICES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
<TABLE>
<CAPTION>
FOR THE PERIOD
FOR THE OCTOBER 1, 1996
YEAR ENDED (INCEPTION) TO
JUNE 30, 1998 JUNE 30, 1997
------------- ---------------
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income.................................................. $ 5,456 $ 692
Adjustments to reconcile net income to net cash flows
provided by (used in) operating activities:
Depreciation and amortization............................. 3,828 1,285
Deferred income taxes..................................... (817) 135
Provision for uncollectible accounts...................... 292 26
Changes in assets and liabilities, net of effects from
acquisitions:
Accounts receivable -- related party................... (19,343) (27,607)
Accounts receivable -- third parties................... (4,092) (2,293)
Other current assets................................... (1,072) 230
Accounts payable and accrued expenses.................. (5,904) (1,309)
Accrued salaries, wages, and payroll taxes............. 26,262 22,865
Accrued interest -- related party...................... -- 693
Accrued workers' compensation and health claims........ 13,417 4,113
Income taxes payable................................... 1,533 902
Other, net............................................. 428 164
-------- --------
Net cash flows provided by (used in) operating
activities........................................ 19,988 (104)
-------- --------
CASH FLOWS FROM INVESTING ACTIVITIES:
Payments for businesses acquired, net of cash acquired...... (11,489) (24,250)
Payment of deferred purchase price obligations.............. (17,172) --
Additions to property and equipment......................... (2,784) (329)
Other, net.................................................. (515) (387)
-------- --------
Net cash flows used in investing activities.......... (31,960) (24,966)
-------- --------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net proceeds from initial public offering of common stock... 45,709 --
Proceeds from note payable to related party................. -- 27,689
Payment of note payable to related party.................... (28,382) --
Proceeds from financing arrangements........................ 9,250 --
Payment of financing arrangements........................... (10,484) (94)
Payment for purchase of treasury stock...................... -- (1,080)
Proceeds from common stock issued........................... 23 914
Other, net.................................................. -- (577)
-------- --------
Net cash flows provided by financing activities...... 16,116 26,852
-------- --------
Net increase in cash and cash equivalents................... 4,144 1,782
Cash and cash equivalents, beginning of period.............. 1,782 --
-------- --------
Cash and cash equivalents, end of period.................... $ 5,926 $ 1,782
======== ========
</TABLE>
The accompanying Notes to Consolidated Financial Statements are an integral part
of these statements.
34
<PAGE> 37
NOVACARE EMPLOYEE SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 1998
(IN THOUSANDS, EXCEPT PER SHARE DATA)
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Nature of Operations: NovaCare Employee Services, Inc. (the "Company") is
a national professional employer organization ("PEO") providing small and
medium-sized businesses with comprehensive, fully integrated outsourcing
solutions to human resource needs, including payroll management, workers'
compensation risk management, health care and other employee benefits
administration, unemployment services, rehabilitation temporary staffing and
human resource consulting services. The Company provides these services to
companies in a variety of industries located primarily in the states of Florida,
Arizona, New York, Maryland, Pennsylvania and California.
PEO services are typically provided under a standard client service
agreement which provides for an initial one year term, and is renewed
periodically. The agreement is subject to termination without cause by the
Company or the client at any time upon 30 days' prior written notice. The
service agreement establishes a "co-employment" relationship whereby the Company
contractually assumes certain administrative, regulatory and financial employer
responsibilities with respect to worksite employees.
The Company was established by NovaCare, Inc. (the "Parent") in September
1996 as a subsidiary and commenced operations in October 1996, concurrent with
the acquisition of Resource One, Inc. ("Resource One"), a PEO based in Florida.
In February 1997, the Company acquired three additional PEOs -- Employee
Services of America, Inc.("ESA"), Prostaff Human Resources, Inc. ("Prostaff")
and The TPI Group, Ltd. ("TPI") and entered into a contract with the Parent to
co-employ substantially all of the Parent's workforce (the "NovaCare Contract")
(see Note 3). The Company completed three acquisitions during the year ended
June 30, 1998, including NovaPro, a rehabilitation temporary staffing business,
acquired from the Parent on July 1, 1997 (see Note 3), AmeriCare Employers
Group, Inc., a PEO based in Phoenix, Arizona, acquired December 1, 1997 and
Staff Leasing Systems, Inc., a PEO based in Bowie, Maryland, acquired on May 1,
1998 (see Note 4).
The Parent established the Company and entered into the NovaCare Contract
primarily because the Company provides a vehicle for the Parent to leverage its
core competencies and investments in human resource management, information
systems, relationship selling, workers' compensation risk management,
outsourcing and management of a dispersed workforce. By leveraging the
investments already made in its core competencies, the Parent can increase the
return to its shareholders from those investments.
With the exception of the NovaCare Contract, the Company does not have a
concentration of customers in any one industry.
Principles of Consolidation: The Consolidated Financial Statements include
the operations of the Company and its wholly owned subsidiaries. All significant
intercompany accounts and transactions have been eliminated in consolidation.
Reclassifications: Certain amounts in the fiscal 1997 consolidated
financial statements have been reclassified to conform with the fiscal 1998
presentation.
Revenue Recognition: Revenues and the related costs of wages, salaries,
and employment taxes pertaining to worksite employees are recognized in the
period in which the employee performs the service. Because the Company is at
risk for all of its direct costs, independently of whether payment is received
from its clients, all amounts billed to clients for gross salaries and wages,
related employment taxes, and health care and workers' compensation coverage are
recognized as revenue by the Company. Revenues relating to worksite employees
with earned but unpaid wages at the end of each period are recognized as
unbilled accounts receivable and the corresponding direct cost as an accrued
liability. The Company establishes an
35
<PAGE> 38
NOVACARE EMPLOYEE SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
JUNE 30, 1998
(IN THOUSANDS, EXCEPT PER SHARE DATA)
allowance for doubtful accounts for accounts receivable based on management
judgement and prior experience.
Use of Estimates: The preparation of financial statements in conformity
with generally accepted accounting principles requires management to make
estimates and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at the date of
the financial statements and the reported amounts of revenues and expenses
during the reporting period. Actual results could differ from those estimates.
Cash and Cash Equivalents: The Company considers its holdings of highly
liquid debt and money-market instruments to be cash equivalents if the
securities mature within 90 days from the date of acquisition. These investments
are carried at cost, which approximates fair value.
Property and Equipment: Property and equipment are stated at cost.
Depreciation is provided on a straight-line basis over the estimated useful
lives of the assets, which principally range from three to ten years. Assets
under capital leases and leasehold improvements are amortized over the lesser of
the lease term or the asset's estimated useful life.
Excess Cost of Net Assets Acquired: Assets and liabilities acquired in
connection with business combinations accounted for under the purchase method
are recorded at their respective fair values. Deferred taxes have been recorded
to the extent of the difference between the fair value and the tax basis of the
assets acquired and liabilities assumed. The excess of the purchase price over
the fair value of net assets acquired, including the recognition of applicable
deferred taxes, consists of non-compete agreements, customer lists, assembled
workforce, and goodwill and is amortized on a straight-line basis over the
estimated useful lives of the assets, which range from five to 40 years.
The Company adopted Statement of Financial Accounting Standards No. 121,
"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to
be Disposed of" ("SFAS 121"), which establishes accounting standards for the
impairment of long-lived assets, certain identified intangible assets and
goodwill related to those assets to be held and used and for long-lived assets
and certain intangible assets to be disposed of. In accordance with SFAS 121,
the Company reviews the realizability of long-lived assets, certain intangible
assets and goodwill whenever events or circumstances occur which indicate
recorded cost may not be recoverable. The Company also reviews the overall
recoverability of goodwill based primarily on estimated future undiscounted cash
flows.
If the expected future cash flows (undiscounted) are less than the carrying
amount of such assets, the Company recognizes an impairment loss for the
difference between the carrying amount of the assets and their estimated fair
value. In estimating future cash flows for determining whether an asset is
impaired, and in measuring assets that are impaired, assets are grouped by
geographic region.
Workers' Compensation: The Company is contractually obligated to provide
workers' compensation coverage for its employees and co-employees. The Company
accomplishes this through a combination of various commercial insurance policies
and self insurance programs. The Company records estimated accruals for workers'
compensation claims, including estimates for incurred but not reported claims,
based upon review of the claims activity and past experience. Management
believes any differences which may arise between actual settlement of claims and
reserves at June 30, 1998 would not have a material effect on the Company's
financial position.
On July 1, 1997, the Company entered into a three-year contract with a
commercial insurance company for workers' compensation coverage. Under this
program, the Parent's worksite employees and third party
36
<PAGE> 39
NOVACARE EMPLOYEE SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
JUNE 30, 1998
(IN THOUSANDS, EXCEPT PER SHARE DATA)
worksite employees are covered under a fixed cost insurance program, which is
subject to certain per incident and aggregate deductibles.
Income Taxes: The Company records deferred tax assets and liabilities for
the expected future tax consequences of events that have been recognized in the
Company's financial statements or tax returns.
Net Income Per Share: The Company adopted the provisions of Statement of
Financial Accounting Standards No. 128, "Earnings per Share" (SFAS 128) during
the second quarter of fiscal 1998. This statement revised the calculation of
earnings per share from the "primary" and "fully diluted" methods previously
employed to the "basic" and "assuming dilution" methods. Under this new
statement, earnings per share-basic represents net income divided by the
weighted average number of shares outstanding during the period. Earnings per
share-assuming dilution represents the basic weighted average shares outstanding
adjusted for the effects of dilutive stock options and contingently issuable
shares under certain acquisition agreements.
In February 1998, the Securities and Exchange Commission issued Staff
Accounting Bulletin No. 98 ("SAB 98"). SAB 98 revised the methods previously
employed in SAB 83, requiring the retroactive restatement of earnings-per-share
information in accordance with SFAS 128, and eliminating the effect of cheap
stock on calculations of net income per share.
In accordance with these standards, the Company has restated net income per
share amounts reported in the Company's Registration Statement to conform with
the provisions of SFAS 128 and SAB 98 as set forth below:
<TABLE>
<CAPTION>
FOR THE PERIOD
FROM
FOR THE YEAR OCTOBER 1, 1996
ENDED (INCEPTION) TO
JUNE 30, 1998 JUNE 30, 1997
----------------------- -----------------------
HISTORICAL PRO FORMA HISTORICAL PRO FORMA
---------- --------- ---------- ---------
<S> <C> <C> <C> <C>
NET INCOME........................................ $ 5,456 $ 5,456 $ 692 $ 692
ADJUSTMENT TO NET INCOME:
Deduct -- accretion of mandatorily redeemable
common stock.................................... (1,185) -- (1,033) --
------- ------- ------- -------
Net income (loss) attributable to common stock.... $ 4,271 $ 5,456 $ (341) $ 692
======= ======= ======= =======
WEIGHTED AVERAGE SHARES OUTSTANDING:
Weighted average shares outstanding -- basic...... 24,942 24,942 18,078 18,078
Stock options................................... 135 135 -- --
Contingently issuable shares -- assuming
dilution..................................... 58 58 -- --
------- ------- ------- -------
Weighted average shares outstanding -- assuming
dilution........................................ 25,135 25,135 18,078 18,078
======= ======= ======= =======
NET INCOME (LOSS) PER SHARE:
Basic........................................... $ .17 $ .22 $ (.02) $ .04
======= ======= ======= =======
Assuming dilution............................... $ .17 $ .22 $ (.02) $ .04
======= ======= ======= =======
</TABLE>
Historical net income per share is computed by dividing net income, net of
the accretion of mandatorily redeemable common stock (see Note 11), by the
weighted average number of shares outstanding.
Pro forma net income per share is computed by dividing net income, without
consideration to the accretion of mandatorily redeemable common stock, by the
weighted average number of shares outstanding.
37
<PAGE> 40
NOVACARE EMPLOYEE SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
JUNE 30, 1998
(IN THOUSANDS, EXCEPT PER SHARE DATA)
Options to purchase 471 shares of common stock for the year ended June 30,
1998 were not included as common stock equivalents in the computation of net
income per share-assuming dilution because the effect would be antidilutive. As
part of certain purchase agreements, the former stockholders are eligible to
receive additional shares of the Company's common stock contingent upon
achieving certain financial and operating criteria over multiple reporting
periods. Approximately 1,272 contingently issuable shares were not included in
the computation of net income per share-assuming dilution because all specified
financial and operating conditions have not been satisfied. There were no
transactions occurring subsequent to June 30, 1998 that would have materially
changed the number of shares used in computing net income per share-basic or net
income per share-assuming dilution.
Recently Issued Accounting Standards: In June 1997, the Financial
Accounting Standards Board issued Statement of Financial Accounting Standards
No. 131, "Disclosures about Segments of an Enterprise and Related Information"
(SFAS 131), which the Company is required to adopt no later than the first
quarter of fiscal 1999. SFAS 131 uses a "management approach" to defining and
reporting the activities of operating segments. The management approach defines
operating segments along the lines used by management to assess performance and
make operating and capital decisions. The Company is in the process of
evaluating the effect this new standard will have on the Company's annual and
interim reporting requirements. Adoption of this accounting standard is for
disclosure purposes only and will not have an adverse effect on the Company's
financial position or results of operations.
In March 1998, the Accounting Standards Executive Committee of the American
Institute of Certified Public Accountants issued Statement of Position ("SOP")
98-1 "Accounting for the Costs of Computer Software Developed or Obtained for
Internal Use". SOP 98-1 provides guidance on accounting for the costs of
computer software developed or obtained for internal use. The SOP is effective
for the year ending June 30, 2000. Management does not believe the adoption of
SOP 98-1 will have a material effect on the Company's financial position or
results of operations.
In June 1998, the Accounting Standards Executive Committee of the American
Institute of Certified Public Accountants issued SOP 98-5 "Reporting on the Cost
of Start-Up Activities" which the Company is required to adopt no later than
June 30, 2000. SOP 98-5 provides the reporting standards for the costs of start-
up activities, including organizational costs, which should be expensed as
incurred. Management does not believe the adoption of SOP 98-5 will have a
material effect on the Company's financial position or results of operations.
2. INITIAL PUBLIC OFFERING
On November 14, 1997, the Company completed an initial public offering of
5,000 shares of its common stock (the "Offering"). Subsequent to the Offering,
the Company issued an additional 750 shares pursuant to the exercise of an
over-allotment provision, for a total issuance of 5,750 shares. The net proceeds
from the Offering, (including the exercise of the over-allotment provision),
after deducting offering costs of $6,041, amounted to $45,709 and were used by
the Company to pay: (i) the Company's outstanding revolving credit loan of
$28,382 from the Parent, (ii) $1,000 to an affiliate of the Company who is a
former owner of a business acquired by the Company, and (iii) $16,172 to retire
deferred purchase obligations. The remaining proceeds have been allocated for
general corporate purposes.
3. RELATED PARTY TRANSACTIONS
In return for its efforts as the founder, its initial investment of $40 and
the use of the Parent's trademark, the Company issued 18,200 shares (as adjusted
for the common stock split -- see Note 10) of common stock to the Parent. Given
that the transactions were between companies under common control, the issuance
of
38
<PAGE> 41
NOVACARE EMPLOYEE SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
JUNE 30, 1998
(IN THOUSANDS, EXCEPT PER SHARE DATA)
shares was recorded at the cost basis of the Parent. The excess of the
consideration given to the Parent over the Parent's cost basis in the assets
transferred was recorded as a reduction of additional paid-in capital, the same
account credited upon issuance of the shares. Therefore, the transaction had no
net effect on shareholders' equity.
Effective October 1996, the Company entered into a line of credit agreement
with the Parent which provided for an unspecified availability. Interest was
charged to the Company at the Parent's borrowing rate, which was the EuroDollar
rate plus a range of 0.5% to 1.125%. The weighted average borrowing rate for
fiscal 1998 and 1997 was 6.8% and 6.6%, respectively. The line of credit
agreement terminated upon the completion of the Company's initial public
offering, at which time all outstanding amounts were paid to the Parent (see
Note 2). The Parent established an irrevocable letter of credit on behalf of the
Company in the amount of $1,141 which expired on December 31, 1997. The letter
was established to meet the security requirements of the Company's workers'
compensation policy held with a commercial insurance carrier at June 30, 1997.
In February 1997, the Parent and the Company entered into the NovaCare
Contract, whereby substantially all of the Parent's employees became co-employed
by the Company under a five-year term with automatic annual renewals. Under the
NovaCare Contract, the Company provides traditional PEO services such as payroll
and benefits administration, worksite safety evaluation, employment-related risk
management and compensation and benefits consultation. The Parent paid the
Company a fee for its services equal to the salary and Federal payroll costs
plus an average base fee of 9.7% of gross earnings of employees, or
approximately 117% of the gross payroll covered by the NovaCare Contract.
Effective July 1, 1998, the NovaCare Contract was amended, whereby the Company
agreed to provide the existing PEO services and a broader array of services,
including recruiting, employee training and orientation, outplacement and human
resource consulting. The new contract is principally a fee-for-service contract,
replacing the previous payment arrangement, which was priced as a percentage of
payroll, as described above.
The amended NovaCare Contract has a four year term and the Parent may not
terminate the NovaCare Contract except in the event of: (i) the breach of any of
the Company's agreements, duties, or performance standards under the NovaCare
Contract; (ii) the making of false or misleading representations, warranties, or
statements of material fact in documents submitted by or on behalf of the
Company to the Parent; or (iii) the insolvency, bankruptcy, or receivership of
the Company.
During fiscal 1998 and 1997, the Parent subleased office space to the
Company. The sublease was a month-to-month arrangement, terminable on 30 days'
notice by either party, under which the Company paid the Parent approximately $9
per month which equals the Parent's cost. The agreement was terminated in
October 1997, concurrent with the Company's relocation to the new corporate
headquarters.
The Parent also provides information systems consulting services and
general administrative and financial services to the Company on an as-needed
basis at the Parent's cost. During fiscal 1998 and 1997, the Company reimbursed
the Parent for certain expenses, in the amount of $220 and $160, respectively,
based upon estimates of time incurred by the Parent's personnel on behalf of the
Company.
Effective July 1, 1997, the Company issued 1,200 shares of its common
stock, valued at $5,400, to acquire the assets and liabilities of NovaPro,
formerly a business of the Parent, in a transaction accounted for as a purchase.
Given that the transaction was between companies under common control, the
transfer of assets and liabilities was recorded at the historical cost basis of
the Parent. The excess paid over the historical cost has been treated as a
reduction of additional paid-in capital, the same account credited upon issuance
of the shares. Therefore the transaction had no effect on shareholders' equity.
The terms of the aforementioned related party transactions are equivalent
to those that would result from transactions among unrelated parties.
39
<PAGE> 42
NOVACARE EMPLOYEE SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
JUNE 30, 1998
(IN THOUSANDS, EXCEPT PER SHARE DATA)
4. ACQUISITIONS
On May 1, 1998, the Company acquired Staff Leasing Systems, Inc. ("SLS"), a
PEO headquartered in Bowie, Maryland, for $2,000 in cash, 120 shares of the
Company's common stock, the assumption of certain liabilities and future
contingent payments.
On December 1, 1997, the Company acquired all of the outstanding stock of
AmeriCare Employers Group, Inc. ("AmeriCare"), a PEO in Phoenix, Arizona, for
$9,000 in cash, 723 shares of the Company's common stock, the assumption of
certain liabilities and future contingent payments.
On July 1, 1997, the Company acquired NovaPro, a rehabilitation temporary
staffing business, from the Parent (see Note 3).
During the period ended June 30, 1997, the Company acquired four PEO
businesses located in Florida and New York (see Note 1).
The following unaudited pro forma consolidated results of the Company give
effect to each of the acquisitions as if they occurred as of October 1, 1996
(the date of inception):
<TABLE>
<CAPTION>
FOR THE PERIOD
FROM
FOR THE YEAR OCTOBER 1, 1996
ENDED (INCEPTION) TO
JUNE 30, 1998 JUNE 30, 1997
------------- ---------------
<S> <C> <C>
Net revenues..................................... $1,365,314 $617,541
Net income (loss)................................ 5,588 (1,010)
Net income (loss) per share -- basic............. .22 (.05)
Net income (loss) per share -- assuming
dilution....................................... .22 (.05)
</TABLE>
The above pro forma information is not necessarily indicative of the
results of operations that would have occurred had the acquisitions been made as
of October 1, 1996, or the results that may occur in the future.
Information with respect to businesses acquired in purchase transactions
was as follows:
<TABLE>
<CAPTION>
AS OF JUNE 30,
------------------
1998 1997
------- -------
<S> <C> <C>
Goodwill................................................. $68,033 $46,440
Customer lists........................................... 7,552 5,488
Other.................................................... 3,820 2,797
------- -------
Cost in excess of fair value of net assets acquired...... 79,405 54,725
Less: accumulated amortization........................... 3,835 1,034
------- -------
$75,570 $53,691
======= =======
</TABLE>
40
<PAGE> 43
NOVACARE EMPLOYEE SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
JUNE 30, 1998
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
FOR THE PERIOD ENDED
JUNE 30,
--------------------
1998 1997
-------- --------
<S> <C> <C>
Cash paid (net of cash acquired)......................... $10,959 $24,250
Common stock issued...................................... 7,590 --
Deferred purchase price obligations...................... 4,600 19,948
Mandatorily redeemable common stock (Note 11)............ -- 2,452
Notes issued............................................. -- 1,328
Other consideration...................................... 1,387 1,178
------- -------
24,536 49,156
Liabilities assumed...................................... 9,297 15,199
------- -------
33,833 64,355
Fair value of assets acquired............................ 9,153 9,630
------- -------
Cost in excess of fair value of net assets acquired...... $24,680 $54,725
======= =======
</TABLE>
The acquisitions were accounted for using the purchase method of
accounting. Accordingly, a portion of the purchase price was allocated to net
assets acquired based on their estimated fair values. Net assets acquired
consisted primarily of accounts receivable and property and equipment.
Certain purchase agreements require additional payments if specific
financial targets and/or operating conditions are met. Of the aggregate
contingent amounts payable under these agreements, 484 shares of common stock,
valued at $4,600 have been accrued at June 30, 1998, and $400 cash and 25,000
shares of mandatorily redeemable common stock, valued at $70 have been accrued
at June 30, 1997. The remaining contingent payments have not been included in
the cost of businesses acquired because the amount of such contingent
consideration, if any, is not presently determinable. The Company paid $1,555 in
cash and issued 93 shares of common stock in fiscal 1998 and $1,428 in cash and
85 shares of mandatorily redeemable common stock in fiscal 1997 in connection
with these agreements.
Deferred current and long term purchase price obligations of $6,206 and
$19,761 at June 30, 1998 and 1997, respectively, represent guaranteed and
contingent purchase price payments to former owners. At June 30, 1998, the
$6,206 consists of guaranteed payments of $1,606 and $4,600 accrued for
contingent payments. Obligations at June 30, 1997, of $19,761 represent $19,291
of guaranteed purchase price payments due to former owners and $470 accrued for
contingent payments. Of the $19,291 guaranteed purchase price payments, $17,172
was paid to the former owners upon the completion of the Offering.
41
<PAGE> 44
NOVACARE EMPLOYEE SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
JUNE 30, 1998
(IN THOUSANDS, EXCEPT PER SHARE DATA)
5. PROPERTY AND EQUIPMENT
The components of property and equipment were as follows:
<TABLE>
<CAPTION>
AS OF JUNE 30,
----------------
1998 1997
------ ------
<S> <C> <C>
Land and buildings......................................... $ 70 $ 70
Property, equipment and furniture.......................... 2,580 1,019
Leasehold improvements..................................... 563 162
Computer equipment and capitalized software................ 2,201 240
------ ------
5,414 1,491
Less: accumulated depreciation and amortization............ 924 165
------ ------
$4,490 $1,326
====== ======
</TABLE>
Depreciation expense for fiscal 1998 and the period from October 1, 1996
(inception) to June 30, 1997 was $759 and $165 respectively.
6. FINANCING ARRANGEMENTS
Financing arrangements consisted of the following:
<TABLE>
<CAPTION>
AS OF JUNE 30,
----------------
1998 1997
------ ------
<S> <C> <C>
$25,000 revolving credit facility, due November 17, 2000... $ -- $ --
Subordinated promissory notes (6% to 10%), payable through
2002..................................................... 678 1,322
Capitalized lease obligations, payable through 2001........ 278 44
------ ------
956 1,366
Less: current portion...................................... 217 298
------ ------
$ 739 $1,068
====== ======
</TABLE>
In November 1997, the Company entered into a three year revolving credit
facility with a syndicate of lenders. The credit facility provides for interest
at a variable rate, depending on certain financial ratios, equal to (a) the
EuroDollar rate plus a range of 1.375% to 2.50% or (b) the lead lender's prime
rate plus a range of 0.125% to 1.25%. The weighted average borrowing rate for
fiscal 1998 was 8.77%. In addition, the Company has agreed to pay a commitment
fee ranging from 0.30% to 0.50% per annum on the unused portion of the
commitment. Loans made under the credit facility are collateralized by a pledge
of all of the (i) Company's interest in the common stock of its subsidiaries,
(ii) assets of the Company and its subsidiaries, and (iii) Parent's interest in
the common stock of the Company. The revolving credit facility requires the
maintenance of minimum capitalization and net worth amounts, capital expenditure
thresholds as well as certain financial ratios. At June 30, 1998, the Company
was in compliance with these requirements.
Under the credit facility, the Company has outstanding a letter of credit
in the amount of $1,141, which guarantees payment of claims to one of the
Company's former workers' compensation insurance carriers. The unused portion of
the credit facility at June 30, 1998 was $23,859 after reduction for the letter
of credit described above.
42
<PAGE> 45
NOVACARE EMPLOYEE SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
JUNE 30, 1998
(IN THOUSANDS, EXCEPT PER SHARE DATA)
At June 30, 1998, aggregate annual maturities of financing arrangements
were as follows for the next five fiscal years and thereafter:
<TABLE>
<CAPTION>
FISCAL YEAR
- -----------
<S> <C>
1999........................................................ $217
2000........................................................ 347
2001........................................................ 326
2002........................................................ 66
2003........................................................ --
Thereafter.................................................. --
----
$956
====
</TABLE>
Interest paid on debt during fiscal 1998 and the period October 1, 1996
(inception) through June 30, 1997, amounted to $804 and $49, respectively.
7. ACCRUED WORKERS' COMPENSATION AND HEALTH CLAIMS
The Company's accruals for claims are summarized as follows:
<TABLE>
<CAPTION>
AS OF JUNE 30,
-----------------
1998 1997
------- ------
<S> <C> <C>
Accrued health benefit premiums payable and claims
reserves........................................ $16,638 $3,756
Accrued workers' compensation premiums payable and
claims reserves................................. 5,776 3,577
------- ------
22,414 7,333
Less: workers' compensation claims and health
benefits claims expected to be settled in less
than one year................................... 17,948 5,423
------- ------
$ 4,466 $1,910
======= ======
</TABLE>
Under the NovaCare Contract, as described in Note 3, the Company is
self-insured for certain health benefits up to $150 per individual per year. The
Company expensed amounts for estimated losses occurring from both asserted and
unasserted claims. The estimate of the liability for unasserted claims arising
from unreported incidents is based on an analysis of historical claims rates.
43
<PAGE> 46
NOVACARE EMPLOYEE SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
JUNE 30, 1998
(IN THOUSANDS, EXCEPT PER SHARE DATA)
8. INCOME TAXES
The components of income tax expense were as follows:
<TABLE>
<CAPTION>
FOR THE
PERIOD FROM
FOR THE OCTOBER 1, 1996
YEAR ENDED (INCEPTION) TO
JUNE 30, 1998 JUNE 30, 1997
------------- ---------------
<S> <C> <C>
Current:
Federal................................ $4,460 $ 937
State.................................. 1,100 470
------ ------
5,560 1,407
------ ------
Deferred:
Federal................................ $ (744) $ 122
State.................................. (73) 13
------ ------
(817) 135
------ ------
$4,743 $1,542
====== ======
</TABLE>
The components of net deferred tax assets as of June 30, 1998 and 1997 were
as follows:
<TABLE>
<CAPTION>
AS OF JUNE 30,
----------------
1998 1997
------ ------
<S> <C> <C>
Net operating loss carryforward.................... $2,058 $2,454
Accruals and reserves not currently deductible for
tax purposes:
Current.......................................... 1,688 296
Non-current...................................... 61 67
------ ------
Gross deferred tax assets.......................... 3,807 2,817
Valuation reserve.................................. (2,058) (2,454)
------ ------
Total deferred tax assets.......................... 1,749 363
Expenses capitalized for financial statement
purposes......................................... (195) (67)
------ ------
Net deferred tax asset............................. $1,554 $ 296
====== ======
</TABLE>
In fiscal 1997, the Company acquired net operating loss carryforwards of
approximately $6,000, of which $5,000 is remaining at June 30, 1998, expiring
through 2010. The Internal Revenue Code of 1986, as amended (the "Code"), places
certain restrictions on the use of net operating loss carryforwards acquired
through purchase transactions. Accordingly, the Company has placed a full
valuation allowance against these amounts.
44
<PAGE> 47
NOVACARE EMPLOYEE SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
JUNE 30, 1998
(IN THOUSANDS, EXCEPT PER SHARE DATA)
The reconciliation of the expected tax expense (computed by applying the
Federal statutory tax rate to income before income taxes) to actual tax expense
was as follows:
<TABLE>
<CAPTION>
FOR THE
PERIOD FROM
FOR THE OCTOBER 1, 1996
YEAR ENDED (INCEPTION) TO
JUNE 30, 1998 JUNE 30, 1997
------------- ---------------
<S> <C> <C>
Expected Federal income tax expense...... $3,468 $ 782
State income taxes, less Federal
benefit................................ 603 470
Non-deductible amortization of excess
cost of net assets acquired............ 914 349
Tax credits.............................. (200) (10)
Other, net............................... (42) (49)
------ ------
$4,743 $1,542
====== ======
</TABLE>
Income taxes paid during fiscal 1998 and the period October 1, 1996
(inception) through June 30, 1997 amounted to $3,960 and $178, respectively.
9. OPERATING LEASES
The Company rents office space and equipment under non-cancelable operating
leases. Total rent expense charged to operations was $1,027 and $394 for fiscal
1998 and the period from October 1, 1996 (inception) to June 30, 1997,
respectively.
Future minimum lease commitments for all non-cancelable leases as of June
30, 1998 are as follows:
<TABLE>
<CAPTION>
OPERATING
FISCAL YEAR LEASES
- ----------- ---------
<S> <C>
1999....................................................... $1,485
2000....................................................... 1,426
2001....................................................... 1,288
2002....................................................... 1,137
2003....................................................... 1,016
Thereafter................................................. 494
------
Total minimum lease payments............................... $6,846
======
</TABLE>
10. SHAREHOLDERS' EQUITY
Preferred Stock
On inception, the Board of Directors authorized 1,000 shares of preferred
stock with a par value of $.01 per share. No shares are issued and outstanding
as of June 30, 1998, nor were there shares issued and outstanding at any time
during the period from inception to June 30, 1998.
Common Stock
During the period from October 1, 1996 (inception) through June 30, 1997,
five employees purchased 430 shares of the Company's common stock. The Chief
Executive Officer of the Company purchased 375 shares of the Company's common
stock on January 10, 1997 at the fair market value of $1.92 per share. The
45
<PAGE> 48
NOVACARE EMPLOYEE SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
JUNE 30, 1998
(IN THOUSANDS, EXCEPT PER SHARE DATA)
other shares were purchased on various dates from February 28, 1997 through June
10, 1997 at the fair market value of $2.80 per share.
On January 2, 1997, the Board of Directors declared a four-for-one stock
split of the Company's common stock to shareholders of record on January 2,
1997. All references in the financial statements to per share amounts have been
retroactively restated to reflect the change in the number of common shares
outstanding as a result of the stock split. Accordingly, $126 was transferred
from additional paid-in capital to common stock, representing the par value of
additional shares issued.
On November 14, 1997, the Company completed the Offering of 5,000 shares of
its common stock. Subsequent to the Offering an additional 750 shares were
issued pursuant to the exercise of an over-allotment provision, for a total
issuance of 5,750 shares (see Note 2). Simultaneously with the completion of the
Offering, all 813 shares of mandatorily redeemable common stock were converted
into common stock (see Note 11).
During the year ended June 30, 1998, the Company issued 2,148 shares of
common stock, in connection with fiscal 1998 and 1997 acquisitions (see Note 4).
Treasury Stock
On January 2, 1997, the Company repurchased 563 shares of mandatorily
redeemable common stock from a former owner of an acquired business. Upon
repurchase, the mandatorily redeemable common stock became a component of
permanent equity. Accordingly, the 563 shares and the related par value and
additional paid-in capital associated with these shares were reflected in the
accompanying consolidated statement of shareholders' equity as treasury stock,
stated at cost. On December 1, 1997, 563 shares were reissued from the treasury
as part of the acquisition purchase price of AmeriCare (see Note 4). At June 30,
1998, there were no shares held in the treasury.
Deferred Compensation
On August 8 and September 5, 1997, the Company granted options to certain
executives, in conjunction with compensation agreements, to purchase shares of
common stock at an exercise price of $4.50 per share. There was no trading
market for the common stock as of each respective date. For financial statement
purposes, a fair market value for the common stock was determined by the Board
of Directors to be $7.12 on August 8, 1997 and $9.00 on September 5, 1997.
Accordingly, the Company has recorded deferred compensation expense based on the
difference between the exercise price and the fair market value of the common
stock on the date of grant, in the aggregate amount of $124. This amount is
recognized as compensation expense over the vesting period of five years, on a
straight-line basis. The unamortized portion of deferred compensation is
recorded as a reduction to shareholders' equity. At June 30, 1998, the remaining
unamortized portion of deferred compensation amounted to $103.
11. MANDATORILY REDEEMABLE COMMON STOCK
In connection with the acquisitions described in Note 4, 1,376 shares (as
adjusted for the stock split -- see Note 10) of common stock were issued subject
to an agreement which provides certain registration rights with respect to the
common stock, as well as the right, two years from the date of acquisition, to
put the shares to the Company at a price of $16.00 per share. The put option was
rendered inoperative due to the Company's completion of the Offering prior to
December 31, 1998.
Of the 1,376 shares, 750 (as adjusted for the stock split), 375 and 155
were issued, as of the date of acquisition, to the selling shareholders of
Resource One, ESA and TPI, respectively, at the fair market value
46
<PAGE> 49
NOVACARE EMPLOYEE SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
JUNE 30, 1998
(IN THOUSANDS, EXCEPT PER SHARE DATA)
of $1.20 per share (as adjusted for the stock split) for Resource One and $2.48
for ESA and TPI. Subsequent to the date of acquisition, contingent and
non-contingent payments of 41, 44, and 11 shares were issued with respect to the
Resource One, ESA and Prostaff acquisitions, respectively, at the fair market
value of $2.80 per share.
The mandatorily redeemable common stock was recorded at the fair value at
the date of issuance. The excess of the put price over the carrying value was
accreted by periodic charges to retained earnings or additional paid-in capital,
as applicable, over a two year period. As of June 30, 1997, 813 shares of
mandatorily redeemable common stock were outstanding. During fiscal 1998 and the
period from October 1, 1996 (inception) to June 30, 1997, the Company recorded
$1,185 and $1,033, respectively, of accretion to retained earnings and
additional paid-in capital. On November 11, 1997, in conjunction with the
Offering, all 813 shares were converted into common stock.
12. BENEFIT PLANS
Stock Option Plan:
On February 28, 1997, the Company's Board of Directors adopted and its
shareholders approved the Company's 1997 Stock Option Plan (the "Plan") under
which 625 shares of common stock were reserved for issuance upon the exercise of
stock options. On November 24, 1997, the plan was amended to increase the number
of shares reserved for issuance to 1,625, and limit the maximum number of
options which may be granted to any person under the plan during any fiscal year
to 200 shares. Under the Plan, substantially all options are granted for a term
of up to 10 years at prices equal to the fair value at the date of grant.
Options granted generally are exercisable over a five to six year period,
although vesting can be accelerated if the Company's stock price achieves stated
levels.
The following summarizes the activity of the stock option plan:
<TABLE>
<CAPTION>
FOR THE PERIOD
FOR THE YEAR OCTOBER 1, 1996
ENDED (INCEPTION) TO
JUNE 30, 1998 JUNE 30, 1997
------------- ---------------
<S> <C> <C>
Options:
Outstanding at the beginning of the year......... 371 --
Granted........................................ 1,091 375
Exercised...................................... (8) --
Canceled....................................... (140) (4)
------------ -----
Outstanding at the end of the year............. 1,314 371
============ =====
Option price per share ranges:
Granted........................................ $2.80 - 9.13 $2.80
Exercised...................................... $ 2.80 $ --
Outstanding at the end of the year............. $2.80 - 9.13 $2.80
Options exercisable at end of year............. 83 --
Exercisable option price ranges................ $ 2.80 $ --
Options available for grant at end of year
under the 1997 stock option plan............ 303 254
</TABLE>
47
<PAGE> 50
NOVACARE EMPLOYEE SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
JUNE 30, 1998
(IN THOUSANDS, EXCEPT PER SHARE DATA)
The Company has adopted the disclosure-only provisions of Statement of
Financial Accounting Standards No. 123, "Accounting for Stock-Based
Compensation" ("SFAS 123"), and applies Accounting Principles Board Opinion No.
25 and related interpretations in accounting for the plan. The table below sets
forth the pro forma information as if the Company had adopted the compensation
recognition provisions of SFAS 123:
<TABLE>
<CAPTION>
FOR THE PERIOD
FOR THE YEAR OCTOBER 1, 1996
ENDED (INCEPTION) TO
JUNE 30, 1998 JUNE 30, 1997
------------- ---------------
<S> <C> <C>
Increase (decrease) to:
Net income..................................... $ (342) $ 13
Net income per share -- basic and assuming
dilution.................................... $ (.01) --
Assumptions:
Expected life (years).......................... 3.2 - 7.5 4.6 - 6.6
Risk-free interest rate........................ 5.8% 6.1% - 6.5%
Volatility..................................... 57.7% 0%
Dividend yield................................. N/A N/A
</TABLE>
The compensation recognition for the period ended June 30, 1997 was
calculated assuming a fair market value for the Company's common stock equal to
the assumed share value as of the date of the initial public offering. Certain
options were grouped together for purposes of valuation based upon vesting
periods and the date of grant. The weighted average fair value of the stock
options, calculated using the Black-Scholes option pricing model, granted during
the fiscal year ended June 30, 1998 and 1997 was $5.63 and $0.82, respectively.
The weighted average remaining contractual life of all options granted as of
June 30, 1998 is 9.27 years.
Retirement Plans:
The Company and the Parent co-sponsor a defined contribution 401(k) plan
covering substantially all of the worksite employees of the Parent and certain
employees of the Company. The contributions for fiscal 1998 and for the period
October 1, 1996 (inception) to June 30, 1997 made on behalf of the Parent and
the Company were $4,508 and $1,612, respectively. The Company and the Parent
also co-sponsor a non-qualified supplemental benefit plan covering certain key
employees. The matching contributions made on behalf of the Parent and the
Company were $859 and $166 for fiscal 1998 and the period October 1, 1996
(inception) to June 30, 1997, respectively.
The Company's subsidiaries maintain defined contribution 401(k) plans
covering certain of their employees and third party worksite employees. The
Company contributes, on behalf of each participating client, varying amounts
based on client elections. The Company's contributions for fiscal 1998 and the
period from October 1, 1996 (inception) to June 30, 1997 were $456 and $85,
respectively.
13. COMMITMENTS AND CONTINGENCIES
The Company is subject to legal proceedings and claims which arise in the
ordinary course of its business. In the opinion of management, the amount of
ultimate liability, if any, with respect to these actions will not have a
materially adverse effect on the financial position or results of operations of
the Company.
The Company's operations are subject to numerous Federal, state and local
laws related to employment, taxes and benefit plan matters. Generally, these
regulations affect all companies in the United States. However, the regulatory
environment for PEOs is an evolving area due to uncertainties resulting from the
non-traditional employment relationship created by PEOs. Many Federal and state
laws relating to tax and
48
<PAGE> 51
NOVACARE EMPLOYEE SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
JUNE 30, 1998
(IN THOUSANDS, EXCEPT PER SHARE DATA)
employment matters were enacted prior to the development of PEO companies and do
not specifically address the obligations and responsibilities of these
co-employer relationships. The Internal Revenue Service ("IRS") has conducted a
market segment study of the PEO industry (the "Market Segment Study") focusing
on selected PEOs (not including the Company) for the purpose of examining the
relationship among PEOs, their clients, worksite employees, and the worksite
owners. IRS officials indicate that the Market Segment Study is near completion
and suggest that an announcement of the IRS' position with respect to PEOs has
been delayed pending the outcome of legislation that has been proposed by the
PEO and other staffing industries. If the IRS concludes that PEOs are not
"employers" of certain worksite employees for purposes of the Internal Revenue
Code, the Company's benefit plans (including cafeteria, health and welfare, and
retirement plans) may lose their favorable tax status, and the Company may no
longer be able to assume its clients' Federal employment tax withholding. The
Company believes that, although unfavorable to the Company, a prospective
application by the IRS of an adverse conclusion would not have a material affect
on its financial position and results of operations. A retrospective application
by the IRS could have a material adverse effect on the Company's business,
financial position, results of operations and liquidity. While the Company
believes that a retrospective disqualification is unlikely, there can be no
assurance as to the ultimate resolution of these issues.
The Parent is considering separating its physical rehabilitation services
business into two publicly held companies -- a long-term care,
geriatric-oriented business and an outpatient physical rehabilitation business.
The precise course and timing of this separation strategy will depend on a
variety of capital markets, tax, regulatory and operational issues. The ultimate
impact on future operating results and financial position of the NovaCare
Contract, in the event the Parent executes some form of a separation strategy,
is not presently determinable.
14. SUBSEQUENT EVENTS
On August 1, 1998, the Company acquired Pay America, Inc., a PEO
headquartered in Salt Lake City, Utah, for $3,000 in cash, 436 shares of the
Company's common stock, the assumption of certain liabilities and future
contingent payments. The transaction will be accounted for as a purchase.
49
<PAGE> 52
NOVACARE EMPLOYEE SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
JUNE 30, 1998
(IN THOUSANDS, EXCEPT PER SHARE DATA)
15. QUARTERLY FINANCIAL INFORMATION (UNAUDITED)
<TABLE>
<CAPTION>
FOURTH THIRD SECOND FIRST
QUARTER QUARTER QUARTER QUARTER
-------- -------- -------- --------
<S> <C> <C> <C> <C>
YEAR ENDED JUNE 30, 1998
Net revenues.................................... $363,882 $338,367 $302,751 $266,757
Gross profit.................................... 12,505 11,302 9,412 8,328
Income from operations.......................... 3,645 2,840 2,287 2,126
Net income...................................... $ 1,921 $ 1,479 $ 1,119 $ 937
Historical net income per share, after accretion
adjustment -- basic and assuming dilution..... $ .07 $ .05 $ .03 $ --
Pro forma net income per share, excluding
accretion adjustment -- basic and assuming
dilution...................................... $ .07 $ .05 $ .05 $ .04
Weighted average shares outstanding:
Basic......................................... 27,635 27,544 23,869 21,009
Assuming dilution............................. 28,018 27,674 24,031 21,009
FOR THE PERIOD FROM OCTOBER 1, 1996 (INCEPTION)
TO JUNE 30, 1997:
Net revenues.................................... $232,223 $151,076 $ 10,894 --
Gross profit.................................... 6,668 4,728 842 --
Income from operations.......................... 1,704 1,073 154 --
Net income...................................... $ 411 $ 220 $ 61 --
Historical net income per share, after accretion
adjustment -- basic and assuming dilution..... $ (.01) $ (.01) $ (.01) --
Pro forma net income per share, excluding
accretion adjustment -- basic and assuming
dilution...................................... $ .02 $ .01 -- --
Weighted average shares outstanding:
Basic......................................... 18,078 17,904 16,855 --
Assuming dilution............................. 18,078 17,904 16,855 --
</TABLE>
Quarterly net income per share for the period October 1, 1996 (inception)
to June 30, 1997 has been restated in accordance with SFAS 128 and SAB 98.
Historical net income per share is computed by dividing net income, net of the
accretion of mandatorily redeemable common stock, by the weighted average number
of shares outstanding. Pro forma net income per share excludes the accretion of
mandatorily redeemable common stock (see Note 1).
50
<PAGE> 53
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and Shareholders of NovaCare Employee Services, Inc.
In our opinion, the consolidated financial statements listed in the
accompanying index appearing under Item 14(a)(1) on page 63 present fairly, in
all material respects, the financial position of NovaCare Employee Services,
Inc. and its subsidiaries at June 30, 1998 and 1997, and the results of their
operations and their cash flows for the year ended June 30, 1998 and the period
from October 1, 1996 (date of inception) to June 30, 1997, in conformity with
generally accepted accounting principles. These financial statements are the
responsibility of the Company's management; our responsibility is to express an
opinion on these financial statements based on our audits. We conducted our
audits of these statements in accordance with generally accepted auditing
standards which require that we plan and perform the audit to obtain reasonable
assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements, assessing the
accounting principles used and significant estimates made by management, and
evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for the opinion expressed above.
PricewaterhouseCoopers LLP
Philadelphia, PA
July 31, 1998
51
<PAGE> 54
INDEPENDENT AUDITOR'S REPORT
To the Stockholders of Resource One, Inc.
We have audited the accompanying combined balance sheets of Resource One,
Inc. as of September 30, 1996 and December 31, 1995 and 1994 and the related
combined statements of income, changes in stockholders' equity and cash flows
for the nine months and years then ended. These financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the combined financial statements referred to above present
fairly, in all material respects, the financial position of Resource One, Inc.
as of September 30, 1996 and December 31, 1995 and 1994, and the results of its
operations and its cash flows for the nine months and years then ended in
conformity with generally accepted accounting principles.
Brewer, Beemer, Kuehnhackl & Koon, P.A.
Orlando, FL
April 4, 1997
52
<PAGE> 55
RESOURCE ONE, INC.
COMBINED BALANCE SHEETS
(SEE NOTE 1)
<TABLE>
<CAPTION>
DECEMBER 31, SEPTEMBER 30,
------------------------ -------------
1994 1995 1996
---------- ---------- -------------
<S> <C> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents.......................... $ 281,585 $ 362,106 $ 194,489
Receivables, net:
Trade, net of allowance for doubtful accounts of
$2,586 in 1994................................ 54,375 46,624 86,721
Accrued leased employee revenue receivable...... 353,074 447,552 817,356
Claims administration fees receivable........... 123,725 121,671 147,406
Administration fees receivable.................. -- -- 32,999
Insurance commissions receivable................ 8,320 7,995 15,673
Deferred income taxes.............................. -- -- 2,347
Other current assets............................... -- -- 23,350
---------- ---------- ----------
Total current assets....................... 821,079 985,948 1,320,341
Property and equipment, net.......................... 166,009 148,423 149,469
Other assets......................................... 18,432 107,090 73,956
---------- ---------- ----------
Total assets......................................... $1,005,520 $1,241,461 $1,543,766
========== ========== ==========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Current portion of notes payable................... $ 94,529 $ 70,233 $ --
Accounts payable and accrued expenses.............. 53,287 13,524 99,607
Accrued leased employee costs and expenses
payable......................................... 404,962 593,570 946,424
Amounts owed to customer........................... -- 47,534 36,410
Income taxes payable............................... 38,525 23,023 4,273
---------- ---------- ----------
Total current liabilities.................. 591,303 747,884 1,086,714
Notes payable, net of current portion.............. 68,848 30,765 7,577
Other liabilities.................................. -- 69,685 --
---------- ---------- ----------
Total liabilities.......................... 660,151 848,334 1,094,291
---------- ---------- ----------
Stockholders' equity:
Common stock, $.01 par value, 1,000,000 shares
authorized, 100,000 shares issued and
outstanding..................................... 1,000 1,000 1,000
Additional paid-in capital......................... 204,280 144,280 144,280
Retained earnings.................................. 140,089 247,847 304,195
---------- ---------- ----------
Total stockholders' equity................. 345,369 393,127 449,475
---------- ---------- ----------
Total liabilities and stockholders' equity........... $1,005,520 $1,241,461 $1,543,766
========== ========== ==========
</TABLE>
See accompanying notes to combined financial statements.
53
<PAGE> 56
RESOURCE ONE, INC.
COMBINED STATEMENTS OF INCOME
(SEE NOTE 1)
<TABLE>
<CAPTION>
NINE MONTHS
YEAR ENDED ENDED
DECEMBER 31, SEPTEMBER 30,
-------------------------- -------------
1994 1995 1996
----------- ----------- -------------
<S> <C> <C> <C>
Revenues:
Leased employee revenues......................... $ 9,975,120 $16,897,280 $22,101,897
Claims administration fees....................... 1,694,251 1,479,232 1,089,355
Insurance commissions............................ 201,335 190,189 168,195
Other administration fees........................ 58,484 127,394 60,019
Other revenues................................... 57,550 55,119 45,254
----------- ----------- -----------
11,986,740 18,749,214 23,464,720
----------- ----------- -----------
Costs and expenses:
Leased employee payroll and benefits............. 9,426,636 16,117,676 21,224,300
Selling, general and administrative expenses..... 2,237,827 2,298,799 2,169,671
----------- ----------- -----------
11,664,463 18,416,475 23,393,971
----------- ----------- -----------
Income from operations............................. 322,277 332,739 70,749
----------- ----------- -----------
Other income (expense):
Interest income.................................. 3,478 7,470 5,535
Interest expense................................. (6,152) (13,132) (3,219)
Miscellaneous income............................. 3,992 400 4,357
----------- ----------- -----------
1,318 (5,262) 6,673
----------- ----------- -----------
Income before income taxes......................... 323,595 327,477 77,422
Income tax expense................................. 94,193 63,534 21,074
----------- ----------- -----------
Net income......................................... $ 229,402 $ 263,943 $ 56,348
=========== =========== ===========
</TABLE>
See accompanying notes to combined financial statements.
54
<PAGE> 57
RESOURCE ONE, INC.
COMBINED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
FOR THE YEARS ENDED DECEMBER 31, 1994 AND 1995 AND THE
NINE MONTHS ENDED SEPTEMBER 30, 1996
(SEE NOTE 1)
<TABLE>
<CAPTION>
ADDITIONAL TOTAL
COMMON PAID-IN RETAINED STOCKHOLDERS'
STOCK CAPITAL EARNINGS EQUITY
------ ---------- --------- -------------
<S> <C> <C> <C> <C>
Balance, December 31, 1993................. $1,000 $206,885 $ 322,168 $530,053
Purchase and retirement of treasury
stock.................................... -- (2,605) -- (2,605)
Distributions to shareholders.............. -- -- (411,481) (411,481)
Net income................................. -- -- 229,402 229,402
------ -------- --------- --------
Balance, December 31, 1994................. 1,000 204,280 140,089 345,369
Purchase and retirement of treasury
stock.................................... (60,000) -- (60,000)
Distributions to shareholders.............. -- -- (156,185) (156,185)
Net income................................. -- -- 263,943 263,943
------ -------- --------- --------
Balance, December 31, 1995................. 1,000 144,280 247,847 393,127
Net income................................. -- -- 56,348 56,348
------ -------- --------- --------
Balance, September 30, 1996................ $1,000 $144,280 $ 304,195 $449,475
====== ======== ========= ========
</TABLE>
See accompanying notes to combined financial statements.
55
<PAGE> 58
RESOURCE ONE, INC.
COMBINED STATEMENTS OF CASH FLOWS
(SEE NOTE 1)
<TABLE>
<CAPTION>
NINE MONTHS
YEAR ENDED ENDED
DECEMBER 31, SEPTEMBER 30,
-------------------- -------------
1994 1995 1996
-------- -------- -------------
<S> <C> <C> <C>
Cash flows from operating activities
Net income............................................ $229,402 $263,943 $ 56,348
Adjustments to reconcile net income to net cash (used
for) provided by operating activities:
Depreciation....................................... 108,182 90,228 52,262
Provision for uncollectible accounts............... 2,586 -- --
Deferred income taxes.............................. -- -- (2,347)
Changes in assets and liabilities:
Increase in accounts receivable.................. (115,258) (84,348) (476,313)
Increase in prepaid expenses..................... -- -- (23,350)
Increase (decrease) in other assets.............. (10,030) (88,658) 33,134
Increase in accounts payable and other
liabilities................................... 34,424 29,922 16,398
Increase in accrued leased employee costs and
expenses payable.............................. 144,348 188,608 352,854
(Increase) decrease in amounts owed to
customer...................................... -- 47,534 (11,124)
(Increase) decrease in income taxes payable...... 38,525 (15,502) (18,750)
-------- -------- --------
Net cash provided by (used for) operating
activities....................................... 432,179 431,727 (20,888)
-------- -------- --------
Cash flows from investing activities
Purchases of property and equipment, net of minor
retirements........................................ (28,024) (72,642) (53,308)
-------- -------- --------
Net cash used for investing activities............. (28,024) (72,642) (53,308)
-------- -------- --------
Cash flows from financing activities
Distributions to shareholders......................... (411,481) (156,185) --
Purchase of treasury stock............................ (2,605) (60,000) --
Principal borrowings on notes payable................. 178,681 60,000 --
Principal repayments on notes payable................. (33,379) (122,379) (93,421)
-------- -------- --------
Net cash used for financing activities............. (268,784) (278,564) (93,421)
-------- -------- --------
Net (increase) decrease in cash....................... 135,371 80,521 (167,617)
Cash and cash equivalents at beginning of period...... 146,214 281,585 362,106
-------- -------- --------
Cash and cash equivalents at end of period............ $281,585 $362,106 $194,489
======== ======== ========
</TABLE>
See accompanying notes to combined financial statements.
56
<PAGE> 59
RESOURCE ONE, INC.
NOTES TO COMBINED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 1994 AND 1995 AND THE
NINE MONTHS ENDED SEPTEMBER 30, 1996
NOTE 1 -- NATURE OF BUSINESS, BASIS OF PRESENTATION AND SUMMARY OF SIGNIFICANT
ACCOUNTING POLICIES:
BUSINESS ACTIVITY AND BASIS OF PRESENTATION
Resource One, Inc. (the "Company") is a Florida corporation with two
wholly-owned subsidiaries -- Human Resource One, Inc. ("HR One"), a Florida
corporation engaged in the business of employee leasing, and Professional
Insurance Planners of Florida, Inc. ("PIP"), a Florida corporation which serves
as a third party administrator for an insurance trust and other commercial
clients which self-insure.
Effective January 1, 1996, the Company, which had no operations prior to
that date, issued 100% of its common shares outstanding in exchange for all of
the outstanding common shares of HR One and PIP. Because the companies are
controlled by a common group of shareholders, the transaction was accounted for
as a combination of interests at historical cost, which is similar to a pooling
of interests.
RX One, Inc. ("RX One") is a Florida corporation engaged in the business of
providing prescription drug cards for the employees of clients of HR One and
PIP. RX One commenced operations during the first quarter of 1996 and has been
included in the combined financial statements because it is affiliated with the
Company through common ownership. Consequently, the accompanying financial
statements reflect the combined financial position and results of operations for
HR One, PIP and RX One for all periods presented.
Any reference made to the Company in the combined financial statements
includes RX One, as well as the Company's wholly-owned subsidiaries.
The Company's customers are businesses operating in a variety of industries
in locations throughout the United States. However, a considerable portion of
the Company's revenues and accounts receivable are related to transactions with
customers located in the State of Florida.
PRINCIPLES OF COMBINATION
The accompanying combined financial statements include the accounts of the
Company, HR One, PIP and RX One after elimination of all material intercompany
balances and transactions.
USE OF ESTIMATES
In preparing the financial statements, management is required to make
estimates and assumptions that affect the reported amounts of assets and
liabilities as of the date of the balance sheets and affect revenue and expense
for the periods presented. Actual results could differ significantly from those
estimates.
CASH AND CASH EQUIVALENTS
The Company considers its holdings of highly liquid debt and money market
instruments to be cash equivalents if the securities mature within 90 days from
the date of acquisition or contain an investor put option which can be exercised
at par within 90 days of acquisition. These investments are carried at cost,
which approximates fair value.
57
<PAGE> 60
RESOURCE ONE, INC.
NOTES TO COMBINED FINANCIAL STATEMENTS -- (CONTINUED)
PROPERTY AND EQUIPMENT
Property and equipment are carried at cost and are depreciated using
straight line and accelerated methods over their estimated useful lives which
range as follows:
<TABLE>
<CAPTION>
YEARS
------
<S> <C>
Computer equipment and software............................. 3 - 10
Office furniture and equipment.............................. 5 - 10
Leasehold improvements...................................... 10
</TABLE>
Expenditures for renewals and betterments that extend the useful lives of
property and equipment are capitalized. Expenditures for maintenance and repairs
are charged to expense as incurred.
INCOME TAXES
The Company uses the liability method of accounting for deferred income
taxes. Consequently, income tax expense consists of Federal and state income
taxes currently payable or refundable, and those deferred because of temporary
differences between the financial statement and tax bases of assets and
liabilities, net of any related valuation allowance. The effective tax expense
rate differs from the combined statutory Federal and state rate primarily due to
Federal income tax credits generated during the years ended December 31, 1994
and 1995 and the nine months ended September 30, 1996.
For the year ended December 31, 1995, HR One elected S corporation status
under the Internal Revenue Code. Consequently, in lieu of corporate income tax
expense for that year, the shareholder of the corporation was taxed on HR One's
taxable income.
58
<PAGE> 61
RESOURCE ONE, INC.
NOTES TO COMBINED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 2 -- SEPARATE COMPANY FINANCIAL INFORMATION:
Revenues, net income and other changes in stockholders' equity of the
separate companies for the periods presented were as follows:
<TABLE>
<CAPTION>
HR ONE PIP RX ONE COMBINED
----------- ---------- -------- -----------
<S> <C> <C> <C> <C>
For the year ended December 31,
1994:
Revenues......................... $ 9,975,120 $2,011,620 $ -- $11,986,740
Net income..................... 72,076 157,326 -- 229,402
Purchase and retirement of
treasury stock.............. -- 2,605 -- 2,605
Distributions to
shareholders................ -- 411,481 -- 411,481
For the year ended December 31,
1995:
Revenues......................... $16,897,280 $1,851,934 $ -- $18,749,214
Net income..................... 144,649 119,294 -- 263,943
Purchase and retirement of
treasury stock.............. 60,000 -- -- 60,000
Distributions to
shareholders................ 156,185 -- -- 156,185
For the nine months ended
September 30, 1996:
Revenues......................... $22,101,897 $1,361,221 $ 1,602 $23,464,720
Net income (loss).............. 42,528 27,809 (13,989) 56,348
Purchase and retirement of
treasury stock.............. -- -- -- --
Distributions to
shareholders................ -- -- -- --
</TABLE>
NOTE 3 -- PROPERTY AND EQUIPMENT:
Property and equipment consist of the following:
<TABLE>
<CAPTION>
DECEMBER 31,
---------------------- SEPTEMBER 30,
1994 1995 1996
--------- --------- -------------
<S> <C> <C> <C>
Computer equipment and software............... $ 532,412 $ 467,021 $ 510,549
Office furniture and equipment................ 158,605 163,668 162,064
Leasehold improvements........................ 10,582 10,582 10,582
--------- --------- ---------
701,599 641,271 683,195
Less accumulated depreciation................. (535,590) (492,848) (533,726)
--------- --------- ---------
$ 166,009 $ 148,423 $ 149,469
========= ========= =========
</TABLE>
Depreciation expense amounted to $108,182, $90,228 and $52,262 for years
ended December 31, 1994 and 1995, and the nine months ended September 30, 1996,
respectively.
59
<PAGE> 62
RESOURCE ONE, INC.
NOTES TO COMBINED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 4 -- NOTES PAYABLE:
Notes payable are summarized as follows:
<TABLE>
<CAPTION>
DECEMBER 31,
-------------------- SEPTEMBER 30,
1994 1995 1996
-------- -------- -------------
<S> <C> <C> <C>
Various installment notes payable monthly
through December 1997, interest rates ranging
from 7% to 8.5%, collateralized by stock and
equipment..................................... $163,377 $100,998 $7,577
Less amount payable within one year............. 94,529 70,233 --
-------- -------- ------
Amount payable after one year................... $ 68,848 $ 30,765 $7,577
======== ======== ======
</TABLE>
Interest paid totaled $6,152, $13,332 and $3,219 for years ended December
31, 1994 and 1995 and the nine months ended September 30, 1996, respectively.
NOTE 5 -- COMMITMENTS AND CONTINGENCIES:
LEASE COMMITMENTS
The Company leases its office space and certain equipment under
noncancelable operating lease agreements. Annual remaining minimum rentals
required by these leases are as follows:
<TABLE>
<CAPTION>
YEAR ENDING SEPTEMBER 30, AMOUNT
------------------------- --------
<S> <C>
1997.................................................... $197,596
1998.................................................... 110,163
1999.................................................... 56,367
2000.................................................... 57,931
2001.................................................... 9,655
--------
$431,712
========
</TABLE>
Rental expense for years ended December 31, 1994 and 1995 and the nine
months ended September 30, 1996 approximated $141,000, $155,000 and $155,000,
respectively.
CONCENTRATION OF CREDIT RISK
The Company extends credit, in the normal course of business, to a variety
of corporate entities located throughout the United States. Although the
Company's trade receivables are typically not collateralized, historically, no
significant credit related losses have been incurred.
As of December 31, 1994, December 31, 1995 and September 30, 1996, the
Company had cash balances on deposit with federally insured financial
institutions which exceeded federally insured limits by approximately $10,000,
$120,000 and $137,000, respectively.
The Company also has an investment account balance with a local bank in
South Miami. As of December 31, 1994 and 1995, and September 30, 1996, the
account balance totaled approximately $240,000, $244,000 and $146,000,
respectively. Such deposits are not covered by Federal depositor insurance;
however, they are secured by U.S. Government securities.
LEGAL MATTERS
The Company is party to litigation arising in the normal course of
business. Management, after consultation with legal counsel, does not believe
that the resolution of any such matters will have a material effect on the
Company's financial position or results of operations.
60
<PAGE> 63
RESOURCE ONE, INC.
NOTES TO COMBINED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 6 -- INCOME TAXES:
The components of income tax expense included in the accompanying
statements of income consist of the following:
<TABLE>
<CAPTION>
NINE
YEAR ENDED MONTHS ENDED
DECEMBER 31, SEPTEMBER 30,
------------------ -------------
1994 1995 1996
------- ------- ----
<S> <C> <C> <C>
Current expense:
Federal................................................ $80,625 $53,198 $19,148
State.................................................. 13,568 10,336 4,273
Deferred benefit......................................... -- -- (2,347)
------- ------- -------
Total income tax expense....................... $94,193 $63,534 $21,074
======= ======= =======
</TABLE>
At December 31, 1994 and 1995, there were no deferred tax assets or
liabilities. At September 30, 1996, the Company had gross deferred tax assets
totaling $2,347 and no deferred tax liabilities. Income taxes paid during the
years ended December 31, 1994 and 1995 and the nine months ended September 30,
1996 totaled approximately $92,000, $44,000 and $86,000, respectively.
NOTE 7 -- STOCKHOLDERS' EQUITY:
On August 31, 1994, PIP entered into an agreement with one of its
stockholders to repurchase the 2,500 shares of common stock owned by that
individual. The purchase price paid for the shares totaled $178,680. In
connection with this transaction, PIP issued a note payable for the purchase
price. The note bore interest at 7% with principal and interest payable monthly
until maturity on September 1, 1996. This note was paid off on January 31, 1996.
On January 1, 1995, HR One entered into an agreement with one of its
stockholders to repurchase the 50,000 shares of common stock owned by that
individual. The purchase price paid for the shares totaled $60,000. In
connection with this transaction, HR One issued a note payable for the purchase
price. The note bore interest at 8% payable monthly and was due in a single
payment on December 31, 1997. This note was paid off during 1996.
NOTE 8 -- SALARY SAVINGS PLAN:
The Company has adopted a salary savings plan (401K) which covers
substantially all employees age twenty-one or over who have completed ninety
days of service. Eligible employees may elect to contribute a portion of their
earnings to the plan. Matching contributions are made by the Company to the plan
on a discretionary basis. No contributions were made by the Company to the plan
during the years ended December 31, 1994 or 1995 or during the nine months ended
September 30, 1996.
NOTE 9 -- SUBSEQUENT EVENT:
Effective October 1, 1996, 100% of the Company's outstanding common stock
was purchased by NovaCare Employee Services, Inc., a Delaware corporation.
61
<PAGE> 64
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURES
The Registrant has had no changes in or disagreements with accountants on
accounting and financial disclosure of the type referred to in Item 304 of
Regulation S-K.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
For information concerning this item, see "Item 1 -- Business -- Executive
Officers of the Registrant" and the table and text under the caption "Name of
Nominee and Biographical Information" and "Section 16(a) Reporting Requirements"
of the Proxy Statement to be filed with respect to the 1998 annual meeting of
shareholders to be held on December 8, 1998 (the "Proxy Statement"), which
information is incorporated herein by reference.
ITEM 11. EXECUTIVE COMPENSATION
For information concerning this item, see the table and text under the
captions "Compensation of Executive Officers of the Company", "Compensation of
Directors of the Company", "Compensation Committee Interlocks and Insider
Participation" and "Employment Agreements" of the Proxy Statement, which
information is incorporated herein by reference.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
For information concerning this item, see the table and text under the
captions "Shares of Common Stock Owned Beneficially as of August 31, 1998" and
"Information Concerning Certain Stockholders" of the Proxy Statement, which
information is incorporated herein by reference.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
For information concerning this item, see the text under the caption
"Certain Transactions" of the Proxy Statement, which information is incorporated
herein by reference.
62
<PAGE> 65
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a) The following documents are filed as part of this report:
<TABLE>
<CAPTION>
PAGE
NUMBER
------
<S> <C> <C>
(1) FINANCIAL STATEMENTS:
NOVACARE EMPLOYEE SERVICES, INC. AND SUBSIDIARIES (THE
"COMPANY")
Consolidated Balance Sheets at June 30, 1998 and 1997....... 31
Consolidated Statements of Operations for the year ended
June 30, 1998 and the period October 1, 1996 (inception)
to June 30, 1997.......................................... 32
Consolidated Statements of Shareholders' Equity for the
period October 1, 1996 (inception) to June 30, 1998....... 33
Consolidated Statements of Cash Flows for the year ended
June 30, 1998 and the period October 1, 1996 (inception)
to June 30, 1997.......................................... 34
Notes to Consolidated Financial Statements.................. 35
Report of Independent Accountants........................... 51
RESOURCE ONE, INC. (THE "PREDECESSOR")
Independent Auditors Report................................. 52
Combined Balance Sheets as of December 31, 1994 and 1995 and
September 30, 1996........................................ 53
Combined Statements of Income for the two years in the
period ended December 31, 1995 and the nine months ended
September 30, 1996........................................ 54
Combined Statements of Changes in Stockholders' Equity for
the two years in the period ended December 31, 1995 and
the nine months ended September 30, 1996.................. 55
Combined Statements of Cash Flows for the two years in the
period ended December 31, 1995 and the nine months ended
September 30 1996......................................... 56
Notes to Combined Financial Statements...................... 57
(2) EXHIBITS (NUMBERED IN ACCORDANCE WITH ITEM 601 OF REGULATION
S-K):
The exhibits required to be filed are listed in the index to
exhibits.................................................. 65
</TABLE>
(b) Current Reports on Form 8-K:
The Company filed no current reports on Form 8-K during the fourth
quarter ended June 30, 1998
63
<PAGE> 66
POWER OF ATTORNEY
The Registrant and each person whose signature appears below hereby appoint
E. Martin Gibson and Loren J. Hulber as attorneys-in-fact with full power of
substitution, severally, to execute in the name and on behalf of the Registrant
and each such person, individually and in each capacity stated below, one or
more amendments to the annual report which amendments may make such changes in
the report as the attorney-in-fact acting in the premises deems appropriate and
to file any such amendment to the report with the Securities and Exchange
Commission.
------------------------
SIGNATURES
Pursuant to the requirements of Section 13 or 15 (d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.
NOVACARE EMPLOYEE SERVICES, INC.
By: /s/ THOMAS D. SCHUBERT
------------------------------------
THOMAS D. SCHUBERT
(SENIOR VICE PRESIDENT AND CHIEF
FINANCIAL
AND ACCOUNTING OFFICER)
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
Registrant and in the capacities and on the dates indicated.
<TABLE>
<CAPTION>
SIGNATURE TITLE DATE
--------- ----- ----
<C> <S> <C>
/s/ E. MARTIN GIBSON Chairman of the Board and September 28, 1998
- --------------------------------------------------- Director
(E. MARTIN GIBSON)
/s/ LOREN J. HULBER President, Chief Executive September 28, 1998
- --------------------------------------------------- Officer and Director
(LOREN J. HULBER)
/s/ THOMAS D. SCHUBERT Senior Vice President and September 28, 1998
- --------------------------------------------------- Chief Financial and Accounting
(THOMAS D. SCHUBERT) Officer
/s/ HARVEY V. FINEBERG, M.D. Director September 28, 1998
- ---------------------------------------------------
(HARVEY V. FINEBERG, M.D.)
/s/ JOHN H. FOSTER Director September 28, 1998
- ---------------------------------------------------
(JOHN H. FOSTER)
/s/ TIMOTHY E. FOSTER Director September 28, 1998
- ---------------------------------------------------
(TIMOTHY E. FOSTER)
/s/ STEPHEN E. O'NEIL Director September 28, 1998
- ---------------------------------------------------
(STEPHEN E. O'NEIL)
</TABLE>
64
<PAGE> 67
INDEX TO EXHIBITS
<TABLE>
<CAPTION>
EXHIBIT PAGE
NUMBER EXHIBIT DESCRIPTION NUMBER
- ------- ------------------- ------
<S> <C> <C>
2(a) Stock Purchase Agreement dated September 16, 1996 by and
among Resource One, Inc., Professional Insurance Planners of
Florida, Inc., Human Resources One, Inc., Rx One, Inc.,
William Mayville, Bernard Clinton Byrd, Jr. and Nova
Resource, Inc. (incorporated by reference to Exhibit 2(a) to
the Company's Registration Statement on Form S-1 (No.
333-35071)) --
2(b) Amendment dated April 8, 1997 to the stock purchase
agreement dated as of September 16, 1996 by and among
Resource One, Inc., Professional Insurance Planners of
Florida, Inc., Human Resource One, Inc., Rx One, Inc.,
William E. Mayville, Bernard Clinton Byrd, Jr. and
NovaSource, Inc (incorporated by reference to Exhibit 2(b)
to the Company's Registration Statement on Form S-1 (No.
333-35071)) --
2(c) Stock Purchase Agreement dated January 24, 1997 by and among
Employee Services of America, Inc., Employee Services of
Florida, Inc., Employers Risk Management, Inc., Employee
Benefits Management, Inc., Employers Diversified Services,
Inc., and Nova Resource, Inc. (incorporated by reference to
Exhibit 2(c) to the Company's Registration Statement on Form
S-1 (No. 333-35071)) --
2(d) Stock Purchase Agreement dated January 31, 1997 by and among
the TPI Group, LTD., Deborah M. Skinner, John Skinner III,
Malvern Tippett, Carolyn Tippett, Terry DeLong, Quansoo-TPI
L.L.C. and NovaSource, Inc. (incorporated by reference to
Exhibit 2(d) to the Company's Registration Statement on Form
S-1 (No. 333-35071)) --
2(e) Stock Purchase Agreement dated December 1, 1997 by and among
AmeriCare Employers Group, Inc., Paralign Staffing
Technologies, Inc., Ronald N. Shostack, Kerran L. Shostack,
Ian Ackerman, Theresa Conroy, Zanza Personnel, Inc. and
NovaCare Employee Services, Inc. (incorporated by reference
to Exhibit 2 to the Company's current report on Form 8-K
dated February 2, 1998) --
3(a) Certificate of Incorporation of the Company (incorporated by
reference to Exhibit 3(a) to the Company's Registration
Statement on Form S-1 (No. 333-35071)) --
3(b) By-laws of the Company, as amended to date (incorporated by
reference to Exhibit 3(b) to the Company's Registration
Statement on Form S-1 (No. 333-35071)) --
4(a) 1997 Stock Option Plan (incorporated by reference to Exhibit
4(a) to the Company's Registration Statement on Form S-1
(No. 333-35071)) --
4(b) Amendment No. 1 to the 1997 Stock Option Plan, dated as of
November 24, 1997 (incorporated by reference to Exhibit 4(a)
to the Company's Quarterly Report on Form 10-Q for the
quarter ended December 31, 1997) --
10(a) Employment Agreement dated as of October 8, 1996 between the
Company and Bernard C. Byrd, Jr. (incorporated by reference
to Exhibit 10(e) to the Company's Registration Statement on
Form S-1 (No. 333-35071)) --
10(b) Amendment dated as of April 8, 1997 to the Employment
Agreement dated October 8, 1996 between the Company and
Bernard C. Byrd, Jr. (incorporated by reference to Exhibit
10(g) to the Company's Registration Statement on Form S-1
(No. 333-35071)) --
10(c) Stock Purchase Agreement dated as of February 28, 1997
between the Company and Bernard C. Byrd, Jr. (incorporated
by reference to Exhibit 10(g) to the Company's Registration
Statement on Form S-1 (No. 333-35071)) --
10(d) Employment Agreement dated as of January 10, 1997 between
the Company and Loren J. Hulber (incorporated by reference
to Exhibit 10(a) to the Company's Registration Statement on
Form S-1 (No. 333-35071)) --
10(e) Stock Purchase Agreement dated as of February 10, 1997
between the Company and Loren J. Hulber (incorporated by
reference to Exhibit 10(b) to the Company's Registration
Statement on Form S-1 (No. 333-35071)) --
10(f) Employment Agreement dated as of April 23, 1997 between the
Company and Andrew Stith (incorporated by reference to
Exhibit 10(h) to the Company's Registration Statement on
Form S-1 (No. 333-35071)) --
10(g) Stock Purchase Agreement dated as of April 23, 1997 between
the Company and Andrew Stith (incorporated by reference to
Exhibit 10(i) to the Company's Registration Statement on
Form S-1 (No. 333-35071)) --
</TABLE>
65
<PAGE> 68
<TABLE>
<CAPTION>
EXHIBIT PAGE
NUMBER EXHIBIT DESCRIPTION NUMBER
- ------- ------------------- ------
<S> <C> <C>
10(h) Employment Agreement dated as of May 7, 1997 between the
Company and Thomas D. Schubert (incorporated by reference to
Exhibit 10(c) to the Company's Registration Statement on
Form S-1 (No. 333-35071)) --
10(i) Stock Purchase Agreement dated as of June 10, 1997 between
the Company and Thomas D. Schubert (incorporated by
reference to Exhibit 10(k) to the Company's Registration
Statement on Form S-1 (No. 333-35071)) --
10(j) Employment Agreement dated as of June 18, 1997 between the
Company and Christina Harris (incorporated by reference to
Exhibit 10(i) to the Company's Registration Statement on
Form S-1 (No. 333-35071)) --
10(k) Employment Agreement dated as of December 10, 1997 between
the Company and Kenneth J. Jankowski (incorporated by
reference to Exhibit 10(a) to the Company's Quarterly Report
on Form 10-Q for the quarter ended December 31, 1997) --
10(l) Agreement dated as of January 25, 1997 between NovaCare,
Inc. and NovaCare Employee Services, Inc. (incorporated by
reference to Exhibit 10(m) to the Company's Registration
Statement on Form S-1 (No. 333-35071)) --
10(m) Agreement dated as of January 25, 1997 between NovaCare,
Inc. and NovaCare Employee Services, Inc. (incorporated by
reference to Exhibit 10(n) to the Company's Registration
Statement on Form S-1 (No. 333-35071)) --
10(n) Amended and Restated Agreement dated as of July 1, 1998
between NovaCare, Inc. and NovaCare Employee Services, Inc.
10(o) Trademark Agreement dated as of February 28, 1997 between
the Company and NovaMark, Inc. (incorporated by reference to
Exhibit 10(o) to the Company's Registration Statement on
Form S-1 (No. 333-35071)) --
10(p) (i) $25,000,000 Revolving Credit Facility Credit Agreement
by and among NovaCare Employee Services, Inc., and certain
of its subsidiaries and the banks party thereto and PNC
Bank, National Association, as agent, dated as of November
17, 1997 (incorporated by reference to Exhibit 10(a) to the
Company's Quarterly Report on Form 10-Q for the Quarter
ended September 30, 1997) --
(ii) Revolving Credit Agreement First Amendment dated as of
March 30, 1998 by and among NovaCare Employee Services, Inc.
and certain of its subsidiaries and PNC Bank, N.A., SunTrust
Bank of Central Florida, N.A., Bank One of Kentucky, N.A.
and AMSouth Bank (incorporated by reference to Exhibit 10(a)
to the Company's Quarterly Report on Form 10-Q for the
quarter ended March 31, 1998) --
(iii) Revolving Credit Agreement Second Amendment dated as
of July 7, 1998 by and among NovaCare Employee Services,
Inc. and certain of its subsidiaries and PNC Bank, N.A.,
SunTrust Bank of Central Florida, N.A., Bank One of
Kentucky, N.A., and AMSouth Bank.
10(q) Supplemental Benefits Plan (incorporated by reference to
Exhibit 10(r) to the Company's Registration Statement on
Form S-1 (No. 333-35071)) --
21 Subsidiaries of the Company
23 Consent of Independent Accountants
24 Power of Attorney (See "Power of Attorney" in Form 10-K) --
27 Financial Data Schedules
</TABLE>
Copies of the exhibits filed with this Annual Report on Form 10-K or
incorporated by reference herein do not accompany copies hereof for distribution
to shareholders of the Company. The Company will furnish a copy of any such
exhibits to any shareholder requesting the same.
66
<PAGE> 1
EXHIBIT 10(n)
AMENDED AND RESTATED SUBSCRIBER SERVICE AGREEMENT
This Amended and Restated Subscriber Service Agreement (the
"Agreement") is made as of the 1st day of July, 1998 (the "Effective Date") by
and between NovaCare, Inc., a Delaware corporation with its principal place of
business at 1016 W. Ninth Avenue, King of Prussia, Pennsylvania 19406 and its
subsidiaries listed on Exhibit A ("Subscriber"), and NovaCare Employee Services,
Inc. ("NovaCare"), a Delaware corporation with its principal place of business
at 2621 Van Buren Avenue, Norristown, Pennsylvania 19403. This Agreement
modifies and supersedes the Subscriber Service Agreement dated January 25, 1997,
between Subscriber and NovaCare (the "Initial Agreement").
W I T N E S S E T H:
WHEREAS, NovaCare has expertise in employment relations matters,
including payroll and benefits administration, workers' compensation insurance
management (including risk assessment, injury prevention and claims management),
recruiting, human resources policies, procedures and practices (including
consulting and intervention to resolve employment-related issues) and training
and development;
WHEREAS, since January 25, 1997, Subscriber has outsourced certain
human resource functions to NovaCare pursuant to the Initial Agreement in order
to improve service and reduce costs by taking advantage of the expertise of a
focused human resources business; and
WHEREAS, Subscriber now wishes to outsource additional human resource
services to NovaCare pursuant to the terms and conditions contained in this
Agreement;
NOW, THEREFORE, in consideration of the premises and the mutual
covenants and promises herein contained, and intending legally to be bound, the
parties have amended and restated the Initial Agreement as follows:
1. Parties' Intent
Subscriber and NovaCare understand and intend that, under this
Agreement, NovaCare will assume certain rights and duties of a co-employer with
respect to employees located at Subscriber worksites or at worksites at which
Subscriber provides services pursuant to a contract with the business located at
the worksite (an employee at any of such worksites hereinafter being referred to
as a "Worksite Employee").
<PAGE> 2
2. Term and Termination.
2.1 Initial Term. The initial term (the "Initial Term") of
this Agreement shall be from July 1, 1998 through June 30, 2002, unless sooner
terminated pursuant to Section 2.3 below.
2.1.2 Renewal Term. This Agreement shall automatically renew
for an additional one-year term (a "Renewal Term") upon the expiration of the
Initial Term and each subsequent Renewal Term, unless written notice of
non-renewal is given by either party at least nine (9) months prior to the
expiration of the Initial or any Renewal Term.
2.1.3 Termination.
2.3.1 By NovaCare. NovaCare may terminate this
Agreement upon notice to Subscriber, in the event that:
(a) Subscriber fails to pay any sums due
hereunder, and such failure continues for three (3) business days after written
notice thereof is sent to Subscriber, certified or registered mail, return
receipt requested;
(b) Subscriber fails at any time to procure
or maintain any insurance coverage required by this Agreement;
(c) Subscriber fails to perform or observe
any duty, obligation or covenant contained in this Agreement other than those
set forth in subparagraph (a) or subparagraph (b) above, and such failure
continues for ten (10) days after written notice thereof is sent to Subscriber,
certified or registered mail, return receipt requested;
(d) Subscriber becomes insolvent (that is,
unable to pay its debts as they mature or in accordance with customary business
practice) or commits an act of bankruptcy, or applies for, consents to, or
acquiesces in the appointment of a trustee or a receiver for it or any of its
property, or, in the absence of such application, consent or acquiescence, a
trustee or receiver is appointed for Subscriber or for a substantial part of its
property and is not discharged within thirty days thereof, or if any bankruptcy
or insolvency proceeding, or any dissolution or liquidation proceeding, is
instituted by or against Subscriber and is consented to or acquiesced in by
Subscriber or remains for thirty (30) days undismissed;
(e) there occurs the termination, cessation
or liquidation of the Subscriber's business;
2
<PAGE> 3
(f) any representation, warranty or
statement of material fact made or furnished to NovaCare or NovaCare's
representatives by or on behalf of the Subscriber, or any document, instrument
or other paper submitted to NovaCare or NovaCare's representatives by or on
behalf of Subscriber, is false or misleading in any material respect;
(g) NovaCare determines, and obtains an
opinion of counsel to the effect, that all or a substantial portion of its
receipts hereunder are or will become subject to a sales, value added, gross
receipts or similar tax in a particular jurisdiction as to which it exercises
its right to terminate;
(h) changes in federal, state or local law,
regulation or controlling legal interpretation occur that make it legally
impossible or economically impractical for NovaCare to carry out its obligations
hereunder in the jurisdiction(s) as to which it exercises its right to
terminate;
(i) Subscriber fails to comply with any
reasonable directive regarding health and safety from NovaCare, NovaCare's
workers' compensation carrier, or any government agency with jurisdiction over a
health or safety matter; or
(j) Subscriber misrepresents workers'
compensation or Fair Labor Standards Act classification or inaccurately reports
employee payroll hours, pay rate or salary.
2.3.2 By Subscriber. Subscriber may terminate this
Agreement upon notice to NovaCare in the event that:
(a) NovaCare fails to pay any sums required
to be paid hereunder by NovaCare as co-employer of the Worksite Employees (i) to
or on behalf of a Worksite Employee or (ii) to a governmental agency, insurance
carrier, third party administrator or other third party, and such failure
continues for three (3) business days after written notice thereof is sent to
NovaCare, certified or registered mail, return receipt requested;
(b) NovaCare fails at any time to procure or
maintain insurance coverage required by this Agreement;
(c) NovaCare fails to meet the following
service performance standards, and such failure continues for a period of sixty
(60) days after written notice thereof is sent to NovaCare, certified or
registered mail, return receipt requested:
3
<PAGE> 4
(i) employee status change
transactions (new hires, wage and salary actions, changes in status from
full-time to part-time or on or off leave and terminations) (hereinafter
referred to as "Status Transactions") received in a form acceptable to NovaCare
by the established payroll cut-cut-off date and time (the "Payroll Cut-off") for
a payroll will be processed for that payroll;
(ii) payroll data received by
NovaCare's designated representative by the Payroll Cut-off will be processed to
deliver payroll on time one hundred percent (100%) of the time, except for
natural disasters or other circumstances beyond NovaCare's control, and
ninety-nine percent (99%) of paychecks will correctly reflect information
transmitted from the Subscriber;
(iii) new hire and status change
benefit forms ("Benefit Forms") will be submitted to the third party
administrator responsible for the applicable benefit plan within one (1) week of
receipt by NovaCare's designated representative. If NovaCare acts as the plan
administrator, it will update its file and provide confirmation;
(iv) ninety percent (90%) of
incoming calls to the employee service center 1-800 phone number, during
established business hours, will be answered immediately and incoming calls
reaching voice mail will be returned by the end of the following business day;
and for open enrollment periods, the calls will be returned within three
business days.
(v) a customer service survey
measuring satisfaction with NovaCare services, in form and substance approved by
Subscriber, whose approval shall not be unreasonably withheld, will be conducted
no later than December 31 each year during the term hereof and the results will
show not greater than a five percent (5%) overall reduction in employee
satisfaction from the baseline established in the first annual survey
(d) NovaCare becomes insolvent (that is,
unable to pay its debts as they mature or in accordance with customary business
practice) or commits an act of bankruptcy, or applies for, consents to, or
acquiesces in the appointment of a trustee or a receiver for it or any of its
property, or, in the absence of such application, consent or acquiescence, a
trustee or receiver is appointed for NovaCare or for a substantial part of its
property and is not discharged within thirty days thereof, or if any bankruptcy
or insolvency proceeding, or any dissolution or liquidation proceeding, is
instituted by or against NovaCare and is consented to or acquiesced in by
NovaCare or remains or thirty (30) days undismissed;
(e) there occurs the termination, cessation
or liquidation of NovaCare's business;
4
<PAGE> 5
(f) any representation, warranty or
statement of material fact made or furnished to Subscriber or Subscriber's
representatives by or on behalf of NovaCare, or any document, instrument or
other paper submitted to Subscriber or Subscriber's representatives by or on
behalf of NovaCare, is false or misleading in any material respect; or
(g) NovaCare fails to perform or observe any
material duty, obligation or covenant contained in this Agreement other than
those set forth in subparagraph (a), subparagraph (b) or subparagraph (c) above,
and such failure continues for ten (10) days after written notice thereof is
sent to NovaCare, certified or registered mail, return receipt requested;
3. Fees.
3.1 Calculation of Fees.
3.1.1 Payroll Fees. The following Subscriber payments
will be processed by NovaCare and billed to Subscriber:
(a) gross earnings, including salary, wages, bonus,
vacation time, paid time off, sick time, commissions and severance pay (before
deductions, whether before tax or after tax) paid to Worksite Employees;
(b) the employer's portion of FICA and FUTA
attributable to gross earnings in accordance with such regulations;
(c) the employer's portion of contributions to the
NCES/NovaCare, Inc. 401(k) Retirement Savings Plan ("the 401(k) Plan") and the
NCES/NovaCare, Inc. Supplemental Benefits Plan ("the SBP"); and
(d) the net amount of expense reimbursement and any
other cash payment to a Worksite Employee that is included in a paycheck at the
request of Subscriber but is not includable in gross earnings for federal or
state tax purposes.
3.1.2 Benefits/Risk Management Fees. For
Benefits/Risk Management Responsibilities assumed hereunder, including
unemployment, workers compensation and health and welfare benefit plans,
Subscriber shall pay Benefits/Risk Management Fees to NovaCare equal to the
costs of handling such responsibilities, plus an annual fixed fee, which
initially shall be $4,000,000 on an annual basis, to be paid in monthly
installments; provided that the foregoing annual fee shall be adjusted annually,
as appropriate, to reflect material deviations in the scope of NovaCare's
responsibility with respect to Benefits/Risk Management.
3.1.3 Administrative Fees. For Administrative
Responsibilities assumed hereunder, Subscriber shall pay to NovaCare
Administrative Fees equal to an
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aggregate of $8,424,000 annually, to be paid in equal monthly installments,
provided that the total number of Worksite Employees employed during each
calendar month (derived by adding the number of Worksite Employees who start
employment as new hires during the month and the number of Worksite Employees
terminated during the month, to the number of Worksite Employees actually
employed on the first day of the month) is not less than 15,900 and not more
than 17,900. If the number of Worksite Employees falls beneath 15,900 during any
given calendar month, the Administrative Fees for that month shall be reduced by
an agreed upon amount for each incremental change up to 1,000 Worksite
Employees; and if the number of Worksite Employees exceeds 17,900 during any
given calendar month, the Administrative Fees for that month shall be increased
by an agreed upon amount (currently computed at $150,000 per annum) for each
incremental change up to 1,000 Worksite Employees.
3.1.4 Consulting Fees. For Consulting
Responsibilities assumed hereunder, Subscriber shall pay Consulting Fees to
NovaCare as negotiated between Subscriber and NovaCare (and confirmed in a
writing signed by both parties) for all projects requested. Subscriber and
NovaCare agree that the aggregate Consulting Fees for all such projects
requested by Subscriber during the twelve-month period beginning July 1, 1998
and ending June 30, 1999 shall in no event be less than $8,400,000 set forth on
schedule 3.1.4 attached hereto is a list of Consulting Projects identified by
the parties for the period of July 1, 1998 through June 30, 1999.
3.1.5 Outplacement Fees. For Outplacement
Responsibilities assumed hereunder, Subscriber shall pay Outplacement Fees to
NovaCare in the amount of $166,667 per calendar month for the period from July
1, 1998 to June 30, 2000.
3.1.6 Recruiting Fees. For Recruiting
Responsibilities assumed hereunder, Subscriber shall pay Recruiting Fees to
NovaCare in an aggregate annual amount equal to $12,800,000, to be paid in equal
monthly installments, for recruiting up to 4,300 individuals for the period July
1, 1998 to June 30, 1999. For each Worksite Employee actually commencing
employment annually during the term of this Agreement in excess of 4,300,
Subscriber shall pay NovaCare $2,235 per Worksite Employee as a result of the
recruiting function performed by NovaCare.
3.1.7 Additional Fees. Subscriber may request
NovaCare to assume additional responsibilities pursuant to Section 4.7 below
(hereinafter referred to as "Additional Responsibilities"). The fee for such
Additional Responsibilities shall be set forth in an addendum to this Agreement.
3.1.8 All fees and services noted in the above
categories will be negotiated annually between the two parties, but shall remain
as set forth herein unless otherwise mutually agreed by the parties. Any such
mutually determined changes will be reflected as contract amendments.
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3.2 Payment of Fees.
3.2.1 Payroll and Benefits/Risk Management Fees.
Subscriber shall fund an account with the amount of the Payroll Fees and
Benefits/Risk Management Fees (the "Payroll Account") in advance of each payroll
payment date. NovaCare shall have the right to draw against the Payroll Account
an amount equal to the Payroll Fees and Benefits/Management Fees for the
applicable payroll payment date. Subscriber agrees to collect, verify and
transmit to NovaCare's administrative office, no less than seven (7) business
days before each NovaCare payroll date, any information required to determine
correctly and accurately the amount of the payment due NovaCare. If Subscriber
defaults in paying the amounts due NovaCare and NovaCare continues to pay wages
for Worksite Employees at a rate not below the statutory minimum wage,
Subscriber shall fully indemnify and hold NovaCare harmless from any and all
claims made by employees for wages in excess of the amount paid by NovaCare and
any and all legal fees and expenses incurred in defense of such claims.
Additionally, Subscriber must immediately inform NovaCare of any situation in
which payment will not be immediately forthcoming and thereafter, at the request
of NovaCare, Subscriber shall terminate the employment of persons for whom
payment by Subscriber to NovaCare will not be made.
3.2.2 Administrative, Consulting, Outplacement and
Recruiting Fees. Administrative Fees, Consulting Fees, Outplacement Fees and
Recruiting Fees shall be invoiced monthly for delivery of services to be
completed during the month by NovaCare. Subscriber shall pay such invoices
within five days after receipt.
3.2.3 Additional Fees. Additional fees provided for
under Section 3.1.7 above shall be payable as specified in the applicable
addendum to this Agreement.
3.2.4 Subscriber is responsible for all sales,
franchise and use taxes applicable to the states in which business is being
conducted.
4. NovaCare's Responsibilities.
4.1 Payroll Responsibilities. NovaCare shall be responsible
for and shall perform the following functions ("Payroll Responsibilities") with
respect to Worksite Employees in consideration of the payment of Payroll Fees:
(i) Payment of wages based on hours, wage and salary
rates and other information supplied by Subscriber, including application of
set-offs owed to Subscriber and implementation of garnishment orders;
(ii) Calculation of Paid Time Off (in accordance with
Subscriber's policies);
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(iii) Calculation and payment of sign-on, relocation
and other bonuses;
(iv) Collection, reporting and payment of applicable
federal, state and local payroll taxes (exclusive of state unemployment
insurance);
(v) Calculation and payment of the employer's portion
of contributions to the 401(k) Plan and the SBP; and
(vi) Payment of expense reimbursement and any other
non-wage payments to Worksite Employees, as requested by Subscriber.
4.2 Benefits Responsibilities. NovaCare shall be responsible
for and shall perform the following functions with respect to Worksite Employees
in consideration of the payment of Benefits Fees:
(i) Collection of employee contributions, payment of
premiums and administration under the Plans;
(ii) Funding of Plans that require funding within the
time required by law;
(iii) Reporting and payment of applicable state
unemployment insurance;
(iv) Administration of unemployment compensation
claims; and
(v) Payment of workers' compensation insurance
premiums and administration and management of workers' compensation claims,
including payment of claims not paid by an insurance carrier or other third
party.;
4.3 Administrative Responsibilities. NovaCare shall be
responsible for and shall perform the following functions with respect to
Worksite Employees in consideration of the payment of Administrative Fees:
(i) Completion, reporting and maintenance of payroll
and Plan records, with the exception of records of hours worked, which shall be
collected, verified and maintained by Subscriber, provided that Subscriber shall
make available to NovaCare copies of such records of hours worked as NovaCare
may require for the purpose of maintaining the Plans;
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(ii) Analysis, transfer and integration of payroll
and benefits for Worksite Employees newly employed as a result of Subscriber's
acquisitions of businesses employing those individuals;
(iii) Operation of an employee service center
providing Worksite Employees with access for the purpose of making changes and
resolving questions relating to Plans and paychecks;
(iv) Administration of Compensation and Incentive
Plans;
(v) Development and implementation, not later than
September 30, 1998, of a system designed to report service of payroll "On time
delivery and accuracy" and responsiveness to incoming 1-800 calls to service
centers; and
(vi) Provision of reports within fifteen (15) days
after the last day of each calendar month showing its performance compared to
the performance standards established in Section 4.3. (v).
4.4 Consulting Responsibilities. Upon request of Subscriber,
NovaCare shall be responsible for the following functions with respect to
Worksite Employees in consideration of the payment of Consulting Fees:
(i) Design and communication of compensation,
incentive compensation and benefit programs;
(ii) Orientation of Worksite Employees who start
employment as new hires during the term of this Agreement;
(iii) Development of human resource policies and
procedures; and
(iv) Support of Subscriber's supervisory
representatives with respect to employee relations matters.
4.5 Outplacement Responsibilities. NovaCare shall be
responsible for the following function with respect to Worksite Employees in
consideration of the payment of Outplacement Fees:
(i) Assistance with resume preparation;
(ii) Inventorying of skills relevant to employment
searches;
(iii) Assistance with interviewing preparation.
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4.6 Recruiting Responsibilities. NovaCare shall be responsible
for the following functions with respect to Worksite Employees in consideration
of the payment of Recruiting Fees:
(i) Assist Subscriber in development of
specifications for open job requisitions identified by Subscriber;
(ii) Sourcing of candidates against the recruitment
profiles provided by job requisitions;
(iii) Conducting of preliminary interviews and
screens of candidates; and
(iv) Presentation to Subscriber of qualified
candidates for hiring identified through the sourcing, preliminary interviewing
and screening processes.
4.7 Additional Responsibilities. NovaCare may assume
additional responsibilities not covered by Sections 4.1-4.6 above. Any such
additional responsibilities shall be provided pursuant to a written addendum to
this Agreement, executed by both parties, setting forth the services to be
provided and the fee for such services.
5. Rights, Duties and Obligations of Subscriber.
5.1 Supervision of Employees. Subscriber will be responsible
for supervision and direction of Worksite Employees in carrying out the work of
Subscriber's business, and shall provide all instrumentalities (including
uniforms, tools, equipment and other supplies) necessary to the performance of
job functions.
5.2 Reports of Hours Worked. Subscriber shall maintain
accurate records of actual time worked, shall make accurate reports of time
worked by Worksite Employees to NovaCare in accordance with the requirements of
the Fair Labor Standards Act and any applicable similar state law and shall
verify the accuracy of such reports. Subscriber shall maintain the records
required to be kept under this Section 5.2 for seven (7) years.
5.3 Employment Decisions. Any common-law employee of
Subscriber shall be deemed a Worksite Employee hereunder. Subscriber shall
determine employment eligibility of all Worksite Employees. If a Worksite
Employee is required to possess or maintain a license, or to be supervised by a
supervisor who is required to possess or maintain a license, Subscriber shall be
responsible for verifying such licensure or providing such required supervision.
In taking any adverse action with respect to the pay, conditions of employment
or employment status of a Worksite Employee (an "Adverse Action"), Subscriber
shall comply with applicable law governing employment. Worksite Employees who
are supervisory employees shall act in that capacity in
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compliance with applicable law. Supervisors' actions alleged to be in violation
of law are outside the scope of their responsibility as NovaCare employees and
supervisory employees acting in violation of law shall be deemed to be acting
solely as agents of Subscriber.
5.4 Employee Benefit Plans. Subscriber shall not adopt,
establish, maintain, operate or contribute to any "employee benefit plan" as
defined in Section 3(3) of the Employee Retirement Income Security Act of 1974,
as amended, without the express written consent of NovaCare.
5.5 Financial Controls. Subscriber accepts sole responsibility
for accounting and other financial control policies (and fidelity bonding
requirements) applicable to Worksite Employees or their conduct.
5.6 Compliance With Law. Subscriber accepts sole
responsibility for compliance with the following provisions of law applicable to
Worksite Employees:
(i) the Occupational Safety and Health Act (OSHA) and
related or similar federal, state or local regulations and the employer's common
law duty to supervise the worksite and provide a safe working environment;
(ii) government contracting requirements under a)
Executive Order 11246, b) the Vocational Rehabilitation Act of 1973, c) the
Vietnam Era Veterans' Readjustment Assistance Act of 1974, d) the Walsh-Healy
Public Contracts Act, e) the Davis-Bacon Act, f) the Service Contract Act of
1965, and g) any and all similar, related, or like federal, state, or local
laws, regulations, ordinances, and statutes;
(iii) Worker Adjustment and Retraining Notification
Act ("WARN");
(iv) laws affecting assignment of and ownership of
intellectual property rights including, but not limited to, inventions, whether
patentable or not, and patents resulting therefrom, copyrights and trade
secrets;
(v) the Immigration Reform and Control Act of 1986,
except as otherwise provided in Section 6.1 (iv); and
(vi) the Fair Labor Standards Act, Title VII of the
Civil Rights Act of 1964, as amended, the Family and Medical Leave Act, the Age
Discrimination in Employment Act, as amended, the Americans With Disabilities
Act (including provisions thereunder relating to Subscriber's premises), and any
other federal, state, county or local laws, regulations, ordinances, and
statutes which govern the employer/employee relationship.
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5.7 Safety. Subscriber shall report all accidents in which
Worksite Employees are injured immediately (by telephone within one working day
of Subscriber's knowledge of an injury, and in writing by fax within forty-eight
(48) hours) to NovaCare or NovaCare's designee. Subscriber shall cooperate in
any safety inspection or investigation of a worksite injury conducted by or on
behalf of NovaCare. Subscriber shall reasonably cooperate with NovaCare in
returning injured Worksite Employees to work in available modified-duty
positions and in making reasonable accommodations under applicable disability
laws, subject to receipt of an appropriate medical release.
Where required by applicable state law, NovaCare
shall retain a right of direction and control over the management of safety,
risk and hazard control involving Worksite Employees. However, liability for
employee safety is a responsibility of Subscriber, who controls the worksites
and their business operations. Subscriber acknowledges that it is responsible
for maintaining a safe working environment, providing proper training in
compliance with federal or state law or regulation, and establishing and
maintaining such safety programs, safety policies, and safety committees as may
be required by law. NovaCare, NovaCare's workers' compensation and liability
insurance carriers or their assignees have the right to survey the Subscriber's
worksites to look for unsafe conditions or unsafe acts which may lead to
accidents. However, the retention of such right by NovaCare does not relieve
Subscriber of any obligations that it has pursuant to the federal Occupational
Safety and Health Act (OSHA) or any other federal, state or local law intended
to provide employees at Subscriber's worksites with a safe work environment.
5.8 COBRA. NovaCare shall be responsible for providing
continued health care coverage required under the Consolidated Omnibus Budget
Reconciliation Act of 1985, as amended ("COBRA Coverage") to each employee and
former employee (and their dependents) of the Subscriber who is eligible for
such COBRA Coverage on the effective date hereof. Subject to Section 7.1 and
Subscriber's reimbursement obligation (as set forth below), upon termination of
this Agreement, NovaCare shall provide COBRA Coverage to each Worksite Employee,
former Worksite Employee, their dependents and any individual entitled to COBRA
Coverage under the preceding sentence (collectively, the "COBRA Participants")
who are eligible for such coverage under any NovaCare "group health plan" (as
defined in Section 4980B(g)(2) of the Code) on the date of termination of this
Agreement or who become eligible for COBRA Coverage as a result of the
termination of this Agreement.
5.9. Provision of Information. Subscriber shall provide to
NovaCare such true and accurate information as NovaCare may request as necessary
to comply with requirements of law with respect to Subscriber's ownership and
organizational structure and compensation packages of its senior executives and
structure and operation of benefit plans offered to Worksite Employees by
Subscriber.
6. Rights, Duties and Obligations of NovaCare.
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6.1 Compliance With Law. Provided that Subscriber has given to
NovaCare all information required hereunder, NovaCare accepts sole
responsibility for compliance with the following provisions of law applicable to
Worksite Employees:
(i) all rules and regulations governing the
reporting, collecting and payment of federal and state payroll taxes on wages
paid under this Agreement, including, but not limited to, a) federal income tax
withholding provisions of the Internal Revenue Code, b) state and/or local
income tax withholding provisions, if applicable, c) Federal Insurance
Contributions Act (FICA), d) Federal Unemployment Tax Act (FUTA), and e)
applicable state unemployment tax provisions;
(ii) except as provided below, applicable workers'
compensation laws including, but not limited to, a) procuring workers'
compensation insurance, b) completing and filing all required reports, and c)
administering, managing, and otherwise processing claims and related procedures
provided that Subscriber agrees to reimburse NovaCare for any monies found due,
whether by audit or otherwise as a result of any workers' compensation
classification information provided by Subscriber to NovaCare;
(iii) Internal Revenue Code Section 4980B, subject to
the provisions of Section 5.8;
(iv) Section 1324A(b) of the Immigration Reform and
Control Act of 1986, assuming that Subscriber has provided to NovaCare all
necessary and accurate documentation required by such law;
(v) the Consumer Credit Protection Act, Title III;
and
(vi) the Fair Labor Standards Act, 29
U.S.C.Section 201 et seq., based solely on information provided by Subscriber
pursuant to Section 5.2 hereof.
6.2 Delivery of Services.
6.2.1 Information Systems. NovaCare shall make
available to Subscriber the data and reports listed in Exhibit C (the "Operating
Information") through either hard copy or electronic information systems (the
"Systems").the NovaCare shall not change the Systems in a way that deprives
Subscriber of access to the Operating Information in the electronic format used
as of July 1, 1998 without first obtaining Subscriber's written approval.
Subscriber may, as a condition to granting approval of a change in Systems,
require that NovaCare be responsible for costs necessary to create, or that
NovaCare create, any interface or translation required to provide Subscriber
with access to Operating Information comparable to its access on the effective
date hereof. Subscriber hereby confirms its grant to NovaCare of a non-exclusive
license, effective for the term of this Agreement, to use the Systems only as
necessary to provide services to Subscriber under this Agreement. NovaCare shall
not obtain any ownership interest in
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the Systems pursuant to such license. Any changes to the Systems made by
NovaCare shall become the property of Subscriber and NovaCare shall execute at
its own cost such assignments and other documents as may be necessary or
appropriate for transferring and/or confirming ownership to and in Subscriber.
6.2.2 Organization. NovaCare shall consult with
Subscriber and shall consider Subscriber's recommendations before making any
material change in the size, structure, span of responsibility or location of
any organizational element providing service to Subscriber under this Agreement.
7. Effect of Termination.
7.1 COBRA. In the event of termination of this Agreement, the
Subscriber shall immediately provide coverage under a "group health plan" (as
defined in Section 4980B(g)(2) of the Code) to all Worksite Employees, former
Worksite Employees, and their dependents who were eligible for coverage under
any NovaCare group health plan immediately before such event. The Subscriber's
group health plan provided under the preceding sentence shall not contain any
exclusion or limitation with respect to any pre-existing condition applicable to
any Worksite Employee, former Worksite Employee or their dependents.
7.2 Accrued Pay. If this Agreement is terminated and if the
affected employees are entitled to the payment of any accrued bonus, vacation,
sick or personal leave, Subscriber shall be liable for the payment thereof and
will make such payments directly to NovaCare. If, however, Subscriber continues
to employ such affected employee(s) after termination of this Agreement, the
Subscriber shall be liable to the employee(s) for same and NovaCare shall have
no obligation therefor.
7.3 Survival. The indemnification, contribution and duty to
cooperate provisions of this Agreement shall survive the expiration of this
Agreement or other termination of this Agreement indefinitely.
7.4 Duration of Obligations. Upon the termination of this
Agreement for any reason, the parties shall continue to have the following
obligations through and including the termination date:
(i) NovaCare shall have the obligation for wages and
benefits payable to the employees through and including the termination date. If
for any reason (whether or not required by applicable law) NovaCare makes any
payment to any of the employees after this Agreement has been terminated,
NovaCare shall be entitled to full reimbursement for such expenditures;
(ii) Except as otherwise provided herein, all
obligations of NovaCare under this Agreement to maintain workers' compensation
insurance coverage and health care coverage on behalf of the Worksite Employees
shall cease, effective as of
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the termination date. All such employees shall be immediately informed by
Subscriber that they are no longer covered by NovaCare's workers' compensation
policy. Subscriber shall immediately assume all federal, state and local
obligations of an employer to the employees which are not in conflict with state
or federal law, and shall immediately assume full responsibility for providing
workers' compensation coverage. NovaCare shall immediately be released from such
obligations as are permitted by law, except that NovaCare shall remain
responsible for the cost of claims for workers' compensation incurred prior to
the date of termination. It is the intent of the parties that, to the extent
allowed by law, they be placed in their respective positions immediately before
their entry into this Agreement in the event of a termination or Subscriber's
failure to pay NovaCare; and
(iii) Subscriber shall have the obligation to pay all
fees payable in accordance with the provisions of this Agreement, which are
attributable to the period ending on the termination date.
8. Indemnification.
8.1 Indemnification by Subscriber. Subscriber agrees to
indemnify, hold harmless, protect and defend NovaCare, its subsidiaries and
affiliates and each of their officers, directors, agents, attorneys and
employees from any claims, expenses (including court costs and attorneys' fees),
damages and liabilities (including severance payments to Worksite Employees)
(collectively hereinafter referred to as "Damages"), from claims, actions,
suits, judgments or settlements arising out of negligence, malpractice, tortious
conduct, violation of any statute, law, or regulation, criminal or dishonest
activity by any Worksite Employee, product liability related to products
manufactured or distributed by Subscriber, Subscriber's breach of any of its
obligations or warranties under this Agreement, or any action by Subscriber or
its agents which may result in a violation of any law or regulation, including,
but not limited to, Damages allegedly arising out of an Adverse Action or out of
worksite conditions or actions of any kind. If such indemnification is for any
reason not available or insufficient to hold NovaCare harmless, Subscriber
agrees to contribute to the losses involved in such proportion as is appropriate
to reflect the relative benefits received (or anticipated to be received) by
Subscriber and by NovaCare with respect to the matters contemplated by this
Agreement or, if such allocation is judicially determined to be unavailable, in
such proportion as is appropriate to reflect not only such relative benefits,
but also other equitable considerations such as the relative fault of
Subscriber, on the one hand, and of NovaCare, on the other hand; provided,
however, that Subscriber shall be responsible for all losses which in the
aggregate are in excess of the amount of all fees actually received by NovaCare
from Subscriber in connection with the services to be provided hereunder.
NovaCare shall give Subscriber prompt written notice of any claim for which
indemnification will be sought hereunder, shall cooperate in the investigation
and defense of any such claim and shall not settle or compromise any such claim
without the approval of Subscriber unless Subscriber fails to provide evidence
of ability to pay a judgment in excess of the proposed settlement amount.
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8.2 Indemnification by NovaCare. NovaCare assumes
responsibility for the payment of wages to the Worksite Employees without regard
to payments by Subscriber to NovaCare, although in doing so NovaCare does not
waive or limit any claim against Subscriber. NovaCare agrees to indemnify, hold
harmless, protect and defend Subscriber, its subsidiaries and affiliates and
each of their officers, directors, agents, attorneys and employees from and
against any claims, expenses (including attorneys' fees and court costs),
damages and liabilities from claims, actions, suits, judgments or settlements
arising out of NovaCare's breach of its obligations or warranties under this
Agreement or any action by NovaCare or its agents or employees (other than
Worksite Employees) which may result in a violation of any law or regulation,
except violations resulting from conduct of Worksite Employees or worksite
conditions. Subscriber shall give NovaCare prompt written notice of any claim
for which indemnification will be sought hereunder, and shall cooperate in the
investigation and defense of any such claim and shall not settle or compromise
any such claim without the approval of NovaCare. Where Subscriber has followed
or complied with a request or recommendation of NovaCare or otherwise properly
relied on information supplied by NovaCare, it shall be relieved of
responsibility for back pay and damages for such actions (unless Subscriber has
failed to comply with its obligations hereunder to provide accurate information
to NovaCare) and NovaCare shall indemnify and hold Subscriber harmless from and
against any and all liabilities arising therefrom.
8.3 Subrogation. Each party hereby waives any claim in its
favor against the other party by way of subrogation or indemnification which may
arise during the term of this Agreement for any and all loss of or damage to any
of its property, or for bodily injury or death, which loss, damage, or bodily
injury or death is covered by insurance to the extent that such loss or damage
is recovered under such policies of insurance as required herein. The
subrogation and indemnification concept set forth in this provision is intended
to apply only to insurance matters, and nothing in this provision is intended to
alter the indemnification rights set forth elsewhere in this Agreement. Each
party shall assure that its insurance policies contain provisions authorizing
waiver of subrogation consistent with this Section 7.3.
9. Representations and Warranties.
9.1 Fair Labor Standards Act. Subscriber agrees not to
withhold a payment to NovaCare absent NovaCare's express permission, or in any
manner, or by any device, act in violation of, cause, or seek to cause a
violation of any applicable federal, state or local law, ordinance, or
regulation pertaining to the terms, conditions, and services of this Agreement.
Subscriber further warrants that it shall not make any taxable payment of any
kind, except profit-sharing or pension plan distributions pursuant to the terms
of a qualified plan, to any employee covered by this Agreement, and that any
such payment shall be a breach of this Agreement, and at the election of
NovaCare, grounds for immediate termination of this Agreement.
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9.2 Employment Matters. Subscriber warrants that there are no
collective bargaining agreements binding upon Subscriber or affecting Worksite
Employees, and that there are no pending governmental investigations or any
lawsuit material in nature related to Worksite Employees, the working conditions
of the Worksite Employees, the products or services produced or provided by
Worksite Employees or any other matters affecting the performance of NovaCare
under this Agreement except as otherwise disclosed to NovaCare. Subscriber
warrants that all hazardous materials, if any, on its premises are maintained,
stored and disposed of in accordance with applicable law. Subscriber agrees to
provide any and all protective safety equipment required for safe performance of
job duties or required under local, state or federal law.
10. Workers' Compensation. NovaCare shall provide workers' compensation
insurance for Worksite Employees in compliance with applicable law. Workers
performing services for Subscriber not covered by this Agreement and not on
NovaCare's payroll shall not be covered by NovaCare's workers' compensation
insurance. NovaCare will not provide workers' compensation coverage to any
employee for whom Subscriber is not reporting hours of payroll. Subscriber
further agrees to require any independent contractor it utilizes to provide
evidence of workers' compensation coverage before the independent contractor
commences work at the worksite. Subscriber acknowledges that NovaCare's workers'
compensation carrier or NovaCare is entitled to periodically audit the employee
classification lists for each Subscriber location to make sure that employees
are classified properly for workers' compensation purposes. In the event that
during such an audit, or at any other time, NovaCare finds that Worksite
Employees have been misclassified and such misclassification resulted from
information supplied to NovaCare by Subscriber, Subscriber will promptly
reimburse NovaCare, upon invoice, for charges which otherwise would have been
payable by Subscriber had such employee been properly classified. NovaCare
retains the responsibility for the management of workers' compensation claims,
claim filings and related procedures. Subscriber agrees to cooperate with
NovaCare in that regard, including in regard to the notification of injuries
required by this Agreement or by law.
11. Insurance. During the Initial Term of this Agreement and any
Renewal Term, Subscriber shall obtain and maintain the following types of
insurance:
11.1 Automobile. Subscriber shall obtain and maintain
automobile insurance for all owned, non-owned, and hired vehicles used in
connection with the work performed on its premises or in connection with its
business, and will cause its insurance carrier to issue a Certificate of
Insurance evidencing same to NovaCare, naming NovaCare as an additional named
insured and allowing not less than thirty (30) days' notice of cancellation or
material change. The policy shall insure against liability for bodily injury and
property damage, with a minimum combined single limit of Five Hundred Thousand
Dollars ($500,000) and Uninsured Motorist or PIP equivalent coverage of at least
the minimum limits required by the State where a "no fault" law shall apply.
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11.2 General Liability. Subscriber shall obtain and maintain
general liability insurance, and cause its insurance carrier to issue a
Certificate of Insurance evidencing same to NovaCare, naming NovaCare as an
additional named insured and allowing not less than thirty (30) days' notice of
cancellation or material change. The minimum requirement shall be One Million
Dollars ($1,000,000) combined single limit, Three Million Dollars ($3,000,000)
aggregate limit, including, but not limited to, where applicable, premises,
operations, products, completed operations, contract and broad form property
damage, independent contractors, personal injury, host liquor, and full liquor
liability. If Subscriber renders professional services, it shall obtain and
maintain throughout the term, and any succeeding terms of this Agreement,
professional liability coverage as applicable, and will cause its insurance
carrier to issue a Certificate of Insurance evidencing same to NovaCare allowing
not less than thirty (30) days' notice of cancellation or material change.
Unless otherwise agreed to, such policy shall have a combined single limit of
not less than One Million Dollars ($1,000,000), Three Million Dollars
($3,000,000) aggregate limit.
Subscriber agrees that NovaCare shall not provide any
general liability insurance coverage for products liability, completed
operations or professional liability for any Worksite Employee or the
Subscriber. Subscriber shall further agree that NovaCare shall have no
obligation to provide any form of automobile insurance coverage on behalf of any
Worksite Employee or for Subscriber.
12. Miscellaneous.
12.1 Third Party Rights. This Agreement is intended solely for
the mutual benefit of the parties hereto and does not create any rights of any
kind in a third party. Each party hereto reserves the right and from time to
time to assign its rights, duties and obligations hereunder to any affiliate,
provided that the assigning party shall guarantee the performance and liability
of any such affiliate. Any such assignment may be limited to a portion of such
party's obligations arising in one or more jurisdictions.
12.1.2 Integration. This Agreement constitutes the entire
agreement between the parties with regard to the subject matter hereof and
supersedes any and all agreements (including the Initial Agreement), whether
oral or written, between the parties with respect to its subject matter.
12.3 Waiver. Failure by either party at any time to require
performance by the other party or to claim a breach of any provision of this
Agreement will not be construed as a waiver of any subsequent breach nor affect
the effectiveness of this Agreement, nor any part thereof, nor prejudice either
party as regards to any subsequent action.
12.1.4 Governing Law. This Agreement shall be subject to the
laws of the Commonwealth of Pennsylvania.
18
<PAGE> 19
12.5 Dispute Resolution.
12.5.1 Arbitration. The parties shall attempt
amicably to resolve disagreements by negotiating with each other. In the event
that the matter is not amicably settled through negotiation, any controversy,
dispute or disagreement arising out of or relating to this Agreement (a
"Controversy") shall be resolved exclusively by binding arbitration, which shall
be conducted by a single arbitrator in the Philadelphia, PA area, in accordance
with the J-A-M-S/ENDISPUTE Streamlined (in the case of a dispute within the
scope of the Streamlined Rules and Procedures) or Comprehensive Arbitration
Rules and Procedures (the "Rules"). The parties agree that notwithstanding
anything to the contrary contained in the Rules, the arbitrator shall not award
consequential, exemplary, incidental, punitive or special damages.
12.5.2 Procedure. It is agreed that if any party
shall desire relief of any nature whatsoever from any other party as a result of
any Controversy, such party will initiate such arbitration proceedings within a
reasonable time, but in no event more than twelve (12) months after the facts
underlying said Controversy first arise or become known to the party seeking
relief (whichever is later). The failure of such party to institute such
proceedings within said period shall be deemed a full waiver of any claim for
such relief. The parties shall bear equally all costs of said arbitration (other
than their own attorney's fees and costs). The parties agree that the decision
and award of the Arbitrator shall be final and conclusive upon the parties, in
lieu of all other legal, equitable (except as provided in 12.5.3. below) or
judicial proceedings between them, and that no appeal or judicial review of the
award or decision of the Arbitrator shall be taken, but that such award or
decision may be entered as a judgment and enforced in any court having
jurisdiction over the party against whom enforcement is sought.
12.5.3. Equitable Relief. The parties recognize that
irreparable injury may result from a breach of this Agreement and that money
damages may be inadequate to fully remedy the injury. Therefore, either party
may, in any such instance, seek and obtain from a court of competent
jurisdiction one or more preliminary or permanent orders designed to maintain
the status quo ante pending arbitration by (i) restraining and enjoining any act
that would constitute a breach or (ii) compelling the performance of any
obligation that, if not performed, would constitute a breach. Any relief awarded
under this paragraph shall be dissolved upon issuance of the Arbitrator's
decision and order.
12.6 Subscriber Intellectual Property Rights. Subscriber shall
own any and all intellectual property rights incident to any and all process,
products, inventions and discoveries that are created or invented by a Worksite
Employee and who was directed by Subscriber to create or develop such process,
product, discovery or invention. Subscriber shall bear any and all costs
associated with any copyrights, trademarks or patents that Subscriber chooses to
obtain to protect Subscriber's intellectual property rights.
19
<PAGE> 20
12.7 Duty to Cooperate. In the event that an employee or a
government agency or entity files any type of claim, lawsuit or charge against
NovaCare, Subscriber or both, alleging a violation of any law or failure to do
something which was otherwise required by law, Subscriber and NovaCare mutually
agree to cooperate with each other in the defense of any such claim, lawsuit or
charge. NovaCare and Subscriber will make available to each other upon request
any and all documents that either party has in its possession which relate to
any such claim, lawsuit or charge. However, neither party shall have the duty to
cooperate with the other if the dispute is between the parties themselves, nor
shall this provision preclude the raising of cross claims or third party claims
between Subscriber and NovaCare.
12.8 Severability. Should any term, warranty, covenant,
condition, or provision of this Agreement be held to be invalid or
unenforceable, the balance of this Agreement shall remain in force and shall
stand as if the unenforceable part did not exist. The captions in this Agreement
are provided for convenience only and are not part of the terms and conditions
of this Agreement.
12.9 Modification and Implementation. Any modifications to
this Agreement must be in writing and executed by NovaCare and Subscriber to be
enforceable.
12.10 No Partnership. Nothing set forth herein shall be deemed
to create a partnership or joint venture between Subscriber and NovaCare and no
fiduciary duty shall arise from the relationship created herein.
12.11 Notification of Termination to Employees. NovaCare will
notify all Worksite Employees covered by this Agreement of that status after
Subscriber provides the names of such persons to NovaCare. NovaCare will also
provide each Worksite Employee with any required notice pursuant to applicable
state law or such person's status under this Agreement and shall obtain from
such person any required acknowledgment of such status. If for any reason this
Agreement is terminated, NovaCare will notify all Worksite Employees of whom it
is aware of the termination of this Agreement and Subscriber shall also notify
all Worksite Employees of the termination of this Agreement and shall inform
them that they are no longer covered by NovaCare's benefits or workers'
compensation policy.
12.12 Counterparts. This Agreement may be signed in one or
more counterparts, each of which when executed shall be deemed an original and
together shall constitute one and the same instrument.
20
<PAGE> 21
12.13 Intention of the Parties. The intention of the parties
with respect to allocation between them of rights, duties and obligations is as
set forth in this Agreement. To the extent that the law of any state requires a
different form of agreement to effect the intention of the parties, the parties
agree to negotiate in good faith and to execute separate agreements applicable
to such state.
NOVACARE, INC. NOVACARE EMPLOYEE
for itself and as Agent for its SERVICES, INC.
Subsidiaries listed on Exhibit A.
/s/ Timothy E. Foster /s/ Thomas D. Schubert 6/30/98
- -------------------------------- ---------------------------------
Signature Date Signature Date
Timothy E. Foster Thomas D. Schubert
- -------------------------------- ---------------------------------
Printed or Typed Name Printed or Typed Name
Chief Executive Officer SVP & CFO
- -------------------------------- ---------------------------------
Title Title
21
<PAGE> 1
EXHIBIT 10(p)(iii)
NOVACARE EMPLOYEE SERVICES, INC.
2621 Van Buren Avenue
Norristown, PA 19403
July 7, 1998
PNC Bank, National Association,
as Agent
One PNC Plaza
249 Fifth Avenue
Pittsburgh, PA 15222-2707
Attn: Marcie Knittel, Vice President
RE: Consent and Second Amendment to Credit Agreement
(the "Second Amendment")
Dear Marcie:
We refer to that certain Credit Agreement, dated as of November 17, 1997
(as amended, the "Credit Agreement"), by and among NovaCare Employee Services,
Inc. (the "Borrower"), the Guarantors party thereto, the Banks party thereto
and PNC Bank, National Association, as agent for the Banks ("Agent"). Defined
terms used herein, not otherwise defined herein, shall have the meanings given
to them under the Credit Agreement as amended hereby.
The Borrower has advised the Banks and the Agent that the Parent desires
to transfer all of the issued and outstanding shares of stock of the Borrower
owned by the Parent to NC Resources, Inc., a Delaware corporation and wholly
owned Subsidiary of the Parent ("NC Resources").
Accordingly, the Borrower, the Guarantors, the Agent and the Banks desire
to amend the Credit Agreement as hereinafter provided.
The parties hereto in consideration of their mutual covenants and
agreements hereinafter set forth, and intending to be legally bound hereby,
covenant and agree as follows:
AGREEMENT
1. Amendment of Credit Agreement
The parties hereto do hereby modify and amend the Credit Agreement as
follows:
(a) Section 1.1. [Certain Definitions] is hereby amended by
inserting between the definitions of "Multiple Employer Plan" and "Notes" the
following new definitions of "NCES Stock Transfer" and "NC Resources":
<PAGE> 2
Schedule 6.1.3 Subsidiaries
Schedule 6.1.8 Owned and Leased Real Property
Schedule 6.1.18 Partnership Agreements; LLC Agreements
Schedule 6.1.19 Insurance Policies
Schedule 6.1.21 Material Contracts
4. Conditions of Effectiveness.
The effectiveness of this Second Amendment is expressly conditioned
upon the Agent's receipt of: (i) this Second Amendment duly executed by the
Borrower, the Guarantors, and the Required Banks; (ii) a Pledge Agreement,
satisfactory in form and substance to the Agent, duly executed by NC Resources
pledging all of the shares of capital stock owned by it in the Borrower,
together with the original certificates evidencing such stock with appropriate
stock powers signed in blank; (iii) an incumbency certificate and a certificate
signed by the Secretary or Assistant Secretary of NC Resources, certifying as to
all action taken by NC Resources to authorize the execution, delivery and
performance of the Pledge Agreement; (iv) an opinion of Christina Harris, Acting
General Counsel of the Borrower, reasonably satisfactory to the Agent regarding
NC Resources; (v) amended Schedules to the Credit Agreement and the other Loan
Documents, if any, to update such schedules with respect to the ownership by NC
Resources of stock in the Borrower, such amended Schedules to be in form and
substance satisfactory to the Required Banks; and (vi) a Certificate signed by
the Secretary or Assistant Secretary of each Loan Party confirming that no Event
of Default or Potential Default under the Credit Agreement shall have occurred
and be continuing or shall exist.
This Second Amendment shall be dated as of and shall be effective as
of the date and year first above written which shall be the date of satisfaction
of all conditions precedent to effectiveness as set forth in this Section 2.
5. Consent of Required Banks.
Pursuant to Section 11.1 of the Credit Agreement, this Second
Amendment shall require the written consent of the Required Banks.
6. Full Force and Effect.
Except as expressly modified and amended by this Second Amendment,
the Credit Agreement and the other Loan Documents are hereby ratified and
confirmed and shall remain in full force and effect.
7. Costs, Expenses, Disbursements.
The Borrowers hereby agree to reimburse the Agent and the Banks on
demand for all costs, expenses and disbursements relating to this Second
Amendment which are payable by the Borrower as provided in Section 10.5 of the
Credit Agreement.
3
<PAGE> 3
8. Counterparts.
This Second Amendment may be executed by different parties hereto in
any number of separate counterparts, each of which, when so executed and
delivered, shall be an original, and all of such counterparts shall together
constitute one and the same instrument.
9. Governing Law.
This Second Amendment shall be deemed to be a contract under the laws
of the Commonwealth of Pennsylvania and for all purposes shall be governed by
and construed and enforced in accordance with the internal laws of the
Commonwealth of Pennsylvania without regard to its conflict of laws principles.
[SIGNATURES BEGIN ON NEXT PAGE]
4
<PAGE> 4
[SIGNATURE PAGE 1 OF 2 TO SECOND AMENDMENT]
IN WITNESS WHEREOF, the parties hereto, by their officers thereunto duly
authorized, have executed this Amendment as of the day and year first above
written.
BORROWERS AND GUARANTORS:
NOVACARE EMPLOYEE SERVICES, INC.
By: /s/ Thomas D. Schubert
------------------------------------
Thomas D. Schubert
Chief Financial Officer
On behalf of each Guarantor listed on
Schedule A attached hereto
By: /s/ Thomas D. Schubert
------------------------------------
Thomas D. Schubert, Chief Financial
Officer of each Guarantor listed on
Schedule A attached hereto which is
a corporation and of each general
partner of each Guarantor listed on
Schedule A attached hereto which is
a partnership
On behalf of each Guarantor listed on
Schedule B attached hereto
By:
------------------------------------
Robert C. Campbell, Vice President
of each Guarantor listed on Schedule
B attached hereto
<PAGE> 5
[SIGNATURE PAGE 1 OF 2 TO SECOND AMENDMENT]
IN WITNESS WHEREOF, the parties hereto, by their officers thereunto duly
authorized, have executed this Amendment as of the day and year first above
written.
BORROWERS AND GUARANTORS:
NOVACARE EMPLOYEE SERVICES, INC.
By:
----------------------------------------------
Thomas D. Schubert
Chief Financial Officer
On behalf of each Guarantor listed on Schedule A
attached hereto
By:
----------------------------------------------
Thomas D. Schubert, Chief Financial Officer of
each Guarantor listed on Schedule A attached
hereto which is a corporation and of each
general partner of each Guarantor listed on
Schedule A attached hereto which is a
partnership
On behalf of each Guarantor listed on Schedule B
attached hereto
By: /s/ Robert C. Campbell
----------------------------------------------
Robert C. Campbell, Vice President of each
Guarantor listed on Schedule B attached hereto
<PAGE> 6
[SIGNATURE PAGE 2 OF 2 TO SECOND AMENDMENT]
AGENT AND BANKS:
PNC BANK, NATIONAL ASSOCIATION,
individually and as Agent
By: /s/ Justin J. Falgione
------------------------------
Name: Justin J. Falgione
----------------------------
Title: Assistant Vice President
---------------------------
AMSOUTH BANK
By: /s/ David A. Simmons
------------------------------
Name: David A. Simmons
----------------------------
Title: Senior Vice President
---------------------------
BANK ONE, KENTUCKY, NA
By: /s/ Todd D. Munson
------------------------------
Name: Todd D. Munson
----------------------------
Title: Senior Vice President
---------------------------
SUNTRUST BANK, CENTRAL FLORIDA, NA
By: /s/ Janet P. Sammons
------------------------------
Name: Janet P. Sammons
----------------------------
Title: Vice President
---------------------------
<PAGE> 7
STATE OF GEORGIA
COUNTY OF FULTON
On the 23rd day of June, 1998 personally appeared Janet P. Sammons, as the Vice
President of SunTrust Bank, Central Florida, National Association, and before
me executed the attached Second Amendment to Credit Agreement dated as of July
7, 1998 between NovaCare Employee Services, Inc., with SunTrust Bank, Central
Florida, National Association, as Lender.
IN WITNESS WHEREOF, I have hereunto set my hand and official seal, in the state
and county aforesaid.
/s/ Tonya Adams
-----------------------------------------------------
Signature of Notary Public, State of Georgia
----------------
Tonya Adams Notary Public, Coweta County, Georgia
My Commission Expires May 6, 2001
-----------------------------------------------------
(Print, Type or Stamp Commissioned Name of Notary
Public)
Personally known X ; OR Produced Identification
---
-----------------------------------------------------
Type of identification produced:
--------------------
-----------------------------------------------------
<PAGE> 8
SCHEDULE A
----------
NovaCare Employee Services Resource One, Inc.
NovaCare Employee Services of Orlando, Inc.
Professional Insurance Planners of Florida, Inc.
NovaCare Administrative Employee Services of New York, Inc.
NovaCare Employee Services Northeast, Inc.
NovaCare Employee Services of Boston, Inc.
NovaCare Employee Services of New York, Inc.
Staffing Technologies, Inc. (a New York corporation)
NovaCare Employee Services of America, Inc.
Employee Benefits Management, Inc.
Employee Services Inc. of North Carolina
Employers' Risk Management, Inc.
NovaCare Administrative Employee Services, Inc.
NovaCare Employee Services Club Staff, Inc.
NovaCare Employee Services Easy Staff, Inc.
NovaCare Employee Services of Florida, Inc.
Rx One, Inc.
NovaCare Employee Services TPI, Inc.
ConsulTemps, Inc.
NovaCare Employee Services West, Inc.
Paralign Staffing Technologies, Inc.
NCES Partners (IND), LP (NovaCare Employee Services, Inc. is a general partner)
<PAGE> 9
SCHEDULE B
NCES Finance, Inc.
NCES Holdings, Inc.
NCES Licensing, Inc.
<PAGE> 10
SCHEDULE 6.1.1
QUALIFICATIONS TO DO BUSINESS
<TABLE>
<CAPTION>
STATE OF
LOAN PARTY FORMATION QUALIFICATIONS
---------- --------- --------------
<S> <C> <C>
NovaCare Employee Services, Inc. DE AZ, AR, CA, CO, CT,
DC, FL, GA, IN, IA,
KY, LA, ME, MD, MA,
MI, MN, MS, MO, NE,
NV, NH, NJ, NM, NY,
NC, ND, OH, OK, OR,
PA, RI, SC, SD, TN,
TX, VT, VA, WA, WY
NovaCare Administrative Employee Services
of New York, Inc. NY -
NovaCare Administrative Employee
Services, Inc. FL -
NovaCare Employee Services Club Staff, Inc. FL -
NovaCare Employee Services Easy Staff, Inc. FL -
NovaCare Employee Services Northeast, Inc. NY -
NovaCare Employee Services Resource
One, Inc. FL -
NovaCare Employee Services TPI, Inc. NY -
NovaCare Employee Services of America, Inc. FL -
</TABLE>
<PAGE> 11
<TABLE>
<CAPTION>
STATE OF
LOAN PARTY FORMATION QUALIFICATIONS
---------- --------- --------------
<S> <C> <C>
NovaCare Employee Services of Boston, Inc. DE NY
NovaCare Employee Services of Bradenton, Inc. FL --
NovaCare Employee Services of Florida, Inc. FL AL, GA, MD, NC,
SC, TN, VA, WV
NovaCare Employee Services of New York, Inc. NY VT
NovaCare Employee Services of Orlando, Inc. FL AR, CA, IL, ME,
MN, NV, NH, NM,
NC, OR, SC, TN,
TX, UT, VT, WV
ConsulTemps, Inc. VA --
Employee Benefits Management, Inc. FL --
Employee Services Inc. of North Carolina NC --
Employers' Risk Management, Inc. FL --
Professional Insurance Planners of
Florida, Inc. FL --
RX One, Inc. FL --
Staffing Technologies, Inc. NY --
</TABLE>
2
<PAGE> 12
<TABLE>
<CAPTION>
STATE OF
LOAN PARTY FORMATION QUALIFICATIONS
---------- --------- --------------
<S> <C> <C>
NCES Finance, Inc. DE --
NCES Holdings, Inc. DE --
NCES Licensing, Inc. DE --
AmeriCare Employers Group, Inc. AZ CA, CO, FL, GA,
NV, NM, OH, OR,
SC, TX
Paralign Staffing Technologies, Inc. AZ CA, GA, MS, TX,
WA
NCES Partners (IND), L.P. IN --
</TABLE>
-3-
<PAGE> 13
SCHEDULE 6.1.3
SUBSIDIARIES
<TABLE>
<CAPTION>
Borrower/ Authorized No. of
Subsidiary Jurisdiction Guarantor Capital Shares Issued Shareholder
- ---------- ------------ ---------- ----------- ------------- -----------
<S> <C> <C> <C> <C> <C>
AmeriCare Employers Group, Inc. AZ G 1,000,000 common shares 98,069 NovaCare Employee Services, Inc.
no par value
ConsulTemps, Inc. VA G 5,000 common shares 1,000 NovaCare Employee Services Easy
$1.00 par value Staff, Inc.
Employee Benefits FL G 800,000 common shares 428,747 NovaCare Employee Services of
Management, Inc. $.01 par value America, Inc.
Employee Services Inc. of NC G 800,000 common shares 428,747 NovaCare Employee Services of
North Carolina $.10 par value America, Inc.
Employers' Risk FL G 800,000 common shares 428,747 NovaCare Employee Services of
Management, Inc. $.01 par value America, Inc.
NCES Finance, Inc. DE G 3,000 common shares 100 NovaCare Employee Services, Inc.
$.01 par value
NCES Holdings, Inc. DE G 3,000 common shares 100 NovaCare Employee Services, Inc.
$.01 par value
</TABLE>
1
<PAGE> 14
<TABLE>
<CAPTION>
BORROWER/ AUTHORIZED NO. OF
SUBSIDIARY JURISDICTION GUARANTOR CAPITAL SHARES ISSUED SHAREHOLDER
---------- ------------ --------- ------- ------------- -----------
<S> <C> <C> <C> <C> <C>
NCES Licensing, Inc. DE G 3,000 common shares 100 NovaCare Employee Services, Inc.
$.01 par value
NovaCare Administrative FL G 800,000 common shares 428,747 NovaCare Employee Services of
Employee Services, Inc. $.01 par value America, Inc.
NovaCare Administrative NY G 200 common shares 1 NovaCare Employee Services TPI, Inc.
Employee Services of New no par value
York, Inc.
NovaCare Employee Services FL G 800,000 common shares 428,747 NovaCare Employee Services of
Club Staff, Inc. $.01 par value America, Inc.
NovaCare Employee Services FL G 800,000 common shares 428,747 NovaCare Employee Services of
Easy Staff, Inc. $.01 par value America, Inc.
NovaCare Employee Services NY G 200 common shares 1 NovaCare Employee Services TPI, Inc.
Northeast, Inc. no par value
NovaCare Employee Services FL G 800,000 common shares 428,747 NovaCare Employee Services, Inc.
of America, Inc. $.01 par value
500,000 preferred 0
shares
no par value
NovaCare Employee Services DE G 200 common shares 1 NovaCare Employee Services TPI, Inc.
of Boston, Inc. $1.00 par value
</TABLE>
2
<PAGE> 15
<TABLE>
<CAPTION>
BORROWER/ AUTHORIZED NO. OF
SUBSIDIARY JURISDICTION GUARANTOR CAPITAL SHARES ISSUED SHAREHOLDER
---------- ------------ --------- ---------- ------------- -----------
<S> <C> <C> <C> <C> <C>
NovaCare Employee Services FL G 50 common shares 50 NovaCare Employee Services
of Bradenton, Inc. no par value of America, Inc.
NovaCare Employee Services FL G 800,000 common shares 428,747 NovaCare Employee Services
of Florida, Inc. $.01 par value of America, Inc.
NovaCare Employee Services NY G 200 common shares 1 NovaCare Employee Services
of New York, Inc. no par value TPI, Inc.
NovaCare Employee Services FL G 1,000,000 common 50,000 NovaCare Employee Services
of Orlando, Inc. shares Resource One, Inc.
$.01 par value
NovaCare Employee Services FL G 1,000,000 common 100,000 NovaCare Employee
Resource One, Inc. shares Services, Inc.
$.01 par value
NovaCare Employee Services NY G 11,111 common shares 6,261 NovaCare Employee
TPI, Inc. $.01 par value Common Services, Inc.
4,850 preferred 4,850 NovaCare Employee
shares Preferred Services, Inc.
$.01 par value
Paralign Staffing AZ G 10,000 common shares 1,000 AmeriCare Employers
Technologies, Inc. $1.00 par value Group, Inc.
Professional Insurance FL G 5,000 common shares 250 NovaCare Employee Services
Planners of Florida, Inc. $.10 par value Resource One, Inc.
</TABLE>
3
<PAGE> 16
<TABLE>
<CAPTION>
Borrower/ Authorized No. of
Subsidiary Jurisdiction Guarantor Capital Shares Issued Shareholder
---------- ------------ --------- ---------- ------------- -----------
<S> <C> <C> <C> <C> <C>
Rx One, Inc. FL G 1,000,000 common 100,000 Novacare Employee Services, Inc.
shares
$.01 par value
Staffing Technologies, Inc. NY G 200 common shares 1 Novacare Employee Services TPI, Inc.
no par value
</TABLE>
4
<PAGE> 17
PARTNERSHIP INTERESTS
<TABLE>
<CAPTION>
Name Jurisdiction Partnership Interest Borrower/Guarantor
---- ------------ -------------------- ------------------
<S> <C> <C> <C>
NCES Partners (IND), LP Indiana 1% general partnership interest owned G
by NovaCare Employees Services, Inc.;
99% limited partnership interest owned
by NCES Holdings, Inc.
</TABLE>
5
<PAGE> 18
SCHEDULE 6.1.8
OWNED AND LEASED REAL PROPERTY
A. OWNED REAL PROPERTY
Owner Location
NovaCare Administrative Employee 310 Bay Road
Services of New York, Inc. Queensbury, NY 12804
B. LEASED REAL PROPERTY
Lessee Location
NovaCare Employee Services, Inc. 2621 Van Buren Avenue
Norristown, PA 19403
NovaCare Administrative Employee 90 N. Pearl Street
Services of New York, Inc. Albany, NY
NovaCare Employee Services Club Staff, 402 43rd Street West
Inc. Bradenton, FL 34209
NovaCare Employee Services Easy Staff, 402 43rd Street West
Inc. Bradenton, FL 34209
NovaCare Employee Services Northeast, 310 Bay Road
Inc. Queensbury, NY 12804
NovaCare Employee Services Resource 601 South Lake Destiny Drive
One, Inc. Suite 250
Maitland, FL 32751
NovaCare Employee Services TPI, Inc. 310 Bay Road
Queensbury, NY 12804
NovaCare Employee Services of America, 402 43rd Street West
Inc. Bradenton, FL 34209
NovaCare Employee Services of Boston, 310 Bay Road
Inc. Queensbury, NY 12804
NovaCare Employee Services of 1111 5th Street W.
Bradenton, Inc. Palmetto, FL 34221
<PAGE> 19
Lessee Location
- ------ --------
NovaCare Employee Services of Florida, Inc. 402 43rd Street West
Bradenton, FL 34209
NovaCare Employee Services of New York, Inc. 310 Bay Road
Queensbury, NY 12804
NovaCare Employee Services of Orlando, Inc. 601 South Lake Destiny Drive
Suite 250
Maitland, FL 32751
ConsulTemps, Inc. 7275 Glen Forest Drive
Suite 200
Richmond, VA 23226
Employee Benefits Management, Inc. 402 43rd Street West
Bradenton, FL 34209
Employee Services Inc. of North Carolina 225 Hillsborough Street
Raleigh, NC 27603
Employers' Risk Management, Inc. 402 43rd Street West
Bradenton, FL 34209
Professional Insurance Planners of Florida, Inc. 1501 Venera Avenue
Suite 320
Coral Gables, FL 33146
RX One, Inc. 601 South Lake Destiny Drive
Suite 250
Maitland, FL 32751
Staffing Technologies, Inc. 310 Bay Road
Queensbury, NY 12804
NCES Finance, Inc. 103 Foulk Road
Suite 262
Wilmington, DE 19803
NCES Holdings, Inc. 103 Foulk Road
Suite 262
Wilmington, DE 19803
<PAGE> 20
LESSEE LOCATION
- ------ --------
NCES Licensing, Inc. 103 Foulk Road
Suite 262
Wilmington, DE 19803
NovaCare Administrative Employee 402 43rd Street West
Services, Inc. Bradenton, FL 34209
6220 Manatee Avenue West
Bradenton, FL 34209
4620 N. SR7 Bldg. H, #210
Ft. Lauderdale, FL 33319
8140 College Parkway, #101
Ft. Myers, FL 33919
203 S. Airport Road
Naples, FL 33942
11350 66th Street N. #101
Largo, FL 34643
519 Beverly Street
Tallahassee, FL 32301
7402 N. 56th St., #850
Tampa, FL 33617-7731
3940 Barbara Terrace
St. Augustine, FL 32086
1191 Romaine Circle East
Jacksonville, FL 32225
1401 Dove Street
Newport Beach, CA
AmeriCare Employers Group, Inc. 4350 E. Camelback Road, Suite 100E
Phoenix, AZ 85018
4350 E. Camelback Road, Suite 170C
Phoenix, AZ 85018
4350 E. Camelback Road, Suite 160E
Phoenix, AZ 85018
<PAGE> 21
<TABLE>
<CAPTION>
Lessee Location
- ------ --------
<S> <C>
4350 E. Camelback Road, Suite 280E
Phoenix, AZ 85018
4800 N. 22nd Street, 210
Phoenix, AZ 85016
4045 S. Nonchalant Circle, 1 and 7
Colorado Springs, CO 80917
5151 E. Broadway Blvd. 530
Tucson, AZ 85711
Paralign Staffing Technologies, Inc. 1161 N. El Dorado Place, B343
Tucson, AZ 85715-33
NCES Partners (IND), LP 13159 Knollton Court
Fishers, IN 46038
</TABLE>
<PAGE> 22
SCHEDULE 6.1.18
PARTNERSHIP AGREEMENTS: LLC AGREEMENTS
--------------------------------------
1. NCES Partners (IND), L.P., Limited Partnership Agreement dated October 1,
1997 between NovaCare Employee Services, Inc. (General Partner) and NCES
Holdings, Inc. (Limited Partner)
<PAGE> 23
SCHEDULE 6.1.19
INSURANCE POLICIES
<TABLE>
<CAPTION>
INSURANCE
LINE OF COVERAGE LIMIT COMPANY POLICY NUMBER
---------------- ----- --------- -------------
<S> <C> <C> <C> <C>
Novacare Employee
Services, Inc.(1) Liability $5,000,000 AIG 2651945
Workers Compensation Statutory Liberty Mutual Various
Umbrella $25,000,000 AIG BE9323272
Professional Liability $5,000,000 AIG 819-60-64
Fiduciary Liability $5,000,000 AIG 4860959
Crime $5,000,000 AIG CF4861131
NovaCare, Inc.(2) Auto $21,000,000 Travelers PJ810181X8840-T1L-97
Property $200,000,000 Travelers KTJCMB-251T049-9-96
</TABLE>
- --------------
(1) Policies cover all Loan Parties
(2) NovaCare Employee Services is an additional insured for autos and
property under the NovaCare policy
<PAGE> 24
SCHEDULE 6.1.21
MATERIAL CONTRACTS
1. Underwriting Agreement
2. Stock Purchase Agreement dated September 16, 1996 by and among Resource One,
Inc., Professional Insurance Planners of Florida, Inc., Human Resource One,
Inc., Rx One, Inc., William E. Mayville, Bernard Clinton Byrd, Jr. and
NovaResource, Inc. [now known as NovaCare Employee Services, Inc.]
3. Amendment dated April 8, 1997 to the Stock Purchase Agreement dated as of
September 16, 1996 by and among Resource One, Inc., Professional Insurance
Planners of Florida, Inc., Human Resource One, Inc., Rx One, Inc., William
E. Mayville, Bernard Clinton Byrd, Jr. and NovaSource, Inc. [now known as
NovaCare Employee Services, Inc.]
4. Stock Purchase Agreement dated January 24, 1997 by and among Employee
Services of America, Inc., Employee Services of Florida, Inc., Employers'
Risk Management, Inc., Employee Benefits Management, Inc., Employers
Diversified Services, Inc. and Nova Resource, Inc. [now known as NovaCare
Employee Services, Inc.]
5. Stock Purchase Agreement dated January 31, 1997 by and among The TPI Group,
LTD., Deborah M. Skinner, John Skinner III, Malvern Tippett, Carolyn
Tippett, Terry DeLong, Quansoo-TPI L.L.C. and NovaSource, Inc. [now known as
NovaCare Employee Services, Inc.]
6. Stock Option Plan
7. Employment Agreement dated as of January 27, 1997 between NovaSource, Inc.
[now known as NovaCare Employee Services, Inc.] and Loren J. Hulber.
8. Stock Purchase Agreement dated as of February 10, 1997 between NovaSource,
Inc. [now known as NovaCare Employee Services, Inc.] and Loren J. Hulber.
9. Employment Agreement dated as of May 7, 1997 between NovaCare Employee
Services, Inc. and Thomas D. Schubert.
10. Stock Purchase Agreement dated as of June 10, 1997 between NovaCare Employee
Services, Inc. and Thomas D. Schubert.
11. Employment Agreement dated as of October 8, 1996 between NovaResource, Inc.
[now known as NovaCare Employee Services, Inc.] and Bernard C. Byrd, Jr.
<PAGE> 25
12. Amendment dated as of April 8, 1997 to the Employment Agreement dated
October 8, 1996 between NovaResource, Inc. [now known as NovaCare Employee
Services, Inc.] and Bernard C. Byrd, Jr.
13. Stock Purchase Agreement dated as of February 28, 1997 between NovaCare
Employee Services, Inc. and Bernard C. Byrd, Jr.
14. Employment Agreement dated as of April 23, 1997 between NovaCare Employee
Services, Inc. and Andrew Stith.
15. Stock Purchase Agreement dated as of April 23, 1997 between NovaCare
Employee Services, Inc. and Andrew Stith.
16. Employment Agreement dated as of February 6, 1997 between NovaSource, Inc.
[now known as NovaCare Employee Services, Inc.] and Deborah M. Skinner.
17. Employment Agreement dated as of February 27, 1997 between NovaSource,
Inc. [now known as NovaCare Employee Services, Inc.] and James Boyd.
18. Employment Agreement dated as of June 18, 1997 between NovaCare Employee
Services, Inc. and Christina Harris.
19. Subscriber Service Agreement dated as of January 25, 1997 between NovaCare,
Inc. and NovaCare Employee Services, Inc.
20. Agreement dated as of January 25, 1997 between NovaCare, Inc. and NovaCare
Employee Services, Inc.
21. Trademark Agreement dated as of February 28, 1997 between NovaSource, Inc.
[now known as NovaCare Employee Services, Inc.] and NovaMark, Inc.
22. Loan Agreement dated as of September 18, 1996 between NovaFunds, Inc. and
NovaResource, Inc. [now known as NovaCare Employee Services, Inc.]
23. Sublease Agreement dated as of June 4, 1997 between NovaCare, Inc. and
NovaCare Employee Services, Inc.
24. Supplemental Benefits Plan
25. Employment Agreement dated as of December 10, 1997 between NovaCare
Employee Services, Inc. and Kenneth J. Jankowski.
26. Amendment #1 to the NovaCare Employee Services, Inc. Stock Option Plan.
27. Employment Agreement dated as of December 31, 1997 between NovaCare
Employee Services, Inc. and Ronald N. Shostack.
2
<PAGE> 1
Exhibit 21
NOVACARE EMPLOYEE SERVICES, INC.
Subsidiaries of the Company
Employee Benefits Management, Inc.
Employers' Risk Management, Inc.
NCES Finance, Inc.
NCES Holdings, Inc.
NCES Licensing, Inc.
NovaCare Administrative Employee Services of New York, Inc.
NovaCare Administrative Employee Services, Inc.
NovaCare Employee Services Club Staff, Inc.
NovaCare Employee Services Easy Staff, Inc.
NovaCare Employee Services Northeast, Inc.
NovaCare Employee Services of America, Inc.
NovaCare Employee Services of Boston, Inc.
NovaCare Employee Services of Florida, Inc.
NovaCare Employee Services of New York, Inc.
NovaCare Employee Services of Orlando, Inc.
NovaCare Employee Services Resource One, Inc.
NovaCare Employee Services TPI, Inc.
NovaCare Employee Services West, Inc.
NovaCare Employee Services, Inc.
Paralign Staffing Technologies, Inc.
Professional Employer Systems, Inc.
Professional Insurance Planners of Florida, Inc.
Rx One, Inc.
Staffing Technologies, Inc.
<PAGE> 1
Exhibit 23
CONSENT OF INDEPENDENT ACCOUNTANTS
We hereby consent to the incorporation by reference in the Registration
Statement on Form S-8 (No. 333-47001) of NovaCare Employee Services, Inc. of
our report dated July 31, 1998 appearing on page 51 of this form 10-K.
PricewaterhouseCoopers LLP
Philadelphia, PA
September 23, 1998
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
CONSOLIDATED BALANCE SHEET AS OF JUNE 30, 1998 AND THE CONSOLIDATED STATEMENT OF
OPERATIONS FOR THE FISCAL YEAR ENDED JUNE 30, 1998, AND IS QUALIFIED IN ITS
ENTIRETY BY REFERENCE TO SUCH STATEMENTS ON FORM 10-K FOR THE FISCAL YEAR ENDED
JUNE 30, 1998.
</LEGEND>
<CIK> 0001045536
<NAME> NOVACARE EMPLOYEE SERVICES, INC.
<MULTIPLIER> 1,000
<CURRENCY> U.S. DOLLARS
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> JUN-30-1998
<PERIOD-START> JUL-01-1997
<PERIOD-END> JUN-30-1998
<EXCHANGE-RATE> 1
<CASH> 5,926
<SECURITIES> 0
<RECEIVABLES> 66,964
<ALLOWANCES> 318
<INVENTORY> 0
<CURRENT-ASSETS> 76,532
<PP&E> 5,414
<DEPRECIATION> 924
<TOTAL-ASSETS> 157,421
<CURRENT-LIABILITIES> 84,431
<BONDS> 0
0
0
<COMMON> 273
<OTHER-SE> 61,533
<TOTAL-LIABILITY-AND-EQUITY> 157,421
<SALES> 0
<TOTAL-REVENUES> 1,271,757
<CGS> 0
<TOTAL-COSTS> 1,257,766<F1>
<OTHER-EXPENSES> 2,581<F2>
<LOSS-PROVISION> 292
<INTEREST-EXPENSE> 919
<INCOME-PRETAX> 10,199
<INCOME-TAX> 4,743
<INCOME-CONTINUING> 5,456
<DISCONTINUED> 0
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<CHANGES> 0
<NET-INCOME> 5,456
<EPS-PRIMARY> .22
<EPS-DILUTED> .22
<FN>
<F1>"Total Costs" consist of cost of services and selling and administrative
expenses.
<F2>"Other Expenses" consist of amortization of goodwill offset by interest income.
</FN>
</TABLE>
