U.S. SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
FORM 10-K
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 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 N. 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
Rights to Purchase Shares of Series A Junior Participating Preferred Stock
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
--- ---
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of Registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [ ]
The aggregate market value of the voting stock held by non-affiliates of the
Registrant, based upon the $ 4.906 closing price of the Registrant's Common
Stock as reported on the NASDAQ National Market on March 25, 1998, was
approximately $130.1 million. Shares of Common Stock held by each executive
officer and director and by each person who owns 10% or more of the outstanding
Common Stock have been excluded in that such persons may be deemed to be
affiliates. This determination of affiliate status is not necessarily conclusive
for other purposes.
The number of outstanding shares of the Registrant's Common Stock as of March
25, 1998, was 31,731,945.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Registrant's Proxy Statement for the Registrant's 1998 Annual
Meeting of Shareholders are incorporated by reference in Part III hereof.
<PAGE>
EMPLOYEE SOLUTIONS, INC.
FORM 10-K ANNUAL REPORT
YEAR ENDED DECEMBER 31, 1997
TABLE OF CONTENTS
PART I
ITEM 1. - BUSINESS
ITEM 2. - PROPERTIES
ITEM 3. - LEGAL PROCEEDINGS
ITEM 4. - SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
ITEM 4A. - EXECUTIVE OFFICERS OF THE REGISTRANT
PART II
ITEM 5. - MARKET FOR REGISTRANT'S COMMON EQUITY AND
RELATED SHAREHOLDER MATTERS
ITEM 6. - SELECTED CONSOLIDATED FINANCIAL DATA
ITEM 7. - MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
ITEM 7A. - QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
ITEM 9. - CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS
ON ACCOUNTING AND FINANCIAL DISCLOSURE
PART III
ITEM 10. - DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
ITEM 11. - EXECUTIVE COMPENSATION
ITEM 12. - SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS
AND MANAGEMENT
ITEM 13. - CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
PART IV
ITEM 14. - EXHIBITS AND REPORTS ON FORM 8-K
SIGNATURES
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PART I
Except for the historical information contained herein, the discussion in this
Form 10-K contains or may contain forward-looking statements (including
statements in the future tense and statements using the terms "believe,"
"anticipate," expect," "intend" or similar terms) which are made pursuant to
safe harbor provisions of the Private Securities Litigation Reform Act of 1995.
These forward-looking statements involve risks and uncertainties that could
cause the Company's actual results to differ materially from those discussed
herein. Factors that could cause or contribute to such differences include, but
are not limited to, those discussed in "Item 1 -- Business" and "Item 7 --
Management's Discussion and Analysis of Financial Condition and Results of
Operations" (particularly "Outlook: Issues and Risks" therein), as well as those
factors discussed elsewhere herein or in any document incorporated herein by
reference.
Unless otherwise indicated, all share and per share information herein has been
restated to reflect the Company's two-for-one stock splits which occurred in
1996.
ITEM 1. BUSINESS
- ----------------
The Company
Employee Solutions, Inc. (together with its subsidiaries ESI or the Company) is
one of the largest professional employer organizations (PEO) and is the most
geographically diverse PEO in the United States, specializing in integrated
employment outsourcing solutions for small and mid-sized businesses. As of
December 31, 1997, the Company served approximately 1,700 client companies
representing 45,200 worksite employees in 47 states.
The Company offers a broad array of integrated outsourcing solutions which
provide businesses throughout the United States with comprehensive and flexible
outsourcing services to meet their payroll, benefits and human resources needs
while helping manage their overall costs. The Company provides significant
benefits to its client companies and their worksite employees, including: (i)
managing escalating costs associated with workers' compensation, health
insurance, workplace safety and employment policies and practices; (ii)
enhancing employee recruiting and retention by providing employees with access
to a menu of healthcare and other benefits that are more characteristic of
larger employers; (iii) providing expertise in transportation personnel and in
labor relations; and (iv) reducing the time and effort required by the employer
to deal with an increasingly complex administrative, legal and regulatory
environment.
As a PEO, ESI and its "client company" typically agree that ESI will become the
"employer of record" for the client company's employees. ESI generally assumes
designated obligations for payroll processing and reporting, payment of payroll
taxes, human resources management and the provision of employee benefit plans
and risk management/workers' compensation services. Additionally, ESI may
provide other products and services directly to worksite employees, such as
employee payroll deduction programs for disability and specialty health
insurance, prepaid telephone cards and other personal financial services. The
client company generally retains management control of the worksite employees,
including hiring, supervision and termination and determining the employees' job
descriptions and salaries.
Industry Overview
The PEO industry has undergone rapid growth in recent years. According to the
National Association of Professional Employer Organizations (NAPEO), the
industry has grown at a compound rate of 29% from 1991 to 1996. Industry
analysts expect the PEO industry to continue to grow rapidly due to the
increased regulatory and administrative burden being experienced by all
employers and the ongoing requirements of businesses to manage their overall
employee related costs. For example, recent tax legislation will require all
companies with annual payroll tax deposits in excess of $50,000 to settle such
taxes electronically or suffer monetary penalties. The Small Business
Administration estimated that in 1994 there were nearly 6 million businesses
with fewer than 500 employees which employ over 51 million employees with an
aggregate payroll of approximately $1.2 trillion. It is estimated that the
entire PEO industry currently has between two and three million worksite
employees with annual payrolls of over $17 billion. The large size of the
potential client market leaves room for substantial continued growth of the PEO
industry.
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The PEO industry began to evolve in the 1980s, primarily in response to the
increasing burdens on small to medium-sized employers resulting from a complex
regulatory and legal environment. While various service providers assisted these
businesses with specific tasks, PEOs began to emerge as providers of a more
comprehensive range of employment-related services. As the industry has evolved,
the term "professional employer organization" came to be used to describe an
entity which establishes a three-party relationship among the PEO, a client
business, and the employees of that client business. For client employers, PEOs
can perform the functions of human resources, payroll and benefits
administration departments of larger companies. The PEO offers employers a one
stop shop with a menu of choices for the client company to bundle the payroll
and benefit related services into one contract. The primary services performed
by PEOs are payroll administration, workers' compensation insurance, medical
benefits and 401(k) retirement plans. The growth of the PEO industry results, in
significant part, from the demand by relatively small businesses for assistance
in administrative aspects of the employer/employee relationship, as well as a
means to allow participation of their employees in attractive employee benefit
programs. By having their employees become part of a larger employee pool,
employers often can provide access to enhanced benefits, such as medical
insurance, which would not be economically available to relatively small
employers.
The Company believes that an important aspect of the growth of the PEO industry
has been the increased recognition and acceptance of PEOs, and the
employer/employee relationships they create, by federal and state governmental
authorities. The concept of PEO services has become better understood by
regulatory authorities, as legitimate industry participants have overcome the
well-publicized earlier failures of some PEOs. The Company believes that the
regulatory environment has begun to shift to one of regulatory cooperation with
the industry, although significant issues (particularly tax-related) remain
unresolved. Through NAPEO, the Company and other industry leaders work with
government entities for the establishment of appropriate regulatory frameworks
to protect clients and employees and thereby promote the acceptance and further
development of the PEO industry. See "Industry Regulation."
Clients
As of December 31, 1997, the Company's full-service PEO client base consisted of
approximately 1,700 client companies, representing approximately 45,200
employees in 47 states. At that date, the Company had customers in more than 12
specific industries, based on Standard Industrial Classification ("SIC") codes,
and no more than 33% of the Company's customers were classified in any one SIC
code. The Company's approximate client company distribution by major industry
grouping as of December 31, 1997 is set forth below:
Percent of
Industry Group Clients
-------------- ----------
Transportation:
Private carriage/driver leasing 7%
For hire/standard PEO 26
-----------
Total 33
Services:
Professional 13
Light Industrial 7
Real Estate 3
-----------
Total 23
Manufacturing 8
Construction 11
Retail Trade 8
Entertainment 8
Wholesale Trade 5
Agriculture and Fishing 1
Other 3
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As part of its business strategy, the Company targets a nationwide client base
composed primarily of the above categories. Although the Company has identified
certain industries such as transportation, which it believes particularly
benefit from its services and expertise, the Company also seeks to maintain an
overall diversity of clients, in both industries and geographical scope. This
diverse base enables the Company to minimize its exposure to cyclical downturns
in specific industries and geographic regions.
The Company's average full-service PEO client had approximately 20 employees as
of December 31, 1997 (excluding TEAM Services which employs a substantial number
of worksite employees in the entertainment industry on a part-time or periodic
basis), while the average client added through internally-generated sales in
1997 (excluding US Xpress discussed below) exceeded 17 employees. The Company
focuses primarily on employers with fewer than 500 employees. However, the
Company believes that the benefits of PEO services remain attractive for larger
employers in many circumstances.
Effective January 1, 1997, the Company has entered into a PEO arrangement with
US Xpress, a publicly-held transportation company, currently with approximately
5,000 employees who became Company worksite employees. The addition of the
worksite employees of US Xpress, which has become the Company's largest single
client, increased the average number of worksite employees per client and the
percentage of the Company's worksite employees in the transportation industry.
US Xpress accounted for $183.3 million or 20% of the Company's total revenue in
1997.
The Company generally has benefited from a high level of client retention,
resulting in a significant recurring revenue stream. NAPEO's standard for
measuring attrition is computed by dividing the number of clients lost during
the period by the sum of the number of clients at the beginning of the period
plus the number of clients added during the period (Client Attrition Rate).
Based on this standard, the Company's Client Attrition Rate was approximately
25%, 21%, and 25%, respectively, for the years ended December 31, 1997, 1996,
and 1995. The Company's Client Attrition Rate is attributable to a variety of
factors, including (i) termination by the Company because the client did not
make timely payments or failed to meet the Company's client risk profile, (ii)
client nonrenewal due to repricing, or service or price dissatisfaction and
(iii) client business failure, downsizing, or sale or acquisition of the client.
The general division of responsibilities between the Company and its client as
co-employers under the Company's standard forms of subscriber agreements for PEO
services is as follows:
The Company:
------------
* Payroll preparation and reporting
* Tax reporting and payment (state and federal withholding,
FICA, FUTA, state unemployment)
* Workers' compensation compliance, procurement, management,
reporting
* Employment benefit procurement, administration and payment
* Monitoring changes in certain governmental regulations
governing the employer/employee relationship and updating the
client when necessary
The Client:
-----------
* Supervision and direction of job specific activities and
designation of job description and duties
* Hiring, firing and disciplining of employees
* Determination of salaries and wages
* Selection of fringe benefits, including employee leave
policies
* Professional and business licensing and permits
* Compliance with immigration laws
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* Compliance with health, safety and work laws and regulations
Joint:
------
* Implementation of policies and practices relating to the
employer/employee relationship
* Employer liability under workers' compensation laws
The Company varies its standard contractual terms, including the apportioning of
responsibilities, when necessary to meet various states' regulatory requirements
or other circumstances. For example, Texas and Florida require the Company to
retain certain additional control rights over worksite employees as compared to
the Company's standard arrangements.
The Company's standard subscriber agreement may be canceled by either party upon
30 days written notice and also may be canceled more quickly by the Company
under certain circumstances such as nonpayment of fees by the client. The fee
paid by the client to the Company includes amounts for gross payroll and wages
and a service fee (from which the Company must pay employment taxes and benefits
and workers' compensation coverage). The specific service fee varies by client
based on factors including market conditions, client needs and services
required, the clients' workers' compensation and benefit plan experience and the
administrative resources required. The service fee generally is expressed as a
fixed percentage of the client's gross salaries and wages.
As a result of an acquisition in August 1996, the Company began providing driver
leasing services in which the Company acts as sole employer of the worksite
employee. In such cases, the Company contracts with certain of its clients to
provide transportation workers who are sole employees of the Company. For these
workers, the Company makes hiring, termination and placement decisions, and
assumes more related obligations than in the general "co-employer" situation.
The Company may also contract to provide additional services on a fee basis,
such as negotiating collective bargaining agreements on behalf of its clients,
maintaining department of transportation requirements and drug testing. The
Company expects that for certain industries this type of all-inclusive program
will become a more significant part of its business, which may expose the
Company to greater risk of liability for its employees' actions both because of
the nature of the employment relationship and because of the incidence of
injuries inherent in a transportation program (such as those from vehicle
accidents).
In addition to its full-service PEO client customers, the Company also has
provided stand-alone risk management/workers' compensation services. These
services were provided to approximately 83 employers, covering approximately
11,100 employees as of December 31, 1997. The Company's stand-alone risk
management/workers' compensation clients and employees are primarily in the
manufacturing, construction, transportation and temporary services industries.
Under the Company's new guaranteed cost arrangements, the Company expects that
recent reductions in its stand-alone workers' compensation insurance program
will continue. See "Risk Management/Workers' Compensation Program -- Stand-alone
Workers' Compensation".
Services and Products
The Company provides its clients with a comprehensive offering of employment
related services and products. The Company's flexible approach allows its
clients to select packages best suited for their needs. These services and
products generally cover five categories: payroll, human resources
administration, regulatory compliance, risk management/workers' compensation,
and benefits programs.
Payroll
As the employer of record, the Company assumes responsibility for making payroll
payments to the worksite employees and for payroll tax deposits, payroll tax
reporting, employee file maintenance, unemployment claims, and monitoring and
responding to changing laws and regulations relating to payroll taxes. Although
the Company typically bills a client company in advance of each payroll date and
reserves the right to terminate its agreement with the client if payment is not
received within two days of the billing date, limited extended payment terms are
offered in certain cases subject to local competitive conditions. In certain
industry segments where such practices are customary (such as those in the
entertainment industry and in certain parts of the transportation industries)
the Company extends to its clients payment terms
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ranging from 15 to 45 days. See " Item 7 -- Management's Discussion and Analysis
of Financial Condition and Results of Operations -- Liquidity and Capital
Resources."
Human Resources Administration
The Company's comprehensive human resources services reduce the
employment-related administrative burdens faced by its clients. Worksite
employer supervisors are provided with consulting services, which can include
employee handbook preparation, policy and procedure review, job description
development, and an analysis of performance review processes and/or
employment-related documentation procedures. The Company is a party to
collective bargaining agreements in its driver leasing programs, and is
available to provide other clients with assistance in collective bargaining upon
request. In certain market segments, the Company also provides placement
services.
Employer Regulatory Compliance
The Company, upon request, helps its clients understand and comply with
employment-related requirements. Laws and regulations applicable to employers
include state and federal tax laws, state unemployment laws, federal and state
job security/plant closing laws, workers' compensation laws, occupational safety
and health laws, laws governing benefits plans such as ERISA and COBRA,
immigration laws, the Americans with Disabilities Act, family and medical leave
laws, and discrimination, sexual harassment and other civil rights laws.
Risk Management/Workers' Compensation
The Company offers its clients a fully-insured, first-dollar coverage workers'
compensation insurance program. Effective January 1, 1998, this program is
provided through third party insurers, on a fully-insured, guaranteed cost basis
to the Company. The Company's risk management/workers' compensation program
provides its clients with access to safety programs through the Company's
experienced safety professionals, early return to work programs and access to
managed care networks for workers' compensation services as part of the PEO
package. The Company also offers its fully insured, first-dollar coverage
workers' compensation insurance program on a stand-alone basis. Under the
Company's new guaranteed cost arrangements, the Company expects that recent
reductions in its stand-alone workers' compensation insurance program will
continue. Many aspects of the Company's risk management/workers' compensation
program were developed prior to 1998, during a period when the Company partially
self-insured for certain workers' compensation risks. The Company believes many
of these structures and programs will continue to assist the Company in managing
workers' compensation premium expense.
Benefits Programs
The Company believes it generally can obtain employee benefits, negotiate annual
plan arrangements, and administer the plans and related claims at rates
generally not available to small and medium-sized firms (depending upon
geographic location, plan design and census demographics of the group). The
Company's benefits programs include (i) major medical indemnity, preferred
provider and health maintenance organization plans; (ii) group term life and
accidental death and dismemberment insurance; (iii) dental indemnity and
preferred provider insurance; (iv) vision care discount programs; (v) long term
disability insurance; and (vi) short term disability and other supplemental
insurance programs. Except for one self-insured health care program, the health
care programs of the Company are fully insured by third-party insurers. See
"Medical Programs" below. In addition, the Company offers pre-tax health care
spending plans, pre-tax premium conversion and dependent care spending plans,
and qualified retirement plans, such as 401(k) plans, in which worksite
employees may participate, and assists the client by helping explain the
advantages and mechanics of such programs to employees.
In June 1997, the Company entered into a strategic relationship with Aetna US
Healthcare (Aetna), a national managed-care company, and the Company now offers
Aetna's high-quality, competitively priced medical and dental plans to the
Company's full-time corporate and worksite employees in areas of the country
where Aetna maintains preferred provider networks in addition to the Company's
other medical programs including a self-insured program. The Company believes
that the value and comprehensiveness of Aetna's health benefit plans will allow
the Company to consolidate and simplify its benefit plan offerings, improve
service and reduce costs. The Company has negotiated competitive premium rates
by geographic regions with all of its third party health care insurers that are
generally effective through December 31, 1998, at which time renewal provisions
would apply.
Worksite Employee Services
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The Company also provides benefits and services directly to its worksite
employees. The Company provides national and regional bank affiliations to
expedite payroll check cashing and direct deposit services, and also offers
credit union access to employees. The Company also provides discount passes for
a variety of recreational, entertainment, social and cultural items across the
United States, and for certain types of services. The Company has introduced a
payroll deduction program under which the Company currently offers to worksite
employees the ability to purchase pre-paid telephone cards and specialized
insurance at competitive prices. The Company intends to offer in the future
other goods and services such as homeowners, automobile and other types of
personal insurance and travel services.
Sales and Marketing
Although the PEO industry has grown significantly since its inception, it has
not yet achieved widespread customer familiarity in many markets. As a result,
the Company generally must first explain to potential clients what a PEO does
and the benefits a PEO generally offers before the Company can sell its
particular services to the potential client. The Company therefore believes that
its services can best be sold by experienced sales agents at individual,
face-to-face meetings with potential clients. The Company has developed an
internal sales and marketing capacity, and has entered into several strategic
marketing alliances to promote the Company's services.
Sales
The Company has recently adopted a consolidated, centralized sales management
structure, located at its Phoenix headquarters. In implementing this operational
restructure, the Company has recruited additional management, and hired key
sales training and administrative personnel as part of an ongoing process to
increase internal sales.
The Company's national telemarketing operations generate new leads, which are
supported by a nationwide network of sales representatives. Headquarters sales
management provides continuous training and sales support to all Company sales
agents, assists them in new client pricing, and manages new case flow between
the field and Company corporate offices in Phoenix.
The Company's field sales operations are coordinated by Regional Vice Presidents
of sales ("RVPs") located in various cities. These RVPs manage a network of
full-time sales agents and part-time sales brokers. In certain circumstances,
the Company appoints general agents who supervise several sales agents whom
report to an RVP. To assure a significant nationwide selling presence, the
Company believes it is appropriate to maintain a large sales force. At December
31, 1997, the Company's sales force included 72 RVPs, general agents and sales
agents.
The RVPs, general agents and sales agents currently are compensated primarily
via commissions, subject to certain vesting and production requirements. The
RVPs and general agents also receive an override commission on sales generated
by sales agents which report to them. Each RVP, general agent and sales agent is
responsible for his or her own operating expenses such as rent, hiring outside
salespersons, permanent staff salaries, telephone, travel, entertainment,
training and other expenses, although the Company defrays a portion of such
expenses for the RVPs. Commissions may be payable after termination in certain
circumstances.
The Company recently began executing its plan to place employee salespersons in
key markets. Employee-salespersons will be compensated through a combination of
base salary and commissions, and will be eligible for participation in the
Company's stock option programs.
The Company's stand-alone risk management/workers' compensation services
generally have been placed through ESI Risk Management Agency, Inc., a wholly
owned subsidiary of the Company (RMA). The Company established RMA as its
professional brokerage division to act as the Company's conduit for its
marketing alliance relationships with insurance wholesalers. Independent
agencies and sales representatives receive compensation from RMA based on
production.
Marketing
The Company's marketing operations provide comprehensive marketing support for
all of the Company's operations. This support focuses on communications
strategies, market research and analysis, product development and strategic
alliances. The marketing department also provides empirical data for
salespersons to assist in prospecting activities in targeted industries and
regions.
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The marketing department has developed a communications strategy to provide
continuity and consistency of the Company's message. This strategy also seeks to
expand the Company's contacts through new relationships and expand relationships
with current clients.
Marketing Alliances
The Company has entered into several strategic alliances which it believes may
enhance the marketing of its products and services by leveraging from the
experience, industry expertise, geographical reach and customer contacts of such
alliances. These alliances may provide the Company with profitable business
opportunities to either expand its customer base or expand the services and
products which the Company may offer.
The Company's current alliances include: cross selling arrangements;
arrangements to offer prepaid telephone cards and specialty insurance products
to worksite employees; benefits education for worksite employees, and a
nationwide check-cashing program for worksite employees.
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 and relatively few worksite employees, but the
Company believes that several are larger than or comparable to the Company in
size. As the PEO concept becomes better known and achieves greater market
penetration, the Company expects the PEO market to become substantially more
competitive. In areas of the country where PEOs have achieved greater market
recognition and penetration, competition has become intense. While price is the
principal competitive factor, service and the coverage and quality of benefits
programs are important ancillary competitive considerations. 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.
The Company believes that currently its greatest competition is with the
traditional model in which clients provide employment-related services in-house
together with the use of independent insurance brokers. Further, certain large
insurance companies have become more aggressive in workers' compensation and
have reduced pricing in order to obtain market share, and price competition from
state workers' compensation insurance funds has intensified in certain markets.
The Company also incurs direct competition from numerous PEOs, some of which
have greater resources, greater assets and larger marketing staffs than the
Company. The Company also competes with payroll processing firms, temporary
personnel companies and human resource consulting firms. In addition, the
Company expects that as the PEO industry becomes better established, competition
will increase because existing PEO firms will likely consolidate into fewer and
better competitors and well organized new entrants with greater resources than
the Company, including some of the non-PEO companies described above, will enter
the PEO market.
Information Systems
The Company utilizes integrated payroll processing, billing and benefits
management information and processing systems. The Company also has recently
converted an advanced management system which allows for real time reporting of
worksite accidents and injuries and assists the Company in executing its risk
management program. Effective January 1998, the Company has completed the
transition of all PEO processing to a unified software platform and a
centralized client server at its Phoenix headquarters, and expects to complete
the installation of a new Company-wide accounting software package in April
1998. While the Company expects improved performance from these developments,
there can be no assurance that the Company will not encounter delays or other
difficulties as new systems are implemented, which may materially adversely
affect its performance. See also "Item 7 - Management's Discussion and Analysis
- - Outlook: Issues and Risks, Year 2000 Compliance" herein.
The Company has acquired various products installed at certain PEO client
locations to facilitate the transmission of payroll-related data. These include
a PC-based software product, electronic time clocks and direct dial-in modems.
Investment Policy
The basic objectives of the Company's investment policy are the safety and
preservation of the invested funds, the liquidity of investments to meet cash
flow requirements (including future claims payments and related requirements for
its risk management/workers' compensation
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program), and the realization of a maximum rate of return on investments
consistent with capital preservation. The investment policy defines eligible
investments, investment limits and investment maturities as guidelines to meet
the policy's objectives. The Company has appointed outside investment managers
to assist in portfolio management. The Company invests its available funds
primarily in commercial paper, U.S. government and agency securities rated
A-2/P-2 or better and other short- term liquid investments.
Risk Management/Workers' Compensation Program
Recent Developments
The Company recently changed its business strategy with respect to its workers'
compensation program in response to the changing profile of, and greater risks
associated with, its worksite employee base, increased competition and reduced
margin opportunities, and in an effort to reduce the uncertainty associated with
its quarterly workers' compensation expense. As part of the Company's change in
business strategy, the Company obtained fully-insured guaranteed cost workers'
compensation coverage effective January 1, 1998, thereby eliminating, with
limited exceptions, the Company's risk retention on workers' compensation claims
arising after that date. The coverage was obtained through Stirling Cooke Risk
Management Services, Inc. under a three-year arrangement, with pricing subject
to annual review. The Company will retain risk up to $250,000 per occurrence
with respect to a defined portfolio of stand-alone policies which were in place
at December 31, 1997, which policies expire at various dates during 1998. The
Company also will retain risk up to $50,000 per occurrence for claims under
Ohio's monopolistic workers' compensation structure, with an aggregate liability
limitation based on a percentage of Ohio manual premium. The Company also is
pursuing aggressively a loss portfolio transfer or similar reinsurance, for
pre-1998 claims. However, there can be no assurance that the Company will
successfully complete such a transaction, or of the terms on which such a
transaction could be completed.
Because many of the Company's programs and structures will remain in effect as a
means of managing risks in the future, and because they may continue to be
utilized by the Company in managing its pre-1998 claims, a description of the
Company's pre-1998 partially self-insured program is included below.
Background
Workers' compensation is a statutory system which requires employers to purchase
insurance or to self-insure in order to provide their employees with medical
care and other specified benefits for work-related injuries or illnesses.
Compensation is payable regardless of who is at fault and the workers'
compensation policy generally is the employee's sole source of recovery. Four
types of benefits typically are payable under workers' compensation policies:
medical benefits, indemnity payments for lost wages, payments for job retraining
and payments for permanent disabilities or death. The amounts of disability and
death benefits payable for claims are established by statute, but no dollar
limitation is set forth for medical benefits. Regulations governing workers'
compensation vary by state.
As the employer of record for its worksite employees, the Company is required to
provide workers' compensation insurance to its leased employees unless other
arrangements are made by the client.
In June 1995 the Company began providing workers' compensation insurance through
Camelback Insurance, Ltd. (Camelback), its wholly-owned insurance company
chartered in Bermuda, in coordination with its servicing insurers (primarily
Reliance National Indemnity Company ("Reliance")) which provided full first
dollar insurance coverage for workers' compensation losses. Camelback reinsured
the servicing insurers' obligation for losses up to $250,000 ($350,000 for
certain transportation programs and $500,000 in two states with "monopolistic"
workers' compensation insurance structures) for each occurrence. The servicing
insurer arrangements are subject to certain standard exceptions and exclude
coverage of certain high risk employees; the Company typically does not accept
clients with those types of employees although exceptions may exist. To further
reduce its potential liability, the Company secured accidental death and
dismemberment insurance that covers losses of up to $500,000 (increased from
$250,000 in July 1996 to obtain a net reduction in excess reinsurance costs) for
certain types of serious claims and maintains umbrella coverage for certain
liabilities (other than losses resulting from workers' compensation claims) the
Company may incur in connection with its administration of its risk
management/workers' compensation program. The Company terminated its accidental
death and dismemberment policy effective February 1, 1998 in conjunction with
the transition to a guaranteed cost environment.
10
<PAGE>
The Company has utilized its selective evaluation process, safety programs and
active claims management to manage its loss experience. While the Company has
entered into a guaranteed cost, fully-insured program effective January 1, 1998,
the Company remains subject to liabilities for losses and claims arising prior
to that time, and there may exist further liability for claims which have not
yet been reported. Changes in workers' compensation experience could affect the
Company's future costs. Factors such as weakened underwriting standards as a
result of internal growth, loss experience of recently acquired operations,
changes in the risk profile of the Company's worksite employee base, or
increased competition could affect workers' compensation experience, and an
increase in the Company's loss experience could materially adversely affect the
Company's results of operations, business and financial performance. See "Item 7
- - Management's Discussion and Analysis -- Outlook: Issues and Risks, Adequacy of
Loss Reserves; Loss and Claims Experience" herein.
Underwriting
The Company works to control the Company's exposure to losses by ensuring that
prospective clients present acceptable risks. The Company reviews most
prospective clients' prior loss experience and safety record, the extent to
which such losses can be prevented, job and industry classifications and current
workers' compensation premium rates. The Company's nationwide presence permits
it to select those industries and clients that present risk profiles that it
believes it can manage effectively. The Company carefully scrutinizes each
prospective client's risk profile. Many prospective clients submitted to the
Company are rejected and do not become clients of the Company. Once a prospect
is accepted, the Company periodically reviews the client's claims experience and
costs to determine whether fee adjustments or other changes are needed. The
Company generally may terminate its relationship with PEO clients on 30 days
notice, and thereby quickly reduce any unacceptable exposure to workers'
compensation claims.
Safety Control
The Company provides continuing assistance to its clients in developing and
maintaining safety programs and procedures. The Company reviews periodic loss
reports, attempts to identify weaknesses in the client company's loss control
procedures and assists the client in correcting those weaknesses. The Company
can mandate that its PEO clients implement recommended safety procedures as a
condition to receiving PEO services or workers' compensation coverage.
Claims Management
The Company seeks through active claims management to resolve claims quickly and
at the lowest possible cost. The Company emphasizes prompt attention to injuries
and claims, striving to achieve immediate reporting of injuries and with a goal
of contacting the employee, the client employer and the treating physician
within 24 hours of the time an injury is reported. The Company follows up with
an injured employee on a regular basis, and emphasizes return to work programs
to minimize lost productivity. The Company makes available managed care programs
to treat employees and audits medical bills.
The Company and the Third Party Claims Administrator ("TPA") work together to
administer each claim, maintaining contacts with the claimant employees, medical
providers and client companies, investigating claims reports and controlling
medical, rehabilitation and other claims settlement costs. In addition, the TPA
cannot settle any claim without the Company's prior approval. The Company
believes its proactive claims management approach permits it to close its
claims, on average, more quickly than ordinary workers' compensation insurers.
Stand-Alone Workers' Compensation
The Company has provided its workers' compensation program to non-PEO customers
on a stand-alone basis. The stand-alone program primarily was intended to
provide an opportunity to establish relationships with companies which were not
currently seeking PEO services but were believed to be candidates for future
conversion into a comprehensive PEO relationship, and further was intended to
permit the Company to leverage its workers' compensation expertise. The Company
does not intend to actively market its stand-alone program in 1998 because it
has determined to emphasize other PEO marketing strategies and because of the
decreased profit opportunities resulting from increased price competition in the
overall workers' compensation market. The decision also is based on the terms of
the Company's guaranteed cost program, which limit the Company's profit
potential on stand-alone cases written after January 1, 1998 to commission
income.
11
<PAGE>
Medical Programs
In addition to its medical insurance plans which are fully insured by several
third party providers, the Company offers a self-insured program through an
arrangement with Provident Life & Accident Company (Provident). (Two prior
partially self-insured arrangements were terminated on December 31, 1997, and
the administrators of those arrangements are presently handling claim run-off in
accordance with the applicable programs.) As of December 31, 1997, approximately
933 employees were insured under the Provident program. Under the Provident
program, the maximum policy coverage is $100,000 per covered individual per
year, for which the Company is responsible. Working with Provident, the Company
seeks to limit its risk by performing a review of loss factors, and carefully
monitoring claims experience. The Company establishes reserves for anticipated
liabilities; however, there can be no assurance that the reserves will be
adequate due to such factors as unanticipated loss development on known claims,
increases in the number and severeity of new claims, and a lack of historical
claims experience with new clients.
In June 1997, the Company entered into a strategic relationship with Aetna US
Healthcare, and the Company now offers Aetna's high-quality, competitively
priced medical and dental plans to the Company's full-time corporate and
worksite employees in areas of the country where Aetna maintains preferred
provider networks. The Company believes that the value and comprehensiveness of
Aetna's health benefit plans will allow the Company to consolidate and simplify
its benefit plan offerings, improve service and reduce costs. The Company has
negotiated competitive premium rates by geographic regions with all of its third
party health care insurers that are generally effective through December 31,
1998, at which time renewal provisions would apply.
Employees
At December 31, 1997, the Company employed 332 full-time corporate employees in
addition to the worksite employees. The Company considers its employee relations
to be very good.
Industry Regulation
Federal Regulation
Employers in general are regulated by numerous federal 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
employers. 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.
Compliance with these laws and regulations is time consuming and expensive. The
Company's standard forms of agreement provide that the client is responsible for
compliance with certain employment-related laws and regulations, and that the
client is obligated to indemnify the Company against breaches of the agreement.
However, some legal uncertainty exists with respect to the potential scope of
the Company's liability in the event of violations by its clients of employment,
discrimination and other laws.
Taxes
As employer of record for its clients' employees, the Company assumes
responsibility for the payment of federal and state employment taxes with
respect to wages and salaries paid to its worksite employees. There are
essentially three types of federal employment tax obligations: income tax
withholding requirements, social security obligations under the Federal Income
Contribution Act ("FICA") and unemployment obligations under the Federal
Unemployment Tax Act ("FUTA"). Under the Internal Revenue Code of 1986, as
amended (the "Code"), the employer has the obligation to remit the employer
portion and, where applicable, withhold and remit the employee portion of these
taxes. In addition, the Company is obligated to pay state unemployment taxes and
withhold state income taxes.
12
<PAGE>
The Internal Revenue Service ("IRS") has formed a Market Segment Study Group to
examine whether PEOs such as the Company are for certain employee benefit and
tax purposes the "employers" of worksite employees under the Code. 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.
With respect to benefit plans, the tax qualified status of the Company's 401(k)
plans could be revoked, and the Company's cafeteria and medical reimbursement
plans may lose their favorable tax status (resulting in employer liability,
including penalties for failure to withhold applicable taxes in connection with
the cafeteria and medical reimbursement plans). The Company cannot predict
either the timing 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. Effective as of January 1, 1997, the Company has implemented a new
401(k) retirement plan which involves both the client and the Company as
co-sponsors of the plan and is intended to be a "multiple employer" plan under
Code Section 413(c). The Company believes that this multiple employer plan is
less likely to be adversely affected by any IRS determination that no employer
relationship exists between the Company and worksite employees. While the
Company does sponsor some sole employer plans covering worksite employees which
the Company assumed in connection with other acquired PEO operations and which
could be adversely affected by any unfavorable IRS determination, the Company
intends to convert the majority of the sole employer plans into one or more
multiple employer plans, and the Company believes that any unfavorable IRS
determination, if applied prospectively (that is, applicable only to periods
after such a determination is reached), probably would not have a material
adverse effect on the Company's financial position or results of operations.
However, 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 claims by clients or worksite employees.
A determination by the IRS that the Company is not an "employer" under certain
provisions of the Code also could lead the IRS to conclude that federal taxes
were not paid by the proper party, because such taxes must be paid by the
employer. This conclusion could lead to actions by the IRS against clients of
the Company seeking direct payment of taxes, plus penalties and interest, even
though the taxes were previously paid by the Company. Further, if the Company
were required to report and pay such taxes on account of its clients, rather
than on its own account as the employer, the Company could incur increased
administrative burdens and costs.
In light of the IRS Market Segment Study Group and the general uncertainty in
this area, certain 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 and 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.
In addition to the employer/employee relationship requirement described above,
pension and profit sharing plans including the Company's 401(k) plans must
satisfy certain other requirements under the Code. These other requirements are
generally designed to prevent discrimination in favor of highly compensated
employees to the detriment of non-highly compensated employees with respect to
both the availability of and the benefits rights and features offered in
qualified employee benefit plans. The Company has made a good faith attempt to
apply the non-discrimination requirements of the Code in an effort to maintain
its 401(k) plans in compliance with the requirements of the Code.
Employee pension welfare benefit plans are also governed by ERISA. ERISA defines
an employer as "any person acting directly as an employer, or indirectly in the
interest of an employer, in relation to an employee benefit plan." ERISA defines
the term employee as "any individual employed by an employer." The United States
Supreme Court has held that the common law test of employment must be applied to
determine whether an individual is an employee or an independent contractor
under ERISA.
A definitive judicial interpretation of an employer in the context of a
full-service PEO arrangement has not been established. If the Company were found
not to be an employer for ERISA purposes, its plans would not comply with ERISA
and the level of services the Company could offer may be materially adversely
affected. Further, as a result of such finding, the Company and its plans would
not enjoy the pre-emption
13
<PAGE>
of state laws provided by ERISA and could be subject to varying state laws and
regulations as well as to claims based upon state common law.
While the Department of Labor has issued advisory opinions to one or more staff
leasing companies indicating that their welfare plans, which cover worksite
employees, are multiple employer welfare arrangements rather than single
employer plans, the Company has not been the subject of any such advisory
opinion. If, however, the Company's welfare benefit plans were found to be
multiple employer welfare arrangements, ERISA would not pre-empt the application
of certain state insurance laws to the plans.
Certain company clients maintain their own retirement and/or welfare benefit
plans covering worksite employees. The Company's involvement in these plans is
limited to forwarding payroll amounts to the client as directed by the client to
fund such plans and the Company has assumed no obligation in connection with the
sponsorship or administration of such plans. While the Company believes that it
has no liability in connection with any of these client plans, due to the legal
uncertainty that exists in this area, the Company cannot guarantee that such is
the case.
Workers' Compensation
Camelback is subject to the insurance laws and regulations of Bermuda. Such laws
and regulations generally are designed to protect the interests of
policyholders, as opposed to the interests of shareholders such as the Company.
Such laws and regulations, among other things, relate to capital and surplus
levels, levels of dividends payable by subsidiaries to their parent companies,
financial disclosure, reserve requirements, investment parameters and premium
rates. In general, the regulatory authorities have broad administrative
authority over insurers domiciled in their jurisdictions. Among other
requirements and limitations, Bermuda law requires that Camelback must maintain
statutory capital and surplus based primarily on premium volume. The Company is
subject to additional requirements pursuant to its arrangements with Reliance.
See "Item 7 -- Management's Discussion and Analysis -- Liquidity and Capital
Resources." The laws of Bermuda also place certain limitations upon the transfer
of statutory capital and surplus from an insurer to its parent company (whether
via dividend or otherwise), and regulate the circumstances under which an
insurer is permitted to loan funds to its parent company.
From June 1994 through December 1997 the Company's risk management/workers'
compensation services program primarily was conducted via "fronting"
arrangements with insurers, under which another insurer issues a policy on
behalf of Camelback. The National Association of Insurance Commissioners
("NAIC") recently adopted a model act concerning "fronting" arrangements. The
model act requires reporting and prior approval of reinsurance transactions
relating to these arrangements, and limits the amount of premiums that can be
written under certain circumstances. No determination can be made as to whether,
or in what form, such act may ultimately be adopted by any state and, the
Company is therefore unable to predict whether the model act will affect its
relationships with its insurers in the future should it wish to resume its
self-insured program.
State regulation requires licensing of persons soliciting the sale of workers'
compensation insurance within that state. In certain states, licenses are
obtained by individual agents rather than a corporate entity. The Company, or
one of its employees, is licensed in most states. Although the Company does not
believe that its activities require such licenses because it solicits through
other licensed entities, it is a risk that the Company may be deemed to be
making sales without a license in jurisdictions where it is not licensed, or
that it would cease to maintain necessary licenses upon the departure of the
employee who holds certain of such licenses.
Health Care Reform
Various proposals for national health care reform have been under discussion in
recent years, including proposals to extend mandatory health insurance benefits
to virtually all classes of employees. Any health care reform proposal which
mandated health insurance benefits based on the number of employees employed by
an entity could adversely affect PEOs such as the Company, which for some
purposes are deemed to employ all their clients' employees. In addition, certain
reform proposals have sought to include medical costs for workers' compensation
in the reform package. If such proposals increased the cost of medical payments
or limited the Company's ability to control its workers' compensation costs, the
Company's ability to offer competitively-priced workers' compensation coverage
to its clients could be adversely affected. While the Company is unable to
predict whether or in what form health care reform will be enacted, aspects of
such reform, if enacted, may have an adverse effect upon the Company's medical
and workers' compensation insurance programs.
14
<PAGE>
State and Local Regulation
The Company is subject to regulation by local and state agencies pertaining to a
wide variety of labor related laws. As is the case with federal regulations
discussed above, many of these regulations were developed prior to the emergence
of the PEO industry and do not specifically address non-traditional employers.
While many states do not explicitly regulate PEOs, eighteen states have passed
laws that have licensing or registration requirements and several others are
considering such regulation. Further, a number of other states have passed laws
defining PEOs for purposes of addressing, in particular contexts, whether PEOs
constitute employers under certain state laws applicable to employers generally.
The Company believes it is licensed where required. Such laws vary from state to
state but generally provide for monitoring the fiscal responsibility of PEOs.
Some states also specify contractual arrangements between the PEO and the client
company, and the PEO and the worksite employee. For example, some states require
an employment relationship under which the Company must retain sole or shared
control over worksite employees, thereby requiring the Company to bear more
responsibility than under its standard co-employer model. Because existing
regulations are relatively new, there is limited interpretive or enforcement
advice available. The development of additional regulations and interpretation
of existing regulations can be expected to evolve over time.
The Company has formed Camelback in part to avail itself of the favorable tax
treatment of insurance companies, which pay state premium taxes rather than
income taxes and which may tax deduct reserves when booked. 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.
ITEM 2. PROPERTIES
- ------------------
The Company leases all of its offices.
The Company's headquarters office space at 6225 North 24th Street, Phoenix,
Arizona is leased for a term expiring in 2004. The lease took effect on April 1,
1997, and increased the useable space for the Company's home office operations
from approximately 18,000 square feet to 58,000 square feet, allowing the
Company to consolidate various Phoenix operations and maintain space for
expansion.
The Company also leases smaller amounts of office space at various locations in
a number of other cities for its sales and operations offices. The Company
believes that these facilities are adequate for its existing operations,
although further acquisitions or expansion could increase its office space
needs.
Substantially all of the Company's assets are pledged to secure the Company's
revolving bank line of credit.
15
<PAGE>
ITEM 3. - LEGAL PROCEEDINGS
- ---------------------------
Securities Class Actions
As previously reported, the Company and certain of its present and former
directors and executive officers have been named as defendants in ten actions
filed between March 1997 and May 1997. While the exact claims and allegations
vary, they all allege violations by the Company of Section 10(b) of the 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 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 Company 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 of the U.S. District
Court in Phoenix, Arizona. The Court has appointed lead plaintiffs for the
putative class, approved plaintiffs' selection of counsel, and ordered
plaintiffs to file a consolidated, amended complaint on or about April 6, 1998.
The Company believes the actions are without merit and intends to defend the
cases vigorously. However, the ultimate resolution of these actions could have a
material adverse effect on the Company's results of operations and financial
condition.
Other
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. The
Company's standard form 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, the Company may be
subject to liability for violations of these or other laws despite these
contractual provisions and 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 employees' actions. The
Company has been sued in 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 materially 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, 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.
The Company was named as a defendant in an action filed by Ladenburg Thalmann &
Co., Inc. in the United States District Court, Southern District of New York,
No. 97-CIV-4685 (TPG), in May 1997 alleging breach of contract under certain
stock warrants. The plaintiff seeks damages of at least $2.5 million. The
Company believes the action is without merit and intends to defend the case
vigorously.
ITEM 4. - SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
- -------------------------------------------------------------
No matters were submitted to a vote of the Company's shareholders during the
fourth quarter of 1997.
16
<PAGE>
ITEM 4A. - EXECUTIVE OFFICERS OF THE REGISTRANT
- -----------------------------------------------
The names of the Company's executive officers, and certain information about
them, are set forth below.
<TABLE>
<CAPTION>
- --------------------------------------------------------------------------------------------------------------------
Officer/Director
Name Age Position(s) with Company Since
- ----------------------- --- ----------------------------------------------------- -----
<S> <C> <C> <C>
Marvin D. Brody 54 Chairman of the Board, President, 1993
Chief Executive Officer and Director
Roy A. Flegenheimer 50 Chief Operating Officer 1993
Morris C. Aaron 33 Chief Financial Officer and Treasurer 1996
Paul M. Gales 42 Senior Vice President, General Counsel and Secretary 1996
Mark J. Gambill 38 Senior Vice President Sales and Marketing 1997
- --------------------------------------------------------------------------------------------------------------------
</TABLE>
Marvin D. Brody co-founded the Company in 1991. He has been a Director of the
Company since 1993 and became the Company's Chief Executive Officer in November
1994 and President in June 1996. Prior to becoming the Company's Chief Executive
Officer, Mr. Brody was engaged in the private practice of law since 1973.
Roy A. Flegenheimer has been the Chief Operating Officer of the Company since
July 12, 1995. Mr. Flegenheimer was the Company's Treasurer from June 1994 until
November 1996. Mr. Flegenheimer joined the Company as its Vice President of
Finance in February 1993 and was Chief Financial Officer from June 1994 until
January 1996 and the Company's Secretary from December 1995 to July 1997. From
1988 until 1993, he was Executive Vice President and Chief Financial Officer of
Avesis Incorporated, a publicly held marketer and administrator of dental,
vision and hearing benefit plans. From 1980 until 1988, Mr. Flegenheimer was an
audit partner in the accounting firm of Arthur Andersen LLP.
Morris C. Aaron joined the Company as its Chief Financial Officer in January
1996, and became its Treasurer in November 1996. From September 1986 to January
1996, Mr. Aaron served in various professional positions in the Financial
Consulting Services Group of Arthur Andersen LLP.
Paul M. Gales joined the Company as its Vice President and General Counsel in
October 1996 and has been the Company's Secretary since July 1997. Mr. Gales was
a partner at Quarles & Brady, Phoenix, Arizona from 1992 to 1996. Prior to that
time, he practiced as an attorney since 1982.
Mark J. Gambill joined the Company as its Vice President of Marketing in March
1997, and was named Senior Vice President - Sales and Marketing in December
1997. From 1994 to 1997, Mr. Gambill was Director of National Accounts and
Strategic Alliances for Paychex, Inc., a payroll processing company. Prior to
that time, Mr. Gambill was a senior manager in sales and marketing for Ceridian
Corporation, a payroll processing and human resources company.
The Company has announced that it intends to hire a new President, and has
commenced an executive search to identify qualified candidates. It is expected
that the person identified will assume significant operational responsibilities
for the Company, although the exact nature of those responsibilities will likely
depend upon the experience and qualifications of the person identified. There
can be no assurance as to when, or if, a qualified candidate will be identified,
or the conditions under which the Company will be able to obtain that person's
services.
17
<PAGE>
PART II
ITEM 5. - MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED SHAREHOLDER MATTERS
- -------------------------------------------------------------------------------
The Company's Common Stock began trading on the NASDAQ National Market under the
symbol "ESOL" in January 1996. Previously, the Company's Common Stock traded on
the NASDAQ Smallcap Market under the symbol "ESOL" from August 1993 to January
1996.
The following table sets forth for the quarters indicated the range of high and
low sales prices of the Company's Common Stock as reported by the NASDAQ
National Market since January 1996. As of March 25, 1998, the Company had 230
shareholders of record and over 15,000 beneficial holders.
<TABLE>
<CAPTION>
- --------------------------------------------------------------------------------------------------------------------
Quarter Ended High Low
---------------------- ---------- ----------
<S> <C> <C>
December 31, 1997 $ 7 15/16 $ 4 1/16
September 30, 1997 $ 6 1/8 $ 5
June 30, 1997 $ 7 3/8 $ 3 15/16
March 31, 1997 $28 3/8 $ 5 5/8
December 31, 1996 $24 5/8 $16 5/8
September 30, 1996 $18 7/8 $12 7/8
June 30, 1996 $21 5/8 $12 1/4
March 31, 1996 $19 $ 7 1/4
- --------------------------------------------------------------------------------------------------------------------
</TABLE>
Dividend Policy
The Company has never paid cash dividends on its Common Stock and intends to
retain earnings, if any, for use in the operation and expansion of its business.
The Company's revolving line of credit, and the Indenture relating to its 10%
Senior Notes due 2004 (the "Notes"), limit the payment of dividends by the
Company. The amount of future dividends, if any, will be determined by the Board
of Directors based upon the Company's earnings, financial condition, capital
requirements and other conditions.
Miscellaneous
The Company has issued securities in private placement transactions pursuant to
Section 4(2) of the Securities Act of 1933 (the "1933 Act") as described in the
following paragraphs.
As part of the September 1997 acquisition of Phoenix Capital Management, Inc.
and several related PEO companies designated as "ERC," as previously reported,
the Company issued 752,587 restricted unregistered shares of the Company's
Common Stock to one individual, who owned the acquired companies. Additionally,
the Company agreed to issue additional restricted shares, if earned, to be
determined based upon ERC earnings after the acquisition. The 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.
In an October 1997 institutional placement pursuant to Rule 144A under the
Securities Act of 1933, as previously reported, the Company issued $85 million
of Notes for cash.
18
<PAGE>
ITEM 6. - SELECTED CONSOLIDATED FINANCIAL DATA
- ----------------------------------------------
The following selected consolidated financial data should be read in conjunction
with the Company's Consolidated Financial Statements and the Notes thereto, and
"Item 7 - Management's Discussion and Analysis of Financial Condition and
Results of Operations" appearing elsewhere herein. The selected consolidated
financial data presented below as of December 31, 1997, 1996, 1995 and 1994 and
for the years then ended are derived from the consolidated financial statements
of the Company, which consolidated financial statements have been audited by
Arthur Andersen LLP, independent public accountants. The selected consolidated
financial data presented below as of December 31, 1993 and for the year then
ended are derived from the consolidated financial statements of the Company,
which consolidated financial statements have been audited by Semple & Cooper,
P.L.C., independent public accountants. Except for 1994 and 1993, the earnings
per share amounts for all prior years have been restated to conform with the
presentation requirements of Statement of Financial Accounting Standards No.
128, "Earnings per Share". Management does not believe the impact of restatement
for 1994 and 1993 would be material.
<TABLE>
<CAPTION>
- --------------------------------------------------------------------------------------------------------------------
Years Ended December 31,
-----------------------------------------------------------------
(In thousands of dollars) 1997 1996 1995 1994 1993
----------- ----------- ----------- ----------- -----------
Consolidated Statements of Earnings Data:
<S> <C> <C> <C> <C> <C>
Revenues $ 933,817 $ 439,016 $ 164,455 $ 74,334 $ 48,571
Cost of revenues 903,255 400,862 150,675 71,068 46,501
Gross profit 30,562 38,154 13,780 3,266 2,070
Selling, general and
administrative expenses 33,411 17,310 7,183 2,297 1,471
Depreciation & amortization 4,617 2,073 426 269 128
Income (loss) from operations (7,466) 18,771 6,171 700 471
Non-operating income (expense), net (3,849) (364) 510 129 (263)
Income before provision for taxes (11,315) 18,407 6,681 829 208
Income tax provision (benefit) (2,819) 6,381 2,846 450 98
Net income (loss) (8,496) 12,026 3,835 379 110
- --------------------------------------------------------------------------------------------------------------------
</TABLE>
19
<PAGE>
<TABLE>
<CAPTION>
- --------------------------------------------------------------------------------------------------------------------
As of and for the Years Ended December 31,
-----------------------------------------------------------------
(In thousands, except per share data) 1997 1996 1995 1994 1993
----------- ----------- ----------- ----------- -----------
Consolidated Balance Sheet Data:
<S> <C> <C> <C> <C> <C>
Working capital (deficit) $ 58,329 $ 30,449 $ 8,589 $ 2,394 $ (36)
Total assets 207,217 125,969 36,840 9,310 6,399
Long-term debt 85,000 42,800 -- -- --
Stockholders' equity 42,389 46,507 19,943 6,401 3,451
Common Stock Data
Earnings (loss) per share
Basic (.27) .40 .17 .02 .01
Diluted (.27) .37 .16 .02 .01
Weighted average common and
equivalent shares outstanding
Basic 31,193 30,224 22,392 20,145 11,414
Diluted 31,193 32,168 23,507 20,145 15,716
Growth Percentages
Revenues 113% 167% 121% 53% 334%
Net income (171)% 214% 912% 246% 129%
At period end:
Worksite employees 45,200 30,000 11,000 3,600 2,200
Client companies 1,700 1,200 920 450 250
States with worksite employees 47 46 40 20 15
- --------------------------------------------------------------------------------------------------------------------
</TABLE>
20
<PAGE>
ITEM 7. - 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. 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-K contains or may contain forward-looking statements (which include
statements in the future tense, statements using the terms "believe,"
"anticipate," "expect," "intend" or similar terms and the discussions under
"1998 Outlook") 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 herein particularly in "Outlook: Issues and Risks" below, and in "Item
1 -- Business," 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, expected profit, and
other factors. These 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.
Costs of Revenues
The Company's 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 may be responsible for payment of these costs even if not reimbursed
by its clients.
Employment related taxes consist of the employer's portion of payroll taxes
required under 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 vary from state to state.
Prior to January 1, 1998, 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 and accidental death and dismemberment
insurance premiums. The Company retained workers' compensation liabilities up to
certain specified amounts under its pre 1998 workers' compensation insurance
agreements. 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
21
<PAGE>
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. Changes in the liability are charged or credited to operations as the
estimates are revised. Administrative costs include fees paid to the Company's
insurers 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 and accidental death and dismemberment
relate to premium payments to the Company's insurers for the retention of risks
above specified limits.
In periods from and after January 1, 1998, workers' compensation liabilities are
fully insured under a guaranteed cost policy, subject to limited exceptions
described below. Accordingly, workers' compensation expense would include
premiums paid to the Company's third party insurance carriers for workers'
compensation insurance. Workers' compensation expense during 1998 also will
include the cost of a defined portfolio of stand-alone policies in place at
December 31, 1997 which policies expire at various dates during 1998 and as to
which the Company retains liability of $250,000 per occurrence plus fees as
described above; and costs under the Company's self-insurance program in Ohio,
with respect to which the Company retains liability of $50,000 per occurrence
with an aggregate liability limitation based on a percentage of the Ohio manual
premium.
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 for healthcare and workers' compensation claims are adequate for future
claims payments, 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 personnel expenses, other general
and administrative expenses, and sales and marketing expenses. Personnel
expenses include compensation, fringe benefits and other personnel expenses
related to the Company's internal employees. Other general and administrative
expenses include rent, office supplies and expenses, legal and accounting fees,
bad debt expenses, insurance and other operating expenses. Sales and marketing
expenses include commissions to sales personnel 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, whereby the results of such acquired companies are
reflected in the Company's financial statements prospectively from the date of
acquisition. 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. Further during the transition period after an
acquisition the Company may act to implement pricing changes where appropriate
and to eliminate client relationships which do not meet the Company's risk or
profitability profiles. Acquisition activity historically has increased the
Company's workers' compensation expense, primarily by accelerating the Company's
overall growth rate and accelerating its exposure in specific higher-risk
segments, such as transportation. The Company also seeks to eliminate certain
general and administrative costs of acquired companies although such results may
not be achieved.
Company PEO acquisitions which have affected recent periods have included the
following: Hazar, Inc. and affiliates ("Hazar") in October 1995; TEAM Services
in June 1996; Leaseway Personnel Corporation and Leaseway Administrative
Personnel, Inc.
22
<PAGE>
(collectively, "Leaseway") in August 1996; the McClary-Trapp group of companies
("McClary-Trapp") in November 1996; ETIC Corporation d/b/a Employers Trust
("ETIC") in February 1997; CMGR Inc. and Humasys, Inc. (collectively, "CMGR") in
February 1997; and four related PEO companies referred to as "Employee Resources
Corporation" (collectively, "ERC") in September 1997. In addition, in September
1997, the Company acquired Phoenix Capital Management, Inc. ("PCM"), a PEO
service provider.
Operating Results
Margin comparisons are affected by the relative mix of stand-alone risk
management/workers' compensation services, full PEO services, TEAM Services
services, and driver leasing services acquired in the Leaseway acquisition
("LPC") in any particular period.
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
positively impacts on the Company's working capital and results of operations as
the year progresses. Also, fourth quarter revenues are typically increased by
year-end bonuses and distributions paid to worksite employees, historically
resulting in little to no revenue growth from fourth to first quarter (excluding
acquisitions). In addition, the Company's first quarter revenues tend to be
adversely affected by decreased activity by various of its transportation
clients due to seasonal factors.
Results of Operations--Year Ended December 31, 1997 Compared to Year Ended
December 31, 1996
<TABLE>
<CAPTION>
- --------------------------------------------------------------------------------------------------------------------
Percent
(In thousands) 1997 Change 1996
------------- ------------- -------------
<S> <C> <C> <C>
Revenues $ 933,817 113% $ 439,016
Cost of revenues 903,255 125 400,862
Gross profit 30,562 (20) 38,154
Selling, general and administrative 33,411 93 17,310
Depreciation and amortization 4,617 123 2,073
Interest income 1,303 56 833
Interest expense 5,102 327 1,196
Net (loss) income (8,496) (171) 12,026
- --------------------------------------------------------------------------------------------------------------------
</TABLE>
Revenues
Revenues increased to $933.8 million for the year ended December 31, 1997 from
$439.0 million for the year ended December 31, 1996, an increase of 113%.
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 industries. The
number of worksite employees increased to approximately 45,200 covering
approximately 1,700 client companies at December 31, 1997 from approximately
30,000 covering 1,200 client companies at December 31, 1996.
Revenues related to stand-alone risk management/workers' compensation services
were $10.3 million for the year ended December 31, 1997 (which included
non-recurring revenue of approximately $1.0 million related to stand-alone
workers' compensation premiums that were
23
<PAGE>
under-billed for policies written in the previous year) compared with revenues
of $16.1 million for the year ended December 31, 1996. The decline in
stand-alone revenues primarily is attributable to increased competition in the
workers' compensation market. Stand-alone revenues in 1997 and 1996 include
significant amounts from a former client with which disputes have arisen. The
Company has initiated litigation against the former client seeking, among other
remedies, collection of a receivable for unpaid premium of approximately $2.9
million. While the Company believes that it will prevail in the litigation,
there can be no assurance that this will be the case and an adverse outcome
could result in the write-off of all or a substantial portion of the receivable.
The Company does not intend to actively market its stand-alone program in 1998
because it has determined to emphasize other PEO marketing strategies and
because of the decreased profit opportunities resulting from increased price
competition in the overall workers' compensation market. The decision also is
based on the terms of the Company's guaranteed cost program, which limit the
Company's profit potential on stand-alone cases written after January 1, 1998 to
commission revenue. See "Liquidity and Capital Resources."
Cost of revenues
Cost of revenues increased 125%, to $903.3 million in the year ended December
31, 1997 from $400.9 million for the year ended December 31, 1996. This increase
is primarily due to the increase in the Company's business as previously
described and as described below.
Workers' compensation expense for the year ended December 31, 1997 was $30.4
million compared to $10.0 million in the prior year. The increase primarily is
due to the rapid growth in the Company's overall business, as discussed above,
accelerated by acquisition activity and the addition of US Xpress, all of which
have increased exposure in higher-risk market segments such as transportation.
The increase is also due to an unexpected and significant increase in claims
activity, particularly in the fourth quarter of 1997, including loss development
on prior period claims. This increase led in turn to a significant increase in
the Company's workers' compensation reserves as established via the independent
actuarial review upon which the Company's workers' compensation reserves are
based (see discussion below). In light of the unanticipated increased claims and
reserve requirements, and taking into account prior unanticipated increases in
actuarial reserve requirements (in particular, an unanticipated increase taken
at December 31, 1996), the Company has implemented a change in its business
strategy whereby the Company seeks to minimize future uncertainty associated
with its worker's compensation expense. The change in strategy is based on
competitive market conditions which provide an opportunity to obtain third-party
insurance at a favorable cost and which limit opportunities for the Company to
profit from risk retention and the changing profile of its worksite employee
base. Consistent with this strategy, the Company increased its workers'
compensation reserves at December 31, 1997 approximately $6.0 million to
establish its reserves at a level intended to eliminate any risk of future
workers' compensation loss development expense related to pre-1998 occurrences.
Consistent with Company policy, the Company commissioned an independent third
party actuarial review of the Company's workers' compensation reserves at year
end 1997, as it had in 1996 and 1995. The Company's workers' compensation
reserves at December 31, 1997 are based on a review by that independent actuary,
which was the same actuary that provided the report upon which the Company's
December 31, 1996 reserves were based. The Company consistently established its
workers' compensation reserves on a quarterly basis throughout 1997 based on
reviews by that same independent actuary. The actuary relied on industry
standards, while taking into account the Company's specific risk structure and
philosophy, in determining its findings.
As part of the Company's change in business strategy, the Company obtained
fully-insured guaranteed cost workers' compensation coverage effective January
1, 1998, thereby eliminating the Company's risk retention on workers'
compensation claims arising after that date except for costs associated with
certain stand-alone cases and Ohio claims. Consistent with the change in
business strategy, the Company also is pursuing aggressively a loss portfolio
transfer for pre-1998 claims although there can be no assurance that such a
transaction can be completed on satisfactory terms.
The Company believes that the transition to a guaranteed cost program and the
increase in reserves at December 31, 1997 will reduce the uncertainty associated
with quarterly workers' compensation costs while providing a cost structure for
1998 which compares favorably with historical costs. The Company also believes
that its workers' compensation reserves have been established at a level which
is consistent with its change in business strategy described above (including
expense associated with a loss portfolio transfer should such a transfer be
completed), though there can be no assurance that this is the case. See
"Outlook: Issues and Risks - Adequacy of Loss Reserves- Loss and Claims
Experience."
The following table provides an analysis of the Company's workers' compensation
reserves associated with its partially self-insured programs for the periods
presented. Effective July 1, 1997, and included in the 1997 reserve, is a
provision for losses and payments for self insurance programs in Ohio.
24
<PAGE>
<TABLE>
<CAPTION>
- --------------------------------------------------------------------------------------------------------------------
(In thousands) 1997 1996 1995
------------- ------------- -------------
<S> <C> <C> <C>
Reserve - Beginning of period $ 5,154 $ 1,052 $ 45
Losses 30,407 10,034 2,230
Payments (14,043) (5,932) (1,223)
------------- ------------- -------------
Reserve - End of period $ 21,518 $ 5,154 $ 1,052
============== ============= =============
End of Period
Worksite employees 45,200 30,000 11,000
Stand-alone employees 11,100 13,500 3,500
------------- ------------- -------------
Total employees 56,300 43,500 14,500
============== ============= =============
- --------------------------------------------------------------------------------------------------------------------
</TABLE>
Gross profit
The Company's gross profit margin decreased from 8.7% in the year ended December
31, 1996 to 3.3% in the year ended December 31, 1997. This decrease was
attributable to several factors including higher workers' compensation costs,
the impact of repricing existing clients due to competitive factors, and lower
margins on new business. The proportion of TEAM Services revenues, which have
lower margins, increased during 1997. In addition, while a significant portion
of the Company's total 1997 revenue was derived from US Xpress, as discussed
previously, the gross profit on that revenue was negligible for the year ended
December 31, 1997. The Company generally has earned 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. Stand-alone revenues represented a significantly smaller percentage
of 1997 revenues as compared to prior periods, thereby reducing margin.
Selling, general and administrative
Selling, general and administrative expenses for the year ended December 31,
1997 increased by approximately $16.1 million to $33.4 million, or 93%, from
$17.3 million for the year ended December 31, 1996. 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 216
corporate employees at December 31, 1996 to 332 at December 31, 1997, the
relocation of the Company's office space to a larger facility to accommodate
growth, increased bad debt expense and increased professional services fees due
in part to litigation commenced against the Company in early 1997. 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 year ended December 31, 1997 compared to the same periods in 1996 due to
the increase in revenues discussed above. 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. As discussed
under "1998 Outlook," below, the Company anticipates that it will incur costs in
connection with the expansion of its sales force and the addition of account
executives during 1998.
Depreciation and amortization
Depreciation and amortization represents depreciation of property and equipment
and amortization of organizational costs, customer lists and goodwill. For the
year ended December 31, 1997, depreciation and amortization expense totaled $4.6
million compared to $2.1 million for the year ended December 31, 1996. The
increase was due primarily to depreciation of communication and computer systems
and goodwill amortization resulting from acquisitions, with Leaseway and
McClary-Trapp in 1996 and ETIC and CMGR in 1997 being the most significant.
Goodwill amortization of these acquisitions was recognized from the date of
acquisition. See "Liquidity and Capital Resources" below regarding the Company's
issuance of $85 million in 10% Senior Notes due 2004, in particular as to the
approximately $3.3 million in offering expenses which will be amortized over the
term of the Notes.
Interest
Interest expense for the year ended December 31, 1997 totaled $5.1 million
compared to $1.2 million for the year ended December 31, 1996. The increase in
interest expense is primarily due to increased borrowings. For the year ended
December 31, 1997 interest income totaled $1.3 million compared to $833,000 for
the year ended December 31, 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 the Company's wholly owned
insurance subsidiary, Camelback and cash held at the corporate level.
25
<PAGE>
On October 21, 1997, the Company issued $85 million of 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. See "Liquidity and Capital
Resources" below.
Effective tax rate
The Company's effective tax rate provides for federal, state and local income
taxes. The effective tax rate for the year ended December 31, 1997 was a benefit
of 25% as compared to a provision of 34.7% for the year ended December 31, 1996.
The tax rate used in each quarterly reporting period generally was an estimate
of the Company's effective tax rate for the calendar year. The Company
recognized a tax benefit in 1997 as a result of its loss. The effective tax rate
for 1997 and 1996 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 the Company's various 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."
1998 Outlook
The Company firmly established itself as one of the country's leading PEOs
following rapid internal growth and the completion of numerous acquisitions from
1995 through 1997. Beginning in late 1996, the Company began to experience the
effects of increased competition and a general weakening in the workers'
compensation and employee benefits markets, which developments have reduced the
Company's operating margins. These factors also have slowed the Company's
internally-generated revenue growth, though overall revenues continued to
increase rapidly during this period due to acquisitions and the addition of US
Xpress as a client. Due primarily to reduced internally-generated growth, the
absence of new acquisition activity and seasonal client turnover at year-end,
the total number of worksite employees has been relatively flat from October
1997 through February 1998.
In view of these developments, the Company has developed and is implementing
specific action plans intended to leverage the Company's extensive nationwide
platform and core PEO strengths and take advantage of the significant
opportunities available in the rapidly growing PEO marketplace. The primary
plans are summarized below.
As discussed above, in October 1997, the Company completed an $85 million
offering of its 10% Senior Notes due 2004. This transaction has resulted in an
enhanced financial foundation for the Company, including cash and marketable
securities of approximately $40.1 million at December 31, 1997.
In recent months, the Company consolidated its sales management functions at its
Phoenix headquarters under new leadership. Programs have been initiated to spur
internal sales growth by increasing the size of the Company's sales force,
including the addition of employee-salespersons to the current base of
independent sales agents, and by the planned entry into new markets via the
acquisition of local PEOs or the establishment of new sales offices. Further,
the Company has initiated programs intended to improve client retention,
including the addition of account executives at key locations throughout the
country during 1998 with specific client service and retention responsibilties.
26
<PAGE>
The Company has taken specific steps to position itself to manage costs more
effectively and improve overall operating efficiencies. Effective January 1998,
the Company has completed the transition of all PEO processing to a unified
software platform and a centralized client server at its Phoenix headquarters,
which is expected to improve consistency and efficiency while simultaneously
affording better local client service. In April 1998, the Company expects to
complete the installation of a new Company-wide accounting software package,
which will improve significantly the quality and detail of information available
to management while simultaneously speeding its delivery. The Company has also
retained a team of independent consultants who are charged with developing
detailed recommendations to improve the Company's internal structures and
processes at corporate headquarters and throughout the Company's regional
offices. The Company has consolidated certain facilities obtained via
acquisitions. The Company expects to gain greater control over its workers'
compensation costs via the transition to fully-insured, guaranteed cost coverage
from third-party insurers effective January 1, 1998.
The Company also is taking specific actions to focus its resources more tightly
on its core PEO competencies. All existing programs are under careful review. As
a result of this review, the Company already has determined to discontinue
altogether writing new stand-alone workers' compensation cases effective May
1998, primarily due to the desire to focus corporate resources on core PEO
activities, increased competition and the reduced profit potential on
stand-alone cases under the Company's new guaranteed cost workers' compensation
arrangements.
The Company has taken specific actions to improve the depth of its senior
management team in light of recent rapid growth. As noted above, sales
management has been consolidated at the Company's Phoenix headquarters and
significant additions have been made to the sales management team. The Company
recently announced the addition of two independent directors to improve the
quality of the strategic direction and assistance provided at the Board level.
The Company also has announced the retention of an executive search firm to
identify candidates for the position of corporate President, and intends to
retain an individual who will bring to the position proven operational skills
and the highest possible leadership potential. The Company will continue to
evaluate and act upon management needs.
The Company also is pursuing diligently the transfer of pre-1998 workers'
compensation claims pursuant to a loss portfolio transfer or similar
transaction. The Company believes that such a transaction can be accomplished
without a charge to earnings in future periods based on the level of workers'
compensation reserves at December 31, 1997, and further believes that funds
currently held as restricted cash will be sufficient to fund the transfer.
As discussed above, the Company believes that it has identified and is
implementing appropriate specific actions which, over time, will result in
significant revenue and margin enhancement and overall operational improvement
from the extensive national PEO platform which has been successfully built in
prior years. However, the Company also anticipates that many of these actions
will require a period of time to implement properly, and further anticipates
that the benefits of these actions will be realized incrementally over the
course of 1998 and beyond. In addition, certain costs will be incurred before
results can be achieved or evaluated.
Factors which could affect the Company's intended results include delays in
implementing sales force or systems improvements, increased competition,
unfavorable regulatory developments, general market acceptance of the Company's
PEO services, cancellation or renegotiation of contracts, failure to conclude a
loss portfolio transfer or similar transaction, increases in the anticipated
pricing or changes in the anticipated terms of a loss portfolio or similar
transaction, failure to conclude acquisition transactions or successfully
integrate completed acquisitions, fluctuations in margins, the financial
condition of the Company's clients, demand fluctuations, and other risks set
forth herein. The Company therefore further cautions that there can be no
assurance of the success of any or all of the specific actions described above.
27
<PAGE>
Results of Operations--Year Ended December 31, 1996 Compared to Year Ended
December 31, 1995
<TABLE>
<CAPTION>
- --------------------------------------------------------------------------------------------------------------------
Percent
(In thousands) 1996 Change 1995
------------- ------------- -------------
<S> <C> <C> <C>
Revenues $ 439,016 167% $ 164,455
Cost of revenues 400,862 166 150,675
Gross profit 38,154 177 13,780
Selling, general and administrative 17,310 141 7,183
Depreciation and amortization 2,073 387 426
Interest income 833 181 296
Interest expense 1,196 4,684 25
Net income 12,026 214 3,835
- --------------------------------------------------------------------------------------------------------------------
</TABLE>
Net income for the year ended December 31, 1996, was $12.0 million, or $.37 per
diluted share, reflecting significant growth from 1995 net income of $3.8
million, or $.14 per diluted share. Revenues of $439.0 million for the year
ended December 31, 1996, were 167% higher than 1995. The growth was the result
of integration of several acquisitions; the growth in the Company's risk
management/workers' compensation program; direct PEO sales and marketing
efforts; and the efficient administration of existing business.
Revenues
Revenues increased from $164.5 million for the year ended December 31, 1995, to
$439.0 million for the year ended December 31, 1996, a 167% increase. The
increase in revenues was partially due to sales from the Company's expanded PEO
sales force. Acquisitions accounted for a significant increase in revenues
between the periods. The number of worksite employees increased from
approximately 11,000 at December 31, 1995, to approximately 30,000 at December
31, 1996. In 1995, the Company commenced placing risk management/workers'
compensation services to clients which are not full-service PEO clients of the
Company. As of December 31, 1996, the Company provided risk management/workers'
compensation services to approximately 13,500 workers as compared to 3,500 at
December 31, 1995. Revenues related to stand alone risk management/workers'
compensation were $16.1 million in 1996 compared with $3.6 million for 1995.
Cost of Revenues
Cost of revenues increased 166% from $150.7 million for the year ended December
31, 1995, to $400.9 million in the year ended December 31, 1996. This increase
is primarily due to the increase in the Company's business as explained in the
section above and in increased workers' compensation expense.
Workers' compensation expenses increased approximately 355% to $10.0 million in
1996 from $2.2 million in 1995, due primarily to the increase in earned premiums
on the stand-alone risk management/workers' compensation program and growth in
the core PEO business, including acquisitions. See discussion of cost of
revenues under "Results of Operations - Year Ended December 31, 1997 Compared to
Year Ended December 31, 1996" for further information.
28
<PAGE>
Gross Profit
The Company's gross profit margin increased from 8.4% in the year ended December
31, 1995 to 8.7% in the year ended December 31, 1996. This increase primarily
was attributable to the Company's stand-alone risk management/workers'
compensation program which was in place for the full year ended December 31,
1996, versus only eight months in 1995. The eight-month period included
approximately 5,600 Hazar employees who were provided stand-alone risk
management/workers' compensation from May 1995 through September 1995, when the
Hazar assets became included in the Company's PEO business upon the acquisition
of certain Hazar assets by the Company.
The Company also received the benefits of reduced administrative costs with
Camelback for the entire year ended December 31, 1996 as compared with the same
period in 1995 which only included seven months of benefit because Camelback was
not operative until June 1995. The Company also has increased the number of
claims managers to 37 at December 31, 1996 compared to 7 at December 31, 1995.
Selling, General and Administrative
Selling, general and administrative expenses increased by $10.1 million or 141%
from $7.2 million for the year ended December 31, 1995 to $17.3 million for the
year ended December 31, 1996. As a percent of gross profit, selling, general and
administrative expenses decreased from 52% to 45% during the year ended December
31, 1995 and 1996, respectively. Factors contributing to the increase in
selling, general and administrative expenses in 1996 over 1995 are the
integration of the operations of various acquisitions including an increase from
60 corporate employees at December 31, 1995 to 216 at December 31, 1996,
resulting in a significant increase in personnel costs, and the expansion of the
Company's office space. Additionally, the Company's results for the year
reflected six months of expenses for TEAM Services and five months of expense
for Leaseway, both recent acquisitions which historically have maintained a
higher ratio of selling, general and administrative expense to gross profit than
the Company. 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, including
consolidation of certain acquired companies' administration. The Company's
general liability insurance costs have increased due in part to the added
corporate staff and increased costs for directors' and officers' liability
insurance. Commission expenses increased in the year ended December 31, 1996
compared to 1995 due to the increase in revenues discussed above.
Depreciation and Amortization
Depreciation and amortization represented depreciation of property and equipment
and amortization of organizational costs, customer lists and goodwill in the
year ended December 31, 1996 and 1995. The increase was due primarily to
depreciation of new phone and computer systems and goodwill amortization
resulting from acquisitions, with Hazar, Leaseway, and McClary-Trapp being the
most significant.
Interest
Interest income increased from $296,000 for the year ended December 31, 1995 to
$833,000 for the year ended December 31, 1996, primarily due to interest earned
on both the restricted cash held for the future payment of workers' compensation
claims at Camelback and cash held at the corporate level raised through the
exercise of common stock purchase warrants and through operations. Interest
expense increased from $25,000 for the year ended December 31, 1995 to $1.2
million for the year ended December 31, 1996, primarily due to interest accrued
on the Company's revolving line of credit. The line was first utilized in August
1996 and had an average outstanding balance of $34 million for the five months
ended December 31, 1996. See "Liquidity and Capital Resources."
Effective Tax Rate
The Company's effective tax rate provides for federal, state and local income
taxes. The effective tax rate for fiscal 1996 is 34.7% as compared to 42.6% for
the year ended December 31, 1995. The effective tax rate for 1996 was positively
impacted by a state tax benefit in the amount of approximately $430,000 relating
to 1995. The effective tax rate would have been approximately 37% without this
benefit. This downward year-to-year revision reflects a reduction resulting from
the increased operations of the Company's wholly-owned subsidiary, Camelback,
which pays state premium tax rather than state income tax.
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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
1997 was from financing activities and operations.
Cash provided by operating activities was $7.2 million during 1997 compared to a
use of $3.3 million during 1996, and cash provided of $6.3 million during 1995.
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
McClary-Trapp, and the Company's stand-alone program adversely affected the
Company's operating cash flows in 1996 as these operations extend credit terms
generally from 15 to 45 days as is customary in their respective market
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. 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.
Cash used in investing activities was $15.0 million, $46.9 million and $2.2
million in 1997, 1996, and 1995, respectively. The Company expects to use
certain of the net proceeds from the Note Offering (see below) to finance future
acquisitions. Future acquisitions are expected to be a significant use of cash.
See "Outlook: Issues and Risk-Management of Rapid Growth". In addition, cash
purchase price payments are due in the second quarter of 1998 for two 1997
acquisitions. The amounts of the payments are based on the terms of the
applicable purchase agreements and have not yet been determined. For 1997, 1996
and 1995, capital expenditures were $2.5 million, $.7 million and $.2 million,
respectively. Capital expenditures in 1997 consisted primarily of communications
and computer equipment to enhance the Company's ability to support the Company's
increased client base and the centralization of payroll processing. In addition,
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 1998, 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 1998 capital expenditures will continue, and may significantly exceed
amounts spent in 1997, in order to meet the needs of the Company's base of
worksite employees.
Cash provided by financing activities was $36.9 million for 1997 compared to
$47.2 million for 1996 and $8.0 million for 1995. Cash flows from financing
activities during 1997 resulted primarily from the issuance of the Notes offset
by the repayment of existing long-term debt.
At December 31, 1997 and 1996, the Company had cash and cash equivalents of
$40.1 million and $11.0 million, respectively. Cash and cash equivalents
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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 arising under its pre-1998 program. Such restricted
cash and investments have been calculated based on estimates of ultimate losses
under its workers' compensation program. 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 are 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 December 31, 1997, $19 million
was on deposit at Camelback as restricted cash and investments, as compared to
$11.5 million at December 31, 1996. In the event the Company effects a loss
portfolio transfer, the Company will be required to make a cash payment, which
may (but is not expected to) exceed the amount of the restricted cash, to fund
the transfer of liabilities to a third party.
At December 31, 1997 and 1996, the Company had working capital of $58.4 million
and $30.4 million, respectively.
Under Bermuda law, Camelback must maintain statutory capital and surplus in an
amount based primarily on premium volume. Bermuda law also regulates the
circumstances under which Camelback may loan funds to its parent company. In
1997, the Company paid to Reliance approximately $25.0 million of which
approximately $19.9 million was ceded to the trust account at Camelback for
payment of claims and approximately $2.1 million was ceded directly to Camelback
as unrestricted. For the same period the Company also paid to Legion Insurance
Company approximately $2.6 million of which approximately $2.3 million in loss
funds is expected to 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 Camelback to transfer funds to its parent company (whether via
dividend or otherwise).
Prior Credit Facility
In August 1996, the Company established a revolving line of credit facility
("Prior Credit Facility") for acquisition financing, working capital and other
general corporate purposes. The original credit facility was a three year $35
million revolving line of credit. The line was expanded to $45 million in
October 1996 and to $60 million in February 1997. 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 sale of the Notes and replaced it with the Amended Credit
Facility. See "Amended Credit Facility" below.
Note Offering
On October 21, 1997, the Company issued $85 million of Notes in an Offering (the
"Offering") effected under Rule 144A of 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 $3.3 million and will amortize such costs over the life of the
Notes. The Company agreed to file under the Securities Act, a registration
statement relating to an exchange offer for these Notes. If this registration
was not declared effective prior to the 120th day after the issue date of
October 21, 1997 (which it was not), the interest rate can increase up to a
maximum of 12% per annum of the principal amount of such Notes, increasing by
1/2% every 90 days. The indenture under which the Notes were issued includes
certain restrictions on use of cash, and other expenditures, by the Company
including limitations on dividends and repurchases of Company shares.
Amended Credit Facility
In connection with the Offering, the Company entered into an amended and
restated credit facility (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 year thereafter; senior debt to earnings before income
taxes, interest expense and depreciation and amortization (EBITDA), as defined
therein for the preceding four fiscal quarters of not more than 2.0 to 1 as of
the end of each calendar year 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 is secured by substantially all of the Company's
assets. As a result of 1997 performance, the Company is not in compliance with
certain financial covenants under the Amended Credit Facility, and may not
borrow under the Amended Credit Facility unless it returns to compliance or is
able to agree with the bank to the new covenants, as to which there can be no
assurance. Because of the Company's current cash status, the Company does not
believe that the current unavailability of the Amended Credit Facility will
materially affect its liquidity, although there can be no assurance this will
remain the case if cash needs significantly increase in the future.
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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. See also "1998 Outlook," above.
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 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. The pricing of the Company's guaranteed cost and Ohio
reinsurance policies in place as of January 1, 1998 are subject to annual
negotiation, and the above factors could materially increase the Company's costs
under such policies.
Adequacy of Loss Reserves; Loss and Claims Experience
Under its partially self-insured workers' compensation arrangements in effect
until January 1, 1998, 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 circumstances that are
highly variable and difficult to predict. 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
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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 recently changed its business strategy with respect to its workers'
compensation program and related workers' compensation reserves in response to
the changing risk profile of its worksite employee base, increased competition
and reduced margin opportunities, the availability of third party insurance at
attractive rates, and in an effort to reduce the uncertainty associated with its
quarterly workers' compensation expense. As part of the Company's change in
business strategy, the Company obtained fully-insured guaranteed cost workers'
compensation coverage effective January 1, 1998, thereby eliminating, with
limited exceptions, the Company's risk retention on workers' compensation claims
arising after that date. The coverage was obtained through Stirling Cooke Risk
Management Services, Inc. under a three-year arrangement, with pricing subject
to annual review. The Company will retain risk up to $250,000 per occurrence
with respect to a defined portfolio of stand-alone policies which were in place
at December 31, 1997, which policies expire at various dates during 1998. The
Company also will retain risk up to $50,000 per occurrence for claims under
Ohio's monopolistic workers' compensation structure, with an aggregate liability
limitation based on a percentage of Ohio manual premium. Consistent with the
change in strategy, the Company also increased its workers' compensation
reserves at December 31, 1997 to reflect a one-time charge of approximately $6.0
million to establish its reserves at a level intended to eliminate any risk of
future workers' compensation charges for pre-1998 claims. The Company also is
pursuing aggressively a loss portfolio transfer or similar reinsurance, for
pre-1998 claims. However, there can be no assurance that the Company will
successfully complete such a transaction, or of the terms on which such a
transaction could be completed.
The Company believes that the transition to a guaranteed cost program and the
increase in reserves at December 31, 1997 will reduce the uncertainty associated
with the quarterly calculation of workers' compensation costs while providing a
premium cost structure for 1998 which compares favorably with historical costs.
The availability of coverages and premium costs in future years are subject to
change (including possible material upward adjustment of premium costs) based on
loss experience and competitive conditions in the overall workers' compensation
market. The Company also believes that its workers' compensation reserves have
been established at a level which is consistent with its change in business
strategy described above (including expense associated with a loss portfolio
transfer should such a transfer be completed), although there can be no
assurance that this is the case.
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, and directly impacts
the Company under its self insured medical program. 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 PEOs with lower
claims rates that may offer lower rates to clients. The Company has an
arrangement with its largest client under which the Company remains responsible
for medical claims above an agreed limit. While the Company does not believe
that it will incur material liabilities under this arrangement, there can be no
assurance that this will be the case.
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 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 employee benefit and tax purposes the "employers"
of worksite employees under the Code. The Company cannot predict either the
timing 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. With respect to benefit plans, the tax qualified status of the
Company's 401(k) plans could 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.
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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.
Credit Risks
As the employer of record for its worksite employees, the Company is obligated
to pay their wages, benefit costs and payroll taxes. The Company typically bills
a client company for these amounts in advance of or at each payroll date, and
reserves the right to terminate its agreement with the client, and thereby the
Company's liability for future payrolls to the client's worksite employees, if
payment is not received within two days of the invoice date. Limited extended
payment terms are offered in certain cases subject to local competitive
conditions. The rapid turnaround necessary to process and make payroll payments
leaves the Company vulnerable to client credit risks, some of which may not be
identified prior to the time payroll payments are made. There can be no
assurance that the Company will be able to timely terminate any delinquent
accounts or that its contractual termination rights will be judicially enforced.
In addition, the Company has recently entered several market segments through
acquisitions in which PEOs typically advance wages, benefit costs and payroll
taxes to their clients. The Company intends to continue this practice despite
the potentially greater credit risk posed by such practices. Also, in its
stand-alone risk management/worker's compensation program, the Company has
structured certain of its clients' premium payments so that less than the full
premium is billed periodically through the policy year, with the difference to
be paid by the client on a deferred basis after the end of the policy year.
Following the completion of the Company's first series of policy audits, the
Company determined in late 1997 that collection rates from these clients would
be lower than expected, due in part to the Company's non-renewal of the affected
policies as part of the overall de-emphasis of its stand-alone program. The
Company conducts a limited credit review before accepting new clients. However,
the nature of the Company's business and pricing margins is such that a small
number of client credit failures could have an adverse effect on its business
and financial performance.
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Litigation
As previously reported, the Company and certain of its present and former
directors and executive officers have been named as defendants in ten actions
filed between March 1997 and May 1997. While the exact claims and allegations
vary, they all allege violations by the Company of Section 10(b) of the 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 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 Company 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 of the U.S. District
Court in Phoenix, Arizona. The Court has appointed lead plaintiffs for the
putative class, approved plaintiffs' selection of counsel, and ordered
plaintiffs to file a consolidated, amended complaint on or about April 6, 1998.
The Company believes the actions are without merit and intends to defend the
cases vigorously. However, the ultimate resolution of these actions could have a
material adverse effect on the Company's results of operations and financial
condition.
Client Relationships
The Company's subscriber agreements with its clients generally may be canceled
upon 30 days written notice of termination by either party. While the Company
believes that it has experienced favorable client retention in the past, there
can be no assurance that those relationships will continue or that historical
rates of retention will continue to be achieved. The short-term nature of most
customer agreements means that clients could terminate a substantial portion of
the Company's business upon short notice.
Through recent acquisitions and internal growth, the percentage of the Company's
clients in the transportation industry has increased. While the Company has
targeted this industry, which it believes could benefit from Company services
and expertise, increased concentration in a single industry could make the
Company subject to risks and trends of that industry. Also, certain aspects of
the transportation industry may be subject to particular risks, such as the risk
of property damage, injury and death from accidents inherent in the operation of
a motor vehicle. In addition, the Company is providing driver leasing services
through LPC, in which the Company acts as sole employer, which may increase risk
to the Company as a result of the direct nature of the employment relationship.
Substantial Leverage
The Company has incurred significant debt primarily in connection with its
expansion through acquisitions and its October 1997 issuance of the Senior
Notes. As of December 31, 1997, the Company had outstanding senior indebtedness
of approximately $85 million and stockholders' equity of approximately $42.4
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, management believes that cash flow from operations
and other available cash, 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, including the Notes, for
the foreseeable future. Due to financial covenant violations, the Company is
currently not able to borrow under the Amended Credit Facility, which had been
another source of liquidity. 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.
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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, various states have passed
laws that have licensing or registration requirements and 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 has
utilized 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, 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
36
<PAGE>
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.
Year 2000 Compliance
Many computer programs process transactions based on using two digits for the
year of the transaction rather than a full four year digits (e.g. "98" for
1998). Systems that process Year 2000 transactions with the year "00" may
encounter significant processing inaccuracies or inoperability. Management has
determined that, like most other companies, it will be required to modify or
replace significant portions of its software so that its information systems
will be able to properly utilize dates subsequent to December 31, 1999. The Year
2000 issue will be addressed through either the modification of existing
software or conversion to new software. However, if such transition is not
completed on a timely basis, the Year 2000 issue could have a material impact on
the Company's operations.
The Company began developing its plan to address Year 2000 in 1997. The plan
includes hardware, software, electronic equipment and building systems, and
evaluates risk associated with vendor readiness. Based on developments to date,
the Company expects that the plan will be completed in a timely fashion and that
Year 2000 issues will not have a material effect on the Company's results of
operations. The Company's expectation in this regard is based upon numerous
assumptions of future events including the availability of certain resources,
third party modifications and other factors, and there can be no assurance that
the Company's current expectations will be met.
ITEM 7A. - QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
- ---------------------------------------------------------------------
These requirements are not yet applicable to the Company.
ITEM 8. - FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
- -----------------------------------------------------
Financial statements required by Form 10-K are set forth at pages F-1 through
F-32 hereof.
ITEM 9. - CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
- --------------------------------------------------------------------------------
FINANCIAL DISCLOSURE
- --------------------
Not applicable.
37
<PAGE>
PART III
ITEM 10. - DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
- -------------------------------------------------------------
The biographical information relating to the Company's directors included under
the caption "Election of Directors" in the Company's definitive Proxy Statement
for its 1998 Annual Meeting of Shareholders (the "Proxy Statement") is
incorporated herein by reference. The Company anticipates filing the Proxy
Statement within 120 days after December 31, 1997. Information as to the
Company's executive officers is set forth in Item 4A above.
ITEM 11. - EXECUTIVE COMPENSATION
- ---------------------------------
The information under the heading "Executive Compensation" and "Compensation of
Directors" in the Proxy Statement is incorporated herein by reference.
ITEM 12. - SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
- -------------------------------------------------------------------------
The information under the heading "Voting Securities and Principal Holders -
Security Ownership of Certain Beneficial Owners and Management" in the Proxy
Statement is incorporated herein by reference.
ITEM 13. - CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
- ---------------------------------------------------------
The information under the heading "Certain Transactions" in the Proxy Statement
is incorporated herein by reference.
PART IV
ITEM 14. - EXHIBITS AND REPORTS ON FORM 8-K
- -------------------------------------------
(a) Exhibits
See attached Exhibit Index, which is incorporated herein by reference.
(b) Reports on Form 8-K for last year
The Company filed a report on Form 8-K dated October 21, 1997 which reported the
Company's sale of $85 million in 10% Senior Notes due 2004 in a private
placement transaction, and entry into the Amended Credit Facility.
Financial statements were not required or filed.
Additionally, the Company filed a report on Form 8-K dated February 20, 1998
which reported the Company's issuance by means of a dividend of Rights to
Purchase Shares of Series A Junior Participating Preferred Stock. Financial
statements were not required or filed.
38
<PAGE>
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange
Act of 1934, the Registrant has duly caused this Report to be signed on its
behalf by the undersigned, thereunto duly authorized.
Dated this 30th day of March, 1998
EMPLOYEE SOLUTIONS, INC.
By /s/ Marvin D. Brody
-----------------------------------
Marvin D. Brody
Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934,
this Report has been signed below by the following persons on behalf of the
Registrant and in the capacities and on the dates indicated:
<TABLE>
<CAPTION>
Signature Title Date
- ------------------------------------------ ------------------------------ --------------
<S> <C> <C>
/s/ Marvin D. Brody Chairman of the Board, Chief March 30, 1998
- ------------------------------------------ Executive Officer, President
Marvin D. Brody And Director
/s/ Harvey A. Belfer Director March 30, 1998
- ------------------------------------------
Harvey A. Belfer
/s/ Sara R. Dial Director March 30, 1998
- ------------------------------------------
Sara R. Dial
Director --
- ------------------------------------------
Edward L. Cain, Jr.
/s/ Jeffrey A. Colby Director March 30, 1998
- ------------------------------------------
Jeffrey A. Colby
/s/ Robert L. Mueller Director March 30, 1998
- ------------------------------------------
Robert L. Mueller
/s/ Quentin P. Smith, Jr. Director March 30, 1998
- ------------------------------------------
Quentin P. Smith, Jr.
/s/ Morris C. Aaron Chief Financial Officer March 30, 1998
- ------------------------------------------
Morris C. Aaron
/s/ John V. Prince Chief Accounting Officer March 30, 1998
- ------------------------------------------
John V. Prince
</TABLE>
39
<PAGE>
EMPLOYEE SOLUTIONS, INC.
(the "Registrant")
EXHIBIT INDEX
TO
REPORT ON FORM 10-K
FOR THE YEAR ENDED DECEMBER 31, 1997
<TABLE>
<CAPTION>
Exhibit Incorporated Herein Filed
Number Description By Reference To Herewith
- ------ --------------------------------------- ------------------------------------ --------
<S> <C> <C> <C>
3(i) Registrant's composite Articles of Registrant's Report on Form 10-K
Incorporation, as amended for the year ended December 31, 1996
("1996 10-K") (See also Exhibit A
included in Exhibit 4.5 below)
3(ii) Registrant's Amended and Restated Bylaws, Registrant's Form 10-Q for the year
as amended through April 30, 1997 ended March 31, 1997 ("March 1997
10-Q")
4.1 Indenture dated October 15, 1997 among the Registrant's Current Report on Form
Registrant, the Guarantor Subsidiaries (as 8-K dated October 21, 1997 ("10/21/97
defined therein) and The Huntington National 8-K")
Bank
4.2 Purchase Agreement dated October 16, 1997 10/21/97 8-K
among the Registrant, the Guarantor
Subsidiaries and First Chicago Capital
Markets, Inc. ("FCMM")
4.3 Registration Rights Agreement dated 10/21/97 8-K
October 21, 1997 among the Registrant,
the Guarantor Subsidiaries and FCCM
4.4 Amended and Restated Loan Agreement 10/21/97 8-K
dated October 21, 1997 between the Company
and Bank One Arizona, NA ("Bank One")
4.5 Rights Agreement dated as of February 4, 1998 Registrant's Form 8-A registration
between the Company and American Securities statement dated February 19, 1998
Transfer and Trust, Inc. which includes, as
Exhibit A thereto, the Certificate of Designation
of Junior Participating Preferred Stock, Series A,
of the Company, as Exhibit B thereto the Form
of Rights Certificate and as Exhibit C thereto the
Summary of Rights to Purchase Preferred Shares
10.1* Registrant's 1993 Employee Incentive Stock Registrant's Form 10-KSB for the
Option Plan, as amended fiscal year ended December 31, 1994
("1994 Form 10-KSB")
10.2* Employee Solutions, Inc. 1995 Stock Option X
Plan, as amended through January 25, 1998
</TABLE>
40
<PAGE>
<TABLE>
<CAPTION>
Exhibit Incorporated Herein Filed
Number Description By Reference To Herewith
- ------ --------------------------------------- ------------------------------------ --------
<S> <C> <C> <C>
10.3 Employment Agreement with Harvey A. Form SB-2
Belfer, as amended
10.4 Employment Agreements dated March 18, 1997
Between Registrant and:
10.4.1* Morris C. Aaron 1996 10-K
10.4.2* Paul M. Gales 1996 10-K
10.4.3* Roy Flegenheimer 1996 10-K
10.5 Joint Venture Agreement among Registrant, Registrant's Form 10-QSB for the
Edward L. Cain, Jr., and Employee Solutions - year ended September 30, 1994
East, Inc. ("September 1994 10-QSB")
10.5.1 Extension of Joint Venture Agreement among 1995 10-K
Registrant, Edward L. Cain, Jr., and
Employee Solutions - East, Inc.
10.5.2 Supplement Agreement to Joint Venture September 1994 10-QSB
Agreement among Registrant, Edward L. Cain,
Jr., and Employee Solutions, inc.
10.6 Agreement and Plan of Reorganization among 1995 10-K
Registrant, Edward L. Cain, Jr., and Employee
Solutions - East, Inc.**
10.7* Amended and Restated Employment Agreement 1995 10-K
among Registrant, Edward L. Cain, Jr., and
Employee Solutions - East, Inc.
10.8 Guarantee of Payment and Performance by September 1994 10-QSB
Employee Solutions, Inc. to and in favor of
Edward L. Cain, Jr.
10.9 Letter Agreement dated March 27, 1997 (and March 1997 10-Q
signed March 30, 1997) between the Company
and Edward L. Cain, Jr.
10.10 Letter Agreement dated March 27, 1997 (and March 1997 10-Q
signed March 31, 1997) between the Company
and Professional Employers Resource
Corporation
10.11 Asset Purchase Agreement dated July 5, 1996 Registrant's Current Report on Form
by and among Leaseway Transportation Corp., 8-K dated August 1, 1996 ("8/1/96
Leaseway Personnel Corp., Leaseway Admin- 8-K")
istrative Personnel, Inc. and Employee Solutions,
Inc.**
</TABLE>
41
<PAGE>
<TABLE>
<CAPTION>
Exhibit Incorporated Herein Filed
Number Description By Reference To Herewith
- ------ --------------------------------------- ------------------------------------ --------
<S> <C> <C> <C>
10.11.1 First Amendment to Asset Purchase Agreement 8/1/96 8-K
Dated August 1, 1996 by and among Leaseway
Transportation Corp., Leaseway Administrative
Personnel, Inc. Employee Solutions, Inc., and
Logistics Personnel Corp.
10.12 Purchase Agreement between Registrant, GCK Registrant's 10-Q for the year ended
Entertainment Services I, Inc., Talent Entertainment June 30, 1996
and Media Services, Inc. (collectively "TEAM
Services") and the shareholders of TEAM Services
10.12.1 Amendment No. 1 to Purchase Agreement between Registrant's 8-K dated June 22,
Registrant, TEAM Services and the shareholders of 1996 ("6/22/96 8-K")
TEAM Services**
10.13* Employment Agreement between Registrant and 6/22/96 8-K
Jeffery Colby*
10.14 Asset Purchase Agreement between the Registrant Registrant's Form 10-Q for the year
And the McClary-Trapp Companies dated as of ended September 30, 1996
November 1, 1996** ("September 1996 10-Q")
10.15 Security Agreement dated August 1, 1996 8/1/96 8-K
between Bank One Arizona, Inc. and Registrant
and certain of its subsidiaries
10.16 Loan Agreement dated August 1, 1996 between 8/1/96 8-K
the Registrant and Bank One Arizona, Inc.
[superseded]**
10.16.1 Amendment No. One thereto, dated October 15, September 1996 10-Q
1996 [superseded]
10.16.2 Second Modification Agreement dated February 1996 10-K
19, 1997 [superseded]
10.16.3 Third Modification Agreement effective as of Registrant's 10-Q for the year
June 30, 1997 [superseded] ended June 30, 1997
10.17 Indemnification Agreements between the
Registrant and:
10.17.1* Marvin D. Brody 1996 10-K
10.17.2* Edward L. Cain 1996 10-K
10.17.3* Jeffrey A. Colby 1996 10-K
10.17.4* Morris C. Aaron (Agreements in this form were 1996 10-K
also entered into between the Company and each
of Roy A. Flegenheimer, and Paul M. Gales.
</TABLE>
42
<PAGE>
<TABLE>
<CAPTION>
Exhibit Incorporated Herein Filed
Number Description By Reference To Herewith
- ------ --------------------------------------- ------------------------------------ --------
<S> <C> <C> <C>
10.17.5* Henry G. Walker (Agreements in this form were also 1996 10-K
entered into between the Company and each of
Quentin P. Smith, Jr. and Sara R. Dial)
10.18 Reinsurance Agreement effective as of May 1, March 1997 10-Q
1995 between Reliance National Indemnity
Company and Reliance Insurance Company
And Camelback Insurance, Ltd., including
Addendum Number One thereto
10.19 Letter Agreement dated February 27, 1998 X
between the Company and Ward Phelan
21.1 Subsidiaries of Registrant X
23.1 Consent of Arthur Anderson LLP X
27 Financial Data Schedule X
</TABLE>
*Designates management or compensatory agreements
**Excluding exhibits or schedules, which will be furnished to the
Commission on request.
43
<PAGE>
Item 8. FINANCIAL STATEMENTS
INDEX
Page
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS F-2
FINANCIAL STATEMENTS
Consolidated Balance Sheets - December 31, 1997 and 1996 F-3
Consolidated Statements of Operations - For the Years
Ended December 31, 1997, 1996 and 1995 F-4
Consolidated Statements of Stockholders' Equity - For the
Years Ended December 31, 1997, 1996 and 1995 F-5
Consolidated Statements of Cash Flows - For the Years
Ended December 31, 1997, 1996 and 1995 F-6
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS F-8
F-1
<PAGE>
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To Employee Solutions, Inc.:
We have audited the accompanying consolidated balance sheets of EMPLOYEE
SOLUTIONS, INC. (an Arizona corporation) and subsidiaries as of December 31,
1997 and 1996, and the related consolidated statements of operations,
stockholders' equity and cash flows for each of the three years in the period
ended December 31, 1997. These financial statements are the responsibility of
the Company's management. Our responsibility is to express an opinion on these
financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of Employee Solutions,
Inc. and subsidiaries as of December 31, 1997 and 1996, and the results of their
operations and their cash flows for each of the three years in the period ended
December 31, 1997, in conformity with generally accepted accounting principles.
Arthur Andersen LLP
Phoenix, Arizona,
March 11, 1998.
F-2
<PAGE>
EMPLOYEE SOLUTIONS, INC.
CONSOLIDATED BALANCE SHEETS
DECEMBER 31, 1997 AND 1996
<TABLE>
<CAPTION>
(In thousands of dollars, except share data) 1997 1996
-------- --------
ASSETS
<S> <C> <C>
CURRENT ASSETS:
Cash and cash equivalents $ 40,110 $ 10,980
Restricted cash and investments 19,000 11,500
Accounts receivable, net 57,467 34,839
Receivables from insurance companies 7,070 5,918
Prepaid expenses and deposits 4,562 1,258
Income taxes receivable 4,080 --
Deferred income taxes 4,138 1,156
-------- --------
Total current assets 136,427 65,651
Property and equipment, net 3,159 1,084
Deferred income taxes 485 539
Goodwill and other assets, net 67,146 58,695
-------- --------
Total assets $207,217 $125,969
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Bank overdraft $ -- $ 2,477
Accrued salaries, wages and payroll taxes 43,263 17,586
Accounts payable 4,363 4,078
Accrued workers' compensation and health insurance 24,586 6,927
Income taxes payable -- 720
Other accrued expenses 5,886 3,414
-------- --------
Total current liabilities 78,098 35,202
-------- --------
Deferred income taxes 517 111
-------- --------
Long-term debt 85,000 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 issued and outstanding -- --
Common stock, no par value, 75,000,000 shares authorized, 31,683,120
shares issued and outstanding in 1997, and 30,729,433 shares issued
and outstanding in 1996 34,420 30,145
Retained earnings 7,866 16,362
Unrealized gain on investment securities 103 --
-------- --------
Total stockholders' equity 42,389 46,507
-------- --------
Total liabilities and stockholders' equity $207,217 $125,969
======== ========
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
F-3
<PAGE>
EMPLOYEE SOLUTIONS, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
<TABLE>
<CAPTION>
(In thousands of dollars, except share and per share data) 1997 1996 1995
------------ ------------ ------------
<S> <C> <C> <C>
Revenues $ 933,817 $ 439,016 $ 164,455
------------ ------------ ------------
Cost of revenues:
Salaries and wages of worksite employees 765,047 341,988 132,379
Healthcare and workers' compensation 75,595 30,234 7,591
Payroll and employment taxes 62,613 28,640 10,705
------------ ------------ ------------
Cost of revenues 903,255 400,862 150,675
------------ ------------ ------------
Gross profit 30,562 38,154 13,780
Selling, general and administrative expenses 33,411 17,310 7,183
Depreciation and amortization 4,617 2,073 426
------------ ------------ ------------
Income (loss) from operations (7,466) 18,771 6,171
Other income (expense):
Interest income 1,303 833 296
Interest expense (5,102) (1,196) (25)
Other (50) (1) 239
------------ ------------ ------------
Income (loss) before provision for income taxes (11,315) 18,407 6,681
Income tax provision (benefit) (2,819) 6,381 2,846
------------ ------------ ------------
Net income (loss) $ (8,496) $ 12,026 $ 3,835
============ ============ ============
Net income (loss) per common and
common equivalent share:
Basic $ (.27) $ .40 $ .17
============ ============ ============
Diluted $ (.27) $ .37 $ .16
============ ============ ============
Weighted average number of common and
common equivalent shares outstanding:
Basic 31,193,367 30,224,357 22,391,616
============ ============ ============
Diluted 31,193,367 32,167,777 23,506,782
============ ============ ============
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
F-4
<PAGE>
EMPLOYEE SOLUTIONS, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
FOR THE YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
<TABLE>
<CAPTION>
Unrealized Total
(In thousands of dollars, Preferred Common Retained Treasury gain on Stockholders'
except share data) Stock Stock Earnings Stock Investments Equity
--------- -------- -------- -------- ----------- ------------
<S> <C> <C> <C> <C> <C> <C>
BALANCE, December 31, 1994 $ 6 $ 5,929 $ 501 $ (35) $ -- $ 6,401
Issuance of 3,887,200 shares of
common stock in connection
with exercise of underwriter and
IPO warrants -- 7,142 -- -- -- 7,142
Issuance of 5,060,000 shares of
common stock in connection with
conversion of preferred stock (6) 6 -- -- -- --
Issuance of 1,305,308 shares of
common stock in connection with
exercise of other warrants and
stock options -- 981 -- -- -- 981
Acquisition of 78,924 shares of
treasury stock through collection
of receivables from officers/directors -- -- -- (296) -- (296)
Issuance of 799,448 shares of common
stock in connection with acquisitions -- 1,613 -- -- -- 1,613
Tax benefit related to the exercise of
stock options -- 267 -- -- -- 267
Net income -- -- 3,835 -- -- 3,835
-------- -------- -------- -------- -------- --------
BALANCE, December 31, 1995 -- 15,938 4,336 (331) -- 19,943
Cancellation of Treasury Stock -- (331) -- 331 -- --
Issuance of 701,000 shares of common
stock in connection with acquisitions -- 4,274 -- -- -- 4,274
Issuance of 1,968,161 shares of common
stock in connection with exercise of
other warrants and stock options -- 7,786 -- -- -- 7,786
Acquisition of 7,850 shares of common
stock through collection of receivables
from officers/directors -- (157) -- -- -- (157)
Tax benefit related to the exercise of
stock options -- 2,635 -- -- -- 2,635
Net income -- -- 12,026 -- -- 12,026
-------- -------- -------- -------- -------- --------
BALANCE, December 31, 1996 -- 30,145 16,362 -- -- 46,507
Issuance of 752,587 shares of common
stock in connection with acquisitions -- 2,585 -- -- -- 2,585
Issuance of 201,100 shares of common
stock in connection with exercise of
common stock options -- 502 -- -- -- 502
Tax benefit related to the exercise of
stock options -- 1,188 -- -- -- 1,188
Change in unrealized net gains,
net of applicable taxes -- -- -- -- 103 103
Net loss -- -- (8,496) -- -- (8,496)
-------- -------- -------- -------- -------- --------
BALANCE, December 31, 1997 $ -- $ 34,420 $ 7,866 $ -- $ 103 $ 42,389
======== ======== ======== ======== ======== ========
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
F-5
<PAGE>
EMPLOYEE SOLUTIONS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
<TABLE>
<CAPTION>
(In thousands of dollars) 1997 1996 1995
--------- --------- ---------
<S> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Cash received from customers $ 911,189 $ 414,256 $ 162,137
Cash paid to suppliers and employees (896,812) (411,438) (155,066)
Interest received 1,303 833 279
Interest paid (5,152) (1,196) (25)
Income taxes paid, net of refunds (3,315) (5,772) (1,046)
--------- --------- ---------
Net cash provided by (used in) operating activities 7,213 (3,317) 6,279
--------- --------- ---------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of property and equipment (2,499) (702) (238)
Business acquisitions (5,024) (37,251) (961)
Cash invested in restricted cash and investments (7,500) (8,757) (1,372)
Issuance of notes receivable and other, net -- (189) 386
--------- --------- ---------
Net cash used in investing activities (15,023) (46,899) (2,185)
--------- --------- ---------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from issuance of long-term debt 6,905 42,800 --
Repayment of long-term debt (49,705) -- --
Proceeds from issuance of long-term senior notes 85,000 -- --
Payment of deferred loan costs (3,285) (515) --
Proceeds from issuance of common stock 502 7,786 8,123
Decrease in bank overdraft and other (2,477) (2,904) (136)
--------- --------- ---------
Net cash provided by financing activities 36,940 47,167 7,987
--------- --------- ---------
Net increase (decrease) in cash and cash equivalents 29,130 (3,049) 12,081
CASH AND CASH EQUIVALENTS, beginning of year 10,980 14,029 1,948
--------- --------- ---------
CASH AND CASH EQUIVALENTS, end of year $ 40,110 $ 10,980 $ 14,029
========= ========= =========
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
F-6
<PAGE>
EMPLOYEE SOLUTIONS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
(CONTINUED)
<TABLE>
<CAPTION>
1997 1996 1995
-------- -------- --------
<S> <C> <C> <C>
RECONCILIATION OF NET INCOME (LOSS) TO NET CASH
PROVIDED BY (USED IN) OPERATING ACTIVITIES:
Net income (loss) $ (8,496) $ 12,026 $ 3,835
-------- -------- --------
ADJUSTMENTS TO RECONCILE NET INCOME (LOSS) TO
NET CASH PROVIDED BY (USED IN) OPERATING
ACTIVITIES:
Depreciation and amortization 4,617 2,073 426
Miscellaneous non-cash charges 58 -- (193)
Increase in accounts receivable, net (22,628) (24,760) (2,249)
Increase in insurance company receivables (1,152) (5,832) (86)
Increase in prepaid expenses and deposits (3,304) (736) (183)
Increase in deferred income taxes, net (2,522) (539) (256)
Increase in other assets (805) (2,532) (17)
Increase in accrued salaries,
wages and payroll taxes 25,677 10,905 1,319
Increase in accrued workers' compensation
and health insurance 17,659 4,464 676
(Decrease) increase in other long-term liabilities (136) 1,349 (39)
Increase (decrease) in accounts payable 285 (2,038) 599
Increase (decrease) in income taxes payable/receivable (3,612) 1,148 2,043
Increase in other accrued expenses 1,572 1,155 404
-------- -------- --------
15,709 (15,343) 2,444
-------- -------- --------
Net cash provided by (used in) operating activities $ 7,213 $ (3,317) $ 6,279
======== ======== ========
</TABLE>
SUPPLEMENTAL DISCLOSURE OF NON-CASH INVESTING AND FINANCING ACTIVITIES:
During the years ended December 31, 1996 and 1995, certain notes receivable from
officers/directors were repaid with the Company's common stock owned by these
individuals in the amount of $157,000 and $296,000, respectively. There were no
activities of this type in 1997.
In connection with business acquisitions during 1997, 1996 and 1995, the Company
assumed net liabilities of $.9 million, $5.5 million and $5.4 million and issued
$2.6 million, $4.3 million and $1.6 million of common stock, respectively.
The accompanying notes are an integral part of these consolidated financial
statements.
F-7
<PAGE>
EMPLOYEE SOLUTIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1997, 1996 AND 1995
(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. At
December 31, 1997, ESI serviced approximately 1,700 client companies with
approximately 45,200 worksite employees in 47 states.
The Company began in 1995 to offer employers stand-alone risk
management/workers' compensation services. At December 31, 1997, this program
serves approximately 83 additional employers.
The Company conducts its business on a national scale across many industries and
is not concentrated to any material extent within a single local market or
industry, although the transportation industry, at approximately 33%, represents
the largest concentration of clients, including one client that generated
approximately 20% of total revenues in 1997.
Principles of Consolidation
The consolidated financial statements include the activities of Employee
Solutions, Inc. and its wholly owned subsidiaries from their respective
acquisition dates. All acquisitions were accounted for as purchases. All
significant intercompany accounts and transactions have been eliminated.
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
retrospectively rated insurance policies. The actual results of these estimates
may be unknown for a period of years. Actual results could differ from those
estimates.
Cash and Cash Equivalents
Cash and cash equivalents consist of cash and highly liquid investments with
original maturities of three months or less. All cash equivalents are invested
in high quality investment grade instruments, such as commercial paper, at
December 31, 1997 and 1996, and are stated at fair market value. Substantially
all cash and cash equivalents, including restricted cash and investments, are
not insured at December 31, 1997.
Restricted Cash and Investments
Prior to January 1, 1998, the Company was partially self insured for workers'
compensation risks. Under such programs, its "fronting" carriers required an
estimated $19 million and $11.5 million at December 31, 1997 and 1996,
respectively, to be held in a restricted bank account for payment of future
claims, and future capitalization of Camelback Insurance, Ltd. (Camelback), the
Company's wholly owned off-shore captive insurance company. Such restricted cash
and investments have been calculated by the Company's carriers 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 carriers utilizing industry-wide data that may not reflect the Company's
historical or expected ultimate losses. Restricted investments consist of U.S.
Treasury and other short term corporate debt securities, purchased in accordance
with the Company's investment policy guidelines, with varying maturities to
coincide with expected liquidity requirements to meet future anticipated claims,
and are accounted for in accordance with Statement of Financial Accounting
Standards No. 115, Accounting for Investments in Certain Debt and Equity
Securities.
F-8
<PAGE>
At December 31, 1997, the Company maintained approximately $22.6 million of
investments in its cash and cash equivalents and restricted cash and investment
accounts. These securities are considered available-for-sale and, accordingly,
are recorded at market value. Securities with original maturities of 90 days or
less consisted of commercial paper and totaled $8.4 million and had estimated
unrealized gains of $58,000, resulting in an estimated fair value of $8.5
million at December 31, 1997. Securities with original maturities greater than
90 days consisted of $5.9 million in commercial paper and $8.1 million in U.S.
Treasury securities and agencies and had estimated unrealized gains of $114,000,
resulting in an estimated fair value of $14.1 million at December 31, 1997.
Insurance Company Receivables
Prior to January 1, 1998, the Company's risk management/workers' compensation
services program was conducted via fronting arrangements with insurers. At
December 31, 1997 and 1996, the Company had receivables from its fronting
companies of $7.1 million and $5.9 million, respectively. Such amounts consist
of the difference between cash contractually required to be advanced to the
insurance companies for loss funds, administrative fees, excess reinsurance
premiums and premium taxes and the Company's estimate of the actual expenses
incurred. The amount of the receivable is subject to reconciliation with the
insurers upon final audit of the various policy periods.
Accounts Receivable/Revenue Recognition
Revenue is recognized as services are performed. Customers cash payments on
stand-alone workers' compensation policies are generally less than the expected
annual policy premium, resulting in unbilled revenues. Unbilled revenues become
billed upon completion of final policy audits. The following table presents a
summary of the Company's accounts receivable.
- -------------------------------------------------------------------------------
December 31,
(In thousands of dollars) 1997 1996
---------- ----------
Trade accounts receivable $ 23,015 $ 17,306
Unbilled salary
and wage accruals 31,513 14,544
Unbilled stand alone premium revenue 657 618
Other 3,386 3,001
Allowance for estimated
uncollectible receivables (1,104) (630)
---------- ----------
Total accounts receivable, net $ 57,467 $ 34,839
========== ==========
- -------------------------------------------------------------------------------
At December 31, 1997 and 1996, receivables from affiliated parties included in
the above totals were $2.9 million and $3.3 million, respectively.
Credit Risk
The Company conducts only a limited credit investigation prior to accepting most
new clients and thus may encounter collection problems which could adversely
affect its cash flow. The nature of the Company's business is such that a small
number of client credit failures could have an adverse effect on its business
and financial condition.
Property and Equipment
Property and equipment primarily consists of software purchased and developed
for internal use and office furniture and equipment and is recorded at cost.
Depreciation is recorded on the straight-line method over the estimated useful
lives of the assets which range from three to five years. Maintenance and
repairs that neither materially add to the value of the property, nor
appreciably prolong its life, are charged to expense as incurred. Betterments or
renewals are capitalized when incurred. Property and equipment is net of
accumulated depreciation of $861,000 and $440,000 at December 31, 1997 and 1996,
respectively.
F-9
<PAGE>
Goodwill and Other Assets
Included in goodwill and other assets is $64.1 million and $55.8 million at
December 31, 1997 and 1996, respectively, representing the unamortized cost of
goodwill. Goodwill represents the excess of the purchase price paid over the
fair market value of the net assets for all acquired companies. As of December
31, 1997, goodwill of $24.9 million is being amortized over 30 years, $39
million over 15 years and $200,000 over shorter periods. The Company
periodically assesses goodwill for impairment using the criteria of SFAS No.
121, Accounting for the Impairment of Long-Lived Assets and for Long-Lived
Assets to be Disposed of.
Goodwill and other assets are net of accumulated amortization of $6.5 million
and $2.5 million at December 31, 1997 and 1996, respectively.
Also included in goodwill and other assets at December 31, 1997 and 1996 is $2.9
million representing the net receivable after reserves for stand-alone workers'
compensation premium due from one customer for a two-year program ended December
31, 1997. The Company believes this to be collectible and has begun litigation
proceedings to collect the outstanding premium.
Bank Overdraft
Bank overdraft represents outstanding checks in excess of cash on hand at the
applicable bank. Historically, these checks are covered when presented for
payment through collection of accounts receivable.
Accrued Workers' Compensation and Health Insurance
Prior to January 1, 1998, the Company offered partially self-insured health
programs through arrangements with Nationwide Life Insurance Company
(Nationwide) and John Alden Life Insurance Company (Alden), and a self-insured
program through an arrangement with Provident Life & Accident Insurance Company
("Provident"), in addition to its fully insured medical plans. Pursuant to the
arrangements with Nationwide and Alden, the Company is responsible for
deductibles of $100,000 and $75,000 per covered individual per year,
respectively. Under the Provident program the maximum policy coverage is
$100,000 per covered individual per year, for which the Company is responsible.
Effective January 1, 1997, the deductible for the Nationwide program was
decreased to $75,000. The Company's aggregate liability limit under the
Nationwide program is based upon covered lives as of the beginning of each month
during the calendar year, and is calculated at 125% of the expected claims
amount. The Alden plan has no stop-loss claim limit. Effective January 1, 1998,
the Nationwide and Alden plans have been discontinued and the covered employees
moved to fully insured programs.
Prior to June 1, 1994 the Company covered its risk management/workers'
compensation obligations with fully insured policies issued by multiple
carriers. From June 1, 1994, to May 31, 1995, coverage was provided through
policies issued by the American International Group (AIG) and Reliance National
Indemnity Company (Reliance). The Company received approval in 1994 to form
Camelback. Camelback was activated in May 1995. Effective June 1, 1995, the
Company began conducting substantially all of its risk management/workers'
compensation program through Camelback in coordination with Reliance. Under
these policies, which provide first dollar coverage to the employees of the
Company, its subsidiaries and the Company's clients, the Company is responsible
for the first $250,000 per occurrence, with no aggregate to limit the Company's
liability.
Individual risk management/workers' compensation claims in excess of $250,000
and up to the statutory limits of the states where the Company operates are the
responsibility of Reliance. The Company's prior arrangements with AIG were
structured in a manner similar to its current arrangements with Reliance. While
the retention of the first $250,000 of individual workers' compensation claims
and the capital requirements resulting from the establishment of Camelback are
intended to enhance profitability, these actions increased the Company's
exposure to risk from workers' compensation claims.
To meet growing needs of the Company's business on August 1, 1996 the Company
entered into an arrangement with Legion Insurance Company (Legion), on
substantially the same terms as the Reliance program except that the Company is
responsible for the first $350,000 per occurrence with no aggregate to limit the
Company's liability. Loss funds, recorded as restricted cash and investments
under the Reliance program, are held by Legion for the Company's benefit and are
included in receivables from insurance companies in the amount of $3.6 and $3.1
million at December 31, 1997 and 1996, respectively.
F-10
<PAGE>
To further reduce its potential liability, the Company has secured Accidental
Death and Dismemberment insurance from an insurance affiliate of the Chubb Group
of Insurance Companies (Chubb) that covers losses up to $500,000 (increased from
$250,000 in July 1996, to obtain a net reduction in excess reinsurance costs)
for certain types of serious claims and maintains umbrella coverage for certain
liabilities (other than losses resulting from workers' compensation claims)
which the Company may incur in connection with its administration of its risk
management/workers' compensation program. The Chubb policy was terminated in
February 1998 in connection with the Company's decision to obtain a fully
insured guaranteed cost program for 1998. Effective January 1, 1998, the Company
obtained workers' compensation insurance coverage on a fully-insured, guaranteed
cost basis. This guaranteed cost program eliminates ESI's risk retention on
workers' compensation claims arising after that date with limited exceptions
related to the stand-alone policies expiring throughout 1998 and Ohio self
insurance as described below.
Effective July 1, 1997, the Company became self-insured for workers'
compensation in the State of Ohio. The Company is responsible for the first
$500,000 per occurrence through December 31, 1997. Beginning January 1, 1998,
the Company has purchased excess reinsurance for Ohio claims, limiting such
claims to $50,000 per occurrence with an aggregate liability limitation based on
a percentage of Ohio manual premium.
The Company recognizes a liability for partially self-insured and self-insured
health insurance and workers' compensation insurance claims at the time a claim
is reported to the Company by the third party administrator. The third party
administrator establishes the initial claim reserve based on information
relating to the nature, severity and the cost of similar claims. The Company
provides for claims incurred, but not reported, based on industry-wide data and
the Company's past claims experience through consultation with third party
actuaries. The liability recorded may be more or less than the actual amount of
the claims when they are submitted and paid. Changes in the liability are
charged or credited to operations as the estimates are revised. During the
fourth quarter of 1997, significant changes in estimates were made to the
estimated workers' compensation liabilities in connection with a change in the
business strategy and, accordingly, a charge of $6.0 million was recorded.
Income Taxes
The Company files a consolidated federal income tax return. Consolidated or
combined state tax returns are filed in certain states.
Deferred income taxes arise from temporary differences resulting from certain
revenue and expense items reported for financial accounting and tax reporting
purposes in different periods. Reductions in current income taxes payable
related to disqualifying dispositions of qualified stock options and the
exercise of non-qualified stock options are credited to common stock.
F-11
<PAGE>
Net Income Per Common and Common Equivalent Share
In February 1997, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 128 (SFAS No. 128), Earnings per Share. The
earnings per share amounts for 1996 and 1995 have been restated to conform to
the 1997 presentation as required by SFAS No. 128. The computation of adjusted
net income and weighted average common and common equivalent shares used in the
calculation of net income per common share is as follows:
- --------------------------------------------------------------------------------
(In thousands of dollars, except share and per share data)
<TABLE>
<CAPTION>
1997 1996 1995
---------------------------- --------------------------- ---------------------------
Basic Diluted Basic Diluted Basic Diluted
---------------------------- --------------------------- ---------------------------
<S> <C> <C> <C> <C> <C> <C>
Weighted average of
common shares outstanding 31,193,367 31,193,367 30,224,357 30,224,357 22,391,616 22,391,616
Dilutive effect of options
and warrants outstanding -- -- -- 1,943,420 -- 1,115,166
------------ ------------ ------------ ------------ ------------ ------------
Weighted average of
Common and common
Equivalent shares 31,193,367 31,193,367 30,224,357 32,167,777 22,391,616 23,506,782
============ ============ ============ ============ ============ ============
Net income (loss) $ (8,496) $ (8,496) $ 12,026 $ 12,026 $ 3,835 $ 3,835
Adjustments to net income -- -- -- -- -- (135)
------------ ------------ ------------ ------------ ------------ ------------
Adjusted net income for
purposes of the income per
common share calculation $ (8,496) $ (8,496) $ 12,026 $ 12,026 $ 3,835 $ 3,700
============ ============ ============ ============ ============ ============
Net income per common and
common equivalent share $ (0.27) $ (0.27) $ 0.40 $ 0.37 $ 0.17 $ 0.16
============ ============ ============ ============ ============ ============
</TABLE>
- --------------------------------------------------------------------------------
Adjustments to 1995 net income in the calculation of diluted earnings per share
reflect the amortization of contingent goodwill related to the acquisitions of
Employment Services of Michigan, Inc. and Hazar, Inc. (see Note 8).
The calculation of weighted average common and common equivalent shares for
purposes of calculating the 1997 diluted earnings per share, excludes
approximately 1,951,049 weighted average shares of options, warrants, and
contingently issuable shares computed under the treasury stock method, as their
effects would be anti-dilutive.
Fair Value of Financial Instruments
Statement of Financial Accounting Standards No. 107 (SFAS 107), Disclosures
about Fair Value of Financial Instruments, requires that the Company disclose
estimated fair values for its financial instruments. Fair value estimates,
methods and assumptions are set forth below for the Company's financial
instruments.
These calculations are subjective in nature, involve uncertainties and matters
of significant judgment and do not include tax ramifications; therefore, the
results cannot be determined with precision, substantiated by comparison to
independent markets and may not be realized in an actual sale or immediate
settlement of the instruments. There may be inherent weaknesses in any
calculation technique, and changes in the underlying assumptions used could
significantly affect the results. For all of these reasons, the aggregation of
the fair value calculations presented herein does not represent, and should not
be construed to represent, the underlying value of the Company.
F-12
<PAGE>
The following table presents a summary of the Company's financial instruments,
as defined by SFAS 107:
<TABLE>
<CAPTION>
- ----------------------------------------------------------------------------------------------
December 31,
--------------------------------------------------
(In thousands of dollars) 1997 1996
---------------------- ----------------------
Carrying Estimated Carrying Estimated
amount fair value amount fair value
-------- ---------- -------- ----------
<S> <C> <C> <C> <C>
Financial Assets
Cash and cash equivalents $40,110 $40,110 $10,980 $10,980
Restricted cash and investments 19,000 19,000 11,500 11,500
Other financial assets, primarily
accounts receivable 67,550 67,550 43,696 43,696
Financial Liabilities
Bank overdraft -- -- 2,477 2,477
Long-term debt 85,000 82,025 42,800 42,800
Other financial liabilities, primarily
accrued liabilities 79,311 79,311 33,354 33,354
- ----------------------------------------------------------------------------------------------
</TABLE>
Financial instruments other than long-term debt approximate fair value because
of their short-term duration. In 1996, long-term debt approximates fair value
because of the variable interest rate.
(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) LEASE COMMITMENTS:
The Company leases office space under non-cancelable operating lease agreements.
Future minimum lease payments due under such agreements are as follows:
- --------------------------------------------------------------------------------
(In thousands of dollars)
Years Ending
December 31, Amount
-------------------- ---------
1998 $ 1,845
1999 1,624
2000 1,507
2001 1,466
2002 1,436
Greater than 5 years 1,800
---------
Total $ 9,678
=========
- --------------------------------------------------------------------------------
Rental expense under all leases was $1.9 million, $734,000, and $162,000 in
1997, 1996 and 1995, respectively.
F-13
<PAGE>
(4) INCOME TAXES:
The components of the provision for income taxes for the years ended December
31, 1997, 1996 and 1995 were as follows:
- --------------------------------------------------------------------------------
(In thousands of dollars) 1997 1996 1995
------- ------- -------
Current $ (297) $ 6,935 $ 3,102
Deferred (2,522) (554) (256)
------- ------- -------
Income tax provision (benefit) $(2,819) $ 6,381 $ 2,846
======= ======= =======
- --------------------------------------------------------------------------------
Income tax expense differs from the amount computed using the statutory federal
income tax rate due to the following:
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
(In thousands of dollars) 1997 1996 1995
------- ------- -------
<S> <C> <C> <C>
Income tax expense (benefit) at statutory rate $(3,847) $ 6,442 $ 2,272
Non-deductible goodwill amortization 271 197 73
Non-deductible per diem and other expenses 336 41 85
State taxes, net of federal benefit 451 179 429
Change in estimate related to 1995 state taxes -- (430) --
Other (30) (48) (13)
------- ------- -------
Income tax provision (benefit) $(2,819) $ 6,381 $ 2,846
======= ======= =======
</TABLE>
- --------------------------------------------------------------------------------
Deferred tax assets and liabilities are comprised of the following temporary
differences at December 31:
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
1997 1996
----------------------- -----------------------
Long-term Long-term
Current Assets Current Assets
(In thousands of dollars) Assets (Liabilities) Assets (Liabilities)
------- ------------- ------- -------------
<S> <C> <C> <C> <C>
Depreciation and amortization $ -- $ (517) $ -- $ (111)
Reserves not deductible
for tax purposes 4,138 485 1,130 539
Other, net -- -- 26 --
------- ------- ------- -------
$ 4,138 $ (32) $ 1,156 $ 428
======= ======= ======= =======
</TABLE>
- --------------------------------------------------------------------------------
F-14
<PAGE>
(5) LONG-TERM DEBT:
On August 1, 1996, the Company entered into a three year $35 million revolving
credit facility (Prior Credit Facility) for acquisition financing, working
capital and other general corporate purposes. The line was expanded to $45
million on October 15, 1996 and to $60 million on February 19, 1997. Total costs
incurred in obtaining this facility and the expansions were approximately
$676,000.
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 the outstanding indebtedness under the
Prior Credit Facility from the net proceeds of a note offering (see below) and
replaced the facility with the Amended Credit Facility. See "Amended Credit
Facility" below. Unamortized deferred financing costs of $252,000 were
written-off in connection with the repayment of the Prior Credit Facility.
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 earnings before income taxes, interest expense and depreciation and
amortization (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 is secured by
substantially all of the Company's assets. Currently, the Company is not
entitled to additional borrowings under the Amended Credit Facility.
Note Offering
On October 21, 1997, the Company issued $85 million of 10% Senior Notes due 2004
(the Notes) in an Offering (the Offering) effected under Rule 144A of the
Securities Act of 1933 as amended (Securities Act). 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 $3.3 million, which is included in other assets, 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. Since this registration was not declared effective prior to the
120th day after the issue date of October 21, 1997, the interest rate increased
by .5%. It can be further increased by an additional 1.5% up to a maximum of 12%
per annum of the principal amount of such Notes if the exchange offer is not
completed. In connection with the issuance of the Notes, the Company modified
its revolving credit facility whereby the total commitment was reduced to $20
million. The Notes contain certain covenants which limit the Company's ability
to incur any future indebtedness.
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 Company or other subsidiaries. The
financial statements presented below include the separate or combined financial
position for the years ended December 31, 1997 and 1996, and the results of
operations and cash flows for each of the three years in the period ended
December 31, 1997, of Employee Solutions, Inc. (Parent), the guarantor
subsidiaries (Guarantors) and the subsidiaries which are not guarantors
(Non-guarantors).
F-15
<PAGE>
<TABLE>
<CAPTION>
BALANCE SHEETS
- -----------------------------------------------------------------------------------------------------------------
For the Year Ended December 31, 1997
- -----------------------------------------------------------------------------------------------------------------
Non-
(Dollars in thousands) Parent Guarantors Guarantors Eliminating Consolidated
-------- ---------- ---------- ----------- ------------
<S> <C> <C> <C> <C> <C>
ASSETS
CURRENT ASSETS:
Cash and cash equivalents $ 22,692 $ 11,848 $ 5,570 $ -- $ 40,110
Restricted cash and
investments -- -- 19,000 -- 19,000
Accounts receivable, net 20,822 34,360 2,285 -- 57,467
Receivable from insurance
companies -- 5,430 1,640 -- 7,070
Prepaid expenses and deposits 2,822 1,465 275 -- 4,562
Income taxes receivable 4,080 -- -- -- 4,080
Deferred income taxes 4,138 -- -- -- 4,138
Due from affiliates 30,346 (1,122) 12,855 (42,079) --
-------- -------- -------- -------- --------
Total current 84,900 51,981 41,625 (42,079) 136,427
Property and equipment, net 2,857 276 26 -- 3,159
Deferred income taxes 485 -- -- -- 485
Goodwill and other assets, net 32,105 34,625 416 -- 67,146
Investment in subsidiaries 46,477 -- -- (46,477) --
-------- -------- -------- -------- --------
Total assets $166,824 $ 86,882 $ 42,067 $(88,556) $207,217
======== ======== ======== ======== ========
LIABILITIES
CURRENT LIABILITIES:
Bank overdraft $ -- $ -- $ -- $ -- $ --
Accrued salaries, wages and
payroll taxes 20,253 21,422 1,588 -- 43,263
Accounts payable 1,082 2,318 963 -- 4,363
Accrued workers' compensation
and benefits 1,612 2,211 20,763 -- 24,586
Other accrued expenses 2,612 2,541 733 -- 5,886
Due to affiliates 13,359 22,243 6,477 (42,079) --
-------- -------- -------- -------- --------
Total current liabilities 38,918 50,735 30,524 (42,079) 78,098
-------- -------- -------- -------- --------
Deferred income taxes 517 -- -- -- 517
-------- -------- -------- -------- --------
Long-term debt 85,000 -- -- -- 85,000
-------- -------- -------- -------- --------
Other long-term liabilities -- 1,213 -- -- 1,213
-------- -------- -------- -------- --------
Commitments and contingencies
STOCKHOLDERS' EQUITY
Class A convertible preferred stock -- -- -- -- --
Common stock, no par value 34,420 2,622 771 (3,393) 34,420
Additional paid in capital -- 26,342 50 (26,392) --
Retained earnings 7,866 5,970 10,722 (16,692) 7,866
Unrealized gain on
investment securities 103 -- -- -- 103
-------- -------- -------- -------- --------
Total stockholders' equity 42,389 34,934 11,543 (46,477) 42,389
-------- -------- -------- -------- --------
Total liabilities and stockholders' equity $166,824 $ 86,882 $ 42,067 $(88,556) $207,217
======== ======== ======== ======== ========
- -----------------------------------------------------------------------------------------------------------------
</TABLE>
F-16
<PAGE>
<TABLE>
<CAPTION>
- ----------------------------------------------------------------------------------------------------------------
For the Year Ended December 31, 1996
- ----------------------------------------------------------------------------------------------------------------
Non-
(Dollars in thousands) Parent Guarantors Guarantors Eliminating Consolidated
-------- ---------- ---------- ----------- ------------
<S> <C> <C> <C> <C> <C>
ASSETS
CURRENT ASSETS:
Cash and cash equivalents $ 2,435 $ 6,747 $ 1,798 $ -- $ 10,980
Restricted cash and
investments -- -- 11,500 -- 11,500
Accounts receivable, net 10,912 23,585 342 -- 34,839
Receivable from insurance
companies -- 3,157 2,761 -- 5,918
Prepaid expenses and deposits 743 394 121 -- 1,258
Deferred income taxes 1,156 -- -- -- 1,156
Due from affiliates 30,279 3,680 12,900 (46,859) --
-------- -------- -------- -------- --------
Total current 45,525 37,563 29,422 (46,859) 65,651
Property and equipment, net 731 317 36 -- 1,084
Deferred income taxes 539 -- -- -- 539
Goodwill and other assets, net 17,546 40,870 279 -- 58,695
Investment in subsidiaries 39,113 -- -- (39,113) --
-------- -------- -------- -------- --------
Total assets $103,454 $ 78,750 $ 29,737 $(85,972) $125,969
======== ======== ======== ======== ========
LIABILITIES
CURRENT LIABILITIES:
Bank overdraft $ -- $ 2,477 $ -- $ -- $ 2,477
Accrued salaries, wages and
payroll taxes 9,890 7,180 516 -- 17,586
Accounts payable 189 3,285 604 -- 4,078
Accrued workers' compensation
and benefits 232 2,219 4,476 -- 6,927
Income taxes payable 720 -- -- -- 720
Other accrued expenses 1,313 2,069 32 -- 3,414
Due to affiliates 1,692 31,909 13,258 (46,859) --
-------- -------- -------- -------- --------
Total current liabilities 14,036 49,139 18,886 (46,859) 35,202
-------- -------- -------- -------- --------
Deferred income taxes 111 -- -- -- 111
-------- -------- -------- -------- --------
Long-term debt 42,800 -- -- -- 42,800
-------- -------- -------- -------- --------
Other long-term liabilities -- 1,349 -- -- 1,349
-------- -------- -------- -------- --------
Commitments and contingencies
STOCKHOLDERS' EQUITY
Class A convertible preferred stock -- -- -- -- --
Common stock, no par value 30,145 22 771 (793) 30,145
Additional paid in capital -- 26,175 -- (26,175) --
Retained earnings 16,362 2,065 10,080 (12,145) 16,362
-------- -------- -------- -------- --------
Total stockholders' equity 46,507 28,262 10,851 (39,113) 46,507
-------- -------- -------- -------- --------
Total liabilities and stockholders' equity $103,454 $ 78,750 $ 29,737 $(85,972) $125,969
======== ======== ======== ======== ========
- ----------------------------------------------------------------------------------------------------------------
</TABLE>
F-17
<PAGE>
STATEMENT OF OPERATIONS
<TABLE>
<CAPTION>
- --------------------------------------------------------------------------------------------------------
For the Year Ended December 31, 1997
- --------------------------------------------------------------------------------------------------------
Non-
(Dollars in thousands) Parent Guarantors Guarantors Eliminating Consolidated
--------- ---------- ---------- ----------- ------------
<S> <C> <C> <C> <C> <C>
Revenues $ 465,847 $ 426,058 $ 74,815 $ (32,903) $ 933,817
--------- --------- --------- --------- ---------
Cost of revenues:
Salaries and wages of
worksite employees 404,316 351,899 36,591 (27,759) 765,047
Healthcare and workers'
compensation 15,134 26,216 34,245 -- 75,595
Payroll and employment taxes 32,814 26,741 3,058 -- 62,613
--------- --------- --------- --------- ---------
Cost of revenues 452,264 404,856 73,894 (27,759) 903,255
--------- --------- --------- --------- ---------
Gross profit 13,583 21,202 921 (5,144) 30,562
Selling, general and
administrative expenses 22,347 10,577 487 -- 33,411
Intercompany selling, general
and administrative expense 770 3,778 596 (5,144) --
Depreciation and amortization 2,863 1,722 32 -- 4,617
--------- --------- --------- --------- ---------
Income (loss) from operations (12,397) 5,125 (194) -- (7,466)
Other income (expense):
Interest income 320 90 893 -- 1,303
Interest expense and other (5,320) (14) 182 -- (5,152)
--------- --------- --------- --------- ---------
Income (loss) before provision
for income taxes (17,397) 5,201 881 -- (11,315)
Income tax provision (benefit) (4,354) 1,295 240 -- (2,819)
--------- --------- --------- --------- ---------
(13,043) 3,906 641 -- (8,496)
Income from wholly-owned
subsidiaries 4,547 -- -- (4,547) --
--------- --------- --------- --------- ---------
Net income (loss) $ (8,496) $ 3,906 $ 641 $ (4,547) $ (8,496)
========= ========= ========= ========= =========
- --------------------------------------------------------------------------------------------------------
</TABLE>
F-18
<PAGE>
<TABLE>
<CAPTION>
- --------------------------------------------------------------------------------------------------------
For the Year Ended December 31, 1996
- --------------------------------------------------------------------------------------------------------
Non-
(Dollars in thousands) Parent Guarantors Guarantors Eliminating Consolidated
--------- ---------- ---------- ----------- ------------
<S> <C> <C> <C> <C> <C>
Revenues $ 128,185 $ 293,874 $ 36,313 $ (19,356) $ 439,016
--------- --------- --------- --------- ---------
Cost of revenues:
Salaries and wages of
worksite employees 103,873 230,469 7,646 -- 341,988
Healthcare and workers'
compensation 4,751 29,585 12,768 (16,870) 30,234
Payroll and employment taxes 8,146 19,721 773 -- 28,640
--------- --------- --------- --------- ---------
Cost of revenues 116,770 279,775 21,187 (16,870) 400,862
--------- --------- --------- --------- ---------
Gross profit 11,415 14,099 15,126 (2,486) 38,154
Selling, general and
administrative expenses 7,963 8,876 471 -- 17,310
Intercompany selling, general
and administrative expense 811 1,486 189 (2,486) --
Depreciation and amortization 983 1,074 16 -- 2,073
--------- --------- --------- --------- ---------
Income (loss) from operations 1,658 2,663 14,450 -- 18,771
Other income (expense):
Interest income 227 92 514 -- 833
Interest expense and other (1,185) (11) (1) -- (1,197)
--------- --------- --------- --------- ---------
Income (loss) before provision
for income taxes 700 2,744 14,963 -- 18,407
Income tax (provision) benefit (506) 1,067 5,820 -- 6,381
--------- --------- --------- --------- ---------
1,206 1,677 9,143 -- 12,026
Income from wholly-owned
subsidiaries 10,820 -- -- (10,820) --
--------- --------- --------- --------- ---------
Net income (loss) $ 12,026 $ 1,677 $ 9,143 $ (10,820) $ 12,026
========= ========= ========= ========= =========
- --------------------------------------------------------------------------------------------------------
</TABLE>
F-19
<PAGE>
<TABLE>
<CAPTION>
- ------------------------------------------------------------------------------------------------------
For the Year Ended December 31, 1995
- ------------------------------------------------------------------------------------------------------
Non-
(Dollars in thousands) Parent Guarantors Guarantors Eliminating Consolidated
--------- ---------- ---------- ----------- ------------
<S> <C> <C> <C> <C> <C>
Revenues $ 108,324 $ 57,099 $ 5,127 $ (6,095) $ 164,455
--------- --------- --------- --------- ---------
Cost of revenues 99,109 53,439 3,464 (5,337) 150,675
--------- --------- --------- --------- ---------
Gross profit 9,215 3,660 1,663 (758) 13,780
Selling, general and
administrative expenses 4,769 3,125 70 (781) 7,183
Depreciation and amortization 338 88 -- -- 426
--------- --------- --------- --------- ---------
Income (loss) from operations 4,108 447 1,593 23 6,171
Other income (expense):
Interest income 205 19 95 (23) 296
Interest expense and other (19) 233 -- -- 214
--------- --------- --------- --------- ---------
Income (loss) before provision
for income taxes 4,294 699 1,688 -- 6,681
Income tax (provision) 1,784 311 751 -- 2,846
--------- --------- --------- --------- ---------
2,510 388 937 -- 3,835
Income from wholly-owned
subsidiaries 1,325 -- -- (1,325) --
--------- --------- --------- --------- ---------
Net income (loss) $ 3,835 $ 388 $ 937 $ (1,325) $ 3,835
========= ========= ========= ========= =========
- ------------------------------------------------------------------------------------------------------
</TABLE>
F-20
<PAGE>
STATEMENT OF CASH FLOWS
<TABLE>
<CAPTION>
- ------------------------------------------------------------------------------------------------------------------
For the Year Ended December 31, 1997
- ------------------------------------------------------------------------------------------------------------------
Non-
(Dollars in thousands) Parent Guarantors Guarantors Eliminating Consolidated
-------- ---------- ---------- ----------- ------------
<S> <C> <C> <C> <C> <C>
RECONCILIATION OF NET INCOME
TO NET CASH PROVIDED BY (USED
IN) OPERATING ACTIVITIES:
Net income (loss) $ (8,496) 3,906 641 (4,547) (8,496)
-------- -------- -------- -------- --------
ADJUSTMENTS TO RECONCILE
NET INCOME TO NET CASH
PROVIDED BY (USED IN)
OPERATING ACTIVITIES:
Depreciation and amortization 2,863 1,722 32 -- 4,617
Increase in accounts receivable, net (9,910) (10,775) (1,943) -- (22,628)
(Increase) decrease in insurance
company receivable -- (2,273) 1,121 -- (1,152)
Increase in prepaid expenses and deposits (2,021) (1,071) (154) -- (3,246)
Increase in deferred income taxes, net (2,522) -- -- -- (2,522)
(Increase) Decrease in other assets (1,023) 324 (106) -- (805)
(Decrease) increase from inter-
company transactions (733) 2,870 (6,684) 4,547 --
Increase in accrued salaries,
wages, and payroll taxes 10,363 14,242 1,072 -- 25,677
Increase (decrease) in accrued workers'
compensation and health insurance 1,381 (8) 16,286 -- 17,659
Increase in other long-term liabilities -- (136) -- -- (136)
Increase (decrease) in accounts payable 893 (967) 359 -- 285
Decrease in income taxes payable/receivable (3,612) -- -- -- (3,612)
Increase in other accrued expenses 399 472 701 -- 1,572
-------- -------- -------- -------- --------
(3,922) 4,400 10,684 4,547 15,709
-------- -------- -------- -------- --------
Net cash provided by (used in)
operating activities (12,418) 8,306 11,325 -- 7,213
-------- -------- -------- -------- --------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of property and equipment (2,446) (53) -- -- (2,499)
Business acquisitions (4,296) (675) (53) -- (5,024)
Cash invested in restricted cash
and investments -- -- (7,500) -- (7,500)
-------- -------- -------- -------- --------
Net cash used in investing
activities (6,742) (728) (7,553) -- (15,023)
-------- -------- -------- -------- --------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from issuance of long-term debt, net 42,200 -- -- -- 42,200
Proceeds from issuance of common stock 502 -- -- -- 502
Disbursements for deferred loan
costs (3,285) -- -- -- (3,285)
Decrease in bank overdraft and other -- (2,477) -- -- (2,477)
-------- -------- -------- -------- --------
Net cash provided by (used
in) financing activities 39,417 (2,477) -- -- 36,940
-------- -------- -------- -------- --------
Net increase in cash and cash
equivalents 20,257 5,101 3,772 -- 29,130
CASH AND CASH EQUIVALENTS,
beginning of period 2,435 6,747 1,798 -- 10,980
-------- -------- -------- -------- --------
CASH AND CASH EQUIVALENTS,
end of period $ 22,692 $ 11,848 $ 5,570 $ -- $ 40,110
======== ======== ======== ======== ========
- -------------------------------------------------------------------------------------------------------------------
</TABLE>
F-21
<PAGE>
<TABLE>
<CAPTION>
- -------------------------------------------------------------------------------------------------------------------
For the Year Ended December 31, 1996
- -------------------------------------------------------------------------------------------------------------------
Non-
(Dollars in thousands) Parent Guarantors Guarantors Eliminating Consolidated
-------- ---------- ---------- ----------- ------------
<S> <C> <C> <C> <C> <C>
RECONCILIATION OF NET INCOME
TO NET CASH (USED IN) PROVIDED
BY OPERATING ACTIVITIES:
Net income (loss) $ 12,026 $ 1,677 $ 9,143 $(10,820) $ 12,026
-------- -------- -------- -------- --------
ADJUSTMENTS TO RECONCILE
NET INCOME TO NET CASH
(USED IN) PROVIDED BY
OPERATING ACTIVITIES:
Depreciation and amortization 983 1,074 16 -- 2,073
Increase in accounts receivable, net (5,464) (18,963) (333) -- (24,760)
Decrease (increase) in insurance
company receivable 86 (3,157) (2,761) -- (5,832)
Increase in prepaid expenses and deposits (486) (129) (121) -- (736)
(Increase) decrease in deferred
income tax asset, net (1,299) 760 -- -- (539)
Increase in other assets -- (2,253) (279) -- (2,532)
(Decrease) increase from inter-
company transactions (62,735) 52,846 (931) 10,820 --
Increase in accrued salaries,
wages, and payroll taxes 6,724 3,665 516 -- 10,905
(Decrease) increase in accrued workers'
compensation and health insurance (50) 1,090 3,424 -- 4,464
Increase in other long term liabilities -- 1,349 -- -- 1,349
Increase (decrease) in accounts payable (406) (1,753) 121 -- (2,038)
Increase in income taxes payable 1,148 -- -- -- 1,148
(Decrease) increase in other accrued expenses (65) 1,188 32 -- 1,155
-------- -------- -------- -------- --------
(61,564) 35,717 (316) 10,820 (15,343)
-------- -------- -------- -------- --------
Net cash (used in) provided by
operating activities (49,538) 37,394 8,827 -- (3,317)
-------- -------- -------- -------- --------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of property and equipment (573) (92) (37) -- (702)
Business acquisitions (10,225) (27,026) -- -- (37,251)
Cash invested in restricted cash
and investments -- -- (8,757) -- (8,757)
Issuance of notes receivable, and other, net -- (189) -- -- (189)
-------- -------- -------- -------- --------
Net cash used in investing
activities (10,798) (27,307) (8,794) -- (46,899)
-------- -------- -------- -------- --------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from issuance of long-term debt 42,800 -- -- -- 42,800
Proceeds from issuance of common stock 7,786 -- -- -- 7,786
Decrease in bank overdraft and other -- (3,419) -- -- (3,419)
-------- -------- -------- -------- --------
Net cash provided by (used
in) financing activities 50,586 (3,419) -- -- 47,167
-------- -------- -------- -------- --------
Net (decrease) increase in cash and cash
equivalents (9,750) 6,668 33 -- (3,049)
CASH AND CASH EQUIVALENTS,
beginning of period 12,185 79 1,765 -- 14,029
-------- -------- -------- -------- --------
CASH AND CASH EQUIVALENTS,
end of period $ 2,435 $ 6,747 $ 1,798 $ -- $ 10,980
======== ======== ======== ======== ========
- -------------------------------------------------------------------------------------------------------------------
</TABLE>
F-22
<PAGE>
<TABLE>
<CAPTION>
- ------------------------------------------------------------------------------------------------------------------
For the Year Ended December 31, 1995
- ------------------------------------------------------------------------------------------------------------------
Non-
(Dollars in thousands) Parent Guarantors Guarantors Eliminating Consolidated
-------- ---------- ---------- ----------- ------------
<S> <C> <C> <C> <C> <C>
RECONCILIATION OF NET INCOME
TO NET CASH PROVIDED BY
OPERATING ACTIVITIES:
Net income (loss) $ 3,835 $ 388 $ 937 $ (1,325) $ 3,835
-------- -------- -------- -------- --------
ADJUSTMENTS TO RECONCILE
NET INCOME TO NET CASH
PROVIDED BY OPERATING ACTIVITIES:
Depreciation and amortization 338 88 -- -- 426
(Increase) decrease in
accounts receivable, net (3,415) 1,089 (9) -- (2,335)
Increase in prepaid expenses and deposits (253) (123) -- -- (376)
Increase in deferred income tax asset, net (256) -- -- -- (256)
Decrease (increase) in other assets 366 (383) -- -- (17)
(Decrease) increase from inter-
company transactions (2,657) (597) 1,929 1,325 --
Increase (decrease) in accrued salaries,
wages, and payroll taxes 1,405 (86) -- -- 1,319
(Decrease) increase in accrued workers'
compensation and health insurance (5) (371) 1,052 -- 676
Decrease in other long term liabilities -- (39) -- -- (39)
Increase in accounts payable 18 104 477 -- 599
Increase (decrease) in income taxes payable 2,056 (13) -- -- 2,043
Increase in other accrued expenses 169 235 -- -- 404
-------- -------- -------- -------- --------
(2,234) (96) 3,449 1,325 2,444
-------- -------- -------- -------- --------
Net cash provided by
operating activities 1,601 292 4,386 -- 6,279
-------- -------- -------- -------- --------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of property and equipment (152) (86) -- -- (238)
Business acquisitions (961) -- -- -- (961)
Cash invested in restricted cash
and investments 1,361 9 (2,742) -- (1,372)
Issuance of notes receivable, and other, net 386 -- -- -- 386
-------- -------- -------- -------- --------
Net cash provided by used in
investing activities 634 (77) (2,742) -- (2,185)
-------- -------- -------- -------- --------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from issuance of common stock 8,002 -- 121 -- 8,123
Decrease in bank overdraft and other -- (136) -- -- (136)
-------- -------- -------- -------- --------
Net cash provided by (used
in) financing activities 8,002 (136) 121 -- 7,987
-------- -------- -------- -------- --------
Net increase (decrease) in cash and cash
equivalents 10,237 79 1,765 -- 12,081
CASH AND CASH EQUIVALENTS
beginning of period 1,948 -- -- -- 1,948
-------- -------- -------- -------- --------
CASH AND CASH EQUIVALENTS
end of period $ 12,185 $ 79 $ 1,765 $ -- $ 14,029
======== ======== ======== ======== ========
- ------------------------------------------------------------------------------------------------------------------
</TABLE>
F-23
<PAGE>
(7) STOCKHOLDERS' EQUITY:
Shareholders Rights Plan
On February 9, 1998, the Company's Board of Directors adopted a shareholders
rights plan. Initially, the rights are attached to the Company's common stock
and are not exercisable. They become detached from the common stock and become
immediately exercisable after any person or group becomes the beneficial owner
of 15 percent or more of the Company's common stock or 10 days after any person
or group announces a tender or exchange offer that would result in that same
beneficial ownership level, subject to certain exceptions.
If a buyer becomes a 15 percent owner in the Company, all rights holders, except
the buyer and certain related persons, will be entitled to purchase Series A
Junior Participating Preferred Stock in the Company at a price discounted from
the then market price. In addition, if the Company is acquired in a merger after
such an acquisition, all rights holders, except the buyer and certain related
persons, will also be entitled to purchase stock in the buyer at a discount in
accordance with the plan.
The distribution of rights was made to common stockholders of record on February
20, 1998, and shares of common stock issued after that date also carry rights
until they become detached from the common stock. The rights will expire on
February 19, 2008. The Company may redeem the rights for $0.001 each at any time
before a buyer acquires a 15 percent position in the Company, and under certain
other circumstances.
Warrants
Warrant activity in 1995, 1996 and 1997 was as follows:
- --------------------------------------------------------------------------------
Weighted-
average
Number Exercise
of Warrants Price
----------- ---------
Outstanding at December 31, 1995 2,936,000 $ 2.32
Exercised (2,816,000) 2.33
----------
Outstanding at December 31, 1996 120,000 1.88
==========
Outstanding at December 31, 1997 120,000 1.88
==========
- --------------------------------------------------------------------------------
All warrants outstanding at the respective year-ends were exercisable. The
remaining outstanding warrants expire on January 2, 1999.
Stock Option Plans
The Company has a 1993 Stock Option Plan and a 1995 Stock Option Plan. The plans
are administered by the Compensation Committee of the Company's Board of
Directors, and certain employees are eligible to participate in the plans and
receive incentive stock options and/or non-qualified options. In addition, all
consultants are eligible to participate in the plans and receive non-qualified
options. Options granted may be either "incentive stock options," within the
meaning of Section 422A of the Internal Revenue Code, or nonqualified stock
options.
The total number of options made available and reserved for issuance under the
1993 and 1995 Plans are 1,200,000 and 3,500,000, respectively. The Company has
granted options on 1,106,659 shares and 3,261,159 shares under the 1993 and 1995
plans, respectively, through December 31, 1997. Under both plans the option
exercise price equals the stock's market price on the date of grant. No
compensation expense was recorded for the stock options under the 1993 or 1995
Plans in the accompanying financial statements as the Company has elected to
retain the accounting prescribed under Accounting Principles Board Opinion No.
25 (APB 25). Employee stock options generally become fully exercisable
F-24
<PAGE>
over three years from the grant date and generally have terms from five to ten
years. Upon termination of employment, the option exercise period is reduced or
the options are canceled.
The following table is a summary of the Company's 1993 and 1995 Stock Option
Plan activity and related information for the three years ended December 31,
1997:
- --------------------------------------------------------------------------------
Weighted-
average
Number Exercise
of Options Price
---------- ---------
Outstanding at December 31, 1994 930,000 $ 1.61
Granted 2,405,000 2.74
Exercised (213,308) .84
Canceled (400,004) 2.35
---------
Outstanding at December 31, 1995 2,721,688 2.56
Granted 982,579 15.38
Exercised (560,161) 2.22
Canceled (30,336) 10.07
---------
Outstanding at December 31, 1996 3,113,770 6.59
Granted 1,070,157 6.08
Exercised (201,100) 2.50
Canceled (589,578) 15.32
---------
Outstanding at December 31, 1997 3,393,249 5.16
=========
Exercisable options as of:
December 31, 1995 859,160
December 31, 1996 791,843
December 31, 1997 1,204,088
Available for future grants
at December 31, 1997 332,182
- --------------------------------------------------------------------------------
F-25
<PAGE>
The following table is a summary of selected information for the Company's
compensatory stock option plans:
<TABLE>
<CAPTION>
- -----------------------------------------------------------------------------------------
December 31, 1997
Weighted-
average Weighted-
Remaining average
Contractual Exercise
Life (yrs.mths) Number Price
--------------- --------- -------------
<S> <C> <C> <C>
RANGE OF EXERCISE PRICES
1993 Stock Option Plan
$1.24 - $3.31
Options outstanding 2.0 379,082 $ 2.29
Options exercisable 325,748 2.12
$7.56
Options outstanding 2.1 40,000 $ 7.56
Options exercisable 26,666 7.56
1995 Stock Option Plan
$2.13 - $5.16
Options outstanding 4.5 1,538,674 2.69
Options exercisable 686,339 2.83
$5.41 - $6.94
Options outstanding 9.6 964,493 5.54
Options exercisable -- --
$10.50 - $21.88
Options outstanding 3.9 471,000 14.56
Options exercisable 165,335 13.71
- -----------------------------------------------------------------------------------------
</TABLE>
The weighted average fair value of options granted under the 1993 and 1995 Stock
Option Plans was $4.46 and $6.10, and $1.07 for 1997, 1996 and 1995,
respectively.
In October 1995, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 123 (SFAS 123), Accounting for Stock-Based
Compensation. This Statement establishes a new fair value based accounting
method for stock-based compensation plans and encourages (but does not require)
employers to adopt the new method in place of the provisions of APB 25.
Companies may continue to apply the accounting provisions of APB 25 in
determining net income; however, they must apply the disclosure requirements of
SFAS 123 for all grants issued after 1994. The Company elected to continue to
apply the provisions of APB 25 in accounting for the employee stock option plans
described. Accordingly, no compensation cost has been recognized for stock
options granted under the 1993 or 1995 Stock Option Plans.
F-26
<PAGE>
Had compensation cost for these employee stock plans been determined based on
the new fair value method under SFAS 123, the Company's net income and earnings
per share would have been reduced to the pro forma amounts indicated below.
<TABLE>
<CAPTION>
- -----------------------------------------------------------------------------------------------------
(In thousands of dollars, except per share data) Year ended December 31,
------------------------------------------
1997 1996 1995
--------- -------- ---------
<S> <C> <C> <C>
Net income (loss):
As reported $ (8,496) $ 12,026 $ 3,835
Pro forma (10,569) 13,233 3,256
Basic earnings (loss) per share:
As reported (.27) .40 .17
Pro forma (.34) .44 .15
Diluted earnings (loss) per share:
As reported (.27) .37 .16
Pro forma (.34) .41 .14
- ------------------------------------------------------------------------------------------------------
</TABLE>
The pro forma amounts noted above only reflect the effects of stock-based
compensation grants made after 1994. Because stock options are granted each year
and generally vest over three years, these pro forma amounts may not reflect the
full effect of applying the (optional) fair value method established by SFAS 123
that would be expected if all outstanding stock option grants were accounted for
under this method and may not be representative of amounts in future years.
The fair value of each option grant is estimated based on the date of grant
using the Black-Scholes options pricing model. The following weighted average
assumptions were used for grants in 1997: risk-free interest rate of 5.92%;
expected dividend yield of 0%; expected lives of 2 years; expected volatility of
98%. The following weighted-average assumptions were used for grants in 1996 and
1995: risk-free interest rate of 5.98%; expected dividend yield of 0%; expected
lives of 2 years; expected volatility of 67%.
F-27
<PAGE>
(7) QUARTERLY FINANCIAL INFORMATION (UNAUDITED):
The following table presents summary unaudited quarterly financial data from the
Company's consolidated statements of operations (all earnings per share
calculations have been restated to conform SFAS No.
128):
<TABLE>
<CAPTION>
- -------------------------------------------------------------------------------------------------------
Quarter ended March 31, June 30, September 30, December 31,
------------ ------------ ------------ -----------
(Dollars in thousands, except share data)
<S> <C> <C> <C> <C>
1997
Revenues $ 195,966 $ 226,058 $ 233,093 $ 278,700
Gross profit 10,268 11,885 10,535 (2,126)
Basic
Net income (loss) 686 824 231 (10,237)
Weighted average shares 30,877,101 30,888,061 31,394,532 31,676,095
Net income (loss) per share .02 .03 .01 (.32)
Diluted
Net income (loss) 673 804 211 (10,237)
Weighted average shares 32,983,120 32,003,224 32,513,699 31,676,095
Net income (loss) per share .02 .03 .01 (.32)
1996
Revenues $ 73,934 $ 91,007 $ 125,238 $ 148,836
Gross profit 7,669 8,826 12,374 9,285
Basic
Net income 2,352 3,116 4,246 2,312
Weighted average shares 29,936,830 30,413,227 30,515,334 30,623,493
Net income per share .08 .10 .14 .08
Diluted
Net income 2,346 3,110 4,238 2,312
Weighted average shares 32,048,552 32,564,993 33,020,742 32,831,079
Net income per share .07 .10 .13 .07
- -------------------------------------------------------------------------------------------------------
</TABLE>
(8) 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 from October 1, 1997 through September 30,
1998. 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. The initial purchase price was
valued at $3.4 million including $2.6 million of common stock plus $.8 million
in assumed liabilities. 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., a PEO
located in Phoenix, Arizona, for $250,000 in cash. 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 CMGR Companies
F-28
<PAGE>
On February 17, 1997, the Company completed the acquisition of the principal
assets of CMGR, Inc., and Humasys (collectively, CMGR) for $3.9 million. At
closing $2.3 million was paid in cash. At December 31, 1997 approximately $3.1
million has been recorded as goodwill. An interim payment of $500,000 toward the
final purchase price was paid 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.
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 $1.0 million 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 The McClary-Trapp Companies
On November 1, 1996, the Company completed the acquisition of the principal
assets of the McClary-Trapp Companies for approximately $10.6 million. The
purchase price has been paid in the form of cash, assumed liabilities, and the
Company's unregistered common stock, valued at the average closing price on the
NASDAQ National Market for the month ended October 31, 1996, less a discount of
35% for lack of marketability of the unregistered shares. Pursuant to the
purchase agreement, the consideration for the assets of McClary-Trapp included
53,000 shares of the Company's unregistered common stock (which carries certain
registration rights) valued at an average price of $13.09 per share ($20.14 per
share less the 35% discount) plus cash in the amount of $9.4 million and assumed
liabilities. The excess of purchase price over net assets acquired was $10.9
million of which $10.6 million has been recorded as goodwill. McClary-Trapp
Companies lease approximately 2,000 worksite employees with a client base
consisting primarily of light industrial, transportation and service companies.
Acquisition of Leaseway Personnel Corporation
On August 1, 1996, the Company completed the acquisition of the principal assets
of Leaseway Personnel Corporation and Leaseway Administrative Personnel, Inc.
(collectively, "Leaseway") for approximately $24 million in cash, plus deferred
acquisition costs of approximately $250,000. The Company acquired the assets of
Leaseway through Logistics Personnel Corp. ("LPC", formerly, Employee Solutions
of Florida, Inc.), a wholly owned subsidiary. Logistics Personnel Corp. is an
employee leasing company providing permanent and temporary private carriage
truck drivers, as well as non-driver employees, including warehouse workers,
mechanics, dispatchers, and administrative personnel to approximately 180
clients in 41 states.
Acquisition of TEAM Services
On June 22, 1996, the Company completed the purchase of all of the outstanding
capital stock of GCK Entertainment Services, Inc. and Talent, Entertainment and
Media Services, Inc. (collectively, "TEAM Services"). TEAM Services is a
Burbank, California based company specializing in leasing commercial talent,
musicians and recording engineers to the music and advertising segments of the
entertainment industry. In connection with the acquisition, the Company assumed
net liabilities of approximately $825,000 which were recorded as goodwill and
are being amortized over a 15 year life. The purchase price will be the sum of
the net liabilities assumed at closing plus four times (4X) total TEAM Services'
pre-tax income for the twelve month period ending June 30, 1999. Additional
purchase price, if any, will be paid in the form of the Company's unregistered
common stock. The unregistered shares are entitled to certain piggyback and
demand registration rights.
Ashlin Transportation Services, Inc.
On June 1, 1996, the Company completed the acquisition of the principal assets
of Ashlin Transportation Services, Inc. (Ashlin), an Indiana based employee
leasing company specializing in the transportation industry. The Company
acquired the assets of Ashlin through ESI-Midwest, Inc. For approximately five
months prior to the purchase, the Company provided risk management/workers'
compensation coverage to Ashlin. The purchase price was paid in cash and assumed
liabilities for a total purchase price of approximately $1.4 million.
F-29
<PAGE>
Acquisition of Employee Solutions-East, Inc. (ESEI)
Effective January 1, 1996, the Company completed its acquisition of ESEI. The
base purchase price consists of 648,000 shares of the Company's unregistered
common stock, including certain registration rights as to these shares, valued
as of the effective date of the transaction at $5.53 per share ($8.50 less a 35%
discount for the lack of marketability of the unregistered shares) for a total
purchase price of $3.6 million plus acquisition costs of $94,000. The excess
purchase price over net assets acquired, was $3,674,000 which has been recorded
as goodwill.
Acquisition of Hazar, Inc.
On October 2, 1995, the Company completed the acquisition of the principal
assets of Hazar, Inc. and certain of its subsidiaries (collectively Hazar) for
$7.0 million plus $50,000 for fixed assets. The purchase price was paid in cash
and by the assumption of certain liabilities. For several months prior to the
purchase, the Company provided workers' compensation coverage to Hazar.
In conjunction with the Hazar acquisition, the Company received an option to
purchase a related entity for $400,000 which was exercised on May 20, 1996. This
acquisition was for the principal assets of Employer Sources, Inc. (formerly
known as LMS), a California based PEO. Prior to the purchase, the Company
provided management and risk management/workers' compensation services to
Employer Sources.
In 1996, the Company completed its purchase accounting and quantified certain
assumed liabilities previously thought to be the responsibility of the seller.
The total purchase price for all Hazar related entities including acquisitions
costs is $9.6 million.
Acquisition of Employment Services of Michigan, Inc.
The Company purchased all of the outstanding capital stock of Employment
Services of Michigan, Inc., effective January 1, 1995. Once acquired by the
Company, Employment Services of Michigan, Inc. was renamed Employee Solutions -
Midwest, Inc. (ESM). The purchase price has been paid in the form of the
Company's unregistered common stock, valued at the average of the NASDAQ daily
closing prices during the 1995 calendar year less a discount of 35% for lack of
marketability of the unregistered shares. Pursuant to the purchase agreement, as
amended, the consideration for the stock of ESM included 799,448 shares of the
Company's common stock valued at an average price of $2.01 per share ($3.10 per
share less the 35% discount) for a total purchase price of approximately
$1,612,000, plus acquisition costs of $22,000. The excess of purchase price over
net assets acquired was $1,634,000 of which $1,584,000 has been recorded as
goodwill.
F-30
<PAGE>
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, TEAM Services and LPC
for the year ended December 31, 1996, and assumes that the acquisitions had been
effective as of the beginning of 1996.
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 value of net
assets acquired and to adjust income taxes for the pro forma adjustments.
- --------------------------------------------------------------------------------
(In thousands of dollars, except share data) 1996
-----------
Total revenues $ 522,286
Net income 12,758
Net income per common and common
equivalent share
Basic .42
Diluted .40
Weighted average number of common and
common equivalent shares outstanding
Basic 30,224,357
Diluted 32,167,777
- --------------------------------------------------------------------------------
(9) 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. 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 December 31, 1997, the compounded interest totaled
approximately $193,000.
As previously reported, the Company and certain of its present and former
directors and executive officers have been named as defendants in ten actions
filed between March 1997 and May 1997. While the exact claims and allegations
vary, they all allege violations by the Company of Section 10(b) of the 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 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 Company 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 of the U.S. District
Court in Phoenix, Arizona. The Court has appointed lead plaintiffs for the
putative class, approved plaintiffs' selection of counsel, and ordered
plaintiffs to file a consolidated, amended complaint on or about April 6, 1998.
The Company believes the actions are without merit and intends to defend the
cases vigorously. However, the ultimate resolution of these actions could have a
material adverse effect on the Company's results of operations and financial
condition.
The Company was named as a defendant in an action filed by Ladenburg Thalmann &
Co., Inc. in the United States District Court, Southern District of New York,
No. 97-CIV-4685 (TPG), in May 1997 alleging breach of contract under certain
stock warrants. The plaintiff seeks damages of at least $2.5 million. The
Company believes the action is without merit and intends to defend the case
vigorously.
From time to time, the Company is named as a defendant in lawsuits in the
ordinary course of business. These lawsuits are not expected to have a material
impact on the Company's financial position or results of operations.
F-31
<PAGE>
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.
(11) RELATED PARTY TRANSACTIONS:
Related party transactions not mentioned elsewhere in the financial statements
are summarized as follows:
<TABLE>
<CAPTION>
- -------------------------------------------------------------------------------------------------
(in thousands of dollars) 1997 1996 1995
-------- ------- --------
<S> <C> <C> <C>
Legal services provided by officer/director $ -- $ -- $ 60
Processing fees paid to company owned by shareholder 1,030 805 820
Risk management/workers' compensation services to a company
owned by a shareholder -- -- 205
Non-compete agreement settlements with two shareholders -- 543 --
Relocation costs for Executive Officer 40 -- --
- -------------------------------------------------------------------------------------------------
</TABLE>
Additionally, the Company provides services to companies affiliated with certain
directors and officers. Revenues were insignificant. The Company also pays
commissions to related parties in the ordinary course of business.
F-32
EMPLOYEE SOLUTIONS, INC.
1995 STOCK OPTION PLAN,
AS AMENDED BY SHAREHOLDER ACTION
ON JUNE 26, 1996 AND JULY 9, 1997
AND BY BOARD OF DIRECTORS ACTION
ON JANUARY 25, 1998
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.
<PAGE>
(g) "ISO Group" means the group consisting of the Company and any
corporation that is a "parent" or a "subsidiary" of the Company.
(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.
2
<PAGE>
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.
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
3
<PAGE>
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 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;
4
<PAGE>
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.
(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
5
<PAGE>
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 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
6
<PAGE>
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 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.
7
<PAGE>
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:
(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
8
<PAGE>
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.
12. Automatic Grants to Certain Directors
(a) Grant. Except in the case of an initial election of a Nonemployee
Director (which shall be governed by subsection (c) hereof) 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) Initial Election to Board of Directors. Any person who initially
becomes a Nonemployee Director, whether at an Annual Meeting of Shareholders or
at any time other than on the date of an Annual Meeting, shall automatically be
granted options exercisable for 10,000 shares of Common Stock for the first year
(including a partial year in the case of an election between Annual Meeting),
and for an additional 2,500 shares of Common Stock for each additional year of
the term to which such Nonemployee Director is elected. Options for one third of
such shares shall vest on each of the first three anniversary dates of the
initial election to the Board. Other terms of such option 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
9
<PAGE>
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.
10
Ward A. Phelan
February 27, 1998
Page 1
[ESI letterhead]
February 27, 1998
Ward A. Phelan, Senior Vice-President
EMPLOYEE SOLUTIONS, INC.
6225 North 24th Street
Phoenix, AZ 85016
Dear Ward:
I would like to thank you again personally for all you have done to
build the Risk Services staff and bring our program forward into a guaranteed
cost environment.
With all of the changes underway, this letter will serve to confirm our
recent conversation in which we agreed that a change in your current status was
in the best interests of the Company and you personally. By signing below,
please indicate your agreement with the following:
1. You will remain as an employee of the Company and will be paid your
current base salary and car allowance through May 31, 2000, at which time your
employment will terminate. While you will remain a full-time employee through
May 31, 2000, you will not be required to report on a daily basis, nor will the
Company require your physical presence at its offices, except as specified in
paragraph five below.
2. During such period, the Company will continue your employee
insurance benefits consistent with current arrangements, will make available to
you future insurance programs subject to the terms offered to all full time
employees, and will continue to pay your ordinary and necessary business mobile
telephone expenses in accordance with Company policy. The Company will bill you
for non-business related calls or service, and you will promptly remit payment
or proof of business relationship. You acknowledge that, in light of the working
relationship described in paragraph one above, you will not participate in paid
time-off arrangements which might otherwise be applicable (such as paid
vacation, sick pay, bereavement pay, jury duty pay, holiday pay or any other
similar arrangement).
3. You are subject to a noncompetition agreement for a period ending
May 31, 2002 on the terms set forth in paragraph 15 of your former Employment
Agreement (the "prior agreement") except that the territory shall be expanded to
include the entire United States. You also are subject to a confidentiality
agreement on the terms set forth in paragraph 6 of the prior agreement and shall
not discuss any Company matters with anyone, including employees of the Company,
except to the extent necessary to perform specific duties required from time to
time under paragraph five hereof. Provided that you comply at all times with
your confidentiality agreement, we agree that, to the
<PAGE>
Ward A. Phelan
February 27, 1998
Page 2
extent doing so does not interfere with the services to be provided by you to
the Company, you may provide consulting services to organizations which do not
compete or intend to compete, directly or indirectly, in any business conducted
by the Company or its subsidiaries or affiliates.
4. You hereby resign as an executive officer of the Company and any of
its subsidiaries, effective March 15, 1998, and thereafter will no longer
function as head of the Risk Services department. At such time, you will also
relocate from your current office space. After this, while you will remain
subject to insider trading laws in the same fashion as any other employee while
you are in possession of material nonpublic information, your transactions in
Company securities generally will no longer be reported publicly. At such time
as you are no longer in possession of such information, you will not be subject
to the Company's pre-clearance procedures with respect to such transactions.
5. You will provide those services in the areas of workers'
compensation and risk management as are requested from time to time by the
Company, in those fields as specified by the prior agreement and with respect to
related matters reasonably requested by the Company. You will also provide
assistance from time to time with respect to current or future litigation
involving the Company. The Company will provide a work space as needed when such
services are requested and will pay or reimburse your qualified expenses
incurred in compliance with Company policy in effect from time to time. You will
report directly to the CEO/President while an employee of the Company, though it
is understood that, upon request, you will work closely in coordination with
other Company employees in connection with providing such services. Requests for
service will be made in writing (including fax, email or similar transmission)
where practicable in the Company's discretion. It is understood that you will
have 24 hours to report in person to handle assignments, provided that you agree
to keep the Company reasonably advised of your whereabouts and to be available
for telephone consultation as promptly as reasonably practicable under the
circumstances.
6. Your current options will remain outstanding pursuant to their
terms.
7. Your employment will be subject to termination only on the terms set
forth in paragraph 5 of the prior agreement.
8. While it is not anticipated that any general announcement will be
issued concerning the change in your duties, the Company agrees that it will
give you the opportunity to
<PAGE>
Ward A. Phelan
February 27, 1998
Page 3
review and approve disclosures relating thereto, subject to its obligations
under the federal securities laws. The Company has not intention of disparaging
and will not disparage you or your performance in discussions with outsiders.
Similarly, you will not disparage the Company or any of its directors, officers,
agents or employees.
9. The Company will lend you $75,000 on March 15, 1998, which amount
shall bear interest at the applicable federal rate. If not repaid by May 31,
1999, you agree that the Company thereafter may obtain payment from time to time
by deducting principal and interest from amounts otherwise payable hereunder
and/or shares of Company common stock otherwise issuable upon exercise of stock
options held by you. You agree that in any event you are personally responsible
for payment of any unpaid principal and interest no later than May 31, 2000. If
requested by the Company, you will sign a non-negotiable note evidencing these
terms prior to receipt of funds.
10. This letter agreement is our entire agreement and supersedes all
prior agreements. This agreement may not be amended except in a writing signed
by both of us. It shall be governed by Arizona law, and venue for any dispute
shall lie exclusively in Maricopa County Superior Court.
Thank you again.
Sincerely,
/s/ Marvin D. Brody
MDB:db Marvin D. Brody
CEO & Chairman of the Board
The terms outlined in the foregoing letter are agreed to and accepted
by me this 27th day of February, 1998.
/s/ Ward A. Phelan
Ward A. Phelan
EXHIBIT 21.1
ESOL 1997 10-K
SUBSIDIARIES OF THE REGISTRANT
Camelback Insurance, Ltd., a Bermuda insurance company
ERC of Indiana, Inc., an Indiana corporation
ERC of Minnesota, Inc., a Minnesota corporation
ERC of Ohio, Inc., a Michigan corporation
ESI America, Inc., a Nevada corporation
ESI-Midwest, Inc., a Nevada corporation
ESI - New York, Inc., an Arizona corporation
ESI Risk Management Agency, Inc., an Arizona corporation
Employee Resources Corporation, an Indiana corporation
Employee Solutions of Alabama, Inc., an Alabama corporation
Employee Solutions of California, Inc., a Nevada corporation
Employee Solutions - Southeast, Inc., a Florida corporation
Employee Solutions - East, Inc., a Georgia corporation
Employee Solutions - Midwest, Inc., a Michigan corporation
Employee Solutions of Ohio, Inc., an Indiana corporation
Employee Solutions of Texas, Inc., a Texas corporation
GCK Entertainment Services I, Inc. (d/b/a TEAM Services), a Delaware corporation
Logistics Personnel Corporation, a Nevada corporation
Phoenix Capital Management, Inc., an Indiana corporation
Talent, Entertainment and Media Services, Inc. (d/b/a TEAM Services), a Delaware
corporation
CONSENT OF INDEPENDENT PUBLIC ACCOUNTANTS
As independent public accountants, we hereby consent to the incorporation of our
report included in this Report on Form 10-K for Employee Solutions, Inc. into
previously filed registration statements File Nos. 33-93822 and 333-1242.
Arthur Andersen LLP
/s/ Arthur Andersen LLP
Phoenix, Arizona
March 11, 1998
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
COMPANY'S FORM 10-K FOR THE PERIOD ENDED DECEMBER 31, 1997 AND IS QUALIFIED IN
ITS ENTIRETY BY REFERENCE TO SUCH FORM 10-K.
</LEGEND>
<MULTIPLIER> 1,000
<CURRENCY> U.S. DOLLARS
<S> <C>
<PERIOD-TYPE> 12-MOS
<FISCAL-YEAR-END> DEC-31-1997
<PERIOD-START> JAN-01-1997
<PERIOD-END> DEC-31-1997
<EXCHANGE-RATE> 1
<CASH> 40,110
<SECURITIES> 19,000
<RECEIVABLES> 64,537
<ALLOWANCES> 0
<INVENTORY> 0
<CURRENT-ASSETS> 136,427
<PP&E> 3,159
<DEPRECIATION> 0
<TOTAL-ASSETS> 207,217
<CURRENT-LIABILITIES> 78,098
<BONDS> 0
0
0
<COMMON> 34,420
<OTHER-SE> 7,866
<TOTAL-LIABILITY-AND-EQUITY> 207,217
<SALES> 0
<TOTAL-REVENUES> 933,817
<CGS> 0
<TOTAL-COSTS> 903,255
<OTHER-EXPENSES> 38,028
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 5,102
<INCOME-PRETAX> (11,315)
<INCOME-TAX> (2,819)
<INCOME-CONTINUING> (8,496)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (8,496)
<EPS-PRIMARY> (0.27)
<EPS-DILUTED> (0.27)
</TABLE>
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
CONSOLIDATED BALANCE SHEET AS OF SEPTEMBER 30, 1997 AND THE CONSOLIDATED
STATEMENT OF INCOME FOR THE YEAR ENDED SEPTEMBER 30, 1997 AS RESTATED PURSUANT
TO STATEMENT OF FINANCIAL ACCOUNTING STANDARD NO. 128, EARNINGS PER SHARE ("SFAS
NO. 128"). IN ADDITION, AN ENTRY ON THIS SCHEDULE HAS BEEN AMENDED FROM THE
PREVIOUS FINANCIAL DATA SCHEDULE FILED FOR THIS PERIOD. THIS SCHEDULE IS
QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS. THIS
EXHIBIT SHALL NOT BE DEEMED FILED FOR THE PURPOSE OF SECTION 11 OF THE
SECURITIES ACT OF 1933 AND SECTION 18 OF THE SECURITIES ACT OF 1934, OR
OTHERWISE SUBJECT TO THE LIABILITY OF SUCH SECTIONS, NOR SHALL IT BE DEEMED A
PART OF ANY OTHER FILING WHICH INCORPORATES THIS REPORT BY REFERENCE, UNLESS
SUCH OTHER FILING EXPRESSLY INCORPORATES THIS EXHIBIT BY REFERENCE.
</LEGEND>
<RESTATED>
<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> .05
<EPS-DILUTED> .05
</TABLE>
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
CONSOLIDATED BALANCE SHEET AS OF JUNE 30, 1997 AND THE CONSOLIDATED STATEMENT OF
INCOME FOR THE YEAR ENDED JUNE 30, 1997 AS RESTATED PURSUANT TO STATEMENT OF
FINANCIAL ACCOUNTING STANDARD NO. 128, EARNINGS PER SHARE ("SFAS NO. 128"). IN
ADDITION, AN ENTRY ON THIS SCHEDULE HAS BEEN AMENDED FROM THE PREVIOUS FINANCIAL
DATA SCHEDULE FILED FOR THIS PERIOD. THIS SCHEDULE IS QUALIFIED IN ITS ENTIRETY
BY REFERENCE TO SUCH FINANCIAL STATEMENTS. THIS EXHIBIT SHALL NOT BE DEEMED
FILED FOR THE PURPOSE OF SECTION 11 OF THE SECURITIES ACT OF 1933 AND SECTION 18
OF THE SECURITIES ACT OF 1934, OR OTHERWISE SUBJECT TO THE LIABILITY OF SUCH
SECTIONS, NOR SHALL IT BE DEEMED A PART OF ANY OTHER FILING WHICH INCORPORATES
THIS REPORT BY REFERENCE, UNLESS SUCH OTHER FILING EXPRESSLY INCORPORATES THIS
EXHIBIT BY REFERENCE.
</LEGEND>
<RESTATED>
<MULTIPLIER> 1,000
<CURRENCY> U.S. DOLLARS
<S> <C>
<PERIOD-TYPE> 6-MOS
<FISCAL-YEAR-END> DEC-31-1997
<PERIOD-START> JAN-01-1997
<PERIOD-END> JUN-30-1997
<EXCHANGE-RATE> 1
<CASH> 10,609
<SECURITIES> 14,000
<RECEIVABLES> 57,372
<ALLOWANCES> 0
<INVENTORY> 0
<CURRENT-ASSETS> 88,508
<PP&E> 2,105
<DEPRECIATION> 0
<TOTAL-ASSETS> 151,757
<CURRENT-LIABILITIES> 53,489
<BONDS> 0
0
0
<COMMON> 31,747
<OTHER-SE> 17,872
<TOTAL-LIABILITY-AND-EQUITY> 151,757
<SALES> 0
<TOTAL-REVENUES> 422,024
<CGS> 0
<TOTAL-COSTS> 399,871
<OTHER-EXPENSES> 17,960
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 2,065
<INCOME-PRETAX> 2,517
<INCOME-TAX> 1,007
<INCOME-CONTINUING> 1,510
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 1,510
<EPS-PRIMARY> .05
<EPS-DILUTED> .05
</TABLE>
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
CONSOLIDATED BALANCE SHEET AS OF MARCH 31, 1997 AND THE CONSOLIDATED STATEMENT
OF INCOME FOR THE YEAR ENDED MARCH 31, 1997 AS RESTATED PURSUANT TO STATEMENT OF
FINANCIAL ACCOUNTING STANDARD NO. 128, EARNINGS PER SHARE ("SFAS NO. 128"). IN
ADDITION, AN ENTRY ON THIS SCHEDULE HAS BEEN AMENDED FROM THE PREVIOUS FINANCIAL
DATA SCHEDULE FILED FOR THIS PERIOD. THIS SCHEDULE IS QUALIFIED IN ITS ENTIRETY
BY REFERENCE TO SUCH FINANCIAL STATEMENTS. THIS EXHIBIT SHALL NOT BE DEEMED
FILED FOR THE PURPOSE OF SECTION 11 OF THE SECURITIES ACT OF 1933 AND SECTION 18
OF THE SECURITIES ACT OF 1934, OR OTHERWISE SUBJECT TO THE LIABILITY OF SUCH
SECTIONS, NOR SHALL IT BE DEEMED A PART OF ANY OTHER FILING WHICH INCORPORATES
THIS REPORT BY REFERENCE, UNLESS SUCH OTHER FILING EXPRESSLY INCORPORATES THIS
EXHIBIT BY REFERENCE.
</LEGEND>
<RESTATED>
<MULTIPLIER> 1,000
<CURRENCY> U.S. DOLLARS
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> DEC-31-1997
<PERIOD-START> JAN-01-1997
<PERIOD-END> MAR-31-1997
<EXCHANGE-RATE> 1
<CASH> 12,623
<SECURITIES> 13,500
<RECEIVABLES> 49,232
<ALLOWANCES> 0
<INVENTORY> 0
<CURRENT-ASSETS> 79,886
<PP&E> 1,349
<DEPRECIATION> 0
<TOTAL-ASSETS> 143,162
<CURRENT-LIABILITIES> 47,978
<BONDS> 0
0
0
<COMMON> 31,487
<OTHER-SE> 17,048
<TOTAL-LIABILITY-AND-EQUITY> 143,162
<SALES> 0
<TOTAL-REVENUES> 195,966
<CGS> 0
<TOTAL-COSTS> 185,698
<OTHER-EXPENSES> 8,378
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 942
<INCOME-PRETAX> 1,143
<INCOME-TAX> 457
<INCOME-CONTINUING> 686
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 686
<EPS-PRIMARY> .02
<EPS-DILUTED> .02
</TABLE>
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
CONSOLIDATED BALANCE SHEET AS OF DECEMBER 31, 1996 AND THE CONSOLIDATED
STATEMENT OF INCOME FOR THE YEAR ENDED DECEMBER 31, 1996 AS RESTATED PURSUANT TO
STATEMENT OF FINANCIAL ACCOUNTING STANDARD NO. 128, EARNINGS PER SHARE ("SFAS
NO. 128"). IN ADDITION, AN ENTRY ON THIS SCHEDULE HAS BEEN AMENDED FROM THE
PREVIOUS FINANCIAL DATA SCHEDULE FILED FOR THIS PERIOD. THIS SCHEDULE IS
QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS. THIS
EXHIBIT SHALL NOT BE DEEMED FILED FOR THE PURPOSE OF SECTION 11 OF THE
SECURITIES ACT OF 1933 AND SECTION 18 OF THE SECURITIES ACT OF 1934, OR
OTHERWISE SUBJECT TO THE LIABILITY OF SUCH SECTIONS, NOR SHALL IT BE DEEMED A
PART OF ANY OTHER FILING WHICH INCORPORATES THIS REPORT BY REFERENCE, UNLESS
SUCH OTHER FILING EXPRESSLY INCORPORATES THIS EXHIBIT BY REFERENCE.
</LEGEND>
<RESTATED>
<MULTIPLIER> 1,000
<CURRENCY> U.S. DOLLARS
<S> <C>
<PERIOD-TYPE> 12-MOS
<FISCAL-YEAR-END> DEC-31-1996
<PERIOD-START> JAN-01-1996
<PERIOD-END> DEC-31-1996
<EXCHANGE-RATE> 1
<CASH> 10,980
<SECURITIES> 11,500
<RECEIVABLES> 34,839
<ALLOWANCES> 0
<INVENTORY> 0
<CURRENT-ASSETS> 65,651
<PP&E> 1,084
<DEPRECIATION> 0
<TOTAL-ASSETS> 125,969
<CURRENT-LIABILITIES> 35,202
<BONDS> 0
0
0
<COMMON> 30,145
<OTHER-SE> 16,362
<TOTAL-LIABILITY-AND-EQUITY> 125,969
<SALES> 0
<TOTAL-REVENUES> 439,016
<CGS> 0
<TOTAL-COSTS> 400,862
<OTHER-EXPENSES> 19,383
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 1,196
<INCOME-PRETAX> 18,407
<INCOME-TAX> 6,381
<INCOME-CONTINUING> 12,026
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 12,026
<EPS-PRIMARY> .40
<EPS-DILUTED> .37
</TABLE>
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
CONSOLIDATED BALANCE SHEET AS OF SEPTEMBER 30, 1996 AND THE CONSOLIDATED
STATEMENT OF INCOME FOR THE YEAR ENDED SEPTEMBER 30, 1996 AS RESTATED PURSUANT
TO STATEMENT OF FINANCIAL ACCOUNTING STANDARD NO. 128, EARNINGS PER SHARE ("SFAS
NO. 128"). IN ADDITION, AN ENTRY ON THIS SCHEDULE HAS BEEN AMENDED FROM THE
PREVIOUS FINANCIAL DATA SCHEDULE FILED FOR THIS PERIOD. THIS SCHEDULE IS
QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS. THIS
EXHIBIT SHALL NOT BE DEEMED FILED FOR THE PURPOSE OF SECTION 11 OF THE
SECURITIES ACT OF 1933 AND SECTION 18 OF THE SECURITIES ACT OF 1934, OR
OTHERWISE SUBJECT TO THE LIABILITY OF SUCH SECTIONS, NOR SHALL IT BE DEEMED A
PART OF ANY OTHER FILING WHICH INCORPORATES THIS REPORT BY REFERENCE, UNLESS
SUCH OTHER FILING EXPRESSLY INCORPORATES THIS EXHIBIT BY REFERENCE.
</LEGEND>
<RESTATED>
<MULTIPLIER> 1,000
<CURRENCY> U.S. DOLLARS
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1996
<PERIOD-START> JAN-01-1996
<PERIOD-END> SEP-30-1996
<EXCHANGE-RATE> 1
<CASH> 12,088
<SECURITIES> 0
<RECEIVABLES> 35,939
<ALLOWANCES> 0
<INVENTORY> 0
<CURRENT-ASSETS> 59,267
<PP&E> 1,047
<DEPRECIATION> 0
<TOTAL-ASSETS> 104,975
<CURRENT-LIABILITIES> 29,862
<BONDS> 0
0
0
<COMMON> 27,710
<OTHER-SE> 14,051
<TOTAL-LIABILITY-AND-EQUITY> 104,975
<SALES> 0
<TOTAL-REVENUES> 290,180
<CGS> 0
<TOTAL-COSTS> 261,310
<OTHER-EXPENSES> 13,897
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 406
<INCOME-PRETAX> 15,197
<INCOME-TAX> 5,482
<INCOME-CONTINUING> 9,715
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 9,715
<EPS-PRIMARY> .32
<EPS-DILUTED> .30
</TABLE>
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
CONSOLIDATED BALANCE SHEET AS OF JUNE 30, 1996 AND THE CONSOLIDATED STATEMENT OF
INCOME FOR THE YEAR ENDED JUNE 30, 1996 AS RESTATED PURSUANT TO STATEMENT OF
FINANCIAL ACCOUNTING STANDARD NO. 128, EARNINGS PER SHARE ("SFAS NO. 128"). IN
ADDITION, AN ENTRY ON THIS SCHEDULE HAS BEEN AMENDED FROM THE PREVIOUS FINANCIAL
DATA SCHEDULE FILED FOR THIS PERIOD. THIS SCHEDULE IS QUALIFIED IN ITS ENTIRETY
BY REFERENCE TO SUCH FINANCIAL STATEMENTS. THIS EXHIBIT SHALL NOT BE DEEMED
FILED FOR THE PURPOSE OF SECTION 11 OF THE SECURITIES ACT OF 1933 AND SECTION 18
OF THE SECURITIES ACT OF 1934, OR OTHERWISE SUBJECT TO THE LIABILITY OF SUCH
SECTIONS, NOR SHALL IT BE DEEMED A PART OF ANY OTHER FILING WHICH INCORPORATES
THIS REPORT BY REFERENCE, UNLESS SUCH OTHER FILING EXPRESSLY INCORPORATES THIS
EXHIBIT BY REFERENCE.
</LEGEND>
<RESTATED>
<MULTIPLIER> 1,000
<CURRENCY> U.S. DOLLARS
<S> <C>
<PERIOD-TYPE> 6-MOS
<FISCAL-YEAR-END> DEC-31-1996
<PERIOD-START> JAN-01-1996
<PERIOD-END> JUN-30-1996
<EXCHANGE-RATE> 1
<CASH> 10,717,673
<SECURITIES> 0
<RECEIVABLES> 24,363,339
<ALLOWANCES> 0
<INVENTORY> 0
<CURRENT-ASSETS> 42,267,506
<PP&E> 885,459
<DEPRECIATION> 0
<TOTAL-ASSETS> 61,124,704
<CURRENT-LIABILITIES> 24,714,146
<BONDS> 0
0
0
<COMMON> 26,561,941
<OTHER-SE> 9,805,617
<TOTAL-LIABILITY-AND-EQUITY> 61,124,704
<SALES> 0
<TOTAL-REVENUES> 164,941,702
<CGS> 0
<TOTAL-COSTS> 148,445,598
<OTHER-EXPENSES> 6,975,184
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 7,198
<INCOME-PRETAX> 9,269,779
<INCOME-TAX> 3,800,655
<INCOME-CONTINUING> 5,469,124
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 5,469,124
<EPS-PRIMARY> .18
<EPS-DILUTED> .17
</TABLE>
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
CONSOLIDATED BALANCE SHEET AS OF MARCH 31, 1996 AND THE CONSOLIDATED STATEMENT
OF INCOME FOR THE YEAR ENDED MARCH 31, 1996 AS RESTATED PURSUANT TO STATEMENT OF
FINANCIAL ACCOUNTING STANDARD NO. 128, EARNINGS PER SHARE ("SFAS NO. 128"). IN
ADDITION, AN ENTRY ON THIS SCHEDULE HAS BEEN AMENDED FROM THE PREVIOUS FINANCIAL
DATA SCHEDULE FILED FOR THIS PERIOD. THIS SCHEDULE IS QUALIFIED IN ITS ENTIRETY
BY REFERENCE TO SUCH FINANCIAL STATEMENTS. THIS EXHIBIT SHALL NOT BE DEEMED
FILED FOR THE PURPOSE OF SECTION 11 OF THE SECURITIES ACT OF 1933 AND SECTION 18
OF THE SECURITIES ACT OF 1934, OR OTHERWISE SUBJECT TO THE LIABILITY OF SUCH
SECTIONS, NOR SHALL IT BE DEEMED A PART OF ANY OTHER FILING WHICH INCORPORATES
THIS REPORT BY REFERENCE, UNLESS SUCH OTHER FILING EXPRESSLY INCORPORATES THIS
EXHIBIT BY REFERENCE.
</LEGEND>
<RESTATED>
<MULTIPLIER> 1,000
<CURRENCY> U.S. DOLLARS
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> DEC-31-1996
<PERIOD-START> JAN-01-1996
<PERIOD-END> MAR-31-1996
<EXCHANGE-RATE> 1
<CASH> 18,441,521
<SECURITIES> 0
<RECEIVABLES> 12,766,743
<ALLOWANCES> 0
<INVENTORY> 0
<CURRENT-ASSETS> 34,810,363
<PP&E> 720,180
<DEPRECIATION> 0
<TOTAL-ASSETS> 50,625,791
<CURRENT-LIABILITIES> 17,939,343
<BONDS> 0
0
0
<COMMON> 25,954,866
<OTHER-SE> 6,688,582
<TOTAL-LIABILITY-AND-EQUITY> 50,625,791
<SALES> 0
<TOTAL-REVENUES> 73,934,030
<CGS> 0
<TOTAL-COSTS> 66,265,114
<OTHER-EXPENSES> 3,866,488
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 2,827
<INCOME-PRETAX> 3,986,591
<INCOME-TAX> 1,634,502
<INCOME-CONTINUING> 2,352,089
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 2,352,089
<EPS-PRIMARY> .08
<EPS-DILUTED> .07
</TABLE>
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
CONSOLIDATED BALANCE SHEET AS OF DECEMBER 31, 1995 AND THE CONSOLIDATED
STATEMENT OF INCOME FOR THE YEAR ENDED DECEMBER 31, 1995 AS RESTATED PURSUANT TO
STATEMENT OF FINANCIAL ACCOUNTING STANDARD NO. 128, EARNINGS PER SHARE ("SFAS
NO. 128"). IN ADDITION, AN ENTRY ON THIS SCHEDULE HAS BEEN AMENDED FROM THE
PREVIOUS FINANCIAL DATA SCHEDULE FILED FOR THIS PERIOD. THIS SCHEDULE IS
QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS. THIS
EXHIBIT SHALL NOT BE DEEMED FILED FOR THE PURPOSE OF SECTION 11 OF THE
SECURITIES ACT OF 1933 AND SECTION 18 OF THE SECURITIES ACT OF 1934, OR
OTHERWISE SUBJECT TO THE LIABILITY OF SUCH SECTIONS, NOR SHALL IT BE DEEMED A
PART OF ANY OTHER FILING WHICH INCORPORATES THIS REPORT BY REFERENCE, UNLESS
SUCH OTHER FILING EXPRESSLY INCORPORATES THIS EXHIBIT BY REFERENCE.
</LEGEND>
<RESTATED>
<MULTIPLIER> 1,000
<CURRENCY> U.S. DOLLARS
<S> <C>
<PERIOD-TYPE> 12-MOS
<FISCAL-YEAR-END> DEC-31-1995
<PERIOD-START> JAN-01-1995
<PERIOD-END> DEC-31-1995
<EXCHANGE-RATE> 1
<CASH> 14,028,898
<SECURITIES> 0
<RECEIVABLES> 7,844,854
<ALLOWANCES> 0
<INVENTORY> 0
<CURRENT-ASSETS> 25,437,061
<PP&E> 439,579
<DEPRECIATION> 0
<TOTAL-ASSETS> 36,839,652
<CURRENT-LIABILITIES> 16,847,885
<BONDS> 0
0
0
<COMMON> 15,937,789
<OTHER-SE> 4,005,065
<TOTAL-LIABILITY-AND-EQUITY> 36,839,652
<SALES> 0
<TOTAL-REVENUES> 164,455,336
<CGS> 0
<TOTAL-COSTS> 150,675,230
<OTHER-EXPENSES> 7,608,892
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 24,864
<INCOME-PRETAX> 6,681,025
<INCOME-TAX> 2,846,117
<INCOME-CONTINUING> 3,834,908
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 3,834,908
<EPS-PRIMARY> .17
<EPS-DILUTED> .16
</TABLE>
