U.S. SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 1997
[ ] TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from _______________ to _________________
Commission file number: 0-22600
EMPLOYEE SOLUTIONS, INC.
(Exact name of registrant as specified in its charter)
Arizona 86-0676898
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
6225 North 24th Street, Phoenix, Arizona 85016
(Address of principal executive offices)
Issuer's telephone number: (602) 955-5556
Securities registered pursuant to Section 12(b) of the Act:
Title of each class: Name of each exchange on which registered:
None N/A
---- ---
Securities registered pursuant to Section 12(g)
of the Act:
No Par Value Common Stock
(Title of Class)
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 report(s)), and (2) has been subject to such filing
requirements for the past 90 days.
Yes X No
--- ---
APPLICABLE ONLY TO CORPORATE ISSUERS
State the number of shares outstanding of each of the issuer's classes of common
stock, as of the latest practicable date:
31,648,121 Common shares, no par value were outstanding as of October 12, 1997.
<PAGE>
EMPLOYEE SOLUTIONS, INC.
FORM 10-Q
Quarterly Report for the Period Ended September 30, 1997
================================================================================
INDEX
Page
PART I. Financial Information Number
------
Item 1. Financial Statements
Consolidated Balance Sheets - September 30, 1997 and
December 31, 1996 2
Consolidated Statements of Operations for the Quarter and
Nine Months Ended September 30, 1997 and 1996 3
Consolidated Statement of Changes in Stockholders' Equity
for the Nine Months Ended September 30, 1997 4
Consolidated Statements of Cash Flows for the Nine Months
Ended September 30, 1997 and 1996 5
Notes to Consolidated Financial Statements 7
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 15
Item 3. Quantitative and Qualitative Disclosure About Market Risk 27
PART II. Other Information
Item 1. Legal Proceedings 28
Item 2. Changes in Securities 28
Item 6. Exhibits and Reports on Form 8-K 29
Signatures 30
================================================================================
1
<PAGE>
Item 1. Financial Statements
EMPLOYEE SOLUTIONS, INC.
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
=============================================================================================
September 30, December 31,
(Dollars in thousands, except share data) 1997 1996
- ---------------------------------------------------------------------------------------------
<S> <C> <C>
ASSETS
CURRENT ASSETS:
Cash and cash equivalents $ 15,618 $ 10,980
Restricted cash and investments 16,000 11,500
Accounts receivable, net 53,333 34,839
Receivable from insurance companies 7,765 5,918
Prepaid expenses and deposits 3,850 1,258
Deferred income taxes 3,690 1,156
-------- --------
Total current assets 100,256 65,651
Property and equipment, net 2,225 1,084
Deferred income taxes -- 539
Goodwill and other assets, net 60,819 58,695
-------- --------
Total assets $163,300 $125,969
======== ========
LIABILITIES
CURRENT LIABILITIES:
Bank overdraft $ 3,245 $ 2,477
Accrued salaries, wages and payroll taxes 35,630 17,586
Accounts payable 4,430 4,078
Accrued workers' compensation
and benefits 13,683 6,927
Income taxes payable -- 720
Other accrued expenses 4,453 3,414
-------- --------
Total current liabilities 61,441 35,202
-------- --------
Deferred income taxes 187 111
-------- --------
Long-term debt 48,000 42,800
-------- --------
Other long-term liabilities 1,213 1,349
-------- --------
Commitments and contingencies
STOCKHOLDERS' EQUITY
Class A convertible preferred stock, nonvoting, no par value,
10,000,000 shares authorized, no shares in 1997 and 1996
issued and outstanding -- --
Common stock, no par value,
75,000,000 shares authorized, 31,648,121 shares
issued and outstanding September 30, 1997, 30,729,433
shares issued and outstanding December 31, 1996 34,356 30,145
Retained earnings 18,103 16,362
-------- --------
Total stockholders' equity 52,459 46,507
-------- --------
Total liabilities and stockholders' equity $163,300 $125,969
======== ========
=============================================================================================
</TABLE>
The accompanying notes are an integral part of these consolidated balance
sheets.
2
<PAGE>
EMPLOYEE SOLUTIONS, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
======================================================================================================================
Quarter ended September 30, Nine months ended September 30,
---------------------------- -------------------------------
(Dollars in thousands, except share data) 1997 1996 1997 1996
- ----------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Revenues $ 233,093 $ 125,238 $ 655,117 $ 290,180
------------ ------------ ------------ ------------
Cost of revenues:
Salaries and wages of worksite employees 191,035 97,511 529,568 226,288
Healthcare and workers' compensation 16,263 7,304 47,372 14,812
Payroll and employment taxes 15,260 8,049 45,489 20,210
------------ ------------ ------------ ------------
Cost of revenues 222,558 112,864 622,429 261,310
------------ ------------ ------------ ------------
Gross profit 10,535 12,374 32,688 28,870
Selling, general and administrative expenses 8,201 5,706 24,113 12,681
Depreciation and amortization 1,055 562 3,103 1,216
------------ ------------ ------------ ------------
Income from operations 1,279 6,106 5,472 14,973
Other income (expense):
Interest income 298 220 745 630
Interest expense and other (1,093) (399) (3,216) (406)
------------ ------------ ------------ ------------
Income before provision for income taxes 484 5,927 3,001 15,197
Income tax provision 253 1,681 1,260 5,482
------------ ------------ ------------ ------------
Net income $ 231 $ 4,246 $ 1,741 $ 9,715
============ ============ ============ ============
Net income per common and common equivalent share:
Primary $ .01 $ .13 $ .05 $ .30
============ ============ ============ ============
Fully diluted $ .01 $ .13 $ .05 $ .30
============ ============ ============ ============
Weighted average number of common and
common equivalent shares outstanding:
Primary 32,513,699 33,020,742 33,229,898 32,446,593
============ ============ ============ ============
Fully diluted 32,592,388 33,043,173 33,229,898 32,817,451
============ ============ ============ ============
======================================================================================================================
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
3
<PAGE>
EMPLOYEE SOLUTIONS, INC.
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY
<TABLE>
<CAPTION>
=============================================================================================================
For the nine months ended September 30, 1997
----------------------------------------------------
Total
Preferred Common Retained Stockholders'
(Dollars in thousands, except share data) Stock Stock Earnings Equity
- -------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
BALANCE, December 31, 1996 $ -- $30,145 $16,362 $46,507
Issuance of 166,101 shares of common stock in
connection with exercise of stock options -- 423 -- 423
Tax benefit related to the exercise of stock options -- 1,188 -- 1,188
Issuance of 752,587 shares of common stock in
connection with acquisition -- 2,600 -- 2,600
Net income -- -- 1,741 1,741
-------- ------- ------- -------
BALANCE, September 30, 1997 $ -- $34,356 $18,103 $52,459
======== ======= ======= =======
============================================================================================================
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
4
<PAGE>
EMPLOYEE SOLUTIONS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
=======================================================================================================
Nine months ended September 30,
-------------------------------
(Dollars in thousands) 1997 1996
- -------------------------------------------------------------------------------------------------------
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Cash received from customers $ 634,776 $ 262,428
Cash paid to suppliers and employees (620,458) (259,319)
Interest received 745 462
Interest paid (3,216) (19)
Income taxes paid, net of refunds (2,711) (7,317)
--------- ---------
Net cash provided by (used in) operating activities 9,136 (3,765)
--------- ---------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of property and equipment (1,520) (700)
Business acquisitions (4,672) (27,691)
Cash invested in restricted cash and investments (4,500) (6,258)
Issuance of notes receivable, and other net -- (182)
--------- ---------
Net cash used in investing activities (10,692) (34,831)
--------- ---------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from issuance of long-term debt 5,200 33,473
Proceeds from issuance of common stock 414 7,411
Decrease in bank overdraft and other 580 (4,229)
--------- ---------
Net cash provided by financing activities 6,194 36,655
--------- ---------
Net increase (decrease) in cash and cash equivalents 4,638 (1,941)
CASH AND CASH EQUIVALENTS, beginning of period 10,980 14,029
--------- ---------
CASH AND CASH EQUIVALENTS, end of period $ 15,618 $ 12,088
========= =========
=======================================================================================================
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
5
<PAGE>
EMPLOYEE SOLUTIONS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(CONTINUED)
<TABLE>
<CAPTION>
=============================================================================================================================
Nine months ended September 30,
-------------------------------
(Dollars in thousands) 1997 1996
- -----------------------------------------------------------------------------------------------------------------------------
<S> <C> <C>
RECONCILIATION OF NET INCOME TO NET CASH (USED IN)
PROVIDED BY OPERATING ACTIVITIES:
Net income $ 1,741 $ 9,715
-------- --------
ADJUSTMENTS TO RECONCILE NET INCOME TO NET CASH (USED IN) PROVIDED BY OPERATING
ACTIVITIES:
Depreciation and amortization 3,103 1,216
Loss on sale of fixed assets 58 --
Increase in accounts receivable, net (18,494) (24,145)
Increase in insurance company receivable (1,847) --
Increase in prepaid expenses and deposits (2,592) (843)
(Increase) decrease in deferred income tax assets (1,995) 149
Decrease (increase) in other assets 2,563 (5)
Increase in accrued salaries,
wages and payroll taxes 18,044 13,452
Increase in accrued workers' compensation
and health insurance 6,756 2,306
Increase (decrease) in accounts payable 352 (6,321)
Decrease in accrued pension contributions (136) 1,417
Increase (decrease) in income taxes payable 468 (1,978)
Increase in other accrued expenses 1,039 1,278
Increase in deferred income tax liabilities $ 76 (6)
-------- --------
7,395 (13,480)
-------- --------
Net cash provided by (used in) operating activities $ 9,136 $ (3,765)
======== ========
=============================================================================================================================
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
6
<PAGE>
EMPLOYEE SOLUTIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 1997
(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:
Nature of Corporation
Employee Solutions, Inc. (together with its subsidiaries, ESI or the Company) is
a leading professional employer organization (PEO) providing employers
throughout the United States with comprehensive employee payroll, human
resources and benefits outsourcing services. The Company's integrated
outsourcing services include payroll processing and reporting, human resources
administration, employment regulatory compliance management, risk
management/workers' compensation services, retirement and health care programs,
and other products and services provided directly to worksite employees.
Basis of Presentation
The accompanying unaudited consolidated financial statements of the Company have
been prepared by the Company pursuant to the rules and regulations of the
Securities and Exchange Commission. Certain information and footnote disclosures
normally included in consolidated financial statements prepared in accordance
with generally accepted accounting principles have been omitted pursuant to such
rules and regulations. In the opinion of management the consolidated financial
statements include all adjustments, consisting only of normal recurring
adjustments, necessary in order to make the consolidated financial statements
not misleading. Results of operations for the three and nine month periods ended
September 30, 1997 are not necessarily indicative of the results that may be
expected for the year ending December 31, 1997. For further information, refer
to the consolidated financial statements and footnotes thereto included in the
Company's Annual Report on Form 10-K for the year ended December 31, 1996.
Principles of Consolidation
The consolidated financial statements include the activities of Employee
Solutions, Inc. and its wholly owned subsidiaries from their respective
acquisition date. All acquisitions were accounted for as purchases. All
significant intercompany accounts and transactions have been eliminated. Certain
amounts have been reclassified from prior years to conform with current year
presentation.
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. The
nature of the Company's business requires significant estimates to be made in
the areas of workers' compensation reserves and revenue recognized for
stand-alone risk management/workers' compensation services, particularly for
retrospectively rated policies. The actual results of these estimates may be
unknown for a period of years. Actual results could differ from those estimates.
7
<PAGE>
Net Income Per Common and Common Equivalent Share
The Company used the treasury stock method to compute net income per share. The
computation of adjusted net income and weighted average common and common
equivalent shares used in the calculation of income per common share is as
follows:
<TABLE>
<CAPTION>
================================================================================================================
Quarter ended September 30,
------------------------------------------------------------------
1997 1996
------------------------------ ------------------------------
Fully Fully
(Dollars in thousands, except share data) Primary Diluted Primary Diluted
---------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Weighted average of
common shares outstanding 31,394,532 31,394,532 30,515,334 30,515,334
Dilutive effect of options
and warrants outstanding 1,119,167 1,197,856 2,505,408 2,527,839
------------ ------------ ------------ ------------
Weighted average of common
and common equivalent
shares 32,513,699 32,592,388 33,020,742 33,043,173
============ ============ ============ ============
Net income $ 231 $ 231 $ 4,246 $ 4,246
Adjustments to net income (20) (20) (8) (8)
------------ ------------ ------------ ------------
Adjusted net income for
purposes of the income per
common share calculation $ 211 $ 211 $ 4,238 $ 4,238
============ ============ ============ ============
Net income per common and
common equivalent share $ 0.01 $ 0.01 $ 0.13 $ 0.13
============ ============ ============ ============
</TABLE>
<TABLE>
<CAPTION>
Nine months ended September 30,
------------------------------------------------------------------
1997 1996
------------------------------ ------------------------------
Fully Fully
(Dollars in thousands, except share data) Primary Diluted Primary Diluted
---------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Weighted average of
common shares outstanding 31,026,938 31,026,938 30,289,612 30,289,612
Dilutive effect of options
and warrants outstanding 2,202,960 2,202,960 2,156,981 2,527,839
------------ ------------ ------------ ------------
Weighted average of common
and common equivalent
shares 33,229,898 33,229,898 32,446,593 32,817,451
============ ============ ============ ============
Net income $ 1,741 $ 1,741 $ 9,715 $ 9,715
Adjustments to net income (53) (53) (20) (20)
------------ ------------ ------------ ------------
Adjusted net income for
purposes of the income per
common share calculation $ 1,688 $ 1,688 $ 9,695 $ 9,695
============ ============ ============ ============
Net income per common and
common equivalent share $ 0.05 $ 0.05 $ 0.30 $ 0.30
============ ============ ============ ============
================================================================================================================
</TABLE>
8
<PAGE>
(2) COMMON STOCK SPLITS:
On December 18, 1995, and June 26, 1996 the Board of Directors authorized
two-for-one common stock splits, effected in the form of 100% stock dividends,
effective on January 16, 1996 and July 26, 1996 respectively, to shareholders of
record at the close of business on January 2, 1996 and July 12, 1996. In this
report, all per share amounts and numbers of shares, including options and
warrants, have been restated to reflect these stock splits.
(3) ACQUISITIONS:
Acquisition of Phoenix Capital Management, Inc. and affiliated companies
Effective September 1, 1997, the Company acquired Phoenix Capital Management,
Inc. (PCM), a PEO services company and four affiliated PEOs (collectively
referred to as Employee Resources Corporation or ERC), for 752,587 restricted
shares of Company common stock plus additional restricted common stock to be
determined based upon ERC earnings after the acquisition. The Company's
unregistered common shares were valued at the average closing price on the
NASDAQ National Market for a 30 day period tied to closing, less a 35% discount
for lack of marketability. Since 1995, the Company has operated under an
agreement whereby PCM provided certain check processing services for the
Company. The acquisition of ERC adds approximately 150 clients with 1,800
worksite employees, primarily in the transportation industry.
Acquisition of Prompt Pay, Inc.
Effective September 1, 1997, the Company acquired Prompt Pay, Inc., PEO located
in Phoenix, Arizona, for $250,000. Prior to the purchase ESI provided payroll
processing services for Prompt Pay, Inc. The acquisition added approximately 350
worksite employees in six southwestern states.
Acquisition of ETIC Corporation
On February 1, 1997, the Company completed the acquisition of the principal
assets of ETIC Corporation, d/b/a Employers Trust (ETIC). The purchase price was
$30,000 plus five times ETIC's total pre-tax income for the 12-month period
ending January 31, 1998. At closing $855,000 was paid in cash. The excess
purchase price over net assets acquired was approximately $944,000 which has
been recorded as goodwill. The final payment of purchase price is due on or
before April 30, 1998, and will be paid in cash. ETIC is a Cincinnati, Ohio
based PEO with a client base consisting primarily of light industrial,
transportation and construction companies, with approximately 150 clients and
2,000 worksite employees.
Acquisition of CMGR Companies
On February 17, 1997, the Company completed the acquisition of the principal
assets of CMGR, Inc., and Humasys (collectively, CMGR) for $3.85 million. At
closing $2.35 million was paid in cash. The excess purchase price over net
assets acquired was approximately $2.6 million which has been recorded as
goodwill. An interim payment of $500,000 toward the purchase price is due nine
months after the closing. Final payment is due on or before April 18, 1998 and
is subject to certain client retention factors. CMGR is a New Jersey based PEO
with a client base consisting primarily of professional, service and light
industrial companies, with approximately 75 clients and 1,700 worksite
employees.
(4) UNAUDITED PRO FORMA FINANCIAL INFORMATION
The following unaudited pro forma combined financial data gives effect to the
combined historical results of operations of the Company and TEAM Services and
Leaseway Personnel Corp. (Leaseway), which were acquired in 1996, for the nine
months ended September 30, 1996, and assumes that the acquisitions had been
effective as of the beginning of such period and compares the pro forma results
in 1996 to actual results in 1997.
The pro forma information is not indicative of the actual results which would
have occurred had the acquisitions been consummated at the beginning of such
periods or of future consolidated operations of the Company. The pro forma
financial information is based on the purchase method of accounting and reflects
adjustments to eliminate nonrecurring general, administrative and other
expenses, to amortize the excess purchase price over the underlying
9
<PAGE>
value of net assets acquired and to adjust income taxes for the pro forma
adjustments.
<TABLE>
<CAPTION>
=========================================================================================================
For the nine months ended September 30,
---------------------------------------
(Dollars in thousands, except share data) 1997 Actual 1996 Pro Forma
- ---------------------------------------------------------------------------------------------------------
<S> <C> <C>
Total revenues $ 655,117 $ 373,450
Net income 1,741 10,446
Net income per common and common equivalent share
Primary .05 .32
Fully diluted .05 .32
Weighted average number of common and common
equivalent shares outstanding
Primary 33,229,898 32,446,593
Fully diluted 33,229,898 32,817,451
=========================================================================================================
</TABLE>
(5) ACCOUNTING PRONOUNCEMENTS NOT YET ADOPTED:
In February 1997, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 128 (SFAS No. 128), Earnings per Share. The
statement establishes standards for computing and presenting earnings per share
and requires dual presentation of basic and diluted earnings per share on the
face of the income statement. SFAS No. 128 is effective for financial statement
periods ending after December 15, 1997. Adoption of SFAS No. 128 would have the
following effect on the September 30, 1997 and 1996 financial statements:
<TABLE>
<CAPTION>
=============================================================================================================================
1997 1996
----------------------------------- --------------------------------------
(Dollars in thousands, except share data) Income Shares Per Share Income Shares Per Share
- -----------------------------------------------------------------------------------------------------------------------------
Quarter ended September 30,
-------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Earnings per common share $ .01 $ .13
====== ======
Earnings per common share - assuming dilution $ .01 $ .13
====== ======
Basic earnings per share
Income available to
common stockholders $ 211 31,394,532 $ .01 $ 4,238 30,515,334 $ .14
Effect of dilutive securities
common stock options -- 1,119,167 -- 2,505,408
-------- ----------- --------- --------------
Diluted earnings per share $ 211 32,513,699 $ .01 $ 4,238 33,020,742 $ .13
======== =========== ====== ========= ============== ======
Nine months ended September 30,
-------------------------------------------------------------------------------
Earnings per common share $ .05 $ .30
====== ======
Earnings per common share - assuming dilution $ .05 $ .30
====== ======
Basic earnings per share
Income available to
common stockholders $ 1,688 31,026,938 $ .05 $ 9,695 30,289,612 $ .32
Effect of dilutive securities
common stock options -- 2,202,960 -- 2,156,981
-------- ----------- --------- --------------
Diluted earnings per share $ 1,688 33,229,898 $ .05 $ 9,695 32,446,593 $ .30
======== =========== ====== ========= ============== ======
=============================================================================================================================
</TABLE>
10
<PAGE>
(6) CONTINGENCIES:
The Company has received a letter from the Arizona Department of Economic
Security indicating that the Company has been assigned a higher state
unemployment tax rate for calendar year 1994 than the Company believes it is
entitled to. In consultation with legal counsel the Company believes that based
on Arizona Revised Statutes it is entitled to the lower rate. If it was
ultimately determined that the higher rate applies, the Company would owe
$500,000 (before interest and the income tax effect) more than is reflected in
the Company's financial statements. As of September 30, 1997, the compounded
interest totaled approximately $173,000.
The Company has received notice from the New York State Department of Labor
indicating that it has recalculated ESI's unemployment rate for New York State
for 1996 and 1997. The impact on the Company would result in a charge of
$108,000 for the year ended 1996 and $426,000 for the nine months ended
September 30, 1997. These actions by the State of New York are on official
appeal by the Company, and the Company believes defenses exist and intends to
defend the cases vigorously.
The Company, and certain of its present and former executive officers and
directors, have been named as defendants in several actions filed in 1997. While
the exact claims and allegations vary, they all allege violations by the Company
of Section 10(b) of the Securities Exchange Act, and Rule 10b-5 promulgated
thereunder, with respect to the accuracy of statements regarding Company
reserves and other disclosures made by the Company and certain directors and
officers. These suits were filed shortly after a significant drop in the trading
price of the Company's common stock in March 1997. Each of the actions seeks
certification of a class consisting of purchasers of securities of the
Registrant over specified periods of time. Each of the complaints seeks the
award of compensatory damages in amounts to be determined at trial, including
interest thereon, and costs of the action, including attorney's fees. The suits
have been consolidated before a single judge of the U.S. District Court in
Phoenix, Arizona. The Court has before it motions by the plaintiffs for the
appointment of representative plaintiffs and approval of selection of lead
counsel. Once these motions are ruled upon, it is anticipated that a
consolidated, amended complaint will be filed. The Company believes the actions
are without merit and intends to defend the cases vigorously.
From time to time, the Company is named as a defendant in lawsuits in the
ordinary course of business. These lawsuits are not considered to have a
material impact on the Company.
The Company believes that it has meritorious defenses to the lawsuits facing it,
including those mentioned above, and intends to assert such defenses vigorously.
However, it is not possible to predict whether such defenses will be
successfully asserted in all cases. The Company would be required to record an
expense and liability as to any matter if, at any time in the future, it became
probable that the Company would not prevail in such matter.
(7) SUBSEQUENT EVENT - ISSUANCE OF NOTES PAYABLE
On October 21, 1997, the Company issued $85 million of 10% Senior Notes due 2004
(the Notes) in a transaction effected under Rule 144A under the Securities Act
of 1933 as amended (Securities Act). A portion of the net proceeds of the
offering, sold through private placement transactions, were used to repay
certain indebtedness, and the remaining balance will be used for additional
capital expenditures and general corporate purposes. Interest under the Notes is
payable semi-annually commencing April 15, 1998, and the Notes are not callable
until October 2001 subject to the terms of the Indenture under which the Notes
were issued. The Company incurred expenses related to the offering of
approximately $3 million and will amortize such costs over the life of the
Notes. The Company has agreed to file a registration statement under the
Securities Act, relating to an exchange offer for these Notes. If this
registration is not declared effective prior to the 120th day after the issue
date of October 21, 1997, the interest rate can increase up to a maximum of 12%
per annum of the principal amount of such Notes. In connection with the issuance
of the Notes, the Company modified its revolving credit facility whereby the
total commitment has been reduced to $20 million. The Notes contain certain
covenants which could limit the Company's ability to incur any future
indebtedness.
11
<PAGE>
The Notes are general unsecured obligations of the Company and are
unconditionally guaranteed on a joint and several basis by certain of the
Company's wholly-owned current and future subsidiaries. The Company's wholly
owned insurance subsidiary, which is a non-guarantor subsidiary, is subject to
certain statutory and contractual restrictions which limit its ability to pay
dividends or make loans to the Parent or other subsidiaries. The financial
statements presented below include the separate or combined financial position,
results of operations and cash flows of Employee Solutions, Inc. (Parent), the
guarantor subsidiaries (Guarantors) and the subsidiaries which are not
guarantors (Non-guarantors), for the nine months ended September 30, 1997.
BALANCE SHEETS
<TABLE>
<CAPTION>
=================================================================================================================================
For the Nine Months Ended September 30, 1997
---------------------------------------------------------------------------
(Dollars in thousands, except share data) Parent Guarantors Non guarantors Eliminating Consolidated
- ---------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
ASSETS
CURRENT ASSETS:
Cash and cash equivalents $ 827 $ 9,416 $ 5,375 $ -- $ 15,618
Restricted cash and investments -- -- 16,000 -- 16,000
Accounts receivable, net 16,367 34,964 2,002 -- 53,333
Receivable from insurance companies -- 5,450 2,315 -- 7,765
Prepaid expenses and deposits 2,033 1,499 318 -- 3,850
Deferred income taxes 3,690 -- -- -- 3,690
Due from affiliates 27,829 (2,517) 2,321 (27,633) --
-------- -------- -------- -------- --------
Total current assets 50,746 48,812 28,331 (27,633) 100,256
Property and equipment, net 1,910 287 28 -- 2,225
Goodwill and other assets, net 31,880 28,461 478 -- 60,819
Investment in subsidiary 47,602 -- -- (47,602) --
-------- -------- -------- -------- --------
Total assets $132,138 $ 77,560 $ 28,837 $(75,235) $163,300
======== ======== ======== ======== ========
LIABILITIES
CURRENT LIABILITIES:
Bank overdraft $ -- $ 3,245 $ -- $ -- $ 3,245
Accrued salaries, wages and payroll taxes 16,141 18,082 1,407 -- 35,630
Accounts payable 320 3,825 285 -- 4,430
Accrued workers' compensation
and benefits 1,893 1,610 10,180 -- 13,683
Income taxes payable (101) (153) -- 254 --
Other accrued expenses 1,295 3,110 48 -- 4,453
Due to affiliates 11,944 14,398 1,545 (27,887) --
-------- -------- -------- -------- --------
Total current liabilities 31,492 44,117 13,465 (27,633) 61,441
-------- -------- -------- -------- --------
Deferred income taxes 187 -- -- -- 187
-------- -------- -------- -------- --------
Long-term debt 48,000 -- -- -- 48,000
-------- -------- -------- -------- --------
Other long-term liabilities -- 1,213 -- -- 1,213
-------- -------- -------- -------- --------
STOCKHOLDERS' EQUITY
Class A convertible preferred stock -- -- -- -- --
Common stock, no par value 34,356 22 771 (793) 34,356
Additional paid in capital -- 26,342 50 (26,392) --
Retained earnings 18,103 5,866 14,551 (20,417) 18,103
-------- -------- -------- -------- --------
Total stockholders' equity 52,459 32,230 15,372 (47,602) 52,459
-------- -------- -------- -------- --------
Total liabilities and stockholders' equity $132,138 $ 77,560 $ 28,837 $(75,235) $163,300
======== ======== ======== ======== ========
=================================================================================================================================
</TABLE>
12
<PAGE>
STATEMENT OF OPERATIONS
<TABLE>
<CAPTION>
===================================================================================================================================
For the Nine Months Ended September 30, 1997
-------------------------------------------------------------------------------
(Dollars in thousands, except share data) Parent Guarantors Non guarantors Eliminating Consolidated
- -----------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Revenues $ 332,596 $ 289,561 $ 54,069 $ (21,109) $ 655,117
--------- --------- --------- --------- ---------
Cost of Revenues:
Salaries and wages of worksite employees 286,717 232,798 27,352 (17,299) 529,568
Healthcare and workers' compensation 10,308 20,093 16,971 -- 47,372
Payroll and employment taxes 24,234 18,926 2,329 -- 45,489
--------- --------- --------- --------- ---------
Cost of Revenues 321,259 271,817 46,652 (17,299) 622,429
--------- --------- --------- --------- ---------
Gross profit 11,337 17,744 7,417 (3,810) 32,688
Selling, general and administrative expenses 16,507 7,293 313 -- 24,113
Intercompany selling, general and
administrative expense 1,038 2,641 131 (3,810) --
Depreciation and amortization 1,743 1,336 24 -- 3,103
--------- --------- --------- --------- ---------
Income from operations (7,951) 6,474 6,949 -- 5,472
Other income (expense):
Interest income 26 79 640 -- 745
Interest expense and other (3,336) 1 119 -- (3,216)
--------- --------- --------- --------- ---------
Income before provisions for income taxes (11,261) 6,554 7,708 -- 3,001
Income tax provision
Tax rate 42% (4,730) 2,753 3,237 -- 1,260
--------- --------- --------- --------- ---------
(6,531) 3,801 4,471 -- 1,741
Income from wholly-owned subs 8,272 -- -- (8,272) --
--------- --------- --------- --------- ---------
Net income $ 1,741 $ 3,801 $ 4,471 $ (8,272) $ 1,741
========= ========= ========= ========= =========
===================================================================================================================================
</TABLE>
13
<PAGE>
STATEMENT OF CASH FLOWS
<TABLE>
<CAPTION>
================================================================================================================================
For the Nine Months Ended September 30, 1997
------------------------------------------------------------------------
(Dollars in thousands, except share data) Parent Guarantors Non guarantors Eliminating Consolidated
- --------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
RECONCILIATION OF NET INCOME TO
NET CASH PROVIDED BY (USED IN)
OPERATING ACTIVITIES:
Net income $ 1,741 $ 3,801 $ 4,471 $ (8,272) $ 1,741
-------- -------- -------- -------- --------
ADJUSTMENTS TO RECONCILE NET
INCOME TO NET CASH PROVIDED BY
(USED IN) OPERATING ACTIVITIES:
Depreciation and amortization 1,743 1,336 24 -- 3,103
Increase in accounts receivable, net (5,455) (11,379) (1,660) -- (18,494)
(Increase) decrease in insurance company
receivable -- (2,293) 446 -- (1,847)
Increase in prepaid expenses and deposits (1,291) (1,105) (196) -- (2,592)
Increase in deferred income taxes (1,995) -- -- -- (1,995)
Decrease in other assets (2,042) 4,828 (165) -- 2,621
(Decrease) increase from intercompany
transactions (2,893) (4,297) (1,082) 8,272 --
Increase in accrued salaries, wages, and payroll
taxes 6,251 10,902 891 -- 18,044
Increase (decrease) in accrued workers'
compensation and health insurance 1,661 (609) 5,704 -- 6,756
Increase in pension payable -- (136) -- -- (136)
Increase (decrease) in accounts payable 131 540 (319) -- 352
Increase (decrease) in income taxes payable 468 -- -- -- 468
Increase in other accrued expenses (18) 1,041 16 -- 1,039
Increase in deferred income tax liabilities 76 -- -- -- 76
-------- -------- -------- -------- --------
(3,364) (1,172) 3,659 -- 7,395
-------- -------- -------- -------- --------
Net cash provided by (used in)
operating activities (1,623) 2,629 8,130 -- 9,136
-------- -------- -------- -------- --------
CASH FLOWS FROM INVESTING
ACTIVITIES:
Purchase of property and equipment (1,467) (53) -- -- (1,520)
Business acquisitions (3,944) (675) (53) -- (4,672)
Cash invested in restricted cash and
investments -- -- (4,500) -- (4,500)
-------- -------- -------- -------- --------
Net cash used in investing activities (5,411) (728) (4,553) -- (10,692)
-------- -------- -------- --------
CASH FLOWS FROM FINANCING
ACTIVITIES:
Proceeds from issuance of long-term debt 5,200 -- -- -- 5,200
Proceeds from issuance of common stock 414 -- -- -- 414
Decrease in bank overdraft and other (188) 768 -- -- 580
-------- -------- -------- -------- --------
Net cash provided by (used in)
financing activities 5,426 768 -- -- 6,194
-------- -------- -------- -------- --------
Net increase (decrease) in cash and
cash equivalents (1,608) 2,669 3,577 -- 4,638
CASH AND CASH EQUIVALENTS, beginning
of period 2,435 6,747 1,798 -- 10,980
-------- -------- -------- -------- --------
CASH AND CASH EQUIVALENTS, end of
period $ 827 $ 9,416 $ 5,375 $ -- $ 15,618
======== ======== ======== ======== ========
================================================================================================================================
</TABLE>
14
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The following discussion should be read in conjunction with, and is qualified in
its entirety by, the Company's Consolidated Financial Statements and the Notes
thereto appearing elsewhere herein and in the Company's Report on Form 10-K for
the year ended December 31, 1996. Historical results are not necessarily
indicative of trends in operating results for any future period.
Except for the historical information contained herein, the discussion in this
Form 10-Q contains or may contain forward-looking statements (which include
statements in the future tense and statements using the terms "believe,"
"anticipate," "expect," "intend" or similar terms) that involve risks and
uncertainties. The Company's actual results could differ materially from those
discussed here. Factors that could cause or contribute to such differences
include, but are not limited to, those discussed in this Management's Discussion
and Analysis (particularly in "Outlook: Issues and Risks") in addition to those
discussed "Item 1 Business" and "Item 7 - Management's Discussion and Analysis
of Financial Condition and Results of Operations" of the Company's Report on
Form 10-K for the year ended December 31, 1996, as well as those factors
discussed elsewhere herein or in any document incorporated herein by reference.
Results of Operations -- Overview
The following is a summary of certain factors which affect results of operations
and which have generally applied to the Company in all periods presented.
Revenues
The most significant components of the Company's revenues are payments received
from customers for gross salaries and wages paid to PEO worksite employees and
the Company's service fee. The Company negotiates service fees on a
client-by-client basis based on factors such as market conditions, client needs
and services requested, the clients' workers' compensation and benefit plan
experience, Company administrative resources required, the expected profit, and
other factors. These fees are generally expressed as a fixed percentage of the
client's gross salaries and wages except for certain costs, primarily employer's
health care contributions, which are billed to clients on an add-on basis.
Because the service fees are negotiated separately with each client and vary
according to circumstances, the Company's service fees, and therefore its gross
margin, will fluctuate based on the Company's client mix.
Revenues from stand-alone risk management/workers' compensation services consist
primarily of gross premiums charged to clients for such services. The Company
also receives fee income for certain other types of services, such as those in
connection with its driver leasing program.
Costs of Revenues
The Company's primary direct costs of revenues include salaries and wages paid
to worksite employees, employment related taxes, costs of health and welfare
benefit plans, and workers' compensation insurance costs.
The largest component of direct costs is salaries and wages to worksite
employees. Although this cost is generally directly passed through to clients,
the Company is responsible for payment of these costs even if not reimbursed by
its clients. The Company has begun extending credit terms to clients in certain
industries. See "Outlook: Issues and Risks - Credit Risks" herein.
Employment related taxes consist of the employer's portion of payroll taxes
required under the Federal Income Contribution Act (FICA), which includes Social
Security and Medicare, and federal and state unemployment taxes. The federal tax
rates are defined by the appropriate federal regulations. State unemployment
rates are subject to change each year based on claims histories and size of
payments, and vary from state to state.
15
<PAGE>
Workers' compensation costs, whether relating to PEO worksite employees or the
Company's stand-alone risk management/workers' compensation program, include the
costs of claims up to the retention limits relating to the Company's workers'
compensation program, administrative costs, premium taxes and excess reinsurance
premiums, and accidental death and dismemberment insurance which the Company
maintains to limit certain of its losses. In its arrangements with the Reliance
Group of Insurance Companies (Reliance) through the Company's wholly-owned
insurance subsidiary, the Company retains workers' compensation liabilities up
to certain specified amounts. The Company maintained a similar program with
Legion Insurance Company (Legion) which it terminated effective August 1, 1997
due to cost and capital considerations. Accrued workers' compensation claims
liability is based upon estimates of reported and unreported claims and the
related claims and claims settlement expenses in an amount equal to the retained
portion of the expected total incurred claim. The Company's accrued workers'
compensation reserves are primarily based on industry-wide data, and to a lesser
extent, the Company's past claims experience up to the retained limits. The
liability recorded may be more or less than the actual amount of the claims when
they are submitted and paid. While the Company believes that its reserves are
adequate for future claims expense, there can be no assurance that this will be
the case. See "Outlook: Issues and Risks." Changes in the liability are charged
or credited to operations as the estimates are revised. Administrative costs
include fees paid to Reliance and Legion and costs of claims management by third
party administrators. Premium taxes include taxes and related fees paid to
various states based on premiums written. Premium for excess reinsurance relates
to premium payments to the Company's insurers for the retention of risks above
specified limits.
Health care and other employee benefits costs consist of medical and dental
insurance premiums, payments of and reserves for claims subject to deductibles
and the costs of vision care, disability, life insurance and other similar
benefit plans. The Company's health care benefit plans consist of a mixture of
fully-insured programs and partially self-insured programs with specific and, in
one program, aggregate stop-loss insurance. The Company recognizes a liability
for partially self-insured health insurance claims at the time a claim is
reported to the Company by the third party claims administrator, and also
provides for claims incurred, but not reported based on industry-wide data and
the Company's past claims experience. The liability recorded may be more or less
than the actual amount of ultimate claims. While the Company believes that its
reserves are adequate for future claims expense, there can be no assurance that
this will be the case. See "Outlook: Issues and Risks" herein.
Selling, General and Administrative Expenses
The Company's primary operating expenses are administrative personnel expenses,
other general and administrative expenses, and sales and marketing expenses.
Administrative personnel expenses include compensation, fringe benefits and
other personnel expenses related to the Company's internal administrative
employees. Other general and administrative expenses include rent, office
supplies and expenses, legal and accounting fees, insurance and other operating
expenses. Sales and marketing expenses include commissions to sales executives
and related expenses.
Depreciation and Amortization
Depreciation and amortization consists primarily of the amortization of goodwill
and acquisition costs from the Company's prior acquisitions. The Company
amortizes goodwill and acquisition costs over periods of three to thirty years,
depending on the assets acquired, using the straight-line method. Acquisitions
generally result in considerable goodwill because PEOs generally require few
fixed assets to conduct their operations.
Acquisitions
Period-to-period comparisons are substantially affected by the Company's recent
substantial growth through acquisition of other companies providing PEO
services. The Company has accounted for its acquisitions using the "purchase"
method of accounting, and prior period financial statements therefore have not
been restated to reflect these acquired operations. In addition to increasing
revenues, acquisition activity can affect gross profits and margins because the
industry mix of the acquired companies may differ from that of the Company and
because of the transition period after an acquisition in which the Company acts
to implement pricing changes where appropriate and to eliminate client
relationships which do not meet the Company's risk or profitability profiles.
16
<PAGE>
Operating Results
Margin comparisons are affected by the relative mix of stand-alone risk
management/workers' compensation services and full PEO services in any
particular period. Significant numbers of conversions from stand-alone risk
management/workers' compensation to full-service PEO arrangements (such as those
which have occurred in connection with certain Company acquisitions) would tend
to increase gross profit amounts while decreasing gross margins because of the
addition of pass-through salaries and wages to both revenues and costs.
Certain employment-related taxes are based on the cumulative earnings of
individual employees up to a specified wage level. Therefore, these expenses
tend to decline over the course of a year. Since the Company's revenues for an
individual client are generally earned and collected at a relatively constant
rate throughout each year, payment of such unemployment tax obligations has a
decreasing impact on the Company's working capital and results of operations as
the year progresses.
Three and Nine Months Results of Operations - September 30, 1997 Compared to
September 30, 1996
<TABLE>
<CAPTION>
==============================================================================================================================
Three months ended September 30, Nine months ended September 30,
---------------------------------------- ----------------------------------------
Percent Percent
(Dollars in thousands) 1997 Change 1996 1997 Change 1996
- ------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Revenues $ 233,093 86% $ 125,238 $ 655,117 126% $ 290,180
Cost of revenues 222,558 97 112,864 622,429 138 261,310
Gross profit 10,535 (15) 12,374 32,688 13 28,870
Selling, general and administrative 8,201 44 5,706 24,113 90 12,681
Depreciation and amortization 1,055 88 562 3,103 155 1,216
Interest income 298 35 220 745 18 630
Interest expense (1,097) 175 (399) (3,163) 679 (406)
Net income 231 (95) 4,246 1,741 (82) 9,715
==============================================================================================================================
</TABLE>
Revenues
Revenues increased to $233.1 million for the quarter ended September 30, 1997
from $125.2 million for the quarter ended September 30, 1996, an 86% increase.
For the nine months ended September 30, 1997, revenue was $655.1 million
compared to $290.2 million for the nine months ended September 30, 1996, an
increase of 126%. Acquisitions, and the addition of US Xpress, Inc. and
affiliates (US Xpress) as a PEO client, primarily accounted for the increase in
revenues between the periods. Growth was in part offset by factors such as
attrition of clients and competitive pressures in the PEO and workers'
compensation industry. The Company's acquisition of ERC effective September 1,
1997, accounted for approximately half of the increase in revenues over the
three months ended June 30, 1997, the balance being derived from internal
growth. The number of worksite employees increased to approximately 46,500
covering 1,679 client companies at September 30, 1997 from approximately 28,000
covering 1,145 client companies at September 30, 1996. In addition, at September
30, 1997, the Company provided risk management/workers' compensation services to
approximately 13,000 employees covering 73 employers. Revenues related to
stand-alone risk management/workers' compensation services were $3.0 million and
$10.2 million for the quarter and nine month period ended September 30, 1997,
respectively (which included first quarter nonrecurring revenue of approximately
$1.0 million related to stand-alone workers' compensation premiums that were
under-billed for policies written in the previous year) compared with revenues
of $3.9 million and $12.4 for the third quarter and nine months ended September
30, 1996. In addition, revenues for risk management/workers'
17
<PAGE>
compensation services include approximately $262,000 and $1.2 million for the
three and nine month periods ended September 30, 1997, respectively, related to
a single customer as to which disputes have arisen. The Company has provided
reserves for such amounts and is considering what further action, including
litigation, may be necessary to collect these amounts. See "Liquidity and
Capital Resources."
The Company began in late 1996 to experience the effects of competition and a
general weakening in the workers' compensation and employee benefits markets,
which slowed revenue growth. This trend has continued into 1997 and is
continuing to be experienced by the Company. Stand-alone policies, subject to
renewal, in place at September 30, 1997 represent annualized premiums of
approximately $10.8 million.
Cost of revenues
Cost of revenues increased 97%, to $222.6 million in the three months ended
September 30, 1997 from $112.9 million for the three months ended September 30,
1996. For the nine month period ended September 30, 1997 the cost of revenues
were $622.4 million compared to $261.3 million for the same period in 1996,
representing a 138% increase. This increase is primarily due to the increase in
the Company's business as previously described and as described below.
Included in the quarterly results are substantially offsetting adjustments for a
benefit derived from a reduction of the Company's experience modification factor
(E-MOD) and certain reserves which were established with respect to state
payroll tax obligations. The nine months ended September 30, 1997, also includes
expense reductions of approximately $900,000 related to retrospective rate
adjustments on workers' compensation programs related to prior periods.
Workers' compensation losses for the third quarter and nine months ended
September 30, 1997 were $6.1 and $15.3 million, respectively. The Company
believes that the overall results of the Company's risk management/workers'
compensation program as measured against industry data can be attributed to the
Company's selectivity in new client acceptance, the effective use of safety
inspections and safety programs and its ability to manage and close open claims
coupled with stop losses of $250,000 and $350,000 per occurrence, the
maintenance of accidental death and dismemberment insurance through the Chubb
Group of Insurance Companies (Chubb) and a 30-day cancellation capability
generally available on PEO business. Although the Company believes its internal
method of establishing reserves continues to be appropriate, the Company
commissioned an independent third party actuarial review of the Company's
workers' compensation reserves at year end 1996, as it had for year end 1995. In
the 1996 review, the actuary primarily relied on industry-wide data, while
taking into account to a lesser extent than in past reviews ESI's specific risk
structure and philosophy in determining its findings. Although the Company
believes that determining reserves based more heavily upon its actual historical
experience is appropriate and adequately addressed its exposure, it determined
to adopt the reserve levels determined by the review for the year ended December
31, 1996, and to use similar methodologies going forward which may have an
impact on future periods. The Company has also increased its internal risk per
occurrence to $500,000 in Ohio and in certain circumstances Washington, as a
result of the Company becoming a self-insurer under those states' monopolistic
workers' compensation structures. See "Adequacy of Loss Reserves" ; "Loss and
Claims Experience" below in "Outlook: Issues and Risks" for a further
explanation of risks and uncertainties relating to the Company's establishment
of reserves.
The Company is in the process of analyzing developments in the workers'
compensation insurance market. In an effort to reduce the uncertainty and
potential expense volatility associated with its retained workers' compensation
insurance risk, the Company is in active negotiations with several insurance
companies regarding various programs which could result in the shifting of all
or a substantial portion of such risk away from the Company. While the Company
believes that market conditions generally are favorable for completion of such a
transaction, there can be no assurance that any such transaction can be
accomplished on terms satisfactory to the Company.
18
<PAGE>
The following table provides an analysis of the Company's workers' compensation
reserves from its partially self-insured programs for the following periods.
Effective July 1, 1997, and included in the third quarter reserve, the provision
for losses and payments includes amounts for self insurance programs in
monopolistic states (primarily Ohio).
<TABLE>
<CAPTION>
========================================================================================================
Quarter ended Year ended
-------------------------------------------------- -----------
September 30, June 30, March 31, December 31,
(Dollars in thousands) 1997 1997 1997 1996
- --------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Reserve - Beginning of period $ 8,409 $ 6,764 $ 5,154 $ 1,052
Provision for losses 6,076 5,236 3,964 10,034
Payments (3,295) (3,591) (2,354) (5,932)
-------- -------- -------- --------
Reserve - End of period $ 11,190 $ 8,409 $ 6,764 $ 5,154
======== ======== ======== ========
========================================================================================================
</TABLE>
The following table summarizes certain indicators of performance regarding the
Company's risk services department's ability to close out workers' compensation
claims in each of the following periods:
===============================================================================
Approximate Approximate
Total Open Claims
Incurred Claims by Number of September 30,
Calendar Period Claims 1997
- -------------------------------------------------------------------------------
Nine months ended
- ------------------
September 30, 1997 3,544 1,626
Year ended
- ------------------
December 31, 1996 3,422 406
December 31, 1995 1,038 48
December 31, 1994 100 0
-------- ---------
8,104 2,080
======== =========
================================================================================
Gross profit
The Company's gross profit margin was 4.5% for the third quarter ended September
30, 1997, compared to 9.9% for the same period in 1996. The gross profit margin
for the nine month period ended September 30, 1997 of 5.0% was down from 9.9%
for the nine month period ended September 30, 1996. This decrease was
attributable to several factors including higher workers' compensation costs
primarily related to the current quarter (as discussed above), the impact of
repricing existing clients due to competitive factors, lower margins on new
business and the change in mix of the Company's stand-alone risk
management/workers' compensation program revenues relative to the revenues
derived from the Company's PEO business. In addition, while a significant
portion of the Company's total 1997 revenue was derived from US Xpress, as
discussed previously, the gross profit was negligible for the nine month period
ended September 30, 1997. Increased competition in certain areas of the
Company's business along with higher workers' compensation claims costs, all
negatively affected the gross profit margin in 1997. The Company generally earns
a higher gross profit margin on revenues derived from its stand-alone risk
management/workers' compensation services than on revenues derived from the
Company's full-service PEO business, as PEO revenues generally include
significant (and substantially offsetting) revenue and expense items for payroll
and payroll-related costs for the worksite employees. Accordingly, the Company's
overall margin is affected in significant part by the mix of revenues derived
from full-service PEO clients and clients for which the Company provides only
risk management/workers' compensation services. Stand-alone risk
management/workers' compensation services revenue decreased from 3.1% of total
revenues for the third quarter of 1996 to 1.3% in the third quarter of 1997.
19
<PAGE>
Selling, general and administration
Selling, general and administrative expenses for the quarter ended September 30,
1997 increased by approximately $2.5 million to $8.2 million, or 44%, from $5.7
million for the quarter ended September 30, 1996. For the nine month periods
ended September 30, 1997 and 1996, respectively, selling, general and
administrative expenses totaled $24.1 million, compared to $12.7 million, or a
90% increase. Factors contributing to the increase in selling, general and
administrative expenses in 1997 over 1996 are the inclusion of the operations of
various acquisitions, an increase from 139 corporate employees at September 30,
1996 to 323 at September 30, 1997, and the relocation of the Company's office
space. These factors which caused increases in selling, general and
administrative expense were partially mitigated by improved systems utilization
and economies of scale achieved within the Company's operations. The Company's
insurance costs have increased due primarily to the Company's growth. Commission
expenses increased in the three and nine months ended September 30, 1997
compared to the same periods in 1996 due to the increase in revenues discussed.
Selling, general and administrative expenses are expected to continue to
increase to meet the needs of new business, though the Company has initiated
efforts to improve efficiencies. The Company signed a seven year lease on new
office space in Phoenix, Arizona containing significantly more space at higher
rates than its previous facilities. The annual rental increase of approximately
$1 million, began in April 1997.
Depreciation and amortization
Depreciation and amortization represented depreciation of property and equipment
and amortization of organizational costs, customer lists and goodwill. Total
depreciation and amortization expense for the three months ended September 30,
1997 was $1.1 million compared to $562,000 for the period ended September 30,
1996. For the nine month period ended September 30, 1997, depreciation and
amortization expense totaled $3.1 million compared to $1.2 million for the nine
month period ended September 30, 1996. The increase was due primarily to
depreciation of new phone and computer systems and goodwill amortization
resulting from acquisitions, with Leaseway and the McClary-Trapp groups of
companies (McClary-Trapp Group) being the most significant. In addition, the
Company acquired ETIC and CMGR in February of 1997. Goodwill amortization of
these acquisitions was recognized from the date of acquisition. Because the
Company intends to focus in the short term on further integrating prior
acquisitions, the Company does not currently expect 1997 acquisition activity to
be as extensive as in 1996. See "Liquidity and Capital Resources" below
regarding the Company's issuance of $85 million in Notes in particular as to the
approximately $3 million in offering expenses which will be amortized in future
periods.
Interest
Interest income increased to $298,000 for the three months ended September 30,
1997 from $220,000 for the same period in 1996. For the nine month period ended
September 30, 1997 interest income totaled $745,000 compared to $630,000 for the
nine months ended September 30, 1996. The increase in interest income is
primarily due to interest earned on both the restricted cash and investments
held for the future payment of workers' compensation claims at Camelback
Insurance Ltd. (Camelback) and cash held at the corporate level. Interest
expense increased to $1.1 million for the three months ended September 30, 1997,
from $399,000 for the three months ended September 30, 1996. Interest expense
for the nine month period ended September 30, 1997 totaled $3.2 million compared
to $406,000 for the nine month period ended September 30, 1996. The increase in
interest expense is primarily due to interest accrued on the Company's prior
revolving line of credit. The line was first utilized in August 1996 and had
average outstanding balances of $48.5 million and $47.2 million for the three
months and nine months ended September 30, 1997, respectively.
On October 21, 1997, the Company issued $85 million of 10% Senior Notes due 1997
(the Notes) in a private placement transaction. The increase in borrowings
pursuant to the Notes as compared to prior borrowings under the revolving credit
facility can be expected to increase interest expense in future periods,
although the Company expects that a portion of the increase will initially be
offset by interest income generated by the net proceeds in excess of the amount
used to repay amounts borrowed under the prior revolving credit facility. See
"Liquidity and Capital Resources" below.
20
<PAGE>
Effective tax rate
The Company's effective tax rate provides for federal, state and local income
taxes. The effective tax rate for the nine months ended September 30, 1997 was
42% as compared to 36.1% for the nine months ended September 30, 1996. The tax
rate used in each quarterly reporting period generally is an estimate of the
Company's effective tax rate for the calendar year, which has increased because
the impact of nondeductible items is somewhat more pronounced at the Company's
level of earnings. The rate reflects the operations of the Company's
wholly-owned subsidiary, Camelback, which pays state premium tax rather than
state income tax. Although the Company believes that it has structured its
Camelback arrangements to qualify for such tax treatment, any disallowance of
this tax treatment could materially affect the Company's results of operations
for the current fiscal year and future fiscal years. The Company's effective tax
rate will vary from time to time depending primarily on the mix of profits
derived from Camelback and the Company's various other profit centers, the
magnitude of nondeductible items relative to overall profitability and other
factors. The Company's estimated effective tax rate for financial reporting
purposes for 1997 is also based on estimates of the following items that are not
deductible for tax purposes:(a) amortization of certain goodwill, and (b)
one-half of the per diem allowance relating to meals paid to truck drivers under
a Company sponsored program.
Additional factors which may impact the Company's future operations and results
are discussed below under "Outlook: Issues and Risks."
Liquidity and Capital Resources
The Company defines liquidity as the ability to mobilize cash to meet operating,
capital and acquisition financing needs. The Company's primary source of cash in
the nine months ended September 30, 1997 were from financing activities.
Cash provided by operating activities was $9.1 million during the nine months
ended September 30, 1997 compared to cash used in operating activities of $3.8
million during the same period of 1996. Operating cash flows are derived from
customers for full PEO services rendered by the Company and for stand-alone risk
management/workers' compensation services. Payments from PEO customers typically
are received on or within a few days of the date on which payroll checks are
delivered to customers, and cover the cost of the payroll, payroll taxes,
insurance, other benefit costs and the Company's administration fee. The
acquisitions of TEAM Services, Leaseway and certain companies in the
McClary-Trapp Group and the Company's stand-alone program adversely affected the
Company's operating cash flows as these operations extend credit terms generally
from 15 to 45 days as is customary in their respective markets segments.
Stand-alone risk management/workers' compensation services are billed in
accordance with individual policies. The Company also extends credit terms for
certain of its stand-alone risk management/workers' compensation clients by
billing less than the expected premium over the policy term, with the difference
paid on a deferred basis after the end of a policy year. In addition, accounts
receivable were increased because of the results of audits of stand-alone
workers' compensation policies which began in the first quarter of 1997. These
audits have indicated additional amounts due to the Company based upon changes
during the policy year, which are being billed to customers. The amounts due as
a result of the audits include $1.0 million recognized in the first quarter of
1997 which relate to prior periods. If the Company expands in these market
segments or enters into new market segments, or extends credit terms to
additional clients, its working capital requirements may increase. Included in
other assets is a net receivable of $2.9 million from a single customer as to
which disputes have risen. Although the Company believes the amount is
collectible, the Company is considering its alternatives, including litigation,
for collection of the receivable.
Cash used in investing activities was $10.7 million and $34.8 million in the
nine months ended September 30, 1997 and 1996, respectively. For 1997 and 1996,
capital expenditures were $1.5 million and $.7 million, respectively. Capital
expenditures in 1997 consisted primarily of computer equipment to enhance the
Company's ability to support the Company's increasing client and employee base.
In April 1997, the Company relocated its Phoenix operations to a new facility.
The leaseholds and improvements will be financed by the landlord as a buildout
allowance, and subsequently reflected in rental payments. Moving costs and
office furniture represented cash outlays in the first and second quarters of
1997 of approximately $1.0 million. During the remainder of 1997, the Company
expects to continue to invest in additional computer and technological
equipment. Although the Company continuously reviews its capital expenditure
needs, management expects that 1997 capital
21
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expenditures will exceed those incurred in prior periods to meet the needs of
the Company's growing base of worksite employees.
Cash provided by financing activities was $6.2 million for the nine months ended
September 30, 1997 compared to cash provided by financing activities of $36.7
million for the same period in 1996. Cash flows from financing activities during
the nine months ended September 30, 1997 and 1996 resulted primarily from the
Company's acquisition financing (see below) and the sale of the Company's common
stock upon exercise of options.
At September 30, 1997 and 1996, the Company had cash and cash equivalents of
$15.6 million and $12.1 million, respectively. Cash and cash equivalents are
generally invested in high investment grade instruments with maturities of less
than 90 days. Certain amounts of restricted cash and investments (see below) may
have maturities beyond 90 days but are highly liquid. The Company generally
maintains large cash balances to meet its daily payroll and payroll tax
obligations. The Company is implementing a nationwide cash management program to
minimize the requirement for cash on hand, though as the business continues to
grow, cash requirements to meet daily obligations will increase. The Company is
required through its fronting arrangements with Reliance to maintain restricted
cash and investments to secure the future payment of workers' compensation
losses. Such restricted cash and investments have been calculated based on
estimates of the future growth in the Company's business and ultimate losses on
such business. For this purpose, ultimate losses are actuarially determined by
the fronting carriers utilizing industry-wide data and regulatory requirements
which may not reflect the Company's historical or expected ultimate losses.
Restricted cash and investments is classified as a current asset as the Company
settles and pays most workers' compensation claims within one year from
occurrence. The Company cannot access restricted cash and investments without
the agreement of Reliance. At September 30, 1997, $16.0 million was on deposit
at Camelback as restricted cash and investments.
At September 30, 1997 and December 31, 1996, the Company had working capital of
$38.8 million and $30.4 million, respectively.
Assuming continued growth of the Company's full-service PEO business and
stand-alone risk management/workers' compensation services program, the Company
anticipates that it will be required under its arrangements with its insurers to
set aside increasing amounts of funds for payment of claims and related
administrative costs.
Under Bermuda law, Camelback must maintain statutory capital and surplus in an
amount equal to at least 20% of the net premiums written through the Company's
fronting arrangements, provided that the percentage requirement is reduced to
10% at such time as annualized premium volume reaches $6 million. The Company
has applied for a new license under which the percentage requirement, if such
license is granted, will be reduced to 15%. Bermuda law also regulates the
circumstances under which Camelback may loan funds to its parent company. In the
nine months ended September 30, 1997, the Company paid to Reliance approximately
$10.7 million of which $6.6 million was ceded to the trust account at Camelback
for payment of claims and $2.1 million was ceded directly to Camelback as
unrestricted. For the same period the Company also paid to Legion approximately
$2.6 million of which $1.7 million in loss funds will be ceded to Camelback upon
the establishment of a separate trust account for the program. In the future,
these factors may limit the ability of the Company to execute its planned growth
strategy and may limit the ability of Camelback to transfer funds to its parent
company (whether via dividend or otherwise).
The Company had a $60 million revolving line of credit under its prior bank
revolving credit facility (Prior Credit Facility) for acquisition financing,
working capital and other general corporate purposes. The Prior Credit Facility
provided for various borrowing rate options including borrowing rates based on a
fixed spread of 25 basis points over the prime rate or 250 basis points over the
London Interbank Offered Rate (LIBOR), as adjusted upward to reflect applicable
reserve requirements. The Company paid a commitment fee of 37.5 basis points on
the unused portion of the line.
Since the Company obtained its Prior Credit Facility in August 1996, the $49.7
million drawn under the line at October 21, 1997 had been used primarily for
acquisition financing including $24.0 million for the acquisition of Leaseway,
$9.4 million for the acquisition of McClary-Trapp, $3.0 million for CMGR, $.9
million for ETIC and approximately $10.0 million to finance accounts receivable
on such acquisitions. The Company repaid outstanding indebtedness under the
Prior Credit Facility with net proceeds of the Offering and replaced it with the
Amended Credit Facility. See "Amended Credit Facility" below.
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The Company has financed its acquisitions through combinations of issuance of
common stock, borrowing under its credit facility, working capital and
assumption of acquired company obligations. The Company's revolving credit
facility restricts its ability to consummate any acquisition prior to creditor
approval. The Company received a waiver under the revolving credit facility to
enter into its agreements to acquire ETIC and CMGR.
Note Offering
On October 21, 1997, the Company issued $85 million of Notes in an Offering (the
Offering) effected under Rule 144A under the Securities Act of 1933 as amended
(Securities Act). Approximately $50 million of the net proceeds of the Offering
was used to repay certain indebtedness, and the remaining balance will be used
for additional capital expenditures and general corporate purposes. Interest
under the Notes is payable semi-annually commencing April 15, 1998, and the
Notes are not callable until October 2001 subject to the terms of the Note
Agreement. The Company incurred expenses related to the Offering of
approximately $3 million and will amortize such costs over the life of the
Notes. The Company has agreed to file under the Securities Act, a registration
statement relating to an exchange offer for these Notes. If this registration is
not declared effective prior to the 120th day after the issue date of October
21, 1997, the interest rate can increase up to a maximum of 12% per annum of the
principal amount of such Notes.
Amended Credit Facility
In connection with the Offering, the Company entered into the Amended Credit
Facility which provided for a revolving line of credit of $20.0 million,
including letters of credit drawn thereunder. The Amended Credit Facility
includes various borrowing rate options including borrowing rates at the prime
rate or 175 basis points over London Interbank Offered Rate (LIBOR). The Company
will pay a commitment fee of 25 basis points on the unused portion of the line
and letter of credit fees of 75 to 175 basis points per annum. The Amended
Credit Facility will mature on August 1, 1999. The principal loan covenants in
the Amended Credit Facility are as follows: current ratio of at least 1.3 to 1;
minimum net worth of at least $45 million as of June 30, 1997, adjusted by 75%
of net income and other factors each and every fiscal quarter thereafter; senior
debt to EBITDA, as defined therein for the preceding four quarters of not more
than 2.0 to 1 as of the end of each calendar quarter and maximum debt to EBITDA
as reduced by a portion of available cash of 4.0 to 1. The Amended Credit
Facility includes certain other customary covenants and will be secured by
substantially all of the Company's assets.
Outlook: Issues and Risks
The following issues and risks, among others (including those discussed
elsewhere herein), should also be considered in evaluating the Company's
outlook.
Management of Rapid Growth.
The Company's success depends, in part, upon its ability to achieve growth and
manage this growth effectively. Since its formation, the Company has experienced
rapid growth which has challenged the Company's management, personnel, resources
and systems. As part of its business strategy, the Company intends to pursue
continued growth through its sales and marketing capabilities, acquisitions and
marketing alliances. Although the Company has expanded its management,
personnel, resources and systems to manage future growth and to assimilate
acquired operations, there can be no assurance that the Company will be able to
maintain or accelerate its growth in the future or manage this growth
effectively. Failure to do so could materially adversely affect the Company's
business and financial performance. To accommodate growth, the Company is
centralizing certain operations, which may result in temporary disruptions in
operations.
The Company has grown substantially in recent years through the acquisition of
other PEO and similar companies. Although the Company has recently focused on
further integrating prior acquisitions into the Company's operations, a key
component of the Company's long-term growth strategy is to continue to pursue
selective attractive acquisition opportunities. There can be no assurance that
the Company will be able to find attractive acquisition candidates at reasonable
prices or, if it does, that other potential acquirers will not compete
successfully with the Company for these candidates. Any significant increase in
the number of companies competing with the Company to acquire PEOs would likely
increase the cost of acquisitions and thereby limit the Company's ability to
grow
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profitably through acquisitions. In addition, although the Company attempts to
evaluate each acquisition candidate thoroughly prior to an acquisition, there
can also be no assurance that, once acquired, the Company will be able to
achieve acceptable levels of revenues, profitability or productivity from the
acquired company.
A portion of the Company's historical growth is attributable to its risk
management/workers' compensation services program. The risks associated with
rapid growth in this area include the potential for inadequate underwriting due
to a lack of experience with new geographic markets and industries served, a
shortage of experienced and trained personnel, and the need for sophisticated
operating systems to help manage these risks. The Company recently converted its
risk management information system to a new operating system to support this
growth; there can be no assurance that this conversion will ultimately prove to
be successful, or that other future changes in systems or procedures will be
successfully completed. Any failure to manage growth in the risk
management/workers' compensation program could adversely affect the Company's
ability to underwrite profitable risks and efficiently resolve claims, which in
turn could have a material adverse effect on the Company's business and
financial performance.
Adequacy of Loss Reserves; Loss and Claims Experience.
Under its present workers' compensation arrangements, the Company is responsible
for the first $250,000 ($350,000 for certain transportation programs and
$500,000 in two states with "monopolistic" workers' compensation insurance
structures) of each occurrence with no aggregate limit to the number of losses
for which the Company may be liable. The Company's reserves for losses and loss
adjustment expenses under its workers' compensation are estimates of amounts
needed to pay reported and unreported claims and related loss adjustment
expenses. Reserves are estimates based on industry data and historical
experience, and include judgments of the effects that future economic and social
forces are likely to have on the Company's experience with the type of risk
involved, circumstances surrounding individual claims and trends that may affect
the probable number and nature of claims arising from losses not yet reported.
Consequently, loss reserves are inherently uncertain and are subject to a number
of highly variable and difficult to predict circumstances. This uncertainty is
compounded in the Company's case by its rapid growth and limited experience. For
these reasons, there can be no assurance that the Company's ultimate liability
will not materially exceed its loss and loss adjustment expense reserves. If the
Company's reserves prove to be inadequate, the Company will be required to
increase reserves or corresponding loss payments with a corresponding reduction,
which may be material, to the Company's operating results in the period in which
the deficiency is identified.
The Company has utilized its selective evaluation process, safety programs,
active claims management and maintenance of its accidental death and
dismemberment policy to manage its loss and claims experience. However, the
Company may experience adverse development on prior losses and may not be able
to maintain its current loss experience over time. Future loss experience could
increase due to weakened underwriting standards as a result of internal growth,
the loss experience of acquired operations, increased competition or other
factors which may affect the Company's standards, procedures or claims
experience. An increase in the Company's loss experience could materially
adversely affect the Company's business and financial performance. As previously
discussed, in an effort to reduce the uncertainty and potential volatility
associated with its workers' compensation programs, the Company is evaluating
its underwriting exposure and is in active negotiations with several major
insurance companies designed to shift workers' compensation insurance risk away
from the Company. If accomplished, such a transaction may involve shifting the
risk associated with liabilities arising before or after the date of such
transaction, or both. While not anticipated, there can be no assurance that
completion of a transaction shifting the risk associated with prior liabilities
will not result in a short-term adverse effect on the Company's results. State
unemployment taxes are, in part, determined by the Company's unemployment claims
experience. Medical claims experience also greatly impacts the Company's health
insurance rates and claims cost from year to year. Should the Company experience
a large increase in claims activity for unemployment, workers' compensation
and/or health care, then its costs in these areas would increase. In such a
case, the Company may not be able to pass these higher costs to its clients and
would therefore have difficulty competing with the PEOs with lower claims rates
that may offer lower rates to clients.
Tax Treatment.
The attractiveness to clients of a full-service PEO arrangement depends in part
upon the tax treatment of payments for particular services and products under
the Internal Revenue Code (the "Code") (for example, the opportunity of
employees to pay for certain benefits under a cafeteria plan using pre-tax
dollars). The Internal Revenue Service ("IRS") has formed a Market Segment Study
Group to examine whether PEOs, such as the Company, are for certain tax purposes
the "employers" of worksite employees under the Code. The Company cannot predict
either the timing
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or the nature of any final decision that may be reached by the IRS with respect
to the Market Segment Study Group or the ultimate outcome of any such decision,
nor can the Company predict whether the Treasury Department will issue a policy
statement with respect to its position on these issues or, if issued, whether
such statement would be favorable or unfavorable to the Company. If the IRS were
to determine that the Company is not an "employer" under certain provisions of
the Code, it could materially adversely affect the Company in several ways.
First, with respect to benefit plans, the tax qualified status of the Company's
401(k) plans would be revoked, and the Company's cafeteria and medical
reimbursement plans may lose their favorable tax status. If an adverse IRS
determination were applied retroactively to disqualify benefit plans, employees'
vested account balances under 401(k) plans would become taxable, an
administrative employer such as the Company would lose its tax deductions to the
extent its matching contributions were not vested, a 401(k) plan's trust could
become a taxable trust and the administrative employer could be subject to
liability with respect to its failure to withhold applicable taxes and with
respect to certain contributions and trust earnings. In such event, the Company
also would face the risk of client dissatisfaction and potential litigation by
clients or worksite employees.
As the employer of record for many client companies and their worksite
employees, the Company must account for and remit payroll, unemployment and
other employment-related taxes to numerous federal, state and local tax, labor
and unemployment authorities, and is subject to substantial penalties for
failure to do so. From time to time, the Company has received notices or
challenges which may adversely affect its tax rates and payments. In light of
the IRS Market Segment Study Group and the general uncertainty in this area,
certain proposed legislation has been drafted to clarify the employer status of
PEOs in the context of the Code and benefit plans. However, there can be no
assurance that such legislation will be proposed and adopted or in what form it
would be adopted. Even if it were adopted, the Company may need to change
aspects of its operations or programs to comply with any requirements which may
ultimately be adopted. In particular, the Company may need to retain increased
sole or shared control over worksite employees if the legislation is passed in
its current form.
Litigation.
The Company and several of its present and former executive officers and
directors have been named as defendants in several actions alleging violations
of securities laws with respect to the accuracy of certain statements regarding
Company reserves and other disclosures made by the Company and certain of its
directors and officers. These suits were filed following a significant drop in
the trading price of shares of the Company's Common Stock in March 1997. The
suits have been consolidated before a single judge of the U.S. District Court in
Phoenix, Arizona. The Court has before it motions by the plaintiffs for the
appointment of representative plaintiffs and approval of selection of lead
counsel. Once these motions are ruled upon, it is anticipated that a
consolidated, amended complaint will be filed.
While the complaints do not specify alleged damages, the Company expects the
requests for damages to be substantial. The Company believes the claims are
without merit, and intends to defend these actions vigorously. However, the
ultimate resolution of these actions could have a material adverse effect on the
Company's results of operations and financial condition. In addition, publicity
relating to the litigation could have a negative effect on the Company's
relationships with its current and prospective clients, employees and suppliers.
Substantial Leverage.
The Company has incurred significant debt primarily in connection with its
expansion through acquisitions and its October 1997 issuance of 10% Senior Notes
due 2004 (the "Notes"). As of September 30, 1997, after giving pro forma effect
to the sale of the Notes and the application of the net proceeds therefrom, the
Company would have had outstanding senior indebtedness of approximately $85
million, which would have consisted of the Notes, and stockholders' equity of
approximately $53.9 million.
The Company's ability to make scheduled principal payments in respect of, or to
pay the interest or liquidated damages, if any, on, or to refinance, any of its
indebtedness (including the Notes) will depend on its future performance, which,
to a certain extent, is subject to general economic, financial, competitive,
regulatory and other factors beyond its control. Based upon the Company's
current level of operations and anticipated growth, management believes that
cash flow from operations and other available cash, together with available
borrowings under the Amended Credit Facility, will be adequate to meet the
Company's anticipated future requirements for working capital expenditures,
scheduled lease payments and scheduled payments of interest on its indebtedness,
25
<PAGE>
including the Notes, for the foreseeable future. The Company may, however, need
to refinance all or a portion of the principal of the Notes at or prior to
maturity. There can be no assurance that the Company's business will generate
sufficient cash flow from operations, that anticipated growth will occur or that
future borrowings will be available under the Amended Credit Facility or
otherwise in an amount sufficient to enable the Company to service or refinance
its indebtedness, including the Notes, or make anticipated capital expenditures
and lease payments. In addition, there can be no assurance that the Company will
be able to effect any such refinancing on commercially reasonable terms. See
"Liquidity and Capital Resources."
The degree to which the Company is leveraged could have important consequences,
including, but not limited to, the following: (i) a substantial portion of the
Company's cash flow from operations will be dedicated to debt service and will
not be available for other purposes; (ii) the Company's ability to obtain
additional financing in the future could be limited; and (iii) the Notes
indenture and the Amended Credit Facility contain financial and restrictive
covenants that limit the ability of the Company to, among other things, borrow
additional funds. Failure by the Company to comply with such covenants could
result in an event of default which, if not cured or waived, could have a
material adverse effect on the Company's business and financial performance.
Uncertainty of Extent of PEO's Liability; Government Regulation of PEOs.
Employers are regulated by numerous federal and state laws relating to labor,
tax and employment matters. Generally, these laws prohibit race, age, sex,
disability and religious discrimination, mandate safety regulations in the
workplace, set minimum wage rates and regulate employee benefits. Because many
of these laws were enacted prior to the development of non-traditional
employment relationships, such as PEO services, many of these laws do not
specifically address the obligations and responsibilities of non-traditional
"co-employers" such as the Company, and there are many legal uncertainties about
employee relationships created by PEOs, such as the extent of the PEO's
liability for violations of employment and discrimination laws. The Company may
be subject to liability for violations of these or other laws even if it does
not participate in such violations. As a result, interpretive issues concerning
the definition of the term "employer" in various federal laws have arisen
pertaining to the employment relationship. Unfavorable resolution of these
issues could have a material adverse effect on the Company's results of
operations or financial condition. The Company's standard forms of client
service agreement establish the contractual division of responsibilities between
the Company and its clients for various personnel management matters, including
compliance with and liability under various governmental regulations. However,
because the Company acts as a co-employer, and in some instances acts as sole
employer (such as in the driver leasing program), the Company may be subject to
liability for violations of these or other laws despite these contractual
provisions, even if it does not participate in such violations. The
circumstances in which the Company acts as sole employer may expose the Company
to increased risk of such liabilities for an employee's actions. The Company has
been sued in tort actions alleging responsibility for employee actions (which it
considers to be incidental to its business). Although it believes it has
meritorious defenses, and maintains insurance (and requires its clients to
maintain insurance) covering certain of such liabilities, there can be no
assurances that the Company will not be found to be liable for damages in any
such suit, or that such liability would not have a material adverse effect on
the Company. Although the client generally is required to indemnify the Company
for any liability attributable to the conduct of the client or employee, the
Company may not be able to collect on such a contractual indemnification claim
and thus may be responsible for satisfying such liabilities. In addition,
employees of the client may be deemed to be agents of the Company, subjecting
the Company to liability for the actions of such employees.
While many states do not explicitly regulate PEOs, fifteen states have passed
laws that have licensing or registration requirements and at least three other
states are considering such regulation. Such laws vary from state to state but
generally provide for monitoring the fiscal responsibility of PEOs. There can be
no assurance that the Company will be able to satisfy licensing requirements or
other applicable regulations of any particular state from time to time.
Government Regulation Relating to Workers' Compensation Program.
As part of its risk management/workers' compensation programs, the Company
utilizes Camelback, a wholly-owned insurance company subsidiary. Insurance
companies such as Camelback are subject to the insurance laws and regulations of
the jurisdictions in which they are chartered; such laws and regulations
generally are designed to protect the interests of policyholders rather than the
interests of shareholders such as the Company. In general, insurance regulatory
authorities have broad administrative authority over insurers domiciled in their
respective jurisdictions, including authority over insurers' capital and surplus
levels, dividend payments, financial disclosure,
26
<PAGE>
reserve requirements, investment parameters and premium rates. The jurisdictions
also limit the ability of an insurer to transfer or loan statutory capital or
surplus to its affiliates. The regulation of Camelback could materially
adversely affect the Company's operations and results.
Competition.
The market for many of the services provided by the Company is highly
fragmented, with over 2,300 PEOs currently competing in the United States. Many
of these PEOs have limited operations with relatively few worksite employees,
but the Company believes that several are larger than or comparable to the
Company in size. The Company also competes with non-PEO companies whose
offerings overlap with some of the Company's services, including payroll
processing firms, insurance companies, temporary personnel companies and human
resource consulting firms. In addition, as the PEO industry becomes better
established, the Company expects that competition will continue to increase as
existing PEO firms consolidate into fewer and better competitors and
well-organized new entrants with potentially greater resources than the Company,
including some of the non-PEO companies described above, continue to enter the
PEO market. The Company's subscriber agreements with its clients generally may
be canceled upon 30 days written notice of termination by either party. The
short-term nature of most customer agreements means that a substantial portion
of the Company's business could be terminated upon short notice. In the
stand-alone risk management/workers' compensation services area, the Company
considers state insurance funds and other private insurance carriers to be its
primary competition.
Dependence on One Insurer
The Company believes that its risk management/workers' compensation services
program has been and will continue to be an important competitive factor in its
growth and profitability. The Company's risk management/workers' compensation
services program is currently being conducted principally in coordination with
one insurer, Reliance. The Company's contract with Reliance is priced annually
and was last renewed as of May 1, 1997, and is subject to further annual renewal
and pricing decisions. The contract may also be canceled by Reliance under
certain conditions. There can be no assurance that upon expiration of the
current term the Company can renew the Reliance program on commercially
reasonable terms. The Company would be materially adversely affected by a
termination of its arrangements with Reliance if the Company could not quickly
make similar arrangements with another insurer. In part to lessen its dependence
upon Reliance, the Company is seeking to establish relationships with additional
insurers. While it had entered into an agreement with Legion for certain Company
programs, the Legion relationship was terminated effective August 1, 1997 due to
cost and capital considerations. However, this change increases the Company's
dependence upon Reliance. The Company's ability to make similar arrangements
with other insurers is limited, however, because other insurers generally
require large segregated books of business in order to lessen the risk of
adverse selection by the Company and to maximize the economic potential of the
arrangement for the insurer. There can therefore be no assurance that the
Company will be able to significantly lessen its dependence on Reliance in the
near future.
Item 3. Quantitative and Qualitative Disclosure About Market Risk
Not yet required by Company.
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PART II - OTHER INFORMATION
Item 1. Legal Proceedings
As the Company has previously reported, the Company and certain of its directors
and executive officers have been named as defendants in several securities
actions filed in 1997. While the exact claims and allegations vary, they all
allege violations by the Company of Section 10(b) of the Securities Exchange
Act, and Rule 10b-5 promulgated thereunder, with respect to the accuracy of
statements regarding Company reserves and other disclosures made by the Company
and certain directors and officers. These suits were filed shortly after a
significant drop in the trading price of the Company's Common Stock in March
1997. Each of the actions seek certification of a class consisting of purchasers
of securities of the Registrant over specified periods of time. Each of the
complaints seeks the award of compensatory damages in amounts to be determined
at trial, including interest thereon, and costs of the action, including
attorneys fees.
The suits have been consolidated before a single judge in the U.S. District
Court in Phoenix, Arizona. The court has before it motions by the plaintiffs for
the appointment of representative plaintiffs and approval of selection of lead
counsel. Once these motions are ruled upon, it is anticipated that a
consolidated, amended complaint will be filed. The Company believes the actions
are without merit and intends to defend the cases vigorously.
In addition to cases which have been previously disclosed by the Company, an
additional action known to the Company as having been filed is:
Billy R. Thedford, Floyd Conway Williams, Michael J. Stecher, Jeffrey A.
Engen and North River Trading, LLC, on behalf of themselves and all others
similarly situated versus Roy Alan Flegenheimer, Morris C. Aaron, Edward L.
Cain, Jr., Harvey A. Belfer, Marvin D. Brody and Employee Solutions, Inc.,
Case No. CIV 97-1077 PHX EHC.
Item 2. Changes in Securities
On October 21, 1997, the Company entered into an Amended and Restated Loan
Agreement with Bank One Arizona, NA (the "Loan Agreement"), which provides a
revised $20 million revolving credit facility for the Company. The Loan
Agreement provides a working capital facility for the Company; as of the date
hereof, there were no outstanding borrowings under the Loan Agreement. On the
same date, the Company entered into a Purchase Agreement, and a related
Indenture (the "Indenture"), whereby it issued $85 million of 10% Senior Notes
Due 2004 (the "Notes") in an institutional private placement transaction. The
Notes are guaranteed by certain of the Company's subsidiaries. The sale of the
Notes, and entry into the Loan Agreement were reported in the Company's Report
on Form 8-K dated October 21, 1997 (the "10/21/97 8-K").
Financial Covenants.
Certain financial covenant provisions of the Indenture and the Loan Agreement
may be determined to affect the rights of holders of the Company's outstanding
securities. The following summary of certain of such provisions is qualified in
its entirety by reference to the respective texts of the Indenture (which
includes the form of Notes) and the Loan Agreement, copies of which have been
filed by the Company as exhibits to the 10/21/97 8-K.
(a) Sections 7.7 of the Loan Agreement and 4.3 of the Indenture provides
that the Company will not, without the bank's consent in the case of
the Loan Agreement or certain tests being met in the case of the
Indenture, pay any dividends or make certain other distributions.
(b) Section 6.12.1 of the Loan Agreement requires the Company to maintain a
current ratio of not less than 1.3-to-1.
(c) Section 6.12.2 of the Loan Agreement requires the Company to maintain a
net worth of $45 million at June 30, 1997, which specific increases
thereafter.
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(d) Sections 6.12.3 and 6.12.4 of the Loan Agreement provides that the
Company's "total debt" as defined to EBITDA may not exceed 4-to-1, and
"total senior debt" to EBITDA greater than 2-to-1.
In addition to the foregoing, among other things, the Loan Agreement and/or the
Indenture contains restrictions on: sale of securities (Section 7.1 of the Loan
Agreement); mergers or the sale of significant assets by the Company and
subsidiaries or use of the proceeds thereof (Sections 7.1 and 7.5 of the Loan
Agreement and Section 4.13 and Article V of the Indenture); certain investments
and business acquisitions by the Company and subsidiaries (Sections 7.4 and 7.5
of the Loan Agreement); and additional indebtedness or liens (as defined) by the
Company or its subsidiaries (Sections 4.10 and 4.12 of the Indenture).
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits
--------
Exhibit
Number Description
------- -------------------------------------------------------
10.1 1995 Stock Option Plan, as amended through July 9, 1997
27 Financial Data Schedule
(b) Reports on Form 8-K.
--------------------
None, although the Company filed a report on Form 8-K dated October 21,
1997 reporting the sale of the Notes and entry into the Loan Agreement.
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SIGNATURES
Pursuant to the requirements of The Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
EMPLOYEE SOLUTIONS, INC.
Date: November 14, 1997 /S/ Marvin D. Brody
---------------------- -------------------------------
Marvin D. Brody
Chief Executive Officer
/S/ Morris C. Aaron
-------------------------------
Morris C. Aaron
Chief Financial Officer
/S/ John V. Prince
-------------------------------
John V. Prince
Chief Accounting Officer
30
EMPLOYEE SOLUTIONS, INC.
1995 STOCK OPTION PLAN,
AS AMENDED BY SHAREHOLDER ACTION
ON JUNE 26, 1996 AND JULY 9, 1997
1. Purpose
The purposes of the 1995 Stock Option Plan ("Plan") of Employee
Solutions, Inc., an Arizona corporation, are to attract and retain the best
available employees and directors of Employee Solutions, Inc. or any parent or
subsidiary or affiliate of Employee Solutions, Inc. which now exists or
hereafter is organized or acquired by or acquires Employee Solutions, Inc.
(collectively or individually as the context requires the "Company") as well as
appropriate third parties who can provide valuable services to the Company, to
provide additional incentive to such persons and to promote the success of the
business of the Company. This Plan is intended to comply with Rule 16b-3 under
Section 16 of the Securities Exchange Act of 1934, as amended or any successor
rule ("Rule 16b-3"), and the Plan shall be construed, interpreted and
administered to comply with Rule 16b-3.
2. Definitions
(a) "Affiliate" means any corporation, partnership, joint venture or
other entity, domestic or foreign, in which the Company, either directly or
through another affiliate or affiliates, has a 50% or more ownership interest.
(b) "Affiliated Group" means the group consisting of the Company and
any entity that is an "affiliate," a "parent" or a "subsidiary" of the Company.
(c) "Board" means the Board of Directors of the Company.
(d) "Committee" means the Compensation or Stock Option Committee of the
Board (as designated by the Board), if such a committee has been appointed.
(e) "Code" means the United States Internal Revenue Code of 1986, as
amended.
(f) "Incentive Stock Options" means options intended to qualify as
incentive stock options under Section 422 of the Code, or any successor
provision.
(g) "ISO Group" means the group consisting of the Company and any
corporation that is a "parent" or a "subsidiary" of the Company.
<PAGE>
(h) "Nonemployee Director" shall have the meaning assigned in Section
4(a)(ii) hereof.
(i) "Nonqualified Stock Options" means options that are not intended to
qualify for favorable income tax treatment under Sections 421 through 424 of the
Code.
(j) "Parent" means a corporation that is a "parent" of the Company
within the meaning of Code Section 424(e).
(k) "Section 16" means Section 16 of the Securities Exchange Act of
1934, as amended.
(l) "Subsidiary" means a corporation that is a "subsidiary" of the
Company within the meaning of Code Section 424(f).
3. Incentive and Nonqualified Stock Options
Two types of options (referred to herein as "options," without
distinction between such two types) may be granted under the Plan: Incentive
Stock Options and Nonqualified Stock Options.
4. Eligibility and Administration
(a) Eligibility. The following individuals shall be eligible to receive
grants pursuant to the Plan as follows:
(i) Any employee (including any officer or director who is an
employee) of the Company or any ISO Group member shall be eligible to receive
either Incentive Stock Options or Nonqualified Stock Options under the Plan. An
employee may receive more than one option under the Plan.
(ii) Any director who is not an employee of the Company or any
Affiliated Group member (a "Nonemployee Director") shall be eligible to receive
only Nonqualified Stock Options in the manner provided in paragraph 12 hereof.
(iii) Any other individual whose participation the Board or
the Committee determines is in the best interests of the Company shall be
eligible to receive Nonqualified Stock Options.
(b) Administration. The Plan may be administered by the Board or by a
Committee appointed by the Board which is constituted so to permit the Plan to
comply under Rule 16b-3. The Company shall indemnify and hold harmless each
director and Committee member for any action or determination made in good faith
with respect to the Plan or any option. Determinations by the Committee or the
Board shall be final and conclusive upon all parties.
<PAGE>
5. Shares Subject to Options
The stock available for grant of options under the Plan shall be shares
of the Company's authorized but unissued or reacquired voting common stock. The
aggregate number of shares that may be issued pursuant to exercise of options
granted under the Plan shall be 3,370,000 shares. No individual shall be granted
options for more than 250,000 shares in any calendar year. If any outstanding
option grant under the Plan for any reason expires or is terminated, the shares
of common stock allocable to the unexercised portion of the option grant shall
again be available for options under the Plan as if no options had been granted
with respect to such shares.
6. Terms and Condition of Options
Option grants under the Plan shall be evidenced by agreements in such
form and containing such provisions as are consistent with the Plan as the Board
or the Committee shall from time to time approve. Each agreement shall specify
whether the option(s) granted thereby are Incentive Stock Options or
Nonqualified Stock Options. Such agreements may incorporate all or any of the
terms hereof by reference and shall comply with and be subject to the following
terms and conditions:
(a) Shares Granted. Each option grant agreement shall specify the
number of Incentive Stock Options and/or Nonqualified Stock Options being
granted; one option shall be deemed granted for each share of stock. In
addition, each option grant agreement shall specify the exercisability and/or
vesting schedule of such options, if any.
(b) Purchase Price. The purchase price for a share subject to (i) a
Nonqualified Stock Option may be any amount determined in good faith by the
Committee, and (ii) an Incentive Stock Option shall not be less than 100% of the
fair market value of the share on the date the option is granted, provided,
however, the option price of an Incentive Stock Option shall not be less than
110% of the fair market value of such share on the date the option is granted to
an individual then owning (after the application of the family and other
attribution rules of Section 424(d) or any successor rule of the Code) more than
10% of the total combined voting power of all classes of stock of the Company or
any ISO Group member. For purposes of the Plan, "fair market value" at any date
shall be (i) the reported closing price of such stock on the New York Stock
Exchange or other established stock exchange or Nasdaq National Market on such
date, or if no sale of such stock shall have been made on that date, on the
preceding date on which there was such a sale, (ii) if such stock is not then
listed on an exchange or the Nasdaq National Market, the last trade price per
share for such stock in the over-the-counter market as quoted on Nasdaq or the
pink sheets or successor publication of the National Quotation Bureau on such
date, or (iii) if such stock is not then listed or quoted as referenced above,
an amount determined in good faith by the Board or the Committee.
(c) Termination. Unless otherwise provided herein or in a specific
option grant agreement which may provide for accelerated vesting and/or longer
or shorter periods of
<PAGE>
exercisability, no option shall be exercisable after the expiration of the
earliest of
(i) in the case of an Incentive Stock Option:
(1) 10 years from the date the option is granted, or
five years from the date the option is granted to an
individual owning (after the application of the family and
other attribution rules of Section 424(d) of the Code) at the
time such option was granted, more than 10% of the total
combined voting power of all classes of stock of the Company
or any ISO Group member,
(2) three months after the date the optionee ceases
to perform services for the Company or any ISO Group member,
if such cessation is for any reason other than death,
disability (within the meaning of Code Section 22(e)(3)), or
cause,
(3) one year after the date the optionee ceases to
perform services for the Company or any ISO Group member, if
such cessation is by reason of death or disability (within the
meaning of Code Section 22(e)(3)), or
(4) the date the optionee ceases to perform services
for the Company or any ISO Group member, if such cessation is
for cause, as determined by the Board or the Committee in its
sole discretion;
(ii) in the case of a Nonqualified Stock Option;
(1) 10 years from the date the option is granted,
(2) two years after the date the optionee ceases to
perform services for the Company or any Affiliated Group
member, if such cessation is for any reason other than death,
permanent disability, retirement or cause,
(3) three years after the date the optionee ceases to
perform services for the Company or any Affiliated Group
member, if such cessation is by reason of death, permanent
disability or retirement, or
(4) the date the optionee ceases to perform services
for the Company or any Affiliated Group member, if such
cessation is for cause, as determined by the Board or the
Committee in its sole discretion;
provided, that, unless otherwise provided in a specific option grant agreement,
an option shall only be exercisable for the periods above following the date an
optionee ceases to perform services to the extent the option was exercisable on
the date of such cessation.
<PAGE>
(d) Method of Payment. The purchase price for any share purchased
pursuant to the exercise of an option granted under the Plan shall be paid in
full upon exercise of the option by
any of the following methods, (i) by cash, (ii) by check, or (iii) to the extent
permitted under the particular grant agreement, by transferring to the Company
shares of stock of the Company at their fair market value as of the date of
exercise of the option as determined in accordance with paragraph 6(b), provided
that the optionee held the shares of stock for at least six months.
Notwithstanding the foregoing, the Company may arrange for or cooperate in
permitting broker- assisted cashless exercise procedures. The Company may also
extend and maintain, or arrange for the extension and maintenance of, credit to
an optionee to finance the optionee's purchase of shares pursuant to the
exercise of options, on such terms as may be approved by the Board or the
Committee, subject to applicable regulations of the Federal Reserve Board and
any other applicable laws or regulations in effect at the time such credit is
extended.
(e) Exercise. Except for options which have been transferred pursuant
to paragraph 6(f), no option shall be exercisable during the lifetime of an
optionee by any person other than the optionee, his or her guardian or legal
representative. The Board or the Committee shall have the power to set the time
or times within which each option shall be exercisable and to accelerate the
time or times of exercise; provided, however, except as provided in paragraph
12, no options may be exercised prior to the later of the expiration of six
months from the date of grant thereof or shareholder approval, unless otherwise
provided by the Board or Committee. To the extent that an optionee has the right
to exercise one or more options and purchase shares pursuant thereto, the
option(s) may be exercised from time to time by written notice to the Company
stating the number of shares being purchased and accompanied by payment in full
of the purchase price for such shares. Any certificate for shares of outstanding
stock used to pay the purchase price shall be accompanied by a stock power duly
endorsed in blank by the registered owner of the certificate (with the signature
thereon guaranteed). If the certificate tendered by the optionee in such payment
covers more shares than are required for such payment, the certificate shall
also be accompanied by instructions from the optionee to the Company's transfer
agent with respect to the disposition of the balance of the shares covered
thereby.
(f) Nontransferability. No option shall be transferable by an optionee
otherwise than by will or the laws of descent and distribution, provided that
the Committee in its discretion may grant options that are transferable, without
payment of consideration, to immediate family members of the optionee or to
trusts or partnerships for such family members; the Committee may also amend
outstanding options to provide for such transferability.
(g) ISO $100,000 Limit. If required by applicable tax rules regarding a
particular grant, to the extent that the aggregate fair market value (determined
as of the date an Incentive Stock Option is granted) of the shares with respect
to which an Incentive Stock Option grant under this Plan (when aggregated, if
appropriate, with shares subject to other Incentive Stock Option grants made
before said grant under this Plan or another plan maintained by the Company or
any ISO Group member) is exercisable for the first time by an optionee during
any calendar year exceeds $100,000 (or such other limit as is prescribed by the
Code), such option grant shall be
<PAGE>
treated as a grant of Nonqualified Stock Options pursuant to Code Section
422(d).
(h) Investment Representation. Unless the shares of stock covered by
the Plan have been registered with the Securities and Exchange Commission
pursuant to Section 5 of the Securities Act of 1933, as amended, each optionee
by accepting an option grant represents and agrees, for himself or herself and
his or her transferees by will or the laws of descent and distribution, that all
shares of stock purchased upon the exercise of the option grant will be acquired
for investment and not for resale or distribution. Upon such exercise of any
portion of any option grant, the person entitled to exercise the same shall upon
request of the Company furnish evidence satisfactory to the Company (including a
written and signed representation) to the effect that the shares of stock are
being acquired in good faith for investment and not for resale or distribution.
Furthermore, the Company may if it deems appropriate affix a legend to
certificates representing shares of stock purchased upon exercise of options
indicating that such shares have not been registered with the Securities and
Exchange Commission and may so notify its transfer agent.
(i) Rights of Optionee. An optionee or transferee holding an option
grant shall have no rights as a shareholder of the Company with respect to any
shares covered by any option grant until the date one or more of the options
granted thereunder have been properly exercised and the purchase price for such
shares has been paid in full. No adjustment shall be made for dividends
(ordinary or extraordinary, whether cash, securities or other property) or
distributions or other rights for which the record date is prior to the date
such share certificate is issued, except as provided for in paragraph 6(k).
Nothing in the Plan or in any option grant agreement shall confer upon any
optionee any right to continue performing services for the Company or any
Affiliated Group member, or interfere in any way with any right of the Company
or any Affiliated Group member to terminate the optionee's services at any time.
(j) Fractional Shares. The Company shall not be required to issue
fractional shares upon the exercise of an option. The value of any fractional
share subject to an option grant shall be paid in cash in connection with an
exercise that results in all full shares subject to the grant having been
exercised.
(k) Reorganizations, Etc. Subject to paragraph 9 hereof, if the
outstanding shares of stock of the class then subject to this Plan are increased
or decreased, or are changed into or exchanged for a different number or kind of
shares or securities, as a result of one or more reorganizations, stock splits,
reverse stock splits, stock dividends, spin-offs, other distributions of assets
to shareholders, appropriate adjustments shall be made in the number and/or type
of shares or securities for which options may thereafter be granted under this
Plan and for which options then outstanding under this Plan may thereafter be
exercised. Any such adjustments in outstanding options shall be made without
changing the aggregate exercise price applicable to the unexercised portions of
such options.
(l) Option Modification. Subject to the terms and conditions and within
the limitations
<PAGE>
of the Plan, the Board or the Committee may modify, extend or renew outstanding
options granted under the Plan, accept the surrender of outstanding options (to
the extent not theretofore exercised), reduce the exercise price of outstanding
options, or authorize the granting of new options in substitution therefor (to
the extent not theretofore exercised). Notwithstanding the foregoing, no
modification of an option (either directly or through modification of the Plan)
shall, without the consent of the optionee, alter or impair any rights of the
optionee under the option.
(m) Grants to Foreign Optionees. The Board or the Committee in order to
fulfill the Plan purposes and without amending the Plan may modify grants to
participants who are foreign nationals or performing services for the Company or
an Affiliated Group member outside the United States to recognize differences in
local law, tax policy or custom.
(n) Other Terms. Each option grant agreement may contain such other
terms, provisions and conditions not inconsistent with the Plan as may be
determined by the Board or the Committee, such as without limitation
discretionary performance standards, tax withholding provisions, or other
forfeiture provisions regarding competition and confidential information.
7. Termination or Amendment of the Plan
The Board may at any time terminate or amend the Plan; provided, that
shareholder approval shall be obtained of any action for which shareholder
approval is required in order to comply with Rule 16b-3, the Code or other
applicable laws or regulatory requirements within such time periods prescribed.
8. Shareholder Approval and Term of the Plan
The Plan shall be effective as of April 6, 1995, the date as of which
it was adopted by the Board, subject to ratification by the shareholders of the
Company within (each of) the time period(s) prescribed under Rule 16b-3, the
Code, and any other applicable laws or regulatory requirements, and shall
continue thereafter until terminated by the Board. Unless sooner terminated by
the Board, in its sole discretion, the Plan will expire on April 6, 2005 solely
with respect to the granting of Incentive Stock Options or such later date as
may be permitted by the Code for Incentive Stock Options, provided that options
outstanding upon termination or expiration of the Plan shall remain in effect
until they have been exercised or have expired or been forfeited.
9. Merger, Consolidation or Reorganization
In the event of a merger, consolidation or reorganization with another
corporation in which the Company is not the surviving corporation, the Board,
the Committee (subject to the approval of the Board) or the board of directors
of any corporation assuming the obligations of the Company hereunder shall take
action regarding each outstanding and unexercised option pursuant to either
clause (a) or (b) below:
<PAGE>
(a) Appropriate provision may be made for the protection of such option
by the substitution on an equitable basis of appropriate shares of the surviving
corporation, provided that the excess of the aggregate fair market value (as
defined in paragraph 6(b)) of the shares subject to such option immediately
before such substitution over the exercise price thereof is not more than the
excess of the aggregate fair market value of the substituted shares made subject
to option immediately after such substitution over the exercise price thereof;
or
(b) Appropriate provision may be made for the cancellation of such
option. In such event, the Company, or the corporation assuming the obligations
of the Company hereunder, shall pay the optionee an amount of cash (less normal
withholding taxes) equal to the excess of the highest fair market value (as
defined in paragraph 6(b)) per share of the Common Stock during the 60-day
period immediately preceding the merger, consolidation or reorganization over
the option exercise price, multiplied by the number of shares subject to such
options (whether or not then exercisable).
10. Dissolution or Liquidation
Anything contained herein to the contrary notwithstanding, on the
effective date of any dissolution or liquidation of the Company, the holder of
each then outstanding option (whether or not then exercisable) shall receive the
cash amount described in paragraph 9(b) hereof and such option shall be
cancelled.
11. Withholding Taxes
(a) General Rule. Pursuant to applicable federal and state laws, the
Company is or may be required to collect withholding taxes upon the exercise of
an option. The Company may require, as a condition to the exercise of an option
or the issuance of a stock certificate, that the optionee concurrently pay to
the Company (either in cash or, at the request of optionee but in the discretion
of the Board or the Committee and subject to such rules and regulations as the
Board or the Committee may adopt from time to time, in shares of Common Stock of
the Company) the entire amount or a portion of any taxes which the Company is
required to withhold by reason of such exercise, in such amount as the Committee
or the Board in its discretion may determine.
(b) Withholding from Shares to be Issued. In lieu of part or all of any
such payment, the optionee may elect, subject to such rules and regulations as
the Board or the Committee may adopt from time to time, or the Company may
require that the Company withhold from the shares to be issued that number of
shares having a fair market value (as defined in paragraph 6(b)) equal to the
amount which the Company is required to withhold.
(c) Special Rule for Insiders. Any such request or election (to satisfy
a withholding obligation using shares) by an individual who is subject to the
provisions of Section 16 shall be made in accordance with the rules and
regulations of the Securities and Exchange Commission promulgated thereunder.
<PAGE>
12. Automatic Grants to Certain Directors
(a) Grant. Each person who is elected as a Nonemployee Director at any
Annual Meeting of Shareholders automatically shall be granted, effective as of
the date of such Annual Meeting, options to acquire 2,500 shares of the
Company's Common Stock for each year of the term to which such Nonemployee
Director is elected. Options granted pursuant to this paragraph 12 shall become
exercisable at the rate of 2,500 shares of the Company's Common Stock upon the
date of each Annual Meeting following the date of grant, provided that the
Nonemployee Director has served as such throughout the preceding year.
Notwithstanding anything herein to the contrary, any person who is a Nonemployee
Director as of April 30, 1996 shall not be entitled to receive any grant under
this paragraph 12 until the 2000 Annual Meeting of Shareholders.
(b) Certain Option Terms. Options granted pursuant to this paragraph 12
shall have a 10-year term from the date of grant, provided that any option held
by a Nonemployee Director who is removed from the Board for cause shall expire
on the date of such removal. The exercise price of all options granted pursuant
to this paragraph 12 shall be the fair market value of the Company's Common
Stock on the date of grant.
c. Election to Board of Directors between Annual Meetings. Any person
who initially becomes a Nonemployee Director at any time other than on the date
of an Annual Meeting of Shareholders shall automatically be granted options
exercisable for 2,500 shares of Common Stock for each full and partial year of
the term to which such Nonemployee Director is elected. Vesting and other terms
of such options shall be as set forth elsewhere in this paragraph 12.
d. Stock Splits. Notwithstanding anything in the Plan to the contrary,
the number of options to be granted pursuant to paragraphs 12(a) and 12(c) shall
not be adjusted for forward stock splits or similar occurrences which are
effected during the year ending December 31, 1996, provided that options granted
pursuant to paragraphs 12(a) or 12(c) prior to the effective date of any such
occurrence shall be subject to adjustment in the same manner as other options
granted pursuant to the Plan.
e. Limitation on Amendment. This paragraph 12 shall not be amended more
than once every six months other than to comport with changes in the Code, the
Employee Retirement Income Security Act, or the rules thereunder.
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
COMPANY'S FORM 10-Q FOR THE PERIOD ENDED SEPTEMBER 30, 1997 AND IS QUALIFIED IN
ITS ENTIRETY BY REFERENCE TO SUCH FORM 10-Q.
</LEGEND>
<MULTIPLIER> 1,000
<CURRENCY> U.S. Dollars
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1997
<PERIOD-START> JAN-01-1997
<PERIOD-END> SEP-30-1997
<EXCHANGE-RATE> 1
<CASH> 15,618
<SECURITIES> 16,000
<RECEIVABLES> 61,098
<ALLOWANCES> 0
<INVENTORY> 0
<CURRENT-ASSETS> 100,256
<PP&E> 2,225
<DEPRECIATION> 0
<TOTAL-ASSETS> 163,300
<CURRENT-LIABILITIES> 61,441
<BONDS> 0
0
0
<COMMON> 34,356
<OTHER-SE> 18,103
<TOTAL-LIABILITY-AND-EQUITY> 163,300
<SALES> 0
<TOTAL-REVENUES> 655,117
<CGS> 0
<TOTAL-COSTS> 622,429
<OTHER-EXPENSES> 27,216
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 3,163
<INCOME-PRETAX> 3,001
<INCOME-TAX> 1,260
<INCOME-CONTINUING> 1,741
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 1,741
<EPS-PRIMARY> 0.05
<EPS-DILUTED> 0.05
</TABLE>
