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, 1999
[ ] 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 (I.R.S. Employer
of 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:
Name of each exchange
Title of each class: on which registered:
-------------------- --------------------
NONE N/A
Securities Registered Pursuant to Section 12(g) of the Act:
No Par Value Common Stock
Rights to Purchase Shares of Series A Junior Participating Preferred Stock
Indicate by check mark whether the Registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the Registrant was
required to file such report(s)), and (2) has been subject to such filing
requirements for the past 90 days. Yes [X] No [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of Registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [ ]
The aggregate market value of the voting stock held by non-affiliates of the
Registrant, based upon the $.78 closing price of the Registrant's Common Stock
as reported on the NASDAQ SmallCap Market on March 20, 2000, was approximately
$29.9 million. Effective March 22, 2000, the Company's Common Stock is traded on
the OTC Bulletin Board. Shares of Common Stock held by each executive officer
and director and by any 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
20, 2000, was 38,433,027.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Registrant's Proxy Statement for the Registrant's 2000 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, 1999
TABLE OF CONTENTS
PART I
ITEM 1. BUSINESS 2
ITEM 2. PROPERTIES 13
ITEM 3. LEGAL PROCEEDINGS 14
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS 15
ITEM 4A. EXECUTIVE OFFICERS OF THE REGISTRANT 15
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED
SHAREHOLDER MATTERS 16
ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA 17
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS 18
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK 34
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA 34
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING
AND FINANCIAL DISCLOSURE 34
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT 34
ITEM 11. EXECUTIVE COMPENSATION 34
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS
AND MANAGEMENT 34
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS 34
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND
REPORTS ON FORM 8-K 35
SIGNATURES
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PART I
EXCEPT FOR THE HISTORICAL INFORMATION CONTAINED HEREIN, THE DISCUSSION IN THIS
FORM 10-K CONTAINS OR MAY CONTAIN FORWARD-LOOKING STATEMENTS (INCLUDING
STATEMENTS IN THE FUTURE TENSE AND STATEMENTS USING THE TERMS "BELIEVE,"
"ANTICIPATE," "EXPECT," "INTEND" OR SIMILAR TERMS) WHICH ARE MADE PURSUANT TO
SAFE HARBOR PROVISIONS OF THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995.
THESE FORWARD-LOOKING STATEMENTS INVOLVE RISKS AND UNCERTAINTIES THAT COULD
CAUSE THE COMPANY'S ACTUAL RESULTS TO DIFFER MATERIALLY FROM THOSE DISCUSSED
HEREIN. FACTORS THAT COULD CAUSE OR CONTRIBUTE TO SUCH DIFFERENCES INCLUDE, BUT
ARE NOT LIMITED TO, THOSE DISCUSSED IN "ITEM 1 -- BUSINESS" AND "ITEM 7 --
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS" (PARTICULARLY "OUTLOOK: ISSUES AND RISKS" THEREIN), AS WELL AS THOSE
FACTORS DISCUSSED ELSEWHERE HEREIN OR IN ANY DOCUMENT INCORPORATED HEREIN BY
REFERENCE.
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, 1999, the Company served
approximately 1,900 client companies representing 34,900 worksite employees in
approximately 46 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, and other personal financial services. The client company generally
retains management control of the worksite employees, including hiring,
supervision and termination and determining the employees' job descriptions and
salaries.
INDUSTRY OVERVIEW
The PEO industry has undergone rapid growth in recent years. 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 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 that 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
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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. 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."
CUSTOMERS
As of December 31, 1999, the Company's full-service PEO customer base consisted
of approximately 1,900 customer companies, representing approximately 34,900
employees in 46 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 29% of the Company's customers were classified in any one SIC
code. The Company's approximate customer company distribution by major industry
grouping as of December 31, 1999 is set forth below:
Percent of
Industry Group Customers
-------------- ---------
Transportation:
Private carriage/driver leasing 10%
For hire/standard PEO 19
---
Total 29
Services:
Professional 13
Light Industrial 4
Real Estate 3
---
Total 20
Manufacturing 7
Construction 9
Retail Trade 6
Entertainment 21
Wholesale Trade 4
Agriculture and Fishing 1
Other 3
As part of its business strategy, the Company has historically targeted a
nationwide customer base. The Company seeks to maintain an overall diversity of
customers, 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 recently refocused its sales and
marketing efforts to target industries and geographic territories that it
believes present the greatest opportunities for profitable growth, and to
emphasize marketing through third-party alliances.
The Company's average full-service PEO customer had approximately 12 employees
as of December 31, 1999 (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 customer added through internally-generated
sales in 1999 was 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.
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The Company generally has benefited from a high level of customer retention,
resulting in a significant recurring revenue stream. One common industry
standard for measuring attrition is computed by dividing the number of customers
lost during the period by the sum of the number of customers at the beginning of
the period plus the number of customers added during the period (Customer
Attrition Rate). Based on this standard, the Company's Customer Attrition Rate
was approximately 19%, 17% and 25%, respectively, for the years ended December
31, 1999, 1998, and 1997. The Company's Customer Attrition Rate is attributable
to a variety of factors, including (i) termination by the Company because the
customer did not make timely payments or failed to meet the Company's customer
risk profile, (ii) customer nonrenewal due to repricing, or service or price
dissatisfaction and (iii) customer business failure, downsizing, or sale or
acquisition of the customer. The Company experienced increased attrition in late
1998 and early 1999 following the closure of certain field offices in connection
with a restructuring plan. The Company also experienced increased attrition in
1999, particularly in its core PEO services. While a portion of this attrition
resulted from the Company's proactive elimination of unprofitable or high-risk
customers, the Company also experienced attrition based on violation of
noncompetition agreements by former salespersons and other factors. The
Company's 2000 operating plan includes continuing improvements in customer
service functions to reduce attrition, and the Company is aggressively seeking
to enforce its noncompetition agreements.
The general division of responsibilities between the Company and its customer as
co-employers under the Company's standard forms of customer 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 CUSTOMER:
* 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
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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, certain states require the Company to
retain certain additional control rights over worksite employees as compared to
the Company's standard arrangements.
The Company's contracts with its customers historically were subject to
cancellation by either party upon 30 days written notice, and could be canceled
more quickly by the Company under certain circumstances such as nonpayment of
fees by the client. In 1999, the Company began entering into multi-year service
agreements with new customers, subject to earlier termination in the event of
certain breaches. The fee paid by the customer 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 customer based on factors including market conditions,
customer needs and services required, the customer's workers' compensation and
benefit plan experience and the administrative resources required. The service
fee generally is expressed as a fixed percentage of the customer's gross
salaries and wages.
The Company also provides 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 customers 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).
SERVICES AND PRODUCTS
The Company provides its customers with a comprehensive offering of
employment-related services and products. The Company's flexible approach allows
its customers 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 customer in advance of each payroll date and
reserves the right to terminate its agreement with the customer 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."
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HUMAN RESOURCES ADMINISTRATION
The Company's comprehensive human resources services reduce the
employment-related administrative burdens faced by its customers. 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
customers 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 customers 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 customers a fully-insured, first-dollar coverage workers'
compensation insurance program. The Company's risk management/workers'
compensation program provides its customers 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
"Medical Programs" below. In addition, the Company offers pre-tax premium
conversion and health care and dependent care spending plans, and qualified
retirement plans, such as 401(k) plans, in which worksite employees may
participate, and assists the customer 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.
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The Company recently announced a preliminary agreement with American Heritage
Life ("AHL"), a member of the Allstate Group, under which the parties will form
a strategic alliance for the marketing of AHL's comprehensive portfolio of
voluntary health and life insurance products to the Company's worksite
employees. The parties are in the process of negotiating a definitive agreement
and currently expect to commence marketing efforts during the second quarter of
2000.
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 customer. The Company believes that its
business-to-business PEO enterprise solution can best be sold by experienced
sales representatives at individual, face-to-face meetings with potential
clients. Commencing in 1999, the Company is implementing several new sales
channel distribution methods.
STRATEGIC ALLIANCE PARTNERS
The Company has aggressively worked to establish long-term strategic alliance
partners with numerous organizations around the United States through which the
Company offers its services to the organizations' members on a preferred basis.
The Company has established definitive agreements with the following
organizations:
Cold Stone Creamery 10 years
Office Furniture USA 10 years
Greater Phoenix Chamber of Commerce 10 years
Grand Canyon Minority Supplier Development Council 3 years
House Doctors 12 years
New Horizons Computer Learning Centers In 6 month pilot phase
Performance Resources 10 years
Irvine Chamber of Commerce 1 year
The Company has also performed endorsed sales into MAACO franchise and Best
Western member locations, though the Company has determined that it will not
pursue additional Best Western member locations in the future due primarily to
the availability of opportunities providing more significant profit potential.
The Company will continue to establish strategic alliance partnerships within 11
targeted geographic markets.
TECHNOLOGY SALES DIVISION
The Company has identified technology companies as favorable candidates for PEO
services due primarily to higher average compensation structures and Internet
capability. The Company has established sales offices in Boston, San Francisco
and Phoenix focused on selling into the technology marketplace.
TELESALES
The Company has established a telesales function with three primary
responsibilities: upselling new Company products or enhanced Company products
and services to the Company's existing customer base; identifying the members
within a strategic alliance partner organization that are most likely to be
receptive to the Company's PEO services, and assisting with sales of American
Heritage Life products by coordinating and scheduling meetings between AHL
agents and the Company's customers. The Company also is expanding its Website to
support the sale of certain of its value-added products via the Internet.
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SALES MANAGEMENT AND PERSONNEL
The Company's senior sales management and sales administration functions are
located at its Phoenix headquarters. Headquarters provides ongoing sales and
customer support training and sales support to all Company sales
representatives, assists in new prospect proposals, performs detailed price
analysis on each prospective customer, and manages business submissions. The
Company's field sales operations are coordinated by regional sales managers
located in various cities, who manage a network of full-time sales
representatives and part-time sales agents. At December 31, 1999, the Company's
sales force included 45 sales representatives. 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
with a competitive base salary and a gross profit focused commissions schedule,
subject to certain vesting and production requirements. Sales managers also
receive a competitive base salary and an override commission on sales generated
by sales representatives that report to them.
MARKETING
The Company's marketing department provides comprehensive marketing support for
all of the Company's operations. This support focuses on communications
strategies and materials, market research and analysis, product development and
marketing alliances for value added-products and services. 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
As discussed above, the Company recently announced a preliminary agreement with
AHL under which the parties will form a strategic alliance for the marketing of
AHL's comprehensive portfolio of voluntary health and life insurance products to
the Company's worksite employees. The parties are in the process of negotiating
a definitive agreement and currently expect to commence marketing efforts during
the second quarter of 2000. The Company intends to enter into additional
marketing 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.
COMPETITION
The market for many of the services provided by the Company is highly fragmented
with over 2,200 PEOs currently competing in the United States. Many of these
PEOs have limited regional or state specific operations and relatively few
worksite employees, though a few, including Staff Leasing, Inc. and Administaff,
Inc., 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, quality of benefits, and performance of the 401(k)
programs are important ancillary competitive considerations.
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
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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 implemented
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. 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.
In 1999, the Company introduced ESI Direct, the customer access portion of the
newly redesigned Web site. ESI Direct allows customers secure access to a
variety of information via dynamic Web interface, and includes a remote payroll
entry application and other service tools designed to maximize efficiency to
better serve customers.
See also "Item 7-- Management's Discussion and Analysis-- Outlook: Issues and
Risks, Year 2000 Compliance" herein.
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.
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 2000 guaranteed cost coverage has been
obtained through American International Group Risk Management (AIGRM). The
Company's 1999 guaranteed cost coverage was obtained through TIG Insurance
Company, with ManagedComp acting as third party administrator and general agent.
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
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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. See "Item 7 - Management's
Discussion and Analysis - Outlook: Issues and Risks -- Increases in Health
Insurance Premiums, Unemployment Taxes and Workers' Compensation Rates;
Availability of Programs."
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, 1999, approximately
798 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 premium rates reflecting
competitive price increases by geographic regions with all of its third party
health care insurers that are generally effective through December 31, 2000, at
which time renewal provisions would apply.
EMPLOYEES
At December 31, 1999, the Company employed 316 full-time corporate employees in
addition to the worksite employees. The Company considers its employee relations
to be very good.
INDUSTRY REGULATION
FEDERAL REGULATION
Employers in general are regulated by numerous federal laws relating to labor,
tax and employment matters. Generally, these laws prohibit race, age, sex,
disability and religious discrimination, mandate safety regulations in the
workplace, set minimum wage rates and regulate employee benefits. Because many
of these laws were enacted prior to the development of non-traditional
employment relationships, such as PEO services, many of these laws do not
specifically address the obligations and responsibilities of non-traditional
employers. As a result, interpretive issues concerning the definition of the
term "employer" in various federal laws have arisen pertaining to the employment
10
<PAGE>
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
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.
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<PAGE>
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.
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, various 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.
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 at its headquarters facilities
and in certain remote locations during 1999 in connection with expense reduction
initiatives.
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ITEM 3. LEGAL PROCEEDINGS
The Company has been named as a defendant in an action filed by James E. Gorman
in Arizona Superior Court in August 1999 alleging breach of contract, fraud,
defamation and related matters in connection with the termination of Mr. Gorman
as the Company's president and chief executive officer in February 1999. The
complaint seeks contractual damages of approximately $588,000 plus unspecified
tort damages. The Company is contesting the claim vigorously. The Court
dismissed the plaintiff's principal tort claims in November 1999.
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 County, 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 $500,000 plus attorneys
fees and costs and unspecified punitive damages. The Company is contesting the
claim vigorously.
Stirling Cooke Insurance Services Inc. filed suit in the United States District
Court for the Middle District of Florida against the Company in December 1999
alleging breach of contract and failure to pay insurance premiums in violation
of Florida law. Stirling Cooke, in its capacity as managing and general agent,
placed workers compensation insurance for the Company with three insurance
companies for calendar year 1998. Stirling Cooke alleges that ESI owes unpaid
premium in the amount of $2,797,905 to those companies. The Company believes
that Stirling Cooke's suit is without merit based on an explicit Memorandum of
Understanding between the parties that defined the applicable rates for the 1998
workers' compensation program and intends to defend the suit vigorously.
The State of Ohio has issued an assessment of $5.2 million (plus interest and
penalty) relating to sales taxes potentially applicable to certain types of PEO
services provided by the Company. 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 State of Ohio further issued a sales tax assessment in the amount of
approximately $16.5 million (including interest and penalties) in July 1999
against HDVT, Inc. (the seller of certain assets acquired by the Company in
February 1997) with respect to the operations of HDVT prior to the Company's
acquisition of certain assets of HDVT (then known as Employers Trust) in
February 1997. The State of Ohio concurrently issued an assessment in the same
amount against the Company as successor to HDVT. The Company believes that
meritorious defenses are available to the assessment. In addition, $6.0 million
of cash and 675,000 shares of the Company's Common Stock are being held in
escrow for payment of amounts, if any, ultimately determined to be due pursuant
to such assessment. If the Company is held to have liability pursuant to such
assessment, the escrowed assets prove insufficient to satisfy such liability,
and HDVT is unable to pay any such shortfall, the Company's maximum liability
with respect to the assessment is approximately $3.2 million.
Four individuals brought suit in Steuben County Superior Court, Angola, Indiana
in 1998 alleging that they were employees of the Company and that they had not
been paid certain wages in connection with the bankruptcy of a former customer
with which the Company had commenced a limited service arrangement. The
individuals purport to represent a class of employees. Plaintiffs seek from the
Company unpaid wages, vacation and other benefits owed by the former customer in
a total amount for the purported class in excess of $600,000, potentially
subject to trebling under applicable wage statutes. The Company does not believe
that it has any liability to the plaintiffs and has successfully obtained a
dismissal of the suit. Plaintiffs have commenced an appeal process in the
Indiana Court of Appeals.
The Company initiated an arbitration proceeding and related suit in November
1999 in the United States District Court for the District of Arizona seeking to
enjoin Edward L. Cain, Jr., a former executive officer and director of the
Company, from violating a noncompetition agreement. The Company's action also
seeks collection of a promissory note from Mr. Cain in the amount of $350,000. A
company affiliated with Mr. Cain, MyBenefitSource.com, has filed suit in Georgia
state court seeking to enjoin the Company's actions. Mr. Cain has counterclaimed
for unspecified damages based on various tort theories, for a declaratory
judgment voiding the noncompetition agreement, and for cancellation of the
promissory note. The Company believes that the counterclaims are without merit
and intends to defend them 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."
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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 1999.
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. 48 Chief Executive Officer,
President and Director 1998
Bill C. Hollis 53 Senior Vice President,
Operations 1999
John V. Prince 45 Senior Vice President,
CFO and Treasurer 1997
Lee E. Martin 38 Senior Vice President,
Sales and Marketing 1999
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 - Operations 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.
Lee E. Martin joined the Company as Senior Vice President - Sales in May 1999
and was named Senior Vice President - Sales and Marketing in August 1999. Mr.
Martin previously served with HNC Software, Inc. as Vice President - Sales from
1993 through 1997 and Vice President - Worldwide Strategic Relationships from
1998 until joining the Company.
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<PAGE>
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED SHAREHOLDER MATTERS
The Company's Common Stock is traded on the OTC Bulletin Board under the symbol
"ESOL" effective March 22, 2000. The Company's Common Stock previously was
traded on the Nasdaq SmallCap Market from November 1998 to March 2000 and 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 20, 2000, the Company had 246 shareholders of record.
================================================================================
Quarter Ended High Low
------------- ----- -----
December 31, 1999 $1.13 $ .63
September 30, 1999 $1.38 $ .78
June 30, 1999 $1.41 $ .81
March 31, 1999 $2.53 $ .81
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
================================================================================
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"),
as well as the Loan Agreement entered into in October 1999, limit the payment of
dividends by the Company. See Item 7 - "Management's Discussion and Analysis -
Liquidity and Capital Resources." 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 June 1996 acquisition of TEAM Services, the Company agreed to
issue shares of its Common Stock in an amount to be determined based upon TEAM
earnings during the year ended June 30, 1999. Pursuant to such agreement, the
Company issued 2,157,753 shares of its Common Stock to the sellers of TEAM
Services on December 28, 1999.
As part of the September 1997 acquisition of Phoenix Capital Management, Inc.
and several related PEO companies designated as "ERC," the Company agreed to
issue shares of its Common Stock in an amount to be determined based upon ERC
earnings after the acquisition. The number of shares issuable has been agreed by
the parties to be approximately 1,150,000 shares, though the Company has the
right to withhold such shares as security for indebtedness owed to the Company
by the seller of the ERC companies. The Company currently is conducting
negotiations with the seller concerning these matters.
In connection with the December 1998 acquisition of Fidelity Resources
Corporation, ("Fidelity"), the Company issued an aggregate of 2,206,258 shares
of its Common Stock in February 2000 as an additional purchase price payment
based on a formula provided in the acquisition agreement.
Under an agreement dated in 1998, pursuant to which securities class action
litigation was settled, the Company is required to issue 851,149 shares of
Common Stock to members of the plaintiff class upon receipt of appropriate
instructions from plaintiffs' counsel.
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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, 1999, 1998, 1997, 1996 and
1995 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.
<TABLE>
<CAPTION>
=================================================================================================
(In thousands of dollars) Year Ended December 31,
-----------------------------------------------------------
1999 1998 1997 1996 1995
-------- -------- -------- -------- -------
<S> <C> <C> <C> <C> <C>
Consolidated Statements of
Operations Data:
Revenues $939,835 $968,909 $933,817 $439,016 $164,455
Cost of revenues 902,208 934,684 903,255 400,862 150,675
Gross profit 37,627 34,225 30,562 38,154 13,780
Selling, general and
administrative expenses 36,228 49,293 33,411 17,310 7,183
Depreciation & amortization 7,492 6,145 4,617 2,073 426
Goodwill impairment 42,205 -- -- -- --
Income (loss) from operations (48,298) (21,213) (7,466) 18,771 6,171
Non-operating income (expense), net (7,619) (6,849) (3,849) (364) 510
Income (loss) before provision
for taxes (55,917) (28,062) (11,315) 18,407 6,681
Income tax provision (benefit) 145 (111) (2,819) 6,381 2,846
Net income (loss) (56,062) (27,951) (8,496) 12,026 3,835
(In thousands of dollars) Year Ended December 31,
except per share data) -----------------------------------------------------------
1999 1998 1997 1996 1995
-------- -------- -------- -------- -------
Consolidated Balance Sheet Data
Working capital $ 15,410 $ 31,665 $ 58,329 $ 30,449 $ 8,589
Total assets 122,327 175,105 207,217 125,969 36,840
Note payable 10,000 -- -- -- --
Long-term debt 85,000 85,000 85,000 -- --
Stockholders' (deficit) equity (28,726) 15,716 42,389 46,507 19,943
Common Stock Data
Earnings (loss) per share
Basic (1.55) (.88) (.27) .40 .17
Diluted (1.55) (.88) (.27) .37 .16
Weighted average common and
equivalent shares outstanding
Basic 36,214 31,817 31,193 30,224 22,392
Diluted 36,214 31,817 31,193 32,168 23,507
At period end:
Worksite employees 34,900 40,800 45,200 30,000 11,000
Client companies 1,900 2,000 1,700 1,200 920
States with worksite employees 46 47 47 46 40
=================================================================================================
</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 (as related to costs
associated with certain discontinued stand-alone program cases and Ohio claims,
18
<PAGE>
as more fully described below), is based upon estimates of reported and
unreported claims and the related claims and claims settlement expenses in an
amount equal to the retained portion of the expected total incurred claim. The
Company's accrued workers' compensation reserves are primarily based on
industry-wide data, and to a lesser extent, the Company's past claims experience
up to the retained limits. The liability recorded may be more or less than the
actual amount of the claims when they are submitted and paid. 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 includes 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
expired 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. Previous
acquisitions have generally resulted in considerable goodwill because PEOs
generally require few fixed assets to conduct their operations.
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ACQUISITIONS
Period-to-period comparisons have been substantially affected by the Company's
previous strategy of growth through acquisitions. 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. 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.
Company PEO acquisitions which have affected recent periods have included the
following: 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 full PEO services, TEAM
Services services, and driver leasing services 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. 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.
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RESULTS OF OPERATIONS-- YEAR ENDED DECEMBER 31, 1999 COMPARED TO YEAR ENDED
DECEMBER 31, 1998
================================================================================
Percent
(In thousands of dollars) 1999 Change 1998
- ------------------------- ---- ------ ----
Revenues $ 939,835 (3)% $ 968,909
Cost of revenues 902,208 (3) 934,684
Gross profit 37,627 10 34,225
Selling, general and administrative 36,228 (27) 49,293
Depreciation and amortization 7,492 22 6,145
Goodwill impairment 42,205 -- --
Interest income 1,196 (37) 1,885
Interest expense 8,854 4 8,541
Net loss (56,062) 101 (27,951)
================================================================================
REVENUES
Revenues decreased from $968.9 million for the year ended December 31, 1998, to
$939.8 million for the year ended December 31, 1999, a 3% decrease. A
contributing factor to the decline in 1999 revenues was ESI's termination of US
Xpress as a major customer that had approximately 6,200 worksite employees.
While an unprofitable relationship for ESI, US Xpress contributed $121.3 million
to 1998 revenues. Excluding this revenue, 1999 revenues reflected an increase of
$92.2 million, or 10.9% over adjusted 1998 revenues. Core PEO revenues for the
1999 calendar year were $561.1 million, a 1% decline from 1998 core PEO revenues
of $569.4 million. Growth from core PEO internal sales was slower than
anticipated as the Company began the initiative of transitioning its sales
efforts away from the transportation services industry and other less profitable
blue collar customers within the core PEO business segment towards a more
profitable high tech and other professional white collar customer profile. Also
contributing to this decline was the Company's implementation of re-pricing
initiatives which included the termination of certain unprofitable customers,
other normal year-end customer attrition, (which was higher than anticipated)
and attrition resulting from breaches of noncompetition agreements by former
salespersons. The number of worksite employees decreased from approximately
40,800 at December 31, 1998, to approximately 34,900 at December 31, 1999. See
"Outlook: Issues and Risks - Implementation of Operating Plan; Customer
Attrition."
Revenues from Logistics Personnel Corp., which provides specialized leasing of
all types of distribution personnel, increased from $102.2 million in 1998 to
$109.8 million for 1999, an increase of 7%. Revenues from TEAM Services, which
provides specialized leasing services to the entertainment industry, increased
from $174.1 million in 1998 to $269.0 million for 1999, an increase of 55%. The
increase at TEAM Services was primarily attributable to growth experienced in
the music touring business, which benefited in part from touring bands and other
concert activities associated with year 2000 events. The Company continues to
engage in discussions with prospective purchasers of its TEAM Services
subsidiary, though there can be no assurance that a sale can be completed on
satisfactory terms.
COST OF REVENUES
Cost of revenues decreased 3% from $934.7 million for the year ended December
31, 1998, to $902.2 million in the year ended December 31, 1999. This decrease
was primarily attributable to the recognition of a $1.7 million refund received
on prior year workers' compensation premiums paid to a state funded insurance
program, the reversal of $1.7 million of reserves previously established for
expected union health and welfare pension fund withdrawals which did not occur,
the termination of US Xpress, and the reversal of $1.8 million in actuarially
determined excess workers' compensation reserves. Cost of revenues also
benefited from Company-initiated terminations of unprofitable customers as well
as customers which did not meet the Company's minimum pricing criteria.
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<PAGE>
Consistent with Company policy, the Company's workers' compensation reserves at
December 31, 1999 (as related to costs associated with certain discontinued
stand-alone program 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.
GROSS PROFIT
The Company's gross profit margin increased from 3.5% in the year ended December
31, 1998 to 4.0% for the year ended December 31, 1999. This increase was due
primarily to lower workers' compensation and health and welfare expenses, as
more fully described above, and the impact of repricing existing clients to meet
minimum pricing standards.
SELLING, GENERAL AND ADMINISTRATIVE
Selling, general and administrative expenses of $36.2 million for the year ended
December 31, 1999 decreased by 27%, or $13.1 million from the $49.3 million
incurred in 1998. This decrease was due primarily to the Company's
implementation of ongoing expense reduction initiatives, and the absence of
certain significant charges that were taken in 1998, as more fully described
below. As a percent of revenues, selling, general and administrative expenses
decreased from 5.1% to 3.9% during the years ended December 31, 1998 and 1999,
respectively. Included in 1999 selling, general and administrative expenses is
$3.8 million in bad debt expense compared to $5.0 million in 1998.
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 $7.5 million for the year ended
December 31, 1999 compared to $6.1 million for the year ended December 31, 1998.
The increase was due primarily to goodwill amortization resulting from an
acquisition in the fourth quarter of 1998, additional purchase price paid on
ETIC, and depreciation of communication and computer systems enhancements
recognized throughout 1999. Goodwill amortization of the fourth quarter 1998
acquisition was recognized from the date of acquisition. Amortization of the
additional purchase price paid on ETIC was recognized prospectively.
GOODWILL IMPAIRMENT
The Company performs quarterly evaluations of its goodwill by estimating the
future cash flows expected to result from customer relationships and other
assets acquired in previous acquisitions. Factors considered in estimating the
expected cash flows include whether there has been an adverse change in the
business climate such as unusually high customer attrition, an adverse action or
assessment by a regulator, a change in legal factors, or a combination of such
factors that may have resulted in an accumulation of costs significantly in
excess of what ultimately may be recoverable through the realization of future
cash flows.
The Company experienced several different adverse developments during 1999,
particularly during the fourth quarter, that resulted in impairment. The Company
was not able to offset the effects of client attrition experienced in 1999
primarily caused by factors including customer concern regarding ESI's financial
condition, the effect on 1999 revenue following the closure of certain field
offices in connection with a restructuring plan, and the Company's failure to
add adequate new revenue from customers meeting ESI's minimum profitability
requirements, particularly in its core PEO services. While a portion of this
attrition resulted from the Company's proactive elimination of unprofitable or
high-risk customers, the Company also experienced unusually high attrition
during the fourth quarter of 1999 based on the violation of noncompetition
agreements by former salespersons and other factors.
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<PAGE>
After performing the fourth quarter 1999 cash flow analysis it was determined
that the unamortized goodwill recorded on several acquisitions exceeded
management's estimate of the amount expected to be realized, and an impairment
write-down of $42.2 million was recorded to adjust remaining goodwill to the
estimated realizable values.
INTEREST
Interest income decreased from $1.9 million for the year ended December 31, 1998
to $1.2 million for the year ended December 31, 1999, primarily due to the
reduction of cash held and invested at the corporate level. Interest expense
increased from $8.5 million for the year ended December 31, 1998 to $8.9 million
for the year ended December 31, 1999, primarily due to interest accrued on the
Company's new $10 million loan and security agreement entered into on October
26, 1999. 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, 1999 was a provision of
.3% as compared to a benefit of .4% for the year ended December 31, 1998. As of
December 31, 1999, 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.
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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. 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.
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 were 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.
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) were 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.
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<PAGE>
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 included
significant charges that were not expected to recur in future periods, as
described below. The most significant charge was $6.2 million in legal expense
to settle the securities class action litigation. In addition, during 1998 the
Company wrote down approximately $1.5 million in receivables relating to general
customer trade receivables and collection difficulties associated with the
discontinuation of the Company's stand-alone workers' compensation program.
Additionally, certain receivables primarily related to former sales and
marketing operations in Atlanta totaling approximately $1.0 million were
reserved for in the second quarter of 1998. The receivables were non-customer
related and included 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
in the third quarter of 1998 related to the implementation of the operational
initiatives. These and other initiatives 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
maintained an active sales and customer service presence to meet the local needs
of customers and to support internal growth.
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<PAGE>
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 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.
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 1999 was from investing activities.
Cash used by operating activities was $6.1 million during 1999 compared to cash
used by operating activities of $15.7 million during 1998. 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. 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 net 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. The Company's suit was dismissed in 1999
on the basis that the Company lacked standing to pursue the collection. The
Company has taken steps that it believes are sufficient to restore its suit.
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 $3.1 million in 1999, compared to $1.2
million in 1998. Included in 1998 investing activities is $10.0 million of cash
derived from maturities of investments in marketable securities that were used
to fund the additional payment made during 1999 to HDVT, Inc. 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 parties entered into a
settlement agreement in June 1999 where ESI paid $7.5 million in cash and
675,000 shares of the Company's Common Stock.
For 1999, 1998 and 1997, capital expenditures were $1.0 million, $2.7 million,
and $2.5 million, respectively. Capital expenditures in 1999 consisted primarily
of capitalized development costs and computer equipment to implement new data
warehouse storage capabilities and to enhance the Company's ability to support
26
<PAGE>
the transition to "ESI Direct" and other service tools designed to maximize
efficiency and better serve customers. During 2000, the Company expects to
continue to invest in additional computer and technological equipment on a
limited basis.
Cash used in financing activities was $2.3 million in 1999, consisting of a
reduction in bank overdrafts of $11.3 million and a $1.1 million payment of
deferred loan costs on a new short-term $20 million credit facility obtained in
October 1999. The new facility also included a $10 million term loan, as more
fully described below. Cash provided in financing activities was $13.7 million
and $36.9 million for 1998 and 1997, respectively.
At December 31, 1999 and December 31, 1998, the Company had cash and cash
equivalents of $34.0 million and $39.3 million, respectively.
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, 1999 and December 31, 1998, the Company had working capital of
$15.4 million and $31.7 million, respectively. See also "FUTURE CAPITAL AND
LIQUIDITY NEEDS; UNCERTAINTY OF ADDITIONAL FINANCING" AND "SUBSTANTIAL
LEVERAGE", NEGOTIATIONS WITH HOLDERS OF INDEBTEDNESS; POTENTIAL SUBSTANTIAL
DILUTION OF COMMON STOCKHOLDERS."
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 was 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 is amortizing 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,
although the note payable described below was a permitted borrowing .
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.
NOTE PAYABLE
On October 26, 1999 the Company entered into a loan and security agreement (the
"Loan Agreement") with Foothill Capital Corporation and Ableco Finance LLC (the
"Lenders") providing for a term loan of $10 million at an interest rate of 13.5%
and a revolving loan (based on eligible accounts receivable) to a maximum of $10
million (including letters of credit drawn thereunder) at an interest rate of
prime plus 2%. The Company received the proceeds of the term loan on October 29,
1999. The Company does not currently intend to draw on the revolving loan
facility except as security for various letters of credit. The Company paid a
closing fee of $800,000 and will pay a commitment fee of 50 basis points on the
unused portion of the revolving line, as well as letter of credit fees of 2.0%.
If the term loan then remains outstanding, the interest rate thereon increases
by 25 basis points per month beginning on July 29, 2000 and a fee of $100,000 is
payable on July 29, 2000 and on October 29, 2000. The Loan Agreement matures on
January 1, 2001. The principal loan covenants are as follows: tangible net worth
of ($72,390,000) at December 31, 1999, ($71,320,000) at March 31, 2000,
($70,220,000) at June 30, 2000, ($68,270,000) at September 30, 2000 and
($66,090,000) at December 31, 2000; and EBITDA (as defined) of $1,230,000 at
December 31, 1999, $2,560,000 at March 31, 2000, $2,780,000 at June 30, 2000,
$3,410,000 at September 30, 2000 and $3,770,000 at December 31, 2000. The Loan
Agreement also includes covenants relating to capital expenditure limits and
worksite employee headcount and average gross margin requirements. The Loan
Agreement further contains, among other limitations, restrictions on mergers or
the sale of significant assets or use of the proceeds thereof, investments and
business acquisitions, and additional indebtedness or liens. The Loan Agreement
includes certain other customary covenants, and is secured by substantially all
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of the Company's assets (including pledges of the stock of the Company's
subsidiaries and control agreements over substantially all of the Company's cash
accounts). The Company anticipates that it will not be in compliance with one or
more of the covenants set forth above as of March 31, 2000 and has therefore
classified the debt obligation as a current liability.
"GOING CONCERN" MATTERS; MANAGEMENT'S PLANS
The accompanying consolidated financial statements of the Company have been
presented on the basis that it is a going concern, which contemplates the
realization of assets and the satisfaction of liabilities in the normal course
of business. As more fully described above in this Item, the liquidity of the
Company has been adversely affected by recurring operating losses (including
significant payments in recent years in settlement of litigation) and the
incurrence of substantial indebtedness. At December 31, 1999, the Company had
outstanding indebtedness of $10.0 million under its secured loan facility,
outstanding senior indebtedness of $85.0 million and a deficit in stockholders'
equity of approximately $28.7 million, respectively. The Company believes that
it currently is leveraged to a significantly greater extent than any of its
principal competitors. In addition, due to the Company's inability to meet
projected revenue growth because of the market's continued negative perception
of the Company's financial stability, which will have an adverse effect on
earnings before interest, taxes, depreciation and amortization (EBITDA), the
Company anticipates that it will not be in compliance with one or more of the
covenants set forth in its secured loan facility as of March 31, 2000. Based on
the factors discussed in this paragraph, the report of the Company's independent
public accountants includes an explanatory paragraph expressing substantial
doubt regarding the Company's ability to continue as a going concern.
The Company is pursuing initiatives intended to improve its cash flows and
liquidity position. The Company has begun negotiations with the holders of the
unsecured senior indebtedness aimed at reducing or eliminating the outstanding
principal amount of such indebtedness (and accrued interest) in exchange for the
issuance of shares of its equity securities. The Company further will seek to
negotiate a waiver of any noncompliance under its secured loan facility. In
addition, the Company is seeking to accelerate revenue growth through a recent
refocus of its sales and marketing efforts to target industries and geographic
territories that it believes present the greatest opportunities for profitable
growth, and to emphasize marketing through third-party alliances. The Company
further is implementing expense reductions to offset the effect of delayed
revenue growth. See also in this Item the discussion under the headings "Issues:
Outlook and Risks - `SUBSTANTIAL LEVERAGE; NEGOTIATIONS WITH HOLDERS OF
INDEBTEDNESS; POTENTIAL SUBSTANTIAL DILUTION OF COMMON STOCKHOLDERS;' `FUTURE
CAPITAL AND LIQUIDITY NEEDS; UNCERTAINTY OF ADDITIONAL FINANCING; POTENTIAL
NONCOMPLIANCE WITH LOAN AGREEMENT ABILITY TO SERVICE INDEBTEDNESS;'
`CONSEQUENCES OF SUBSTANTIAL LEVERAGE;' `IMPLEMENTATION OF OPERATING PLAN;
CUSTOMER ATTRITION.'"
Assuming the success of the initiatives discussed in the preceding paragraph, of
which there can be no assurance, the Company believes that sufficient capital
resources will be generated from operations, equity investment and/or
refinancing of outstanding debt to provide necessary working capital for 2000
and operate as a going concern. Accordingly, the consolidated financial
statements do not include any adjustments relating to the recoverability and
classification of recorded asset amounts or the amounts and classification of
liabilities or any other adjustments that might result should the Company be
unable to continue as a going concern. The Company's continuation as a going
concern is dependent upon its ability to generate sufficient cash flow to meet
its obligations on a timely basis, to comply with the terms of its financing
agreements, to obtain additional financing or refinancing as may be required,
and ultimately to attain profitability.
OUTLOOK: ISSUES AND RISKS
The following issues and risks, among others (including those discussed
elsewhere herein), should also be considered in evaluating the Company's
outlook.
SUBSTANTIAL LEVERAGE; NEGOTIATIONS WITH HOLDERS OF INDEBTEDNESS; POTENTIAL
SUBSTANTIAL DILUTION OF COMMON STOCKHOLDERS
The Company has incurred significant debt primarily in connection with the
October 1997 issuance of its $85 million 10% Senior Notes due 2004 (the "Notes")
and the October 1999 Loan Agreement (described in "Liquidity and Capital
Resources," above). At December 31, 1999, the Company had outstanding
indebtedness of $10.0 million under the Loan Agreement, outstanding senior
indebtedness of $85.0 million and a deficit in stockholders' equity of
approximately $28.7 million, respectively. The Company believes that it
currently is leveraged to a significantly greater extent than any of its
principal competitors.
28
<PAGE>
In an effort to improve cash flows and reduce the Company's indebtedness, the
Company has begun negotiations with the holders of the Notes (the
"Noteholders"). The Company is seeking to negotiate the reduction or elimination
of the outstanding principal amount of the Notes and accrued interest thereon in
exchange for the issuance of shares of its equity securities. If the Company is
able to reach agreement with the Noteholders upon such a transaction, the
Company anticipates that the percentage ownership of the then current
shareholders of the Company will be materially reduced, and the equity
securities issued to participating Noteholders also may have rights, preferences
or privileges senior to those of the holders of the Company's Common Stock. The
Company is seeking to complete negotiations with the Noteholders and currently
intends to submit to shareholders for approval on or before July 15, 2000 a
proposal relating to all or a portion of the negotiations.
There can be no assurance whether or when a satisfactory agreement can be
reached with the Noteholders. If the Company is unable to complete a
satisfactory agreement with the Noteholders, the Company will remain subject to
the current principal and interest obligations (and other terms and conditions)
associated with the Notes, it will not likely be able to retain certain of its
key employees, and its liquidity position and ability to operate will be
materially adversely affected. Among its obligations under the Notes is a
regular semi-annual interest payment of $4.25 million due on April 15, 2000. The
Company currently is evaluating whether it will make such interest payment.
Failure to make such interest payment for thirty (30) days following April 15,
2000 without the consent of the Noteholders would constitute a default under the
Notes and, by virtue of cross-default provisions, the Loan Agreement. See
"FUTURE CAPITAL AND LIQUIDITY NEEDS; UNCERTAINTY OF ADDITIONAL FINANCING;
POTENTIAL NONCOMPLIANCE WITH LOAN AGREEMENT."
FUTURE CAPITAL AND LIQUIDITY NEEDS; UNCERTAINTY OF ADDITIONAL FINANCING;
POTENTIAL NONCOMPLIANCE WITH LOAN AGREEMENT
If a satisfactory agreement with the Noteholders can be reached (see
"Substantial Leverage; Negotiations with Holders of Indebtedness; Potential
Substantial Dilution of Common Stockholders," above), management believes that,
based on its 2000 operating plan and subject to the discussion herein concerning
the Loan Agreement, 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 remaining indebtedness. The Company will need to raise
additional funds through public or private debt or equity financing if
satisfactory arrangements cannot be reached with its principal lenders, the
revenue and cash flow elements of its 2000 operating plan are not met,or to deal
with unanticipated cash requirements, such as adverse litigation outcomes or
material customer payment defaults. For a discussion of risks associated with
the Company's 2000 operating plan, see "Implementation of Operating Plan." If
additional funds are raised through the issuance of equity securities, the
percentage ownership of the then current shareholders of the Company will be
materially 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
acceptable 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,
financial condition and ability to operate will be materially adversely
affected.
Due to the Company's inability to meet projected revenue growth, which will have
an adverse effect on earnings before interest, taxes, depreciation and
amortization (EBITDA), the Company anticipates that it will not be in compliance
with one or more of the covenants set forth in the Loan Agreement as of March
31, 2000. While the Company will seek to negotiate a waiver of such
noncompliance, there can be no assurance that a waiver or similar agreement can
be reached on satisfactory terms. Unless satisfactory refinancing arrangements
can be made, of which there can be no assurance, the Company's financial
condition and ability to operate will be materially adversely affected if the
lenders under the Loan Agreement accelerate the Company's obligations under the
Loan Agreement as a result of such noncompliance or otherwise. At December 31,
1999, the Company had outstanding indebtedness of $10.0 million under the Loan
Agreement.
29
<PAGE>
ABILITY TO SERVICE INDEBTEDNESS; CONSEQUENCES OF SUBSTANTIAL LEVERAGE
The Company's ability to make scheduled principal payments in respect of, or to
pay the interest on, or to refinance, any of its indebtedness (including the
Loan Agreement and any outstanding 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. 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 Loan Agreement and the
Notes, or make anticipated capital expenditures and lease payments. See
"SUBSTANTIAL LEVERAGE; NEGOTIATIONS WITH HOLDERS OF INDEBTEDNESS; POTENTIAL
SUBSTANTIAL DILUTION OF COMMON STOCKHOLDERS," "FUTURE CAPITAL AND LIQUIDITY
NEEDS; UNCERTAINTY OF ADDITIONAL FINANCING; POTENTIAL NONCOMPLIANCE WITH LOAN
AGREEMENT" and "IMPLEMENTATION OF OPERATING PLAN; CUSTOMER ATTRITION."
The degree to which the Company is leveraged has 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, including
repayment of principal, 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 Loan Agreement and Notes indenture contain financial and
restrictive covenants that limit the ability of the Company to, among other
things, borrow additional funds. Failure by the Company to comply with such
covenants could result in an event of default which, if not cured or waived,
could have a material adverse effect on the Company's, liquidity position,
business and financial performance.
IMPLEMENTATION OF OPERATING PLAN; CUSTOMER ATTRITION
The Company's 2000 operating plan depends in significant part upon achieving
revenue growth through internal sales and marketing efforts. The Company
recently refocused its sales and marketing efforts to target industries and
geographic territories that it believes present the greatest opportunities for
profitable growth, and to emphasize marketing through third-party alliances.
While the Company believes that its refocused sales and marketing plan will
result in consistent and profitable revenue growth, the Company has not yet
demonstrated successful implementation of the plan and there can be no assurance
that successful implementation can be achieved.
The Company's 2000 operating plan also depends on a significant reduction of
customer attrition. The Company experienced significant attrition in 1999,
resulting in a net reduction of approximately 5,900 worksite employees during
the year. While a portion of this attrition resulted from the Company's
proactive elimination of unprofitable or high-risk customers, the Company also
experienced attrition based on violation of noncompetition agreements by former
salespersons and other factors. The Company's 2000 operating plan includes
continuing improvements in customer service functions intended to reduce
attrition, and the Company is aggressively seeking to enforce its noncompetition
agreements. There can be no assurance that customer retention can be materially
improved. The Company anticipates that its efforts to achieve revenue growth and
reduce attrition will be adversely affected by the market's current negative
perception of the Company's financial stability.
The Company's agreements with its customers historically have been subject to
cancellation upon 30 days written notice of termination by either party, except
where different arrangements are required by applicable law. While the Company
has commenced the use of longer-term agreements, the short-term nature of most
current customer agreements means that customers could terminate a substantial
portion of the Company's business upon short NOTICE.
DE-LISTING OF COMMON STOCK FROM NASDAQ
Effective March 22, 2000, the Company's Common Stock was delisted from the
Nasdaq SmallCap Market due to noncompliance with the following requirements for
continued listing of its Common Stock: maintenance of a market capitalization of
at least $35 milllion and a minimum bid price of $1.00 per share. As a result of
the de-listing, trading in the Company's Common Stock currently is conducted in
the Over-the-Counter Bulletin Board of the National Association of Securities
Dealers, Inc. and/or the so-called "pink sheets." As a consequence of such
de-listing, investors may find it more difficult to dispose of, or to obtain
accurate quotations as to the price of the Company's Common Stock.
30
<PAGE>
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.
LITIGATION AND OTHER CONTINGENCIES
While certain significant litigation matters were resolved in 1999, other
significant matters remain unresolved. For example, the State of Ohio has
assessed significant sales and use taxes against the Company that the Company
believes have been assessed erroneously and is contesting vigorously. The
Company faces other claims 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.
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 an increase in claims activity for unemployment, workers'
compensation and/or healthcare, or if other factors result in higher expenses in
these areas, the Company's costs in these areas would increase. In such a case,
the Company may not be able to pass these higher costs to its customers due to
contractual or competitive factors. By way of example, the Company experienced
certain cost increases for 2000, not all of which were able to be passed onto
customers. In addition, the Company may experience difficulty competing with
PEOs with lower 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.
31
<PAGE>
As the employer of record for many client companies and their worksite
employees, the Company must account for and remit payroll, unemployment and
other employment-related taxes to numerous federal, state and local tax, labor
and unemployment authorities, and is subject to substantial penalties for
failure to do so. From time to time, the Company has received notices or
challenges which may adversely affect its tax rates and payments. In light of
the IRS Market Segment Study Group and the general uncertainty in this area,
certain proposed legislation has been drafted to clarify the employer status of
PEOs in the context of the Code and benefit plans. However, there can be no
assurance that such legislation will be proposed and adopted or in what form it
would be adopted. Even if it were adopted, the Company may need to change
aspects of its operations or programs to comply with any requirements which may
ultimately be adopted. In particular, the Company may need to retain increased
sole or shared control over worksite employees if the legislation is passed in
its current form.
CREDIT RISKS
As the employer of record for its worksite employees, the Company generally is
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.
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.
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 customer
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
32
<PAGE>
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 are
not 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 expired 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.
YEAR 2000 COMPLIANCE
Many computer programs process transactions based on using two digits for the
year of the transaction rather than a full four year digits (e.g. "98" for
1998). Accordingly, the Company prepared for the Year 2000 issue on the
assumption that systems that process Year 2000 transactions with the year "00"
might encounter significant processing inaccuracies or inoperability. The
Company's preparations included preparing an overall plan for Year 2000
compliance; assessing the potential risks associated with its systems and its
interactions with third parties; testing hardware and software under various
scenarios; obtaining written information from third parties concerning their
state of readiness; and developing contingency plans. Through March 15, 2000,
the Company has not experienced any adverse effects from the Year 2000
conversion and does not currently expect that it will experience any adverse
effects. In addition, the Company has not experienced any adverse effects with
any of its third party vendors or customers. While the Company does not expect
that it will experience any adverse effects related to this issue, it will
continue to monitor for Year 2000 specific issues on an informal basis using
existing staff.
33
<PAGE>
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, 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.
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 2000 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, 1999. 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.
34
<PAGE>
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
None.
35
<PAGE>
ITEM 8. FINANCIAL STATEMENTS
INDEX
Page
----
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS F-2
FINANCIAL STATEMENTS
Consolidated Balance Sheets -
December 31, 1999 and 1998 F-3
Consolidated Statements of Operations -
For the Years Ended December 31, 1999, 1998 and 1997 F-4
Consolidated Statements of Stockholders' Equity -
For the Years Ended December 31, 1999, 1998 and 1997 F-5
Consolidated Statements of Cash Flows -
For the Years Ended December 31, 1999, 1998 and 1997 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,
1999 and 1998, and the related consolidated statements of operations,
stockholders' equity and cash flows for each of the three years in the period
ended December 31, 1999. These financial statements and the schedule referred to
below are the responsibility of the Company's management. Our responsibility is
to express an opinion on these financial statements and schedule based on our
audits.
We conducted our audits in accordance with auditing standards generally accepted
in the United States. 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 financial statements referred to above present fairly, in
all material respects, the financial position of Employee Solutions, Inc. and
subsidiaries as of December 31, 1999 and 1998, and the results of their
operations and their cash flows for each of the three years in the period ended
December 31, 1999, in conformity with accounting principles generally accepted
in the United States.
The accompanying financial statements have been prepared assuming that the
Company will continue as a going concern. As discussed in Note 16 to the
financial statements, the Company has suffered recurring losses from operations
and entered into negotiations to restructure its debt that raises substantial
doubt about its ability to continue as a going concern. Management's plans in
regard to these matters are also described in Note 16. The financial statements
do not include any adjustments relating to the recoverability and classification
of asset carrying amounts or the amount and classification of liabilities that
might result should the Company be unable to continue as a going concern.
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 3, 2000.
F-2
<PAGE>
EMPLOYEE SOLUTIONS, INC.
CONSOLIDATED BALANCE SHEETS
DECEMBER 31, 1999 AND 1998
(In thousands of dollars, except share data) 1999 1998
--------- ---------
ASSETS
CURRENT ASSETS:
Cash and cash equivalents $ 34,014 $ 39,287
Investments and marketable securities 100 9,997
Restricted cash 1,000 1,088
Accounts receivable, net 38,296 38,742
Receivables from insurance companies 6,618 6,704
Prepaid expenses and deposits 1,088 2,303
Income taxes receivable -- 5,040
Deferred income taxes -- 811
--------- ---------
Total current assets 81,116 103,972
Property and equipment, net 4,211 4,543
Deferred income taxes -- 60
Goodwill and other assets, net 37,000 66,530
--------- ---------
Total assets $ 122,327 $ 175,105
========= =========
LIABILITIES AND STOCKHOLDERS' (DEFICIT) EQUITY
CURRENT LIABILITIES:
Bank overdraft $ 2,472 $ 13,727
Accrued salaries, wages and payroll taxes 31,175 28,719
Accounts payable 6,224 5,898
Accrued workers' compensation and
health insurance 7,188 9,617
Income taxes payable 363 751
Other accrued expenses 8,284 13,595
Note payable 10,000 --
--------- ---------
Total current liabilities 65,706 72,307
--------- ---------
Deferred income taxes -- 871
--------- ---------
Long-term debt 85,000 85,000
--------- ---------
Other long-term liabilities 347 1,211
--------- ---------
Commitments and contingencies
Stockholders' (deficit) 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, 36,182,547 shares issued and
outstanding in 1999, and 32,419,595 shares issued
and outstanding in 1998 39,550 35,800
Common stock to be issued, no par value,
4,206,829 shares 7,871 --
Accumulated deficit (76,147) (20,085)
Cumulative unrealized gain on investment securities -- 1
--------- ---------
Total stockholders' (deficit) equity (28,726) 15,716
--------- ---------
Total liabilities and stockholders' (deficit) equity $ 122,327 $ 175,105
========= =========
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, 1999, 1998 AND 1997
<TABLE>
<CAPTION>
(In thousands of dollars, except share
and per share data) 1999 1998 1997
----------- ----------- -----------
<S> <C> <C> <C>
Revenues $ 939,835 $ 968,909 $ 933,817
----------- ----------- -----------
Cost of revenues:
Salaries and wages of worksite employees 804,324 814,453 765,047
Healthcare and workers' compensation 40,690 55,913 75,595
Payroll and employment taxes 57,194 64,318 62,613
----------- ----------- -----------
Cost of revenues 902,208 934,684 903,255
----------- ----------- -----------
Gross profit 37,627 34,225 30,562
Selling, general and administrative expenses 36,228 49,293 33,411
Depreciation and amortization 7,492 6,145 4,617
Goodwill impairment 42,205 -- --
----------- ----------- -----------
Loss from operations (48,298) (21,213) (7,466)
Other income (expense):
Interest income 1,196 1,885 1,303
Interest expense (8,854) (8,541) (5,102)
Other 39 (193) (50)
----------- ----------- -----------
Loss before provision for income taxes (55,917) (28,062) (11,315)
Income tax provision (benefit) 145 (111) (2,819)
----------- ----------- -----------
Net loss $ (56,062) $ (27,951) $ (8,496)
=========== =========== ===========
Net loss per common and common equivalent share:
Basic $ (1.55) $ (.88) $ (.27)
=========== =========== ===========
Diluted $ (1.55) $ (.88) $ (.27)
=========== =========== ===========
Weighted average number of common and common
equivalent shares outstanding:
Basic 36,213,874 31,817,176 31,193,367
=========== =========== ===========
Diluted 36,213,874 31,817,176 31,193,367
=========== =========== ===========
</TABLE>
The accompanying notes are an integral part of these
consolidated financial statements.
F-4
<PAGE>
EMPLOYEE SOLUTIONS, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
FOR THE YEARS ENDED DECEMBER 31, 1999, 1998, AND 1997
<TABLE>
<CAPTION>
Common Retained Cumulative Total
Stock Earnings Unrealized Stockholders' Comprehensive
(In thousands of dollars, Common To Be Accumulated Gain (Loss) on (Deficit) Income
except share data) Stock Issued (Deficit) Investments Equity (Loss)
----- ------ --------- ----------- ------ ------
<S> <C> <C> <C> <C> <C> <C>
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 --
Issuance of 1,668 shares of common
stock in connection with exercise of
common stock options 3 -- -- -- 3 --
Issuance of 75,000 of common stock warrants
in connection with consulting services 41 -- -- -- 41 --
Issuance of 1,771,169 shares of common stock
in connection with settlement of litigation 735 851 -- -- 1,586 --
Issuance of 6,204,794 shares of common
stock in connection with acquisition 2,971 7,020 -- -- 9,991 --
Change in unrealized net gains, net of
applicable taxes -- -- -- (1) (1) (1)
Net loss -- -- (56,062) -- (56,062) (56,062)
-------- ------ -------- ---- -------- --------
COMPREHENSIVE LOSS $(56,063)
========
BALANCE, DECEMBER 31, 1999 $ 39,550 $7,871 $(76,147) -- $(28,726)
======== ====== ======== ==== ========
</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, 1999, 1998 AND 1997
<TABLE>
<CAPTION>
(In thousands of dollars) 1999 1998 1997
--------- --------- ---------
<S> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Cash received from customers $ 940,281 $ 987,634 $ 911,189
Cash paid to suppliers and employees (943,354) (980,636) (896,812)
Cash paid in loss portfolio transfer -- (19,950) --
Interest received 1,196 1,885 1,303
Interest paid (8,681) (8,640) (5,152)
Income taxes refunded (paid), net 4,507 4,008 (3,315)
--------- --------- ---------
Net cash (used in) provided by operating activities (6,051) (15,699) 7,213
--------- --------- ---------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of property and equipment (1,008) (2,749) (2,499)
Business acquisitions (5,896) (3,267) (5,024)
Change in investments and marketable securities 9,897 (9,997) --
Cash (invested in) released from restricted accounts, net 88 17,912 (7,500)
Disbursements for deferred costs -- (723) --
--------- --------- ---------
Net cash provided by (used in) investing activities 3,081 1,176 (15,023)
--------- --------- ---------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from issuance of long-term debt -- -- 6,905
Proceeds from note payable 10,000 -- --
Repayment of long-term debt -- -- (49,705)
Proceeds from issuance of long-term
senior notes -- -- 85,000
Payment of deferred loan costs (1,051) (226) (3,285)
Proceeds from issuance of common stock 3 199 502
Increase (decrease) in bank overdraft (11,255) 13,727 (2,477)
--------- --------- ---------
Net cash (used in) provided by financing activities (2,303) 13,700 36,940
--------- --------- ---------
Net increase (decrease) in cash and
cash equivalents (5,273) (823) 29,130
CASH AND CASH EQUIVALENTS, beginning of year 39,287 40,110 10,980
--------- --------- ---------
CASH AND CASH EQUIVALENTS, end of year $ 34,014 $ 39,287 $ 40,110
========= ========= =========
</TABLE>
The accompanying notes are an integral part of these
consolidated financial statements.
F-6
<PAGE>
EMPLOYEE SOLUTIONS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED DECEMBER 31, 1999, 1998 AND 1997
(CONTINUED)
<TABLE>
<CAPTION>
1999 1998 1997
-------- -------- --------
<S> <C> <C> <C>
RECONCILIATION OF NET LOSS TO NET CASH
PROVIDED BY (USED IN) OPERATING ACTIVITIES:
Net loss $(56,062) $(27,951) $ (8,496)
-------- -------- --------
ADJUSTMENTS TO RECONCILE NET LOSS TO NET CASH
PROVIDED BY (USED IN) OPERATING ACTIVITIES:
Depreciation and amortization 7,492 6,145 4,617
Goodwill impairment 42,205 -- --
Loss on sale of fixed assets -- 193 --
Write-off of deferred acquisition costs -- 772 --
Other non-cash charges, net (1,170) 1,200 58
Decrease (increase) in accounts receivable, net 446 18,725 (22,628)
Decrease (increase) in receivables from
insurance companies 86 366 (1,152)
Decrease (increase) in prepaid expenses and deposits 1,215 2,259 (3,304)
Decrease (increase) in deferred income taxes, net -- 4,106 (2,522)
Decrease (increase) in other assets 784 166 (805)
Increase (decrease) in accrued salaries, wages
and payroll taxes 2,456 (14,544) 25,677
(Decrease) increase in accrued workers'
compensation and health insurance (2,429) (14,969) 17,659
(Decrease) increase in other long-term debt 347 (2) (136)
Increase in accounts payable 326 1,535 285
(Decrease) increase in income taxes payable/receivable 4,652 (209) (3,612)
Increase (decrease) in other accrued expenses (6,399) 6,509 1,572
-------- -------- --------
50,011 12,252 15,709
-------- -------- --------
Net cash provided by (used in) operating activities $ (6,051) $(15,699) $ 7,213
======== ======== ========
</TABLE>
SUPPLEMENTAL DISCLOSURE OF NON-CASH INVESTING AND FINANCING ACTIVITIES:
In connection with business acquisitions during 1999, 1998 and 1997, the Company
assumed net liabilities of $-0-, $300,000, and $900,000 and issued $9,991,000,
$813,000, and $2.6 million of common stock, respectively. In 1999 and 1998,
$41,000 and $298,000 of warrants were also issued, respectively. In addition,
$1,586,000 of common stock was issued in 1999 in connection with settlement of
litigation.
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, 1999, 1998 AND 1997
(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
NATURE OF CORPORATION
Employee Solutions, Inc. (together with its subsidiaries, "ESI" or the
"Company") is a leading professional employer organization (PEO) providing
employers throughout the United States with comprehensive employee payroll,
human resources and benefits outsourcing services. The Company's integrated
outsourcing services include payroll processing and reporting, human resources
administration, employment regulatory compliance management, risk
management/workers' compensation services, retirement and health care programs,
and other products and services provided directly to worksite employees. At
December 31, 1999, ESI serviced approximately 1,900 client companies with
approximately 34,900 worksite employees in 46 states.
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 29%, represents
the largest concentration of customers, including one former customer that
generated approximately 13% of total revenues in 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 accounting principles
generally accepted in the United States 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 certificates
of deposit, at December 31, 1999 and 1998, and are stated at fair market value.
Substantially all cash and cash equivalents, including restricted cash and
investments, are not insured at December 31, 1999.
RESTRICTED CASH
At December 31, 1999, restricted cash was approximately $1 million, which
represented accounts held by banks as security for certain types of controlled
disbursement transaction risk. Subsequent to year end the restriction on this
account was released. At December 31, 1998, restricted cash was approximately
$1.1 million, which represented amounts held for settlement of a legal matter.
Restricted investments consist of certificates of deposit 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."
F-8
<PAGE>
INVESTMENTS AND MARKETABLE SECURITIES
At December 31, 1999, the Company maintained approximately $15.2 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 money market and mutual funds that had an
estimated fair value of $15.0 million at December 31, 1999. Securities with
original maturities greater than 90 days consisted of a certificate of deposit
with a fair value of approximately $151,300.
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, 1999 and 1998, the Company had receivables from its fronting
companies of $6.6 million and $6.7 million, respectively. The receivables
represent cash contractually required to be advanced to the insurance companies
for loss funds, administrative fees, excess reinsurance premiums and premium
taxes. At December 31, 1999 and 1998 the Company has recorded estimates of the
actual expenses incurred of $4.1 million and $3.3 million respectively. 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.
================================================================================
(In thousands of dollars) December 31, December 31,
1999 1998
-------- --------
Trade accounts receivable $ 28,866 $ 27,130
Unbilled salary and wage accruals 11,384 11,921
Unbilled stand alone premium revenue 1,842 1,985
Other, including affiliated parties 2,133 2,628
Allowance for estimated uncollectible receivables (5,929) (4,922)
-------- --------
Total accounts receivable, net $ 38,296 $ 38,742
======== ========
================================================================================
At December 31, 1999 and 1998, receivables from affiliated parties included in
the above totals were $1.3 million and $2.2 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. Improvements
or renewals are capitalized when incurred. Property and equipment is net of
accumulated depreciation of $2,988,000 and $1,681,000 at December 31, 1999 and
1998, respectively.
GOODWILL AND OTHER ASSETS
Included in goodwill and other assets is $31.7 million and $60.6 million at
December 31, 1999 and 1998, 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. During 1999 the
Company recognized a goodwill impairment charge of $42.2 million to write-down
its remaining goodwill to the estimated fair value of $31.7 million. See Note
10.
Goodwill and other assets are net of accumulated amortization of $6.0 million
and $10.2 million at December 31, 1999 and 1998, respectively.
Also included in goodwill and other assets at December 31, 1999 and 1998 is a
$1.4 million net receivable for stand-alone workers' compensation premium due
from one customer for a two-year program that 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.
F-10
<PAGE>
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 the Company is responsible for the first $250,000 per occurrence
with no aggregate to limit the Company's liability.
Individual risk management/workers' compensation claims in excess of $250,000
and up to the statutory limits of the states where the Company operates are the
responsibility of Reliance. The Company's prior arrangements with AIG were
structured in a manner similar to its current arrangements with Reliance.
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 $1.8 and $2.1 million at December 31, 1999 and 1998, respectively.
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.
LOSS CONTINGENCIES
The Company expenses legal fees related to loss contingencies as the legal fees
are incurred.
F-11
<PAGE>
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 SFAS
No. 109. See Note 3.
NET LOSS PER COMMON AND COMMON EQUIVALENT SHARE
The computation of adjusted net loss and weighted average common and common
equivalent shares used in the calculation of net loss per common share is as
follows:
<TABLE>
<CAPTION>
==================================================================================================================
(In thousands of dollars,
except share and per 1999 1998 1997
share data) ------------------------- ------------------------- -------------------------
Basic Diluted Basic Diluted Basic Diluted
----------- ----------- ----------- ----------- ----------- -----------
<S> <C> <C> <C> <C> <C> <C>
Weighted average of
common shares outstanding 36,213,874 36,213,874 31,817,176 31,817,176 31,193,367 31,193,367
Dilutive effect of options
and warrants outstanding -- -- -- -- -- --
----------- ----------- ----------- ----------- ----------- -----------
Weighted average of common
and common equivalent shares 36,213,874 36,213,874 31,817,176 31,817,176 31,193,367 31,193,367
=========== =========== =========== =========== =========== ===========
Net loss $ (56,062) $ (56,062) $ (27,951) $ (27,951) $ (8,496) $ (8,496)
Adjustments to net loss -- -- -- -- -- --
----------- ----------- ----------- ----------- ----------- -----------
Adjusted net loss for purposes
of the loss per common share
calculation $ (56,062) $ (56,062) $ (27,951) $ (27,951) $ (8,496) $ (8,496)
=========== =========== =========== =========== =========== ===========
Net loss per common and common
equivalent share $ (1.55) $ (1.55) $ (0.88) $ (0.88) $ (0.27) $ (0.27)
=========== =========== =========== =========== =========== ===========
==================================================================================================================
</TABLE>
The calculation of weighted average common and common equivalent shares for
purposes of calculating the 1999, 1998 and 1997 diluted loss per share excludes
approximately 39,313, 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.
F-12
<PAGE>
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.
The following table presents a summary of the Company's financial instruments,
as defined by SFAS 107:
<TABLE>
<CAPTION>
============================================================================================
December 31,
------------------------------------------------
1999 1998
--------------------- -----------------------
Carrying Estimated Carrying Estimated
(In thousands of dollars) Amount Fair Value Amount Fair Value
------ ---------- ------ ----------
<S> <C> <C> <C> <C>
Financial Assets
Cash and cash equivalents $34,014 $34,014 $39,287 $39,287
Investments and marketable securities 100 100 9,997 9,997
Restricted cash 1,000 1,000 1,088 1,088
Other financial assets, primarily
accounts receivable 46,302 46,302 46,834 46,834
Financial Liabilities
Bank overdraft 2,472 2,472 13,727 13,727
Note payable 10,000 10,000 -- --
Long-term debt 85,000 42,500 85,000 60,350
Other financial liabilities,
primarily accrued liabilities 53,581 53,581 59,791 59,791
===========================================================================================
</TABLE>
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
estimates.
F-13
<PAGE>
(2) 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
------------------------- -------
2000 $ 1,628
2001 1,536
2002 1,472
2003 1,429
2004 360
-------
Total $ 6,425
=======
================================================================================
Rental expense under all leases was $2.4 million, $2.5 million, and $1.9 million
in 1999, 1998 and 1997, respectively.
(3) INCOME TAXES
The components of the provision for income taxes for the years ended December
31, 1999, 1998 and 1997 were as follows:
================================================================================
(In thousands of dollars) 1999 1998 1997
- ------------------------- ---- ---- ----
Current $145 $(4,217) $ (297)
Deferred -- 4,106 (2,522)
---- ------- -------
Income tax provision (benefit) $145 $ (111) $(2,819)
==== ======= =======
================================================================================
Income tax expense differs from the amount computed using the statutory federal
income tax rate due to the following:
================================================================================
(In thousands of dollars) 1999 1998 1997
- ------------------------- -------- ------- -------
Income tax benefit at statutory rate $(19,571) $(9,822) $(3,847)
Increase in valuation allowance 17,641 9,188 --
Non-deductible goodwill amortization 4,415 352 271
Non-deductible per diem and other expenses 203 193 336
State taxes, net of federal benefit (2,482) 34 451
Other (61) (56) (30)
-------- ------- -------
Income tax provision (benefit) $ 145 $ (111) $(2,819)
======== ======= =======
================================================================================
F-14
<PAGE>
The Company's entire net deferred tax asset was offset with a valuation
allowance at December 31, 1999 and December 31, 1998 in light of the uncertain
future utilization of net operating loss carryforwards (NOLCs), tax credit
carryforwards and other future deductions.
At December 31, 1999 the Company has regular federal NOLCs of approximately
$25.5 million which will expire, if unused, in 2019. At December 31, 1999 the
Company also has federal tax carryforwards of approximately $600,000 a portion
of which will also expire, if unused, in 2019.
Deferred tax assets and liabilities are comprised of the following temporary
differences at December 31:
================================================================================
(in thousands of dollars) 1999 1998
- ------------------------- -------- --------
Deferred tax liabilities:
Depreciation and amortization $ 1,170 $ 871
-------- --------
Deferred tax assets:
Intangible assets with remaining tax basis 12,245 --
Accruals and reserves not deductible for tax purposes 4,927 10,059
Net operating loss carryforwards 10,219 --
Tax credit carryforwards 608 --
Valuation allowance (26,829) (9,188)
-------- --------
Total deferred tax assets 1,170 871
-------- --------
Net deferred taxes $ -- $ --
======== ========
================================================================================
(4) NOTE PAYABLE
On October 26, 1999 the Company entered into a loan and security agreement (the
"Loan Agreement") with Foothill Capital Corporation and Ableco Finance LLC (the
"Lenders") providing for a term loan of $10 million at an interest rate of 13.5%
and a revolving loan (based on eligible accounts receivable) to a maximum of $10
million (including letters of credit drawn thereunder) at an interest rate of
prime plus 2%. The Company received the proceeds of the term loan on October 29,
1999. The Company does not currently intend to draw on the revolving loan
facility except as security for various letters of credit ($5.4 million at
December 31, 1999). The Company paid a closing fee of $800,000 and will pay a
commitment fee of 50 basis points on the unused portion of the revolving line,
as well as letter of credit fees of 2.0%. If the term loan then remains
outstanding, the interest rate thereon increases by 25 basis points per month
beginning on July 29, 2000 and a fee of $100,000 is payable on July 29, 2000 and
on October 29, 2000. The Loan Agreement matures on January 1, 2001. The
principal loan covenants are as follows: tangible net worth of ($72,390,000) at
December 31, 1999, ($71,320,000) at March 31, 2000, ($70,220,000) at June 30,
2000, ($68,270,000) at September 30, 2000 and ($66,090,000) at December 31,
2000; and EBITDA (as defined) of $1,230,000 at December 31, 1999, $2,560,000 at
March 31, 2000, $2,780,000 at June 30, 2000, $3,410,000 at September 30, 2000
and $3,770,000 at December 31, 2000. The Loan Agreement also includes covenants
relating to capital expenditure limits and worksite employee headcount and
average gross margin requirements. The Loan Agreement further contains, among
other limitations, restrictions on mergers or the sale of significant assets or
use of the proceeds thereof, investments and business acquisitions, and
additional indebtedness or liens. The Loan Agreement includes certain other
customary covenants, and is secured by substantially all of the Company's assets
(including pledges of the stock of the Company's subsidiaries and control
agreements over substantially all of the Company's cash accounts). The Company
anticipates that it will not be in compliance with one or more of the covenants
set forth above as of March 31, 2000 and has therefore classified the debt
obligation as a current liability.
F-15
<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, 1999 and 1998, and the results of
operations and cash flows for each of the three years in the period ended
December 31, 1999, of Employee Solutions, Inc. (Parent), the guarantor
subsidiaries (Guarantors) and the subsidiaries which are not guarantors
(Non-guarantors).
F-16
<PAGE>
BALANCE SHEETS
<TABLE>
<CAPTION>
===============================================================================================================
(In thousands of dollars)
- ------------------------- For the Year Ended December 31, 1999
-----------------------------------------------------------
Non-
Parent Guarantors Guarantors Eliminating Consolidated
------ ---------- ---------- ----------- ------------
<S> <C> <C> <C> <C> <C>
ASSETS
CURRENT ASSETS:
Cash and cash equivalents $ 16,452 $ 14,148 $ 3,414 $ -- $ 34,014
Investments and marketable securities 100 -- -- -- 100
Restricted cash 1,000 -- -- -- 1,000
Accounts receivable, net 14,240 23,512 544 -- 38,296
Receivables from insurance companies -- -- 6,618 -- 6,618
Prepaid expenses and deposits 1,023 64 1 -- 1,088
Due from affiliates 8,150 2,644 (7,020) (3,774) --
-------- -------- -------- -------- ---------
Total current assets 40,965 40,368 3,557 (3,774) 81,116
Property and equipment, net 3,937 265 9 -- 4,211
Goodwill and other assets, net 9,947 27,053 -- -- 37,000
Investment in subsidiaries 42,872 -- -- (42,872) --
-------- -------- -------- -------- ---------
Total assets $ 97,721 $ 67,686 $ 3,566 $(46,646) $ 122,327
======== ======== ======== ======== =========
LIABILITIES AND STOCKHOLDERS' (DEFICIT) EQUITY
CURRENT LIABILITIES:
Bank overdraft $ 2,472 $ -- $ -- $ -- $ 2,472
Accrued salaries, wages and payroll taxes 5,607 25,276 292 -- 31,175
Accounts payable 966 1,151 4,107 -- 6,224
Accrued workers' compensation and health
insurance 5 953 6,230 -- 7,188
Income taxes payable 421 (56) (2) -- 363
Other accrued expenses 4,614 976 2,694 -- 8,284
Due to affiliates 17,015 11,300 (24,541) (3,774) --
Note payable 10,000 -- -- -- 10,000
-------- -------- -------- -------- ---------
Total current liabilities 41,100 39,600 (11,220) (3,774) 65,706
-------- -------- -------- -------- ---------
Deferred income taxes -- -- -- -- --
-------- -------- -------- -------- ---------
Long-term debt 85,000 -- -- -- 85,000
-------- -------- -------- -------- ---------
Other long-term liabilities 347 -- -- -- 347
-------- -------- -------- -------- ---------
Commitments and contingencies
STOCKHOLDERS' (DEFICIT) EQUITY
Class A convertible preferred stock -- -- -- -- --
Common stock, no par value 39,550 2,622 771 (3,393) 39,550
Common stock to be issued 7,871 -- -- -- 7,871
Additional paid in capital -- 26,342 50 (26,392) --
(Accumulated deficit) retained earnings (76,147) (878) 13,965 (13,087) (76,147)
-------- -------- -------- -------- ---------
Total stockholders' (deficit) equity (28,726) 28,086 14,786 (42,872) (28,726)
-------- -------- -------- -------- ---------
Total liabilities and stockholders'
(deficit) equity $ 97,721 $ 67,686 $ 3,566 $(46,646) $ 122,327
======== ======== ======== ======== =========
===============================================================================================================
</TABLE>
F-17
<PAGE>
<TABLE>
<CAPTION>
===============================================================================================================
(In thousands of dollars)
- ------------------------- For the Year Ended December 31, 1998
-------------------------------------------------------------
Non-
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 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-18
<PAGE>
STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
===============================================================================================================
(In thousands of dollars) For the Year Ended December 31, 1999
- ------------------------- ---------------------------------------------------------------
Non-
Parent Guarantors Guarantors Eliminating Consolidated
------ --------- ---------- ----------- ------------
<S> <C> <C> <C> <C> <C>
Revenues $ 221,682 $695,487 $ 22,666 $ -- $ 939,835
--------- -------- -------- -------- ---------
Cost of revenues:
Salaries and wages of worksite employees 188,508 596,947 18,869 -- 804,324
Healthcare and workers' compensation 7,966 35,702 (2,978) -- 40,690
Payroll and employment taxes 14,873 40,608 1,713 -- 57,194
--------- -------- -------- -------- ---------
Cost of revenues 211,347 673,257 17,604 -- 902,208
--------- -------- -------- -------- ---------
Gross profit 10,335 22,230 5,062 -- 37,627
Selling, general and administrative expenses 26,005 10,076 147 -- 36,228
Intercompany selling, general and
administrative expense -- -- -- -- --
Depreciation and amortization 5,876 1,587 29 -- 7,492
Goodwill impairment 33,089 8,802 314 -- 42,205
--------- -------- -------- -------- ---------
Loss from operations (54,635) 1,765 4,572 -- (48,298)
Other income (expense):
Interest income 679 136 381 -- 1,196
Interest expense and other (8,828) 13 -- -- (8,815)
--------- -------- -------- -------- ---------
Income (loss) before benefit for income taxes (62,784) 1,914 4,953 -- (55,917)
Income tax provision, net 145 -- -- -- 145
--------- -------- -------- -------- ---------
(62,929) 1,914 4,953 -- (56,062)
Income from wholly-owned subsidiaries 6,867 -- -- (6,867) --
--------- -------- -------- -------- ---------
Net (loss) income $ (56,062) $ 1,914 $ 4,953 $ (6,867) $ (56,062)
========= ======== ======== ======== =========
===============================================================================================================
</TABLE>
F-19
<PAGE>
<TABLE>
<CAPTION>
===============================================================================================================
(In thousands of dollars) For the Year Ended December 31, 1998
- ------------------------- ---------------------------------------------------------------
Non-
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-20
<PAGE>
<TABLE>
<CAPTION>
===============================================================================================================
(In thousands of dollars) For the Year Ended December 31, 1997
- ------------------------- -------------------------------------------------------------
Non-
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-21
<PAGE>
STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
=====================================================================================================================
(In thousands of dollars) For the Year Ended December 31, 1999
- ------------------------- ------------------------------------------------------------
Non-
Parent Guarantors Guarantors Eliminating Consolidated
-------- -------- -------- -------- --------
<S> <C> <C> <C> <C> <C>
RECONCILIATION OF NET INCOME (LOSS) TO NET CASH
PROVIDED BY (USED IN) OPERATING ACTIVITIES:
Net income (loss) $(56,062) $ 1,914 $ 4,953 $ (6,867) $(56,062)
-------- -------- -------- -------- --------
ADJUSTMENTS TO RECONCILE NET INCOME (LOSS) TO NET
CASH PROVIDED BY (USED IN) OPERATING ACTIVITIES:
Depreciation and amortization 5,876 1,587 29 -- 7,492
Goodwill impairment 33,089 8,802 314 -- 42,205
Other non-cash expenses, net 41 (1,211) -- -- (1,170)
Decrease (increase) in accounts receivable, net 1,220 (1,017) 243 -- 446
Decrease in receivables from insurance companies -- -- 86 -- 86
Decrease in prepaid expenses and deposits 509 689 17 -- 1,215
Decrease (increase) in other assets 3,347 (2,515) (48) -- 784
(Decrease) increase from inter-company transactions 10,597 (7,251) (10,213) 6,867 --
Increase (decrease) in accrued salaries, wages,
and payroll taxes (325) 3,109 (328) -- 2,456
(Decrease) increase in accrued workers'
compensation and healthcare (3,136) 335 372 -- (2,429)
Increase in other long-term liabilities 347 -- -- -- 347
Increase (decrease) in accounts payable (618) 100 844 -- 326
Decrease (increase) in income taxes payable/receivable 4,710 (56) (2) -- 4,652
Increase (decrease) in other accrued expenses (5,597) (1,340) 538 -- (6,399)
-------- -------- -------- -------- --------
50,060 1,232 (8,148) 6,867 50,011
-------- -------- -------- -------- --------
Net cash (used in) provided by operating activities (6,002) 3,146 (3,195) -- (6,051)
-------- -------- -------- -------- --------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of property and equipment, net (927) (82) 1 -- (1,008)
Business acquisitions (5,896) -- -- -- (5,896)
Change in investments and marketable securities, net 9,897 -- -- -- 9,897
Cash released from restricted accounts, net 88 -- -- -- 88
-------- -------- -------- -------- --------
Net cash provided by (used in) investing
activities 3,162 (82) 1 -- 3,081
-------- -------- -------- -------- --------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from issuance of short-term borrowing 10,000 -- -- -- 10,000
Proceeds from issuance of common stock 3 -- -- -- 3
Payment of deferred loan costs (1,051) -- -- -- (1,051)
Increase (decrease) in bank overdraft 2,164 (13,419) -- -- (11,255)
-------- -------- -------- -------- --------
Net cash provided by (used in) financing activities 11,116 (13,419) -- -- (2,303)
-------- -------- -------- -------- --------
Net increase (decrease) in cash and cash
equivalents 8,276 (10,355) (3,194) -- (5,273)
CASH AND CASH EQUIVALENTS,
Beginning of year 8,176 24,503 6,608 -- 39,287
-------- -------- -------- -------- --------
CASH AND CASH EQUIVALENTS,
End of year $ 16,452 $ 14,148 $ 3,414 $ -- $ 34,014
======== ======== ======== ======== ========
=====================================================================================================================
</TABLE>
F-22
<PAGE>
<TABLE>
<CAPTION>
======================================================================================================================
(In thousands of dollars) For the Year Ended December 31, 1998
- ------------------------- ------------------------------------------------------------
Non-
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 (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-23
<PAGE>
<TABLE>
<CAPTION>
======================================================================================================================
(In thousands of dollars) For the Year Ended December 31, 1997
- ------------------------- ------------------------------------------------------------
Non-
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-24
<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 1997, 1998 and 1999 was as follows:
================================================================================
Weighted-
Average
Number Exercise
of Warrants Price
-------- -----
Outstanding at December 31, 1997 120,000 1.88
Granted 200,000 2.13
--------
Outstanding at December 31, 1998 320,000 1.93
Granted 75,000 1.00
Expired (120,000) 1.88
--------
Outstanding at December 31, 1999 275,000 1.82
========
================================================================================
None of the warrants were exercisable at December 31, 1999. Of the remaining
outstanding warrants, 200,000 expire on November 30, 2008, and 75,000 expire on
August 18, 2004.
STOCK OPTION PLANS
The Company has a 1993 Stock Option Plan and a 1995 Stock Option Plan. The plans
are administered by the Human Resources 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, net of cancellations, options of 877,958 shares and 3,028,239 shares
under the 1993 and 1995 plans, respectively, through December 31, 1999. Under
both plans the option
F-25
<PAGE>
exercise price must at least equal 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 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,
1999:
================================================================================
Weighted-
Average
Number Exercise
Of Options Price
---------- -----
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
Granted 544,940 3.47
Exercised (1,668) 1.88
Canceled (1,319,687) 4.46
----------
Outstanding at December 31, 1999 2,818,485 3.03
==========
Exercisable options as of:
December 31, 1997 1,204,088 4.23
December 31, 1998 2,012,030 3.72
December 31, 1999 1,278,398 3.75
Available for future grants at December 31, 1999 1,793,803
================================================================================
The following table is a summary of selected information for the Company's
compensatory stock option plans:
================================================================================
December 31, 1999
--------------------------------------------------
Weighted-Average Weighted-Average
Remaining Contractual Exercise
Life (Yrs.mths) Number Price
--------------- ------ -----
RANGE OF EXERCISE PRICES
1993 Stock Option Plan
$1.88
Options outstanding .1 89,337 $ 1.88
Options exercisable 89,337 1.88
1995 Stock Option Plan
$.84 - $3.94
Options outstanding 5.9 2,402,303 2.17
Options exercisable 962,680 2.50
$4.31 - $5.41
Options outstanding 4.8 171,845 4.80
Options exercisable 111,381 4.57
$14.50 - $16.25
Options outstanding 2.8 155,000 15.14
Options exercisable 115,000 14.88
================================================================================
F-26
<PAGE>
The weighted average fair value of options granted under the 1993 and 1995 Stock
Option Plans was $.97, $3.29 and $4.46 for 1999, 1998 and 1997, 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.
Net loss and loss per share would have been changed to the pro forma amounts
indicated below:
================================================================================
(In thousands of dollars,
except per share data) Year Ended December 31,
- ------------------------- ------------------------------------
1999 1998 1997
--------- --------- ---------
Net loss:
As reported $ (56,062) $ (27,951) $ (8,496)
Pro forma (55,977) (30,943) (10,569)
Basic loss per share:
As reported (1.55) (.88) (.27)
Pro forma (1.55) (.97) (.34)
Diluted loss per share:
As reported (1.55) (.88) (.27)
Pro forma (1.55) (.97) (.34)
================================================================================
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 1999: risk-free interest rate of 5.25%;
expected dividend yield of 0%; expected option term of 3 years; and expected
volatility of 108.48%. The following weighted average assumptions were used for
grants in 1998 and 1997: risk-free interest rate of 4.9% and 5.92%,
respectively; expected dividend yield of 0%; expected lives of 2 years; and
expected volatility of 117% and 98%, 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 first plan year in January 2000, whichever price is lower.
The plan has also been renewed on similar terms in 2000. The Company has
reserved 500,000 shares of its Common Stock for issuance under the plan. As of
December 31, 1999 and February 28, 2000 the Company has issued -0- and 44,222
shares, respectively, 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,
---------------------------------
1999 1998 1997
--------- --------- ---------
Revenue
Core PEO $ 561,062 $ 569,394 $ 532,761
US Xpress -- 121,323 180,403
LPC 109,793 102,218 122,550
TEAM 268,980 174,109 87,764
Stand-Alone -- 1,865 10,339
--------- --------- ---------
Consolidated total 939,835 968,909 933,817
--------- --------- ---------
Gross profit
Core PEO 24,450 23,713 17,749
US Xpress -- (66) 541
LPC 10,443 9,919 8,981
TEAM 2,734 2,029 1,742
Stand-Alone -- (1,370) 1,549
--------- --------- ---------
Total 37,627 34,225 30,562
Selling, general and administrative expense 36,228 49,293 33,411
Depreciation and amortization 7,492 6,145 4,617
Goodwill impairment (core PEO) 42,205 -- --
--------- --------- ---------
Loss from operations (48,298) (21,213) (7,466)
--------- --------- ---------
Other income (expense)
Interest income 1,196 1,885 1,303
Interest expense (8,854) (8,541) (5,102)
Other 39 (193) (50)
--------- --------- ---------
Loss before provision for income taxes (55,917) (28,062) (11,315)
Income tax provision (benefit) 145 (111) (2,819)
--------- --------- ---------
Net loss (56,062) (27,951) (8,496)
========= ========= =========
Depreciation and amortization
Core PEO 6,388 5,062 3,608
LPC 973 927 883
TEAM 131 153 121
Stand-Alone -- 3 5
--------- --------- ---------
Consolidated total 7,492 6,145 4,617
========= ========= =========
Goodwill impairment
Core PEO 42,205 -- --
--------- --------- ---------
Total assets
Core PEO 65,447 94,540 106,512
LPC 34,976 35,192 36,825
TEAM 21,904 29,380 14,926
Stand-Alone -- 15,993 48,954
--------- --------- ---------
Consolidated total $ 122,327 $ 175,105 $ 207,217
========= ========= =========
================================================================================
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>
1999
Revenues $ 198,909 $ 206,088 $ 222,418 $ 312,420
Gross profit 7,736 8,575 9,282 12,034
Basic
Net loss (1) (3,462) (3,436) (3,423) (45,741)
Weighted average shares 32,421,263 33,266,969 34,534,260 38,926,531
Net loss per share (2) (.11) (.10) (.10) (1.18)
Diluted
Net loss (3,462) (3,436) (3,423) (45,741)
Weighted average shares 32,421,263 33,266,969 34,534,260 38,926,531
Net loss per share (2) (.11) (.10) (.10) (1.18)
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)
=========================================================================================
</TABLE>
(1) Includes impact of special fourth quarter charge associated with the
$42.2 million goodwill impairment.
(2) Net loss per share in 1999 is less than the sum of the applicable amounts
for each quarter primarily because of the weighting of the fourth quarter
loss.
(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). The Company also issued
warrants to purchase up to 200,000 shares of its common stock that would have
become exercisable at $2.125 per share if earnings targets were achieved in each
of the three years following the closing of the acquisition. On February 3, 2000
the Company issued an additional 2,206,258 shares of common stock so that the
aggregate value of the 625,000 shares (as defined in the purchase agreement)
plus such additional consideration equaled the final purchase price of $2.5
million. On March 17, 2000, the sellers agreed to the cancellation of the
200,000 outstanding warrants.
F-30
<PAGE>
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 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.
On March 1, 1999 IPEO subsequently purchased an exclusive endorsement to offer
bundled human resources, benefits and payroll management services to a national
franchise organization. On May 10, 1999 the Company purchased the endorsement
from IPEO for $416,673 and IPEO repurchased the Series B Preferred Stock at the
original purchase price of $.75 per share for a total payment of $1,000,000. The
Company amortized the $416,673 over the remaining life of the exclusive
endorsement, which expired on December 31, 1999.
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 was 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 Company has recorded the anticipated issuance of an additional
1,149,422 shares of common stock, for a total purchase price of $5,071,251. The
Company has the right to withhold such shares as security for indebtedness owed
to the Company by the seller of the ERC companies. The Company currently is
conducting negotiations with the seller concerning these matters.
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.
F-31
<PAGE>
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. In
February 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, which was recorded as
goodwill. 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.
(10) GOODWILL IMPAIRMENT
The Company performs quarterly evaluations of its goodwill by estimating the
future cash flows expected to result from customer relationships and other
assets acquired in previous acquisitions. Factors considered in estimating the
expected cash flows include whether there has been an adverse change in the
business climate such as unusually high customer attrition, an adverse action or
assessment by a regulator, a change in legal factors, or a combination of such
factors that may have resulted in an accumulation of costs significantly in
excess of what ultimately may be recoverable through the realization of future
cash flows. The Company experienced several different adverse developments
during 1999, particularly during the fourth quarter, that resulted in impairment
in the core PEO business segment (see footnote 7). The Company was not able to
offset the effects of client attrition experienced in 1999 primarily caused by
factors including customer concern regarding ESI's financial condition, the
effect on 1999 revenue following the closure of certain field offices in
connection with a restructuring plan, and the Company's failure to add adequate
new revenue from customers meeting ESI's minimum profitability requirements,
particularly in its core PEO services. While a portion of this attrition
resulted from the Company's proactive elimination of unprofitable or high-risk
customers, the Company also experienced unusually high attrition during the
fourth quarter of 1999 based on the violation of noncompetition agreements by
former salespersons and other factors.
APB Opinion No. 17, INTANGIBLE ASSETS, generally requires a reduction in the
carrying amount of an intangible asset if it exceeds the future benefits
expected to be derived, and additional guidance is provided in SFAS 121,
ACCOUNTING FOR THE IMPAIRMENT OF LONG-LIVED ASSETS AND FOR LONG-LIVED ASSETS TO
BE DISPOSED OF. After performing the fourth quarter 1999 cash flow analysis it
was determined that the unamortized goodwill recorded on the following
acquisitions exceeded management's estimate of the amount expected to be
realized, and an impairment write-down was recorded to adjust the estimated fair
values to the amounts indicated as follows:
================================================================================
Estimated
Impairment Fair Value at
(In thousands of dollars) Write-down December 31, 1999
- ------------------------- ---------- -----------------
Acquisition:
McClary Trapp $ 6,435 $1,324
CMGR 3,556 --
ESI Alabama 131 --
Phoenix Capital Management
and affiliated companies 7,333 899
ESI Midwest 1,423 --
Employee Solutions Midwest, Inc. 1,023 118
Hazar 5,613 1,779
Employers Trust 8,331 353
Prescott Group 1,284 112
ESI East 2,711 --
Fidelity Resources Corp. 4,365 --
------- ------
Total $42,205 $4,585
======= ======
================================================================================
F-32
<PAGE>
Remaining goodwill of $31.7 million includes the unamortized amounts of $26.4
million recorded for Logistics Personnel Corp. and Team Services, which
management believes are not impaired as of December 31, 1999.
(11) 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, 1999, the compounded interest totaled
approximately $315,000.
The Company has been named as a defendant in an action filed by James E. Gorman
in Arizona Superior Court in August 1999 alleging breach of contract, fraud,
defamation and related matters in connection with the termination of Mr. Gorman
as the Company's president and chief executive officer in February 1999. The
complaint seeks contractual damages of approximately $588,000 plus unspecified
tort damages. The Company is contesting the claim vigorously. The Court
dismissed the plaintiff's principal tort claims in November 1999.
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 County, 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 $500,000 plus attorneys
fees and costs and unspecified punitive damages. The Company is contesting the
claim vigorously.
Stirling Cooke Insurance Services Inc. filed suit in the United States District
Court for the Middle District of Florida against the Company in December 1999
alleging breach of contract and failure to pay insurance premiums in violation
of Florida law. Stirling Cooke, in its capacity as managing and general agent,
placed workers compensation insurance for the Company with three insurance
companies for calendar year 1998. Stirling Cooke alleges that ESI owes unpaid
premium in the amount of $2,797,905 to those companies. The Company believes
that Stirling Cooke's suit is without merit based on an explicit Memorandum of
Understanding between the parties that defined the applicable rates for the 1998
workers' compensation program and intends to defend the suit vigorously.
The State of Ohio has issued an assessment of $5.2 million (plus interest and
penalty) relating to sales taxes potentially applicable to certain types of PEO
services provided by the Company. 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 State of Ohio further issued a sales tax assessment in the amount of
approximately $16.5 million (including interest and penalties) in July 1999
against HDVT, Inc. (the seller of certain assets acquired by the Company in
February 1997) with respect to the operations of HDVT prior to the Company's
acquisition of certain assets of HDVT (then known as Employers Trust) in
February 1997. The State of Ohio concurrently issued an assessment in the same
amount against the Company as successor to HDVT. The Company believes that
meritorious defenses are available to the assessment. In addition, $6.0 million
of cash and 675,000 shares of the Company's Common Stock are being held in
escrow for payment of amounts, if any, ultimately determined to be due pursuant
to such assessment. If the Company is held to have liability pursuant to such
assessment, the escrowed assets prove insufficient to satisfy such liability,
and HDVT is unable to pay any such shortfall, the Company's maximum liability
with respect to the assessment is approximately $3.2 million.
Four individuals brought suit in Steuben County Superior Court, Angola, Indiana
in 1998 alleging that they were employees of the Company and that they had not
been paid certain wages in connection with the bankruptcy of a former customer
with which the Company had commenced a limited service arrangement.
F-33
<PAGE>
The individuals purport to represent a class of employees. Plaintiffs seek from
the Company unpaid wages, vacation and other benefits owed by the former
customer in a total amount for the purported class in excess of $600,000,
potentially subject to trebling under applicable wage statutes. The Company does
not believe that it has any liability to the plaintiffs and has successfully
obtained a dismissal of the suit. Plaintiffs have commenced an appeal process in
the Indiana Court of Appeals.
The Company initiated an arbitration proceeding and related suit in November
1999 in the United States District Court for the District of Arizona seeking to
enjoin a former executive officer and director of the Company from violating a
noncompetition agreement. The Company's action also seeks collection of a
promissory note from the defendant in the amount of $350,000. A company
affiliated with the defendant has filed suit in Georgia state court seeking to
enjoin the Company's actions. Counterclaims have been filed against the Company
for unspecified damages based on various tort theories, for a declaratory
judgment voiding the noncompetition agreement, and for cancellation of the
promissory note. The Company believes that the counterclaims are without merit
and intends to defend them 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.
(12) RELATED PARTY TRANSACTIONS
Related party transactions not mentioned elsewhere in the financial statements
are summarized as follows:
================================================================================
(In thousands of dollars) 1999 1998 1997
- ------------------------- ------- ------- -------
Processing fees paid to company owned by shareholder $ -- $ -- $ 1,030
Consulting fees paid to company partially owned
by director 53 -- --
================================================================================
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.
(13) 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 related to lease commitments and termination
penalties associated with the closure of seven offices. Approximately $1.3
million has been charged against the restructuring liability.
(14) 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. SFAS 137, ACCOUNTING FOR
DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES - DEFERRAL OF THE EFFECTIVE DATE
OF FASB STATEMENT NO. 133, defers the effective date of SFAS 133, but encourages
early application. Adoption of SFAS No. 133 would have an immaterial effect on
the December 31, 1999 and 1998 financial statements.
F-34
<PAGE>
(15) 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 1999 and none is
expected in future periods.
(16) GOING CONCERN MATTERS
The accompanying financial statements have been prepared on a going concern
basis, which contemplates the realization of assets and the satisfaction of
liabilities in the normal course of business. The financial statements do not
include any adjustments relating to the recoverability or classification of
assets or liabilities that might be necessary should the Company be unable to
continue as a going concern. The Company has incurred significant debt primarily
in connection with the October 1997 issuance of its $85 million 10% Senior Notes
due 2004 (the "Notes") and the October 1999 Loan Agreement. At December 31,
1999, the Company had outstanding indebtedness of $10.0 million under the Loan
Agreement, outstanding senior indebtedness of $85.0 million and a deficit in
stockholders' equity of approximately $28.7 million, respectively.
In an effort to improve cash flows and reduce the Company's indebtedness, the
Company has begun negotiations with the holders of the Notes (the
"Noteholders"). The Company is seeking to negotiate the reduction or elimination
of the outstanding principal amount of the Notes in exchange for the issuance of
shares of its equity securities. If the Company is able to reach agreement with
the Noteholders upon such a transaction, the Company anticipates that the
percentage ownership of the then current shareholders of the Company will be
materially reduced, and the equity securities issued to participating
Noteholders also may have rights, preferences or privileges senior to those of
the holders of the Company's Common Stock. The Company is seeking to complete
negotiations with the Noteholders and currently intends to submit to
shareholders for approval on or before July 15, 2000 a proposal relating to all
or a portion of the negotiations.
In addition, the Company is seeking to accelerate revenue growth through a
recent refocus of its sales and marketing efforts to target industries and
geographic territories that it believes present the greatest opportunities for
profitable growth, and to emphasize marketing through third-party alliances. The
Company further is implementing expense reductions to offset the effect of
delayed revenue growth.
There can be no assurance whether or when a satisfactory agreement can be
reached with the Noteholders or whether anticipated operational improvements can
be made. If the Company is unable to complete a satisfactory agreement with the
Noteholders, the Company will remain subject to the current principal and
interest obligations (and other terms and conditions) associated with the Notes,
it will not likely be able to retain certain of its key employees, and its
liquidity position and ability to operate will be materially adversely affected.
F-35
<PAGE>
SCHEDULE II
EMPLOYEE SOLUTIONS, INC.
VALUATION AND QUALIFYING ACCOUNTS
FOR THE YEARS ENDED DECEMBER 31, 1999, 1998, AND 1997
================================================================================
December 31,
---------------------------------
1999 1998 1997
------- ------- -------
(in thousands)
Allowance for doubtful accounts:
Balance at beginning of year $ 8,493 $ 5,550 $ 1,729
Provision charged to expense 3,815 5,016 4,159
Charge-offs (2,808) (2,073) (338)
------- ------- -------
Balance at end of year* $ 9,500 $ 8,493 $ 5,550
======= ======= =======
December 31,
---------------------------------
1999 1998 1997
------- ------- -------
(in thousands)
Restructuring allowance:
Balance at beginning of year $ 424 $ -- $ --
Provision charged to expense -- 1,400 --
Payments/usage (367) (976) --
------- ------- -------
Balance at end of year $ 57 $ 424 $ --
======= ======= =======
December 31,
---------------------------------
1999 1998 1997
------- ------- -------
(in thousands)
Tax valuation allowance:
Balance at beginning of year $ 9,188 $ -- $ --
Provision charged to expense 17,641 9,188 --
Payments/usage -- -- --
------- ------- -------
Balance at end of year $26,829 $ 9,188 $ --
======= ======= =======
- ----------
* Included in this amount is a provision for a long-term receivable included in
other assets.
================================================================================
F-36
<PAGE>
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange
Act of 1934, the Registrant has duly caused this Report to be signed on its
behalf by the undersigned, thereunto duly authorized.
Dated this 29th day of March, 2000
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, March 29, 2000
- ---------------------------- Chief Executive Officer,
Quentin P. Smith, Jr. President and Director
/s/ David R. Carpenter Director March 26, 2000
- ----------------------------
David R. Carpenter
/s/ Jeffrey A. Colby Director March 28, 2000
- ----------------------------
Jeffrey A. Colby
/s/ Sara R. Dial Director March 24, 2000
- ----------------------------
Sara R. Dial
/s/ Kennard F. Hill Director March 26, 2000
- ----------------------------
Kennard F. Hill
/s/ Robert L. Mueller Director March 24, 2000
- ----------------------------
Robert L. Mueller
/s/ John V. Prince Chief Financial Officer March 29, 2000
- ----------------------------
John V. Prince
<PAGE>
EMPLOYEE SOLUTIONS, INC.
(THE "REGISTRANT")
EXHIBIT INDEX TO
REPORT ON FORM 10-K
FOR THE YEAR ENDED DECEMBER 31, 1999
<TABLE>
<CAPTION>
Exhibit Incorporated Herein Filed
Number Description by Reference to Herewith
------ ----------- --------------- --------
<S> <C> <C> <C>
3(i) Registrant's composite Articles of Registrant's Report on Form 10-K for the
Incorporation, as amended year ended December 31, 1996 (1996 10- K)
(See also Exhibit A included in Exhibit
4.5 below)
3(ii) Registrant's Amended and Restated Bylaws, Registrant's Form 10-Q for the quarter
as amended through April 30, 1997 ended March 31, 1997 (March 1997 10-Q)
4.1 Indenture dated October 15, 1997 among the Registrant's Current Report on Form 8-K
Registrant, the Guarantor Subsidiaries (as dated October 21, 1997 (10/21/97 8-K)
defined therein) and The Huntington
National Bank
4.2 Purchase Agreement dated October 16, 1997 10/21/97 8-K
among the Registrant, the Guarantor
Subsidiaries and First Chicago Capital
Markets, Inc. (FCMM)
4.3 Registration Rights Agreement dated 10/21/97 8-K
October 21, 1997 among the Registrant, the
Guarantor Subsidiaries and FCCM
4.4 Amended and Restated Loan Agreement dated 10/21/97 8-K
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 Registration
1998 between the Company and American Statement dated February 19, 1998
Securities Transfer and Trust, Inc. which
includes, as Exhibit A thereto, the
Certificate of Designation of Junior
Participating Preferred Stock, Series A,
of the Company, as Exhibit B thereto the
Form of Rights Certificate and as Exhibit
C thereto the Summary of Rights to
Purchase Preferred Shares
4.6** Loan and Security Agreement dated as of Registrant's Form 10-Q for the quarter
October 26, 1999 by and among the ended September 30, 1999
Registrant and certain of its
subsidiaries, Foothill Capital Corporation
and Ableco Finance LLC
10.1* Registrant's 1993 Employee Incentive Stock Registrant's Form 10-KSB for the fiscal
Option Plan, as amended year ended December 31, 1994 (1994 Form
10-KSB)
10.2* Employee Solutions, Inc. 1995 Stock Option Registrant's Form 10-Q for the quarter
Plan, as amended through May 25, 1999 ended June 30, 1999
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
Exhibit Incorporated Herein Filed
Number Description by Reference to Herewith
------ ----------- --------------- --------
<S> <C> <C> <C>
10.3 Indemnification Agreements between the
Registrant and:
10.3.1* Jeffery A. Colby 1996 10-K
10.3.2* Morris C. Aaron (Agreements in this form 1996 10-K
were also entered into between the Company
and each of John V. Prince, Bill C. Hollis
and Lee E. Martin.)
10.3.3* 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, Robert L.
Mueller and Kennard F. Hill)
10.4 Reinsurance Agreement effective as of May March 1997 10-Q
1, 1995 between Reliance National
Indemnity Company and Reliance Insurance
Company And Camelback Insurance, Ltd.,
including Addendum Number One thereto
10.5 Asset Purchase, Joint Venture Termination Registrant's Form 10-Q for the quarter
and Mutual Release Agreement dated as of ended March 31, 1998
April 7, 1998 between ESI, ESI-EAST,
Edward L. Cain and the Edward L. Cain
Agency, Inc.
10.6 Reinsurance Binder for Loss Portfolio Registrant's Form 10-Q for the quarter
Transfer ended March 31, 1998
10.7* Employment agreement dated as of May 11, Registrant's Report on Form 10-Q for the
1998 between Registrant and James E. quarter ended September 30, 1998
Gorman
10.8* Severance Agreement dated July 31, 1997 Registrant's Report on Form 10-K for the
between the Registrant and John V. Prince year ended December 31, 1998 ("1998 10-K")
10.9* Employment Agreement dated February 15, 1998 10-K
1999 between the Registrant and Quentin P.
Smith, Jr.
10.10* Employment Agreement dated August 1, 1996 1998 10-K
between Logistics Personnel Corp., a
subsidiary of the Registrant (LPC) and
Bill C. Hollis
10.11* Amendment to Employment Agreement dated 1998 10-K
March 3, 1999 between the Registrant, LPC
and Bill C. Hollis
10.12* Employment Agreement dated April 30, 1999 Registrant's Form 10-Q for the quarter
between Registrant and Lee E. Martin ended June 30, 1999
10.13* Agreement dated November 8, 1999 between X
Registrant and Marvin D. Brody
10.14* Employment Agreement dated November 30, X
1999 between Registrant and Jeffery A.
Colby
21.1 Subsidiaries of Registrant 1998 10-K
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
AGREEMENT
This Agreement (the "Agreement") is among Marvin D. Brody, ("Brody),
Quentin P. Smith ("Smith") and Employee Solutions, Inc., an Arizona corporation
(the "Company).
For good and valuable consideration, the receipt and sufficiency of which
is acknowledged, the parties wish to provide for the matters set forth herein.
It is therefore agreed that:
1. Brody irrevocably resigns as a Director of the Company, effective November
8, 1999 (the "Effective Date").
2. On the Effective Date, Section 3 of the Memorandum of Understanding between
the Company and Brody dated effective August 6, 1998 (the "MOU") shall be
terminated.
3. Within two business days of the Effective Date, the Company shall make a
lump-sum payment to Brody in an amount equal to the sum of (a) all amounts
earned by Brody under Section 3 of the MOU as of the Effective Date and not
yet paid by ESI, plus (b) all amounts that would be earned by Brody if
Section 3 of the MOU were to remain in effect through July 2000.
4. Brody agrees that, for a period of 15 years following the Effective Date,
Brody will not vote (or cause or permit to be voted) any shares of Common
Stock of ESI beneficially owned by Brody, and will not cause or encourage
any other person (as such term is defined under the federal securities
laws) to vote (or cause or permit to be voted) any shares of Common Stock
of ESI beneficially owned by any other person, or otherwise take any
action, directly or indirectly, in favor or support of the election to the
Company's Board of Directors of Brody or any affiliate or associate (as
such terms are defined under federal securities laws) of Brody.
5. Brody agrees, for a period of 15 years following the Effective Date, that
(a) he will not seek to be nominated or accept a nomination for a position
on the Company's Board of Directors, and if so nominated will decline to be
a candidate for election; and (b) he will not accept a position on the
Company's Board of Directors if elected, and will immediately resign from
such position if elected.
6. It is agreed that the provisions of Sections 1, 4 and 5 are reasonable, but
it is recognized that damages in the event of the breach of any of the
provisions will be difficult or impossible to ascertain; and, therefore,
Brody agrees that, in addition to and without limiting any other right or
remedy which it may have, the Company shall have the right to have an
injunction against Brody, in the Company's discretion, issued by a court of
competent jurisdiction enjoining any such breach.
7. Effective as of the Effective Date, Brody hereby fully and forever releases
and discharges the Company and its parents, affiliates and subsidiaries,
including all predecessors and successors, assigns, officers, directors,
trustees, executives, agents and attorneys, past and present, from any and
all claims, demands, liens, agreements, contracts, covenants, actions,
suits, causes of action, obligations, controversies, debts, costs,
expenses, damages, judgments, orders and liabilities, of whatever kind or
nature, direct or indirect, in law, equity or otherwise, whether known or
unknown, based on any occurrence of circumstance prior to the date hereof.
The foregoing release does not extend to claims solely to enforce the
Company's obligations under this Agreement or the MOU.
8. Effective as of the Effective Date, the Company hereby fully and forever
releases and discharges the Brody and his agents and attorneys, past and
present, from any and all claims, demands, liens, agreements, contracts,
covenants, actions, suits, causes of action, obligations, controversies,
debts, costs, expenses, damages, judgments, orders and liabilities, of
whatever kind or nature, direct or indirect, in law, equity or otherwise,
whether known or unknown, based on any occurrence of circumstance prior to
the date hereof. The foregoing release does not extend to claims solely to
enforce Brody's obligations under this Agreement or the MOU.
9. The parties agree that Smith has a substantial interest in the entering
into and enforcement of Sections 4, 5 and 6 of this Agreement by virtue of
his position as a substantial shareholder of the Company.
10. This Agreement shall be governed in all respects by the laws of the State
of Arizona, and exclusive venue for any controversy or claim arising out
of, or relating to, this Agreement, or its breach, shall lie in Phoenix,
Maricopa County, Arizona.
11. Each party shall be responsible for its own fees and expenses (including
legal fees) in connection with this Agreement. This Agreement shall be
binding upon the parties and their respective successors and assigns.
12. This Agreement, together with the MOU and the Indemnification Agreement
between the Company and Brody dated November 21, 1996 (the "Other
Agreements") constitutes the final written expression of all of the
agreements between the Brody and the Company, 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 agreements and arrangements, if any), except as provided in the
Other Agreements. Any representations, promises, warranties or statements
made by Brody or the Company that differ in any way from the terms of this
Agreement or the Other Agreements 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
hereto.
13. This Agreement shall be effective when signed by all of the parties hereto.
EMPLOYEE SOLUTIONS, INC., an Arizona corporation
By: /s/ Quentin P. Smith
--------------------
Quentin P. Smith, Jr.
President and CEO
/s/ Marvin D. Brody
--------------------
Marvin D. Brody
- ----------------------------
Quentin P. Smith, Jr.
EMPLOYMENT AGREEMENT
This Employment Agreement (the "Agreement") is made effective as of this
30th day of November, 1999 by and between TALENT, ENTERTAINMENT AND MEDIA
SERVICES, INC., a Delaware corporation (the "Company"), and JEFFERY A. COLBY
("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 or other designee of the Board. Employee's title shall
be President, with responsibility for the overall operations of the Company and
such other specific executive responsibilities as may be assigned from time to
time by, and subject to the direction of, the Board or its Chairman or other
designee. Employee's title may be changed by the Company, from time to time, in
the Company's sole discretion, so long as such title realistically reflects
Employee's responsibilities and Employee is maintained in an executive capacity.
Employee shall have all power and authority of a corporate officer as provided
by the Company's bylaws.
2. Term. The employment of Employee by the Company pursuant to this
Agreement shall commence on the date hereof and continue for a term of three
years or until terminated as provided elsewhere herein.
3. Compensation.
a) Salary. The initial monthly base salary payable to Employee shall
be $17,500, which base salary shall be paid according to the Company's
normal payroll practices and shall be reviewed from time to time on the
same schedule as applicable to Senior Vice Presidents of the Company's
parent corporation and in accordance with the Company's policies and
practices regarding periodic review and adjustment of executive
compensation. Employee's base salary shall not be reduced during the term
hereof without Employee's written consent.
b) Incentive Plan. Employee will have the opportunity to earn
incentive compensation pursuant to an incentive compensation plan based
upon Employer's performance. The parties shall endeavor in good faith to
agree upon an incentive compensation plan within 30 days after the date of
this Agreement. This incentive plan may be modified by the Company in its
discretion after January 1, 2001, provided that the Company shall consult
with Employee in developing any such modification.
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
1
<PAGE>
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 equivalent to benefits provided generally to
Senior Vice Presidents of the Company's parent corporation 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 a $500 per month automobile allowance and
all other, non-automobile related, 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. The Company shall also pay
Employee $5,000 per year for individual purchase by Employee of supplemental
insurance products or for use in such other manner as Employee sees fit.
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 and agrees to
diligently pursue completion of such cure as quickly as possible. 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; willful and persistent
failure to attend to material duties or obligations imposed under this
Agreement; commission of a felony, a misdemeanor involving moral turpitude
or any other serious misdemeanor offense or pleading guilty or nolo
contendere to same; an act of fraud, dishonesty or theft on the part of
Employee; or any act or failure to act on the part of Employee, which
materially harms or injures or may materially harm or injure the
reputation, good name or interests of Company (which shall include, to the
extent allowed by applicable law, but not be limited to, any drug, alcohol
and/or any other substance abuse which materially impairs the ability of
Employee to perform his duties and services hereunder).
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. 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.d., it shall: (1) continue coverage of Employee and Employee's
dependents under its medical plans at the Company's expense for the lesser
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); and (2) pay to
Employee 12 months of Employee's then-current base salary; provided,
however, that such salary shall be paid under the normal payment schedule
as if Employee were still employed by Company and shall be reduced by
applicable withholdings.
2
<PAGE>
e) Termination by Employee for Good Reason. Employee may terminate his
employment at any time for Good Reason (as defined below in this
subsection), in which event Employee shall be entitled to payments and
benefits to the same extent and payable in the same manner as if Employee
was terminated without cause as described in Section 7(d). "Good Reason"
shall mean (x) without Employee's express written consent, a reduction of
Employee's base compensation or the assignment to Employee of duties
materially inconsistent with Employee's position, duties, responsibilities
and status, or a demotion or change in titles (except in connection with
termination of Employee's employment in compliance with this Section 7);
(y) a material breach by the Company of its obligations hereunder which (if
curable) is not cured by the Company within 20 days after its receipt of
written notice stating the facts constituting such material breach; or (z)
without Employee's express written consent, relocation of the site of
Employee's duties to a location outside the Los Angeles, California
metropolitan area.
f) Change in Control. If this Agreement is terminated under Section
7(d) or 7(e) within 12 months following the effective date of a Change in
Control (as defined in this Section 7(f)), the amount owed by the Company
as severance shall equal Employee's total cash compensation during the 12
months preceding such termination, payable in the manner described in
Section 7(d). "Change in Control" shall be deemed to have occurred if (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"]) 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 (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.
8. 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.
9. 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.
10. Non-delegability 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.
11. 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.
3
<PAGE>
If to the Company: Talent, Entertainment and Media Services, Inc.
c/o Employee Solutions, Inc.
6225 North 24th Street
Phoenix, Arizona 85016
Attn: Legal Department
If to Employee: Jeffery A. Colby
---------------------
---------------------
---------------------
(Or when sent to such other address as any party shall specify by written notice
so given.)
12. Entire Agreement. This Agreement, together with the confidentiality and
non-solicit agreement dated as of the same date as this Agreement (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.
Notwithstanding anything herein or in the Other Agreements to the contrary, the
parties acknowledge and agree that the confidentiality and non-compete
provisions of Employee's prior employment agreement with Employee Solutions,
Inc., an Arizona corporation, shall continue in full force and effect according
to their terms, except that such non-compete shall expire on the expiration date
determined pursuant to the prior employment agreement or one year after the
effective date of a termination of this Agreement under Section 7(d) or 7(e),
whichever is earlier.
13. 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.
14. 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 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.
15. 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.
16. 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.
17. 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.
18. 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. This Agreement may be
assigned by the Company in its sole discretion, provided that the Company shall
assign this Agreement to any person to which the Company sells all or
substantially all of its assets. Notwithstanding anything contained in this
4
<PAGE>
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.
19. 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.
"COMPANY" "EMPLOYEE"
TALENT, ENTERTAINMENT AND MEDIA SERVICES, INC.,
a Delaware corporation
/s/ Quentin P. Smith /s/ Jeffrey A. Colby
- -------------------- --------------------
By: Quentin P. Smith Jeffery A. Colby
Its: Chief Executive Officer
5
EXHIBIT 23.1
CONSENT OF INDEPENDENT PUBLIC ACCOUNTANTS
As independent public accountants, we hereby consent to the incorporation of our
report dated March 3, 2000 included in this Form 10-K for Employee Solutions,
Inc. into previously filed registration statements File Nos. 33-93822, 333-1242,
333-49891, 333-94923 and 333-94925.
/s/ Arthur Andersen LLP
Phoenix, Arizona,
March 28, 2000.
<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, 1999 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-31-1999
<PERIOD-START> JAN-01-1999
<PERIOD-END> DEC-31-1999
<EXCHANGE-RATE> 1
<CASH> 35,014
<SECURITIES> 100
<RECEIVABLES> 44,914
<ALLOWANCES> 0
<INVENTORY> 0
<CURRENT-ASSETS> 81,116
<PP&E> 4,211
<DEPRECIATION> 0
<TOTAL-ASSETS> 122,327
<CURRENT-LIABILITIES> 65,706
<BONDS> 85,000
0
0
<COMMON> 47,421
<OTHER-SE> (76,147)
<TOTAL-LIABILITY-AND-EQUITY> 122,327
<SALES> 0
<TOTAL-REVENUES> 939,835
<CGS> 0
<TOTAL-COSTS> 902,208
<OTHER-EXPENSES> 85,925
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 8,854
<INCOME-PRETAX> (55,917)
<INCOME-TAX> 145
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</TABLE>
