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, 1998
[ ] 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. [X]
The aggregate market value of the voting stock held by non-affiliates of the
Registrant, based upon the $1.16 closing price of the Registrant's Common Stock
as reported on the NASDAQ Smallcap Market on March 18, 1999, was approximately
$33.1 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
18, 1999, was 32,413,413.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Registrant's Proxy Statement for the Registrant's 1999 Annual
Meeting of Shareholders are incorporated by reference in Part III hereof.
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EMPLOYEE SOLUTIONS, INC.
FORM 10-K ANNUAL REPORT
YEAR ENDED DECEMBER 31, 1998
TABLE OF CONTENTS
PART I
ITEM 1. - BUSINESS 1
ITEM 2. - PROPERTIES 12
ITEM 3. - LEGAL PROCEEDINGS 12
ITEM 4. - SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS 13
ITEM 4A. - EXECUTIVE OFFICERS OF THE REGISTRANT 14
PART II
ITEM 5. - MARKET FOR REGISTRANT'S COMMON EQUITY AND
RELATED SHAREHOLDER MATTERS 15
ITEM 6. - SELECTED CONSOLIDATED FINANCIAL DATA 16
ITEM 7. - MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS 18
ITEM 7A. - QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK 32
ITEM 8. - FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA 32
ITEM 9. - CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS
ON ACCOUNTING AND FINANCIAL DISCLOSURE 32
PART III
ITEM 10. - DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT 33
ITEM 11. - EXECUTIVE COMPENSATION 33
ITEM 12. - SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS
AND MANAGEMENT 33
ITEM 13. - CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS 33
PART IV
ITEM 14. - EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND
REPORTS ON FORM 8-K 33
SIGNATURES 34
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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) in the United
States, specializing in integrated employment outsourcing solutions for small
and mid-sized businesses. As of December 31, 1998, the Company served
approximately 2,000 client companies representing 40,800 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, debit cards, 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.
RECENT DEVELOPMENTS
Effective February 15, 1999, Quentin P. Smith, Jr. was appointed as the
Company's president and chief executive officer. Mr. Smith, a member of the
Company's board of directors since January 1998, had served as chairman of the
board since August 1998. Mr. Smith formerly served as president of Cadre
Business Advisors, LLC, providing professional management consulting services
with emphases on strategic planning, business performance improvement, and
technology integration. Prior to forming Cadre in April 1995, Mr. Smith was
partner-in-charge of Arthur Andersen LLP's Desert Southwest business consulting
practice and co-owner of Data Line Services. Mr. Smith currently serves on the
board of directors of Arizona's largest electric company, Arizona Public
Service. He is a member of the board of directors at Rodel, Inc., a leading
supplier to the semi-conductor industry and a member of Samaritan Health
Systems' board of directors.
The Company recently completed a restructuring and cost-reduction plan primarily
involving the closing of remote payroll processing centers and other offices and
various other expense reduction strategies. Back office functions were
consolidated at the Company's corporate headquarters. These and other
initiatives have successfully resulted in significant reductions in the
Company's ongoing selling, general and administrative expense levels.
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The Company experienced increased customer attrition and decreased internal
sales in late 1998 and early 1999 following the closure of certain field offices
in connection with the restructuring and cost-reduction plan. New management
under Mr. Smith's leadership intends to apply an aggressive focus on new sales
and customer retention through improved service, while maintaining or further
reducing expense levels as needed. In 1999, the Company is placing a greater
emphasis on developing marketing alliances in order to achieve greater
efficiencies in its selling efforts. The Company believes that its reduced cost
structure, strengthened management team and existing cash resources position the
Company to execute its 1999 plan. For a discussion of various matters that
affect the Company's 1999 outlook, see Item 7 - "Management's Discussion and
Analysis - Outlook: Issues and Risks."
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. 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.
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."
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CLIENTS
As of December 31, 1998, the Company's full-service PEO client base consisted of
approximately 2,000 client companies, representing approximately 40,800
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 34% 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 10%
For hire/standard PEO 24
---
Total 34
Services:
Professional 13
Light Industrial 4
Real Estate 3
---
Total 20
Manufacturing 7
Construction 9
Retail Trade 6
Entertainment 15
Wholesale Trade 4
Agriculture and Fishing 1
Other 4
As part of its business strategy, the Company targets a nationwide client base.
The Company 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 15 employees as
of December 31, 1998 (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
1998 exceeded 11 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 August, 1998, the Company terminated its PEO arrangement with US
Xpress Enterprises, Inc. (US Xpress), a publicly-held transportation company
with more than 5,000 worksite employees, due to unsatisfactory financial
results. US Xpress, which had been the Company's largest customer since the time
that it became a customer in January 1997, accounted for $121.3 million or 13%
of the Company's total revenue in 1998, and $180.4 million or 19% 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
17%, 25% and 21%, respectively, for the years ended December 31, 1998, 1997, and
1996. 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 Company experienced increased attrition in late 1998 and early 1999
following the closure of certain field offices in connection with a
restructuring plan.
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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 and
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
* 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 generally 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" relationship.
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).
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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 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 in certain
aspects of its TEAM Services business, 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. 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.
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
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"Medical Programs" below. In addition, the Company offers 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.
WORKSITE EMPLOYEE SERVICES
The Company also provides benefits and services directly to its worksite
employees. In 1998, the Company introduced a debit card for the convenience of
its customers and 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 believes that its
services can best be sold by experienced sales representatives at individual,
face-to-face meetings with potential clients. In 1999, the Company is placing a
greater emphasis on developing marketing alliances in order to achieve greater
efficiencies in its selling efforts.
SALES
The Company's senior sales management and sales administration functions are
located at its Phoenix headquarters. The Company's national telemarketing
operations, also based in Phoenix, generate new leads, which are supported by a
nationwide network of sales representatives. Headquarters provides ongoing
training and sales support to all Company sales representatives, assists them in
new prospect proposals, and manages business submissions. The Company's field
sales operations are coordinated by sales managers located in various cities,
who manage a network of full-time sales representatives and part-time sales
brokers. At December 31, 1998, the Company's sales force included 45 sales
representatives. During 1998, the Company transitioned a substantial majority of
its independent sales representatives to employee status. The Company intends to
build and maintain an internal sales force consisting primarily of employee
sales representatives.
The Company's sales representatives currently are compensated primarily via
commissions, subject to certain vesting and production requirements. In some
instances, base salaries are provided to employee salespersons. Sales managers
also receive an override commission on sales generated by sales representatives
that report to them. Commissions may be payable after termination in certain
circumstances.
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.
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 that 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 that the Company may offer.
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The Company's current alliances include: cross selling arrangements;
arrangements to offer debit cards, prepaid telephone cards and specialty
insurance products to worksite employees; benefits education for worksite
employees; and a nationwide check-cashing program for worksite employees. In
1999, the Company entered into an alliance with IPEO, an Internet-based
professional employer organization targeting technology and technical service
firms. In addition to marketing and technical initiatives, the Company acquired
an equity position in IPEO by investing one million dollars in senior preferred
stock.
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, though
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, have
entered or 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 that assists the Company in executing
its risk management program. In 1998, the Company completed the transition of
all PEO processing to a unified software platform and a centralized client
server at its Phoenix headquarters, and installed a new Company-wide accounting
software package. 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 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.
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RISK MANAGEMENT/WORKERS' COMPENSATION PROGRAM
Workers' compensation is a state-mandated, comprehensive insurance program that
requires employers to fund medical expenses, lost wages and other costs that
result from work-related injuries and illnesses, regardless of fault and without
any co-payment by the employee. The Company has developed various systems and
policies designed to control its workers' compensation costs and assist its
clients. These systems and policies include comprehensive risk evaluation of
prospective clients, the prevention of workplace injuries, early intervention in
employee injury, intensive management of the medical costs related to such
injuries and the prompt return of employees to work.
Since 1998, the Company has maintained workers' compensation insurance coverage
on a guaranteed cost basis. Under its guaranteed cost arrangements, the Company
pays an initial deposit and, thereafter, a fixed percentage of its workers'
compensation payroll on a monthly basis. The Company has no liability in excess
of such amounts paid. The Company's 1999 guaranteed cost coverage has been
obtained through TIG Insurance Company, with ManagedComp acting as third party
administrator and general agent. The Company's 1998 guaranteed cost coverage was
obtained through Stirling Cooke Risk Management Services, Inc.
The Company has been granted self-insured status in the State of Ohio, which the
Company believes provides a competitive advantage under that State's
monopolistic workers' compensation structure. The Company retains workers'
compensation risk on Ohio claims of up to $50,000 per occurrence. Ohio claims
are not included in the guaranteed cost policies described above.
Prior to 1998, the Company operated various partially self-insured workers'
compensation programs. In addition to providing coverage to PEO customers, these
programs included the marketing of workers' compensation coverage to non-PEO
customers on a stand-alone basis. Effective February 28, 1998, the Company
completed a loss portfolio transfer that substantially eliminated the Company's
remaining workers' compensation liability risk on pre-1998 claims under both its
PEO and its stand-alone workers' compensation programs. While the Company
effectively discontinued marketing the stand-alone program at December 31, 1997,
the Company retained risk of up to $250,000 per occurrence on claims taking
place after that date on a defined portfolio of stand-alone policies that were
in place as of such date. All of such stand-alone policies expired in 1998. See
also "Item 7 - Management's Discussion and Analysis - Outlook: Issues and Risks
- - - Adequacy of Loss Reserves" herein.
Although the Company has obtained guaranteed cost workers' compensation
coverage, the Company intends to continue to manage workers' compensation costs
aggressively. Should the Company experience unfavorable trends in its workers'
compensation experience, the availability and/or cost of coverage in future
periods could be materially adversely affected.
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, 1998, approximately
833 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 severity 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 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.
ACQUISITIONS
The Company has experienced significant growth through acquisitions in recent
years. Two acquisitions were completed during 1998. In July 1998, the Company
acquired K.W.M. Corporation, (known in the industry as the National Companies),
a personnel leasing company specializing in driver leasing services based in
City of Industry, California. The acquisition was designed to strengthen ESI's
presence in the strategically important Southern California market. In December
1998, the Company acquired Fidelity Resources Corporation, an Oklahoma
City-based professional employer organization with approximately 1,050 worksite
employees at the time of the acquisition. Fidelity's customers are located
primarily in Oklahoma and surrounding states. The acquisitions completed in 1998
reflect the Company's strategy of targeting smaller PEOs in strategic geographic
areas that can be integrated efficiently and serve as a base for building
long-term internal sales growth. The Company intends to focus on growth through
internal sales in 1999 and does not currently anticipate significant acquisition
activity.
8
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EMPLOYEES
At December 31, 1998, the Company employed 356 full-time corporate employees
(reduced to 327 full-time corporate employees at March 15, 1999) 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; EMPLOYEE BENEFITS
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.
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 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
9
<PAGE>
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 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.
Certain states impose or are considering imposing certain taxes on gross
revenues or service fees of the Company and its competitors. The Company cannot
predict with certainty the extent to which such taxes will be imposed.
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WORKERS COMPENSATION
Workers' compensation is a state-mandated, comprehensive insurance program that
requires employers to fund medical expenses, lost wages and other costs that
result from work-related injuries and illnesses, regardless of fault and without
any co-payment by the employee. In exchange for providing workers' compensation
coverage for employees, the liability of the employer under the workers'
compensation statute generally is exclusive. Workers' compensation benefits and
arrangements vary on a state-by-state basis and are often highly complex.
In most states, workers' compensation benefits coverage (for both medical costs
and lost wages) is available through the purchase of commercial insurance from
private insurance companies, participation in state-run insurance funds or
employer self-insurance. Several states have mandated that employers receive
coverage only from state operated funds. Insurance carriers determine the
employer's premium through an evaluation of risk by industry type, factors
specific to the employer, and the employer's actual loss history. Typically, the
insurance market maintains loss data on an individual employer basis through the
experience rating system. Because PEOs aggregate many individual employer risks
under a single policy, and may fundamentally alter the loss experience of those
risks, PEO relationships have altered traditional methodologies for determining
premium and collecting and maintaining experience rating data. Some states are
evaluating the regulations applicable to the experience rating system to ensure
adequate data and premium collection within the PEO industry. Changes to
existing experience rating mechanisms, if adopted, could materially adversely
affect the cost of providing, and the market for, PEO services.
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<PAGE>
As a creation of state law, workers' compensation is subject to change by the
state legislature and is influenced by the political processes in each state.
Several states have mandated that employers receive coverage only from
state-operated funds. Certain states have adopted legislation requiring that all
workers' compensation injuries be treated through a managed care program.
Moreover, because workers' compensation benefits are mandated by law and are
subject to extensive regulation, payors and employers do not have the same
flexibility to alter benefits as they have with other health benefit programs.
It is difficult for payors and multi-state employers to adopt uniform policies
to administer, manage and control the costs of benefits because workers'
compensation programs vary from state to state.
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.
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.
11
<PAGE>
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. The Company reduced the amount of space during 1998 in connection with
expense reduction initiatives.
ITEM 3. - LEGAL PROCEEDINGS
The Company and certain of its present and former directors and executive
officers were named as defendants in ten actions filed between March 1997 and
May 1997. While the exact claims and allegations varied, they all alleged
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. The suits were consolidated
before the U.S. District Court in Phoenix, Arizona. In November 1998, the
Company entered into a settlement agreement calling for the claims against the
Company and all other defendants to be dismissed with prejudice without
presumption or admission of any liability or wrongdoing. Final terms of the
settlement call for payment to the plaintiffs of $13.8 million in cash and $1.2
million in shares of the Company's Common Stock. A substantial majority of both
the cash portion of the settlement and litigation-related expenses have been
paid by the Company's directors and officers' insurance carriers. The Court
approved the settlement agreement on March 11, 1999.
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 in
May 1997 alleging breach of contract under certain stock warrants. The plaintiff
sought damages of at least $2.5 million. In March 1999, the Court granted the
Company's motion for summary judgment and dismissed the plaintiff's case.
An arbitration panel awarded HDVT, Inc. (the seller of certain assets acquired
by the Company from Employers Trust in February 1997) a total of $10.4 million
in additional acquisition purchase price in February 1999. HDVT has filed an
action to confirm the award in Superior Court, Maricopa County, Arizona. The
Company has filed a motion to vacate the arbitration award, primarily on grounds
that the arbitrators exceeded the scope of their authority. The Company also is
pursuing other available remedies, including seeking a significant reduction of
the purchase price pursuant to a provision of the purchase agreement relating to
the determination of certain workers' compensation expense items. The Company
has been advised that HDVT will seek additional purchase price of approximately
$1 million under this same provision of the purchase agreement, though the
Company does not expect any additional purchase price to become due thereby. At
the time of final resolution, the payment will be accounted for as an
acquisition cost and will be amortized over the remaining term of the
acquisition's original 15-year amortization schedule.
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An arbitration proceeding between the Company and US Xpress is scheduled for May
1999 regarding issues under a PEO service agreement between the parties that was
terminated by the Company in August 1998. The parties recently stipulated to
dismiss related proceedings pending in the United States District Court for the
Eastern District of Tennessee, including US Xpress' request for a preliminary
injunction. US Xpress seeks recovery of approximately $3,000,000 plus
unspecified punitive damages primarily relating to unpaid medical claims. The
Company intends to contest the claim vigorously. As part of the same
arbitration, the Company is seeking recovery of damages for misrepresentations
made by US Xpress (relating primarily to the costs associated with US Xpress's
medical programs) at the time the parties entered into the PEO service
agreement.
The Company has been named as a defendant in an action filed by Bertram Danzig
in February 1999 in Superior Court, Maricopa County, Arizona alleging breach of
contract with respect to certain payments claimed to be owing during and after
his employment with the Company. The complaint seeks damages of approximately
$1.8 million plus the issuance of options to acquire 200,000 shares of Common
Stock. The Company intends to defend the action vigorously. The Company further
will pursue significant counterclaims against Mr. Danzig relating to certain
liabilities and other matters incurred by the Company in connection with its
1996 acquisition of assets from Hazar, Inc., an entity of which Mr. Danzig was a
principal. A director of the Company has agreed to indemnify the Company
personally for amounts paid by the Company to Mr. Danzig in connection with this
matter, if any.
International Color Services, L.L.C. filed for arbitration in December 1998
alleging breach of contract regarding fee issues under the PEO service agreement
between the parties. The Company has filed a complaint in Superior Court,
Maricopa Count, Arizona in January 1999 seeking a declaratory judgment that the
dispute is not subject to arbitration. Plaintiff has filed a motion to compel
arbitration and a counterclaim seeking damages of over $400,000 plus attorneys
fees and costs and unspecified punitive damages. The Company intends to contest
the claim vigorously.
From time to time, the Company is named as a defendant in lawsuits in the
ordinary course of business. See Item 7 - "Management's Discussion and Analysis
- - - Outlook: Issues and Risks - Uncertainty of Extent of PEO's Liability;
Government Regulation of PEOs."
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 1998.
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ITEM 4A. - EXECUTIVE OFFICERS OF THE REGISTRANT
The names of the Company's executive officers, and certain information about
them, are set forth below.
Officer/Director
Name Age Position(s) With Company Since
- - ---- --- -------------------------- -----
Quentin P. Smith, Jr. 47 Chairman of the Board, President, 1998
Chief Executive Officer and Director
Bill C. Hollis 52 Senior Vice President, Customer Service 1999
Delivery
John V. Prince 44 Senior Vice President, CFO and Treasurer 1997
Paul M. Gales 43 Senior Vice President, General Counsel 1996
and Secretary
Mark J. Gambill 39 Senior Vice President and Chief 1997
Marketing Officer
Quentin P. Smith, Jr. has been a Director of the Company since January 1998,
Chairman of the Board of Directors since August 1998, and Chief Executive
Officer and President since February 1999. Mr. Smith was President of Cadre
Business Advisors, LLC, a professional management consulting services company,
from April 1995 to February 1999. Previously, Mr. Smith was Partner-in-Charge of
the Desert Southwest Business Consulting Group of Arthur Andersen LLP from 1993
to 1995 and a co-owner of Data Line Service Company, a data processing service
bureau, from 1988 to 1991. Mr. Smith is a director of Arizona Public Service Co.
Bill C. Hollis was named Senior Vice President - Customer Service Delivery of
the Company in March 1999. Mr. Hollis also serves as Chief Executive Officer of
Logistics Personnel Corp. ("LPC"), the Company's driver leasing subsidiary.
Previously, Mr. Hollis served as President of LPC from the time the Company
acquired LPC in August 1996 until March 1999 and in various management positions
with LPC's predecessor companies for approximately 25 years prior to LPC's
acquisition by the Company, including positions as Vice President with Penske
Truck Leasing, Inc. and Leaseway Transportation Corp.
John V. Prince joined the Company as Vice President - Finance in January 1997
and was named Treasurer in September 1998 and Chief Financial Officer in March
1999. Previously, Mr. Prince held a number of executive positions during a
17-year career with First Interstate Bancorp, Inc. (now Wells Fargo) of Los
Angeles, and First Interstate Banks of Texas and Oklahoma, including controller
of its $1.5 billion Oklahoma affiliate.
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 was named Senior Vice President and Chief Marketing Officer in
March 1999. Mr. Gambill joined the Company as its Vice President of Marketing in
March 1997, and also served as Senior Vice President - Sales and Marketing from
December 1997 to March 1999. 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.
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PART II
ITEM 5. - MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED SHAREHOLDER MATTERS
The Company's Common Stock has traded on the NASDAQ Smallcap Market under the
symbol "ESOL" since November 1998. The Company's Common Stock traded on the
NASDAQ National Market from January 1996 to November 1998.
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 NASDAQ since
January 1996. As of March 18, 1999, the Company had 246 shareholders of record
and over 13,000 beneficial holders.
Quarter Ended High Low
------------- ---- ---
December 31, 1998 $3.31 $1.41
September 30, 1998 $3.78 $1.41
June 30, 1998 $5.28 $3.59
March 31, 1998 $5.84 $4.25
December 31, 1997 $7.94 $4.06
September 30, 1997 $6.13 $5.00
June 30, 1997 $7.38 $3.94
March 31, 1997 $28.38 $5.63
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 Indenture relating to the Company's 10% Senior Notes due 2004 (the "Notes"),
limits 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) (or, in the case of shares being issued pursuant to the securities
class action settlement, Section 3(a)(10)) of the Securities Act of 1933 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," the Company issued
752,587 restricted unregistered shares of the Company's Common Stock in
September 1997 to one individual who owned the acquired companies. Additionally,
the Company agreed to issue additional restricted shares to be determined based
upon ERC earnings after the acquisition. The parties are concluding the
calculation of the number of such additional shares, which will be valued based
on the average closing price of the Company's Common Stock during the one-year
period following the closing of the acquisition.
As part of the December 1998 acquisition of Fidelity Resources Corporation,
("Fidelity"), the Company issued 625,000 restricted unregistered shares of the
Company's Common Stock in December 1998 to two individuals who owned the
acquired company. If the price of the Company's Common Stock (based on the
average price during the 20 days prior to the first anniversary of the closing
date (the "Anniversary Price")) is less than $4.00, the Company will provide
additional cash consideration or issue additional restricted shares (or any
combination thereof, in the Company's discretion) in an amount sufficient so
that the aggregate value of the 625,000 shares (valued at the Anniversary Price)
plus such additional consideration equals $2.5 million. Subject to meeting gross
profit targets on a specific client prior to July 1, 2000, the Company also
agreed to provide up to $500,000 of additional consideration in the form (in the
Company's discretion) of cash or additional restricted shares (valued at the
Anniversary Price). The Company also issued warrants to the two individuals to
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<PAGE>
purchase up to 200,000 shares of its Common Stock. The warrants become
exercisable at $2.125 per share if earnings targets are achieved in each of the
three years following the closing of the acquisition.
The Company has agreed to issue shares of its Common Stock valued at $1.2
million in connection with the settlement of securities class action litigation.
See "Item 3 - Legal Proceedings." The shares will be valued based on the average
price during the 20 trading days preceding the date on which the Court's
judgment approving the settlement becomes final. For purposes of the settlement
agreement, the Court's judgement will be considered final three business days
after the expiration of time to file an appeal (i.e. 30 days from entry of
judgement) or, if an appeal is filed, the date on which the judgement is no
longer subject to further judicial review or appeal.
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, 1998, 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. Except for 1994,
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 would be material.
<TABLE>
<CAPTION>
Year Ended December 31,
------------------------------------------------------
(In thousands of dollars) 1998 1997 1996 1995 1994
---- ---- ---- ---- ----
<S> <C> <C> <C> <C> <C>
Consolidated Statements of Operations Data:
Revenues $968,909 $933,817 $439,016 $164,455 $74,334
Cost of revenues 934,684 903,255 400,862 150,675 71,068
Gross profit 34,225 30,562 38,154 13,780 3,266
Selling, general and
administrative expenses 49,293 33,411 17,310 7,183 2,297
Depreciation & amortization 6,145 4,617 2,073 426 269
Income (loss) from operations (21,213) (7,466) 18,771 6,171 700
Non-operating income (expense), net (6,849) (3,849) (364) 510 129
Income (loss) before provision
for taxes (28,062) (11,315) 18,407 6,681 829
Income tax provision (benefit) (111) (2,819) 6,381 2,846 450
Net income (loss) (27,951) (8,496) 12,026 3,835 379
</TABLE>
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<TABLE>
<CAPTION>
Year Ended December 31,
------------------------------------------------------
(In thousands, except per share data) 1998 1997 1996 1995 1994
---- ---- ---- ---- ----
<S> <C> <C> <C> <C> <C>
Consolidated Balance Sheet Data
Working capital $ 31,665 $ 58,329 $ 30,449 $ 8,589 $ 2,394
Total assets 175,105 207,217 125,969 36,840 9,310
Long-term debt 85,000 85,000 42,800 -- --
Stockholders' equity 15,716 42,389 46,507 19,943 6,401
Common Stock Data
Earnings (loss) per share
Basic (.88) (.27) .40 .17 .02
Diluted (.88) (.27) .37 .16 .02
Weighted average common and
equivalent shares outstanding
Basic 31,817 31,193 30,224 22,392 20,145
Diluted 31,817 31,193 32,168 23,507 20,145
At period end:
Worksite employees 40,800 45,200 30,000 11,000 3,600
Client companies 2,000 1,700 1,200 920 450
States with worksite employees 47 47 46 40 20
</TABLE>
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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) 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
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primarily based on industry-wide data, and to a lesser extent, the Company's
past claims experience up to the retained limits. The liability recorded may be
more or less than the actual amount of the claims when they are submitted and
paid. 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 also includes 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.
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 one self-insured program with a built-in maximum
coverage cap of $100,000 per person per year. Prior to 1998, the Company also
offered certain partially self-insured programs with specific and, in one
program, aggregate stop-loss insurance. The Company recognizes a liability for
self-insured and 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 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.
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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. (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; four related PEO companies referred to as "Employee
Resources Corporation" (collectively, "ERC") in September 1997; Phoenix Capital
Management, Inc. (PCM), a PEO service provider, in September 1997; K.W.M.
Corporation (KWM) in June 1998; and Fidelity Resources Corporation (Fidelity) in
December 1998.
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 or 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, 1998 COMPARED TO YEAR
ENDED DECEMBER 31, 1997
Percent
(In thousands of dollars) 1998 Change 1997
---- ------ ----
Revenues $968,909 4% $933,817
Cost of revenues 934,684 3 903,255
Gross profit 34,225 12 30,562
Selling, general and administrative 49,293 48 33,411
Depreciation and amortization 6,145 33 4,617
Interest income 1,885 45 1,303
Interest expense 8,541 67 5,102
Net loss (27,951) 229 (8,496)
REVENUES
Revenues increased from $933.8 million for the year ended December 31, 1997, to
$968.9 million for the year ended December 31, 1998, a 4% increase. The increase
in revenues was primarily due to increased revenues in TEAM Services.
Acquisitions also accounted for a portion of the increase in revenues between
the periods. Growth from internal sales and acquisitions was in part offset by
factors such as attrition of clients and competitive pressures. The Company
transitioned its sales operations from Atlanta to Phoenix during the first six
months of 1998, which had a short term impact on sales. Execution of the
restructuring and cost reduction plan resulted in increases in client attrition
and decreases in internal sales in late 1998 and early 1999 due primarily to
short-term disruptions in client service. While the Company has taken steps to
address these issues, there can be no assurance that measures recently taken by
the Company to improve customer service, reduce attrition and increase internal
sales will be effective. The Company also terminated its subscriber agreement
with US Xpress effective August 19, 1998. The number of worksite employees
decreased from approximately 45,200 at December 31, 1997, to approximately
40,800 at December 31, 1998. The majority of the decrease was directly
attributable to the Company's termination of the contract with US Xpress, an
unprofitable client that had approximately 6,200 worksite employees.
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In 1998, the Company discontinued offering risk management/workers' compensation
services to customers who are not full-service PEO customers of the Company.
This change was the result of the determination to emphasize other PEO marketing
strategies and because of the decreased profit opportunities resulting from
increased price competition in the overall workers' compensation market.
COST OF REVENUES
Cost of revenues increased 3% from $903.3 million for the year ended December
31, 1997, to $934.7 million in the year ended December 31, 1998. This increase
is primarily due to the increase in the Company's revenues, offset by reduced
costs associated with the transition to a guaranteed cost program as described
below. Additionally, the cost of revenues was adversely affected by $3.2 million
in unusual charges which are not expected to recur, including $1.8 million in
healthcare costs incurred under the US Xpress contract, $1.0 million in
write-offs for certain payroll tax receivables, and $.4 million in other
workers' compensation expenses. The additional healthcare costs described above
in part led to the Company's decision to terminate the US Xpress contract.
Workers' compensation expenses decreased approximately 20% to $24.3 million in
1998 from $30.4 million in 1997, due primarily to the reduced expenses
associated with the Company's change in business strategy to minimize future
uncertainty associated with its workers' compensation programs by converting to
a guaranteed cost workers' compensation program and the discontinued offering of
stand-alone workers' compensation services as described above. The Company's
workers' compensation costs have increased under the terms of its 1999 program
as compared to its 1998 program in part due to continued development of
historical losses.
Consistent with Company policy, the Company's workers' compensation reserves at
December 31, 1998 (as related to costs associated with certain stand-alone cases
and Ohio claims) are based on a review by an independent actuary. The actuary
relied on industry standards, while taking into account the Company's specific
risk structure and philosophy, in determining its findings.
Healthcare expenses decreased approximately 19% to $22.0 million in 1998 from
$27.2 million in 1997, in part due to the termination of the US Xpress contract.
GROSS PROFIT
The Company's gross profit margin increased from 3.3% in the year ended December
31, 1997 to 3.5% in the year ended December 31, 1998. This increase was due
primarily to decreased workers' compensation expenses associated with the
guaranteed cost program and reduced healthcare expenses, offset by the impact of
repricing existing clients due to competitive factors and lower margins on new
business. In addition, the proportion of TEAM Services revenues, which have
lower margins, increased during 1998.
SELLING, GENERAL AND ADMINISTRATIVE
Selling, general and administrative expenses increased by $15.9 million or 48%
from $33.4 million for the year ended December 31, 1997 to $49.3 million for the
year ended December 31, 1998. As a percent of revenues, selling, general and
administrative expenses increased from 3.6% to 5.1% during the years ended
December 31, 1997 and 1998, respectively. Factors contributing to the increase
in selling, general and administrative expenses in 1998 over 1997 include
significant charges not expected to recur in future periods, as described below.
The most significant charge is $6.2 million in legal expense to settle the
securities class action litigation. In addition, during 1998 the Company has
written down approximately $1.5 million in receivables relating to general
customer trade receivables and recent collection difficulties associated with
the discontinuation of the Company's stand-alone workers' compensation program.
Further, certain receivables primarily related to former sales and marketing
operations in Atlanta totaling approximately $1.0 million were reserved for in
the second quarter. The receivables are non-customer related and include
investments in sales personnel and strategic sales partners in the form of loans
or commission advances. Commission expense increased during 1998 due to the
increase in revenues discussed above and an increase in commissionable business.
In addition, the Company also incurred approximately $400,000 in professional
fees associated with acquisition activities that did not result in completed
transactions.
On August 11, 1998, the Company announced a $1.4 million restructuring charge
related to a cost-reduction plan that included initiatives intended to
significantly reduce selling, general and administrative costs. See below
discussion of Restructuring expense and cost-reduction plan. In addition to the
cost reduction plan expenses, the Company incurred non-recurring professional
fees of approximately $550,000 primarily related to certain operational and
strategic initiatives and approximately $372,000 of duplicative salary expense
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in the third quarter of 1998 related to the implementation of the operational
initiatives. These and other initiatives have successfully resulted in
significant reductions in the Company's ongoing selling, general and
administrative expense levels.
DEPRECIATION AND AMORTIZATION
Depreciation and amortization represents depreciation of property and equipment
and amortization of organizational costs, customer lists and goodwill.
Depreciation and amortization expense totaled $6.1 million for the year ended
December 31, 1998 compared to $4.6 million for the year ended December 31, 1997.
The increase was due primarily to goodwill amortization resulting from
acquisitions in 1997 and the second quarter of 1998, depreciation of
communication and computer systems and the installation of a new
fully-integrated accounting system in 1998. 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 $3.5 million in
offering expenses which are being amortized over the term of the Notes.
RESTRUCTURING EXPENSE AND COST-REDUCTION PLAN
On August 11, 1998, the Company announced a restructuring and cost-reduction
plan primarily involving the closing of remote payroll processing centers and
other offices and various other expense reduction strategies. Back office
functions were consolidated at the Company's Phoenix, Arizona headquarters to
take advantage of recent investments in systems upgrades. The Company incurred a
restructuring charge in the third quarter of 1998 of $1.4 million, consisting
primarily of severance and lease cancellation costs. During 1998 the Company
transitioned operations located in Indiana and Massachusetts to its corporate
headquarters in Phoenix. Where offices were closed or consolidated, the Company
maintains an active sales and customer service presence to meet the local needs
of customers and to support internal growth.
INTEREST
Interest income increased from $1.3 million for the year ended December 31, 1997
to $1.9 million for the year ended December 31, 1998, primarily due to interest
earned on cash held at the corporate level including the excess proceeds from
the note offering and restricted cash and investments held for the future
payment of workers' compensation claims at the Company's wholly owned insurance
subsidiary, Camelback. Interest expense increased from $5.1 million for the year
ended December 31, 1997 to $8.5 million for the year ended December 31, 1998,
primarily due to interest accrued on the Company's $85 million in 10% Senior
Notes due 2004. See "Liquidity and Capital Resources."
EFFECTIVE TAX RATE
The Company's effective tax rate provides for federal and state income taxes.
The effective tax rate for the year ended December 31, 1998 was a benefit of .4%
as compared to a benefit of 25% for the year ended December 31, 1997. The tax
rate used in each quarterly reporting period generally was an estimate of the
Company's effective tax rate for the calendar year. As of December 31, 1998, the
Company has incurred losses in excess of what could be carried back and applied
against prior years' income to generate federal income tax refunds. The
remaining net operating loss will be available for carry-forward benefit only to
the extent of any subsequently generated taxable income. Also as of December 31,
1998, the Company established a valuation allowance against a $9.2 million net
deferred tax asset.
The Company's effective tax rate reflects the operations of the Company's
wholly-owned subsidiary, Camelback, which pays state premium tax rather than
state income tax. Although the Company believes that it has structured its
Camelback arrangements to qualify for such tax treatment, any disallowance of
this tax treatment could materially affect the Company's results of operations
for the current fiscal year and future fiscal years. The Company's effective tax
rate will vary from time to time depending primarily on the mix of profits
derived from 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 1998
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.
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RESULTS OF OPERATIONS--YEAR ENDED DECEMBER 31, 1997 COMPARED TO YEAR
ENDED DECEMBER 31, 1996
Percent
(In thousands of dollars) 1997 Change 1996
---- ------ ----
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
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 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 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 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
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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 effected a loss portfolio transfer for
pre-1998 claims.
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.
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.
DEPRECIATION AND AMORTIZATION
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.
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.
EFFECTIVE TAX RATE
The Company's 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 Company recognized a tax benefit in 1997 as a result of its loss.
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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 sources of cash
in 1998 were from investing and financing activities.
Cash used by operating activities was $15.7 million during 1998 compared to cash
provided by operating activities of $7.2 million during 1997 and $3.3 million of
cash used during 1996. Cash used by operating activities in 1998 includes cash
paid in connection with a loss portfolio transfer discussed below. Operating
cash flows are derived from customers for full PEO services rendered by the
Company. 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 Company's TEAM Services and LPC operations
extend credit terms generally from 7 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. If the Company
expands or enters into new market segments, or extends credit terms to
additional clients, its working capital requirements may increase. Included in
other assets is a receivable of approximately $1.4 million from a single
stand-alone client as to which disputes have risen. The Company has initiated
litigation against the former client seeking, among other remedies, collection
of the receivable. 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
unreserved balance of the receivable.
Cash provided by investing activities was $1.2 million in 1998, and cash used in
investing activities was $15.0 million and $46.9 million in 1997 and 1996,
respectively. Included in 1998 investing activities is $10.0 million of cash
representing the Company's investment in marketable securities until such funds
are needed. Acquisitions are not expected to be a significant use of cash in
1999. An arbitration panel awarded HDVT, Inc. (the seller of certain assets
acquired by the Company from Employers Trust in February 1997) a total of $10.4
million in additional acquisition purchase price in February 1999. The Company
has filed a motion to vacate the arbitration award, primarily on grounds that
the arbitrators exceeded the scope of their authority. The Company also is
pursuing other available remedies, including seeking a significant reduction of
the purchase price pursuant to a provision of the purchase agreement relating to
the determination of certain workers' compensation expense items.
For 1998, 1997 and 1996, capital expenditures were $2.7 million, $2.5 million,
and $.7 million, respectively. Capital expenditures in 1998 consisted primarily
of computer equipment to enhance the Company's ability to support the Company's
increased client base and the centralization of payroll processing and
accounting systems. During 1999, 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 1999
capital expenditures will continue in order to meet the needs of the Company's
base of worksite employees.
Cash provided in financing activities was $13.7 million, $36.9 million, and
$47.2 million for 1998, 1997 and 1996, respectively. Cash flows from financing
activities during 1998 resulted primarily from bank overdrafts that generally
result from timing differences in the transfer of funds between banks.
Overdrafts are repaid through the transfer of funds from other Company cash
accounts held in other banks.
At December 31, 1998 and December 31, 1997, the Company had cash and cash
equivalents of $39.3 million and $40.1 million, respectively. Cash and cash
equivalents are generally invested in high investment grade instruments with
maturities of less than 90 days. Certain amounts of restricted cash and
investments (see below) may have maturities beyond 90 days but are highly
liquid. At December 31, 1998, the Company had $10.0 million in investments and
marketable securities, consisting of money market funds, commercial paper,
certificates of deposit and U.S. Treasury and agency notes. The Company
generally maintains large cash balances to meet its daily payroll and payroll
tax obligations. The Company continues to seek improvements in its 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. In April, 1998 the Company completed an LPT which resulted in a one
time payment of $19.9 million funded primarily from restricted cash and
investments (see below).
On April 22, 1998, the Company completed a risk transfer of all of its pre-1998
workers' compensation claims liability to a third party insurer rated AAA by
Standard & Poor's, effected through an LPT valued as of February 28, 1998. In
exchange for a premium of $19.9 million (paid primarily from restricted cash and
investments), the Company acquired reinsurance of $35 million to insure its
pre-1998 workers compensation losses. Based upon the advice of its outside
actuaries, the Company believes that the risk that pre-1998 liability could
exceed the $35 million aggregate limit is extremely remote, although there can
be no assurance. The LPT provides for profit sharing opportunities with the
Company based on ultimate paid claims, though there can be no assurance whether
or when a profit will be realized. No charge to earnings was recorded in
connection with this transaction in 1998 or is expected in future periods.
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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 transfer funds to its parent company,
whether via loan, dividend or otherwise. Primarily due to the transition to a
guaranteed cost workers' compensation program effective January 1, 1998 and the
LPT completed in April 1998, these provisions of Bermuda law do not materially
impact the Company.
The Company is engaged in negotiations with the principal carrier under its
pre-1998 workers' compensation program concerning various issues associated with
closing out such program. During the course of the negotiations, the carrier has
taken the position that amounts are due from the Company to the carrier. The
negotiations are in a preliminary phase and the parties have not reached
agreement on the extent of the Company's liability, if any, to the carrier.
At December 31, 1998 and December 31, 1997, the Company had working capital of
$31.7 million and $58.3 million, respectively. See also "FUTURE CAPITAL NEEDS;
UNCERTAINTY OF ADDITIONAL FINANCING" and "SUBSTANTIAL LEVERAGE" below.
NOTE OFFERING
On October 21, 1997, the Company issued $85 million of Notes in an Offering (the
Offering) effected as an exempt offering under 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 Note Agreement. The Company incurred expenses
related to the Offering of approximately $3.5 million and will amortize such
costs over the life of the Notes. In April 1998, the Company completed an
exchange offer for these notes which was registered under the Securities Act.
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, repurchases of Company shares and the incurrence of new indebtedness.
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. In August 1998 the Company canceled the facility. There was no
outstanding balance on the revolving line of credit when it was canceled, and it
had not been drawn on by the Company during its existence.
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OUTLOOK: ISSUES AND RISKS
The following issues and risks, among others (including those discussed
elsewhere herein), should be considered in evaluating the Company's outlook.
FUTURE CAPITAL NEEDS; UNCERTAINTY OF ADDITIONAL FINANCING
The Company currently anticipates that its available cash resources combined
with funds from operations will be sufficient to meet its presently anticipated
working capital and capital expenditures requirements under its 1999 operating
plan. The Company may need to raise additional funds through public or private
debt or equity financing in order to take advantage of unanticipated
opportunities or to respond to unanticipated competitive pressures or adverse
outcomes associated with litigation or other claims. If additional funds are
raised through the issuance of equity securities, then the percentage ownership
of the then current shareholders of the Company may be reduced and such equity
securities may have rights, preferences or privileges senior to those of the
holders of the Company's Common Stock. There can be no assurance that additional
financing will be available on terms favorable to the Company, or at all. If
adequate funds are not available or are not available on acceptable terms, the
Company's business, operating results and financial condition could be
materially adversely affected.
SUBSTANTIAL LEVERAGE
The Company has incurred significant debt primarily in connection with its
expansion through acquisitions and its October 1997 issuance of its 10% Senior
Notes due 2004. As of December 31, 1998, the Company had outstanding senior
indebtedness of approximately $85 million and stockholders' equity of
approximately $16 million, respectively.
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. 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 funds will be available
from other sources 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 (or any equity
financing) on commercially reasonable terms. Also, the Company is facing several
matters in litigation or arbitration as discussed elsewhere herein, as well as
litigation incidental to its business. The Company's liquidity position could be
materially adversely affected depending on the outcome of these matters. See
"Litigation and Other Contingencies" and "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 contains financial and restrictive covenants that limit the ability of
the Company to, among other things, borrow additional funds. Failure by the
Company to comply with such covenants could result in an event of default which,
if not cured or waived, could have a material adverse effect on the Company's
business and financial performance.
LITIGATION AND OTHER CONTINGENCIES
While certain significant litigation matters have been resolved recently,
including the settlement of a major securities class action brought against the
Company and certain of its officers and directors in March 1997, other
significant matters remain unresolved. For example, the Company is seeking to
vacate a $10.4 million arbitration award obtained by HDVT, Inc. (the seller of
assets acquired by the Company from Employers Trust in February 1997) against
the Company in February 1999. A separate arbitration is scheduled for May 1999
to resolve a claim against the Company by its former client, U.S. Xpress, for
approximately $3 million in unpaid medical claims and to resolve a counterclaim
by the Company against U.S. Xpress for damages for misrepresentations made by it
at the time of contract formation with respect to U.S. Xpress's medical cost
history. The State of Ohio has assessed sales and use taxes of approximately
$5.2 million against the Company that the Company believes have been assessed
erroneously and is contesting vigorously. The Company faces other claims
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relating to prior contractual relationships and other matters. While the Company
will continue to seek vigorously to resolve these matters favorably, there can
be no assurance that the outcome of these matters, or any of them, will not have
a material adverse effect upon the Company's results of operations or financial
position.
RESTRUCTURING AND COST-REDUCTION PLAN; EFFECT ON CLIENT RETENTION
In 1998, the Company completed a restructuring and cost-reduction plan primarily
involving the closing of remote payroll processing centers and other offices and
various other expense reduction strategies. Back office functions were
consolidated at the Company's corporate headquarters. While the Company believes
that completion of the plan will result in long-term improvements in its
operational and customer service capabilities (in addition to significant
operating expense reductions), the plan resulted in increases in client
attrition and decreases in internal sales due primarily to short-term
disruptions in client service. There can be no assurance that measures recently
taken by the Company to improve customer service, reduce attrition and increase
internal sales will be effective.
RISKS ASSOCIATED WITH SIGNIFICANT GROWTH, INCLUDING GROWTH THROUGH ACQUISITIONS
The Company has experienced significant growth that has challenged the Company's
management, personnel, resources and systems. A significant portion of the
Company's growth has been accomplished through the acquisition of other PEOs.
Growth through acquisition involves substantial risks, including the risk of
improper valuation of the acquired business and the risks inherent in
integrating such businesses with the Company's operations. As part of its
business strategy, the Company intends to pursue continued growth. There can be
no assurance that the Company will be able to achieve growth in the future or
manage this growth effectively.
INCREASES IN HEALTH INSURANCE PREMIUMS, UNEMPLOYMENT TAXES AND WORKERS'
COMPENSATION RATES; AVAILABILITY OF PROGRAMS
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. Similarly, workers'
compensation costs are directly affected by experience. Should the Company
experience a large increase in claims activity for unemployment, workers'
compensation and/or healthcare, 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 due to contractual or competitive factors. In addition, the Company
would have difficulty competing with PEOs with lower claims rates that may offer
lower rates to clients.
The maintenance of health and workers' compensation insurance plans that cover
worksite employees is a significant part of the Company's business. While the
Company believes that replacements for its current contracts could be obtained
on competitive terms, if doing so became necessary, without causing significant
disruption to the Company's business, there can be no assurance in this regard.
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.
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
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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 may be
contractually obligated to pay their wages, benefit costs and payroll taxes
whether or not the Company receives payment from its customer. 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 timely payment is not received. 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.
By way of example, a group of employees filed suit against the Company in 1998
alleging that they were employees of the Company and that they had not been paid
certain wages. The maximum amount claimed could have exceeded $500,000. While
the Company did not believe that it had any liability to the plaintiffs based on
the facts of the case, and the Company has successfully obtained a dismissal of
the suit, the Company may be required to deal further with the matter on appeal
and/or deal with similar claims in the future.
In addition, the Company competes in several market segments 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. 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.
CLIENT RELATIONSHIPS
The Company's subscriber agreements with its clients generally may be canceled
upon 30 days written notice of termination by either party, except where
different arrangements are required by applicable law. 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. See RESTRUCTURING AND
COST-REDUCTION PLAN; EFFECT ON CLIENT RETENTION. 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. 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.
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
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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. In addition, the Company believes that a portion of its clients may
not be maintaining the insurance coverage required under their service
agreements with 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.
ADEQUACY OF LOSS RESERVES
The Company obtained fully-insured guaranteed cost workers' compensation
coverage effective January 1, 1998, thereby eliminating, with certain
exceptions, the Company's risk retention on workers' compensation claims arising
after that date. The Company retained 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 retained risk up to $50,000 per occurrence for claims under Ohio's
monopolistic workers' compensation structure, with an aggregate liability
limitation.
The Company's reserves for losses and loss adjustment expenses under the Ohio
and stand-alone programs referred to in the preceding paragraph are estimates of
amounts needed to pay reported and unreported claims and related loss adjustment
expenses. Loss reserves are inherently uncertain and are subject to a number of
circumstances that are highly variable and difficult to predict. If the
Company's reserves prove to be inadequate, the Company will be required to
increase reserves or corresponding loss payments with a corresponding reduction,
which may be material, to the Company's operating results in the period in which
the deficiency is identified.
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,
though 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,
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, have entered or will enter the PEO market.
ISSUANCE OF ADDITIONAL SHARES
As discussed elsewhere herein, the Company anticipates issuing additional shares
of its Common Stock during 1999 (1) in connection with the settlement of the
securities class action litigation; (2) in payment of the purchase price for the
June 1996 acquisition of TEAM Services and (3) in payment of the remaining
purchase price for the September 1997 ERC acquisition. The Company also is
obligated to issue certain additional shares of Common Stock (or pay additional
cash, in its discretion) in connection with the December 1998 acquisition of
Fidelity Resources Corp. if the price of the Company's Common Stock is less than
$4 per share during approximately November 1999, subject to certain conditions.
The numbers of shares to be issued in connection with the class action
settlement, TEAM purchase price and (should the Company elect to make payment in
the form of shares of Common Stock) supplemental Fidelity purchase price varies
in proportion to the Nasdaq trading price of the Common Stock (i.e. the number
of shares increases to the extent the Nasdaq trading price decreases, and vice
versa).
YEAR 2000
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 portions of its software so that its information systems will be able to
properly utilize dates subsequent to December 31, 1999.
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STATE OF READINESS
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. The plan includes (1)
inventorying Year 2000 items; (2) assigning priorities to identified items; (3)
assessing Year 2000 compliance of material items (whether internal or third
party-related); (4) repairing or replacing material items determined not to be
Year 2000 compliant; (5) testing material items; and (6) assessing contingency
plans.
At December 31, 1998, the inventory, priority assessment and internal compliance
assessment phases are substantially completed except for elements of the
operations of the Company's LPC subsidiary. The Company intends to substantially
complete those phases for LPC by mid-1999. Prioritization of items is assigned
based on the level of disruption to Company operations and client service that
would result from noncompliance. While Year 2000 issues present significant
risks for the Company due to the nature of its business, no significant
noncompliance issues were identified during these phases, though there can be no
assurance that such issues will not be identified in the future. Due in part to
the Company's relatively short operating history, the Company operates only one
so-called "legacy" system, limiting its exposure to certain Year 2000 issues.
The repair and replacement phase of the Company's plan has been implemented
primarily through various systems upgrades that have been conducted in the
ordinary course of business, which upgrades primarily were implemented to meet
the Company's needs in view of its rapid growth and independently of Year 2000
considerations. The Company anticipates that repair and replacement
considerations relevant to its LPC subsidiary, if any, will be managed through a
transition of LPC functions onto the Company's core software platform, which
transition previously had been scheduled for operational reasons independent of
Year 2000 considerations. A limited amount of software has been purchased
primarily for Year 2000 compliance purposes.
The Company has commenced the testing phase of its Year 2000 plan. The Company
intends to test its systems for accuracy through the use of test data on a wide
variety of the Company's normal operating transactions under various date
conditions. The testing phase is approximately 30 - 40% complete. The Company is
reviewing software products to assist it in completing the testing phase on an
automated basis. The Company believes that these tests can be completed in
sufficient time to permit required modifications, if any, to be made on a timely
basis.
The Company believes that it does not have material risks associated with Year
2000 issues for non-information technology systems due to the nature of its
operations.
The Company has also assessed its third party relationships and has identified a
list of vendors that it considers most significant to its operations. These
vendors primarily include third party hardware and software vendors, financial
institutions, taxing authorities, third party administrators and benefit
providers. The Company already has obtained compliance statements from a
substantial majority of its key vendors (generally through information publicly
available from such vendors), and has commenced the process of requesting
written information from designated key vendors regarding their Year 2000 plans
and state of readiness. Upon completion of the third-party evaluation and the
testing of its internal systems, the Company intends to test significant data
interfaces with third party vendors to verify their compliant status.
COSTS TO ADDRESS YEAR 2000 ISSUE
The Company has not incurred and does not expect to incur significant costs
related to Year 2000 issues other than the time of internal personnel to
complete the Company's Year 2000 plans. As referred to above, the Company has
expended significant resources to upgrade various systems in the ordinary course
of its business, which upgrades were implemented primarily to meet the Company's
needs in view of its rapid growth and independently of Year 2000 considerations.
A limited amount of software has been purchased primarily for Year 2000
compliance purposes. As noted above, the Company currently is considering
purchasing an additional software product to assist in completing the testing
phase. Total costs for year 2000 upgrades are expected to be less than $25,000.
RISKS ASSOCIATED WITH YEAR 2000 ISSUES; CONTINGENCY PLANNING
The Company presently believes that the Year 2000 issues will not pose
significant operational problems for the Company. However, if all Year 2000
issues are not properly identified, or assessment, repair or replacement, and
testing are not effected timely with respect to Year 2000 problems that are
identified, there can be no assurance that the Year 2000 issues will not
materially adversely impact the Company's results of operations or materially
adversely affect the Company's relationships with customers, vendors or others.
Additionally, there can be no assurance that the Year 2000 issues of other
entities will not have a material adverse impact on the Company's systems or
results of operations. Among the problems which might occur without appropriate
planning and testing are: the inability to transmit direct deposit payroll
through banking systems to deposit funds into worksite employees' bank accounts;
the inability to collect funds electronically in payment of the Company's
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service fees; the failure to properly calculate payroll information; the
untimely transmission of benefits enrollment or claims data to and from benefit
providers; and the inability to deliver payroll checks to employees due to
failure in transportation or courier systems.
The Company has begun, but not yet completed, an analysis of the operational
problems and costs (including loss of revenues) that would be reasonably likely
to result from the failure by the Company and key third parties to complete
efforts necessary to achieve Year 2000 compliance on a timely basis. A
contingency plan has not yet been finalized for dealing with the most reasonably
likely worst case scenario, and such scenario has not yet been clearly
identified. The Company currently plans to complete such analysis and
contingency planning mid-1999.
The costs of the Company's Year 2000 efforts and the dates on which the Company
believes it will complete such efforts are based upon management's best
estimates, which were derived using numerous assumptions regarding future
events, including the continued availability of certain resources, third-party
compliance, and other factors. There can be no assurance that these estimates
will prove to be accurate, and actual results could differ materially from those
currently anticipated. Specific factors that could cause such material
differences include, but are not limited to, the availability and cost of
personnel trained in Year 2000 issues, the ability of the Company and third
parties (including vendors, customers and, in particular, federal, state and
local governments) to identify, assess, replace or repair and test all relevant
items (including embedded technology), the ability of third parties to
communicate compliance issues to the Company on a timely basis, unforeseen
expenses, and similar uncertainties.
ITEM 7A. - QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company is primarily exposed to market risks from fluctuations in interest
rates and the effects of those fluctuations on the market values of its
investments and marketable securities that are classified as available-for-sale
marketable securities. Cash equivalent short-term investments consist primarily
of high quality investment grade instruments, such as commercial paper, which
are not significantly exposed to interest rate risk, except to the extent that
changes in interest rates will ultimately affect the amount of interest income
earned on these investments. The available-for-sale marketable securities are
subject to interest rate risk because these securities generally include
financial instruments such as certificates of deposit, corporate bonds, and U.S.
Treasury securities and agency notes that have an original maturity of greater
than 90 days. Because these instruments are considered highly liquid, they are
not significantly exposed to interest rate risk. However, the market values of
these securities may be affected by changes in prevailing interest rates.
The Company attempts to limit its exposure to interest rate risk primarily
through diversification and strict adherence to the Company's investment policy.
See "Note 1 - Summary of Significant Accounting Policies" to Item 8 - "Financial
Statements." The Company's investment policy is designed to maximize interest
income while preserving its principal investment.
ITEM 8. - FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Financial statements required by Form 10-K are set forth commencing at page F-1
hereof.
ITEM 9. - CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
Not applicable.
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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 1999 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, 1998. 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, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a) (1) Financial statements required by Form 10-K are set forth
commencing on page F-1 hereof.
(a) (2) Financial statement schedules
Schedule II - Valuation and Qualifying Accounts - is set forth at
page F-36 hereof.
(a) (3) 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 November 17, 1998 that
reported that the Company had entered into an agreement to settle all
of the securities class action lawsuits then pending against the
Company. Financial statements were not required or filed.
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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 31st day of March, 1999
EMPLOYEE SOLUTIONS, INC.
By /s/ Quentin P. Smith, Jr.
----------------------------------
Quentin P. Smith, Jr.
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:
Signature Title Date
/s/ Quentin P. Smith, Jr Chairman of the Board, Chief March 31, 1999
- - -----------------------------
Quentin P. Smith, Jr. Executive Officer, President
And Director
/s/ Harvey A. Belfer Director March 31, 1999
- - -----------------------------
Harvey A. Belfer
/s/ Marvin D. Brody Director March 31, 1999
- - -----------------------------
Marvin D. Brody
/s/ David R. Carpenter Director March 29, 1999
- - -----------------------------
David R. Carpenter
/s/ Jeffrey A. Colby Director March 29, 1999
- - -----------------------------
Jeffrey A. Colby
/s/ Sara R. Dial Director March 29, 1999
- - -----------------------------
Sara R. Dial
/s/ James E. Gorman Director March 30, 1999
- - -----------------------------
James E. Gorman
/s/ Robert L. Mueller Director March 27, 1999
- - -----------------------------
Robert L. Mueller
/s/ John V. Prince Chief Financial Officer March 31, 1999
- - -----------------------------
John V. Prince
34
<PAGE>
EMPLOYEE SOLUTIONS, INC.
(THE "REGISTRANT")
EXHIBIT INDEX
TO
REPORT ON FORM 10-K
FOR THE YEAR ENDED DECEMBER 31, 1998
<TABLE>
<CAPTION>
Exhibit Incorporated Herein Filed
Number Description by Reference to Herewith
- - ------ ----------- --------------- --------
<S> <C> <C>
3(i) Registrant's composite Articles of Registrant's Report on
Incorporation, as amended Form 10-K 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 Registrant's Form 10-Q
Bylaws, as amended through April 30, for the quarter ended
1997 March 31, 1997 (March
1997 10-Q)
4.1 Indenture dated October 15, 1997 among Registrant's Current
the Registrant, the Guarantor Report on Form 8-K dated
Subsidiaries (as defined therein) and October 21, 1997
The Huntington National Bank (10/21/97 8-K)
4.2 Purchase Agreement dated October 16, 10/21/97 8-K
1997 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, Registrant's Form 8-A
1998 between the Company and American registration statement
Securities Transfer and Trust, Inc. dated February 19, 1998
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 Registrant's Form 10-KSB
Stock Option Plan, as amended for the fiscal year ended
December 31, 1994 (1994
Form 10-KSB)
10.2* Employee Solutions, Inc. 1995 Stock Registrant's Form 10-Q
Option Plan, as amended through June 2, for the quarter ended
1998 September 30, 1998
(September 1998 10-Q)
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
Exhibit Incorporated Herein Filed
Number Description by Reference to Herewith
- - ------ ----------- --------------- --------
<S> <C> <C>
10.3* Employment Agreement dated March 18, 1996 10-K
1997 Between Registrant and Paul M.
Gales
10.4 Letter Agreement dated March 27, 1997 March 1997 10-Q
(and signed March 30, 1997) between the
Company and Edward L. Cain, Jr.
10.5 Letter Agreement dated March 27, 1997 March 1997 10-Q
(and signed March 31, 1997) between the
Company and Professional Employers
Resource Corporation
10.6 Purchase Agreement between Registrant, Registrant's 10-Q for the
GCK Entertainment Services I, Inc., quarter ended June 30,
Talent Entertainment and Media Services, 1996
Inc. (collectively "TEAM Services") and
the shareholders of TEAM Services
10.6.1 Amendment No. 1 to Purchase Agreement Registrant's 8-K dated
between Registrant, TEAM Services and June 22, 1996 (6/22/96
the shareholders of TEAM Services** 8-K)
10.7* Employment Agreement between Registrant 6/22/96 8-K
and Jeffery Colby*
10.8 Indemnification Agreements between the
Registrant and:
10.8.1* Marvin D. Brody 1996 10-K
10.8.2* Jeffery A. Colby 1996 10-K
10.8.3* Morris C. Aaron (Agreements in this form 1996 10-K
were also entered into between the
Company and each of Paul M. Gales, Mark
J. Gambill, James E. Gorman, John V.
Prince and Bill C. Hollis.)
10.8.4* Henry G. Walker (Agreements in this form 1996 10-K
were also entered into between the
Company and each of Quentin P. Smith,
Jr., Sara R. Dial and David R.
Carpenter)
10.9 Reinsurance Agreement effective as of March 1997 10-Q
May 1, 1995 between Reliance National
Indemnity Company and Reliance Insurance
Company And Camelback Insurance, Ltd.,
including Addendum Number One thereto
10.10* Letter Agreement dated February 27, 1998 Registrant's Form 10-K
between the Company and Ward Phelan for year ended December
31, 1997
10.11* Employment Agreement dated April 16, Registrant's Report on
1998 between Registrant and Mark J. Form 10-Q for the quarter
Gambill ended March 31, 1998
(March 1998 10-Q)
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
Exhibit Incorporated Herein Filed
Number Description by Reference to Herewith
- - ------ ----------- --------------- --------
<S> <C> <C>
10.11.1* Amendment No. 1 to Employment Agreement X
dated March 9, 1999 between Registrant
and Mark J. Gambill
10.12* Second Amended and Restated Employment March 1998 10-Q
Agreement and Amendment to Option
Agreement dated as of April , 1998 by
and among ESI, ESI-EAST, as employer,
and Edward L. Cain, as Employee.
10.13 Asset Purchase, Joint Venture March 1998 10-Q
Termination and Mutual Release Agreement
dated as of April 7, 1998 between ESI,
ESI-EAST, Edward L. Cain and the Edward
L. Cain Agency, Inc.
10.14 Reinsurance Binder for Loss Portfolio March 1998 10-Q
Transfer
10.15* Employment agreement dated as of May 11, September 1998 10-Q
1998 between Registrant and James E.
Gorman
10.16* Memorandum of Understanding dated as of September 1998 10-Q
August 6, 1998 between Registrant and
Marvin D. Brody
10.17* Severance, Release, and Cooperation September 1998 10-Q
Agreement dated as of September 11, 1998
between Registrant and Morris C. Aaron
10.18* Severance Agreement dated July 31, 1997 X
between the Registrant and John V.
Prince
10.19* Employment Agreement dated February 15, X
1999 between the Registrant and Quentin
P. Smith, Jr.
10.20* Employment Agreement dated August 1, X
1996 between Logistics Personnel Corp.,
a subsidiary of the Registrant (LPC) and
Bill C. Hollis
10.21* Amendment to Employment Agreement dated X
March 3, 1999 between the Registrant,
LPC and Bill C. Hollis
21.1 Subsidiaries of Registrant X
23.1 Consent of Arthur Andersen 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.
<PAGE>
ITEM 8. FINANCIAL STATEMENTS
INDEX
Page
----
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS F-2
FINANCIAL STATEMENTS
Consolidated Balance Sheets - December 31, 1998 and 1997 F-3
Consolidated Statements of Operations - For the Years
Ended December 31, 1998, 1997 and 1996 F-4
Consolidated Statements of Stockholders' Equity - For the
Years Ended December 31, 1998, 1997 and 1996 F-5
Consolidated Statements of Cash Flows - For the Years
Ended December 31, 1998, 1997 and 1996 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,
1998 and 1997, and the related consolidated statements of operations,
stockholders' equity and cash flows for each of the three years in the period
ended December 31, 1998. 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, 1998 and 1997, and the results of their
operations and their cash flows for each of the three years in the period ended
December 31, 1998, in conformity with generally accepted accounting principles.
Our audits were made for the purpose of forming an opinion on the basic
financial statements taken as a whole. Schedule II of Part IV, Item 14 herein is
presented for the purpose of complying with the Securities and Exchange
Commission rules and is not part of the basic financial statements. This
schedule has been subjected to the auditing procedures applied in the audits of
the basic financial statements and, in our opinion, fairly states in all
material respects the financial data required to be set forth therein in
relation to the basic financial statements taken as a whole.
Arthur Andersen LLP
Phoenix, Arizona,
March 17, 1999.
F-2
<PAGE>
EMPLOYEE SOLUTIONS, INC.
CONSOLIDATED BALANCE SHEETS
DECEMBER 31, 1998 AND 1997
(In thousands of dollars, except share data)
1998 1997
--------- --------
ASSETS
CURRENT ASSETS:
Cash and cash equivalents $ 39,287 $ 40,110
Investments and marketable securities 9,997 --
Restricted cash and investments 1,088 19,000
Accounts receivable, net 38,742 57,467
Receivables from insurance companies 6,704 7,070
Prepaid expenses and deposits 2,303 4,562
Income taxes receivable 5,040 4,080
Deferred income taxes 811 4,138
--------- --------
Total current assets 103,972 136,427
Property and equipment, net 4,543 3,159
Deferred income taxes 60 485
Goodwill and other assets, net 66,530 67,146
--------- --------
Total assets $ 175,105 $207,217
========= ========
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Bank overdraft $ 13,727 $ --
Accrued salaries, wages and payroll taxes 28,719 43,263
Accounts payable 5,898 4,363
Accrued workers' compensation and health insurance 9,617 24,586
Income taxes payable 751 --
Other accrued expenses 13,595 5,886
--------- --------
Total current liabilities 72,307 78,098
Deferred income taxes 871 517
--------- --------
Long-term debt 85,000 85,000
--------- --------
Other long-term liabilities 1,211 1,213
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, 32,419,595 shares issued and
outstanding in 1998, and 31,683,120 shares
issued and outstanding in 1997 35,800 34,420
(Accumulated deficit) retained earnings (20,085) 7,866
Cumulative unrealized gain on investment securities 1 103
--------- --------
Total stockholders' equity 15,716 42,389
--------- --------
Total liabilities and stockholders' equity $ 175,105 $207,217
========= ========
The accompanying notes are an integral
part of these consolidated balance sheets.
F-3
<PAGE>
EMPLOYEE SOLUTIONS, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
(In thousands of dollars, except share and
per share data) 1998 1997 1996
----------- ----------- -----------
Revenues $ 968,909 $ 933,817 $ 439,016
----------- ----------- -----------
Cost of revenues:
Salaries and wages of worksite
employees 814,453 765,047 341,988
Healthcare and workers' compensation 55,913 75,595 30,234
Payroll and employment taxes 64,318 62,613 28,640
----------- ----------- -----------
Cost of revenues 934,684 903,255 400,862
----------- ----------- -----------
Gross profit 34,225 30,562 38,154
Selling, general and administrative
expenses 49,293 33,411 17,310
Depreciation and amortization 6,145 4,617 2,073
----------- ----------- -----------
Income (loss) from operations (21,213) (7,466) 18,771
Other income (expense):
Interest income 1,885 1,303 833
Interest expense (8,541) (5,102) (1,196)
Other (193) (50) (1)
----------- ----------- -----------
Income (loss) before provision for
income taxes (28,062) (11,315) 18,407
Income tax provision (benefit) (111) (2,819) 6,381
----------- ----------- -----------
Net income (loss) $ (27,951) $ (8,496) $ 12,026
=========== =========== ===========
Net income (loss) per common and
common equivalent share:
Basic $ (.88) $ (.27) $ .40
=========== =========== ===========
Diluted $ (.88) $ (.27) $ .37
=========== =========== ===========
Weighted average number of common and
common equivalent shares outstanding:
Basic 31,817,176 31,193,367 30,224,357
=========== =========== ===========
Diluted 31,817,176 31,193,367 32,167,777
=========== =========== ===========
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, 1998, 1997, AND 1996
<TABLE>
<CAPTION>
Retained Cumulative
Earnings Unrealized Total Comprehensive
(In thousands of dollars, Common (Accumulated Treasury Gain on Stockholders' Income
except share data) Stock Deficit) Stock Investments Equity (Loss)
------------------ ----- -------- ----- ----------- ------ ------
<S> <C> <C> <C> <C> <C> <C>
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 common 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 12,026
------- -------- ----- ----- -------- --------
COMPREHENSIVE INCOME $ 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 -- -- -- 103 103 103
Net loss -- (8,496) -- -- (8,496) (8,496)
------- -------- ----- ----- -------- --------
COMPREHENSIVE LOSS $ (8,393)
========
BALANCE, DECEMBER 31, 1997 34,420 7,866 -- 103 42,389 --
Issuance of 625,000 shares of common
stock and 200,000 warrants
in connection with acquisitions 1,111 -- -- -- 1,111 --
Issuance of 111,475 shares of common
stock in connection with exercise of
common stock options 199 -- -- -- 199 --
Tax benefit related to the exercise of
stock options 70 -- -- -- 70 --
Change in unrealized net gains,
net of applicable taxes -- -- -- (102) (102) (102)
Net loss -- (27,951) -- -- (27,951) (27,951)
------- -------- ----- ----- -------- --------
COMPREHENSIVE LOSS $(28,053)
========
BALANCE, DECEMBER 31, 1998 $35,800 $(20,085) $ -- $ 1 $ 15,716
======= ======== ===== ===== ========
</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, 1998, 1997 AND 1996
(In thousands of dollars) 1998 1997 1996
--------- --------- ---------
CASH FLOWS FROM OPERATING ACTIVITIES:
Cash received from customers $ 987,634 $ 911,189 $ 414,256
Cash paid to suppliers and employees (980,636) (896,812) (411,438)
Cash paid in loss portfolio transfer (19,950) -- --
Interest received 1,885 1,303 833
Interest paid (8,640) (5,152) (1,196)
Income taxes refunded (paid), net 4,008 (3,315) (5,772)
--------- --------- ---------
Net cash provided by (used in)
operating activities (15,699) 7,213 (3,317)
--------- --------- ---------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of property and equipment (2,749) (2,499) (702)
Business acquisitions (3,267) (5,024) (37,251)
Purchase of investments, net (9,997) -- --
Cash (invested in) released from
restricted accounts, net 17,912 (7,500) (8,757)
Issuance of notes receivable and other, net -- -- (189)
Disbursements for deferred costs (723) -- --
--------- --------- ---------
Net cash provided by (used in)
investing activities 1,176 (15,023) (46,899)
--------- --------- ---------
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 (226) (3,285) (515)
Proceeds from issuance of common stock 199 502 7,786
Increase (decrease) in bank overdraft
and other 13,727 (2,477) (2,904)
--------- --------- ---------
Net cash provided by financing
activities 13,700 36,940 47,167
--------- --------- ---------
Net increase (decrease) in cash and
cash equivalents (823) 29,130 (3,049)
CASH AND CASH EQUIVALENTS, beginning of year 40,110 10,980 14,029
--------- --------- ---------
CASH AND CASH EQUIVALENTS, end of year $ 39,287 $ 40,110 $ 10,980
========= ========= =========
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, 1998, 1997 AND 1996
(CONTINUED)
1998 1997 1996
-------- -------- --------
RECONCILIATION OF NET INCOME (LOSS)
TO NET CASH PROVIDED BY (USED IN)
OPERATING ACTIVITIES:
Net income (loss) $(27,951) $(8,496) $ 12,026
-------- ------- --------
ADJUSTMENTS TO RECONCILE NET INCOME (LOSS)
TO NET CASH PROVIDED BY (USED IN)
OPERATING ACTIVITIES:
Depreciation and amortization 6,145 4,617 2,073
Loss on sale of fixed assets 193 -- --
Write-off of deferred acquisition costs 772 -- --
Other non-cash charges 1,200 58 --
Decrease (increase) in accounts receivable, net 18,725 (22,628) (24,760)
Decrease (increase) in receivables from
insurance companies 366 (1,152) (5,832)
Decrease (increase) in prepaid expenses
and deposits 2,259 (3,304) (736)
Decrease (increase) in deferred income
taxes, net 4,106 (2,522) (539)
Decrease (increase) in other assets 166 (805) (2,532)
(Decrease) increase in accrued salaries,
wages and payroll taxes (14,544) 25,677 10,905
(Decrease) increase in accrued workers'
compensation and health insurance (14,969) 17,659 4,464
(Decrease) increase in other long-term
liabilities (2) (136) 1,349
Increase (decrease) in accounts payable 1,535 285 (2,038)
(Decrease) increase in income taxes
payable/receivable (209) (3,612) 1,148
Increase in other accrued expenses 6,509 1,572 1,155
-------- ------- --------
12,252 15,709 (15,343)
-------- ------- --------
Net cash provided by (used in)
operating activities $(15,699) $ 7,213 $ (3,317)
======== ======= ========
SUPPLEMENTAL DISCLOSURE OF NON-CASH INVESTING AND FINANCING ACTIVITIES:
During the year ended December 31, 1996, certain notes receivable from
officers/directors were repaid with the Company's common stock owned by these
individuals in the amount of $157,000. There were no activities of this type in
1997 or 1998.
In connection with business acquisitions during 1998, 1997 and 1996, the Company
assumed net liabilities of $300,000, $900,000 and $5.5 million and issued
$813,000, $2.6 million and $4.3 million of common stock, respectively. In 1998,
$298,000 of warrants were also issued.
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, 1998, 1997 AND 1996
(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, 1998, ESI serviced approximately 2,000 client companies with
approximately 40,800 worksite employees in 47 states.
In 1995 the Company began to offer employers stand-alone risk
management/workers' compensation services. At December 31, 1997, this program
served approximately 83 additional employers, and no additional stand-alone
services were sold during 1998. At December 31,1998, there were no remaining
policies in effect.
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 34%, represents
the largest concentration of customers, including one former customer that
generated approximately 20% and 13% of total revenues in 1997 and 1998.
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 when purchased. All cash equivalents
are invested in high quality investment grade instruments, such as commercial
paper, at December 31, 1998 and 1997, and are stated at fair market value.
Substantially all cash and cash equivalents, including restricted cash and
investments, are not insured at December 31, 1998.
RESTRICTED CASH AND INVESTMENTS
Prior to January 1, 1998, the Company was partially self-insured for workers'
compensation risks. Under such programs, at December 31, 1997, its "fronting"
carriers required an estimated $19 million 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 were 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.
F-8
<PAGE>
At December 31, 1998, restricted cash was approximately $1.1 million, which
represented amounts held for settlement of a legal matter (see footnote 10).
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 (SFAS) No. 115,
"Accounting for Investments in Certain Debt and Equity Securities."
INVESTMENTS AND MARKETABLE SECURITIES
At December 31, 1998, the Company maintained approximately $16.8 million of
investments in its cash and cash equivalents and investments and marketable
securities 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, money market and mutual funds
that had an estimated fair value of $6.8 million at December 31, 1998.
Securities with original maturities greater than 90 days consisted of $600,000
in certificates of deposit, $4.0 million in commercial paper, $4.1 million in
corporate bonds and $1.3 million in U.S. Treasury securities and agency notes
and had an estimated fair value of $10 million at December 31, 1998.
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, 1998 and 1997, the Company had receivables from its fronting
companies of $6.7 million and $7.1 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.
The Company is engaged in negotiations with the principal carrier under its
pre-1998 workers' compensation program concerning various issues associated with
closing out such program. During the course of the negotiations, the carrier has
taken the position that amounts are due from the Company to the carrier. The
negotiations are in a preliminary phase and the parties have not reached
agreement on the extent of the Company's liability, if any, to the carrier.
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) 1998 1997
-------- --------
Trade accounts receivable $ 27,130 $ 23,015
Unbilled salary
and wage accruals 11,921 31,513
Unbilled stand alone premium revenue 1,985 657
Other, including affiliated parties 2,628 3,386
Allowance for estimated
uncollectible receivables (4,922) (1,104)
-------- --------
Total accounts receivable, net $ 38,742 $ 57,467
======== ========
At December 31, 1998 and 1997, receivables from affiliated parties included in
the above totals were $2.2 million and $2.9 million, respectively.
F-9
<PAGE>
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 $1,681,000 and $861,000 at December 31, 1998 and
1997, respectively.
GOODWILL AND OTHER ASSETS
Included in goodwill and other assets is $65.2 million and $64.1 million at
December 31, 1998 and 1997, 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, 1998, goodwill of $26 million is being amortized over 30 years, $38.4
million over 15 years and $800,000 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 $10.2 million
and $6.5 million at December 31, 1998 and 1997, respectively.
Also included in goodwill and other assets at December 31, 1998 and 1997 is $1.4
million and $2.9 million, respectively, 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 commenced litigation proceedings to collect the outstanding
premium.
BANK OVERDRAFT
Bank overdraft represents outstanding checks in excess of cash on hand at the
applicable bank, and generally result from timing differences in the transfer of
funds between banks. Historically, these checks are covered when presented for
payment through the transfer of funds from other Company cash accounts held in
other banks.
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.
F-10
<PAGE>
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 $2.1 and $3.6
million at December 31, 1998 and 1997, respectively.
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. A
valuation allowance is provided against deferred tax assets which, in the
opinion of management, do not meet the "more likely than not" criteria of
statement of Financial Accounting Standards No. 109. Because of recent operating
losses, a valuation allowance of $9.2 million was provided in 1998. See Note 4.
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 has been restated to conform to the 1997 and
1998 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:
<TABLE>
<CAPTION>
(In thousands of dollars, except share and per share data)
1998 1997 1996
------------------------- ------------------------- ------------------------
Basic Diluted Basic Diluted Basic Diluted
<S> <C> <C> <C> <C> <C> <C>
Weighted average of
common shares outstanding 31,817,176 31,817,176 31,193,367 31,193,367 30,224,357 30,224,357
Dilutive effect of options
and warrants outstanding -- -- -- -- -- 1,943,420
----------- ----------- ----------- ----------- ----------- -----------
Weighted average of
common and common
equivalent shares 31,817,176 31,817,176 31,193,367 31,193,367 30,224,357 32,167,777
=========== =========== =========== =========== =========== ===========
Net income (loss) $ (27,951) $ (27,951) $ (8,496) $ (8,496) $ 12,026 $ 12,026
Adjustments to net income -- -- -- -- -- --
----------- ----------- ----------- ----------- ----------- -----------
Adjusted net income for
purposes of the income per
common share calculation $ (27,951) $ (27,951) $ (8,496) $ (8,496) $ 12,026 $ 12,026
=========== =========== =========== =========== =========== ===========
Net income per common and
common equivalent share $ (0.88) $ (0.88) $ (0.27) $ (0.27) $ 0.40 $ 0.37
=========== =========== =========== =========== =========== ===========
</TABLE>
The calculation of weighted average common and common equivalent shares for
purposes of calculating the 1998 and 1997 diluted earnings per share excludes
approximately 2,163,506 and 1,951,049, respectively, 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:
December 31,
---------------------------------------------
1998 1997
--------------------- ---------------------
(In thousands of dollars) Carrying Estimated Carrying Estimated
Amount Fair Value Amount Fair Value
------ ---------- ------ ----------
Financial Assets
Cash and cash equivalents $39,287 $39,287 $40,110 $40,110
Investments and marketable
securities 9,997 9,997 -- --
Restricted cash and investments 1,088 1,088 19,000 19,000
Other financial assets, primarily
accounts receivable 46,834 46,834 67,550 67,550
Financial Liabilities
Bank overdraft 13,727 13,727 -- --
Long-term debt 85,000 60,350 85,000 82,025
Other financial liabilities,
primarily accrued liabilities 59,040 59,040 79,311 79,311
Financial instruments other than long-term debt approximate fair value because
of their short-term duration. The value of long-term debt is based on market
quotes.
(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
------------ ------
1999 $1,775
2000 1,601
2001 1,526
2002 1,436
2003 1,423
Thereafter 348
------
Total $8,109
======
Rental expense under all leases was $2.5 million, $1.9 million, and $734,000 in
1998, 1997 and 1996, respectively.
F-13
<PAGE>
(4) INCOME TAXES:
The components of the provision for income taxes for the years ended December
31, 1998, 1997 and 1996 were as follows:
(In thousands of dollars) 1998 1997 1996
-------- -------- --------
Current $(4,217) $ (297) $6,935
Deferred 4,106 (2,522) (554)
------- ------- ------
Income tax provision (benefit) $ (111) $(2,819) $6,381
======= ======= ======
Income tax expense differs from the amount computed using the statutory federal
income tax rate due to the following:
(In thousands of dollars) 1998 1997 1996
------- ------- ------
Income tax expense (benefit) at statutory rate $(9,822) $(3,847) $6,442
Increase in valuation allowance 9,188 -- --
Non-deductible goodwill amortization 352 271 197
Non-deductible per diem and other expenses 193 336 41
State taxes, net of federal benefit 34 451 179
Change in estimate related to 1995 state taxes -- -- (430)
Other (56) (30) (48)
------- ------- ------
Income tax provision (benefit) $ (111) $(2,819) $6,381
======= ======= ======
Deferred tax assets and liabilities are comprised of the following temporary
differences at December 31:
1998 1997
--------------------- ---------------------
Long-term Long-term
Current Assets Current Assets
(In thousands of dollars) Assets (Liabilities) Assets (Liabilities)
------ ------------- ------ -----
Depreciation and amortization $ -- $(871) $ -- $(517)
Reserves not deductible
for tax purposes 9,404 655 4,138 485
Valuation allowance (8,593) (595) -- --
------- ------ ------ -----
$ 811 $(811) $4,138 $ (32)
======= ===== ====== =====
F-14
<PAGE>
(5) LONG-TERM DEBT:
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 $3.5 million, which is included in other assets, and will amortize
such costs over the life of the Notes. In April 1998, the Company completed an
exchange offer for these notes which was registered under the Securities Act.
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, repurchases of Company shares and the incurrence of new 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, 1998 and 1997, and the results of
operations and cash flows for each of the three years in the period ended
December 31, 1998, of Employee Solutions, Inc. (Parent), the guarantor
subsidiaries (Guarantors) and the subsidiaries which are not guarantors
(Non-guarantors).
F-15
<PAGE>
BALANCE SHEETS
<TABLE>
<CAPTION>
For the Year Ended December 31, 1998
------------------------------------------------------------
Non-
(In thousands of dollars) Parent Guarantors Guarantors Eliminating Consolidated
------ ---------- ---------- ----------- ------------
<S> <C> <C> <C> <C> <C>
ASSETS
CURRENT ASSETS:
Cash and cash equivalents $ 8,176 $24,503 $ 6,608 $ -- $ 39,287
Investments and marketable securities 9,997 -- -- -- 9,997
Restricted cash and
investments 1,088 -- -- -- 1,088
Accounts receivable, net 15,460 22,495 787 -- 38,742
Receivables from insurance
companies -- -- 6,704 -- 6,704
Prepaid expenses and deposits 1,532 753 18 -- 2,303
Income taxes receivable 5,040 -- -- -- 5,040
Deferred income taxes 811 -- -- -- 811
Due from affiliates 7,789 2,711 (6,726) (3,774) --
-------- ------- -------- -------- --------
Total current assets 49,893 50,462 7,391 (3,774) 103,972
Property and equipment, net 4,213 314 16 -- 4,543
Deferred income taxes 60 -- -- -- 60
Goodwill and other assets, net 34,044 32,208 278 -- 66,530
Investment in subsidiaries 36,005 -- -- (36,005) --
-------- ------- -------- -------- --------
Total assets $124,215 $82,984 $ 7,685 $(39,779) $175,105
======== ======= ======== ======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Bank overdraft $ 308 $13,419 $ -- $ -- $ 13,727
Accrued salaries, wages and
payroll taxes 5,932 22,167 620 -- 28,719
Accounts payable 1,584 1,051 3,263 -- 5,898
Accrued workers' compensation
and health insurance 3,141 618 5,858 -- 9,617
Income taxes payable 751 -- -- -- 751
Other accrued expenses 9,123 2,316 2,156 -- 13,595
Due to affiliates 1,789 16,030 (14,045) (3,774) --
-------- ------- -------- -------- --------
Total current liabilities 22,628 55,601 (2,148) (3,774) 72,307
-------- ------- -------- -------- --------
Deferred income taxes 871 -- -- -- 871
-------- ------- -------- -------- --------
Long-term debt 85,000 -- -- -- 85,000
-------- ------- -------- -------- --------
Other long-term liabilities -- 1,211 -- -- 1,211
-------- ------- -------- -------- --------
Commitments and contingencies
STOCKHOLDERS' EQUITY
Class A convertible preferred stock -- -- -- -- --
Common stock, no par value 35,800 2,622 771 (3,393) 35,800
Additional paid in capital -- 26,342 50 (26,392) --
(Accumulated deficit) retained earnings (20,085) (2,792) 9,012 (6,220) (20,085)
Unrealized gain on investments 1 -- -- -- 1
-------- ------- -------- -------- --------
Total stockholders' equity 15,716 26,172 9,833 (36,005) 15,716
-------- ------- -------- -------- --------
Total liabilities and stockholders'
equity $124,215 $82,984 $ 7,685 $(39,779) $175,105
======== ======= ======== ======== ========
</TABLE>
F-16
<PAGE>
<TABLE>
<CAPTION>
For the Year Ended December 31, 1997
------------------------------------------------------------
Non-
(In thousands of dollars) 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
Receivables 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 assets 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 AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
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-17
<PAGE>
<TABLE>
<CAPTION>
STATEMENTS OF OPERATIONS
For the Year Ended December 31, 1998
------------------------------------------------------------
Non-
(In thousands of dollars) Parent Guarantors Guarantors Eliminating Consolidated
------ ---------- ---------- ----------- ------------
<S> <C> <C> <C> <C> <C>
Revenues $ 265,523 $ 670,874 $ 34,201 $ (1,689) $ 968,909
--------- --------- -------- -------- ---------
Cost of revenues:
Salaries and wages of
worksite employees 221,615 563,715 29,123 -- 814,453
Healthcare and workers'
compensation 14,913 39,028 1,972 -- 55,913
Payroll and employment taxes 20,362 41,079 2,877 -- 64,318
--------- --------- -------- -------- ---------
Cost of revenues 256,890 643,822 33,972 -- 934,684
--------- --------- -------- -------- ---------
Gross profit 8,633 27,052 229 (1,689) 34,225
Selling, general and
administrative expenses 12,951 33,652 2,690 -- 49,293
Intercompany selling, general
and administrative expense 769 821 99 (1,689) --
Depreciation and amortization 4,518 1,599 28 -- 6,145
--------- --------- -------- -------- ---------
Loss from operations (9,605) (9,020) (2,588) -- (21,213)
Other income (expense):
Interest income 1,159 169 557 -- 1,885
Interest expense and other (9,033) (3) 302 -- (8,734)
--------- --------- -------- -------- ---------
Loss before benefit
for income taxes (17,479) (8,854) (1,729) -- (28,062)
Income tax benefit, net -- (92) (19) -- (111)
--------- --------- -------- -------- ---------
(17,479) (8,762) (1,710) -- (27,951)
Income from wholly-owned
subsidiaries (10,472) -- -- 10,472 --
--------- --------- -------- -------- ---------
Net loss $ (27,951) $ (8,762) $ (1,710) $ 10,472 $ (27,951)
========= ========= ======== ======== =========
</TABLE>
F-18
<PAGE>
<TABLE>
<CAPTION>
For the Year Ended December 31, 1997
------------------------------------------------------------
Non-
(In thousands of dollars) 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
(benefit) 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-19
<PAGE>
<TABLE>
<CAPTION>
For the Year Ended December 31, 1996
------------------------------------------------------------
Non-
(In thousands of dollars) 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 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 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 $ 12,026 $ 1,677 $ 9,143 $(10,820) $ 12,026
========= ========= ======== ======== =========
</TABLE>
F-20
<PAGE>
<TABLE>
<CAPTION>
STATEMENTS OF CASH FLOWS
For the Year Ended December 31, 1998
------------------------------------------------------------
Non-
(In thousands of dollars) Parent Guarantors Guarantors Eliminating Consolidated
------ ---------- ---------- ----------- ------------
<S> <C> <C> <C> <C> <C>
RECONCILIATION OF NET LOSS TO
NET CASH PROVIDED BY (USED IN)
OPERATING ACTIVITIES:
Net loss $(27,951) $ (8,762) $ (1,710) $ 10,472 $(27,951)
-------- -------- -------- -------- --------
ADJUSTMENTS TO RECONCILE NET
LOSS TO NET CASH PROVIDED
BY (USED IN) OPERATING
ACTIVITIES:
Depreciation and amortization 4,518 1,599 28 -- 6,145
Loss on sale of assets 192 -- 1 -- 193
Write-off of deferred acquisition costs 772 -- -- -- 772
Other non-cash expenses 1,200 -- -- -- 1,200
Decrease in accounts receivable, net 5,362 11,865 1,498 -- 18,725
(Increase) decrease in receivables
from insurance companies -- 5,430 (5,064) -- 366
Decrease in prepaid expenses and deposits 1,290 712 257 -- 2,259
Decrease in deferred income taxes, net 4,106 -- -- -- 4,106
Decrease in other assets 165 -- 1 -- 166
(Decrease) increase from inter-
company transactions 20,000 (8,726) (802) (10,472) --
Increase (decrease) in accrued
salaries, wages, and payroll taxes (14,321) 745 (968) -- (14,544)
Increase (decrease) in accrued workers'
Compensation and healthcare 1,529 (1,593) (14,905) -- (14,969)
Decrease in other long-term liabilities -- (2) -- -- (2)
Increase (decrease) in accounts payable 502 (1,267) 2,300 -- 1,535
Decrease in income taxes payable/receivable (209) -- -- -- (209)
Increase (decrease) in other
accrued expenses 5,311 (225) 1,423 -- 6,509
-------- -------- -------- -------- --------
30,417 8,538 (16,231) (10,472) 12,252
-------- -------- -------- -------- --------
Net cash provided by (used in)
operating activities 2,466 (224) (17,941) -- (15,699)
-------- -------- -------- -------- --------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of property and equipment (2,566) (184) 1 -- (2,749)
Business acquisitions (2,889) (356) (22) -- (3,267)
Purchase of investments, net (9,997) -- -- -- (9,997)
Cash invested in restricted cash
and investments (1,088) -- 19,000 -- 17,912
Disbursements for deferred costs (723) -- -- -- (723)
-------- -------- -------- -------- --------
Net cash provided by (used in)
Investing activities (17,263) (540) 18,979 -- 1,176
-------- -------- -------- -------- --------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from issuance of common stock 199 -- -- -- 199
Payment of deferred loan costs (226) -- -- -- (226)
Increase in bank overdraft 308 13,419 -- -- 13,727
-------- -------- -------- -------- --------
Net cash provided by
financing activities 281 13,419 -- -- 13,700
-------- -------- -------- -------- --------
Net increase (decrease) in cash and cash
equivalents (14,516) 12,655 1,038 -- (823)
CASH AND CASH EQUIVALENTS,
beginning of year 22,692 11,848 5,570 -- 40,110
-------- -------- -------- -------- --------
CASH AND CASH EQUIVALENTS,
end of year $ 8,176 $ 24,503 $ 6,608 $ -- $ 39,287
======== ======== ======== ======== ========
</TABLE>
F-21
<PAGE>
<TABLE>
<CAPTION>
For the Year Ended December 31, 1997
------------------------------------------------------------
Non-
(In thousands of dollars) 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 (LOSS) 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 receivables
from insurance companies -- (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 healthcare 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
Payment 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 year 2,435 6,747 1,798 -- 10,980
-------- -------- -------- -------- --------
CASH AND CASH EQUIVALENTS,
end of year $ 22,692 $ 11,848 $ 5,570 $ -- $ 40,110
======== ======== ======== ======== ========
</TABLE>
F-22
<PAGE>
<TABLE>
<CAPTION>
For the Year Ended December 31, 1996
------------------------------------------------------------
Non-
(In thousands of dollars) 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 $ 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 receivables
from insurance companies 86 (3,157) (2,761) -- (5,832)
Increase in prepaid expenses and
deposits (486) (129) (121) -- (736)
(Increase) decrease in deferred
income taxes, 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 healthcare (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/receivable 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 year 12,185 79 1,765 -- 14,029
-------- -------- -------- -------- --------
CASH AND CASH EQUIVALENTS,
end of year $ 2,435 $ 6,747 $ 1,798 $ -- $ 10,980
======== ======== ======== ======== ========
</TABLE>
F-23
<PAGE>
(6) 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 1996, 1997 and 1998 was as follows:
Weighted-
average
Number Exercise
of Warrants Price
----------- -----
Outstanding at December 31, 1996 120,000 1.88
=======
Outstanding at December 31, 1997 120,000 1.88
=======
Granted 200,000 2.13
-------
Outstanding at December 31, 1998 320,000 1.93
=======
The number of warrants exercisable were 120,000 at each respective year-end. Of
the remaining outstanding warrants, 120,000 expire on January 2, 1999 and
200,000 expire on November 30, 2008.
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 4,500,000, respectively. The Company has
granted options of 1,096,659 shares and 3,584,285 shares under the 1993 and 1995
plans, respectively, through December 31, 1998. 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 over
F-24
<PAGE>
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,
1998:
Weighted-
average
Number Exercise
of Options Price
---------- -----
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
Granted 2,030,770 3.26
Exercised (101,475) 1.75
Canceled (1,727,644) 6.60
----------
Outstanding at December 31, 1998 3,594,900 3.50
==========
Exercisable options as of:
December 31, 1996 791,843 2.57
December 31, 1997 1,204,088 4.23
December 31, 1998 2,012,030 3.72
Available for future grants
at December 31, 1998 1,019,056
F-25
<PAGE>
The following table is a summary of selected information for the Company's
compensatory stock option plans:
December 31, 1998
-----------------------------------------------
Weighted-
average Weighted-
Remaining average
Contractual Exercise
Life (Yrs.mths) Number Price
--------------- ------ -----
RANGE OF EXERCISE PRICES
1993 Stock Option Plan
$1.84 - $3.31
Options outstanding 1.4 269,706 $ 2.57
Options exercisable 269,706 2.57
$7.56
Options outstanding 2.0 40,000 7.56
Options exercisable 40,000 7.56
1995 Stock Option Plan
$1.81 - $3.94
Options outstanding 5.6 2,721,099 2.40
Options exercisable 1,406,674 2.53
$4.31 - $5.72
Options outstanding 7.0 306,595 5.06
Options exercisable 123,983 4.71
$10.50 - $21.25
Options outstanding 2.5 257,500 13.71
Options exercisable 171,667 13.71
The weighted average fair value of options granted under the 1993 and 1995 Stock
Option Plans was $3.29, $4.46 and $6.10 for 1998, 1997 and 1996, 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. The Company measures the compensation costs of
its employee stock option plan using the intrinsic value based method of
accounting prescribed in APB 25. Accordingly, no compensation cost has been
recognized for stock options granted under the 1993 or 1995 Stock Option Plans.
F-26
<PAGE>
Net income (loss) and earnings (loss) per share would have been changed to the
pro forma amounts indicated below:
(In thousands of dollars, except Year Ended December 31,
per share data) ---------------------------------
1998 1997 1996
--------- -------- ---------
Net income (loss):
As reported $(27,951) $ (8,496) $12,026
Pro forma (30,943) (10,569) 13,233
Basic earnings (loss) per share:
As reported (.88) (.27) .40
Pro forma (.97) (.34) .44
Diluted earnings (loss) per share:
As reported (.88) (.27) .37
Pro forma (.97) (.34) .41
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 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 1998: risk-free interest rate of 4.90%;
expected dividend yield of 0%; expected option term of 2 years; and expected
volatility of 117%. The following weighted average assumptions were used for
grants in 1997 and 1996: risk-free interest rate of 5.92% and 5.98%,
respectively; expected dividend yield of 0%; expected lives of 2 years; and
expected volatility of 98% and 67%, respectively.
The Company adopted an Employee Stock Purchase Plan effective March 1999.
Participating employees are permitted to acquire shares of the Company's common
stock through payroll deduction at a 15% discount from the average trading price
during the 10 days prior to implementation of the plan or the 10 days prior to
the expiration of the plan in January 2000, whichever price is lower. The
Company has reserved 500,000 shares of its Common Stock for issuance under the
plan.
F-27
<PAGE>
(7) SEGMENT INFORMATION
The Company, in relation to SFAS No. 131 "Disclosure About Segments of an
Enterprise and Related Information," has defined the following five reportable
segments: Core PEO services, Logistics Personnel Corp, TEAM Services and
Stand-Alone Workers' Compensation services and US Xpress.
The Company, through its Core PEO segment, provides a full-range of services and
products to its customers. Typically, ESI becomes the "employer of record" for
the client company's employees and provides payroll administration, workers'
compensation insurance and risk management administration, human resources
administration and benefits programs. Additionally, other products and services
are offered directly to worksite employees, such as employee payroll deduction
programs for disability and specialty health insurance, debit cards, prepaid
telephone cards and other personal financial services.
Formerly, the Company provided its Core PEO services to US Xpress, a large
transportation company. US Xpress was the Company's largest customer with
approximately 6,200 worksite employees. The Company terminated its subscriber
service agreement with US Xpress effective August 19, 1998.
Logistics Personnel Corp (LPC) provides specialized leasing of all types of
distribution personnel, including drivers, warehouse workers, mechanics,
dispatchers, forklift operators and administrators. A full range of services,
including employee recruiting, hiring and management; payroll administration;
claims and audit handling; workers' compensation insurance coverage; employee
benefits programs and tax reporting is provided to its customers.
TEAM Services specializes in leasing commercial talent (actors and actresses),
musicians and recording engineers to the music and advertising segments of the
entertainment industry. In addition, TEAM generates revenue from touring bands
with the entertainment industry.
The Company, formerly through its Stand-Alone Workers' Compensation segment,
provided its workers' compensation program to non-PEO customers on a stand-alone
basis. Based on a change in business strategy as of 1998, the Company will no
longer market new stand-alone policies. This change is the result of a
determination 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 accounting policies of the segments are the same as those described in the
summary of significant accounting policies.
F-28
<PAGE>
Information concerning revenue, gross profit and assets by business segment was
as follows (in thousands):
For the Year Ended December 31,
----------------------------------
1998 1997 1996
-------- -------- --------
REVENUE
Core PEO $569,394 $532,761 $347,219
US Xpress 121,323 180,403
LPC 102,218 122,550 42,739
TEAM 174,109 87,764 32,525
Stand-Alone 1,865 10,339 16,532
-------- -------- --------
Consolidated Total 968,909 933,817 439,016
-------- -------- --------
GROSS PROFIT
Core PEO 23,713 17,749 22,842
US Xpress (66) 541
LPC 9,919 8,981 4,874
TEAM 2,029 1,742 881
Stand-Alone (1,370) 1,549 9,557
-------- -------- --------
Total 34,225 30,562 38,154
SELLING, GENERAL AND ADMINISTRATIVE EXPENSE 49,293 33,411 17,310
DEPRECIATION AND AMORTIZATION 6,145 4,617 2,073
-------- -------- --------
INCOME/(LOSS) FROM OPERATIONS (21,213) (7,466) 18,771
-------- -------- --------
OTHER INCOME/(EXPENSE)
Interest income 1,885 1,303 833
Interest expense (8,541) (5,102) (1,196)
Other (193) (50) (1)
-------- -------- --------
INCOME/(LOSS) BEFORE PROVISION FOR
INCOME TAXES (28,062) (11,315) 18,407
INCOME TAX PROVISION (BENEFIT) (111) (2,819) 6,381
-------- -------- --------
NET INCOME (LOSS) $(27,951) $ (8,496) $ 12,026
======== ======== ========
DEPRECIATION AND AMORTIZATION
Core PEO $ 5,062 $ 3,608 $ 1,638
LPC 927 883 379
TEAM 153 121 53
Stand-Alone 3 5 3
-------- -------- --------
Consolidated Total $ 6,145 $ 4,617 $ 2,073
======== ======== ========
TOTAL ASSETS
Core PEO $ 94,540 $106,512 $ 58,727
LPC 35,192 36,825 36,302
TEAM 29,380 14,926 4,329
Stand-Alone 15,993 48,954 26,611
-------- -------- --------
Consolidated Total $175,105 $207,217 $125,969
======== ======== ========
F-29
<PAGE>
(8) 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 to SFAS No. 128):
<TABLE>
<CAPTION>
(In thousands of dollars, except share and per share data)
Quarter Ended
------------------------------------------------------
March 31, June 30, September 30, December 31,
--------- -------- ------------- ------------
<S> <C> <C> <C> <C>
1998
Revenues $ 220,930 $ 254,399 $ 231,636 $ 261,944
Gross profit 9,466 8,471 8,970 7,318
Basic
Net loss (905) (5,722) (7,168) (14,156)
Weighted average shares 31,701,036 31,766,725 31,792,787 32,005,193
Net loss per share (.03) (.18) (.23) (.44)
Diluted
Net loss (905) (5,722) (7,168) (14,156)
Weighted average shares 31,701,036 31,766,725 31,792,787 32,005,193
Net loss per share (.03) (.18) (.23) (.44)
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)
</TABLE>
(9) ACQUISITIONS:
ACQUISITION OF FIDELITY RESOURCES CORPORATION
Effective December 1, 1998, the Company acquired Fidelity Resources Corporation
(Fidelity), a PEO services company by issuing 625,000 restricted shares of the
Company's common stock, valued at $1.30 per share ($2.00 less a 35% discount for
the lack of marketability of the restricted shares). If the price of the
Company's common stock (based on the average price during the 20 days prior to
the first anniversary of the closing date (the "Anniversary Price")) is less
than $4.00, the Company will provide additional cash consideration or issue
additional restricted shares (or a combination thereof) in an amount sufficient
so that the aggregate value of the 625,000 shares (valued at the Anniversary
Price) plus such additional consideration equals $2.5 million. Subject to
meeting gross profit targets on a specific client prior to July 1, 2000, the
Company also agreed to provide up to $500,000 of additional consideration in the
form of cash or additional restricted shares (valued at the Anniversary Price).
The Company also issued warrants to purchase up to 200,000 shares of its common
stock that become exercisable at $2.125 per share if earnings targets are
achieved in each of the three years following the closing of the acquisition.
INVESTMENT IN IPEO
At December 31, 1998, accounts receivable includes a $300,000 short-term
convertible secured promissory note receivable from PEO Partners, Inc. d/b/a
IPEO ("IPEO"). In 1999 the Company has subsequently entered into an alliance
with IPEO, an Internet-based professional employer organization targeting
technology and technical service firms. On January 22, 1999, the Company
acquired $1 million of Series B Preferred Stock at $.75 per share, through
conversion of the promissory note and an additional payment of $668,923.
F-30
<PAGE>
ACQUISITION OF K.W.M. CORPORATION
In July 1998, the Company acquired K. W. M. Corporation, a personnel leasing
company specializing in driver leasing services based in City of Industry,
California. The total purchase price was $560,000, of which $220,000 was paid at
closing, and $340,000 is due to be paid on April 5, 1999.
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. Additionally, the Company agreed to issue additional
restricted shares to be determined based upon ERC earnings after the
acquisition. The parties are concluding the calculation of the number of such
additional shares, which will be valued based on the average closing price
during the one-year period following the closing of the acquisition. From 1995
to the date of acquisition, the Company had operated under an agreement whereby
PCM provided certain check processing services for the Company. The acquisition
of ERC added 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
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 had been recorded as goodwill. An interim payment of $500,000 toward the
final purchase price was paid nine months after the closing. During 1998 interim
payments of $250,000 were advanced towards the purchase price, and on October
15, 1998 a final payment was made in the amount of $625,000. CMGR was 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 was due on or
before April 30, 1998, and was to have been paid in cash. See Note 10 for a
description of the dispute that has arisen related to the purchase. ETIC was 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
F-31
<PAGE>
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. The final
settlement was completed on January 6, 1999, and resulted in a reduction of the
final purchase price in the amount of $156,945. McClary-Trapp Companies leased
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.
ACQUISITION OF EMPLOYEE SOLUTIONS-EAST, INC. (ESEI)
Effective January 1, 1996, the Company completed its acquisition of ESEI. The
base purchase price consisted 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.
F-32
<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 and per 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
(10) 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, 1998, the compounded interest totaled
approximately $252,000.
The State of New York has asserted that the Company is a successor for state
unemployment insurance (SUI) purposes to certain entities from which the Company
acquired limited assets in connection with the Hazar acquisition effective
January 1996. The State further asserts that the Company was subject to
increased tax rates during 1996 and 1997 as a result of successor status. The
liabilities asserted are approximately $500,000. The Company is appealing the
determination.
The State of Ohio has issued a preliminary assessment of $5.2 million (plus
penalty) relating to sales taxes potentially applicable to certain types of
services. While the Company believes that no tax ultimately will be payable
based on the preliminary assessment, there can be no assurance that this will be
the case.
The Company and certain of its present and former directors and executive
officers were named as defendants in ten actions filed between March 1997 and
May 1997. While the exact claims and allegations varied, they all alleged
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. The suits were consolidated
before the U.S. District Court in Phoenix, Arizona. In November 1998, the
Company entered into a settlement agreement calling for the claims against the
Company and all other defendants to be dismissed with prejudice without
presumption or admission of any liability or wrongdoing. Final terms of the
settlement call for payment to the plaintiffs of $13.8 million in cash and $1.2
F-33
<PAGE>
million in shares of the Company's Common Stock. A substantial majority of both
the cash portion of the settlement and litigation-related expenses have been
paid by the Company's directors and officers' insurance carriers. The Court
approved the settlement agreement on March 11, 1999. The Company recorded
expense of approximately $6.2 million during 1998 related to this litigation.
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 in
May 1997 alleging breach of contract under certain stock warrants. The plaintiff
sought damages of at least $2.5 million. In March 1999, the Court granted the
Company's motion for summary judgment and dismissed the plaintiff's case.
An arbitration panel awarded HDVT, Inc. (the seller of certain assets acquired
by the Company from ETIC in February 1997) a total of $10.4 million in
additional acquisition purchase price in February 1999. HDVT has filed an action
to confirm the award in Superior Court, Maricopa County, Arizona. The Company
has filed a motion to vacate the arbitration award, primarily on grounds that
the arbitrators exceeded the scope of their authority. The Company also is
pursuing other available remedies, including seeking a significant reduction of
the purchase price pursuant to a provision of the purchase agreement relating to
the determination of certain workers' compensation expense items. At the time of
final resolution, the payment will be accounted for as an acquisition cost and
will be amortized over the remaining term of the acquisition's original 15-year
amortization schedule.
An arbitration proceeding between the Company and US Xpress Enterprises, Inc.
(US Xpress) is scheduled for May 1999 regarding issues under a PEO service
agreement between the parties that was terminated by the Company in August 1998.
The parties recently stipulated to dismiss related proceedings pending in the
United States District Court for the Eastern District of Tennessee, including US
Xpress' request for a preliminary injunction. US Xpress seeks recovery of
approximately $3.0 million plus unspecified punitive damages primarily relating
to unpaid medical claims. The Company intends to contest the claim vigorously.
As part of the same arbitration, the Company is seeking recovery of damages for
misrepresentations made by US Xpress (relating primarily to the costs associated
with US Xpress's medical programs) at the time the parties entered into the PEO
service agreement.
The Company has been named as a defendant in an action filed by an employee in
February 1999 in Superior Court, Maricopa County, Arizona alleging breach of
contract with respect to certain payments claimed to be owing during and after
his employment with the Company. The complaint seeks damages of approximately
$1.8 million plus the issuance of options to acquire 200,000 shares of Common
Stock. The Company intends to defend the action vigorously. The Company further
will pursue significant counterclaims against the employee relating to certain
liabilities and other matters incurred by the Company in connection with its
1996 acquisition of assets from Hazar, Inc., an entity of which the employee was
a principal. A director of the Company has agreed to indemnify the Company
personally for amounts paid by the Company to the employee in connection with
this matter, if any.
International Color Services, L.L.C. filed for arbitration in December 1998
alleging breach of contract regarding fee issues under the PEO service agreement
between the parties. The Company has filed a complaint in Superior Court,
Maricopa Count, Arizona in January 1999 seeking a declaratory judgment that the
dispute is not subject to arbitration. Plaintiff has filed a motion to compel
arbitration and a counterclaim seeking damages of over $400,000 plus attorneys
fees and costs and unspecified punitive damages. The Company intends to contest
the claim 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
adverse effect on the Company's financial position or results of operations.
F-34
<PAGE>
(11) RELATED PARTY TRANSACTIONS:
Related party transactions not mentioned elsewhere in the financial statements
are summarized as follows:
(In thousands of dollars) 1998 1997 1996
---- ---- ----
Processing fees paid to company owned
by shareholder $ -- $1,030 $805
Non-compete agreement settlements with
two shareholders -- -- 543
Additionally, the Company provides services to companies affiliated with certain
directors and officers. The Company also pays commissions to related parties in
the ordinary course of business.
(12) RESTRUCTURING CHARGE:
On August 11, 1998, the Company announced a restructuring and cost-reduction
plan primarily involving the closing of remote payroll processing centers and
other offices and various other expense reduction strategies. As a result, the
Company incurred a restructuring charge in the third quarter of 1998 of $1.4
million, consisting primarily of severance and lease cancellation costs.
Included in the $1.4 million restructuring charge were $900,000 of severance and
other employee termination costs related to the termination of certain
individuals. The remaining portion relates to lease commitments and termination
penalties associated with the closure of seven offices. Approximately $976,000
has been charged against the restructuring liability. Most of the $1.4 million
has been or is expected to be paid in cash.
(13) ACCOUNTING PRONOUNCEMENTS NOT YET ADOPTED:
In June 1998, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 133 (SFAS No. 133), ACCOUNTING FOR DERIVATIVE
INSTRUMENTS AND HEDGING ACTIVITIES. The statement establishes accounting and
reporting standards requiring that every derivative instrument be recorded on
the balance sheet at its fair value. SFAS No. 133 is effective for financial
statements for periods beginning after June 15, 1999. Adoption of SFAS No. 133
would have an immaterial effect on the December 31, 1998 and 1997 financial
statements.
(14) LOSS PORTFOLIO TRANSFER
On April 22, 1998, the Company completed a risk transfer of all of its pre-1998
workers' compensation claims liability to a third party insurer, rated AAA by
Standard & Poor's, effected through a Loss Portfolio Transfer (LPT) valued as of
February 28, 1998. In exchange for a premium of $19.9 million (paid primarily
from restricted cash and investments), the Company acquired reinsurance of $35
million to insure its pre-1998 workers' compensation losses. Based upon the
advice of its outside actuaries, the Company believes that the risk that
pre-1998 liability could exceed the $35 million aggregate limit is remote,
although there can be no assurance. The LPT provides for profit sharing
opportunities with the Company based on ultimate paid claims, though there can
be no assurance whether or when a profit will be realized. No charge to earnings
was recorded in connection with this transaction in 1998 or is expected in
future periods.
F-35
<PAGE>
SCHEDULE II
EMPLOYEE SOLUTIONS, INC.
VALUATION AND QUALIFYING ACCOUNTS For
the Years Ended December 31, 1998, 1997, and 1996
December 31,
------------------------------
1998 1997 1996
---- ---- ----
(in thousands)
Allowance for doubtful accounts:
Balance at beginning of year $ 5,550 $ 1,729 $ 215
Provision charged to expense 3,431 4,159 1,918
Charge-offs (488) (338) (404)
------- ------- -------
Balance at end of year* 8,493 $ 5,550 $ 1,729
======= ======= =======
December 31,
------------------------------
1998 1997 1996
---- ---- ----
(in thousands)
Restructuring allowance:
Balance at beginning of year $ -- $ -- $ --
Provision charged to expense 1,400 -- --
Payments/usage (976) -- --
------- ------- -------
Balance at end of year $ 424 $ -- $ --
======= ======= =======
December 31,
------------------------------
1998 1997 1996
---- ---- ----
(in thousands)
Tax valuation allowance:
Balance at beginning of year $ -- $ -- $ --
Provision charged to expense 9,188 -- --
Payments/usage -- -- --
------- ------- -------
Balance at end of year $ 9,188 $ -- $ --
======= ======= =======
* Included in this amount is a provision for a long-term receivable included
in other assets.
F-36
EMPLOYEE SOLUTIONS, INC.
EXHIBIT 10.11.1
TO REPORT ON FORM 10-K
Amendment No. 1 to Employment Agreement
This Amendment is made this 9th day of March, 1999 by and between
Employee Solutions, Inc., an Arizona corporation (the "Company"), and Mark J.
Gambill ("Employee") and amends the Employment Agreement between the Company and
Employee dated as of April 16, 1998.
The parties consent to the following amendment: Section 1 of the
Agreement is replaced with the following:
1. EMPLOYMENT. Subject to the terms and conditions of this
Agreement, the Company employs Employee to serve in an executive
capacity and Employee accepts such employment and agrees to dedicate
all of his business time and effort to Company business and perform
such reasonable responsibilities and duties as may be assigned to him
from time to time by the Company's Chief Executive Officer, President
and/or Board of Directors (the "Board"). Employee's title shall be
Senior Vice President and Chief Marketing Officer, with responsibility
for the Company's marketing and related functions and such executive
responsibilities as may be assigned from time to time by, and subject
to the direction of, the Board, the Chief Executive Officer and/or the
President. Employee shall report directly to the Chief Executive
Officer or President. Subject to Sections 7.f and 8, such title and
duties may be changed from time to time by the Board, so long as
Employee is maintained in an executive capacity throughout the term of
his employment
"COMPANY"
"EMPLOYEE"
EMPLOYEE SOLUTIONS, INC.,
an Arizona corporation
By /s/ Quentin P. Smith By /s/ Mark J. Gambill
---------------------------------- ---------------------
Quentin P. Smith, President and Mark J. Gambill
Chief Executive Officer
EMPLOYEE SOLUTIONS, INC.
EXHIBIT 10.18
TO REPORT ON FORM 10-K
SEVERANCE AGREEMENT
This Severance Agreement (the "Agreement") is made this 31st day of
July, 1997 by and between EMPLOYEE SOLUTIONS, INC., an Arizona corporation (the
"Company"), and JOHN V. PRINCE ("Employee").
In consideration of the mutual promises and covenants set forth herein
and for other good and valuable consideration, the receipt and sufficiency of
which are hereby acknowledged, the parties agree as follows:
1. TERMINATION. Employee's employment with the Company may be
terminated with or without cause by either party at any time.
2. DEFINITION OF CAUSE; EFFECT OF TERMINATION FOR CAUSE. In the event
of a termination for cause, the Company shall be obligated to pay the Employee
only the base salary due him through the date of termination. Cause shall
include willful and persistent failure to abide by instructions or policies from
or set by the Board of Directors, willful and persistent failure to attend to
material duties or obligations imposed under this Agreement, or commission of a
felony or serious misdemeanor offense or pleading guilty or NOLO CONTENDERE to
same.
3. EFFECT OF TERMINATION WITHOUT CAUSE OR FOR GOOD REASON. The Company
may terminate Employee's employment by the Company at any time, without cause,
by giving 30 days written notice to the Employee. If the Company terminates
under Section 3, it shall pay to Employee an amount equal to 12 months base
salary, payable monthly, less applicable withholdings; and shall continue
coverage of Employee and Employee's dependents under its medical plans an other
benefit arrangements for 12 months or until Employee secures other employment
(unless continuation of coverage under such plans is unfeasible, in which event
the Company will provide substantially similar benefits). If Employee resigns
for Good Reason (as defined in Section 4.c below), Employee shall be entitled to
the same severance benefits as described in the preceding sentence; provided,
however, that Employee shall be entitled to the severance benefits set forth in
Section 4.e if Employee resigns for Good Reason within 12 months after a Change
in Control (as defined in Section 4.b below).
4. CHANGE IN CONTROL.
a. SEVERANCE BENEFITS. If Employee's employment with the Company
terminates within 12 months after a Change in Control (as defined in Section 4.b
below), Employee shall be entitled to the severance benefits provided in Section
4.e, unless such termination is for cause and defined in Section 2 above or is
due to Employee's death, disability or resignation without Good Reason (as
defined below).
b. "CHANGE IN CONTROL" shall be deemed to have occurred if (i)
any "person" (as such term is used in Paragraphs 13(d) and 14(d) of the
Securities Exchange Act of 1934, as amended [the "Exchange Act"]), other than a
trustee or other fiduciary holding securities under an employee benefit plan of
the Company or a corporation owned directly or indirectly by the stockholders of
the Company in substantially the same proportions as their ownership of stock of
the Company, is or becomes the "beneficial owner" (as defined in Rule 13d-3
under said Act), directly or indirectly, of securities of the Company
representing 20% or more of the total voting power represented by the Company's
then outstanding Voting Securities, or (ii) during any period of two consecutive
years, individuals who at the beginning of such period constitute the Board of
Directors of the Company and any new director whose election by the Board of
Directors or nomination for election by the Company's; stockholders was approved
by a vote of at least two-thirds (2/3) of the directors then still in office who
either were directors at the beginning of the period or whose election or
nomination for election was previously so approved, cease for any reason to
constitute a majority thereof, or (iii) the stockholders of the Company approve
a merger or consolidation of the Company with any other corporation, other than
a merger or consolidation which would result in the Voting Securities of the
Company outstanding immediately prior thereto continuing to represent (either by
remaining outstanding or by being converted into Voting Securities of the
surviving entity) at least 80% the total voting power represented by the Voting
Securities of the Company or such surviving entity outstanding immediately after
such merger or consolidation, or the stockholders of the Company approve a plan
of complete liquidation of the Company or an agreement for the sale or
disposition by the Company of (in one transaction or a series of transactions)
all or substantially all the Company's assets.
c. "GOOD REASON" shall mean, for purposes of the Agreement, (i)
without Employee's express written consent, a reduction of Employee's
compensation or the assignment to Employee of duties inconsistent with
Employee's positions, duties, responsibilities and status with the Company
immediately prior to the Change in Control, or demotion or a change in titles or
offices as in effect immediately prior to a Change in Control (except in
connection with termination of Employee's employment in compliance with Section
2 or upon death or disability); (ii) a material breach by the Company of any of
its obligations hereunder which (if curable) is not cured by the Company within
twenty (20) days after written notice thereof; or (iii) without Employee's
express written consent, relocation of the site of Employee's duties to a
location outside the Phoenix, Arizona metropolitan area, or a requirement that
Employee average more than 10 business days outside of the Phoenix, Arizona
metropolitan area per month.
d. "VOTING SECURITIES" shall mean any securities of the Company
which vote generally in the election of the directors.
e. AMOUNT OF BENEFIT. If Employee is entitled to severance
benefits under Section 4.a, the amount of such benefit shall equal (i) a
lump-sum payment equal to 24 months base pay; (ii) a continuation of medical
coverage and other benefits in the manner contemplated in Section 3 above for 24
months; and (iii) such other benefits to which the Employee is entitled under
the Company's benefits plans and policies as in effect immediately prior to the
Change in Control with respect to terminated Employees.
5. NOTICES. All notices, demands and communications required by this
Agreement shall be in writing and shall be deemed to have been given for all
purposes when sent to the respective addresses set forth below, (i) upon
personal delivery, (ii) one day after being sent, when sent by overnight courier
service to and from locations within the continental United States, (iii) three
days after posting when sent by registered, certified, or regular United States
mail, with postage prepaid and return receipt requested, or (iv) on the date of
transmission when sent by confirmed facsimile.
If to the Company: Employee Solutions, Inc.
6225 North 24th Street
Phoenix, Arizona 85016
Attn: Marvin D. Brody
Chief Executive Officer
If to Employee: John V. Prince
5119 E. Aire Libre Avenue
Scottsdale, Arizona 85254
(Or when sent to such other address as any party shall specify by written notice
so given.)
6. ENTIRE AGREEMENT. This Agreement constitutes the final written
expression of all of the agreements between the parties, and is a complete and
exclusive statement of those terms. It supersedes all understandings and
negotiations concerning the matters specified herein. Any representations,
promises, warranties or statements made by either party that differ in any way
from the terms of this written Agreement shall be given no force or effect. No
addition to or modification of any provision of this Agreement shall be binding
upon any party unless made in writing and signed by all parties.
7. INVALIDITY OF ANY PROVISION. The provisions of this Agreement are
severable, it being the intention of the parties hereto that should any
provisions hereof be invalid or unenforceable, such invalidity or
unenforceability of any provision shall not affect the remaining provisions
hereof, but the same shall remain in full force and effect as if such invalid or
unenforceable provisions were omitted.
8. APPLICABLE LAW. This Agreement shall be governed by and construed in
accordance with the internal laws of the State of Arizona exclusive of the
conflict of law provisions thereof. The parties agree that in the event of
litigation, venue shall lie exclusively in Maricopa County, Arizona.
9. HEADINGS; CONSTRUCTION. Headings in this Agreement are for
informational purposes only and shall not be used to construe the intent of this
Agreement. The language in all parts of this Agreement shall in all cases be
construed as a whole according to its fair meaning and not strictly for nor
against any party.
10. BINDING EFFECT; BENEFITS. This Agreement shall be binding upon and
shall inure to the benefit of the parties hereto and their respective heirs,
successors, executors, administrators and assigns. Notwithstanding anything
contained in this Agreement to the contrary, nothing in this Agreement,
expressed or implied, is intended to confer on any person other than the parties
hereto or their respective heirs, successors, executors, administrators and
assigns any rights, remedies, obligations or liabilities under or by reason of
this Agreement.
11. BINDING EFFECT ON MARITAL COMMUNITY. Employee represents and
warrants to the Company that he has the power to bind his marital community (if
any) to all terms and provisions of this Agreement by his execution hereof.
IN WITNESS WHEREOF, each of the parties hereto has executed this
Severance Agreement and caused the same to be duly delivered on its behalf as of
the date first above written.
"COMPANY"
EMPLOYEE SOLUTIONS, INC.
an Arizona corporation
By /s/ Marvin D. Brody
-------------------------------------
Marvin D. Brody, Chief Executive Officer
"EMPLOYEE"
/s/ John V. Prince
----------------------------------------
John V. Prince
EMPLOYEE SOLUTIONS, INC.
EXHIBIT 10.19
TO REPORT ON FORM 10-K
EMPLOYMENT AGREEMENT
This Employment Agreement (the "Agreement") is made effective as of
this 15th day of February, 1999 by and between EMPLOYEE SOLUTIONS, INC., an
Arizona corporation (the "Company"), and QUENTIN P. SMITH, JR. ("Employee").
RECITALS
A. The Company wishes to employ Employee, and Employee wishes to be
employed by the Company.
B. The parties wish to set forth in this Agreement the terms and
conditions of such employment.
AGREEMENTS
In consideration of the mutual promises and covenants set forth herein
and for other good and valuable consideration, the receipt and sufficiency of
which are hereby acknowledged, the parties agree as follows:
1. EMPLOYMENT. Subject to the terms and conditions of this Agreement,
the Company employs Employee to serve in an executive capacity and Employee
accepts such employment and agrees to dedicate all of his business time and
effort to Company business and perform such reasonable responsibilities and
duties as may be assigned to him from time to time by the Company's Board of
Directors (the "Board") or the Chairman of the Board. Employee's title shall be
Chief Executive Officer and President, with responsibility for the overall
operations of the Company and its subsidiaries and such other executive
responsibilities as may be assigned from time to time by, and subject to the
direction of, the Board or the Chairman of the Board.
2. TERM. The employment of Employee by the Company pursuant to this
Agreement shall commence on the date hereof and continue through February 14,
2002 or until terminated as provided elsewhere herein.
3. COMPENSATION.
a. SALARY. The initial monthly base salary payable to Employee
shall be $31,250, which base salary shall be reviewed at least annually in
accordance with the Company's policies and practices regarding periodic review
and adjustment of executive compensation.
1
<PAGE>
Employee's base salary shall not be reduced during the term hereof without
Employee's written consent.
b. INCENTIVE PLAN. Employee agrees that the base salary described
above shall be Employee's sole cash compensation and that no bonus payment will
be offered by the Company or accepted by Employee. The parties agree that
Employee's incentive compensation opportunity shall be in the form of options
for the purchase of the Company's Common Stock.
4. FRINGE BENEFITS. In addition to the options for shares of the
Company's Common Stock available to Employee under the same terms as those
available to Company employees, and any other employee benefit plans generally
available to Company employees, the Company shall include Employee (and
Employee's dependents) in any group medical insurance plan maintained for the
employees of the Company at the Company's expense. The manner of implementation
of such benefits with respect to such items as procedures and amounts is
discretionary with the Company but shall be commensurate with Employee's
executive status and shall include medical, dental and hospital coverage for
Employee and Employee's dependents who are eligible under the applicable plans.
5. VACATION. Employee shall be entitled to vacation with pay in keeping
with Employee's established vacation practices, but in no event less than four
weeks per service anniversary year. In addition, Employee shall be entitled to
such holidays as the Company may approve for its executive personnel.
6. EXPENSE REIMBURSEMENT. In addition to the compensation and benefits
provided above, the Company shall pay all reasonable expenses of Employee
incurred in connection with the performance of Employee's duties and
responsibilities to the Company pursuant to this Agreement, upon submission of
appropriate vouchers and supporting documentation in accordance with the
Company's usual and ordinary practices, provided that such expenses are
reasonable and necessary business expenses of the Company. The Company shall pay
Employee's reasonable cellular telephone expenses that are related to Company
business. The Company further agrees to reimburse Employee for rent expense
under the lease agreement for Employee's current office location until the lease
is terminated or the space is sublet, provided that the Company's reimbursement
obligation under this sentence shall be capped at $10,000.
7. TERMINATION. This Agreement may be terminated in the manner provided
below:
a. FOR CAUSE. The Company may terminate Employee's employment by
the Company, for cause, upon written notice to the Employee stating the facts
constituting such cause, provided that Employee shall have 20 days following
such notice to cure any conduct or act, if curable, alleged to provide grounds
for termination for cause hereunder. In the event of termination for cause, the
Company shall be obligated to pay the Employee only the base salary due him
through the date of termination. Cause shall include willful and persistent
failure to abide by instructions or policies from or set by the Board of
Directors, wilful and persistent failure to attend to material duties or
obligations imposed under this Agreement, or commission of a felony or serious
misdemeanor offense or pleading guilty or NOLO CONTENDERE to same.
2
<PAGE>
b. DISABILITY. If Employee experiences a permanent disability (as
defined in Section 22(e)(3) of the Internal Revenue Code of 1986, as amended),
the Company shall have the right to terminate this Agreement without further
obligation hereunder except for any amounts payable pursuant to disability plans
generally applicable to executive employees.
c. DEATH. If Employee dies, this Agreement shall terminate
immediately, and Employee's legal representative shall be entitled to receive
the base salary due to Employee through the 60th day from the date on which his
death shall have occurred and any other death benefits generally applicable to
executive employees.
d. TERMINATION WITHOUT CAUSE. Should the Company incur liability
to Employee as a result of terminating Employee's employment without cause, the
Company's liability to Employee in connection with such termination shall equal
12 months of Employee's then-current base salary.
8. CHANGE IN CONTROL.
a. SEVERANCE BENEFITS. If Employee's employment with the Company
terminates within 12 months after a Change in Control (as defined in Section 8.b
below), Employee shall be entitled to the severance benefits provided in Section
8.d unless such termination is in accordance with Section 7.a, 7.b or 7.c above,
in which case such other section shall apply.
b. "CHANGE IN CONTROL" shall be deemed to have occurred if,
within 12 months after the date of any "Hostile Proposal" (as such term is
defined in Section 8.e hereof),
(i) a "person" (as such term is used in Paragraphs 13(d) and
14(d) of the Securities Exchange Act of 1934, as amended [the "Exchange Act"])
that has made a Hostile Proposal becomes the "beneficial owner" (as defined in
Rule 13d-3 under said Act), directly or indirectly, of securities of the Company
representing more than 50% of the total voting power represented by the
Company's then outstanding Voting Securities;
(ii) the stockholders of the Company approve a merger or
consolidation of the Company with any person that has made a Hostile Proposal
(other than a merger or consolidation which would result in the Voting
Securities of the Company outstanding immediately prior thereto continuing to
represent (either by remaining outstanding or by being converted into Voting
Securities of the surviving entity) 50% or more of the total voting power
represented by the Voting Securities of the Company or such surviving entity
outstanding immediately after such merger or consolidation); or
(iii) the stockholders of the Company approve a plan of
complete liquidation of the Company or an agreement for the sale or disposition
by the Company of (in one transaction or a series of transactions) all or
substantially all the Company's assets to any person that has made a Hostile
Proposal.
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c. "VOTING SECURITIES" shall mean any securities of the Company
which vote generally in the election of directors.
d. AMOUNT OF BENEFIT. If Employee is entitled to severance
benefits under Section 8.a, such benefit shall be a lump-sum payment equal to
the difference between $5 million and the "aggregate profit" on Company stock
options which have been exercised by Employee at any time prior to the Change in
Control or which are exercisable or become exercisable in connection with the
Change in Control. "Aggregate profit" for purposes of this paragraph shall mean
the difference between the exercise price of the options and the market price of
the Company's Common Stock on the date of the Change in Control (determined by
the closing price on the principal trading market on which the Common Stock is
then traded).
e. "HOSTILE PROPOSAL" shall mean any of the following which
occurs without the prior concurrence, approval or consent of the Board of
Directors or a duly designated committee thereof (with the terms "person" and
"beneficial owner" in this Section 8.e defined as in Section 8.b above):
(i) the public announcement (whether by press release,
filing with or notice to a government agency, or any other means) by a person of
any plan, proposal or specific intention to (A) become the beneficial owner of
15% or more of the Voting Securities, (B) effect or cause to be effected a
merger or consolidation of the Company (other than a merger or consolidation
which would result in the Voting Securities of the Company outstanding
immediately prior thereto continuing to represent (either by remaining
outstanding or by being converted into Voting Securities of the surviving
entity) 50% or more of the total voting power represented by the Voting
Securities of the Company or such surviving entity outstanding immediately after
such merger or consolidation); or (C) effect or cause to be effected a complete
liquidation of the Company or the sale or disposition by the Company of (in one
transaction or a series of transactions) all or substantially all the Company's
assets;
(ii) a person becomes the beneficial owner of 15% or more of
the Voting Securities; or
(iii) the receipt by the Company of a plan or proposal to
effect a transaction or series of transactions which would fall within subpart
8.e(i) above which, or which is accompanied by a communication which, states,
implies or threatens that material actions will be taken to pursue the
transaction or series of transactions without the cooperation or participation
of the Company if the proposal is not accepted in substantially the form
presented.
9. RETURN OF THE COMPANY'S MATERIALS. Upon the termination of this
Agreement, Employee shall promptly return to the Company all files, credit
cards, keys, instruments, equipment, and other materials owned or provided by
the Company. Employee shall retain ownership of the items listed on Attachment
1.
10. INSURANCE. The Company shall use commercially reasonable efforts to
carry director's and officer's professional liability insurance coverage for
Employee while in the performance of Employee's duties hereunder in an amount of
at least $10,000,000.
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11. NONDELEGABILITY OF EMPLOYEE'S RIGHTS AND COMPANY ASSIGNMENT RIGHTS.
The obligations, rights and benefits of Employee hereunder are personal and may
not be delegated, assigned, or transferred in any manner whatsoever, nor are
such obligations, rights or benefits subject to involuntary alienation,
assignment or transfer. The Company may transfer its obligations hereunder to a
subsidiary, affiliate or successor.
12. NOTICES. All notices, demands and communications required by this
Agreement shall be in writing and shall be deemed to have been given for all
purposes when sent to the respective addresses set forth below, (i) upon
personal delivery, (ii) one day after being sent, when sent by overnight courier
service to and from locations within the continental United States, (iii) three
days after posting when sent by registered, certified, or regular United States
mail, with postage prepaid and return receipt requested, or (iv) on the date of
transmission when sent by confirmed facsimile.
If to the Company: Employee Solutions, Inc.
6225 North 24th Street
Phoenix, Arizona 85016
Attn: Legal Department
If to Employee: Quentin P. Smith, Jr.
10361 North 117th Place
Scottsdale, Arizona 85259
(Or when sent to such other address as any party shall specify by written notice
so given.)
13. ENTIRE AGREEMENT. This Agreement (with Attachment 1), together with
the noncompete and confidentiality agreement and the stock option grant letter,
each dated as of February 15, 1999 (the "Other Agreements") constitutes the
final written expression of all of the agreements between the parties, and is a
complete and exclusive statement of those terms. It supersedes all
understandings and negotiations concerning the matters specified herein
(including all prior written employment agreements and arrangements, if any),
except as provided in the Other Agreements. Any representations, promises,
warranties or statements made by either party that differ in any way from the
terms of this written Agreement or the Other Agreements shall be given no force
or effect. Except as provided in the Other Agreements, the parties specifically
represent, each to the other, that there are no additional or supplemental
agreements between them related in any way to the matters herein contained
unless specifically included or referred to herein. No addition to or
modification of any provision of this Agreement shall be binding upon any party
unless made in writing and signed by all parties.
14. WAIVER. The waiver by either party of the breach of any covenant or
provision in this Agreement shall not operate or be construed as a waiver of any
subsequent breach by either party.
15. INVALIDITY OF ANY PROVISION. The provision of this Agreement are
severable, it being the intention of the parties hereto that should any
provisions hereof be invalid or
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unenforceable, such invalidity or unenforceability of any provision shall not
affect the remaining provisions hereof, but the same shall remain in full force
and effect as if such invalid or unenforceable provisions were omitted.
16. APPLICABLE LAW. This Agreement shall be governed by and construed
in accordance with the internal laws of the State of Arizona exclusive of the
conflict of law provisions thereof. The parties agree that in the event of
litigation, venue shall lie exclusively in Maricopa County, Arizona.
17. HEADINGS; CONSTRUCTION. Headings in this Agreement are for
informational purposes only and shall not be used to construe the intent of this
Agreement. The language in all parts of this Agreement shall in all cases be
construed as a whole according to its fair meaning and not strictly for nor
against any party.
18. COUNTERPARTS; FACSIMILE SIGNATURES. This Agreement may be executed
simultaneously in any number of counterparts, each of which shall be deemed an
original but all of which together shall constitute one and the same agreement.
Delivery by any party of a facsimile signature to the other parties to this
Agreement shall constitute effective delivery by said party of an original
counterpart signature to this Agreement.
19. BINDING EFFECT; BENEFITS. This Agreement shall be binding upon and
shall inure to the benefit of the parties hereto and their respective heirs,
successors, executors, administrators and assigns. Notwithstanding anything
contained in this Agreement to the contrary, nothing in this Agreement,
expressed or implied, is intended to confer on any person other than the parties
hereto or their respective heirs, successors, executors, administrators and
assigns any rights, remedies, obligations or liabilities under or by reason of
this Agreement.
20. BINDING EFFECT ON MARITAL COMMUNITY. Employee represents and
warrants to the Company that he has the power to bind his marital community (if
any) to all terms and provisions of this agreement by his execution hereof.
21. TERMINATION OF CONSULTING AGREEMENT. The parties agree that the
current consulting agreement between them is terminated effective as of the date
hereof and that no further consideration of any kind is payable thereunder.
22. BOARD OF DIRECTORS POSITIONS; ORGANIZATION DUES. The Company
acknowledges that Employee intends to serve or continue serving on the boards of
four companies. The Company consents to such service provided that it does not
materially adversely affect Employee's performance under this Agreement.
Employee will not join any additional boards of directors or take any similar
position without the prior written consent of the Company. The Company further
agrees to pay annual membership dues to the Greater Phoenix Leadership (to a
maximum of $20,000 per year) at Employee's request during the term of this
Agreement commencing with the payment due January 31, 2000.
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IN WITNESS WHEREOF, each of the parties hereto has executed this
Employment Agreement and caused the same to be duly delivered on its behalf as
of the date first above written.
EMPLOYEE SOLUTIONS, INC.,
an Arizona corporation
By: /s/
------------------------------
Its:
-----------------------------
"COMPANY"
/s/ Quentin P. Smith, Jr.
-----------------------------
Quentin P. Smith, Jr.
"EMPLOYEE"
7
EMPLOYMENT AGREEMENT
This Employment Agreement (the "Agreement") is made as of August 1,
1996 by and between LOGISTICS PERSONNEL CORP., a Nevada corporation (the
"Company"), and BILLY C. HOLLIS ("Employee").
RECITALS
A. The Company wishes to employ Employee, and Employee wishes to be
employed by the Company.
B. The parties wish to set forth in this Agreement the terms and
conditions of such employment.
AGREEMENTS
In consideration of the mutual promises and covenants set forth herein
and for other good and valuable consideration, the receipt and sufficiency of
which are hereby acknowledged, the parties agree as follows:
1. EMPLOYMENT. Subject to the terms and conditions of this Agreement,
the Company employs Employee to serve in an executive capacity and Employee
accepts such employment and agrees to dedicate all of his business time and
effort to Company business and perform such reasonable responsibilities and
duties as may be assigned to him from time to time by the Company's Chief
Executive Officer (the "Chief Executive Officer"), the Company's Board of
Directors (the "Board"), and/or the Chief Operating Officer of the Company's
parent corporation, EMPLOYEE SOLUTIONS, INC., an Arizona corporation ("ESI").
Employee's title shall be President, with responsibility for the operational and
managerial functions and such executive responsibilities as may be assigned from
time to time by, and subject to the direction of, the Board, the Chief Executive
Officer and/or the Chief Operating Officer of ESI (hereinafter sometimes
referred to as "ESI's Chief Operating Officer"). Employee shall report directly
to ESI's Chief Operating Officer. Subject to Section 7, such title and duties
may be changed from time to time by the Board, so long as Employee is maintained
in an executive capacity throughout the term of his employment.
2. TERM. The employment of Employee by the Company pursuant to this
Agreement shall commence on the date hereof and continue for a five (5)-year
term (subject to early termination as provided elsewhere herein). The term may
be extended thereafter by written agreement of the parties.
<PAGE>
3. COMPENSATION.
a. SALARY. As partial consideration for the services to be
rendered by Employee hereunder, Company agrees to pay Employee an annual salary
equal to One Hundred Thirty Thousand Dollars ($130,000.00) which will be payable
in twenty-six (26) bi-weekly installments of Five Thousand Dollars ($5,000.00)
each, less applicable income tax, social security tax and Medicare tax
withholding. In the event Employee's employment terminates during a particular
year of service, this salary will be prorated based upon the number of days in
the particular year during which Employee was actually providing services to
Company hereunder.
b. INCENTIVE PLAN. The Company may establish and implement an
incentive compensation system which will provide additional incentive payments
to Employee based upon his performance and the performance of the Company.
c. STOCK OPTIONS. Employee will also be entitled to options to
purchase sixty-two thousand five hundred (62,500) shares of the post-July 26,
1996 two-for-one split no par value voting common stock ("Common Stock") of ESI,
which options will be issued upon the following terms and conditions:
(1) Within thirty (30) days after the execution of this
Agreement, ESI will deliver to Employee a grant letter, with an effective date
of August 1, 1996, for the purpose of transferring and conveying to Employee
options to purchase sixty-two thousand five hundred (62,500) shares of ESI's
Common Stock at an exercise price of Seventeen Dollars and Twenty-five Cents
($17.25) per share.
(2) Except as provided in paragraph 3(c)(3) below, the
options will be granted pursuant to ESI's 1995 Employee Incentive Stock Option
Plan ("Option Plan"), pursuant to the standard grant letter for options issued
pursuant to said plan and, for purposes of said Option Plan, will be exercisable
over three (3) years of service by Employee hereunder at the rate of one-third
(1/3) of the total (or 20,833 and one-third shares) for each completed year of
service hereunder.
(3) In the event Employee's employment should terminate
under the provisions of any of paragraphs 7(b), 7(c) or 7(d) below, or upon the
expiration of the term of this Agreement, any unvested options then held by
Employee shall immediately vest in full. This special vesting provision shall
also apply to any other stock options which ESI may grant to Employee during the
term hereof.
d. SALARY INCREASES. In the sole discretion of the Board,
Employee's salary may be increased, from time to time, consistent with Company
policy.
4. FRINGE BENEFITS. In addition to the options for shares of the
Company's Common Stock available to Employee under the same terms as those
available to Company employees, and any other employee benefit plans generally
available to Company employees, the Company shall
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<PAGE>
include the Employee in any group medical insurance plan and any group life
insurance plan which is maintained for the benefit of the employees of the
Company. The manner of implementation of such benefits with respect to such
items as procedures and amounts is discretionary with the Company but shall be
commensurate with Employee's executive status and shall include medical coverage
for Employee and Employee's family members who are eligible under the applicable
plans.
5. VACATION. Employee shall be entitled to vacation with pay in keeping
with Employee's previously established vacation practices. In addition, Employee
shall be entitled to such holidays as the Company may approve for its executive
personnel.
6. EXPENSE REIMBURSEMENT. In addition to the compensation and benefits
provided above, the Company shall pay all reasonable expenses of Employee
incurred in connection with the performance of Employee's duties and
responsibilities to the Company pursuant to this Agreement, upon submission of
appropriate vouchers and supporting documentation in accordance with the
Company's usual and ordinary practices, provided that such expenses are
reasonable and necessary business expenses of the Company. The Company shall pay
Employee's reasonable cellular telephone expenses that are related to Company
business. During the term of his employment, Company will also provide Employee
with a One Thousand Dollar ($1,000.00) per month automobile expense allowance.
7. TERMINATION. The Company may terminate Employee's employment prior
to the expiration of this Agreement, in the manner provided below:
a. FOR CAUSE. The Company may terminate Employee's employment by
the Company prior to the expiration of this Agreement, for cause, upon written
notice to the Employee stating the facts constituting such cause, provided that
Employee shall have 20 days following such notice to cure any conduct or act, if
curable, alleged to provide grounds for termination for cause hereunder. In the
event of termination for cause, the Company shall be obligated to pay the
Employee only the base salary due him through the date of termination. Cause
shall include willful failure to abide by instructions or policies from or set
by the Company, commission of a felony or serious misdemeanor offense or
pleading guilty or NOLO CONTENDERE to same, Employee's material breach of this
Agreement, or breach by Employee of any other material obligation to the
Company.
b. WITHOUT CAUSE. The Company may terminate Employee's employment
by the Company at any time immediately, without cause, by giving written notice
to the Employee. If the Company terminates under this Section 7.b. it shall pay
to Employee a lump-sum amount equal to the greater of (i) the base salary due
the Employee under the remaining term of this Agreement; or (ii) 12 months base
salary, in each case less applicable withholdings; and shall continue coverage
of Employee and Employee's dependents under its medical plans for the earlier of
12 months or until Employee secures other employment (unless continuation of
coverage under such plans is unfeasible, in which event the Company will provide
substantially similar benefits).
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<PAGE>
c. DISABILITY. If during the term of this Agreement, Employee
experiences a permanent disability (as defined in Section 22(e)(3) of the
Internal Revenue Code of 1986, as amended), the Company shall have the right to
terminate this Agreement without further obligation hereunder except for any
bonus amount payable in accordance with the next sentence and any amounts
payable pursuant to disability plans generally applicable to executive
employees. Within 90 days after the end of the fiscal year in which termination
pursuant to this Section 7.c. occurs, so long as Employee is in full compliance
with this Agreement, Employee shall be entitled to receive an incentive
compensation payment (calculated and payable in the manner referred to in
Section 3.b.), if any, based upon the Company's financial performance for such
fiscal year, which shall be prorated to the extent that Employee's employment
during such fiscal year was for a period of less than the full year.
d. DEATH. If the Employee dies during the term of this Agreement,
this Agreement shall terminate immediately, and the Employee's legal
representative shall be entitled to receive the base salary due to Employee
through the 60th day from the date on which his death shall have occurred and
any other death benefits generally applicable to executive employees. In
addition, if Employee's death occurs during the term hereof, Employee's legal
representative shall be entitled to receive, at the end of the first quarter of
the year following the fiscal year in which such death shall have occurred, an
incentive compensation payment (calculated and payable in the manner referred to
in Section 3.b.), if any, based upon the Company's financial performance for
such fiscal year, which shall be prorated to the extent that Employee's
employment during such fiscal year was for a period of less than the full year.
8. CONFIDENTIALITY. Employee acknowledges that Employee may receive, or
contribute to the production of, confidential, proprietary, and trade secret
information of the Company, and others with whom the Company may be doing
business. For purposes of this Agreement, Employee agrees that "Confidential
Information" shall mean information or material proprietary to the Company or
designated as Confidential Information by the Company and not generally known by
non-Company personnel, which Employee develops or to which Employee may obtain
knowledge or access through or as a result of Employee's relationship with
Company (including information conceived, originated, discovered, or developed
in whole or in part by Employee). Confidential Information includes, but is not
limited to, the following types of information and other information of a
similar nature (whether or not reduced to writing): discoveries, inventions,
ideas, concepts, research, development, processes, procedures, "know-how",
formulae, marketing techniques and materials, marketing and development plans,
business plans, customer names and other information related to customers, price
lists, pricing policies, financial information, employee compensation, and
computer programs and systems. Confidential Information also includes any
information described above which the Company obtains from another party and
which the Company treats as proprietary or designates as Confidential
Information, whether or not owned by or developed by the Company. Employee
acknowledges that the Confidential Information derives independent economic
value, actual or potential, from not being generally known to, and not being
readily ascertainable by proper means by, other persons who can obtain economic
value from its disclosure or use.
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<PAGE>
Information publicly known without breach of this Agreement that is
generally employed by the trade at or after the time Employee first learns of
such information, or generic information or knowledge which Employee would have
learned in the course of similar employment or work elsewhere in the trade,
shall not be deemed part of the Confidential Information.
Employee further agrees:
a. To furnish Company on demand, at any time during or after
employment, a complete list of the names and addresses of all present, former,
and potential customers and other contacts gained while an employee of the
Company, whether or not in the possession or within the knowledge of the
Company.
b. That all notes, computer or disk memory, memoranda,
documentation, and records in any way incorporating or reflecting any
Confidential Information shall belong exclusively to the Company, and Employee
agrees to turn over all copies of such materials in Employee's control to
Company upon request or upon termination of Employee's employment with the
Company, regardless of whether the materials were prepared by or with the
assistance of Employee.
c. That while employed by the Company and thereafter Employee
will hold in confidence and not directly or indirectly reveal, report, publish,
disclose, or transfer any of the Confidential Information to any person or
entity, or utilize any of the Confidential Information for any purpose, except
in the course of Employee's work for the Company.
d. That any ideas in whole or in part conceived of or made by
Employee during the term of his employment or relationship with the Company
which are made through the use of any of the Confidential Information of the
Company or any of the Company's equipment, facilities, trade secrets, or time,
or which result from any work performed by Employee for the Company, shall
belong exclusively to the Company and shall be deemed a part of the Confidential
Information for purposes of this Agreement. Employee hereby assigns and agrees
to assign to the Company all rights in and to such Confidential Information
whether for purposes of obtaining patent or copyright protection or otherwise.
Employee shall acknowledge and deliver to the Company, without charge to Company
(but at its expense) such written instruments and do such other acts, including
giving testimony in support of Employee's authorship or inventorship, as the
case may be, necessary in the opinion of the Company to obtain patents or
copyrights or to otherwise protect or vest in the Company the entire right and
title in and to the Confidential Information.
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<PAGE>
9. NON-COMPETITION.
a. NON-COMPETITION DURING EMPLOYMENT TERM. Employee agrees that during
the term of Employee's employment by the Company, Employee will devote all of
Employee's business time and effort to and give undivided loyalty to the
Company, and will not engage in any way whatsoever, directly or indirectly, in
any business that is competitive with the Company or its affiliates, nor
solicit, or in any other manner work for or assist any business which is
competitive with the Company or its affiliates. During the term of Employee's
employment by the Company, Employee will undertake no planning for or
organization of any business activity competitive with the Company or its
affiliates, and Employee will not combine or conspire with any other employee of
the Company or any other person for the purpose of organizing any such
competitive business activity.
b. NON-COMPETITION AFTER EMPLOYMENT TERM. The parties acknowledge that
Employee will acquire much knowledge and information concerning the business of
the Company and its affiliates as the result of Employee's employment. The
parties further acknowledge that the scope of business in which Company is
engaged as of the date of execution of this Agreement is world-wide and very
competitive and one in which few companies can successfully compete. Competition
by Employee in that business after this Agreement is terminated would severely
injure Company. Accordingly, until two (2) years, or a reasonable term
determined by Arizona state law, after this Agreement is terminated or Employee
leaves the employment of Company for any reason whatsoever, Employee will not:
(1) Within any jurisdiction or marketing area in which Company or any
of its affiliates is doing business or is qualified to do
business, directly or indirectly manage, operate, join, control,
or participate or become interested in or be connected with as an
employee, partner, officer, director, stockholder, consultant, or
investor, any corporation, partnership, or other business entity
other than the Company or its affiliates, which shall operate a
business in competition with the business conducted by the
Company or its affiliates. Nothing herein shall prohibit Employee
from owning, solely for investment purposes, publicly-traded
securities of any company which operates a business otherwise
covered by this Section, provided that such ownership constitutes
less than 1% of the issued and outstanding equity or debt
securities, as the case may be, of said company.
(2) Persuade or attempt to persuade any potential customer or client
to which Company or any of its affiliates has made a proposal or
sale, or with which Company or any of its affiliates has been
having discussions, not to transact business with Company or such
affiliate, or instead to transact business with another person or
organization;
(3) Solicit the business of any company which is a customer or client
of the Company or any of its affiliates at any time during
Employee's employment by the Company, or was its customer or
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client within 3 years prior to the date of this Agreement,
provided, however, if Employee becomes employed by or represents
a business that exclusively sells products that do not compete
with products then marketed or intended to be marketed by the
Company, such contact shall be permissible; or
(4) Solicit, endeavor to entice away from the Company or any of its
affiliates, or otherwise interfere with the relationship of the
Company or any of its affiliates with, any person who is employed
by or otherwise engaged to perform services for the Company or
any of its affiliates, whether for Employee's account or for the
account of any other person or organization.
c. MODIFICATION. The covenants set forth in Sections 8 and 9
shall be construed as independent of any other covenant or provision of this
Agreement or any other agreement. The Company may reduce the scope of the
Employee's obligations under the covenant unilaterally and without consent of
any other person or entity, effective upon giving notice thereof.
d. TIME AND TERRITORY REDUCTION. If the period of time and/or
territory described above are held to be in any respect an unreasonable
restriction, it is agreed that the court so holding may reduce the territory to
which the restriction pertains or the period of time in which it operates or may
reduce both such territory and such period, to the minimum extent necessary to
render such provision enforceable.
e. SURVIVAL. The obligations described in Sections 8 and 9 shall
survive any termination of this Employment Agreement or any termination of the
employment relationship created hereunder.
10. RETURN OF THE COMPANY'S MATERIALS. Upon the termination of this
Agreement, Employee shall promptly return to the Company all files, credit
cards, keys, instruments, equipment, and other materials owned or provided by
the Company.
11. INSURANCE. ESI currently has two (2) policies of director's and
officer's professional liability insurance providing Fifteen Million Dollars
($15,000,000) of total coverage covering ESI, the Company, other ESI
subsidiaries, Employee and the other officers and directors of ESI, the Company
and said other ESI subsidiaries; provided, however, that it is understood and
acknowledged that the total Fifteen Million Dollars ($15,000,000) of coverage is
shared among all such person and entities. During the term hereof, ESI shall use
commercially reasonable efforts to maintain such coverage or substantially
similar or better director's and officer's professional liability insurance
coverage.
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12. REMEDIES.
a. COMPANY REMEDIES. In addition to other remedies provided by law or
equity, upon a breach by Employee of any of the covenants contained herein, the
Company shall be entitled to have a court of competent jurisdiction enter an
injunction against Employee prohibiting any further breach of the covenants
contained herein. The parties further agree that the services to be performed
hereunder are of a unique, special, and extraordinary character and that any
breach or threatened breach by Employee of any provision of Section 8 or 9 of
this Agreement shall cause the Company irreparable harm which cannot be remedied
solely by damages. Therefore, in the event of any controversy concerning the
rights or obligations under this Agreement, such rights or obligations shall be
enforceable in a court of competent jurisdiction at law or equity by a decree of
specific performance or, if the Company elects, by obtaining damages or such
other relief as the Company may elect to pursue. Such remedies, however, shall
be cumulative and nonexclusive and shall be in addition to any other remedies
which the Company may have.
b. EMPLOYEE REMEDIES. In addition to other remedies provided by law or
equity, upon a breach by Company of any of the covenants contained herein, the
Employee shall be entitled have a court of competent jurisdiction enter an
injunction against Company prohibiting any further breach of the covenants
contained herein. The parties further agree that any breach or threatened breach
by Company of any provision of Section 4 or 11 of this Agreement shall cause the
Employee irreparable harm which cannot be remedied solely by damages. Therefore,
in the event of any controversy concerning the rights or obligations under this
Agreement, such rights or obligations shall be enforceable in a court of
competent jurisdiction at law or equity by a decree of specific performance or,
if the Employee elects, by obtaining damages or such other relief as the
Employee may elect to pursue. Such remedies, however, shall be in addition to
any other remedies which the Employee may have.
c. VENUE. The parties agree that in the event of litigation, venue
shall lie exclusively in Maricopa County, Arizona.
13. COMMON LAW OF TORTS OR TRADE SECRETS. Nothing in this Agreement
shall be construed to limit or negate the common law of torts or trade secrets
where such common law provides Company with broader protection than the
protection provided by this Agreement.
14. NONDELEGABILITY OF EMPLOYEE'S RIGHTS AND COMPANY ASSIGNMENT RIGHTS.
The obligations, rights, and benefits of Employee hereunder are personal and may
not be delegated, assigned, or transferred in any manner whatsoever, nor are
such obligations, rights, or benefits subject to involuntary alienation,
assignment, or transfer. The Company may transfer its obligations hereunder to a
subsidiary, affiliate or successor.
15. NOTICES. All notices, demands, and communications required by this
Agreement shall be in writing and shall be deemed to have been given for all
purposes when sent to the respective addresses set forth below, (i) upon
personal delivery, (ii) one day after being sent, when sent by overnight courier
service to and from locations within the continental United States, (iii) three
days after posting when sent by registered, certified, or regular United States
mail, with postage prepaid and return receipt requested, or (iv) on the date of
transmission when sent by confirmed facsimile.
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<PAGE>
If to the Company: Logistics Personnel Corp.
2929 East Camelback Road
Suite 220
Phoenix, Arizona 85016
Attn: Marvin D. Brody
Chief Executive Officer
If to Employee: Billy C. Hollis
6139 E. Andersen Drive
Scottsdale, Arizona 85254
(Or when sent to such other address as any party shall specify by written notice
so given.)
16. ENTIRE AGREEMENT. This Agreement constitutes the final written
expression of all of the agreements between the parties, and is a complete and
exclusive statement of those terms. It supersedes all understandings and
negotiations concerning the matters specified herein. Any representations,
promises, warranties, or statements made by either party that differ in any way
from the terms of this written Agreement shall be given no force or effect. The
parties specifically represent, each to the other, that there are no additional
or supplemental agreements between them related in any way to the matters herein
contained unless specifically included or referred to herein. No addition to or
modification of any provision of this Agreement shall be binding upon any party
unless made in writing and signed by all parties.
17. WAIVER. The waiver by either party of the breach of any covenant or
provision in this Agreement shall not operate or be construed as a waiver of any
subsequent breach by either party.
18. INVALIDITY OF ANY PROVISION. The provisions of this Agreement are
severable, it being the intention of the parties hereto that should any
provisions hereof be invalid or unenforceable, such invalidity or
unenforceability of any provision shall not affect the remaining provisions
hereof, but the same shall remain in full force and effect as if such invalid or
unenforceable provisions were omitted.
19. APPLICABLE LAW. This Agreement shall be governed by and construed
in accordance with the internal laws of the State of Arizona exclusive of the
conflict of law provisions thereof.
20. ATTORNEYS' FEES. If any party reasonably employs legal counsel to
bring an action at law or other proceedings against the other party to enforce
any of the terms hereof, the party prevailing in any such action or other
proceeding shall be paid by the other party its reasonable attorneys' fees as
well as court costs, all as determined by the court and not a jury.
21. HEADINGS; CONSTRUCTION. Headings in this Agreement are for
informational purposes only and shall not be used to construe the intent of this
Agreement. The language in all parts of this Employment Agreement shall in all
cases be construed as a whole according to its fair meaning and not strictly for
nor against any party.
- 9 -
<PAGE>
22. COUNTERPARTS; FACSIMILE SIGNATURES. This Agreement may be executed
simultaneously in any number of counterparts, each of which shall be deemed an
original but all of which together shall constitute one and the same agreement.
Delivery by any party of a facsimile signature to the other parties to this
Agreement shall constitute effective delivery by said party of an original
counterpart signature to this Agreement.
23. BINDING EFFECT; BENEFITS. This Agreement shall be binding upon and
shall inure to the benefit of the parties hereto and their respective heirs,
successors, executors, administrators, and assigns. Notwithstanding anything
contained in this Agreement to the contrary, nothing in this Agreement,
expressed or implied, is intended to confer on any person other than the parties
hereto or their respective heirs, successors, executors, administrators, and
assigns any rights, remedies, obligations, or liabilities under or by reason of
this Agreement.
24. BINDING EFFECT ON MARITAL COMMUNITY. Employee represents and
warrants to the Company that he has the power to bind his marital community (if
any) to all terms and provisions of this agreement by his execution hereof.
IN WITNESS WHEREOF, each of the parties hereto has executed this
Employment Agreement and caused the same to be duly delivered on its behalf as
of the date first above written.
LOGISTICS PERSONNEL CORP.,
a Nevada corporation
By /s/ Marvin D. Brody
-----------------------------------------
Marvin D. Brody, Chief Executive Officer
"COMPANY"
/s/ Billy C. Hollis
------------------------------------------
Billy C. Hollis
"EMPLOYEE"
- 10 -
EMPLOYEE SOLUTIONS, INC.
EXHIBIT 10.21
TO REPORT ON FORM 10-K
Amendment No. 1 to Employment Agreement
This Amendment is made this 3rd day of March, 1999 by and between
Employee Solutions, Inc., an Arizona corporation ("ESI"), Logistics Personnel
Corp, a Nevada corporation (the "Company") and Billy C. Hollis ("Employee") and
amends the Employment Agreement between the Company and Employee dated as of
August 1, 1996.
The parties consent to the following amendment: Section 1 of the
Agreement is replaced with the following:
1. EMPLOYMENT.
(a) Subject to the terms and conditions of this Agreement, the
Company employs Employee to serve in an executive capacity and Employee
accepts such employment and agrees to dedicate reasonable business time
and effort to Company business and to perform such reasonable
responsibilities and duties as may be assigned to him from time to time
by the Company's Board of Directors (the "Board"), and/or the CEO or
President of ESI. Employee's title shall be Chief Executive Officer,
with responsibility for overseeing the operational and managerial
functions and such executive responsibilities as may be assigned from
time to time by, and subject to the direction of, the Board, and/or the
CEO or President of ESI. Employee shall report directly to ESI's CEO or
President. Subject to Section 7, such title and duties may be changed
from time to time, so long as Employee is maintained in an executive
capacity throughout the term of his employment.
(b) Subject to the terms and conditions of this Agreement, ESI
employs Employee to serve in an executive capacity and Employee accepts
such employment and agrees to dedicate all of his business time and
effort to ESI business (except for limited services to be provided to
the Company pursuant to Section 1(a) hereof) and perform such
reasonable responsibilities and duties as may be assigned to him from
time to time by ESI's Board of Directors, CEO or President. Employee's
title shall be Senior Vice President -- Customer Service Delivery, with
responsibility for overseeing ESI's customer service delivery functions
and such other executive responsibilities as may be assigned from time
to time by, and subject to the direction of, ESI's Board, CEO or
President. Employee shall report directly to ESI's CEO or President.
Subject to Section 7, such title and duties may be changed from time to
time, so long as Employee is maintained in an executive capacity
throughout the term of his employment.
"COMPANY" "EMPLOYEE"
LOGISTICS PERSONNEL CORP.,
a Nevada corporation
By /s/ Quentin P. Smith By /s/ Billy C. Hollis
---------------------------------- -------------------------
Quentin P. Smith, Billy C. Hollis
Chief Executive Officer
EMPLOYEE SOLUTIONS, INC.,
an Arizona corporation
By /s/ Quentin P. Smith
----------------------------------
Quentin P. Smith, President and
Chief Executive Officer
EMPLOYEE SOLUTIONS, INC.
EXHIBIT 21.1
TO
REPORT ON FORM 10-K
FOR THE YEAR ENDED DECEMBER 31, 1998
STATE DATE
CORPORATION NAME INCORPORATED INCORPORATED
---------------- ------------ ------------
Camelback Insurance, Ltd. Bermuda 8/24/94
E.R.C. of Indiana, Inc. Indiana 10/23/87
Employee Resources Corporation Indiana 8/25/95
Employee Solutions - Ohio, Inc. Indiana 12/28/90
Employee Solutions of Alabama, Inc. Alabama 7/1/93
Employee Solutions of California, Inc. Nevada 5/3/96
Employee Solutions of Texas, Inc. Texas 10/24/91
Employee Solutions-East, Inc. Georgia 6/24/94
Employee Solutions-Midwest, Inc. Michigan 5/8/91
Employee Solutions-North America, Inc. Delaware 12/17/91
Employee Solutions-Southeast, Inc. Florida 1/16/85
ERC of Minn, Inc. Minnesota 1/2/97
ERC of Ohio, Inc. Michigan 5/8/91
ESI - Nevada Holding Co. Nevada 7/10/98
ESI America, Inc. Nevada 10/2/95
ESI Risk Management Agency, Inc. Arizona 10/2/95
ESI-Midwest, Inc. Nevada 5/14/96
ESI-New York, Inc. Arizona 12/9/97
Fidelity Resources Corporation Oklahoma 12/1/98
Logistics Personnel Corp. Nevada 9/8/95
Phoenix Capital Management, Inc. Indiana 12/23/90
Talent, Entertainment And Media Services, Inc. Delaware 1/10/96
TEAM Benefits Corp. Delaware 3/12/98
TEAM Tours, Inc. Arizona 12/30/98
EXHIBIT 23.1
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, 333-1242 and
333-49891.
/s/ Arthur Andersen LLP
Phoenix, Arizona,
March 17, 1999.
<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, 1998 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-31-1998
<PERIOD-START> JAN-01-1998
<PERIOD-END> DEC-31-1998
<EXCHANGE-RATE> 1
<CASH> 40,375
<SECURITIES> 9,997
<RECEIVABLES> 45,446
<ALLOWANCES> 0
<INVENTORY> 0
<CURRENT-ASSETS> 103,972
<PP&E> 4,543
<DEPRECIATION> 0
<TOTAL-ASSETS> 175,105
<CURRENT-LIABILITIES> 72,307
<BONDS> 0
0
0
<COMMON> 35,800
<OTHER-SE> (20,085)
<TOTAL-LIABILITY-AND-EQUITY> 175,105
<SALES> 0
<TOTAL-REVENUES> 968,909
<CGS> 0
<TOTAL-COSTS> 934,684
<OTHER-EXPENSES> 55,438
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 8,541
<INCOME-PRETAX> (28,062)
<INCOME-TAX> (111)
<INCOME-CONTINUING> (27,951)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (27,951)
<EPS-PRIMARY> (0.88)
<EPS-DILUTED> (0.88)
</TABLE>
