Back to GetFilings.com
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
ANNUAL REPORT UNDER SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 28, 2002
COMMISSION FILE NUMBER: 0-21533
TEAM AMERICA, INC.
(Name of registrant as specified in its charter)
OHIO 31-1209872
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
130 E. WILSON BRIDGE ROAD WORTHINGTON, OHIO 43085
(Address of principal executive offices) (Zip Code)
(614) 848-3995
(Registrant's telephone number, including area code)
SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT: NONE
SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:
COMMON STOCK, NO PAR VALUE
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports), and (2) has been subject to the
filing requirements for at least the past 90 days. Yes |X| No | |
Indicate by check mark if disclosure of delinquent filers pursuant to
Item 405 of Regulation S-K is not contained herein, and will not be contained,
to the best of registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. |X|
Indicate by check mark whether the registrant is an accelerated filer
(as defined in Rule 12b-2 of the Securities Exchange Act of 1934). Yes | | No
|X|
Aggregate market value of the Company's voting common equity held by
its non-affiliates as of June 28, 2002 was approximately $5,913,000 based on
the closing price of the Company's common stock on the NASDAQ.
There were 8,215,628 shares of the Company's common stock outstanding
at March 25, 2003.
Documents Incorporated by Reference: Portions of the registrant's
definitive Proxy Statement for its Annual Meeting of Shareholders are
incorporated by reference into Part III of this Annual Report on Form 10-K.
TABLE OF CONTENTS
PAGE
PART I
Item 1. Business...................................................................................... 1
Item 2. Properties.................................................................................... 10
Item 3. Legal Proceedings............................................................................. 11
Item 4. Submission of Matters to a Vote of Security Holders........................................... 11
PART II
Item 5. Market for Registrant's Common Equity and Related Stockholder Matters......................... 12
Item 6. Selected Financial Data....................................................................... 12
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operation.......... 14
Item 7A. Quantitative and Qualitative Disclosures About Market Risk.................................... 30
Item 8. Financial Statements and Supplementary Data................................................... 30
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure.......... 59
PART III
Item 10. Directors and Executive Officers of the Registrant............................................ 60
Item 11. Executive Compensation........................................................................ 60
Item 12. Security Ownership of Certain Beneficial Owners and Management................................ 60
Item 13. Certain Relationships and Related Transactions................................................ 60
Item 14. Controls and Procedures....................................................................... 60
PART IV
Item 15. Exhibits, Financial Statement Schedules and Reports on Form 8-K............................... 63
Signatures .............................................................................................. 66
Certifications .............................................................................................. 67
PART I
This document contains forward-looking statements within the meaning of Section
27A of the Securities Act of 1933, as amended (the "Securities Act") and Section
21E of the Securities Exchange Act of 1934, as amended (the "Exchange Act"). You
can identify such forward-looking statements by the words "expects," "intends,"
"plans," "projects," "believes," "estimates," and similar expressions. It is
important to note that the Company's actual results could differ materially from
those projected in such forward-looking statements. In the normal course of
business, we, in an effort to help keep the Company's shareholders and the
public informed about our operations, may from time to time issue such
forward-looking statements, either orally or in writing. Generally, these
statements relate to business plans or strategies, projected or anticipated
benefits or other consequences of such plans or strategies, or projections
involving anticipated revenues, earnings or other aspects of operating results.
We base the forward-looking statements on our current expectations, estimates
and projections. We caution you that these statements are not guarantees of
future performance and involve risks, uncertainties and assumptions that we
cannot predict. In addition, we have based many of these forward-looking
statements on assumptions about future events that may prove to be inaccurate.
Therefore, the actual results of the future events described in the
forward-looking statements in this Annual Report on Form 10-K, or elsewhere,
could differ materially from those stated in the forward-looking statements.
Among the factors that could cause actual results to differ materially are the
risks and uncertainties discussed in this Annual Report on Form 10-K, including,
without limitation, factors discussed under the caption "Risk Factors,"
beginning on page 27. Shareholders are cautioned not to put undue reliance on
forward-looking statements. In addition, the Company does not have any intention
or obligation to update forward-looking statements after the date hereof, even
if new information, future events, or other circumstances have made them
incorrect or misleading. For those statements, the Company claims the protection
of the safe harbor for forward-looking statements contained in the Private
Securities Litigation Reform Act of 1995.
As used in this Annual Report on Form 10-K and except as the context otherwise
may require, "Company," "we," "us," and "our" refer to TEAM America, Inc. and
its subsidiaries.
ITEM 1. BUSINESS.
GENERAL
TEAM America, Inc. (the "Company") is a Business Process Outsourcing company
that specializes in human resource management and administration, which was
formed in December 2000 through the merger of TEAM America Corporation and
Mucho.com, Inc. The Company currently operates primarily as a Professional
Employer Organization ("PEO") throughout the United States. The Company, through
its subsidiaries, provides comprehensive human resource services, including
payroll and payroll administration, benefits administration, on-site and on-line
employee and employer communications, employment practices and human resource
risk management and workforce compliance administration. The Company provides
these services by becoming a co-employer of its clients' employees.
In addition to these traditional PEO services, the Company introduced a new
suite of products during March 2003 aimed at assisting our clients with employee
recruiting and retention issues. These services can be marketed to the Company's
existing clients and to other businesses.
By becoming the co-employer of its clients' employees, the Company is able to
take advantage of certain economies of scale in the "business of employment" and
to pass those benefits on to its clients and worksite employees. As a result,
clients are able to obtain, at an economical cost, services and expertise
similar to those provided by the human resource departments of large companies.
These services provide substantial benefits to both the client and its worksite
employees. The Company believes its services assist business owners by:
- permitting the managers of the client to concentrate on the
client's core business as a result of the reduced time and
effort that they are required to spend dealing with complex
human resource, legal and regulatory compliance issues and
employee administration; and
- managing escalating costs associated with unemployment,
workers' compensation, health insurance coverage, worksite
safety programs and employee-related litigation.
The Company also believes that worksite employees benefit from their
relationship with the Company by having access to better, more affordable
benefits, enhanced benefit portability, improved worksite safety and employment
stability.
1
The Company provides its services by entering into a client services agreement,
which usually establishes a three-party relationship whereby it and the client
act as co-employers of the employees who work at the client's location
("worksite employees"). In connection with the client services agreement, the
Company typically charges a comprehensive service fee, which is invoiced
concurrently with the processing of payroll for the worksite employees of the
client.
The Company believes that there is an increasing trend of businesses to
outsource non-core activities and functions. Only a relatively small percentage
of businesses, however, currently utilize PEOs, although there is significant
growth in the number of small businesses. The Company believes that these
factors, coupled with the ever increasing complexity of the human resource,
legal and regulatory framework and the costs associated with implementing the
necessary management information systems to deal with these issues, will lead to
growth opportunities in the PEO industry.
The Merger. On June 16, 2000, TEAM America Corporation entered into an agreement
and plan of merger with TEAM Merger Corporation, a wholly-owned subsidiary, and
Mucho.com, Inc., pursuant to which TEAM Merger Corporation would be merged with
and into Mucho.com, and Mucho.com would become a wholly-owned subsidiary of TEAM
America Corporation. Under the terms of the merger agreement, TEAM America
Corporation agreed to acquire all of the stock (including options and warrants)
of Mucho.com in exchange for up to 5,925,925 shares of TEAM America
Corporation's common stock. The merger was completed on December 28, 2000.
Pursuant to the terms of the merger agreement, 3,643,709 shares of common stock
were issued, 196,105 shares were reserved for future issuance for Mucho.com
options and 1,111,111 shares were placed in escrow (the "Escrow"). In July 2001,
these shares were released from escrow.
Simultaneous with the merger, the Company announced an issuer tender offer to
all of its existing shareholders. Under the terms of the issuer tender offer,
the Company offered to purchase up to 2,175,492 shares of its common stock,
representing 50% of its outstanding common stock on November 10, 2000, at a
price of $6.75 per share. In connection with the issuer tender offer, a total of
1,721,850 shares of its common stock were tendered and accepted for payment at
$6.75 per share, for a total redemption of $11,622,488.
On December 28, 2000, immediately following the merger, the Company received a
$10 million investment from Stonehenge Opportunity Fund, LLC and Provident Bank
for 100,000 shares of its Series 2000 Class A cumulative convertible preferred
stock ("2000 Class A Preferred Shares"), which as of December 28, 2002 were
convertible into 1,481,481 shares of its common stock. As additional
consideration for the purchase of the preferred stock, the Company issued a
warrant to purchase an additional 1,481,481 shares of its common stock at an
exercise price of $6.75 per share, exercisable for a period of ten years from
December 28, 2000. The Company also secured up to $18 million of senior secured
credit from Provident and from Huntington National Bank for acquisitions.
On March 13, 2001, the Company acquired certain assets of Professional Staff
Management, Inc. ("PSMI"). The purchase price of $6,664,000 included cash of
$4,250,000, seller financing of $1,000,000, common shares of TEAM America, Inc.
(74,074 shares), 10,000 shares of 2000 Class A Preferred Shares and 148,148
common stock warrants. PSMI was based in Salt Lake City, Utah and had clients
throughout the United States, but primarily in Utah, Nevada and Ohio.
RECENT DEVELOPMENTS
Restructuring of Bank Debt and Preferred Stock
On March 28, 2003, the Company entered into certain agreements with its bank
group and its 2000 Class A Preferred Shareholders. The Company entered into a
Third Amendment and Waiver to its Senior Credit Facility (the "Bank Agreement")
and a Memorandum of Understanding (the "Preferred Agreement") with its 2000
Class A Preferred Shareholders.
Bank Agreement
The Company and its senior lenders agreed to amend the Senior Credit Facility as
follows:
- - The outstanding amounts under the Senior Credit Facility of $8,728,000 were
restructured into three separate tranches. Tranche A representing a
$6,000,000 Term Loan, Tranche B representing a $2,728,000 Balloon Loan and
Tranche C representing $914,000 of outstanding letters of credit.
- - The Senior Credit Facility is senior to the $1,500,000 subordinated note
issued in satisfaction of the Bridge Note discussed below under Preferred
Agreement.
2
- - The maturity of the Senior Credit Facility is January 5, 2004.
- - The interest rate on each tranche is: Tranche A - the Provident Bank Prime
Commercial Lending Rate plus two percent (6.25% at March 28, 2003); Tranche
B - 12%, eight percent payable in cash and four percent payable in kind;
and Tranche C (if drawn) - the Provident Bank's Prime Lending Rate plus
five percent (9.25% at March 28, 2003).
- - Tranche A requires principal payments of $100,000 per month beginning July
2003, Tranche B is due at maturity and Tranche C is due immediately upon
any draw under the letters of credit.
In addition to the above terms, the Company issued to the banks 1,080,000
warrants to purchase common stock of the Company at a price of $0.50 per share.
These warrants expire in seven years. The Bank Agreement states that no new
indebtedness may be incurred under the facility and that any future acquisitions
are subject to consent of the banks.
The Senior Credit Facility is collateralized by all of the assets of the
Company.
Preferred Agreement
The Company and its Class A 2000 Preferred Shareholders agreed to restructure
the preferred shareholders' investment in the Company as follows:
- - The $1,500,000 Bridge Note that was to be paid from proceeds of an equity
financing that would occur prior to August 9, 2002, will be converted into
subordinated debt with an interest rate accruing at 14%, which shall be
subordinated to the Senior Credit Facility (the "Subordinated Debt").
The Subordinated Debt will be due June 30, 2006 along with all accrued
interest.
- - The Series 2000 Preferred Shares will be exchanged by the holders for:
- - $2,500,000 Class B Series 2003 Preferred Shares which will have a dividend
rate of 14% and be non-voting shares. This dividend will be accrued and
paid-in-kind. These shares will maintain a liquidation preference equal to
par value plus accrued and unpaid dividends. The holders of these shares
may, at any time, after the third anniversary of the issuance of such
shares and with the consent of holders of no fewer than two-thirds of the
shares, may require the Company to redeem all or any portion of such
shares at par value plus accrued and unpaid dividends;
- - Warrants to purchase 2,400,000 common shares of the Company at an exercise
price of $0.50 per share. These warrants expire in 10 years; and
- - 4,800,000 common shares of the Company.
The following table shows the pro forma capitalization of the Company as of
December 28, 2002 assuming the above transactions were consummated as of that
date:
3
YEAR ENDED
DECEMBER 28, PRO FORMA
2002 ADJUSTMENTS PRO FORMA
------------ ----------- ---------
(UNAUDITED) (UNAUDITED)
Bank debt............................... $ 600 $ - $ 600
Other current liabilities............... 29,132 - 29,132
--------------- --------------
Total Current Liabilities...... 29,732 - 29,732
Bank debt, non-current.................. 8,128 (8,128) (a) $ -
Bank debt, Term Loan A.................. - 5,400 (a) 5,400
Bank debt - Term Loan B................. - 2,728 (a) 2,728
Other non-current liabilities........... 4,748 - 4,748
--------------- --------------
Total Non-Current Liabilities.. 12,876 12,876
Subordinated debt....................... - 1,500 (c) 1,500
Series 2003 Preferred Sock.............. - 2,500 (d) 2,500
Preferred stock......................... 9,552 (9,552) (d) -
Bridge note............................. 1,500 (1,500) (c) -
Other - common.......................... - - -
Shareholders' equity.................... 9,603 270 (b) -
700 (d) -
- 6,352 (d) 16,925
--------------- --------------
Total Liabilities and Shareholders'
Equity............................... $ 63,263 $ 63,533
=============== ==============
(a) Exchange existing Bank Credit Facility for Term Loan A and Term Loan B
(b) Issue warrants to bank (1,080,000 at an assumed fair value of $0.25
per share)
(c) Exchange Bridge Note for Subordinated Debt
(d) Exchange existing preferred for $2,500,000 new preferred; 4,800,000 common
shares; 2,800,000 warrants (assumed fair value of $0.25 per share)
Restatement of 2001 and 2000 Financial Statements
During the first quarter of 2002, management became aware that the accounting
applied to the issuance of preferred stock, common stock and warrants in
December 2000 was not in accordance with Emerging Issues Task Force ("EITF")
Issue Nos. 98-5, "Accounting for Convertible Securities with Beneficial
Conversion Features or Contingently Adjustable Conversion Ratios," and 00-27
"Application of EITF Issues 98-5, "Accounting for Convertible Securities with
Beneficial Conversion Features or Contingently Adjustable Conversion Ratios."
Accordingly, the Company restated its 2001 and 2000 financial statements to
properly account for these transactions. The result of the restatement (as more
fully described in Note 4 to the Company's financial statements) was to
increase the net loss for 2000 by approximately $1,047,000, or $0.37 per share.
Additionally, the allocation of amounts between preferred stock and common stock
were adjusted as of December 29, 2001 and December 31, 2000. In connection with
these adjustments, the Company filed restated financial statements on Form
10-K/A with the SEC on August 13, 2002.
NASDAQ Matters
On August 21, 2002, the Company received notification from the NASDAQ that it
was not in compliance with the NASDAQ continued listing requirements relative to
compliance with the Exchange Act. As a result of restating its 2001 and 2000
financial statements in August 2002 and its change in auditors, the Company was
not able to have the restatement of its 2001 and 2000 financial statements
audited in connection with the filing of its Annual Report on Form 10-K/A. As a
result, the NADSAQ determined that the Company was not in compliance with the
NASDAQ listing requirements and issued the delisting notification. Management
responded to the delisting notification and requested a hearing regarding the
matter before the NASDAQ panel. Such hearing was granted and took place on
September 21, 2002. As a result of the
4
hearing, the NASDAQ panel determined that the Company would remain listed with
an "E" until such time as the Company becomes compliant with the NASDAQ listing
requirements, which was deemed to be with a timely filing of this Form 10-K.
Acquisitions
On March 1, 2002, the Company acquired certain assets and assumed certain
liabilities of Strategic Staff Management, Inc. ("SSMI"). The purchase price
of $476,000 included cash of $300,000, the assumption of customer deposits of
$172,000 and other costs of $4,000. The Company borrowed $750,000 under its
Credit Facility in connection with this acquisition. SSMI operated as a PEO
primarily in Nebraska and Iowa.
On May 1, 2002, the Company purchased certain assets of Inovis Corporation
("Inovis"). Under the terms of this transaction, the Company is required to pay
the greater of $1,150,000, (the "Minimum Price") or a factor of gross profits
generated by the Inovis business over the 24 months beginning May 2002 and
ending April 2004. Inovis was based in Atlanta, Georgia and had clients
throughout the United States, but primarily concentrated in Georgia.
PEO INDUSTRY
The PEO industry began to evolve in the early 1980's largely in response to the
burdens placed on small and medium-sized employers by an increasingly complex
legal and regulatory environment. While various service providers were available
to assist these businesses with specific tasks, PEOs emerged as providers of a
more comprehensive range of services relating to the employer/employee
relationship. PEO arrangements generally transfer broad aspects of the
employer/employee relationship to the PEO. Because PEOs provide employee-related
services to a large number of employees, they can achieve economies of scale
that allow them to perform employment-related functions more efficiently,
provide employee benefits at a level typically available only to large
corporations with substantial resources and devote more attention to human
resources management.
The Company believes that growth in the PEO industry has been significant. The
Company believes that the key factors driving demand for PEO services include
(i) trends relating to the growth and productivity of the small and medium-sized
business community in the United States, such as outsourcing and a focus on core
competencies, (ii) the need to provide competitive health care and related
benefits to attract and retain employees, (iii) the increasing costs associated
with health and workers' compensation insurance coverage, workplace safety
programs, employee-related complaints and litigation and (iv) complex regulation
of labor and employment issues and the related costs of compliance, including
the allocation of time and effort to such functions by owners and key
executives.
A significant factor in the growth of the PEO industry has been increasing
recognition and acceptance of PEOs and the co-employer relationship by federal
and state governmental authorities. The Company and other industry leaders, in
concert with the National Association of Professional Employer Organizations
(NAPEO), have worked with the relevant governmental entities for the
establishment of a regulatory framework that would clarify the roles and
obligations of the PEO and the client in the "co-employee" relationship. While
47 states have recognized PEOs in their employment laws, many states do not
explicitly regulate PEOs. However, 21 states have enacted legislation containing
licensing, registration, or certification requirements, and several others are
considering such regulation. Such laws vary from state to state but generally
provide for monitoring the fiscal responsibility of PEOs. State regulation
assists in screening insufficiently capitalized PEO operations and, in the
Company's view, has the effect of legitimizing the PEO industry by resolving
interpretive issues concerning employee status for specific purposes under
applicable state law. The Company has actively supported such regulatory efforts
and is currently licensed or registered in 47 of these states. The cost of
compliance with these regulations is not material to the Company's financial
position or results of operations.
Two federal bills have been introduced, H.R. 2807 and S. 1305, that would
formally legislate the regulation of PEOs nationally. Currently, PEOs are
subject to a variety of state laws that require the Company to submit filings,
maintain state specific data and incur the expense of auditing certain states
separately. The Company believes that enacted federal legislation will
facilitate the development of the PEO industry.
SERVICES
Client Service Teams. The Company has five regional directors who oversee a
service staff consisting of Human Resource Consultants (HRC) and Human Resource
Assistants (HRA). An HRC and/or HRA is assigned to each client. The HRC is
responsible for the client's personnel administration, for coordinating the
Company's response to client needs for administrative support and for responding
to any questions or problems encountered by the client.
5
The HRC acts as the principal client contact and typically is on call and in
contact with each client throughout the week. This individual serves as the
communication link between the Company's corporate departments and the client's
on-site supervisor, who in many cases is the owner of the client's business.
Accordingly, this individual is involved in every aspect of delivery of services
to clients. For example, the HRC is responsible for gathering all information
necessary to process each payroll of the client and for all other information
needed by the Company's human resources, accounting and other departments with
respect to such client and to worksite employees. An HRC also actively
participates in hiring, disciplining and terminating worksite employees;
administering employee benefits; and responding to employee complaints and
grievances.
Core Activities. The Company provides professional employer services through six
core activities:
- - human resources administration;
- - regulatory compliance management;
- - employee benefits administration;
- - risk management services and employer liability protection;
- - payroll and payroll tax administration; and
- - placement services.
Human Resources Administration. The Company provides its clients with a broad
range of human resource services including on-going supervisory education and
training regarding risk management and employment laws, policies and procedures.
In addition, the Company's Human Resources Department handles sensitive and
complicated employment issues such as employee discipline, termination, sexual
harassment, and wage and salary planning and analysis. The Company provides a
comprehensive employee handbook, including customized, site-specific materials
concerning each worksite, to all worksite employees. In addition, extensive
files and records regarding worksite employees for compliance with various state
and federal laws and regulations are maintained. This extensive record keeping
is designed to substantially reduce legal actions arising from lack of proper
documentation.
Regulatory Compliance Management. Under its client agreement, the Company may
assume responsibility for complying with many employment related regulatory
requirements. Accordingly, it must comply with numerous federal, state and local
laws, including:
- - certain tax, workers' compensation, unemployment, immigration, civil
rights, and wage and hour laws;
- - the Americans with Disabilities Act of 1990;
- - the Family and Medical Leave Act;
- - laws administered by the Equal Employment Opportunity Commission; and
- - employee benefits laws, such as ERISA and COBRA.
The Company provides bulletin boards to its clients and maintains them for
compliance with required posters and notices. It also assists clients in their
efforts as employers to comply with and understand certain other laws and
responsibilities with respect to which it does not assume liability and
responsibility. For example, while the Company may provide significant safety
training and risk management services to its clients, it may not assume
responsibility for compliance with the Occupational Safety and Health Act
because the client controls its worksite facilities and equipment.
Employee Benefits Administration. The Company offers a broad range of employee
benefit programs to its worksite employees. The Company administers such benefit
programs, thereby reducing the administrative responsibilities of its clients
for maintaining complex and tax-qualified employee benefit plans. By combining
multiple worksite employees, the Company is able to take advantage of certain
economies of scale in the administration and provision of employee benefits. As
a result, the Company is
6
able to offer to its worksite employees benefit programs that are comparable to
those offered by large corporations. Eligible worksite and corporate staff
employees are entitled to participate in the Company's employee benefit programs
without discrimination. Such programs include life insurance coverage as well as
a cafeteria plan that offers a choice of different health, dental, vision and
prescription card coverage. In addition, each eligible employee may participate
in a 401(k) retirement plan and a medical and dependent care reimbursement
program. Each worksite employee is given the opportunity to purchase
group-discounted, payroll-deducted optional life insurance and long-term
disability insurance and various other discount programs.
By offering its worksite employees a broad range of large corporation style
benefit plans and programs, the Company believes it is able to reduce worksite
employee turnover, which results in cost savings for its clients. The Company
performs regulatory compliance and plan administration in accordance with state
and federal benefit laws.
Risk Management Services and Employer Liability Protection. The Company's risk
management of the worksite includes policies and procedures designed to
proactively prevent and control costs of lawsuits, fines, penalties, judgments,
settlements and legal and professional fees. In addition, it controls benefit
plan costs by attempting to prevent fraud and abuse by closely monitoring
claims. Other risk management programs include effectively processing workers'
compensation and unemployment claims and aggressively contesting any suspicious
or improper claims. The Company believes that such risk management efforts
increase its profitability by reducing liability exposure and by increasing the
value of the services it provides.
Payroll and Payroll Tax Administration. The Company provides its clients with
comprehensive payroll and payroll tax administration services. Subject to the
client's obligation to pay, the Company as the co-employer, assumes
responsibility for the obligations of clients to make federal and state
unemployment and workers' compensation filings, FICA deposits, child support
levies and garnishments, and new hire reports. The Company receives all payroll
information, calculates, processes and records all such information, and either
issues payroll checks or directly deposits the net pay of worksite employees
into their bank accounts. All payroll checks are delivered either to the on-site
supervisor of the worksite or directly to the worksite employees.
Placement Services. As a part of the overall employment relationship, the
Company assists its clients in their efforts to hire new employees. As a result
of the Company's advertising volume and contracts with newspapers and other
media, it is able to place such advertisements at significantly lower prices
than are available to its clients. In addition, in some cases, the Company does
not have to place such advertisements because it already has multiple qualified
candidates in a job bank or pool of candidates. The Company interviews, screens
and pre-qualifies candidates based on criteria established in a job description
prepared by it with the client's assistance and performs background checks. In
addition, depending on the needs of the client, the Company may test worksite
employees for skills, health, and drug-use in accordance with state and federal
laws. Following the selection of a candidate, the Company completes all hiring
paperwork and, if the employee is eligible, enrolls the employee in benefit
programs. The Company believes that this unique approach in providing such
services gives it an advantage over its competitors. These services also enable
it to reduce administrative expenses and employee turnover and to avoid hiring
unqualified or problem employees.
CLIENTS
Client Services Agreement. The Company's client services agreement generally is
for one year and provides for an on-going relationship thereafter, subject to
termination by the Company or the client upon 30 days written notice.
The client services agreement establishes a comprehensive service fee, which is
subject to periodic adjustments to account for changes in the composition of the
client's workforce and statutory changes that affect costs. The client services
agreement also establishes the division of responsibilities between the Company
and the client. Pursuant to the client services agreement, the Company is
responsible for all personnel administration and is liable for certain
employment-related government regulation. In addition, subject to the obligation
of the client to pay the Company, the Company assumes responsibility for payment
of salaries and wages of worksite employees and responsibility for providing
employee benefits to such persons. The client retains the employees' services
and remains liable for compliance with certain governmental regulations, which
requires control of the worksite, daily supervisory responsibility, or is
otherwise beyond the Company's ability to assume. A third group of
responsibilities and liabilities are shared by the Company and the client where
such joint responsibility is appropriate.
Because the Company is a co-employer, it is possible that it could incur
liability for violations of certain employment laws even if it is not
responsible for the conduct giving rise to such liability. The client services
agreement addresses this issue by providing that the client will indemnify the
Company for liability incurred to the extent the liability is attributable to
conduct by the client. Notwithstanding this contractual right to
indemnification, it is possible that the Company could be unable to collect on a
claim for
7
indemnification and may therefore be ultimately responsible for satisfying the
liability in question. The Company maintains certain general insurance coverages
(including coverages for its clients) to manage its exposure for these types of
claims, and, as a result, settlement costs with respect to this exposure have
historically been insignificant to its operating results.
Clients are generally required to remit their comprehensive service fees no
later than one day prior to the applicable payroll date by wire transfer or
automated clearinghouse transaction. The Company retains the ability to
terminate the client services agreement as well as the continued employment of
the employees upon non-payment by a client. This right, the periodic nature of
payroll and the overall quality of the client base has resulted in an excellent
overall collection history.
At December 28, 2002, the Company served approximately 1,500 clients and
approximately 12,750 worksite employees resulting in an average of nine worksite
employees per client. No single client accounted for more than 1.5% of revenues
for the 12 months ended December 28, 2002. As a result of acquisitions in 1997
and 1998, the Company's clientele is geographically diverse. In 1996,
approximately 94% of the client base was located in Ohio. At December 28, 2002,
less than 30% of the worksite employees were located in Ohio. The client base is
broadly distributed throughout a wide variety of industries, but is heavily
weighted towards professional, service, light manufacturing and non-profit
businesses. Exposure to higher workers' compensation claims businesses such as
construction, transportation and commercial is less than 5% of the Company's
total business.
In general, the Company has benefited from a high level of client retention,
resulting in a significant recurring revenue stream. The attrition that has been
experienced has typically been caused by a variety of factors, including:
- - sale or acquisition of the client;
- - termination resulting from the client's inability to make timely
payments;
- - client business failure or downsizing; and
- - client non-renewal due to price or service dissatisfaction.
The Company believes that the risk of a client terminating its relationship with
the Company decreases substantially after the client has been associated with it
for over one year because of the client's increased appreciation of its
value-added services and because of the difficulties associated with a client
reassuming the burdens of being the sole employer. The Company believes that
only a small percentage of nonrenewing clients withdraw due to dissatisfaction
with services or to retain the services of a competitor. The Company did,
however, experience an increase in attrition during fiscal 2002 due to the
Company's efforts to change its client base to larger metropolitan areas, a
change in medical insurance premiums by one of the Company's suppliers and
issues faced by clients as a result of the general downturn in the economy.
SALES AND MARKETING
The Company markets its services through a direct sales force. Each of its sales
personnel enters into an employment agreement that establishes a
performance-based compensation program, which currently includes a base salary,
sales commissions and a bonus for each new worksite employee enlisted. These
employment agreements contain certain non-competition and non-solicitation
provisions that prohibit the sales personnel from competing against the Company.
In certain states, the non-compete agreements may have limited enforceability
but non-solicitation is protected by federal trade secrets laws. The
productivity of the Company's sales personnel is attributed in part to their
experience in fields related to one or more of the Company's core services. The
background of the Company's sales personnel includes experience in industries
such as information services, health insurance, business consulting and
commercial sales. Sales materials emphasize a broad range of high-quality
services and the resulting benefits to clients and worksite employees.
The Company's sales and marketing strategy is to achieve higher penetration in
certain existing markets by increasing sales productivity. Currently, sales
leads are generated from the two primary sources of referrals and direct sales
efforts. These leads result in initial presentations to prospective clients.
Sales personnel gather information about the prospective client and its
employees, including job classification, workers' compensation and health
insurance claims history, salary and the desired level of employee benefits. The
Company performs a risk management analysis of each prospective client which
involves a review of such factors as the client's credit history, financial
strength, and workers' compensation, and health insurance and unemployment
claims history. Following a review of these factors, a client proposal is
prepared for acceptable clients. Stringent underwriting procedures greatly
reduce controllable costs and liability exposure.
8
COMPETITION
The PEO industry is highly fragmented and served by many companies operating in
small geographical areas. The Company believes it is one of the largest PEOs
operating on a national scale. Some of the Company's principal competitors, all
of which are larger than the Company, include Administaff, Gevity HR, Inc.,
TeamStaff, Inc. and PEO divisions of large business service companies like
Automated Data Processing, Inc. and Paychex, Inc. The Company considers its
primary competition to be traditional in-house providers of human resource
services.
INFORMATION TECHNOLOGY
Since October 1995, the Company has been developing and continues to develop its
proprietary integrated information system based on client-server technology
using an Oracle(TM) relational database. The system, called TEAM Direct(TM)
allows clients to enter and submit payroll data via modem and over the Internet.
The system also is used to store and retrieve information regarding all aspects
of the Company's business, including human resource administration, regulatory
compliance management, employee benefits administration, risk management
services, payroll and payroll tax administration, and placement services. As of
December 28, 2002, all Company locations were utilizing TEAM Direct(TM). The
Company believes that this system will be capable of being upgraded and expanded
to meet its needs for the foreseeable future.
The Company's primary information-processing center is located at its corporate
headquarters near Columbus, Ohio. Other offices are connected to its centralized
system through network services. Industry-standard software is used to process
payroll and other commercially available software manages standard business
functions such as accounting and finance. The Company maintains a back-up
payroll processing facility in Atlanta, Georgia, and maintains a back up of its
TEAM Direct(TM) PEO operating system. The Company also maintains a contract with
a mobile recovery service as part of a disaster recovery plan for its corporate
headquarters.
CORPORATE EMPLOYEES
As of December 28, 2002, the Company had 174 corporate employees located at its
headquarters in Worthington, Ohio and at its offices around the country.
PEO RESPONSIBILITIES
Federal, State and Local Employment Taxes. The Company assumes the
administrative responsibility for the payment of federal, state and local
employment taxes with respect to wages and salaries paid to its employees,
including worksite employees. There are essentially three types of federal,
state and local employment tax obligations:
- - income tax withholding requirements;
- - social security obligations under FICA; and
- - unemployment obligations under FUTA and SUTA.
Under these Internal Revenue Code sections, the employer has the obligation to
withhold and remit the employer portion and, where applicable, the employee
portion of these taxes.
Employee Benefit Plans. TEAM America offers various employee benefit plans to
its worksite employees. These plans include a multi-employer 401(k) plan, a
section 125 plan, group health plans, dental and vision insurance, a group life
insurance plan, a group disability insurance plan and an employee assistance
plan. Generally, employee benefit plans are subject to the provisions of the
Internal Revenue Code and ERISA. The Company's corporate employees also
participate in these plans.
In order to qualify for favorable tax treatment under the Internal Revenue Code
(the "Code"), benefit plans must be established and maintained for the exclusive
benefit of the Company's employees. In addition to the employer/employee
threshold, pension and profit sharing plans, including plans under Code Section
401(k) and matching contributions under Code Section 401(m), 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
the availability of, and the benefits, rights and features offered in qualified
employee benefit plans.
In April 2002, the IRS issued Revenue Procedure 2002-21 ("Rev. Proc. 2002-21").
While Rev. Proc. 2002-21 is intended to describe the steps that may be taken to
ensure the qualified status of defined contribution plans maintained by PEO's
for the benefit of worksite employees, there remain uncertainties regarding the
operating and interpretation of that revenue procedure. Under Rev. Proc.
2002-21, if a PEO operates a multiple employer retirement plan in accordance
with Code Section 413(c), the IRS will not disqualify the retirement plan solely
on the grounds that the plan violates or has violated the exclusive benefit
rule. The Company's current, active retirement savings plan is designed and
intended to be operated in accordance with the Code Section 413(c). Rev. Proc.
2002-21 also provides that if a PEO's retirement savings plan is not operated as
a multiple employer
9
retirement savings plan, the plan risks disqualification for violation of the
exclusive benefit rule unless the PEO either converts the plan to a multiple
employer plan or terminates the plan by December 31, 2003. The Company also
maintains a "frozen" retirement savings plan that is not a multiple employer
plan. The Company anticipates that it will terminate this plan in accordance
with Rev. Proc. 2002-21.
Workers' Compensation. Workers' compensation is a state mandated, comprehensive
insurance program that requires employers to fund medical expenses, lost wages
and other costs resulting from work-related injuries, illnesses and deaths. In
exchange for providing workers' compensation coverage for employees, employers
are not subject to litigation by employees for benefits in excess of those
provided by the relevant state statute. In most states, the extensive benefits
coverage (for both medical cost and lost wages) is provided through the purchase
of commercial insurance from private insurance companies, participation in
state-run insurance funds or employer self-insurance. Workers' compensation
benefits and arrangements vary on a state-by-state basis and are often highly
complex. These laws establish the rights of workers to receive benefits and to
appeal benefit denials.
As a creation of state law, workers' compensation is subject to change by the
state legislature in each state and is influenced by the political processes in
each state. Four states, including Ohio, have mandated that employers receive
coverage only from state operated funds. Although Ohio maintains such a "state
fund," it does allow employers that meet certain criteria to self-insure for
workers' compensation purposes. The Company maintained a self-insured workers'
compensation program for most of its Ohio corporate and worksite employees from
July 1999 through May 2002 and maintained a high retention workers' compensation
policy covering most of its non-Ohio employees until December 31, 2002. The
Company records workers' compensation expense for the historical loss sensitive
programs based upon the estimated ultimate total cost of each claim, plus an
estimate for incurred but not reported claims. Under the Ohio self-insured
program, the Company was self-funded up to $250,000 per occurrence through
December 31, 2001 and $500,000 per occurrence for the period January 1, 2002
through May 31, 2002 and purchased private insurance for individual claims in
excess of that amount. Effective June 1, 2002, the Company's Ohio worksite
employees became insured through the Ohio Bureau of Workers' Compensation
Program, which is a fully insured program, where premiums represent the maximum
cost.
Under its insured program for non-Ohio employees that was in existence for 2002
and prior years, the Company has a per claim retention limit of $500,000 for the
first two occurrences and $250,000 per occurrence thereafter. For the insurance
program covering the periods July 1, 1999 through September 30, 2000, October 1,
2000 through December 31, 2001 and January 1, 2002 through December 31, 2002,
the aggregate caps are estimated to be $4,176,000, $4,950,000 and $9,000,000,
respectively.
Effective January 1, 2003, the Company participates in fully insured workers'
compensation programs provided by Cedar Hill Zurich, various other regional
insurers and certain state workers' compensation funds. Under these programs,
the Company's maximum cost is represented by the premiums paid to these
insurers.
Other Employer Related Requirements. As an employer, the Company is subject to a
wide variety of federal and state laws and regulations governing
employer-employee relationships, including the Immigration Reform and Control
Act, the Americans with Disabilities Act of 1990, the Family Medical Leave Act,
the Occupational Safety and Health Act and comprehensive state and federal civil
rights laws and regulations, including those prohibiting discrimination and
sexual harassment. The definition of employer may be broadly interpreted under
these laws.
Responsibility for complying with various state and federal laws and regulations
is allocated by agreement between the Company and its clients, or, in some
cases, is the joint responsibility of both. Because the Company acts as a
co-employer of worksite employees for many purposes, it is possible that it
could incur liability for violations of laws even though it is not contractually
or otherwise responsible for the conduct giving rise to such liability. The
standard client agreement generally provides that the client will indemnify the
Company for liability incurred both as a result of an act of negligence of a
worksite employee under the direction and control of the client and to the
extent the liability is attributable to the client's failure to comply with any
law or regulation for which it has specified contractual responsibility.
However, there can be no assurance that the Company will be able to enforce such
indemnification, and may therefore be ultimately responsible for satisfying the
liability in question.
ITEM 2. PROPERTIES.
The Company leases office facilities in Worthington, Ohio, Las Vegas, Nevada,
Dallas and Midland, Texas, Atlanta, Georgia, Salt Lake City, Utah and Bethesda,
Maryland. Its corporate headquarters is located in Worthington, Ohio, a suburb
of Columbus, Ohio, in two leased buildings that house its executive offices and
operations for central Ohio worksite employees. Other offices are used to
service local PEO operations and are also leased. The Company believes that its
current facilities are adequate for its current needs and that additional
suitable space will be available as required.
10
ITEM 3. LEGAL PROCEEDINGS.
The Company is not involved in any material pending legal proceedings, other
than ordinary routine litigation incidental to its business. The Company does
not believe that any such pending legal proceedings, individually or in the
aggregate, will have a material adverse effect on its financial results.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
No matters were submitted to a vote of security holders during the fourth
quarter of the fiscal year ended December 28, 2002.
11
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.
The Company's common stock was quoted on the Nasdaq National Market under the
symbol "TMAM" from the commencement of its initial public offering on December
10, 1996 until October 1, 1999, when the Company's common stock began trading on
the Nasdaq SmallCap Market. Following the merger with Mucho.com, Inc. on
December 28, 2000, the Company's trading symbol was changed to "TMOS." Since
August 23, 2002, the Company's trading symbol has been "TMOSE." The
following table sets forth, for the periods indicated, the high and low bid
prices for the Company's common stock, as reported on the Nasdaq SmallCap
Market.
CALENDAR PERIOD COMPANY COMMON STOCK
- --------------- --------------------
HIGH LOW
---- ---
Fiscal 2001:
First Quarter................................................................... $ 5.06 $ 2.50
Second Quarter.................................................................. $ 3.54 $ 2.50
Third Quarter................................................................... $ 3.30 $ 2.51
Fourth Quarter.................................................................. $ 5.30 $ 2.70
Fiscal 2002:
First Quarter .................................................................. $ 3.98 $ 2.11
Second Quarter.................................................................. $ 3.60 $ 1.90
Third Quarter................................................................... $ 2.50 $ 0.25
Fourth Quarter.................................................................. $ 0.71 $ 0.10
Fiscal 2003:
First quarter (through March 26, 2003).......................................... $ 0.58 $ 0.32
As of March 26, 2003, the number of record holders of the Company's common stock
was approximately 247. The closing sales price of the common stock on March 26,
2003 was $0.48.
The Company has not paid any cash dividends to holders of its common stock and
does not anticipate paying any cash dividends in the foreseeable future, but
intends instead to retain any future earnings for reinvestment in its business.
The payment of any future dividends is currently contingent upon approval of the
Company's 2000 Class A Preferred Shareholders and its lenders.
In April 2002, the Company entered into a Bridge Agreement and Common Stock
Purchase Agreement with one of its 2000 Class A Preferred Shareholders. In
connection with these agreements, the Company issued 166,667 shares of common
stock for $500,000. In addition, the purchaser received a warrant to purchase
100,000 shares of common stock exercisable at $3.00 per share.
In March 2001, the Company received $1 million from the issuance of additional
2000 Class A Preferred Shares. As additional consideration for the purchase,
the Company issued a warrant to purchase an additional 148,148 shares of
common stock exercisable at $6.75 per share.
In connection with the purchase of substantially all of the assets of
Professional Staff Management, Inc., the Company issued 74,074 common shares.
The following table sets forth information about the Company's common stock
that may be issued under the Company's existing equity compensation plans as
of December 28, 2002:
NUMBER OF SHARES WEIGHTED AVERAGE NUMBER OF
TO BE ISSUED UPON PRICE OF SECURITIES REMAINING
EXERCISE OF OUTSTANDING AVAILABLE FOR
OPTIONS OPTIONS FUTURE ISSUANCE
------- ------- ---------------
Equity compensation plans approved by
security holders........................ 1,289,000 $ 5.93 523,000
ITEM 6. SELECTED FINANCIAL DATA.
SUMMARY OF TEAM AMERICA, INC. SELECTED FINANCIAL DATA
The following table presents summary selected financial data of TEAM America,
Inc. as of and for the period from July 8, 1999 to December 31, 1999, and as of
and for the years ended December 28, 2002, December 29, 2001 and December 31,
2000. This
12
financial data should be read in conjunction with TEAM America, Inc.'s
historical financial statements and "Management's Discussion and Analysis of
Financial Condition and Results of Operations" contained elsewhere in this
Annual Report on Form 10-K.
The reported results for 1999 and 2000 are those of Mucho.com, Inc. No PEO
results are provided for fiscal years 1999 and 2000.
(000'S OMITTED, EXCEPT PER SHARE DATA)
PERIOD FROM
YEAR ENDED YEAR ENDED YEAR ENDED INCEPTION TO
DECEMBER 28, DECEMBER 29, DECEMBER 31, DECEMBER 31,
2002 2001 2000 1999
---- ---- ---- ----
Statement of Operations Data:
Revenues (2)........................... $ 58,939 $ 57,036 $ 51 $ -
--------------- -------------- -------------- ------------
Cost of Services........................ 38,334 37,167 - -
--------------- -------------- -------------- ------------
Gross Profit............................ 20,605 19,869 51 -
--------------- -------------- -------------- ------------
Expenses:
Administrative salaries.............. 11,377 10,743 5,651 883
Other selling, general and
administrative expenses........... 7,925 7,588 2,468 271
Depreciation and amortization........ 1,414 2,808 262 20
Restructuring charges................ 738 1,834 654 -
Systems and operations development
costs ............................ 312 - - -
--------------- -------------- -------------- ------------
Total operating expenses.......... 21,766 22,973 9,035 1,174
--------------- -------------- -------------- ------------
Loss from operations.............. (1,161) (3,104) (8,984) (1,174)
---------------- --------------- --------------- -------------
Interest expense..................... (1,672) (1,051) (512) (80)
---------------- --------------- --------------- -------------
Income tax benefit (expense)......... 982 (35) - -
--------------- --------------- -------------- ------------
Net loss................................ (1,851) (4,190) (9,496) (1,254)
Deemed dividend (1)..................... - (1,047) -
Preferred stock dividends............... (1,224) (1,100) - -
---------------- --------------- -------------- ------------
Net loss attributable to common
shareholders (1)..................... $ (3,075) $ (5,290) $ (10,543) $ (1,254)
================ =============== =============== =============
Net loss per common share
Basic and diluted (1)................ $ (0.38) $ (0.72) $ (3.74) $ (0.66)
Balance Sheet Data:
Working capital deficit................. $ (9,241) $ (8,222) $ (4,803) $ (957)
Total assets............................ $ 63,263 $ 58,844 $ 56,960 $ 292
Long-term obligations................... $ 12,876 $ 13,044 $ 3,665 $ 62
Total shareholders' equity (deficit) (1) $ 9,603 $ 12,064 $ 17,021 $ (803)
(1). As described in Note 4 to the Company's Consolidated Financial
Statements, the Company's Statements of Operations and of Cash Flows
for the year ended December 31, 2000 and its Balance Sheets and
Statements of Changes in Shareholders' Equity at December 29, 2001 and
December 31, 2000 have been restated.
(2). As described in Note 2 to the Company's Consolidated Financial
Statements, revenues for 2001 have been reclassified to conform to the
2002 presentation.
13
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS.
OVERVIEW
The Company has operated as a Professional Employer Organization ("PEO")
actively since 1986 as TEAM America. The Company participated in a reverse
merger with Mucho.com (based in Lafayette, California) on December 28, 2000,
which had operated as an Online Business Center ("OBC") since July 1999.
PEO revenue is recognized as service is rendered. The PEO revenue consists of
charges by the Company for the administrative service fees, health insurance,
workers' compensation charges and employer paid unemployment insurance. These
charges, along with gross payroll, payroll taxes and retirement benefits are
invoiced to the client at the time of each periodic payroll. The Company
negotiates the pricing for its various services on a client-by-client basis
based on factors such as market conditions, client needs and services requested,
the client's workers' compensation experience, credit exposure and the required
resources to service the account. Because the pricing is negotiated separately
with each client and varies according to circumstances, the Company's revenue,
and therefore its gross margin, will fluctuate based on the Company's client
mix. Costs of services in the Company's Statement of Operations are reflective
of the type of revenue being generated. Costs of services include health
insurance, workers' compensation insurance and unemployment insurance costs. The
Company maintained a self-insured workers' compensation program for most of its
Ohio employees from July 1999 through May 2002 and maintained a high retention
workers' compensation policy covering most of its non-Ohio employees or all
other states ("AOS") until December 31, 2002. Effective June 1, 2002, the
Company's Ohio worksite employees became insured through the Ohio Bureau of
Workers' Compensation Program, which is a fully insured program, where premiums
represent the maximum cost. Effective January 1, 2003, the Company participates
in fully insured workers' compensation programs provided by Cedar Hill Zurich,
various other regional insurers and certain state workers' compensation funds.
Under these programs, the Company's maximum cost is represented by the premiums
paid to these insurers. The Company does not provide workers' compensation
coverage to non-employees of the Company. The AOS workers' compensation
insurance program provider was The Hartford Insurance Company ("Hartford") for
the period July 1999 through December 2002.
With respect to the historical loss sensitive programs, the Company records in
cost of services a monthly charge based upon its estimate of the year's ultimate
fully developed losses plus the fixed costs charged by the insurance carrier to
support the program. This estimate is established each quarter based in part
upon information provided by the Company's insurers, internal analysis and its
insurance broker. The Company's internal analysis includes a quarterly review of
open claims and review of historical claims and losses related to the workers'
compensation programs. While management uses available information, including
nationwide loss ratios, to estimate ultimate losses, future adjustments may be
necessary based on actual losses.
As of December 28, 2002, the adequacy of the workers' compensation reserves were
determined, in management's opinion, to be reasonable. However, since these
reserves are for losses that have not been sufficiently developed due to the
relatively young age of these claims, and variables such as timing of payments
are uncertain or unknown, actual results may vary from current estimates. The
Company will continue to monitor the development of these reserves, the actual
payments made against the claims incurred, the timing of these payments and
adjust the reserves as deemed appropriate.
The Company's clients are billed at fixed rates determined when the contract is
negotiated with the client. The fixed rates include charges for workers'
compensation based upon the Company's assessment of the costs of providing
workers' compensation to the client. If the Company's costs for workers'
compensation are greater than the costs included in the client's contractual
rate, the Company may be unable to recover these excess charges from the
clients. The Company reserves the right in its contracts to increase the
workers' compensation charges on a prospective basis only.
On March 1, 2002, the Company acquired certain assets and assumed certain
liabilities of Strategic Staff Management, Inc. ("SSMI"). The purchase price of
$476,000 included cash of $300,000, the assumption of customer deposits of
$172,000 and other costs of $4,000. The Company borrowed $750,000 under its
Credit Facility in connection with this acquisition. SSMI operated as a PEO
primarily in Nebraska and Iowa.
On May 1, 2002, the Company purchased certain assets of Inovis Corporation
("Inovis"). Under the terms of this transaction, the Company is required to pay
the greater of $1,150,000, (the "Minimum Price") or a factor of gross profits
generated by the Inovis business over the 24 months beginning May 2002 and
ending April 2004. Inovis was based in Atlanta, Georgia and had clients
throughout the United States, but primarily concentrated in Georgia.
14
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
The Company's discussion and analysis of its financial condition and results of
operations are based upon its consolidated financial statements, which have been
prepared in accordance with accounting principles generally accepted in the
United States. The preparation of these financial statements requires the
Company to make estimates and judgments that affect the reported amounts of
assets, liabilities, revenues and expenses, and related disclosure of contingent
assets and liabilities. On an on-going basis, the Company evaluates its
estimates, including those related to customer bad debts, workers' compensation
reserves, income taxes, and contingencies and litigation. The Company bases its
estimates on historical experience and on various other assumptions that are
believed to be reasonable under the circumstances, the results of which form the
basis for making judgments about the carrying values of assets and liabilities
that are not readily apparent from other sources. Actual results may differ from
these estimates.
The Company believes the following critical accounting policies reflect the more
significant judgments and estimates used in the preparation of its consolidated
financial statements:
Revenue Recognition. The Company bills its clients on each payroll date for (i)
the actual gross salaries and wages, related employment taxes and employee
benefits of the Company's worksite employees, (ii) actual advertising costs
associated with recruitment, (iii) workers' compensation and unemployment
service fees and (iv) an administrative fee. The Company's administrative fee is
computed based upon either a fixed fee per worksite employee or an established
percentage of gross salaries and wages (subject to a guaranteed minimum fee per
worksite employee), negotiated at the time the client service agreement is
executed. The Company's administrative fee varies by client based primarily upon
the nature and size of the client's business and the Company's assessment of the
costs and risks associated with the employment of the client's worksite
employees. Accordingly, the Company's administrative fee income will fluctuate
based on the number and gross salaries and wages of worksite employees, and the
mix of client fee income will fluctuate based on the mix of total client fee
arrangements and terms. Although most contracts are for one year and renew
automatically, the Company and its clients generally have the ability to
terminate the relationship with 30 days' notice.
The Company bills its clients for workers' compensation and unemployment costs
at rates that vary by client based upon the client's claims and rate history.
The amount billed is intended (i) to cover payments made by the Company for
insurance premiums and unemployment taxes, (ii) to cover the Company's cost of
contesting workers' compensation and unemployment claims, and other related
administrative costs and (iii) to compensate the Company for providing such
services. The Company has an incentive to minimize its workers' compensation and
unemployment costs because the Company bears the risk that its actual costs will
exceed those billed to its clients, and conversely, the Company profits in the
event that it effectively manages such costs. The Company believes that this
risk is mitigated by the fact that its typical standard client agreement
provides that the Company, at its discretion, may adjust the amount billed to
the client to reflect changes in the Company's direct costs, including, without
limitation, statutory increases in employment taxes and insurance. Any such
adjustment that relates to changes in direct costs is effective as of the date
of the changes, and all changes require 30 days' prior notice.
In accordance with Emerging Issues Task Force (EITF) Issue No. 99-19, "Reporting
Revenue Gross as a Principal versus Net as an Agent," the Company recognizes
amounts billed to clients for administrative fees, health insurance, workers'
compensation and unemployment insurance as revenues as the Company acts as a
principal with regards to these matters. Amounts billed for gross payrolls (less
employee health insurance contributions), employer taxes and 401(k) matching are
recorded net as the Company is deemed to act only as an agent in these
transactions. The Company recognizes in its balance sheet the entire amounts
billed to clients for gross payroll and related taxes, health insurance,
workers' compensation, unemployment insurance and administrative fees as
unbilled receivables, on an accrual basis, any such amounts that relate to
services performed by worksite employees that have not yet been billed to the
client at the end of an accounting period. The related gross payroll and related
taxes and costs of health insurance, workers' compensation and unemployment
insurance are recorded as accrued compensation at the end of an accounting
period.
Because the acquisition of TEAM America Corporation occurred on December 28,
2000, the Company recognized no revenue or expenses related to the PEO business
segment prior to 2001. Unbilled revenues on the balance sheet at December 31,
2000 represent amounts generated by TEAM America Corporation prior to the
acquisition and billed to clients after the acquisition.
Workers' Compensation. The Company maintained a self-insured workers'
compensation program for most of its Ohio employees from July 1999 through May
2002 and maintained a high retention workers' compensation policy covering most
of its non-Ohio employees until December 31, 2002. The Company records workers'
compensation expense for the loss
15
sensitive programs based upon the estimated ultimate total cost of each claim,
plus an estimate for incurred but not reported claims. Under the Ohio
self-insured program, the Company was self-funded up to $250,000 per occurrence
through December 31, 2001 and $500,000 per occurrence for the period January 1,
2002 through May 31, 2002 and purchased private insurance for individual claims
in excess of that amount. Effective June 1, 2002, the Company's Ohio worksite
employees became insured through the Ohio Bureau of Workers' Compensation
Program, which is a fully insured program, where premiums represent the maximum
cost.
Under its historical insured program for non-Ohio employees, the Company has a
per claim retention limit of $500,000 for the first two occurrences and $250,000
per occurrence thereafter. For the insurance program covering the periods July
1, 1999 through September 30, 2000, October 1, 2000 through December 31, 2001
and January 1, 2002 through December 31, 2002, the aggregate caps are estimated
to be $4,176,000, $4,950,000 and $9,000,000, respectively.
In addition to providing the claims expense under the plan, as described above,
the Company was required to "pre-fund" a portion of the estimated claims under
the non-Ohio program. The amounts "pre-funded" are used by the insurance carrier
to pay claims. The amount "pre-funded" is measured at various periods in the
insurance contract to determine, based upon paid and incurred claims history,
whether the Company is due a refund or owes additional funding.
Effective January 1, 2003, all workers' compensation coverage has been obtained
on a guaranteed cost basis, so that the premiums for any program represents the
Company's maximum liability.
Goodwill. Effective December 30, 2001, the Company adopted SFAS No. 142,
"Goodwill and Other Intangible Assets." Under SFAS No. 142, the Company no
longer amortizes goodwill, but is required to test for impairment on an annual
basis and at interim periods if certain factors are present that may indicate
that the carrying value of the reporting unit is greater than its fair value.
The Company has determined that it operates as a single reporting unit,
therefore, any potential goodwill impairment is measured at the corporate level.
In connection with the adoption of SFAS No. 142, management, in determining its
methodology for measuring fair value, assessed that its market price may not be
reflective of fair value due to various factors, including that the Company's
officers, directors and significant shareholders own a controlling interest in
the Company's common shares and, as a result, that the market may be illiquid at
times with regard to the remaining shares as such shares are thinly traded.
Accordingly, in order to assess fair value of the Company, management determined
that a number of measures should be considered, including but not limited to,
market capitalization of the Company, market capitalization of the Company plus
a "control" premium, discounted projected earnings before interest, depreciation
and amortization (EBITDA), multiples of sales and EBITDA as compared to other
industry participants and comparison of historical transactions.
SFAS No. 142 required that the Company adopt an annual date at which it would
test for impairment of goodwill. In connection with the adoption of this
statement, the Company chose the end of the third quarter as its date to test
for such impairment. At the end of the third quarter of fiscal year 2002,
management determined that no impairment existed using the following
calculations and assumptions:
- - The common shareholders' equity of the Company at the end of the third
quarter of 2002 was $9,481,000.
- - Calculations and assumptions used in the determination of fair value
included the following:
- Market capitalization of the Company based on the closing
price of the Company's common shares on September 27, 2002 was
$0.70 per share. Using this market price, the Company's market
capitalization at the end of the third quarter of fiscal year
2002 was approximately $5,751,000.
- Market capitalization plus a "control" premium assumed to be
20% was approximately $6,901,000.
- The Company prepared a discounted EBITDA analysis based upon
the Company's forecast EBITDA (before restructuring charges)
for 2002 and applying certain growth factors for 2003 through
2007. The significant assumptions used in these calculations
included:
- Fiscal year 2003 EBITDA was estimated assuming a
gross margin similar to 2002 and certain changes
in the Company's business, including the impact of
2002 restructuring.
16
- Management assumed the following growth rates in
gross margin: 2004-10%, 2005-8%, 2006-6%, and
2007-4%. Corporate payroll and selling, general and
administrative expenses were assumed to remain at
similar levels relative to gross margin.
- A 20% discount rate was used as well as a 20%
"control" premium.
- Using the above assumptions, the discounted EBITDA
was calculated to be approximately $35,760,000. In
order to arrive at a value attributable to the common
shares, management reduced this amount by the
Company's outstanding senior debt of $8,744,000 and
the amount for preferred shareholders of $9,235,000.
The residual amount of $17,781,000 was used as the
estimate of fair value of the Company under this
methodology.
In assessing the Company's fair value at the end of the third quarter of 2002,
management determined that the Company's market capitalization was not
reflective of fair value as the common stock price dropped precipitously
immediately following a NASDAQ required press release describing NASDAQ's
initial determination that the Company was not in compliance with NASDAQ listing
requirements and was therefore subject to delisting. These events were caused by
the Company's filing of its second quarter Form 10-Q without an independent
auditor's review, due to the demise of Arthur Andersen LLP, and the Company's
related restatement of its 2001 and 2000 financial statements as described in
Note 4. In accordance with this process, the NASDAQ appended an "E" to the
Company's trading symbol, noting the failure to comply with continued listing
requirements and potential delisting. Following the Company's press release, the
Company's common stock price dropped from $1.36 to $0.45 per share. For the
period from July 1, 2002 up to the date of the press release, the common stock
had traded in the range of $1.36 to $2.50. Accordingly, in management's
judgment, the drop in the stock price is a temporary event related to the
potential delisting and not due to fundamental changes in the business.
Management believes that shortly following a timely filing of this 10-K, the
appended "E" will be removed.
Based upon management's determination that the market capitalization was not
necessarily reflective of fair value, the other measurement factors were heavily
considered in this analysis, the most significant being the discounted EBITDA
model that yielded a value of approximately $17,781,000. In order to reconcile
this back to the market capitalization, management assessed the market price
($1.36) immediately prior to the press release regarding delisting and the
average market price ($1.54) for the quarter. Based on each of these measures,
the market capitalization of the Company would have been $11,173,000 using the
market price of $1.36 per share and $12,652,000 using the average price of $1.54
per share for the third quarter of 2002.
After assessing all of the information regarding fair value as outlined above,
management determined that as of the end of the third quarter, no impairment
charge of goodwill was required. Had the Company used only the market
capitalization of the Company as a measure of fair value, an impairment charge
would have been required. Management estimates that the minimum required charge
under this market capitalization methodology would have been approximately
$3,484,000.
During the fourth quarter of 2002, management, as required by SFAS No. 142,
assessed whether or not events or circumstances had occurred subsequent to the
Company's annual measurement date that would more likely than not reduce the
fair value of the Company below its carrying amount. Based upon its assessment,
management determined that there were no factors subsequent to the third quarter
that would more likely than not reduce the fair value of the Company. Management
believes that during the fourth quarter positive developments occurred,
including improvement in EBITDA and the signing of a Forbearance Agreement with
its banks. Moreover, management assessed that the stock price had continued to
trade in a range of approximately $0.40 per share to $0.70 per share subsequent
to the third quarter. Consistent with their conclusions at the end of the third
quarter, management determined that the market price was not reflective of fair
value due to the appended "E" denoting potential delisting of its common shares
and, therefore, was not an indicator that potential impairment may exist.
Management will continue to assess the potential indicators of impairment,
including the Company's common stock price during 2003. If after removal of the
appended "E" to the Company's trading symbol, the common stock price does not
positively change, management believes that the declined stock price may then be
an indicator of potential impairment and will perform an interim test at that
time. Should the market price of the Company's common stock not improve,
management believes that this test may be performed as early as the second
quarter of 2003. Had management performed the same test of fair value as of the
end of the year that was applied at the end of the third quarter, management
believes that the results would have been similar to those described above for
the third quarter. Accordingly, management does not believe that this test would
have resulted in an impairment charge. Had an interim impairment test been
required and had management used only the market capitalization of the Company
to measure fair value at December 28, 2002, an impairment charge would have been
required. Management estimates that the minimum required charge under this
methodology market capitalization would have been approximately $5,413,000.
17
There can be no assurance that future goodwill impairment tests, including
interim tests as may be required, will not result in a charge to future
operations.
Further, there can be no assurance that the Staff of the United States
Securities and Exchange Commission will not have different views in respect to
whether the Company's stock price is reflective of an active market and that the
use of market price should have been used in valuation of goodwill. As
previously stated, the use of only quoted market price to determine any goodwill
impairment would have resulted in a minimum impairment charge of approximately
$5,413,000 at December 28, 2002.
During 2001, the Company recognized $1,783,000 of amortization expense related
to goodwill. Had the Company adopted SFAS No. 142 as of the beginning of 2001,
$1,783,000 of amortization expense would not have been recognized and net loss
would have decreased by $1,783,000 and loss per share attributable to common
shareholders would have decreased by $0.24 per share.
FISCAL YEAR 2002 COMPARED TO FISCAL YEAR 2001
REVENUES
For the fiscal year ended December 28, 2002, total revenues increased by
$1,903,000, or 3.34%, as compared to the fiscal year ended December 29, 2001.
This higher revenue is a result of the combination of the Company's efforts
during 2002 and 2001 to focus its sales efforts in certain major metropolitan
markets, where clients represent lower risk and have higher gross margin
potential and the revenue added by two market acquisitions, which was partially
offset by a decline in worksite employees in the Company's existing client base
at the beginning of the year. As a result of the above factors, the average
number of paid worksite employees during 2002 decreased to 12,849 from 14,154 in
2001, or a reduction of 9.22%. At the same time, the average revenue per
worksite employee increased to $4,587 in 2002 from $4,030 in 2001, representing
an increase of 13.82%.
During 2002, the Company added incremental worksite employees through its
acquisitions of SSMI and Inovis. From their respective dates of acquisition,
SSMI contributed 712 and Inovis contributed 2,008 average worksite employees. On
an annualized basis, revenues per worksite employee for SSMI were $3,687 and for
Inovis were $7,732. Excluding the effect of these acquisitions, average paid
worksite employees decreased to 10,917 from 14,154, or 22.87%, while the revenue
per worksite employee increased to $4,618 from $4,030, or 14.59%.
COST OF REVENUE/GROSS PROFIT
For the fiscal year ended December 28, 2002, gross profit was $20,605,000, or
34.96% of revenues compared to the fiscal year ended December 29, 2001 gross
profit of $19,869,000, or 34.84% of revenues, representing an increase in gross
profit of $736,000, or 3.70%. This increase in gross profit is primarily
attributable to the Company's focus on lower risk higher margin business in
major metropolitan markets. Gross margin per average paid worksite employees
increased to $1,604 in 2002 from $1,404 in 2001, resulting in an increase of
$200, or 14.25%. The annualized gross profit per average paid worksite employee
for the clients acquired through the SSMI acquisition was $784 and the Inovis
acquisition was $1,058. Excluding the impact of these acquisitions, gross profit
per average paid worksite employee increased by $311, or 22.15%, to $1,715 in
2002.
OPERATING EXPENSES
For the fiscal year ended December 28, 2002, total operating expenses were
$21,766,000, or 36.93% of revenues, compared to $22,973,000, or 40.28% of
revenues, for the fiscal year ended December 29, 2001. This decrease of
$1,207,000, or 5.25%, is due to a decrease in depreciation and amortization
expense of $1,394,000 and a decrease in restructuring costs charges of
$1,096,000 partially offset by increases in corporate administrative salaries of
$634,000, an increase in other selling, general and administrative expenses of
$337,000 and certain expenses related to systems development of $312,000.
Depreciation and amortization expense decreased primarily as a result of the
elimination of amortization expense related to goodwill. During 2001, the
Company recorded $1,783,000 of goodwill amortization expense that was not
recognized in 2002. This decrease was offset by additional amortization expense
incurred during 2002 as a result of the acquisitions of SSMI and Inovis. During
2002, the Company recorded $211,000 of amortization expense related to customer
relationships acquired in those acquisitions.
The Company continued its efforts to reduce costs in 2002 through the
consolidation of operating centers and the associated elimination of corporate
positions. During 2002, the Company recognized $738,000 of restructuring costs
associated with these efforts compared to $1,834,000 in 2001. The 2002
restructuring costs include $158,000 paid in employee severance, $199,000
related to employee relocation and $381,000 for leases related to sales and
services offices, as well as a payroll
18
processing center closed during the year.
Corporate administrative salaries were $11,377,000, or 19.30% of revenue, in
2002 compared to $10,743,000, or 18.84% of revenue, in 2001, representing an
increase of $634,000, or 5.90%. During 2002, the Company reduced its corporate
payroll headcount from 209 at the beginning of the year to 174 at the end of the
year. A significant portion of this reduction was attributable to the
consolidation of sales and service offices and the closing of a payroll
processing center. These consolidations took place during the fourth quarter
2002; therefore, a significant portion of the savings were not realized in 2002.
Additionally, the Inovis acquisition was primarily operated as a stand-alone
business from the date of acquisition, May 2002, through its integration into
the Company's operating systems in November 2002. This resulted in additional
headcount and payroll dollars through 2002.
Other selling, general and administrative expenses were $7,925,000, or 13.45% of
revenues, in 2002 compared to $7,588,000, or 13.3% of revenues, in 2001,
representing an increase of $337,000, or 4.44%.
Significant increases in selling, general and administrative expense categories
included professional fees of $413,000, banking fees of $140,000, rent of
$130,000, other consulting fees of $106,000, corporate insurance of $82,000,
investor relations of $78,000 and marketing costs of $49,000. These increases
were partially offset by decreases in bad debt expense of $156,000, temporary
labor of $68,000 and information technology consulting of $39,000.
Professional fees increased primarily due to the Company's change in auditors
during the year, as well as costs associated with restating its 2001 and 2000
financial statements. Additional professional fees were also incurred as a
result of the potential NASDAQ delisting. Rent and marketing costs increased
primarily as a result of having a full year of operations in Dallas, Texas
compared to only three months in fiscal 2001, as well as the addition of markets
in Omaha, Nebraska and Atlanta, Georgia through acquisitions. Banking fees
increased as a result of additional cost incurred related to cash collections
from clients associated primarily with moving a substantial number of clients
from ACH collection to wire. Other consulting fees increased primarily due to
costs associated with various advisors regarding capital raises and/or strategic
opportunities. Corporate insurance increased due to related premium increases.
The reduction in bad debt expense is primarily attributable to concerted efforts
on behalf of the Company to adhere to strict financial underwriting criteria, as
well as the elimination of certain credit risk due to the changing demographics
of its book of business. Temporary labor and information technology consulting
costs decreased primarily as a result of no significant systems charges or
issues such as those incurred in 2001 surrounding the implementation of the
Great Plains accounting system.
RESTRUCTURING AND OTHER COSTS
The Company incurred $738,000 of restructuring costs during 2002 compared to
$1,834,000 in 2001. The 2002 restructuring was primarily focused on the
Company's consolidation of operations and the associated relocation of key
personnel, as well as the resultant rationalization of the Company's workforce.
In connection with this restructuring, the Company closed several sales and
service offices, as well as a payroll processing center. The major components of
this restructuring charge included relocation costs of $199,000, employee
severance of $158,000 and costs associated with building leases of $381,000.
As a result of the problems associated with the implementation of the Great
Plains accounting system in 2001, the Company hired an outside consultant to
assist in the assessment of and to make recommendations regarding improvements
to the Company's information systems and processes. The Company incurred
$312,000 of costs associated with this project.
OPERATING LOSS
For the fiscal year ended December 28, 2002, the Company's operating loss was
$1,161,000 compared to $3,104,000 for the fiscal year ended December 29, 2001.
This improvement of $1,943,000 was attributable to the combination of factors
discussed in Gross Profit and Operating Expenses above.
INTEREST EXPENSE
For the fiscal year ended December 28, 2002, the Company incurred $1,565,000 of
interest expense compared to $863,000
19
for the fiscal year ended December 29, 2001. The increase in net interest
expense of $702,000 is attributable to interest on the bridge note of $81,000,
amortization of warrants issued in connection with the bridge note of $105,000,
increased interest associated with capital leases of $74,000, an increase in
interest associated with an interest rate swap instrument of $128,000 and an
increase in amortization of deferred financing costs of $371,000 offset by other
changes, net of $49,000.
The increase in amortization of deferred financing costs is primarily
attributable to amounts paid by the Company related to entering into an Omnibus
Forbearance Agreement in October 2002. These costs included legal fees,
consulting fees and a $100,000 forbearance fee. As the term of the Forbearance
Agreement was six months, the Company is amortizing these costs over that
period.
In connection with its Credit Facility, the Company was required to enter into
an interest rate swap agreement. This instrument has not been designated as a
hedge. Accordingly, changes in the fair value of this instrument are recorded as
a gain or loss in the Company's financial statements. The Company recorded
expense representing losses due to the change in fair value of this instrument
of $107,000 during 2002 and $188,000 during 2001.
INCOME TAX BENEFIT
For the fiscal year ended December 28, 2002, the Company recorded a federal
income tax benefit of $1,067,000. The Company incurred certain state and local
income tax expense of approximately $85,000. The tax provision in the fiscal
year ended December 29, 2001 related entirely to state and local taxes. The
significant change in federal income taxes for 2002 is primarily due to a change
in tax law during 2002 that allowed the carryback of net operating losses for
five years as opposed to the prior law of three years. This change in tax law
allowed the Company to carryback its net operating losses and recover previously
paid taxes. The Company continues to carry net deferred tax assets related to
certain temporary differences. A valuation allowance has been provided for all
deferred tax assets related to net operating loss carryfowards. Management
believes that it is more likely than not that the remaining deferred tax assets
are realizable primarily through various tax planning strategies.
NET LOSS AND LOSS PER SHARE ATTRIBUTABLE TO COMMON SHAREHOLDERS
The Company incurred a net loss of $1,851,000 in its fiscal year ended December
28, 2002 compared to $4,190,000 in its fiscal year ended December 29, 2001. This
improvement is due to the factors described above. The Company recorded
preferred stock dividends of $1,224,000 during fiscal year 2002 and $1,100,000
during fiscal year 2001. After the preferred stock dividend, the Company had a
net loss attributable to common shareholders of $3,075,000, or $0.38 per share,
for the fiscal year ended December 28, 2002 and $5,290,000, or $0.72 per share,
for the fiscal year ended December 29, 2001.
The weighted average number of shares used in the calculation of per share loss
attributable to common shareholders for the fiscal years ended December 28, 2002
and December 29, 2001, excludes options, warrants and convertible preferred
stock, as their inclusion would be anti-dilutive.
FISCAL YEAR 2001 COMPARED TO FISCAL YEAR 2000
The Company's revenue changed substantially from the 2000 and 1999 fiscal years.
The Company's reported results for 1999 were those of the Mucho.com Internet
operations based in Lafayette, California. Accordingly, no meaningful comparison
can be made on the Company's overall results for fiscal years 2001 to 2000.
The Company's revenues for the fiscal year ended December 2001 were $57,036,000,
of which $78,000 was related to the Mucho.com Internet operations. This compares
to Mucho.com's reported revenue for fiscal year 2000 of $51,000, which
represents an increase of 52.9%. The Mucho.com Internet operations were closed
in Lafayette, California by December 29, 2001.
Costs of services for fiscal year 2001 were $37,167,000. As a percentage of
revenue, cost of services for fiscal year 2001 was 65.16%.
Gross profits were $19,869,000 for fiscal year 2001. Gross profits, as a
percentage of revenue, were 34.84% for the fiscal year 2001. Additional expenses
were incurred as a result of the events surrounding the September 11th tragedy.
These expenses, totaling $149,000, were primarily due to additional charges
associated with the delivery of payroll by ground and other available means due
to the problems associated with air freight around the country.
20
Selling, general and administrative expenses ("SG&A") for fiscal 2001 amounted
to $7,588,000, or 13.30% of revenue. The Company incurred expenditures to open a
new Dallas office ($250,000), the PSMI integration costs ($683,000), the closure
of certain offices (Boise, Memphis, Orlando, and Orem, UT [$150,000]), and
additional IT consulting and programming capacity to expand the Company's
processing capabilities as it continued to integrate new books of business and
open new offices during the 2002 fiscal year. Difficulties associated with
previous accounting software platforms along with the implementation challenges
associated with the Company's new platform caused the Company to file its third
quarter 10-Q late and to incur some additional expenses. This resulted in
additional expenses of approximately $300,000. The Company implemented a new
accounting platform to help prevent this from occurring in the future.
Depreciation and amortization was $2,808,000 in fiscal year 2001 primarily due
to amortization of goodwill from the acquisitions of TEAM America in December
2000 and PSMI in March 2001, offset by a reduction in depreciation expense from
assets that were fully depreciated in fiscal 2001.
In conjunction with the integration of the TEAM America acquisition, the Company
incurred $1,834,000 of restructuring charges. The charges related primarily to
exit costs associated with the on-line business center, including the relocation
of certain key executives, employee severance and the write-down of impaired
assets. Total restructuring costs were 3.22% of revenues.
Interest expense in fiscal year 2001 was $1,051,000 as the Company's
indebtedness reached $9,049,000. Including letters of credit with regards to the
Company's workers' compensation programs in Ohio and with the Hartford Insurance
Company, the Company's total indebtedness was approximately $11,000,000.
Income tax expense for fiscal year 2001 was $35,000. The Company has substantial
net operating losses carried forward from Mucho.com that, while limited in the
amount that can be used in one individual year by Internal Revenue Code
provisions, will permit the Company to reduce its tax expense in the future
based upon the Company generating operating income.
Net loss for fiscal year 2001 was $4,190,000. The Company's 2001 fiscal year was
characterized by a downturn in the economic climate, the tragic events of
September 11th and the aftermath of a hardening insurance market. These market
dynamics provided management with challenges as it undertook plans to transition
the TEAM America book of business to a lower risk profile. The Company's
workers' compensation manual rate dropped from $3.20 to $2.84 per $100 of
payroll year over year. This reduction, as well as the introduction of a new
pricing structure, allowed the Company to increase its gross margin from $1,186
to $1,404 per worksite employee, representing an increase of approximately 18%.
Historically, the number of worksite employees is positively correlated to
changes in the employment rate. This suggests that as the percentage of the
country or region's available workforce becomes employed increases then the
Company's number of worksite employees will increase as well. This important
factor will be a good indicator of the change in the Company's revenue and
worksite employee count in the future.
LIQUIDITY AND CAPITAL RESOURCES
Net cash used in operating activities was $3,452,000 for the fiscal year ended
December 28, 2002 compared to net cash provided by operating activities of
$664,000 for the fiscal year ended December 29, 2001. This decrease in cash flow
from operations of $4,116,000 is primarily due to an increase in accounts
receivable of $3,036,000 and increases in prepaid expenses and other assets of
$1,122,000, offset by an increase in accounts payable and other liabilities of
$1,451,000. The increase in accounts receivable is due to changes in the mode of
payments by clients. In connection with the Company entering into the Omnibus
Forbearance Agreement with its lenders, the Company agreed to reduce the number
of clients that pay via Automated Clearinghouse transactions. While the Company
converted many of its larger clients to payment by wire, this method of payment
is uneconomical for many of the Company's smaller clients. Accordingly, a
substantial number of smaller clients are now paying via check which has caused
accounts receivable to increase due to the timing of deposits of such checks.
Additionally, for fiscal year 2001, the Company received $1,490,000 of
prepayments related to client payrolls after year-end, which reduced the
unbilled receivables. For fiscal year 2002, the corresponding amount was
$756,000. This difference is due to month-end payrolls (December 31) being on
the Monday following the December 29, 2001 year-end but not being until Tuesday
for the year ended December 28, 2002. As such, a substantial portion of those
payrolls were paid prior to year-end in fiscal 2001. The increase in prepaid
expenses and other assets is due to payments made related to the Company's
workers' compensation programs. Deposits made for future claims payment under
the Company's loss sensitive workers' compensation program for the program years
1999 - 2002 increased by $1,008,000 during fiscal year 2002. Additionally, as a
result of the Company's transition from loss sensitive workers' compensation
programs to fully insured
21
programs for fiscal 2003, the Company made substantial deposit and prepayments
in order to participate in such programs. These deposits and prepayments were
$810,000 as of December 28, 2002. No such corresponding deposit or prepayments
were required at December 29, 2001.
Net cash used in investing activities was $765,000 for the fiscal year ended
December 28, 2002 compared to $5,688,000 for the fiscal year ended December 29,
2001. The primary use of cash for investing activities for fiscal year 2002 was
$300,000 for the acquisition of customer relationship rights from SSMI and a
related non-compete agreement and $250,000 for the acquisition of certain assets
of Inovis. During fiscal year 2001, the Company used $4,250,000 related to the
acquisition of PSMI. Property and equipment additions were $215,000 during
fiscal 2002 and $1,438,000 during fiscal year 2001. Other equipment additions
during 2002 were funded primarily through capital leases.
Net cash provided by financing activities in 2002 was $2,770,000 compared to net
cash used in financing activities in 2001 of $4,454,000. The net cash provided
by financing activities during fiscal year 2002 was $1,696,000 from checks drawn
in excess of bank balances, $750,000 from borrowing under the Company's Bank
Credit Facility, $1,500,000 from a Bridge Loan and $500,000 from the issuance of
common stock. The sources of cash were offset by financing uses of cash of
$900,000 of payments on bank debt, $320,000 payments on capital leases and
$456,000 payment of financing costs. The checks drawn in excess of bank balances
is primarily a timing function related to the Company's cash inflows from
clients being distributed between electronic payments and cash payments and the
majority of the Company's cash outflows for worksite employees payrolls and tax
remittances being paid electronically. The $750,000 borrowed under the Company's
Bank Credit Facility was used in connection with the SSMI acquisition. The
proceeds of the $1,500,000 bridge loan and the $500,000 from the issuance of
common stock were used for working capital purposes. The net cash flow used in
financing activities for fiscal year 2001 was primarily the payment of
$11,622,000 related to a stock repurchase in connection with the TEAM America
and Mucho.com reverse merger transaction and $755,000 in financing costs
associated with the same transaction. During 2001 the Company made two draws
totaling $8,250,000 under its Credit Facility. The Company borrowed $4,000,000
in January 2001 under this facility in connection with the TEAM America and
Mucho.com merger. In March 2001, an additional $4,250,000 was borrowed in
connection with the Company's acquisition of PSMI.
In connection with the borrowing of $750,000 in March 2002, the Company and its
lenders agreed to temporarily reduce the Credit Facility from $18,000,000 to
$14,000,000. As of December 28, 2002, the Company had outstanding loans against
the Credit Facility of $8,728,000 and outstanding letters of credit of $914,000.
As a result of the SSMI transaction completed March 1, 2002, and the Inovis
transaction completed May 1, 2002, the Company has added incremental gross
margin to its operations, which contributes to cash flow from operations. In
addition to the incremental gross margin from these transactions, the Company is
continually evaluating its operating expenses and is in the process of
implementing various cost-saving measures, including the active restructuring of
corporate payroll costs.
On April 9, 2002, the Company entered into a Bridge Agreement and Common Stock
Purchase Agreement with one of its 2000 Class A Preferred Shareholders (the
"Purchaser"). Under the terms of these agreements, the Purchaser acquired
166,667 shares of common stock for $500,000. In addition, the Purchaser provided
a short-term bridge note of $1,500,000 to the Company, which was due August 9,
2002, and bore interest at 15% per annum.
Effective September 30, 2002, the Company and its senior lenders entered into an
Omnibus Forbearance and Modification Agreement (the "Forbearance"), which ends
on the earlier of March 31, 2003 or the date of Forbearance Default, as defined
in the Forbearance (the "Forbearance Period"). Under the terms of the
Forbearance, the senior lenders forbear from exercising any other rights or
remedies available to them with regards to the covenant violations under the
Credit Facility. In connection with the Forbearance, the Company is obligated to
pay interest only on a monthly basis as required under the terms of the Credit
Facility. All unpaid principal and interest is due and payable on April 1, 2003.
During the Forbearance Period, interest will accrue at the default rate of prime
plus four (8.25% at December 28, 2002), but the Company is only required to pay
interest monthly at a rate of prime plus one (5.25% at December 28, 2002). In
addition to the payment of principal and interest, the Company is required to
pay a $100,000 Forbearance Fee at the end of the Forbearance Period. The terms
of the Forbearance include monthly financial covenants that must be maintained
by the Company, the most stringent being the maintenance of minimum monthly
Earnings Before Interest, Taxes, Depreciation and Amortization. At December 28,
2002, the Company was in compliance with these covenants.
The Forbearance also precludes the Company from (i) making any distributions
with respect to its preferred and/or common shares; (ii) making any payments
with respect to indebtedness that has been subordinated to the Credit Facility;
(iii) making any pay increases or loans to executive officers; and (iv) making
any payment not in the ordinary course of business. Additionally, the Company
may not make any acquisitions that require capital outlays during the
Forbearance Period without
22
lenders approval. The Company is required to engage a financial consultant to
conduct an analysis of the Company's cash flow projections and to provide a
written report to the lenders regarding such analysis.
As a result of the default and Forbearance, the Company's debt outstanding under
the senior credit facility is classified in the Company's balance sheet as a
current liability at December 28, 2002.
Under the terms of the Company's Series A Preferred Securities Purchase
Agreement, should the Company be declared in default under the terms of its
Credit Facility and fail to cure such default during the cure period, the
Company would then be in default of its Series A Preferred Securities Purchase
Agreement. As a result, the holders of these preferred shares would have certain
rights under this agreement, including the right to put the shares back to the
Company.
Additionally, should the Company be in default of the Series A Preferred
Securities Purchase Agreement, the dividend rate on the 2000 Class A Preferred
Shares would be increased to 20% thereafter, and the holders of such shares
would be entitled to an extraordinary special dividend in an amount equal to
what would have been recorded had all previously declared dividends at 9.75%
been accrued at 20%. Under the terms of the Forbearance, the Company is
currently in a cure period; accordingly, the preferred shares are not deemed to
be in default. On March 28, 2003, the Company entered into certain agreements
with its bank group, which are described below, and have in effect terminated
the Forbearance. See below "Restructuring of Bank Debt and Preferred Stock."
In addition to the above, the $1,500,000 Bridge Note was due on August 9, 2002.
In accordance with the terms of the agreement, this note can only be paid out of
an equity financing occurring prior to August 9, 2002. Since no such financing
occurred, the note has been classified as mezzanine equity in the accompanying
balance sheet. Ongoing discussions with the Related Party as to the ultimate
disposition of this note may result in a reclassification of this financial
instrument in the Company's balance sheet.
The Company's future contractual cash commitments are as follows:
Less Than 1
Contractual Obligations Total Year 1-3 Years 4-5 Years After 5 Years
- ----------------------- ----- ---- --------- --------- -------------
Bank Debt $ 8,899,000 $ 771,000 $ 8,128,000 $ -- $ --
Capital Lease Obligations 862,000 357,000 471,000 34,000 --
Other Long-Term Payments 1,484,000 960,000 524,000 -- --
----------- ----------- ----------- ----------- ------
Total Contractual Cash
Obligations $11,245,000 $ 2,088,000 $ 9,123,000 $ 34,000 $ --
=========== =========== =========== =========== ======
Other Long-Term Payments includes estimated amounts due to the former owners of
Inovis Corporation and amounts due under a separation agreement to a former
executive of the Company.
Restructuring of Bank Debt and Preferred Stock
On March 28, 2003, the Company entered into certain agreements with its bank
group and its 2000 Class A Preferred Shareholders. The Company entered into a
Third Amendment and Waivers to its Senior Credit Facility (the "Bank Agreement")
and a Memorandum of Understanding (the "Preferred Agreement") with its 2000
Class A Preferred Shareholders.
Bank Agreement
The Company and its senior lenders agreed to amend the Senior Credit Facility as
follows:
- - The outstanding amounts under the Senior Credit Facility of $8,728,000 were
restructured into three separate tranches. Tranche A representing a
$6,000,000 Term Loan, Tranche B representing a $2,728,000 Balloon Loan and
Tranche C representing $914,000 of outstanding letters of credit.
- - The Senior Credit Facility is senior to the $1,500,000 subordinated note
issued in satisfaction of the Bridge Note.
- - The maturity of the Senior Credit Facility is January 5, 2004.
23
- - The interest rate on each tranche is: Tranche A - the Provident Bank Prime
Commercial Lending Rate plus two percent (6.25% at March 28, 2003);
Tranche B - 12%, eight percent payable in cash and four percent
payable in kind and Tranche C (if drawn) - the Provident Bank's
Prime Lending Rate plus five percent (9.25% at March 28, 2003).
- - Tranche A requires principal payments of $100,000 per month beginning July
2003, Tranche B is due at maturity and Tranche C is due immediately upon
any draw under the letters of credit.
In addition to the above terms, the Company issued to the banks 1,080,000
warrants to purchase common stock of the Company at a price of $0.50 per share.
These warrants expire in seven years. The Bank Agreement states that no new
indebtedness may be incurred under the facility and that any future acquisitions
are subject to consent of the banks.
The Senior Credit Facility is collateralized by all of the assets of the
Company.
Preferred Agreement
The Company and its 2000 Class A Preferred Shareholders agreed to restructure
the preferred shareholders' investment in the Company as follows:
- - The $1,500,000 Bridge Note that was to be paid from proceeds of an equity
financing that would occur prior to August 9, 2002, will be converted into
subordinated debt with an interest rate accruing at 14%, which shall be
subordinated to the Senior Credit Facility (the "Subordinated Debt").
The Subordinated Debt will be due June 30, 2006 along with all accrued
interest.
- - The 2000 Class A Preferred Shares will be exchanged by the holders for:
- $2,500,000 Class B Series 2003 Preferred Shares which will have a
dividend rate of 14% and be non-voting shares. This dividend will be
accrued and paid-in-kind. These shares will maintain a liquidation
preference equal to par value plus accrued and unpaid dividends. The
holders of these shares may, at any time, after the third anniversary
of the issuance of such shares and with the consent of holders of no
fewer than two-thirds of the shares, may require the Company to redeem
all and any portion of such shares at par value plus accrued and
unpaid dividends;
- Warrants to purchase 2,400,000 common shares of the Company at an
exercise price of $0.50 per share. These warrants expire in 10 years;
and
- 4,800,000 common shares of the Company.
The following table shows the pro forma capitalization of the Compan